PUBLIC SECTOR BORROWING IN AUSTRALIA

Transcription

1 PUBLIC SECTOR BORROWING IN AUSTRALIA edited by R. L. Mathews Centre for Research on Federal Financial Relations,

2 This book was published by ANU Press between This republication is part of the digitisation project being carried out by Scholarly Information Services/Library and ANU Press. This project aims to make past scholarly works published by The Australian National University available to a global audience under its open-access policy.

3 PUBLIC SECTOR BORROWING IN AUSTRALIA edited by R. L. Mathews Centre for Research on Federal Financial Relations, The Australian National University, Canberra, 1982 Distributed by ANU Press, Canberra, Australia, London, England and Miami, Florida, U.S.A.

4 F ir s t published in A u stra lia 1982 P rin ted in A u stra lia fo r the C entre for Research on Federal F in an cial R e la tio n s, The A u stralian N ational U n iv e rsity, C anberra. The c o n trib u to rs 1982 T his book is c o p y rig h t. Apart from any f a i r d ealin g for the purposes of p riv a te stu d y, re s e a rc h, c r i ti c is m, or review, as perm itted under the Copyright A ct, no p a rt may be reproduced by any process w ithout w ritte n perm ission. In q u irie s should be made to the p u b lish e r. N ational L ibrary of A u stra lia C a ta lo g u in g -in -P u b lic a tio n e n try Public secto r borrowing in A u s tr a lia. ISBN Loans - A u s tr a lia. I. Mathews, R. L., (R u sse ll L loyd), I I. A u stra lia n N ational U n iv e rsity. Centre for R esearch on Federal F in a n c ia l R e la tio n s '4 ' L ib rary of Congress C atalog Card Number

5 CONTENTS Chapter Page Tables and Figures Editors's Foreword Contributors vii viii xii I CRITERIA FOR BORROWING PROGRAMS 1 R.H. Scott Introduction 1 The Standing of Borrowers 1 The Nature of Capital 4 Productive and Unproductive Spending 8 The Allocation of Resources 11 Income Distribution, Welfare and Other Policies 16 The Selection of Projects 20 The Criteria 23 Institutional Arrangements 24 II BORROWING FOR NATIONAL DEVELOPMENT 27 L.A. Hielscher Introduction 27 Why Should Governments be Involved? 27 Why Borrow? 29 How Much Should be Borrowed by Governments? 30 Who Should Control the Amounts Borrowed? 33 What Should be the Source of Borrowing? 34 Conclusion 34 III GOVERNMENT BORROWING AND OFFICIAL ARRANGEMENTS 39 FROM THE VIEWPOINT OF STATUTORY AUTHORITIES R.E. Hurley Introduction 39 Problems of Financial Planning in Statutory Authority 39 Business Undertakings Comparison with Private Enterprise 41 Offshore Funding and Infrastructure Financing 41 Constraints on Statutory Authority Borrowing 42 The Need for Changed Institutional Arrangements 43 IV GOVERNMENT DEBT AND THE CAPITAL MARKET 45 J.K. Bain Government Borrowing: Some Facts 45 Does the Large Government Borrowing Requirement 47 Matter? Markets for Government Securities: Existing 48 Arrangements Markets for Commonwealth Securities: A Critique 50 Markets for Semi-Government Securities: A Critique 53 Conclusion 54 v

6 CONTENTS (Contd) Chapter Page V GOVERNMENT BORROWING IN THE CONTEXT OF MONETARY 61 POLICY AND THE CAPITAL MARKET D.N. Sanders Debt Management and Monetary Policy 61 Government Deficits and Borrowing Requirements 62 The Shortening Maturity of Commonwealth Debt 63 Market Uncertainty and Volatility 63 Arrangements for Issuing Debt 64 The Market's Information Needs 65 Semi-Government Borrowing 65 Conclusion 67 VI MEASURES OF PUBLIC SECTOR BORROWING AND INDEBTEDNESS 69 J.P. MaAuley Net Borrowing and Net Debt 69 Changes in Australian Public Sector Indebtedness 70 Factors Influencing High Interest Rates 70 Borrowing by Commercial Public Authorities 71 VII CONCLUDING COMMENTARY 73 P. Groenewegen The Role of Public Sector Borrowing 73 Borrowing for National Development 74 Financial Planning in Public Enterprises 74 Public Sector Borrowing and the Capital Market 75 vi

7 TABLES Page II-l II-2 II-3 II-A II-B II-C S elected S tate Borrowing as Percentage of Gross 30 Domestic Product P ublic Fixed C ap ital E xpenditure as Percentage of 31 T otal Fixed C ap ital E xpenditure Government New Money Borrowing as Percentage of Public 32 Gross Fixed C ap ital E xpenditure S elected S tate Borrowing, to Public Fixed C ap ital E xpenditure as Percentage of 36 T otal Fixed C ap ital Expenditure Government Borrowing as P ercentage of P ublic Gross 37 Fixed C ap ital Expenditure IV-1 IV-2 IV-3 IV-4 A u s tr a lia : Government Finance 58 Local and Semi-Government A u th o ritie s - Loan Council 59 Approved Borrowings S ales of Commonwealth Government S e c u r itie s, Local and Semi-Government S e c u ritie s - Major H olders 60 as a t 30 June FIGURES IV-1 IV-2 IV-3 IV-4 IV-5 Public Sector D e fic it as P ercentage of Gross Domestic 56 P roduct, to Government S e c u ritie s on Is su e, Average M aturity of Commonwealth Government S e c u r itie s, (Excludes Savings Bonds) Cumulative Domestic D e fic it of Commonwealth Government 57 Y ields on Commonwealth Bonds 58 vii

8 EDITOR'S FOREWORD The papers in this book were originally presented at a Seminar of the Centre's Research Advisory Committee in Canberra on 20 May The theme of the Seminar, which was suggested by Mr I.G. Baker, Director of Finance in the Treasury of Victoria, was one that was especially timely having regard to a number of recent developments and issues affecting Australian public sector borrowing. These included: the presentation of the Final Report of the Committee of Inquiry into the Australian Financial System (the Campbell Committee) in September 1981;^ continued questioning about the present and future role of the Australian Loan Council in relation to such matters as the determination of State borrowing programs, the approval of infrastructure financing for resource development and the regulation of borrowing by local and semi-government authorities; the relationship between public sector borrowing requirements, public debt management and economic management generally; the role of the Reserve Bank with respect to the relationship between government borrowing operations, monetary policy and the marketing of Commonwealth securities; and the role of the market in meeting the borrowing requirements of different levels of government and different kinds of public authorities. Among other things, the Campbell Committee had recommended that the authorities should follow a market-oriented approach in the sale of government securities, including the substitution of a tender system for the existing tap system of marketing Commonwealth bonds; that local and semigovernment authorities which could be shown to be subject to market disciplines should be viewed as commercial authorities and should be free of Loan Council control with respect to the volume, terms and conditions of their borrowing, which should then not be subject to government guarantees; that non-commercial authorities should continue to be subject to government guarantees and Loan Council oversight in respect of the overall volume of borrowing, but that the terms and conditions of their borrowing should not be subject to Loan Council control but should be negotiable between the government guarantor, the borrower and the lender; and that consideration should be given to the establishment of State Central Borrowing Authorities to borrow on behalf of individual non-commercial local and semi-government authorities. The papers in this book consider the foregoing developments and issues in public sector borrowing from the viewpoint of general criteria (Mr Scott), a State Treasury (Mr Hielscher), a State commercial authority (Mr Hurley), a market practitioner (Mr Bain), the Reserve Bank (Mr Sanders) and a State Bank (Mr McAuley). The concluding commentary is by a university economist (Professor Groenewegen). Unfortunately, it was not possible to obtain a Commonwealth Treasury contributor. In Chapter I, Mr Scott provides an historical perspective to the role of and the criteria which should apply to government borrowing, and concludes by critically examining existing institutional arrangements in Australia. After noting that the Loan Council provides neither for a market evaluation of borrowing for specific projects nor for the determination of economic priorities in allocating funds between governments and projects, he suggests that the role of the Council should be either reduced or enlarged. Australian Financial System, Australian Government Publishing Service Canberra, viii

9 Mr H ie ls c h e r's concern in Chapter II is to show th a t governments have a genuine ro le in the provision of in d u s tria l in f ra s tru c tu re and th a t, in perform ing th is r o le, they must r e s o r t to borrowing on a la rg e sc a le. He shows th a t the growth in borrowing by S tate semi-government a u th o r it ie s, from 1.4 per c en t of gross dom estic product (GDP) in to 1.9 per cent in , has been more than o f f s e t by a red u ctio n in the r e la tiv e siz e of S ta te loan programs over the same p erio d, from 3.2 per cent to 1.0 per c e n t, a red u ctio n which has re fle c te d Commonwealth d ecisio n s undertaken for economic management purposes. H ie lscher d is tin g u is h e s between general in d u s tr ia l in f r a s tr u c tu r e, the p ro v isio n of which cannot be financed by charges based on usage, and commercial in d u s tria l in f r a s tr u c tu r e, which i s more d ir e c tl y a sso c ia te d w ith u sers in the p riv ate secto r who may by charged d ir e c tl y for the serv ices they re c e iv e. While he b e lie v e s th a t th ere is a continuing need for a body such as the Loan Council to co -o rd in ate borrowing for the p ro v isio n of gen eral in d u s tr ia l in f r a s tr u c tu r e, he argues th a t the long-term economic b e n e fits of in f ra s tru c tu re development need to be given g re a te r w eight, r e l a ti v e to the present preoccupation with sh o rt-term economic management c o n s id e ra tio n s, and th a t more fle x ib le and e q u ita b le arrangem ents for the a llo c a tio n of funds need to be d evised. As to commercial in d u s tr ia l in f r a s tr u c tu r e, H ielscher follow s the Campbell Committee in suggesting th a t borrowing for th is purpose should be removed from Loan Council co n tro l and l e f t to the m arket. The fin a n c ia l planning problems of commercial a u th o r itie s su b je c t to Loan Council c o n tro ls are the su b ject of d e ta ile d c o n sid e ra tio n by Mr Hurley in Chapter I I I. He shows th a t the c o n s tra in ts imposed by the Loan Council s ig n if ic a n tly lim it the a b il it y of commercial a u th o r itie s to achieve a d e s ira b le c a p ita l s tru c tu r e, respond to market fo rc e s, arrange debt o b lig a tio n s th a t are c o n siste n t w ith a s s e t s tr u c tu r e, meet cash flow needs and develop investm ent stra te g y on the b a sis of a d e s ira b le time span. W hilst not d isag reein g with the need for the Loan Council to give high p r i o r i t y to sho rt-term p o li ti c a l and economic c o n sid e ra tio n s, he argues th a t Loan Council c o n tro ls are incom patible w ith the long-term funding needs of commercial a u th o r itie s. He th e re fo re concludes, along w ith H ielscher and the Campbell Committee, th a t such a u th o r itie s should be removed from Loan Council c o n tr o l. He then examines the im p licatio n s of such a d e c isio n w ith re sp e c t to le g i s l a ti v e provision regarding c a p ita l s tr u c tu r e, re tu rn on investm ent and p ricin g p o licy. In Chapter IV, Mr Bain draws a tte n tio n to the s ig n ific a n t in crease th a t has occurred in the A u stralian public se c to r borrowing requirem ent in recen t years and to asso ciated developments including the in crease in in te r e s t ra te s to h i s to r i c a ll y high le v e ls, the dram atic shortening in the average m a tu rity of government debt and the in crease in the volume of overseas borrowing. While not arguing for a red u ctio n in public se c to r c a p ita l ex p e n d itu re, Bain suggests th a t, i f the government borrowing requirem ent is not kept w ithin reasonable li m i ts, strong upward pressu res w ill emerge on in t e r e s t ra te s and fin a n c ia l m arkets w ill be s tra in e d. A fter reviewing e x is tin g arrangem ents for the issu e of pu b lic debt in A u s tr a lia, Bain concludes th a t the market in T reasury n o tes has g e n e ra lly worked very w ell but th a t there have been serio u s shortcom ings in the tap system for m arketing Commonwealth bonds and in the uncom petitive y ie ld s of A u stra lia n Savings Bonds (ASBs). Arguing th at the a u th o r itie s need to be p ric e -ta k e rs ra th e r than p ric e - m akers, he supports the Campbell Committee proposal for the adoption of a tender system for the m arketing of Commonwealth bonds. I n te r e s t ra te s on ASBs, Bain su g g ests, must remain fle x ib le and com petitive i f governments are ix

10 to r e ta in access to p riv a te savings and i f o th er forms of government s e c u r itie s are not to ca rry too heavy a lo ad. Turning to the market fo r semi-government s e c u r i t i e s, Bain concludes th a t in t e r e s t ra te s for these s e c u r itie s have remained more or le s s c o m p e titiv e, d e sp ite the continued ex isten ce of some c a p tiv e m ark ets, but th a t th e re have been o th er m arketing shortcom ings a sso c ia te d with the lack of inform ation about th e ir aggregate borrowing req uirem ents, in s u f f ic ie n t f l e x i b i l i t y between y ie ld s on Commonwealth and semi-government s e c u r itie s and in the y ie ld s of d if f e r e n t is su e s of semi-government s e c u r iti e s, and in s u f f i c ie n t f l e x i b i l i t y in the m a tu rity s tru c tu r e of semi-government s e c u r iti e s. In Chapter V, Mr Sanders reviews government borrowing in the c o n te x t of monetary p o licy and the c a p it a l m arket. He does not b eliev e th a t th e re is n e c e s s a rily a c o n f lic t between debt management and m onetary p o lic y. Sound debt management p o lic y, designed to provide for the governm ent's needs a t low est cost w ith an ap p ro p riate spread of m a tu r itie s, can a s s i s t in e s ta b lis h in g s a tis f a c to r y m onetary c o n d itio n s. The problem a r is e s when governments seek to achieve low borrowing c o sts by m onetising debt through borrowing from the c e n tr a l bank. I f they finance th e ir needs from the market at r e a l i s t i c y ie ld s, a m ajor p o ssib le d istu rb an ce to monetary c o n d itio n s i s removed. Commenting on Mr B ain 's paper, Sanders shows th a t i t is p o ss ib le to exaggerate the e f f e c t of the recen t in crease in government borrowing requirem ents on the c a p ita l m arket. As a percentage of GDP, t o t a l government s e c u r itie s on issu e (Commonwealth s e c u r itie s issued in A u stra lia and overseas as w ell as semi-government is su e s in A u stra lia and overseas) have f a lle n from 60 per cent in 1970 to 39 per cent in 1981; while to t a l government s e c u r iti e s as a percentage of the a s s e ts of fin a n c ia l in s t i t u t i o n s have fa lle n from 48 per cent in 1970 to 29.5 per cent in Sanders sh ares the unease of o ther c o n trib u to rs about the shortening of m a tu ritie s and suggests in p a rtic u la r th a t the s e a s o n a lity of Commonwealth financing should be reduced. But w hile he in d ic a te s th a t the Reserve Bank would have no d i f f i c u l t y w ith the proposal for a tender system for m arketing Commonwealth s e c u r iti e s, he r a is e s doubts about the p a rtic u la r system advocated by Bain and about the ex ten t to which the market should be given inform ation about government borrowing req u irem en ts. Because debt management and market o p eratio n s are p o licy in stru m en ts, Sanders su g g ests, i t is not p o ssib le for the a u th o r itie s to give a n eg ativ e pledge ag ain st v a r ia tio n s in th e ir use for po licy purposes. On semi-government borrow ing, Sanders q u estio n s the su g g e stio n, made by the Campbell Committee and o th e r c o n trib u to rs in th i s book, th a t government g u aran tees should cease to o p erate i f commercial a u th o r itie s are freed from Loan Council c o n tr o l, by asking what would happen i f a non-guaranteed a u th o r ity were to f a il? Mr McAuley's c o n trib u tio n in Chapter VI i s m ainly in the form of a comment on measures of public se c to r borrowing and in d eb ted n ess, in which he po in ts out the need for the conceptual lin k between public se c to r net borrowing and net debt to be tra n s la te d in to ap p ro p ria te s t a t i s t i c a l ta b u la tio n s ; and for net advances by governments to o th er s e c to rs to be tre a te d as a financing item and o f f s e t ag a in st net borrowing (a s in Reserve Bank flow -o f-fu n d s s t a t i s t i c s ) in stead of being tre a te d as an ex p en d itu re item which augments the size of the government d e f i c i t (as in Commonwealth Government and A u stra lia n Bureau of S t a t i s t i c s ta b u la tio n s ). McAuley jo in s o th er c o n trib u to rs in noting th a t th ere have been s ig n ific a n t s h i f t s in the re la tio n s h ip of n et debt to GDP as between d if f e r e n t s e c to rs of government (Commonwealth, S ta te, and lo c a l and sem i-governm ent), w hile po in tin g out th a t the Commonwealth is s t i l l a n et c re d ito r d e sp ite the growth in i t s borrowing x

11 requirem ent during recen t y ears. In th is c o n te x t, he co n sid ers th a t the growth in the public s e c to r 's net debt has had only a m arginal e f f e c t on in t e r e s t r a te s. F in a lly, McAuley takes up the proposals of the Campbell Committee th a t borrowing by commercial lo c a l and semi-government a u th o r itie s should be freed from Loan Council co n tro l and th a t borrowing by non-commercial a u th o r itie s should be co n tro lle d only in resp ect of the volume of borrowing and not in re sp e c t of terms and co n d itio n s; he suggests th a t such a system would tend to favour stronger commercial a u th o r itie s a t the expense of weaker a u th o r itie s and p riv ate secto r borrow ers. In h is concluding commentary in Chapter V II, P rofessor Groenewegen c r i t i c a l l y reviews a number of is su e s which have been id e n tif ie d by o ther c o n tr ib u to rs, including h is to r i c a l views about and c u rre n t a tt it u d e s to the ro le of public borrow ing, the macro-economic sig n ific a n c e of budget d e f i c it s and public secto r borrowing requirem ents, and the re la tio n s h ip between public borrowing and fin a n c ia l m arkets. Some of the issu e s ra ise d by c o n trib u to rs and summarised above were resolved subsequently to the Seminar, p a r t ia l ly or tem porarily a t l e a s t, as a r e s u lt of a number of im portant d e c isio n s taken by the A u stralian Loan Council on 24 June These included: (a) a d ecisio n to introduce a tender system for s e llin g T reasury bonds as soon as p ra c tic a b le, in place of the tap system, and to deleg ate to the Commonwealth T reasurer as Chairman of the Council the power to decide on the m a tu r itie s, coupons, volume and tim ing of each tender and to a l l o t the amount offered a t y ie ld s bid; ( b) a decisio n to deleg ate to the Commonwealth T reasurer the power to determ ine the terms and co n d itio n s of A u stralian Savings Bonds; and (c) agreement th a t the major e l e c t r i c i t y a u th o r itie s should be free to borrow o u tsid e Loan Council c o n s tra in ts w ith re sp e c t to program c o n tro ls or maximum ra te s imposed by the C ouncil, su b je c t to the requirem ent th a t overseas borrowing by those a u th o r itie s would continue to be su b ject to Loan Council review and Commonwealth ap p ro v al. The E ditor records h is a p p re c ia tio n to the c o n trib u to rs in th is volume, to Mr I.G. Baker and Mr R. H. Scott for th e ir ro le in planning the Seminar, and to Mrs A.M. W ilkinson and Mrs R. Barker for th e ir a s s is ta n c e in making the necessary ad m in istrativ e and p u b lic a tio n arrangem ents. Thanks are also due to Ms J. Baines for typing the m an u scrip t, and to the ANU Graphic Design u n it for designing the cover of th is book. November 1982 R.L. Mathews xi

12 CONTRIBUTORS Bain, J.K. Groenewegen, P.D. Chairman of Partners, Bain & Company, Sydney Professor of Economics, University of Sydney Hi el scher, L.A. Hurley, R.E. McAuley, J.P. Sanders, D.N. Scott, R.H. Under Treasurer, Queensland Treasury, Brisbane Assistant General Manager, (Administration), State Electricity Commission of Victoria Melbourne Chief Economist, State Bank of New South Wales, Sydney Deputy Governor, Reserve Bank of Australia, Sydney Visiting Fellow, Centre for Research on Federal Financial Relations, Canberra xii

13 CRITERIA FOR BORROWING PROGRAMS R.H. Scott 'He i s a g re a te r fool than many Who'd sign a note to get h is penny; He h e a rs not when the people quote: "The w olf e a ts you and not your n o te ".'^ Introduction Borrowing is a long and w e ll-e sta b lis h e d custom w ith i t s own f o lk - ta le s (as the v erse quoted above su g g e s ts), moral codes and le g a l req uirem ents. The f i r s t may provide en tertain m en t (and some in s tru c tio n ) fo r the so lv en t; the second, reassuran ce for the v irtu o u s ; and the th i r d, employment fo r many. N either these asp ects of the su b je c t nor the fe a rs of the in s o lv e n t, the s in fu l or the re je c te d are the concern of th is paper; i t s focus is upon the borrowing of one p a r tic u la r kind of deb to r - governments - and i t s concern is w ith the economics o f government borrowing. The economics of the su b ject has a much sh o rte r h is to ry than the p ra c tic e of borrowing i t s e l f. We g e n e ra lly think of economics, or p o l i t i c a l economy, as having i t s o rig in s in the E nglish-speaking world in the w ritin g s of Adam Smith, p a r tic u la r ly in h is The Wealth of Nations, published in the l a s t q u a rte r of the 18th century - only 200 years ago. To some e x te n t, of co u rse, Smith c r y s ta ll is e d in h is own work many th in g s th a t o th e rs had alread y been saying; but i t does not d e tr a c t from the uniqueness of h is own c o n trib u tio n th a t he drew on o th e r s. Subsequently, the su b je c t has flo u rish e d g re a tly, p a rtly in lin e w ith a g en eral advance of knowledge and p a rtly in response to the growing com plexity and im portance of economic a f f a i r s. The development of the su b ject i s g e n e ra lly seen tö have been la r g e ly promoted by th re e major steps in the E nglish-speaking world - the w ritin g s of Ricardo and the other E nglish philosopher-econom ists of h is tim e; the m a rg in a lis t rev o lu tio n which was A lfred M a rsh a ll's memorial; and the so -c a lle d Keynesian re v o lu tio n. In Europe, th ere were im portant c o n trib u tio n s by Walras and P a re to, by the A ustrian School and an im portant group of Swedish econom ists. A ll have made th e i r c o n trib u tio n s to the th eo ry of pu b lic d e b t. Economic th eo ry, lik e theory in o th er f i e l d s, is c le a r ly an evolving su b je c t. Running through i t are many unresolved q u estio n s among which the n atu re of c a p ita l is p a r t ic u l a r ly im portant to our su b je c t; b u t, more l a t t e r l y, monetary c o n sid e ra tio n s have aroused co n sid erab le in t e r e s t. These and oth er to p ic s must have a tte n tio n. Theory, of co u rse, e x p la in s why borrow ers borrow and len d ers lend and the consequences of th e ir tra n s a c tio n s ; but le n d e rs, p rag m atically and tr a d itio n a l l y, have looked - and s t i l l do look - askance a t would-be borrow ers. The Standing of Borrowers The a tt it u d e s of le n d e rs to d if f e r e n t kinds of borrow ers have changed over the c e n tu rie s. Thus, of banking in the c i t y of Florence i t has been w r it te n : 1 S eb astian B rant, The Ship of Fools, F ir s t published in B asel, 1494, T rs. by W. G i l l i s, The Folio S ociety, London, 1971, p. 64.

14 'In the same year (1398), he entered in to p a rtn e rsh ip with another P ra te se, Bartolomeo Cambione, and opened with him a bank in F lo ren ce,.... The bank offered i t s c lie n ts a v a rie ty of se rv ic e s: acceptance and issu e of b i l l s of exchange, loans (though only to o ther trading-com panies or p riv a te c l i e n t s, not to pr-inces, Popes or Coimunes),.... ' 2 The fo rtu n es of p rin ces - and even of Popes and no le s s of Communes - were indeed u n certain and the p o li ti c a l philosophy of the tim es took account of i t. Thus, M ach iav elli, in the The P rin ce, w ritte n ju s t over a century l a t e r, says: 'You must r e a lis e th i s : th a t a p rin c e, and e s p e c ia lly a new p rin c e, cannot observe a l l those th in g s which give men a re p u ta tio n for v ir tu e, because in order to m aintain h is s ta te he is o ften forced to act in d efian ce of good f a i t h, of c h a r ity, of k indness, of r e lig io n.... As I said above, he should not dev iate from what is good, i f th a t is p o ss ib le, but he should know how to do e v il, i f th a t is necessary. N early 200 y ears la t e r the s ta te was s t i l l suspect as a borrow er. Smith, w ritin g of borrowing p ra c tic e s, quotes th is occurrence: Adam 'In 1695, the persons who had purchased these a n n u itie s were allowed to exchange them for o th ers.... the d iffe re n c e between 14% for l i f e, and 14% for 96 y e a rs, was sold for years' purchase. Such was the supposed i n s t a b i l i t y o f government th a t even these terms procured few p u rc h a s e rs.'^ N ev ertheless, Adam Smith saw borrowing and lending as a n a tu ra l process with an in tim ate and in e v ita b le connection between the two. Borrowers and len d ers could take u n fo rtu n ate d e c isio n s; b u t, o v e ra ll, n a tu ra l laws would p re v a il. 'The same commercial s ta te of so c ie ty which, by the o p eratio n of moral causes, b rin g s government in th i s manner in to the n e c e ss ity of borrow ing, produces in the su b je c ts both an a b i l i t y and an in c lin a tio n to lend. If i t commonly brin g s along with i t the n e c e ss ity of borrow ing, i t likew ise brin g s along with i t the f a c i l i t y of doing s o.'^ Times were changing! Another 200 y ears la t e r some su spicion of governments rem ains although now, in our tim e, they are m ostly regarded as re p u ta b le, i f not wholly r e l ia b l e. Thus, a C hancellor of the Exchequer in the United Kingdom could w rite ( f i r s t in the 1920s in th is sense): 2 I r i s O rigo, The Merchant o f P ra to, The R eprint S ociety, Oxford, 1959, pp. 145, 148. ^ Nicolo M ach iav elli, The P rince, W ritten T rs. by George B ull, The Folio S ociety, London, 1970, p. 95. ^ Adam Smith, The Wealth o f N ations, 1776/8, Everyman's L ib rary, 10th R eprint, J.M. Dent and Sons., London, 1937, Vol. 2, p I b i d., p

15 'Except in settled economic weather, loans, even to the most respectable governments, carry risks, and sudden storms may wash away even the most reasonable expectations of creditors. But it is surprising how little, in most cases, and for how short a time, the public credit suffers.'^ Nevertheless, it has taken a long time for governments - whether of princes or communes - to win the faith of lenders and it can still be lost all too easily, and quickly. In Australia, the Financial Agreement of the late 1920s and the insertion of section 105A in the federal Constitution have conferred upon the Commonwealth Government the power to ensure that other governments meet their debt obligations; but this power is, of course, no stronger than the will of the Commonwealth Government. The power - and the will - have been tested, in 1932, in the case of a threatened New South Wales default. 'The agreement has also been used to ensure that all governments carry out their public debt obligations. Difficulties in the way of enforcing the agreement might, however, arise if the Commonwealth government were to default, or if that government were unwilling to enact enforcement legislation against a defaulting state.,7 Despite this instance of compulsion in Australia, legislation in general does not constitute a substitute for willingness in money markets; and clearly, a first criterion of borrowing is whether it secures and maintains the interest of lenders. This depends initially on the good faith of the borrower but it inevitably involves as well the public assessment of his good sense; faith is no substitute for capacity and the intention to repay will have little meaning without a belief in the ability to repay. In the case of governments today, the ability to service their debts lies initially in the productive capacity of the economy over which they preside and then in their budgetary commitments. 'The liability to interest payments and debt charges provides an important constraint on government borrowing: a large public debt with the high debt charges it entails pre-empts a great deal of the freedom of choice in future expenditure decisions because the contractual obligation of the government to pay these charges ranks among the first items of essential government expenditure.' This is not all. Because the interdependence of each and every part of an economic system is both more evident and more widely understood than previously, and because of the growing importance of the public sector in the functioning of modern economies and the influence of government policies on economic - and especially monetary - conditions, government borrowing should not seem to and should not in fact de-stabilise the economy and its money markets. Hugh Dalton, Principles of Public Finance, 4th edn, George Routledge & Sons, London, 1954, p Gordon Greenwood, The Future of Australian Federalism, 2nd edn, University of Queensland Press, Brisbane, 1976, p Peter Groenewegen, Public Finance in Australia: Theory and Practice, Prentice-Hall of Australia Pty Ltd., Sydney, 1979, p

16 The standing of governments as borrow ers has improved over tim e; they are to -d ay, in advanced c o u n trie s, b e tte r regarded than a t any o th er tim e. But th e ir b e tte r standing has meant th a t more is expected of them - th a t they should keep f a ith w ith th e ir c r e d ito r s ; th a t they should show good sense in the management o f th e ir a f f a i r s ; and, f i n a ll y, th a t they should show good sense, a ls o, in the management of the economy. To the old v ir tu e of fin a n c ia l p ro b ity has been added the new requirem ent of economic re c titu d e. The Mature o f C apital Among the th e o r is t s, the natu re of c a p ita l a ttra c te d more a tte n tio n in the second h a lf of the 19th century than i t had done e a r l i e r. The m atter is s t i l l debated, although in a d if f e r e n t context than th en, but i t is the 19th century debate which concerns us h ere. The word c a p it a l, i t is s a id, was unknown in E nglish before I t was c u rre n t by the time of Adam Smith but r e la tiv e ly l i t t l e used and Adam Smith him self used the word 's to c k ' more o ften than 'c a p i t a l '. 'C a p ita l' came into prominence w ith the accum ulation of fixed a s s e ts which accompanied the rapid in d u s tr i a li s a t io n of the 19th century (when trad in g stock declined in r e la tiv e im portance). C ap ital was f i r s t viewed as a m onetary e n ti ty, the fin a n c ia l investm ent of p ro p rie to rs in a p ro je c t. Econom ists, as they debated the m atter from Adam Smith onwards, in c re a sin g ly a ttr ib u te d a b s tra c t meanings to the word - stored-up la b o u r, accumulated w aiting-tim e and so on. The A u strian, Bohm- Bawerk, developed the concept of time preference and had a consid erab le in fluence upon both h is contem poraries in the 19th century and subsequent g e n e ra tio n s. With the ferment of debate of the tim e, i t is h ard ly su rp ris in g th at those charged w ith the r e s p o n s ib ility of a u d itin g the accounts of b u siness e n te r p ris e s should also be concerned with sharpening th e ir understanding of the im p licatio n s of those accounts. Throughout the l a s t q u arter of the 19th cen tu ry, the jo u rn al The Accountant, published weekly in England from 1874, c a rrie d numerous a r t i c l e s about the r e s p o n s ib ilitie s of a u d ito rs, the r ig h ts of sh areh o ld ers and p a r tic u la r ly the d is tin c tio n between income and c a p ita l and whether dividends could or should be paid out of c a p ita l or only income. The acco u n tan ts' debates focussed m ainly, how ever, on d e p re c ia tio n. In th e ir d e b a te s, the accountants g e n e ra lly accepted the p re v a ilin g ideas of econom ists; th ere i s, fo r in s ta n c e, more than one referen ce to M arshall. The acco untants' d eb a te s, however, were ra th e r more pragmatic in th e ir nature than those of the econom ists. They included much d iscu ssio n of ju d ic ia l proceedings and indeed the le g a l judgments of th a t time were s ig n ific a n t for much subsequent accounting p ra c tic e. Apart from th a t, the debates and th e ir su b ject m atter were and remain im portant for public e n te r p ris e s, and for th e ir borrowing. One p e rs is te n t w rite r in The Accountant saw the c a p ita l of a firm as i t s su rplus of a s s e ts over l i a b i l i t i e s ; oth ers were concerned w ith p r o p r ie to r 's c o n trib u tio n s ; and more with fixed a s s e ts. In the course of so rtin g out the d is tin c tio n s between these item s of the balance sh e e t, accountants were developing th e ir views of d e p re c ia tio n and the p reserv atio n of c a p ita l. They were moving, i t seems in re tro s p e c t, to a view of c a p ita l as an incom e-yielding e n ti ty taking a v a rie ty of forms according to the nature of the e n te rp ris e and the w herewithal i t needed to pursue i t s stated o b je c tiv e s. The w herewithal was predom inantly then a m atter of fixed a s s e ts

17 Such a view is not explicitly set down but the elements of it are there in the published material. The preservation of this income-yielding entity had various implications: repairs and maintenance carried out were separate from depreciation; depreciation charges, as a general rule, should be made before profit was determined for distribution; and depreciation needed to be charged over the life of fixed assets to enable income-earning capacity to be maintained when the time came to discard them. Repairs and maintenance were separate from depreciation for they kept assets in working condition and, while they might have helped to postpone replacement, they did not contribute to replacement. (They needed, also, to be distinguished from new capital expenditure. Confusion about this, particularly in the case of public enterprises, did, indeed, lead to what could properly be called additional capital expenditure being written off on more than one occasion as repairs and maintenance.) Depreciation charges were to be levied before dividends were paid in order to avoid capital being run down when profits would not support both dividends and depreciation charges; the accordance of priorities was important. Associated with this was an interest in the rate at which depreciation charges should be made, as distinct from the total amount of depreciation due over the life of an asset. Various ideas were canvassed. Finally, it was necessary to charge depreciation in order to maintain intact the income-yielding capacity put into a business as far as this could reasonably be done. Losses on capital account were to be expected in some cases for reasons which could not be foreseen or were beyond the control of a business and it could not necessarily always be held responsible for not providing for them; but a business should be expected to provide against the wearing out of its fixed assets in the course of time. Here, however, a question of valuation arose. Common opinion developed that fixed assets should be brought into a balance sheet at cost; the arguments were lengthy and not worth the repetition. At the same time, a strong body of opinion arose that depreciation should be sufficient to maintain the business as a going concern whatever the changes in costs since its establishment. The question did not arise in the case of small items with a very short life; they could legitimately be written off, it was thought, to repairs and maintenance. Nor did the question arise in the case of permanent assets such as land for there could not be any question of replacement for them. But these were exceptions to the general rule. At the time these matters were under debate, it was not uncommon for obsolescence to intrude to shorten the life of fixed assets. Frequently, however, obsolescence was accompanied by the availability of capital equipment at an aggregate cost lower than that of the machines which were displaced; the conditions of our times, with rising costs as well as unit productivity, were not nearly as prevalent then as now - and less emphasis was given to what we now call current cost accounting. Public enterprises attracted special attention in the debates of those times. They operated on borrowed funds; and it was obligatory upon them by statute to make provision out of current earnings for the repayment of their borrowings. They were seen, by virtue of this requirement, to be placed at a disadvantage with private enterprises; and this was a matter of some importance at a time when the market for the services of some utilities was frequently shared by both public and private enterprises. The disadvantage arose if public enterprises made provision for both sinking funds - to provide for repayment of their borrowings - and depreciation, to maintain their fixed assets, before offering a return to ratepayers (in the case of local governments, which mainly operated utilities in 19th century England). For some, this meant that sinking funds should be taken to perform the dual function of repaying debt and providing for replacement of fixed assets; after all, the repayment of debt cleared the way for renewed borrowing by which out-worn assets could be replaced. This was vehemently denied by - 5-

18 o th e r s. A leading accountant of h is tim e, Lawrence R. D icksee, w rote in 1903 in D epreciation, R eserves and Reserve Funds: 'The p rin c ip le s underlying the su b ject w ill have been but i l l ex p lain ed, i f the read er of the previous c h a p te rs has not firm ly grasped the underlying p rin c ip le th a t the q u estion what ( i f any) p rovision is n ecessary to cover the D ep reciation of a s s e ts is a m atter dependent upon the n atu re of the a s s e ts them selves and the co n d itio n s under which they are worked, but in no sense whatever dependent upon the n a tu r e, or c o n s titu tio n, of the community of persons c o n s titu tin g for the tim e being the le g a l owners of those a s s e t s.... ' 'One of the most fa v o u rite argum ents a g a in st p ro v isio n for D epreciation in connection w ith lo c a l a u th o r itie s is th a t, in as much as loan C ap ital has to be redeemed over a lim ite d period of tim e, an ex cep tio n al co n d itio n of a f f a i r s is c re a te d, which v i t i a t e s the analogy between the accounts of lo c a l a u th o r itie s and those of p ro p rie ta ry u n d ertak in g s. Nothing can be more i l l o g i c a l. The d iffe re n c e - in so fa r as th ere is a d iffe re n c e - a ris e s from the sp e c ia l circum stance th a t lo c a l a u th o r itie s trad e upon borrowed C ap ital a lo n e, whereas no o th er known form of p ro p r ie to r ship ever attem p ts anything so f in a n c ia lly unsound.... ' 'T h ese, however, are no new argum ents, and d o u b tless those who are in te re s te d in the m aintenance of the s ta tu s quo w ill continue to a s s e r t th a t D ep reciatio n of w asting a s s e ts need not be provided for in connection w ith the accounts of lo c a l a u th o r itie s because, before those a s s e ts have been worn out, the loans th a t were ra ise d to enable the a s s e ts to be purchased w ill have been redeemed. The connection between the two m a tte rs is by no means c le a r ; but i t may be pointed out t h a t, a p a rt from the r is k th a t the loans m ight not have been redeemed (which in the g re a t m a jo rity of cases would appear to be extrem ely p ro b a b le ), a t the b est the u ltim a te p o sitio n of a f f a i r s must be th a t, by the time the loan has been re p a id, a more or le s s w o rth less and worn-out "carcass" of an undertaking w ill be a l l th a t rem ains to show fo r i t. Upon these lin e s i t may w ell be asked how i t w ill be p o ssib le for any genuine fin a n c ia l progress to be made by those undertak in g s; f o r, p u ttin g upon one side a lto g e th e r the r i s k of o b so lescen ce, ap p aren tly th e whole business of borrowing money fo r trad in g purposes w ill have to be re-perform ed re g u la rly once or tw ice in every g e n e ra tio n. If th a t be the avowed p o licy of the advocates of unsoundness in connection w ith m unicipal fin a n c e s, i t would seem to be d e s ira b le that the p o lic y should be more c le a r ly s ta te d than has h ith e r to been the case;...'^ Strong words! Another a u th o r, E. H artley Turner (w ritin g in The A ccountant, 16 June 1894) saw the charging of sinking fund in sta lm e n ts and d e p re c ia tio n as p u ttin g a double burden on one g en e ra tio n of ra te p a y e rs, the redem ption of debt and the replacem ent of c a p it a l. He sought some compromise to spread the burden more evenly over successive g en e ra tio n s but i t is not c le a r th a t i t could be done in h is way. The s ta tu s quo to which Dicksee re fe rre d - the treatm ent of sin k in g funds e sta b lish e d by lo c a l governments as embracing p ro v isions fo r Lawrence R. D icksee, D epreciation, R eserves and Reserve Funds, 1st edn, Gee & Co., London, 1903, pp. 69, 74,

19 d e p re c ia tio n - was preserved. th is century and l a t e r, said: Hugh D alton, w ritin g in the f i r s t q u arter of 'When a debt is incurred by a subordinate public a u th o rity, for the c re a tio n or a c q u is itio n of tan g ib le a s s e ts, in the form of c a p ita l goods, i t is common fo r a co ndition to be imposed by a superior public a u th o rity th at the debt must be repaid w ithin a fixed period. The period has some r e la tio n to the n atu ral li f e of the c a p ita l goods and the sinking fund i s, th e re fo re, in such c a se s, e q u iv alen t to a d e p re c ia tio n fund. The p rin c ip le, which in general is a sound one, is th a t, by the time the c a p ita l goods are worn o u t, the debt should be paid off.'10 Well and good, as fa r as i t goes! D alto n 's P rin ciples of Public Finance was a popular te x t book in A u stra lia and sev eral g en eratio n s of students of economics in th is country must have absorbed th i s point of view. I t c e rta in ly prevailed in the accounting p ra c tic e s of at le a s t some s ta tu to ry corp o ratio n s in the various S ta te s of A u stra lia. Changing circum stances, however, have revealed problems with i t s im plem entation. Growth and growing c o sts make replacem ent c o stly ; and ris in g in te r e s t ra te s make the burden of new debt p a rtic u la rly heavy. Not l e a s t, although far from widely recognised, is the im plication i t has for the pricin g p o lic ie s of public u t i l i t i e s and the consequences of adopting p ricing p o lic ie s based on co sts th a t do not include provision for d e p re c ia tio n ch arges. One consequence w ill be an in fla te d demand for the under-priced se rv ic e s re la tiv e to the demand for o th er goods and se rv ic e s. At the same tim e, to add d e p reciatio n charges to provisions for sinking funds over id e n tic a l periods of time would impose a burden on e a r l ie r as compared with la t e r g en e ra tio n s. In te rg e n e ra tio n a l equity could be preserved by spreading sinking fund p ro v isions over the expected l i f e of the e n te r p r is e, not ju s t the l i f e of the loan or the fixed a ss e ts whose a c q u is itio n i t financed. To use the l i f e of the e n te rp rise as a y ard stick im plies longer term borrowing or sp e c ific - but s te a d ily d eclin in g - refin an cin g. As w ell, however, the absence of provision for d ep reciatio n by lo cal public e n te rp ris e s m ust, in many ca se s, penalise ratep ay ers to the advantage of bond-holders! I t is a n eg lect of the in te r e s ts of the members of a community for a public e n te rp rise created to serve them to f a i l to acquire on th e ir behalf some eq u ity in th e ir e n te r p ris e, e ith e r held in th e ir e n te rp rise or d is trib u te d through reb ates of le v ie s (or r a te s ). The point does not a r i s e, of co u rse, in the case of permanent a s s e ts (nor those which la s t le s s than a year or two); but most fixed a s s e ts are today in the nature of reproducible ta n g ib le a s s e ts (o r, in terms of the e a r l ie r d ebate, w asting a s s e t s ). It seems reaso n ab le, th e re fo re, to heed D icksee's plea for a statem ent of policy by public e n te rp ris e s but b e tte r expressed, perhaps, as a statem ent of borrowing purpose. Adoption of such a p ra c tic e would permit judgment of the ap p ro p riaten ess of public borrowing in r e la tio n to the nature of the a s s e ts whose c re a tio n or a c q u is itio n i t is to finance and the management p o lic ie s to be adopted for the use of those a s s e ts. C learly, replacement borrowing i. e. ra isin g loans to finance the replacement of a s s e ts as they wear o u t, must be suspect as an adequate discharge of public r e s p o n s ib ilitie s. D alton, P rin ciples of Public Finance, 3rd edn, George Routledge & Sons L td., London, 1936, p

20 I t is not th a t replacem ent borrowing should be re je c te d when occasion fo r i t a r i s e s ; i t i s, in s te a d, th a t the occasion should be prevented from a ris in g and i t s appearance become the sign of a need fo r change in management p ra c tic e s. And i t m ight be u sefu l to in c re a se the inform ation in loan pro sp ectu ses to rev eal w hether the money i s to be ra ise d fo r a b u sin ess-ty p e v en tu re or a w elfare agency. This in tro d u ces a concept of the economic ro le of public e n te r p ris e s as d i s t i n c t from th e ir fu n c tio n a l ro le ; and i t a p p lie s - because of the p ricin g im p lic a tio n s i t c a r r ie s - as much to n a tio n a l a u th o r it ie s as to lo c a l a u t h o r i t i e s. Purpose has fo r many y ears - and, in d eed, the l a s t two c e n tu rie s - been a fe a tu re of any judgment of pu b lic a u th o r ity borrow ing. Here, however, purpose has been more c lo s e ly d e lin e a te d than has been custom ary. P rodu ctive and Unproductive Spending The purposes of public borrowing have p re v io u sly had a le s s sp e c ific focus than now suggested. Purpose, in e a r l i e r tim es, had been concerned sim ply w ith a d is ti n c ti o n between p ro d u ctiv e and unproductive spending but even th is had become clouded. The terms p ro d uctive and unproductive were probably f i r s t used in an ex p o sitio n of economic th eo ry by the school of th in k e rs we c a ll the p h y sio c ra ts, flo u ris h in g in the France of the 18th c en tu ry. The terms were picked up and used by Adam Smith, in m isu n d erstan d in g, i t has been s a id, of the meanings a ttr ib u te d to them by the p h y sio c ra ts them selves. I t i s, however, q u ite c le a r th a t Smith understood th a t he used the words in d if f e r e n t senses from those applied by the p h y s io c ra ts. In The Wealth o f Nations (Chapter I I I, Book I I ) Smith acknowledged in a fo o tn o te: 'Some French au th o rs of g re a t le a rn in g and in g en u ity have used those words in a d if f e r e n t sen se. In the l a s t ch ap ter of the fo u rth book I s h a ll endeavour to show th a t th e i r sense is an improper o n e. '^ The p h y sio crats used the term s p ro d u ctiv e and unproductive in a h ig h ly te c h n ic a l sense, productive meaning re p e a ta b le or rep ro d u cib le and nonp ro d u c tiv e, non re p e a ta b le or n o n -rep ro d u cib le ( a s, fo r example, in m ining). I t is arguable th a t the meaning a ttr ib u te d to them by Adam Smith also d i f f e r s from any im p lic a tio n s the words m ight hold today in o rd in ary d is c o u rse. Smith was q u ite s p e c ific about the meanings he a ttr ib u te d to productive and unproductive: 'There is one s o rt of labour which adds to the value of the su b ject upon which i t is bestowed: th ere is another which has no such e f f e c t. The form er, as i t produces a v a lu e, may be c a lle d productive; the l a t t e r, unproductive la b o u r. Thus the labour of a m anufacturer adds, g e n e ra lly, to the value of the m a te ria ls which he works upon, th a t of h is own m aintenance, and of h is m a s te r's p r o f it. The labour of a m enial se rv a n t, on the c o n tra ry, adds to the value of nothing. Though the m anufacturer has h is wages advanced to him by h is m a ste r, h e, in r e a l i t y, c o s ts him no 11 Smith, The Wealth o f N ations, op. c i t, Vol. I, p

21 expense, the value of those wages being generally restored, together with a profit, in the improved value of the subject upon which his labour is bestowed. But the maintenance of a menial servant never is restored. A man grows rich by employing a multitude of manufacturers: he grows poor by maintaining a multitude of menial servants. The labour of the latter, however, has its value, and deserves its reward as well as that of the former. But the labour of the manufacturer fixes and realises itself in some particular subject or vendible commodity, which lasts for some time at least after the labour is past. It is, as it were, a certain quantity of labour stocked and stored up to be employed, if necessary, upon some other occasion. That subject, or what is the same thing, the price of that subject, can afterwards, if necessary, put into motion a quantity of labour equal to that which had originally produced it. The labour of the menial servant, on the contrary, does not fix or realise itself in any particular subject or vendible commodity. His services generally perish in the very instant of their performance, and seldom leave any trace or value behind them for which an equal quantity of service could afterwards be procured.'^2 This, in the terms in which it is described, is neither more nor less than the distinction made today between investment and consumption! More mundanely, it might be described as a distinction between the production of goods and the production of services. Common parlance, however, would today attribute a physiocratic-style meaning - fertile and barren - to productive and unproductive in some instances but it would also designate productive labour or productive activity as a process yielding useful (and perhaps saleable) results; and unproductive labour or activity as something useless or of no avail. These are both wider and different meanings as compared to those assigned to these words by either the physiocrats or Adam Smith (on any interpretation). Considering that governments borrowed mainly to finance wars, Adam Smith saw their borrowing as unproductive in his terms and to be avoided as much as possible; and it did not take long for the two words to be applied to government borrowing with pejorative connotations. Their use in this way has persisted, yet they command popular support on the basis of the meanings current in common parlance! Public borrowing for the creation or acquisition of fixed assets even today earns expert and popular support; and public borrowing for any other purpose remains, at the least, suspect (as it was to Adam Smith). As late as 1936, Hugh Dalton was writing: 'A distinction is often drawn between "reproductive debt"... and "deadweight debt. The former is debt which is fully covered, or balanced, by the possession of assets of equal value; the latter is debt to which no existing assets correspond.'^ Although the missing words read, in reference to 'reproductive debt': 'an absurd phrase', the distinction carried weight and special pleas as strong as the exigencies of war - and little else - were needed to justify 'deadweight debt'. This follows closely the judgments of Adam Smith, more than one hundred and fifty years after those judgments were made. 12 Ibid, Vol. 1, pp Dalton, 3rd edn, op. cit., p

22 The so -calle d Keynesian re v o lu tio n was to a l t e r th i s. However, i t did nothing to overturn the c la s s ic a l or n e o -c la ssic a l system - whatever terms one lik e s to use to id e n tify mainstream economic theory p rio r to in i t s fundamentals or as i t applied to co n ditions of f u ll employment. I t was a rev o lu tio n in the sense th a t i t re je c te d Say's Law but Say's Law turned out to be, not a cornerstone of the system, but only one of a number of runners (in terms of a c o n stru c tio n a l analogy). The re je c tio n of Say's Law - th at supply c re a te s i t s own demand - allowed the sp e c ia l circum stances of in v oluntary unemployment to be explained and c o rre c te d. It was a featu re of the Keynesian an a ly sis as presented in The General Theory o f Employment, In te r e s t and Money th a t governments could u s e fu lly borrow money to finance w asteful expenditure. 'W asteful loan e x p e n d itu re ', Keynes w rote, 'may n e v erth eless en rich the community on b a la n c e '. To th is he add ed: ' I t is often convenient to use the term "loan expenditure" to include both public investm ent - (the cu rren t a d d itio n s to the value of the c a p ita l equipment which has re s u lte d from the productive a c tiv ity of the period) - financed by borrowing from in d iv id u a ls and also any o ther cu rren t public expenditure which is so f inanced. ' Loan ex p en d itu re, i. e. public a u th o rity borrow ing, could le g itim a te ly embrace, in e f f e c t, consumer spending or consumption by public a u th o r itie s. The arguments of The General Theory need no r e p e titio n here; i t is enough to draw a tte n tio n to them and to cate g o rise th e ir p ro g n o sticatio n s in c u rre n t term inology. Doing so rev eals the narrowness and the unnecessary, indeed harm ful, r e s tr ic tio n of the concept of productive or reproductive spending or borrowing. I t m atters not th at subsequent argument has urged th a t the concepts of public a u th o rity in te rv e n tio n to secure f u ll employment by pumppriming depend as much i f not more on the monetary im p licatio n s of f is c a l policy as on the f is c a l actio n i t s e l f. The fact remains th a t there is a stro n g, if not overwhelming case for public borrowing to break the b a r r ie r s of e a r l ie r r e s tr ic tio n s in times of s ig n ific a n t dep artu re from the assumption of f u ll employment inherent in a l l e a r l ie r economic a n a ly s is. Since 1936, public a u th o r itie s have been able to extend the purposes of borrowing considered le g itim a te by economic theory beyond the confines of e a r l ie r years. In A u stra lia, E.R. Walker ( l a te r S ir Ronald Walker) was an e a rly exponent of the new id e a s. In Unemployment P o licy (published in 1936), Walker wrote: 'A government pledged to resp ect p riv ate property and to p ro tect freedom of e n te rp rise can n ev erth eless undertake, q u ite c o n s is te n tly, a larg e programme of public works. Some works are not l e f t to u n fettered free e n te rp rise because they involve monopoly power for those who co n tro l them, and a government may decide to prevent e x p lo ita tio n of the community by undertaking such works i t s e l f. Again, some works w ill y ield an adequate fin a n c ia l re tu rn, only a f te r so long a "w aiting period" as to discourage sh o rt-liv e d man from investing in them but the State is expected to take a longer view, e sp e c ia lly i f the works provide co n d itions favourable to a growing population. S t i l l other works may not yield a d ir e c t fin a n c ia l re tu rn, even in the long run, J.M. Keynes, The General Theory o f Employment, In te re st and Money, 1st edn, Macmillan & Co., London, 1936, p

23 but may in crease the gen eral earning power and tax-paying power o f the community, and i t may "pay the S tate to undertake them fo r these in d ir e c t re a so n s. L a s tly, works may be undertaken because they are thought to be s o c ia lly w orthw hile, even though they do not y ie ld d ir e c tl y or in d ir e c tly any fin a n c ia l re tu rn commensurate w ith th e ir c o s t.' '.... we may r e f e r b r i e f ly to the re la te d q u estio n of budget b a la n c in g. I t has g e n e ra lly been claim ed, even by advocates of p u b lic works, th a t budget balance was e s s e n tia l to recovery b u t, r e l a t i v e l y to the savin g s-in v estm en t a n a ly s is, unbalanced budgets perform e x a c tly the same fu n ctio n in d ep ressio n as pu b lic works do. When p riv a te investm ent is le s s than c u rre n t sav in g s, the excess of savings can be absorbed by an excess of public spending over r e c e i p ts. Borrowing fo r the purpose of paying c i v i l se rv a n ts to perform th e i r d u tie s is no d i f f e r e n t, in the monetary a n a ly s is, from borrowing fo r the purpose of paying workmen to c o n s tru c t a ro a d. ' ^ A fa r c ry from Adam Smith! And, i f not a re v o lu tio n in th o u g h t, re v o lu tio n a ry in appearance! In e f f e c t, however, a v a r ie ty of reasons for governm ents to borrow had been taken under the cloak of r e s p e c ta b i lit y - o r, perhaps more a c c u ra te ly, were in the process of being taken under i t. This was a l l e s s e n tia l ly pragm atic; b u t, g e n e ra lly, the employment c o n d itio n s in which i t occurred were to rank h ig h ly in the l i s t of c r i t e r i a to be ap p lied to government borrow ing. The employment d e b a te, however, had given a v aried co n ten t to these c r i t e r i a and th e i r li m i t s, i f lim its e x is te d, were by no means c le a r! The A llo c a tio n o f Resources Some re a c tio n was, p erhaps, in e v ita b le. I t came in 1948 in an a r t i c l e in the American Economic Review by M ilton Friedman of Chicago. Hayek had alread y w ritte n The Road to Serfdom but th i s was predom inantly an exp ressio n of p o li ti c a l p referen ces which, although many subscribed to them, did nothing to advance the th eo ry of econom ics. F riedm an's a r t i c l e purported to do ju s t th a t under the t i t l e 'A Monetary and F is c a l Framework for Economic S t a b i l i t y '. He s ta te d h is case in an h i s t o r i c a l co n tex t: 'During th e la t e n in e te e n th and e a rly tw e n tie th c e n tu rie s the problems of the day were of a kind th a t led econom ists to c o n c e n tra te on the a llo c a tio n of re s o u rc e s, and, to a le s s e r e x te n t, economic grow th, and to pay l i t t l e a tte n tio n to sh o rt-ru n f lu c ta tio n s of a c y c lic a l c h a ra c te r. Since the Great D epression o f the 1930s, th is emphasis has been re v e rse d. Economists now tend to co n cen trate on c y c lic a l movements, to a c t and ta lk as if any improvement, however s l i g h t, in c o n tro l of the cy cle j u s ti f ie d any s a c r i f i c e, however la r g e, in the long-run e ff ic ie n c y, or ^ E.R. W alker, Unemployment P o lic y (With Special Reference to A u stra lia ), 1st edn, Angus and Robertson L td., Sydney, 1936, pp ,

24 prospects for growth, of the economic system. Proposals for the control of the cycle thus tend to be developed almost as if there were no other objectives and as if it made no difference within what general framework cyclical fluctuations take place. A consequence of this attitude is that inadequate attention is given to the possibility of satisfying both sets of objectives simultaneously.'^ These were very persuasive words. However, Harrod was already writing about economic growth in a Keynesian context and Domar was not far behind. Nevertheless, the direction of attention to the potential for conflict between stabilisation policy and efficient resource allocation appeared to have particular importance - especially in a world rebuilding after war - and it also raised important issues. The efficient allocation of resources had emerged as a feature of the theories of the marginalist revolution. Two particular principles lay at the heart of the marginalist system. In the words of the man - H.H. Gossen ( ) - now given credit for one of its earliest and clearest expositions, these were: 1. 'The amount of one and the same enjoyment diminishes continuously as we proceed with that enjoyment without interruption, until satiety is reached.' 2. 'In order to obtain the maximum sum of enjoyment, an individual who has a choice between a number of enjoyments, but insufficient time to procure all completely, is obliged - however much the absolute amount of individual enjoyments may differ - to procure all partially, even before he has completed the greatest of them. The relation between them must be such that at the moment when they are discontinued, the amounts of all enjoyments are equal.'^ This was the law of diminishing returns converted into diminishing utility, and the maximisation of utility made dependent upon equating all last - i.e. marginal - increments of utility. The marginalist system which was built on these two propositions - when the system was generally accepted - gave a more detailed and apparently applicable content to the theory of value and the explanation of the formation of prices than had previously existed; and it provided a rationale and a justification for the allocation of resources to their various uses by market forces. The system explained more than the philosophical speculations of earlier writers seemed to do. It also appeared to be more firmly based and, indeed, to be scientific in both its basis and content - as science was understood then - than the judgments and deductions of an earlier time. This seemed to be as it should; science was becoming a great deal more fashionable than philosophy. ^ Milton Friedman, 'A Monetary and Fiscal Framework for Economic Stability', in Milton Friedman, Essays in Positive Economics, University of Chicago Press, Chicago, 1953, p ^ Quoted in J.W. McConnell, Economists Past and Present, Doubleday and Co. Inc., 1943, reprinted by Barnes and Noble, New York, 1958, p

25 Economics as i t has come down to us over two c e n tu rie s had i t s o rig in s as a branch of Moral Philosophy. That is to say, the economics we have in h e rite d had i t s beginnings in p re s c rip tio n s for human behaviour, both in d iv id u a l and c o lle c tiv e. The m arginal re v o lu tio n, however, marked a change to a science of economics. Ir o n ic a lly, lik e c la s s ic a l economics, i t was in tune w ith the philosophy of i t s tim es; but now i t was a philosophy of science and the new economics of the la te 19th cen tu ry sought to ex plain human b ehaviour, a t le a s t in i t s economic a s p e c ts, and not to p rescrib e for i t. I t was the consequences of in te rfe re n c e w ith th is d e te rm in is tic world of economic a f f a i r s which were la t e r to be seen as the source of c o n flic t between the m easures advocated under s t a b il is a t io n p o lic ie s and those proposed for the e f f i c i e n t a llo c a tio n of reso u rces in an economy. However, to s u s ta in such a view, i t was necessary to s h if t the emphasis in the Keynesian a n a ly s is of c y c lic a l unemployment from re a l to monetary v a ria b le s ; in th is way was monetarism born (o r, a t l e a s t, clothed as we know i t today). M ilton Friedman took the view th a t the o rig in of c y c lic a l flu c tu a tio n s lay in m istaken m onetary management; and th a t th e ir c o rre c tio n la y, n o t in sp ecial f i s c a l m easures, but in follow ing out pre-determ ined ru le s fo r monetary p o lic y. Thus could market fo rces achieve both f u l l employment and an e f f i c i e n t a llo c a tio n of reso u rces. Subsequently, Richard Musgrave sought a compromise so lu tio n through the concept of compensatory fin a n c e, leaving the a llo c a tio n of reso u rces to market fo rces and r e s tr i c ti n g f is c a l s t a b il is a t io n p o lic ie s to varying tr a n s fe r payments (on the expenditure side) and tax ra te s (to a f f e c t the revenue side of b u d g e ts ).^ A lready, however, the foundations of m arginalism - and much of the t o t a l i t y of economic theory - had come under q u estio n. M arginalism, lik e c la s s ic a l economics before i t, was concerned w ith a p a r tic u la r aspect of human behaviour; and a concept of economic and then ra tio n a l man developed which became the more qu estio n ab le the more i t s im portance to theory grew. As an a n a ly tic a l to o l, the concept was u se fu l; i f i t asp ired to be a d e s c rip tio n of r e a l i t y, i t had d e fic ie n c ie s. That m arkets should be free in some sense had a lso been a u sefu l assum ption for the c o n stru c tio n of th e o rie s o ffe rin g im portant in s ig h ts in to the working of the economic world; but i t became in c re a sin g ly evident th a t an assum ption of free m arkets f e l l short of the mark as a d e s c rip tio n of r e a l i t y in the 20th cen tu ry. These and other qu estio n s ra ise d doubts about the v a li d it y of conventional theory as the 20th ce n tu ry pro g ressed. An o p p o rtu n ity to re s to re the a u th o rity of.conventional theory came w ith changes in the th eo ry of knowledge and the philosophy of science. The 19th cen tu ry view of the world as d isco v erab le through a p p lic a tio n of the lo g ic a l dev ices of in duction and deduction was changed beyond reco g n itio n in the 20th c e n tu ry. The lo g ic of in d u ctio n had always presented d i f f i c u l t i e s ; and p e rs is te n t questioning e v e n tu a lly toppled the in ductive process from i t s pre-em inence. The p o s s ib il it y of d isco v erin g tr u th was, i t s e l f, questioned; and Karl P opper's concept of f a l s i f i c a t i o n replaced v e r if ic a tio n as the te s t of an h y p o th esis. Hypotheses were now seen as human c o n s tru c ts which did not n e c e s s a rily have any ex istence in r e a l it y ; b u t, even so, they were u sefu l i f th e ir p re d ic tiv e power was adequate. 18 See Richard A. Musgrave, The Theory o f P u b lic F inan ce, In te rn a tio n a l Student E d itio n, McGraw-Hill Kogakusha L td., Tokyo, 1961, P art IV

26 The new th eo ry o f knowledge was ab ly expounded in i t s a p p li c a b il it y to economics by M ilton Friedman in 'The Methodology of P o sitiv e E c o n o m ic s'.^ 'The u ltim ate goal of a p o s itiv e science is the development of a "theory" or "hypothesis" th a t y ie ld s v a lid and m eaningful ( i. e. not t r u i s t i c ) p re d ic tio n s about phenomena not yet observed. 'Viewed as a body of su b s ta n tiv e hypotheses, th eo ry is to be judged by i t s p re d ic tiv e power for the c la s s of phenomena which i t is intended to "e x p la in ". Only fa c tu a l evidence can show whether i t is " rig h t" or "wrong" o r, b e t t e r, te n ta tiv e ly "accepted" as v a lid or r e je c te d. As I s h a ll argue a t g re a te r len g th below, the only re le v a n t te s t of the v a li d it y of a h y p o th esis is comparison of i t s p re d ic tio n s w ith ex p erien ce. The hy p o th esis is re je c te d i f i t s p re d ic tio n s are c o n tra d ic te d (" fre q u e n tly " or more o fte n than p re d ic tio n s from an a lte r n a tiv e h y p o th esis); i t is accepted i f i t s p re d ic tio n s are not c o n tra d ic te d ; g re a t confidence is attach ed to i t i f i t has survived many o p p o rtu n itie s for c o n tra d ic tio n. F actual evidence can never "prove" a h y p o th e sis; i t can only f a i l to disprove i t, which i s what we g e n e ra lly mean when we say, somewhat in e x a c tly, th a t the h y p o th esis has been "confirm ed" by e x p erien ce. ' 'The v a li d it y of a h y p o th esis in th is sense is not by i t s e l f a s u f f ic ie n t c r i te r io n fo r choosing among a lte r n a tiv e hypotheses. Observed fa c ts are n e c e s s a rily f i n i t e in number; po ssib le hypotheses i n f i n i t e. If th e re is one h y p othesis th a t is c o n siste n t w ith the a v a ila b le evidence, there is always an in f in i te number th a t are.... The choice among a lt e r n a tiv e hypotheses e q u a lly c o n s is te n t w ith the a v a ila b le evidence must to some e x ten t be a r b i tr a r y, though th ere is gen eral agreement th a t re le v a n t c o n sid e ra tio n s are suggested by the c r i t e r i a "sim p lic ity " and " f r u it f u l n e s s ", them selves n o tio n s th a t defy com pletely o b jectiv e s p e c i f ic a tio n.' '.... t o suppose th a t hypotheses have not only "im p licatio n s" but also "assum ptions" and th a t the conform ity of these "assum ptions" to " r e a lity " is a te s t of the v a li d it y of the h y p o th esis d if f e r e n t from or a d d itio n a l to the te s t by im p lic a tio n s.... is fundamenta lly wrong and productive of much m isch ief. Far from providing an e a s ie r means fo r s i f ti n g v a lid from in v alid h y potheses, i t only confuses the i s s u e.... ' 'T ru ly im portant and s ig n if ic a n t hypotheses w ill be found to have "assum ptions" th a t are w ild ly in acc u rate d e s c r ip tiv e re p re se n t a tio n s of r e a l i t y.... ' 19 M ilton Friedman, 'The Methodology of P o sitiv e Economics' Positive Economics, op. cit., pp. 7, 8-10, 14. in Essays in - 14-

27 The emphasis was sh ifte d from the v a li d it y of prem ises to the accuracy of p re d ic tio n s ; th u s, fo r those who wanted i t, could the q uestioning of the foundations o f economic theory be s t i l l e d. Not everyone accepted th is in te r p r e ta tio n of the developing theory of knowledge. Samuel son did n ot; he claimed th ere were indeed 'm eaningful theorems in d iv erse fie ld s of economic a f f a i r s. They are not deduced from th in a i r or from a p r io r i p ro p o sitio n s of u n iv e rsa l tr u th and vacuous a p p l i c a b i l i t y '. ^ He d id, in d eed, i n s i s t on 'a reasonably high standard of v e ra c ity in the assum ptions.... ' ^ Nor had the development of the theory of knowledge sto p p ed, or even paused. W riters a f t e r Popper, lik e Kuhn and la t e r L akatos, were concerned more to analyse and p rescrib e fo r s c i e n ti f ic advance. O thers, lik e Hempel and Nagel, were reviewing the advances in the philosophy of science alread y made, an aly sin g and re fin in g them and in te g ra tin g them w ith the la rg e core of tr a d itio n a l philosophic thought s t i l l ex tan t to give a balance and a p e rsp ectiv e to the theory of knowledge. And so a view was formed of the formal requirem ents of s c i e n ti f ic explanation which is now w idely, i f not u n iv e rs a lly accepted. However, i t is not now the p ra c tic e to judge a science and i t s laws by the e x ten t to which they do or do not conform to formal requirem ents of v a li d it y. I t is n e v e rth e le ss u sefu l to re f e r to those requirem ents as a guide to the adequacy of the lo g ic of an exp lan atio n and for help in forming a view as to i t s soundness and e s p e c ia lly the degree of i t s soundness in r e la tio n to th a t of o th er ex p lan a tio n s, or in terms of the v ario u s stag es of the development of a science and i t s p a rts. C u rre n tly, i t is believed th a t the terms or concepts of an exp lan atio n should be p ro p erly d is trib u te d through th a t exp lan atio n (so th a t logic is s a t i s f i e d ) ; th a t the prem ises of an exp lan atio n should be tru e - o r, more c a u tio u s ly, th a t they should be w ell corroborated (so th a t realism is s a t i s f i e d ) ; and th a t the ex planation should be re fu ta b le by em p irical te s t of i t s p re d ic tio n s (so th a t a p p lic a b ility is te s te d ). This is c a lle d the 'h y p o th e tic o -d e d u c tiv e ' theory of e x p la n a tio n.^ I t is not always p o ssib le to advance as fa r as ex p la n a tio n, a t le a s t not w ithout the passage of time; and so we have the concepts of th e o rie s and hyp o th eses, forming successive sta g e s, in rev erse o rd e r, in an advance to ex p lan a tio n. The p h ilo so p h ical j u s t i f i c a t i o n of the n e o -c la s s ic a l views offered now c le a r ly does not measure up to the main stream of philosophic thought on the requirem ents of s c i e n ti f ic ex p lan a tio n ; i t s prem ises a re, as a d e s c rip tio n of r e a l i t y, suspect a t the very b e s t; and a t le a s t one major p ro tag o n ist of the n e o -c la s s ic a l school d enies th a t h is prem ises even should conform to what is now the conventional t e s t of th e ir adequacy. H is, i t would seem, was a prem ature statem ent. 90 Paul A. Samuel son, Foundations o f Economic A n a ly sis, Harvard U n iv ersity P ress, Cambridge, U.S.A., 1948, p D.M. B ensusan-b utt, 1978, p On Economic Man, 1st edn, ANU P re ss, C anberra, 99 See Alan Ryan, The Philosophy o f the Social S cien ces, 1st edn 1970, 5th R eprint 1976, The Macmillan Press L td., London, 1976, Chapter

28 At the same time, concern with an efficient allocation of resources and the adoption of policies consistent with it may still be justified in the absence of any adequate substitute. Concern with resource allocation arises, so a modern text says, 'because resources are scarce, which makes it essential that they be both fully and efficiently employed. If they are not, the potential of the economic system to generate welfare cannot be fully realised.'22 But is it necessary that it should be? Are there no other aims in life? Are there no other requirements of human behaviour? May we - indeed, do we - not behave other than as rational men concerned only with economic selfinterest? Apart from such questions as these, it might usefully be noted that an efficient allocation of resources as specified in neo-classical theory is not an observable or measurable condition; indeed, it smacks very much of the metaphysical. Modern philosophy recognises the occurrence of such statements in the sciences, statements which do not seem to be obviously testable; and it categorises them as '... loosely framed empirical hypotheses which need to be made more exact and therefore testable, or else they are analytic truths, mere definitions'.2^ In other words, the realisation of an efficient allocation of resources by the operation of unfettered market forces could be regarded as an interesting, even important, feature of a free market system; but achievement of an efficient allocation of resources as a chosen objective of policy is another matter. To assign this role to the efficient allocation of resources is to mistake a quality of a thing for the thing itself. Samuelson, in Foundations of Economic Analysis2-* specifically exluded the metaphysical from economics as he viewed it; and nowhere in that volume was any mention to be found of the efficient allocation of resources. It must take a considerable lack of purpose and direction in both the private and public sectors of an economy for resort to be necessary to such an unfounded criterion of action! Income Distribution, Welfare and Other Policies Economic theory has been given a twofold content for some time - the positive and the normative. J.N. Keynes, writing in 1891,2^ sought both to elucidate and extend it in order to reconcile the different schools of thought of his time; and he offered a distinction between positive economics and normative economics and also the art of economics. The last class- 2 3 K.D. George and John Shorey, The Allocation of Resources - Theory and Policy, 1st edn, George Allen & Unwin, London, 1978, p. 11. ^ Ryan, op. cit., p ^ Ibid. 9 f* Milton Friedman, 'The Methodology of Positive Economics', op. cit.; Phyllis Deane, The Evolution of Economic Ideas, Cambridge University Press, Cambridge, 1978; Mark Blaug, The methodology of economics, Cambridge University Press, Cambridge,

29 i f ic a t io n re fe rre d to economic management and government in te rv e n tio n in the economy. In so fa r as income d is tr i b u ti o n is concerned, i t is im portant th a t these d is tin c tio n s be borne very much in mind l e s t views of what ought to be cloud the a n a ly s is of what may be! The d is ti n c ti o n was not n e c e s s a rily very im portant fo r the m a rg in a lis ts fo r, to them, what ought to be was also la rg e ly what was; and our th e o rie s of income d is tr i b u ti o n, lik e id eas of resource a llo c a tio n, owe much to neoc la s s ic a l m a rg in a lis t theory. However, un lik e the concept of an e f f i c i e n t a llo c a tio n of re s o u rc e s, th e re is nothing of the m etaphysical about the idea of income d is tr i b u ti o n i t s e l f. There are some conceptual problems clouding d e f in itio n and th ere are some d i f f i c u l t i e s of measurement but income, in some shape or form, is an e n tity known to a l l of us and one which has a measure of some s o r t. S tr ic tu r e s about some asp ects of n e o -c la s s ic a l thought are even fu rth e r removed from the problems of income d is tr i b u ti o n ra ise d by public se c to r borrow ing, because here the su b je c t-m a tte r is not th a t of fa c to r re tu rn s, as i t is in the m arginal a n a ly s is, but the incidence of ta x, i t s tim ing and the burden of d e b t. The s u b je c t, as lim ited by the p a rtic u la r focus applied to i t h e re, has a strong pragm atic co n ten t; yet i t may s t i l l a t t r a c t strong fe e lin g s of what ought to happen as d i s t i n c t from what does happen. A s u b s ta n tia l consensus of opinion has been reached among econom ists about the burden of the public deb t. Perhaps the f i r s t point to be noted is the im p o s s ib ility of s h if tin g the burden of the resource use financed by in te rn a l borrowing w ithin an economy away from the g en eratio n experiencing th a t u se. In the case of e x te rn a l d e b t, on the o th er hand, to the e x ten t th a t a d d itio n a l reso u rces are added to those produced w ithin the economy, any presen t burden is avoided. For se rv ic in g and repayment of public d e b t, tl.e rev erse is found. There is no burden imposed on the community as a whole in the case of in te rn a l d e b t, fo r a l l tr a n s f e r s are from one group to another w ith in the economy. I f, however, the c o sts of se rv ic in g are unevenly d is tr ib u te d by comparison w ith the b e n e fits received from s e rv ic in g, th i s w ill follow more from previous income in e q u a litie s than from c u rre n t ev en ts. In the case of e x te rn a l d e b t, on the o th er hand, se rv ic in g and repayment both re q u ire a tra n s fe r of reso u rces away from the deb to r community to another and th is does impose a burden on the fu tu re. At the same tim e, to the e x te n t th a t the borrowing has been used to g en erate income in the deb to r community, the burden w ill be e a s ie r to bear than would otherw ise have been the case. E xternal borrow ing, in th is c o n te x t, is any borrowing extending beyond the geographic boundary of a u th o r ity of the borrow er. As such, i t a p p lie s to lo c a l governments and reg io n al governm ental a u th o r itie s w ithin a n a tio n a l context as w ell as n a tio n a l governments in a world c o n te x t. Borrowing, whether in te rn a l or e x te r n a l, o ff e rs an o p p o rtu n ity to place the burden of debt on the u se rs of any goods or se rv ic e s becoming a v a ila b le as a r e s u lt of the borrowing (to th o se, indeed, who may be supposed to receiv e value fo r the le v ie s imposed upon them, e ith e r by tax es in the case of public goods or by serv ice c h arg es). The recoupment of funds for debt serv icin g (and repayment) may, of c o u rse, be spread over the period for which goods or se rv ic e s continue to flow; and th is w ill th en, in e f f e c t, c o n s titu te a form of consumer finance - pay-as-you-use finance - and would serve to advance in time the re c e ip t of b e n e f its. There are two o th er asp ects of the m atter to be taken in to account: the e ff e c t on income d is tr ib u tio n of the d e c isio n to make the s p e c ific goods or serv ices a v a ila b le which follow from the borrow ing, in stead of some o th e rs (fo r those goods or serv ices thus made a v a ila b le may not be eq u ally accep t able to a l l members of the community and some may be deprived of th e ir - 17-

30 preferences); and the effect on aggregate productivity of the investment the borrowing finances compared with productivity as it might otherwise have been. Measurement is difficult in both cases. It may also be mentioned that a choice between borrowing and taxing to finance public investment may be a choice between drawing resources from personal consumption or private investment. But this is the other side of the picture just drawn and it is no more quantifiable than the other. Against this background, it is sometimes claimed that welfare will be maximised if public consumption is financed from taxation and public investment in fixed assets from borrowing. But this is to go beyond the pragmatic analysis of what income distribution may follow from specified events and once more embraces the metaphysical; welfare is not easily identified nor changes in it readily observable. Neither, of course, is it measurable. Conclusions about welfare cannot be tested; and whereas the normal way of testing a theory in positive economics is to test its conclusions, the normal way of testing a welfare proposition is to test its assumptions'.22 Once again, be it noted, an offence is apparent against the tenets of scientific explanation! In the final analysis, decisions about the distribution of the burden of debt and income distribution in our economy rest on commonly held views of justice and equity. If there is widespread agreement about these matters, decisions can readily be made but they are not decisions for economists to make on the basis of economic theory! In Graaff's words: 'It is sometimes suggested that there is in fact a comprehensive enough consensus of opinion on ends, or on essentially ethical matters, to give welfare theory some scope. Thus it may be argued that there is to-day almost universal agreement on the desirability of full employment, the necessity of maintaining a reasonably stable level of prices, or of solving the dollar crisis. But it does not seem to be realised how detailed the agreement on ends must be if a consistent theory of welfare economics is to be erected. There are an infinite number of policy combinations capable (in theory) of securing full employment. No two will have precisely similar effects on all the variables which influence welfare. How are we to choose between them? I doubt if any two people really agree in detail on the best way of securing full employment, no matter how many may agree that it should be secured.' 'We have seen that, to build even the elements of a theory of welfare along the conventional lines, we must have agreement on the horizon (which demarcates the group of men in whose welfare we are interested), on such specific matters as the items of terminal capital equipment (which together play an important role in determining the general rate of economic "progress") and the "correct" attitude to uncertainty. It seems to me extremely improbable that agreement on these basic matters will ever be obtained. And it seems to me, therefore, that the possibility of building a useful and interesting theory of welfare economics - i.e. one which consists of something more than the barren formulations typified by the marginal equivalences of conventional theory - is exceedingly small.' 22 J. de V. Graaff, Theoretical Welfare Economics, First Published 1957, 3rd Reprint, Cambridge University Press, London, 1967, p

31 'I f p o s itiv e economics can provide people w ith an understanding of the v ario u s fa r-re a c h in g in d ire c t e f f e c ts of p a r tic u la r p o li c ie s, i t w ill probably also provide them w ith a b a s is fo r draw ing w elfare c o n clu sio n s, for them selves and according to th e i r own r i g h t s. In my view the job of the economist is not to tr y to reach w elfare conclusions for o th e r s, but ra th e r to make a v a ila b le the p o s itiv e knowledge - the inform ation and the u n d erstan d in g - on the b a sis of which laymen (and econom ists th em selv es, out of o ff ic e hours) can pass ju d g em en t.'28 Mishan, w ritin g in 1960, said much the same: w elfare p ro p o sitio n s r e s t on both fa c tu a l and e th ic a l assum ptions. Unless both are g ra n te d, the f i r s t as being " r e a l i s t i c ", the second as being "w idely a c c e p ta b le ", the w elfare p ro p o s itio n s deduced from them are of no p ra c tic a l im p o rtan ce. ' 2^ T in bergen, w ritin g in 1952, took a more pragm atic view: 'Sometimes the problems may be sim p lifie d by making simple and somewhat a r b i tr a r y - though o ften r e a l i s t i c choices.... The procedure followed amounts to assuming as being given: (1) the s tr u c tu r e of an economy, (2) the ta r g e t v a r ia b le s, (3) th e ir num erical v a lu e s and (4) the n atu re of the instrum ent v a r i a b le s.' This su g g ested, n e v e rth e le s s, only a lim ite d p o s s ib il it y and Tinbergen a ls o made a strong plea for fu r th e r (and s p e c ific ) research in the f i e ld of p o s itiv e economics. Other p roposals to overcome the d i f f i c u l t i e s have been made from time to time - involving a concept of consum er's su rp lu s and an other of com pensation - but Winch, review ing developments in 1971, im p lic itly confirm ed the e a r l i e r view s: ' I f we always had the necessary in form ation in the rig h t form, the assessm ent of a lte r n a te p o lic ie s would be so simple th a t the com plicated e d if ic e of w elfare economics would be u n n ecessary.' As m a tte rs sta n d, in the absence of o th e r guides and in the face of n e c e s s ity (when i t a r i s e s ), re fe re n c e to the p recep ts of w elfare theory must be made in choosing between p o lic ie s to be adopted by governments; but th is must not be to the d etrim ent of any more c e rta in conclusions derived from o th e r f i e l d s (such as p o li ti c a l sc ie n c e, i f i t does o ffe r firm guidance, or so c io lo g y ). T h is, of co u rse, u n d e rlin e s again the need fo r research and g re a te r knowledge and perhaps also a more a p p ro p ria te d iv is io n of labour (o r re s p o n s ib ility ) between econom ists and p o li ti c ia n s. I t a lso po in ts to the need for econom ists (and exponents of debt theory) to take account of the 28 G ra a ff, T h eoretical Welfare Economics, op. c i t., pp , E.J. M ishan, 'A Survey of W elfare Economics ', Economic Journal, Vol. 70, No. 278, R eprinted in E.J. Mishan, Welfare Economics - Five Introductury E ssays, 2nd edn, Random House, New York, 1967, p J. T inbergen, On the Theory o f Economic P o lic y, 1st edn, 1952, 7th p rin tin g, North Holland Publishing Co., Amsterdam, 1977, p D.M. Winch, A n a lytica l Welfare Economics, 1st edn, Penguin Books L td., London, 1971, p

32 views of o th e rs and the oth er p a rts of the t o t a l i t y of economic p o lic y. It is c le a r th a t, at th is sta g e, a firm requirem ent from the econom ists' point of view is th a t borrowing - as fa r as i t s im p lic a tio n s can be foreseen - should be c o n siste n t w ith c u rre n tly dominant views w ithin the community about ju s tic e and eq u ity ; and what these are is not fo r econom ists alone to d ecide. I t is the re la tio n of debt policy to o th er po licy o b je c tiv e s which is im p o rtan t. And so i t is w ith o th er p o lic ie s ; c o n siste n c y, in a l l i t s a s p e c ts, needs to be re a lise d between public borrowing and o th er a llie d a c t i v i t i e s. E ffe c tiv e n e s s, i t can h ard ly be d en ied, i s im paired by unco-ordinated management, whether i t i s the e th ic s or some o th e r asp ect of a s itu a tio n which i s n e g le c te d. This much is su re ly ax io m atic. A p a rtic u la r fie ld fo r c o -o rd in a tio n l i e s in th e re la tio n between debt and monetary p o lic ie s. T heir connection is in tim a te ; and there is a whole realm of tech n ical co n sid e ra tio n s which hold a co nsiderable p o te n tia l for d iscord between th e ir various d iv is io n s. The conceivable in sta n c e s of such d iscord are not enumerated here although to set them out might help the d iscovery of some general p rin c ip le to illu m in a te th e ir sig n ific a n c e. In s te a d, a tte n tio n is drawn to some a tt r i b u te s of the concept of co n sisten cy. For debt p o licy to be c o n s is te n t w ith monetary p o lic y, i t is not necessary th a t i t should also be an instrum ent o f monetary policy. The n atu re of a c o n siste n t r e la tio n s h ip must depend on the r e la tiv e im portance attach ed to the separate p a rts so re la te d ; th is is a m atter of p r i o r i t i e s. A fu rth e r c o n sid e ra tio n to take in to account is whether p r i o r i t i e s are to be ab solute or r e la tiv e. In the n atu re of th in g s, th ere w ill be le s s o p p o rtu n ity to e s ta b lis h ab so lu te p r i o r it y of one p o licy over another than to achieve a s h if t in p r i o r i t i e s a t the margin of events. I t w ill also be more reasonable - su re ly, a g a in, a x io m a tic a lly - to accommodate a scale of p references in which changes may be made than to r e a lis e an absolute p r io r ity fo r one p o licy over an o th er. Indeed, the determ in atio n of r e la tiv e p r i o r i t i e s i s, im aginably, an e s s e n tia l p art of arranging co n sisten cy. P o sitiv e economics may make the co n d itio n s of co n sisten cy, in th is sense, p lain in some in sta n c e s. In o th e r s, referen ce w ill need to be made to dominant community views about o b je c tiv e s b u t, id e a lly, those views should be as w ell informed as p o ssib le about what p o sitiv e economics rev eals is li k e ly to be the e f f e c t of th e ir adoption. The Selection of Projects Resource a llo c a tio n - whether i t is su b ject to some requirem ent for e ffic ie n c y or not and whether i t is an o b je c tiv e of po licy or not - is concerned w ith: 1. what goods are produced and in what q u a n titie s ; 2. what methods are used in production; and 3. how goods are d is trib u te d between consumers. In the p riv a te secto r in so -c a lle d c a p i t a l i s t s o c ie tie s, the answers are provided by the o p eratio n of m arkets, whether they are free or re g u la te d, p erfect or im perfect. Because of th a t, the answers encompass the views of a v a rie ty of people and th e ir v arious in t e r e s t s even i f there are b iases in the d is tr i b u ti o n of income and w ealth and power. In the public se c to r of an economy, i t is also true th a t d e c isio n s about what to do and how to do i t and who w ill b e n e fit involve a v a rie ty of people, but not n e c e ss a rily as many - 20-

33 people d ir e c tl y ; and the c o n s tra in ts imposed by the views of a g reat number and v a rie ty of people are g e n e ra lly le s s immediately f e l t. In sh o rt, investm ent d e c is io n s in the public secto r can be made independently of market co n d itio n s; and th is may give g re a te r freedom to decision-m akers to widen the horizons to which they reach o u t, the o b je c tiv e s they seek and the ways they seek them. Such freedom also removes from decision-m akers some, and sometimes im p o rtan t, p a rts of the guidance they would lik e to have, or o th ers would lik e them to have about community views and p referen ces. A technique fo r ev alu atin g and choosing between a lte rn a tiv e proposals to be adopted in the public se c to r has become more and more d e s ira b le as the scope of government has widened in our tim e. C o st-b en efit a n a ly sis has th e re fo re been devised to match the discounted present value techniques used in making investm ent d e c is io n s in the p riv a te se c to r. The main d iffe re n c e between the techniques of discounted present value and c o s t-b e n e fit a n a ly sis is the need for the l a t t e r to take into account extra-m arket c o n sid e ra tio n s, including co sts and b e n e fits a ffe c tin g p a rtie s o th er than those d ir e c tly involved in tra n s a c tio n s. The main lim ita tio n of c o s t-b e n e fit a n a ly s is is the v a lu a tio n problem caused by the lack of guidance conferred by market p ric e s. Both techniques have some common problems, such as the d i f f i c u l t y of foreseeing accu rately the events which follow from d e c isio n s and the timing of those e v en ts, and of discounting for time so as to reduce a l l v alu es to present value. The v alu atio n problem is more complex in public se c to r d ecisio n s than in p riv ate d e c is io n s, because opportunity co sts are not as re a d ily id e n tif ia b le in the case of public secto r d e c is io n s. C o st-b en efit a n a ly s is also has sp ecial problems of i t s own; the i d e n t i f i catio n of b e n e fits im plies some concept of so c ia l w elfare and, consequently, some involvement w ith w elfare theory. The involvement may n o t, however, always be very firm or intim ate although i t w ill be a severe handicap in some ca se s. In W inch's words: 'The technique is in v a ria b ly couched in terms of p a r tia l eq u ilib riu m a n a ly s is. I t c o n sists of the enumeration and ev a lu a tio n of a set of consequences of a p a rtic u la r change in the context of a much wider economic environment th a t remains e s s e n tia lly u n affected. This constant background provides the frame of referen ce in terms of the value of money th a t perm its b e n e fits and c o sts to be expressed m eaningfully in money.' 'Where the p o licy under c o n sid eratio n would s u b s ta n tia lly change the e n tire economic system i t would be necessary to analyse i t in a general equ ilib riu m context and no usable body of theory p resen tly e x is ts for such a task. Thus while the b asic idea of c o s t-b e n e fit a n a ly s is is as relev an t to big changes as to sm all, the developed techniques of applying the idea are more re lia b le the sm aller the change under c o n sid e ra tio n. S im ilarly the basic idea is re le v a n t to any policy change; but i t s a p p lic a tio n c a ll s fo r enum eration and ev alu atio n of e ff e c ts th a t can be handled best by a v a ila b le techniques when they m anifest them selves in changes in q u a n titie s or p rices of goods and fa c to rs. The tech niques, i f not the concept, are far more p e rtin e n t to an investm ent in a public u t i l i t y than to a major so cial se rv ic e, the primary e f f e c ts of which may be in ta n g ib le. It is for these reasons th a t c o s t-b e n e fit a n a ly sis has had i t s w idest a p p lic a tio n in the f ie ld s of public works p ro je c ts and public u t i l i t i e s. ' 'The technique can be applied to a number of questions at d if fe re n t le v e l s, but always involves a comparison of two or more - 21-

34 a lt e r n a t iv e s. The sim p lest q u estio n is w hether to undertake a p a r tic u la r p ro je c t when a l l the consequences o f doing so are known and the only a lt e r n a t iv e is to remain in the known p resen t p o s itio n. More common, b u t le s s sim ple, are cases in which a number of a lt e r n a t iv e p ro je c ts must be considered sim ultan eo u sly. I t might then be p o ssib le to undertake c e r ta in com binations of p ro je c ts but not o th e r s.' C o st-b e n e fit a n a ly s is is e a s ie s t to apply to the problem of what methods to use in pro d u ctio n, th a t is to say in cases where a lte r n a tiv e proposals are designed to achieve the same s p e c if ic, id e n t if ia b l e o b je c tiv e. Such c a se s, come down, in e f f e c t, to an a n a ly s is of c o s t- e f f e c tiv e n e s s. A nalysis is more d i f f i c u l t the more a b s tr a c t the o b je c tiv e. C o st-b e n e fit a n a ly s is is thus lim ite d in i t s a p p lic a tio n where a choice needs to be made as to what goods are to be produced, but i t s a p p lic a tio n is made e a s ie r in such cases i f an o rder of im portance can be given to any re le v a n t p o l i t i c a l aim s. I t is l e a s t a p p lic a b le to q u estio n s of how goods are to be d is trib u te d (to whom and on what c o n d itio n s ). I t remains n ecessary, how ever, to a l l o t p r i o r i t i e s or o rd ers of preferen ce to d if f e r e n t pro p o sals i f a l l emerging p roposals cannot be accommodated; and th e re is no reason to b e lie v e they can. C o st-b e n e fit a n a ly s is o ff e rs a u se fu l o p p o rtu n ity to do so on a r a tio n a l b a s is but two f u r th e r w arnings of a p r a c tic a l kind should be sounded. I f occasion a r is e s to compare a p ro je c t proposed fo r the public se c to r w ith an o th er in the p riv a te s e c to r, assessm ent o f the one by c o s t- b e n e f it a n a ly s is and the o th er by discounted presen t v a lu e s may favour the p u b lic secto r p ro je c t by v ir tu e of the in c lu sio n of e x te rn a l b e n e fits in c o s t-b e n e fit a n a ly s is ; or the p riv a te secto r by the om ission of e x te rn a l c o s ts. C onsistency emerges again as im p o rtan t, th is time in the choice of assessm ent tech n iq u es. C onsistency is also im portant in the e v a lu a tio n of p ro je c ts w ith in the p u b lic s e c to r: '.... c o s t-b e n e fit a n a ly s is.... leav e s scope fo r d iffe re n c e s of opinion as to the m onetary v a lu a tio n to be placed on many c o sts and b e n e fits.... If plan n ers in d if f e r e n t in d u s trie s d i f f e r in th e ir su b je c tiv e e stim a tio n of these f a c t o r s, con sisten cy in decision-m aking w ill not e a s ily be a c h ie v e d.'33 Is there a case for c e n tr a lis e d assessm ent? Carr r e je c ts i t : 'On the oth er hand o n e 's mind boggles a t the prospect of p u ttin g a l l public investm ent p ro p o sa ls, or even a l l major schemes, b efo re a c e n tra l e v a lu a tio n board.... c o n tr o llin g the deployment of c a p ita l throughout the pu b lic se c to r; even companies of q u ite modest size have learned th a t o v e r - c e n tr a lis a tio n of d e c is io n making can reduce e ff ic ie n c y...' 'In the a u th o r 's opinion i t is a t le a s t e q u a lly d i f f i c u l t to imagine th a t a comprehensive s e t of r u le s fo r c o s t-b e n e fit a n a ly s is could be produced and c ir c u la te d to managements in the public se c to r, w ith p e rio d ic amendments n o tif ie d and pasted in lik e amendments to the Manual of M ilita ry Law.... ' Winch, A n a lytica l Welfare Economics, op. cit., pp J. Laurie C arr, Investm ent Economics, 1st edn, Sage P u b lic a tio n s In c., Beverley H ills, U.S.A., 1969, p I b id, p

35 Yet the need remains fo r some machinery for the re c o n c ilia tio n of competing aims. C o st-b en efit a n a ly s is has an im portant c o n trib u tio n to make to th is ta sk but i t has lim ita tio n s which need to be recognised the more a b s tra c t the choices th a t have to be made or the wider the scope of th e ir a p p lic a tio n. The a lte r n a tiv e is to turn to markets for guidance, th is to be given by way of w illin g n ess to subscribe to borrowing to finance sp e c ific in d iv id u al p ro je c ts. But m arkets may be ill-in fo rm e d and im perfect; and market judgments may serve n e ith e r the requirem ents of resource a llo c a tio n nor those of w elfare. Indeed, to meet those requirem ents, m arkets need to conform to sp e c ific co n d itio n s which i t is no longer thought p rev ail o v e ra ll; and w hile there may be doubts about the e x ten t of the im perfection of m arkets by these sp ecifie d standards and the exact sig n ific a n c e of those im p erfectio n s, doubts about the e ffic a c y of m arkets, p a r tic u la r ly money m arkets, as guides to community preferences rem ain. The C rite ria There follow s from th is prolonged discourse a short l i s t of pragmatic c r i t e r i a to apply to proposals for governmental borrowing: (1) The borrowing should not be se lf-d e fe a tin g ; i t should not damage the le n d e r 's b e lie f in the good fa ith of the borrower or in h is good sense in the management of h is a f f a ir s ; nor should i t, in to d ay 's complex w orld, do damage to the c a p ita l market from which loans are drawn. More p o s itiv e, and more demanding perhaps, the approach to borrowing by the borrower should be c o n stru c tiv e. (2) The borrowing should not be misconceived or be in c o n siste n t with the purpose for which i t is sought or the o b jectiv es being pursued by the borrow er. More p o s itiv e, the borrower and the lender should both be c le a r about the intended use of the borrowed funds, the aims being pursued by th a t use and the relevance of the one to the o th e r. The borrowing should be able to lead to fu lfilm e n t of the borrow er's aims. (3) The borrow ing, the use to which i t is put and the aims pursued, should not c o n f lic t with the o ther p o lic ie s being pursued by the borrower (and with the e th ic a l standards of the community). The borrower should not work ag ain st him self; he should be c o n siste n t in a l l h is p o lic ie s. The question of con sisten cy is the more im portant the more in tim ately other p o lic ie s are re la te d to debt policy and management; and a v i t a l aspect of co n sisten cy w ill be the assessm ent of the re la tiv e importance of d if f e r e n t p o lic ie s. These co n sid e ra tio n s apply most stro n g ly to the re la tio n between debt policy and monetary p o licy. (4) The borrowing should not be made and used independently of co n sid eratio n of the v ario u s methods av a ila b le to r e a lis e the purpose of the borrowing; or of the choice made between the v arious aims which might be pursued. In sh o rt, the borrowing should conform to a scale of p r i o r i t i e s for the ways in which aims are pursued and for the choice of aims. Governments may take th is m atter to the market place or take i t in hand them selves, but the former may be ill-in fo rm ed and im perfect and the l a t t e r ill-e q u ip p e d. While the need for e sta b lish in g p r i o r it ie s and the a v a il a b il it y of techniques for doing so in many cases should be reco g n ised, so should the lim ita tio n s of those techniques

36 (5) Borrowing should not be fo r the p u rs u it of illu s o r y aims; ra th e r the r e s u lts follow ing from borrowing should be d eterm in ab le. The same c r i t e r i a can be ap p lied to the e v a lu a tio n of public borrowing a f t e r the event but with some changes in emphasis and, as a r e s u l t, more c e r t a in t y. The in form ation a v a ila b le a f t e r the event w ill re f e r to the past and the then present in stead of to the p resen t and i t s fu tu re as when the p ro je c t is yet to be adopted. I n s titu tio n a l Arrangements The e x is te n c e of a fe d e ra l system of government r a is e s q u estio n s about the a p p ro p ria te d iv is io n of r e s p o n s ib i li ty between the v ario u s le v e ls of governm ent. In A u s tr a lia, in the co n te x t of the p resen t d is c u s s io n, should deployment of the n a tio n 's reso u rces be a r e s p o n s ib ility of the Federal Government; o f in d iv id u a l governments w ith in th e ir a re a s of a u th o r ity ; or of a l l governm ents to g eth er? The choice taken has involved jo in t a c tio n under an intergovernm ental agreem ent, the F in a n c ia l Agreement of 1927 as subsequently amended. The o rig in of the F in a n c ia l A greem ent-is g e n e ra lly a ttr ib u te d to a common d e s ire on the p art of A u stra lia n governments to avoid com petition fo r funds between them selves and between the pu b lic and p riv a te s e c to rs ; th e re was a fe e lin g th a t public requirem ents were h in d erin g p riv a te a c t i v i t i e s and th a t the co st of finance was r is in g too much fo r governm ents. At the tim e, debate was conducted on f a i r l y pragm atic li n e s. More re c e n tly, the g en esis of the F in a n c ia l Agreement has received some th e o r e tic a l ju stifica tio n.^ And the Agreement c le a r ly stre n g th e n s the stan d in g of the borrow ers. Subsequently, the Loan Council th a t had been e sta b lish e d as a r e s u lt of the F in an cial Agreement was used to implement a Keynesian type s t a b i l i s a t i o n p o lic y. S ir Robert Menzies w rote of i t : 'In most years in my time as Prime M in iste r, the Loan Council has not purported to decide how much could be borrowed, "at reasonable ra te s and c o n d itio n s. I t has fixed a loan works programme which the Commonwealth has been w illin g to accept and has d is tr ib u te d i t, by agreem ent, among the S ta te s. This new p rocedure, adopted by t a c i t consent w ithout any formal amendment of the F in an cial Agreement.... has given the Commonwealth e f f e c tiv e o v e ra ll c o n tro l of the S ta te s ' works programmes. 'I n s h o r t, the Loan Council tends to become a c e n tra l piece of m achinery in an economic planning concept involving Commonwealth and S ta te s ' c o - o p e r a t i o n.'^ This has been under some s t r a in fo r some tim e. ^ R.E. Wagner, 'O p tim a lity in Local Debt L im ita tio n ' and A. B reton, 'The Theory of Local Government Finance and the Debt R egulation of Local Governments' in B.S. G rew al, G. Brennan and R.L. Mathews ( e d s ), The Economics o f Federalism, ANU P re s s, C anberra, 1980, P art Six. ^ S ir Robert M enzies, C entral Power in the A u stralian Commonwealth, C assell & Co. L td., London, 1967, pp. 105,

37 Attention has tended to be given mainly to totals and not much to distribution. Under the Agreement, distribution of the totals of the agreed programs was to be by unanimous agreement or, failing that, by formula. The formula (which has never been applied) was based on the shares of each State in the total programs in earlier years, while agreement on distribution at Loan Council meetings has been on a State basis, not on a project basis or with much reference to aims or purposes. The outcome of our institutional arrangements has broadly been to award an absolute priority to private investment over public investment at any time of conflict in the last fifty years; and largely to substitute a regional (i.e. State) allocation of funds for consideration of aims, purposes or projects. Indeed, Loan Council procedures provide neither for a market evaluation of borrowing for specific projects nor for any setting of economic priorities in the allocation of funds between governments and projects. The Loan Council should, perhaps, do one or the other - either reduce its role or enlarge it! - 25-

38 I I BORROWING FOR NATIONAL DEVELOPMENT L.A. Hi e l sc h e r Introduction The to p ic on which I h ave been asked to sp e a k, B orrow ing f o r N a tio n a l D e v elo p m en t', is an e x tre m e ly broad one. In d e e d, i t im m ed iately r a i s e s two q u e s tio n s : borrow ing by whom? and what i s m eant by n a ti o n a l developm ent? For the p u rp o ses o f t h i s p a p e r, I have ta k e n borrow ing to be governm ent borro w in g and th u s have made no r e f e r e n c e to b orrow ing by th e p r iv a te s e c to r. At th e same tim e, how ever, I have n ot a tte m p te d to d i s t i n g u i s h betw een borro w in g by the Commonwealth (and i t s a u t h o r i t i e s ) and borrow ing by the S ta te s (and t h e i r a u t h o r i t i e s ). However, th e f a c t o f th e m a tte r i s t h a t th e Commonwealth i s g e n e r a ll y n o t a b o rro w er f o r o th e r th a n economic management r e a s o n s. So f a r as n a tio n a l developm ent i s c o n c e rn e d, I h av e c o n sid e re d t h i s in i t s b ro a d e s t sense and have n o t lim i te d i t m ere ly to th e p r o v is io n o f i n d u s t r i a l i n f r a s t r u c t u r e. I h av e done t h i s b ecau se I c o n s id e r t h a t both s o c ia l and i n d u s t r i a l i n f r a s t r u c t u r e a re i n t e g r a l com ponents o f n a tio n a l developm ent and must proceed hand in hand in a b a la n ce d fa s h io n i f a l l s e c tio n s o f th e n a tio n a re to b e n e f i t from d ev elo p m en t. I h a v e, how ever, d iv id e d i n d u s t r i a l i n f r a s t r u c t u r e in to two s u b - c a te g o r ie s : (1 ) G eneral i n d u s t r i a l i n f r a s t r u c t u r e, w hich i s m eant to cover the p r o v is io n of t h a t type o f i n d u s t r i a l i n f r a s t r u c t u r e fo r which i t is not p o s s ib le or p r a c t ic a b le to le v y a d i r e c t c h a rg e based on u sa g e. Roads e x p e n d itu r e, o r a t l e a s t a p r o p o r tio n o f ro ad s e x p e n d itu re, i s an exam ple o f t h i s. ( 2 ) Commercial i n d u s t r i a l i n f r a s t r u c t u r e, which r e l a t e s to i n f r a s t r u c t u r e more d i r e c t l y a s s o c ia te d w ith p r i v a t e s e c to r u s e r s and f o r which d i r e c t u s e r c h a rg e s a re l e v i e d. Examples o f t h i s in c lu d e th e p r o v is io n o f f a c i l i t i e s and s e r v ic e s in the f i e l d s of e l e c t r i c i t y, r a ilw a y s ( o r a t l e a s t p o r tio n of r a ilw a y s ), and p o r ts and h a rb o u rs. In each o f th e s e f i e l d s, g overnm ents g e n e r a ll y a tte m p t to re c o v e r c o s t s th ro u g h u s e r c h a rg e s an d, d e p en d in g on in d iv i d u a l governm ent p h ilo s o p h y, to g e n e r a te s u r p lu s e s. S o c ia l i n f r a s t r u c t u r e, o f c o u r s e, c o v e rs th e p r o v is io n o f f a c i l i t i e s and s e r v ic e s in s c h o o ls, h o s p i t a l s, w e lfa re s e r v ic e s and th e l i k e. Why Should Governments Be Involved? P erh a p s th e m ost fu n d am en tal q u e s tio n t h a t can be r a is e d i s why should governm ents be in v o lv e d in th e p r o v is io n o f i n f r a s t r u c t u r e? So f a r as th e p r o v is io n o f s o c i a l i n f r a s t r u c t u r e i s c o n c e rn e d, th e r e i s l i t t l e d isa g ree m e n t today w ith the p r o p o s itio n t h a t governm ents should p ro v id e th e n e c e s s a ry f a c i l i t i e s. T h is would n o t, o f c o u r s e, have been the case in the l a s t c e n tu ry b u t w ith th e grow th o f th e w e lfa re s t a t e th e r e i s now l i t t l e d i s p u t e. Even p ro p o n e n ts o f s m a lle r governm ent c o n c e n tr a te on th e quantum of governm ent e x p e n d itu re in t h i s a re a and n o t on w h eth er governm ent should be in v o lv e d

39 Furthermore, government involvement enables there to be a more equitable distribution of social infrastructure throughout the nation than would be the case if it were provided in an alternative manner, for example by private individuals themselves or by the private sector generally. The situation with respect to general industrial infrastructure is, I suggest, not significantly different from that with respect to social infrastructure. Because of the nature of the infrastructure involved, it is not practicable for it to be provided other than by government - at least not in an equitable and efficient manner. However, the situation with respect to the provision by government of commercial industrial infrastructure is much less clear cut and views about the role of government are far from unanimous. Indeed, the questions can rightly be asked as to why governments should be involved in the provision of infrastructure which directly benefits the private sector and why the private sector itself should not be required to provide this infrastructure direc tly? Indeed, if the infrastructure involved will benefit only a single user or a limited number of known users, then I suggest that, as a general rule, government should not provide it. However, when the infrastructure will be used by a large number of users, it is impracticable for the users themselves to attempt to provide the facilities. This is especially the case when the infrastructure will benefit future users as well. The government's role in these situations is to provide the facilities and to regulate and co-ordinate their use on an equitable basis, while at the same time ensuring that each user pays an appropriate charge for use. There are also instances where, although it may be possible for the private sector to provide the facilities, the government needs to be involved to ensure that the facilities are used in the most efficient and equitable manner so as to maximise the benefits accruing from them. If private enterprise is left to provide major multi-user facilities, then I suggest that it is quite likely that the facilities will not be provided or will be provided in an inefficient and inequitable manner, so that economic growth will suffer. To give a practical example of what I have been saying, the situation with regard to the mining industry in Queensland is that, if industrial infrastructure can be attributed to a single user, then the State will generally require that user to meet the cost of providing it, usually through what is known as a 'security deposit' arrangement. Accordingly, each mining company is required to meet the full cost of the railway facilities (i.e. trackwork, signalling and rolling stock) necessary to convey the mineral to the port. This is, of course, in addition to the costs of the mine itself, the township and the associated community infrastructure which must be met by the mining company. However, at the port it is not economic for each company to establish its own loading facilities and there is therefore a number of users each wanting part use of a single loading facility. Furthermore, there is a need to ensure that future users will have equitable use of the facility. In such circumstances the government will fund the offshore loading facility and then recover the costs through user agreements with the mining companies. The mining companies themselves are required to provide the necessary onshore loading facilities as these are discrete facilities which relate separately to their own exports. In other words, the miners directly fund the industrial infrastructure which is clearly attributable to them while the government funds the joint or multi-user infrastructure and then recovers the cost through user charges

40 Why Borrow? I f we accept th a t governments do have a genuine ro le in the p rovision of in d u s tr ia l in f r a s tr u c tu r e, the q u estion then a r is e s as to why th is expenditure should be funded by way of borrow ing. In considering t h i s, I have adopted a wider than normal d e f in itio n of borrowing. In th is regard, d ir e c t borrowing is but one means of funding the pro v isio n of in f ra s tru c tu re over tim e. Other means of funding include commercial b u y e r/su p p lie r c r e d i ts, export c r e d i ts, leasin g and the l i k e. However, w h ilst they may d if f e r in form, th e ir o b jectiv e is the same: to spread the co st of providing the in f ra s tru c tu re over a number of y e a rs. R eferences to borrowing should th e re fo re be read as referen ces to a l l means of spreading co st over time through the use of fin an ce. In my view, th ere are th ree m ajor reasons why in d u s tr ia l in f ra s tru c tu re should be funded by way of borrowing: (1) E q u ity. This demands th a t f a c i l i t i e s which w ill be used in the futu re and which w ill g en erate economic b e n e fits over time should be paid for over th e ir l i f e and th a t cu rren t users should not be req u ired to pay the f u l l cost of them now, as would be the case i f the f a c i l i t i e s were not funded by way of borrowing. (2) M aximisation o f economic o p p o r tu n itie s. Economic o p p o rtu n itie s such as we p re se n tly have with resp ect to the development of our n a tu ra l reso u rces may w ell be lim ite d in time. By th is I mean th a t there is no c e rta in ty th a t the o p p o rtu n itie s which are p re s e n tly before us w ith re s p e c t to the development of our n a tu ra l reso u rces w ill always be th e re. Indeed, i f we are slow in grasping our o p p o rtu n itie s, then they may w ell not recu r as o th e r co u n trie s w ill quickly move to f i l l the void. In th is re g a rd, Canada and the United S tates are already a g g ressiv ely seeking new coal export m arkets in com petition w ith A u s tra lia, p a r tic u la r ly in Japan and Europe, while c o u n trie s such as Indonesia and B razil are seeking increased usage of th e ir cheap h y d ro -e le c tric power, p a rtic u la rly in the area of aluminium sm elting. If we w ait u n til we are ab le to finance f a c i l i t i e s from re c u rre n t revenues, i t is q u ite p o ssib le th a t the o p p o rtu n itie s w ill have passed us by. v (3) Improvement in our standard o f liv in g. Borrowing enables us to provide the necessary in f r a s tr u c tu r e more quickly than would otherw ise be the c a se. This then enables us to develop our economic p o te n tia l more q uickly and th e re fo re to increase our standard of liv in g e a r l i e r and to a g re a te r ex te n t than we would otherw ise be able to. The a lte r n a tiv e to borrow ing, i f we are to finance the same amount of ex p en d itu re, is e ith e r to in crease charges and ta x a tio n or to p rin t money. N either of these a lte r n a tiv e s is a c c e p ta b le. In so far as increased charges and taxes are concerned, the in c re a se s th a t would be req u ired make i t im possible to consider th is as a v ia b le a lt e r n a t iv e. This is e s p e c ia lly the case in view of the m assive in c re a se s in c a p ita l expenditure th a t are n ecessary i f we are to c a p ita lis e on the resource development p o te n tia l of our country at th is tim e. In th is reg ard, in the area of e l e c t r i c i t y a lo n e, ex penditure of some $7 b il li o n is planned in Queensland over the next decade to meet the a n tic ip a te d growth in demand, which is expected to tr e b le over the p eriod. Approxim ately one-h alf of th is in crease r e l a te s to major bulk u s e rs, many of - 29-

41 whom are not present users. With respect to coal development in Queensland, whereas we presently have one export coal facility capable of handling the new generation of 150,000 to 200,000 tonne coal ships, by 1985 we will have four such facilities, at an estimated cost of the order of $350 million. Again, many of the companies which will use these facilities are presently not involved in the export of coal from Queensland. In the above situations, not only would the increases in charges or taxation be far too massive to contemplate, but they would also result in the clearly inequitable situation of current consumers being required to finance the provision of infrastructure which has as its main aim the servicing of the future requirements of future users. Finally, in the private sector borrowing is the generally accepted form of funding capital expansion. There is no reason why governments should not adopt a similar strategy. How Much Should Be Borrowed By Governments? This is a matter which is the subject of much debate. Indeed, I believe that there is a general view held that governments (and particularly State governments) are borrowing too much and are taking up too much of the nation's scarce capital funds. However, as I will outline in the following paragraphs, this concern about the level of government borrowing is ill considered. In this regard, much of the concern stems from the fact that visible State borrowing (i.e. direct borrowing by State semi-government authorities) has increased in recent years, from 1.4 per cent of Gross Domestic Product (GDP) in to 1.9 per cent of GDP in However, during the same period direct borrowing by the Commonwealth on behalf of State loan programs diminished significantly as a percentage of GDP from 3.2 per cent to 1.0 per cent. This fact has tended to be overlooked as this borrowing is subsumed within the Commonwealth's overall borrowing, which is mainly undertaken for economic management purposes. Overall, the situation is that direct borrowing by or on behalf of the States has decreased over the past two decades as indicated in Table II-l (see also Appendix Table II-A). Table II-l SELECTED STATE BORROWING AS PERCENTAGE OF GROSS DOMESTIC PRODUCT Five-Year Period Borrowing by Larger and Smaller Authorities (Including Infrastructure) Borrowing on Behalf of States Capital Programs (Including) Capital Grant) Total Borrowing % % %

42 At the same tim e, however, to t a l government fixed c a p ita l expenditure as a percentage of to ta l fixed c a p ita l expenditure has tended to remain f a i r ly co n stan t as in d icated in Table II-2 (see also Appendix Table I I - B ). Table II-2 PUBLIC FIXED CAPITAL EXPENDITURE AS PERCENTAGE OF TOTAL FIXED CAPITAL EXPENDITURE * * This fig u re is in f la te d by abnormal fig u re s in the y ears to From , annual fig u res re tu rn to the range per c e n t. % In o ther words, the government c a ll on n a tio n a l reso u rces fo r c a p ita l expenditure has remained broadly in accord w ith th a t by the p riv a te se c to r. O v e ra ll, the fa c t of the m atter is th a t governments are now funding a g re a te r p ro p o rtio n of th e ir expenditures by means o th er than d ir e c t borrowing than was the case p rev io u sly. W hilst th is may be p a rtly caused by financing tra n sa c tio n s o th er than d ir e c t borrowing (le a s in g, b u y e r/su p p lie r c r e d its and the l i k e ), a s ig n if ic a n t cause of th is is no doubt the fa c t th a t governments are in c re a sin g ly financing c a p ita l expenditure from re c u rre n t sources. In th is regard the Queensland Government has been providing s ig n ific a n t funds for c a p ita l expenditure from re c u rre n t sources since , when $69 m illio n was provided. In , the amount is estim ated to be at le a s t $150 m illio n. Furtherm ore, in the e l e c t r i c i t y in d u stry 25 per cent of r e t a i l t a r i f f s is se t asid e to meet c a p ita l expenditure w ithin the in d u stry ; in th is is estim ated to generate approxim ately $130 m illio n. These g en eral tre n d s have re s u lte d in a d eclin e in the percentage of to ta l public c a p ita l expenditure in A u stra lia th a t is funded by way of d ir e c t borrow ing, as in d ic a te d in Table II-3 (see also Appendix Table I I - C ). While I have in d icated th a t the o v erall in tru s io n of government in to the c a p ita l area is not grow ing, I am not n e c e s s a rily suggesting th a t the cu rren t le v e l of government expenditure (o r borrowing) is a p p ro p ria te. Because of the involvement of government in the pro v isio n of so c ia l in f r a s tr u c tu r e (and to a le s s e r e x te n t, because of the involvement of government in the p ro v isio n of gen eral in d u s tr ia l in f ra s tru c tu re ) the ap p ro p riate le v e l of government borrowing is a m atter of p o li ti c a l judgment. In th is re g a rd, the amount which governments should borrow i s not a m atter which can be considered in is o la tio n. I t depends, among o th er th in g s, on the macro-economic judgment of government as to the maximum amount of borrowing (both public and p riv a te ) which the o v e ra ll economy can s u s ta in. This is b a s ic a lly a fu n ctio n o f, in te r a lia, the le v e l of re a l resources in the economy and the source of finance of the c a p ita l expenditure ( i. e. whether i t is overseas or n o t). However, in determ ining the maximum le v e l of borrowing which the economy can s u s ta in, i t is im portant not to place too much emphasis on the p o te n tia l - 31-

43 Table II-3 GOVERNMENT NEW MONEY BORROWING^a) AS PERCENTAGE OF PUBLIC GROSS FIXED CAPITAL EXPENDITURE Note: (a) Total borrowing by and on behalf of the States and their authorities has been used as an indicator of total government new money borrowing, because it is not possible to estimate Commonwealth borrowing for capital purposes as this is subsumed within Commonwealth borrowing for economic management purposes. % negative effects, particularly on short-term problems. Indeed, what is needed is for governments to be forward thinking and to take a more entrepreneurial approach to the provision of public sector infrastructure. There is no doubt that short-term problems in the economy will occur as we attempt to grasp the many and varied opportunities that are available to us at this time. However, the potential benefits in terms of job opportunities, value added and the like are enormous and I fear that we are presently pursuing a strategy which attempts to minimise the short-term consequences rather than maximise the long-term benefits. Commercial industrial infrastructure provided by government is generally complementary to private sector capital expenditure. Accordingly, I believe that it should be regarded as such and should be subject to no greater degree of central control than is seen as necessary for the overall economy. Unfortunately, this is not the view held in certain areas where a clear distinction is drawn between government and private commercial industrial infrastructure, as if they were substitutes for each other. As a result, we have the situation where private sector capital expenditure has continued at a pace and has in fact been encouraged, while severe restrictions have been placed on the provision of funds for government commercial industrial infrastructure projects directly supportive of the private sector developments. This attitude appears to stem from a lack of conceptual differentiation between social and general industrial infrastructure and commercial industrial infrastructure provided by governments. At the same time, social and general industrial infrastructure needs cannot be ignored, as there is little sense in pursuing the provision of commercial industrial infrastructure and private sector capital expenditure to the maximum if it means that there are no funds left for the provision of other infrastructure needs. What is needed, therefore, is an appropriate balance between social and general industrial infrastructure on the one hand and commercial industrial infrastructure and private sector capital expenditure on the other

44 Who Should C ontrol The Amounts Borrowed? At p re se n t, the Loan Council attem p ts to c o n tro l government borrowing for a l l c a te g o rie s of in f r a s tr u c tu r e - s o c i a l, gen eral in d u s tr ia l and commercial in d u s tr ia l i n f r a s t r u c t u r e. So fa r as s o c ia l and g en eral in d u s tr ia l in f r a s tr u c tu r e is concerned, i t is an undeniable fa c t t h a t, provided the debt burden does not become too g re a t (and we are not y et in th a t s i t u a t i o n ), governments have an in s a tia b le a p p e tite fo r borrowing for such ex p en d itu res. Furtherm ore, the very nature of the ex p en d itu re makes i t d i f f i c u l t to a llo c a te i t as between S ta te s on o th er than the b ro ad est c r i t e r i a. I t is thus d i f f i c u l t to m eaningfully rank in p r i o r it y borrowing of $1 m illio n fo r a new w ater supply scheme in an outback Queensland town and borrowing of $1 m illio n for sewerage expenditure in suburban Sydney. There is th e re fo re a need for a n a tio n a l co -o rd in a tin g body which can determ ine an o v e ra ll le v e l o f borrowing for so c ia l in f r a s tr u c tu r e and general in d u s tr ia l i n f r a s t r u c t u r e, which i s c o n s is te n t w ith n a tio n a l economic goals and o b je c tiv e s, and then a llo c a te th is amount between the S ta te s on a broadly e q u ita b le b a s is (w hich, o f co u rse, need not be the same fo r the two d if f e r e n t types of in f r a s t r u c t u r e ). Indeed, th is is what the Loan Council attem pts to do. U n fo rtu n a te ly, w h ils t i t may be su ccessfu l in determ ining the aggregate amount of borrowing (and th i s is d eb ata b le), i t i s c le a r th a t i t f a l l s w ell sh o rt of a llo c a tin g the funds on an e q u ita b le b a s is. In th is re g a rd, the p ro p o rtio n ate a llo c a tio n s to the v ario u s S ta te s have remained broadly unchanged over the y e a rs, d e s p ite s ig n if ic a n tly d if f e r e n t population and in d u s tr ia l growth r a t e s. So fa r as commercial in d u s tr i a l in f r a s tr u c tu r e is concerned, the s itu a tio n i s, I b e lie v e, q u ite d if f e r e n t. As I have pointed out e a r l i e r, such in f r a s tr u c tu r e is g e n e ra lly complementary to and not a s u b s titu te for p riv a te se c to r c a p ita l in v estm ent, and is only provided when the demand is c le a r ly th e r e. In p a r t i c u l a r, i t can be d if f e r e n tia te d from general in d u s tr ia l in f r a s tr u c tu r e in th a t i t is u su a lly p ro je c t s p e c ific. In a d d itio n, government charges fo r the p ro v isio n of such in f r a s tr u c tu r e are an in te g ra l p art of the c o s t-b e n e fit analyses undertaken by the p riv a te secto r in determ ining whether the p ro je c ts w ill proceed. A ccordingly, th ere is no need fo r c e n tr a l c o n tro l over the le v e l of government borrowings for commercial in d u s tr ia l i n f r a s t r u c t u r e, as th is w ill be e f f e c tiv e ly c o n tro lle d by the m arket. If the p riv a te secto r p ro je c t goes ahead, then the public secto r commercial in d u s tr ia l in f r a s tr u c tu r e must proceed a ls o. I t is not p o ssib le to have one w ithout the o th e r. Furtherm ore, c o n tra ry to a view which appears to pervade in c e rta in a re a s, governm ents g e n e ra lly do not provide commercial in f ra s tru c tu re ahead of req u irem en ts. Indeed, governments w ill u su a lly not proceed u n til firm take or pay arrangem ents have been entered in to for the use of the f a c i l i t i e s a f t e r they have been c o n s tru c te d. However, i t must be accepted th a t a t tim es there w ill be tim ing d if fe re n c e s in the d e c isio n s to be taken by governments and by the p riv a te s e c to r. A c le a r example of th is is th a t i t tak es approxim ately seven years to b uild a power s ta tio n but only th ree years to c o n stru c t an aluminium sm elter. A ccordingly, p riv a te e n te r p ris e is u n w illing to give firm commitments u n til an investm ent d e c is io n has been made, w hile government must take i t s d e c isio n some y ears e a r l i e r i f i t is to have adequate g en eratin g cap acity on stream when p riv a te e n te r p ris e re q u ire s i t. In th is re g a rd, i t is o ften n ecessary fo r the government se c to r to take a somewhat e n tre p re n e u ria l approach and to proceed w ith i t s p ro je c ts in a n tic ip a tio n of the p riv a te se c to r development also proceeding. At the same tim e, however, w h ilst i n i t i a l ex p enditure must be incurred ahead of p riv a te secto r commitments, - 33-

45 major expenditure commitments are not entered into unless the demand for the use of a f a c i l i t y is firm. What Should Be the Source o f Borrowing? If the funds are a v a ila b le, A u stralian d o lla r s are c le a rly p re fe ra b le as a borrowing currency. However, the a v a il a b il it y of funds in A u stra lia f a l ls well short of th a t n ecessary to develop A u stra lia to i t s f u l l p o te n tia l. In th is reg ard, A u stra lia i s a reso u rces ric h and, r e l a ti v e ly, c a p ita l poor country. A ccordingly, recourse must be had to offsh o re sources of funds, which bring w ith them the r is k of currency lo s s e s (and g a in s ). As would be the case w ith any prudent borrow er, governments must attem pt to minimise these ris k s and there is a v a rie ty of ways in which th is can be done. These include: (1) Back-to-back hedge arrangem ents w ith A u stralian ex p o rters ( e ith e r d ir e c t or through an interm ediary such as a bank). (2) Borrowing in a basket of c u rre n c ie s. In th is reg ard, as the A u stra lia n d o lla r i t s e l f flu c tu a te s in accordance with movements in a trade-w eighted basket of c u rre n c ie s, when borrowing is made in accordance w ith th a t basket then exchange ra te gains or lo s s e s can be m inim ised. O v erall, i t is e s s e n tia l th a t government borrowers pursue a r is k avoidance s tra te g y, ra th e r than one of p r o f it m axim isation. This is because the c o ro lla ry of p r o f it m axim isation is p o te n tia l lo s s m axim isation. However, notw ithstanding the ris k s inv olved, government borrowers should not shy away from the need to ra is e o ffsh o re deb t. As I in dicated e a r l i e r, w h ilst th ere are r i s k s, the rew ards from the development of our reso u rces are p o te n tia lly g re a t and one can dw ell too much on the r is k s. Furtherm ore, the h is to r y of A u stralian p riv a te se c to r development is th a t i t has been funded to a s ig n ific a n t ex ten t by o ffsh o re c a p ita l inflow and there is no reason why government in f r a s tr u c tu r e should not be funded in the same manner. Conclusion 1 b e lie v e th a t s u b s ta n tia l government borrowing for n atio n al development is e s s e n tia l i f we are to maximise the b e n e fits to A u stralian so c ie ty th a t can flow from the f u l l development of our reso u rces. There i s, however, a need to ensure th a t a p p ro p ria te mechanisms e x is t fo r c o n tro llin g the le v e l of th is borrowing. In th is re g a rd, I b eliev e th a t i t is e s s e n tia l th a t so c ia l and g en eral in d u s tr ia l in f r a s tr u c tu r e be tre a te d d if f e r e n tly from commercial in d u s tr ia l i n f r a s t u r c t u r e. With re sp e c t to the form er, th ere is a need fo r a n atio n al c o -o rd in atin g body such as the Loan C ouncil. However, in the d ischarge of i t s co n tro l function i t is e s s e n tia l th a t th is body give f u l l weight to the s u b s ta n tia l long-term b e n e fits th a t flow from the expenditure of a government c a p ita l d o lla r now and not confine i t s m easures to the probable short-term d is b e n e fits based on th is y e a r 's economic model. There is a real need also fo r, f i r s t, an updating of the d is tr ib u tio n a l ro le of th is c o n tro l body, and then for g re a te r f l e x i b i l i t y in i t s d e c is io n s. In so far as commercial in d u s tr ia l in f r a s tr u c tu r e is concerned, I b eliev e th a t there is a c le a r case for excluding th is segment of government c a p ita l expenditure from the su rv e illa n c e of the Loan Council and for allow ing i t in stead to be determ ined by the m arket, in the same way as the p riv a te secto r c a p ita l expenditure th a t i t supplem ents. 34

46 Appendix T ab le I I -A SELECTED STATE BORROWING, TO Year GDP (A t C urrent P ric e s ) (1) B orrow ings b y la r g e r and S n a ile r A u th o r itie s (2) (2 ) (1 ) (3) S ta te lo a n A llo c a tio n s (In c lu d in g ) C a p ita l G ran ts) (4) (4 ) (1) (5) (2 ) + (4 ) (6) (6 ) (1) (7) $ m $ m % $ m % $ m % , , , , , y rs ,878 1, , , , , , , , , , , y rs ,493 2, , , ,650 4 % , , , , , , , , , , y rs ,951 3, , , ,492 1, , , ,048 1, , , ,%7 1, , , ,081 1, , , ,037 2, , , y rs ,605 7, , , Source: A u s tra lia n Bureau o f S t a t i s t i c s, Australian National- Axxnrvts, C a n b erra, v a rio u s y e a rs ; Cannon w e a lth Budget Ih p e r No. 7, RiynsTts to or for the S tates..., A u s tra lia n Government P u b lish in g S e rv ic e, C an b erra, v a rio u s y e a rs

47 Appendix Table II-B PUBLIC FIXED CAPITAL EXPENDITURE AS PERCENTAGE OF TOTAL FIXED CAPITAL EXPENDITURE Year Public Gross Total Fixed Fixed Capital Capital (2) Expenditure Expenditure (1) (1) (2) $ m $ m % ,256 3, ,402 3, ,443 4, ,595 4, ,861 5, years ,557 21, ,052 5, ,171 5, ,356 6, ,524 7, ,744 7, years ,847 33, ,920 8, ,285 9, ,455 10, ,962 11, ,606 14, years ,228 54, ,398 16, ,136 18, ,944 20, ,222 22, ,080 25, years , , ,786 31, Source: Australian Bureau of Statistics, Australian National Accounts, Canberra, various years

48 Appendix Table II-C COVERNMENT BORROWING AS PERCENTAGE OF PUBLIC GROSS FIXED CAPITAL EXPENDITURE Year Government Public Fixed Borrowing Capital (1) Expenditure (2) (1) (2) $ m $ m % , , , , , years , , , , , , , , , , years , , , , , , , , , , , , years , , , , , , , , , , , , years , , S o u r c e : (1) Commonwealth Budget Paper No. 7, P a y m e n ts t o o r f o r t h e S t a t e s..., A ustralian Government Publishing Service, Canberra various years. (2) Australian Bureau of S ta tis tic s, A u s t r a l i a n N a t i o n a l A c c o u n ts Canberra, various years

49 I l l GOVERNMENT BORROWING AND OFFICIAL ARRANGEMENTS FROM THE VIEWPOINT OF STATUTORY AUTHORITIES R.E. Hurley* In trodu ction In h is p a p e r, Mr S c o tt has provided us w ith a u s e fu l a n a ly s is of the developm ent of economic th eo ry and i t s re le v an c e to borrow ing by the p u b lic s e c to r from the days of R icardo to the p re se n t tim e of Hayek, Friedman and o th e r s. From t h is he has e s ta b lis h e d a l i s t of c r i t e r i a fo r governm ental b o rrow ing. I summarise th ese as fo llo w s: (1) The approach to borrow ing by the borrow er should be cons t r u c t i v e. (2 ) The borrow er and the le n d e r should both be c le a r about the in ten d ed use of the funds borrow ed, the aims being pursued by th a t use and the re le v an c e of one to th e o th e r. (3) The borrow er should be c o n s is te n t in a l l h is p o l ic i e s. (4 ) The borrow ing should conform to a sc a le of p r i o r i t i e s fo r the ways in which aims a re pursued and fo r the ch o ice of aim s. I would n ot s e r io u s ly argue w ith th ese c r i t e r i a. I t is i n te r e s t in g to c o n sid e r how each o f the s e c to r s o f government borrow ing match up to th ese c r i t e r i a. You w ill a l l make your own judgm ents. Problems o f Financial Planning in S ta tu to ry A uthority Business Undertakings B efore c o n sid e rin g what changes could be made to the p re se n t arra n g e m e n ts, I propose to make some g e n e ra l comments on the problem s which s t a t u t o r y a u t h o r i t i e s o p e ra tin g as b u sin e ss u n d e rta k in g s face in d ev elo p in g and c a rry in g o ut t h e i r f in a n c ia l plan s in the environm ent of c o n tr o ls by th e Loan C o u n c il. I should add th a t my d is c u s s io n must be la r g e ly based on the c irc u m sta n c e s r e la ti n g to the S ta te E l e c t r i c i t y Commission of V ic to ria (SECV). However, I su sp e c t th a t th e p r i n c i p l e s involved r e l a t e to any c a p i t a l in te n s iv e s t a tu t o r y a u th o r ity u n d e rta k in g b u sin e ss a c t i v i t i e s, d if f e r e n c e s b eing o n ly in the degree o f em phasis. Q uite o b v io u sly the SECV f a l l s w ith in the c a te g o ry of comm ercial i n d u s t r i a l i n f r a s tr u c tu r e as d e fin e d by Mr H ie ls c h e r. In V ic to r ia more th an 90 per cen t of the S t a t e s f o s s i l fu e l re so u rc e s is in the form of brown c o a l. As in the p a s t, the m ajor p art of the power developm ent in the S ta te must be based on the u t i l i s a t i o n o f t h is re s o u rc e, a t l e a s t fo r the next two d e cad es. Due to i t s hig h m o istu re c o n te n t and low c a l o r i f i c v a lu e, p r o je c ts based on th is re so u rc e must be on a la rg e s c a le so as to ach iev e econom ies of sc a le and en su re th a t they are econom ic. F o rtu n a te ly the p h y sic a l c h a r a c t e r i s t i c s o f the d e p o s its a re such as to The view s e x p ressed in t h is paper a re n ot n e c e s s a r ily the views o f the S ta te E l e c t r i c i t y Commission of V ic to ria or fo r th a t m a tte r the S ta te of Vic t o r i a

50 permit large-scale operations. Outputs in excess of 100,000 tonnes a day have already become commonplace. These factors lead to long-term plans which involve projects with long lead times. A major brown coal power project has about a ten-year lead time from the point of making the initial decision to the time the first unit commences production. The further development of the project to its ultimate completion could take a further ten years. As a consequence, the process involves making significant financial commitments many years ahead. Herein lies the major problem facing such statutory authorities in their financial planning. This is the incompatibility of having to make long-term decisions involving major financial outlays and of having access to the major source of external funds constrained by annual decisions through the operations of the Australian Loan Council and the Gentlemen's Agreement. It may be argued that long-term plans do not necessarily involve entering into contractual financial commitments with such a long lead time. This is partly true. However, those who advance this thought are implying that the entering into contractual commitments can be subject to significant shortterm manipulation to match unforeseen variations in the availability of funds. Such an approach may be adopted in a housing estate development. However, a major power development is a complex and highly integrated project. Each component is dependent on the completion of others. A missing link will render the whole project useless. Likewise any significant slowing down of progress of a project will result in significant penalties which, other than in times of crisis, will be financially and politically unacceptable. It should also be noted that some contracts can involve long time spans. For example, in the case of SECV Loy Yang power development, some contracts will have a nine-year life from the time of the first financial commitment to the completion of the contract. On the other hand, it may be contended that it should be possible to assume, with a reasonable degree of certainty, the likely level of new borrowing approvals that will be approved by the Loan Council. Unfortunately the experience of history does not provide that confidence. The level of new loan authority for the SECV has varied from 30 per cent to 48 per cent of the Commission's capital works program over the last nine years. There is no consistent trend. There have been periods of no change along with periods of significant change. In earlier years, loan authority was significantly supplemented by advances from the State Government of Victoria. This only increased the variability, with a range of 34 per cent to 65 per cent of the capital works program when loan authority and advances from the State Government of Victoria are combined. Short-term political and economic considerations appear to have had higher priority in the Loan Council considerations than the long-term funding needs of statutory authorities. I am not saying this should not be so. In fact I would on balance support their dominance. The question really is whether or not statutory authority business undertakings should be part of the Loan Council determinations. Mr Hielscher makes a strong case that they should not be. I address this question later. To add further to the financial management problems of such statutory authorities, the annual decisions of the Loan Council are barely made before the commencement of the financial year. By this time the level of activity on new capital programs for the ensuing year is virtually committed. It can only be significantly varied with penalties which lead to serious inefficiencies in the carrying out of projects. In addition to this late determination of the annual borrowing approvals, the timing of access to the capital markets is also controlled. While I appreciate that large industrial organisations in the private sector may have many problems not faced by - 40-

51 statutory authorities, I doubt whether they would exchange them for the constraints imposed on public enterprise. Despite the foregoing comments, it should be acknowledged that this unique system of Commonwealth-State financial relationships has, in an overall sense, served Australia well. We can readily bring to mind instances where the system has helped to prevent what some have regarded as imprudent financial actions from taking place. Whether statutory authorities have benefited is another question. However, history also shows that arbitrary rules and gentlemen s agreements often break down in times of pressure. Is this what we have been witnessing over recent years? The initiatives of State governments and statutory authorities in such areas as trade credit suggest this. Dare I also mention leverage leasing? Perhaps we have come to a time when what some may describe as Commonwealth paternalism should come to an end. Comparison with Private Enterprise Many of the problems facing statutory authorities have been referred to in my previous comments. However, let us compare the situation of an organisation in the private sector with that of a staturoty authority to emphasise the point. The Financial Manager of an industrial/commercial enterprise will base his financial strategy on several factors. He will establish capital structure objectives appropriate to his particular line of business. Market conditions and trends will be analysed and related to these objectives. Desirable debt maturities compatible with the assets of the business will also be considered. Cash flow needs will be determined. From these an appropriate financial plan and strategy will be developed, properly responding to the signals of the market and in turn signalling to the market, all aiding the healthy development of the economy and financial markets. This activity is also influenced by initiatives taken by the authorities in the area of taxation, exchange management, tariffs, etc. Many of these are also proper responses by the authorities to market and economic conditions as well as being motivated by political and social objectives. The end result, however, is a strategy which is predominantly marketoriented and which covers a time span appropriate to the particular business. The Financial Manager of a statutory authority will undertake a similar exercise. However, he is far less likely to be able to implement a strategy as close to the optimum as that of his counterpart in the private sector. The constraints that exist significantly limit his ability to achieve a desirable capital structure, readily respond to financial market forces, enter into debt obligations that are compatible with the assets of the authority, meet cash flow needs and develop a strategy covering a desirable time span. The statutory authority Financial Manager will find that the amount of debt he may obtain is limited by annual decisions made well after the authority has physical plans in place. There is no certainty as to future years. Offshore Funding and Infrastructure Financing Prior to the mid-1970s, the statutory authorities of the States had had little exposure to offshore funding. What little activity there was generally related to trade credit financing. As their need for funds started to increase rapidly in the second half of the 1970s, the normal loan authority approvals of the Loan Council were becoming totally inadequate. Some authorities, and my organisation was one of them, looked for other avenues for obtaining funds. They realised that the then guidelines - 41-

52 regarding trade credit financing could be exploited to a far greater degree than they had previously. Several significantly large contracts were financed on this basis with offshore funds. The Loan Council realised that this could lead to a significant weakening of control over borrowing by statutory authorities. This led to the establishment of the infrastructure concept and offshore funding of trade credit was restricted to the offshore content of contracts. Future students of political history may conclude that this move represented a significant stage in Commonwealth-State financial relationships. At about this time, Commonwealth leaders publicly encouraged the States to develop energy-related projects and offered support for their funding under the infrastructure concept. This has resulted in the Commonwealth and the Loan Council becoming more closely involved in decision making relating to specific projects of each State. Whether this is a good or bad thing has been and will continue to be debated. In the event the States responded enthusiastically to the Commonwealth invitation. Unfortunately, subsequent events have overtaken the situation. What was at one time an atmosphere of euphoria has now become one of concern, because the political, economic and financial problems associated with these projects have placed considerable burdens on the States. So much for a brief background comment on recent events which have resulted in statutory authorities becoming more involved in offshore capital markets. Constraints on Statutory Authority Borrowing At this stage it is useful to remind ourselves of the major constraints on borrowing by statutory authorities (in addition to the absolute limit on annual borrowing). They are: (a) (b) (c) (d) (e) (f) no more than two-thirds of the total new and renewal borrowing authority can be raised in the first half of the financial year; generally no more than 50 per cent of the infrastructure approval can be raised offshore; no more than 25 per cent of the infrastructure approval can be raised offshore in the first half of the financial year; the inability of the domestic market to fund the balance of the infrastructure approval must be demonstrated before approval to go offshore is granted; there are restrictions on what offshore capital markets can be entered; and there is no provision for carry over into the next year. Loan Council controls on interest rates can also be a major problem, when they do not readily respond to market trends. One has to be constantly aware of the timing of both Federal and State elections and the predictions of opinion polls. Placement fees help underwriters to match market yields if coupons are reasonably close to the market. In these circumstances the underwriting of statutory authorities* public loans is in effect a tender system

53 The r e s u lt of these ru le s is th a t the F in an cial Manager of a s ta tu to ry a u th o r ity aims to f i l l h is loan a u th o rity as quickly as p o ss ib le. L it tl e c o n sid e ra tio n can be given as to the rig h t time to approach the m arket. You ju s t hope th a t you are lucky in the draw. You a lso aim to o b tain approval to go o ffsh o re as e a rly as p o ss ib le to avoid an end o f-y ear scram ble. All in a l l t h i s d e sc rib e s a s i tu a t io n th a t h a rd ly meets the c r i t e r i a for e f f i c i e n t governm ental borrowing suggested by Mr S c o tt. The r e s t r i c t i o n as to what o ffsh o re c a p ita l m arkets can be approached f u r th e r in h i b it s e f f i c i e n t f in a n c ia l management. The r e s t r i c t i o n is designed to ensure th a t s ta tu to ry a u th o r itie s o p erate only in m arkets which have no re a d ily a v a ila b le secondary market in which the paper of the a u th o r itie s can be re g u la rly trad ed. I must confess th a t I have never had i t s a t i s f a c t o r i l y explained to me why the paper of a s ta tu to r y a u th o r ity should not be re g u la rly traded on o ffsh o re m arkets. The r e s u lt is th a t finance cannot be obtained as cheaply as by bodies overseas which c a rry out s im ila r fu n ctio n s to those of our s ta tu to r y a u th o r it ie s. I t has a lso led to the development of many in n o v ativ e id eas to h e lp m inim ise the d i s a b i l i t i e s of the r e s t r i c t i o n. These, however, add to the com plexity and the a d m in istra tiv e c o s ts. I t c e r ta in ly has been a growth in d u s try fo r the le g a l p ro fe ssio n. O ther a sp ects of Loan Council req u irem en ts, such as p rio r n o ti f i c a ti o n, are not com patible w ith e f f i c i e n t fin an cin g even in some of the m arkets which meet the 'no secondary m arket' c r i te r io n.. Market o p p o rtu n itie s o fte n req u ire d e c is io n s in a m atter of days and on some o ccasions in h o u rs. The Loan Council approval process cannot be expected to respond in these short time sp an s. Again fin an cin g packages are being devised to h e lp overcome t h i s, but u su a lly at some c o st. The 'Need, fo r Changed I n s titu tio n a l Arrangements The q u estio n now a r is e s as to where we go from here? Mr S cott concludes h is paper w ith the comment th a t the Loan Council should e ith e r reduce i t s ro le or en larg e i t. Some may accuse Mr S cott of being a ty p ic a l econom ist, by having a b et each way, but I th in k t h i s i s being u n ju s t. What he has dem onstrated is th a t the p resen t arrangem ents are u n s a tis f a c to r y and th at th ere is a need for change. He makes the p o in t th a t the c u rre n t i n s t i t u t i o n a l arrangem ents award ab so lu te p r i o r it y to p riv a te investm ent over public investm ent whenever th e re is a c o n f l i c t, and s u b s titu te a r b itr a r y re g io n a l a llo c a tio n s for c o n sid e ra tio n of aim s, purposes or p ro je c ts. I make the o b se rv a tio n here t h a t, to j u s t i f y Loan Council c o n s tra in ts on borrowing by s ta tu to ry a u th o r it ie s on the ground of r e s t r i c t i n g the demands of the s o -c a lle d unproductive public se c to r to make room for the productive p riv a te s e c to r, is h ard ly economic lo g ic. I am not aware th a t the words unproductive and p ro d uctive are synonymous w ith public and p riv a te, p a r t ic u l a r ly as many of the s ta tu to r y a u th o r it ie s could re a d ily be tr a n s fe r re d to the p riv a te se c to r by a p p ro p ria te changes in le g i s l a ti o n. I b e lie v e th a t for the Loan Council to en larg e i t s ro le i t would be n e c e ssa ry to move tow ards more c o n tro l by a c e n tr a lis e d bureaucracy. I t is d o u b tfu l i f such an ero sio n of S tate powers would be p o l i t i c a l l y a ccep tab le. S tate governm ents would have even le s s in c e n tiv e to co n sid er the economic impact of th e i r p o lic ie s. They would have even more scope to blame the Commonwealth Government fo r th e ir d i f f i c u l t i e s. If the concept of federalism is to be promoted i t is necessary for S ta te s to assume more in d iv id u a l r e s p o n s ib i li ty fo r m a tte rs p rim a rily w ith in th e ir own b o rd e rs. Mature government only comes w ith commensurate p o l i t i c a l and economic r e s p o n s ib ility

54 It w ill be obvious by now and probably no su rp rise th a t I, lik e Mr H ie lsc h e r, advocate the removal of sta tu to ry a u th o r itie s undertaking commercial a c t i v i t i e s from the um brella of the Loan Council. This r a is e s the question of what c r i t e r i a or p rin c ip le s determ ine whether or not an a u th o rity is a commercial undertaking for th is purpose. The Campbell Committee in i t s rep o rt re fe rre d to the need for such bodies to be: (a) f i l l i n g a market gap in the most cost e ff e c tiv e way; (b) econom ically v ia b le ; and (c) not causing market in e f fic ie n c ie s or d is to r tio n s as a consequence of unequal com petition. To ensure adherence to these p rin c ip le s, i t w ill be necessary to make le g is la tiv e provision regarding c a p ita l stru c tu re and the desired re tu rn on investm ent. It may also be d e sira b le for the establishm ent of an independent price review body. On the su b ject of p ric in g, i t may be of in te r e s t to note th a t recent stu d ie s in d ic a te th a t the p rice e l a s t i c i t y of e l e c t r i c i t y appears to be clo ser to u n ity than to zero. I think th is is an in d ic a to r th a t e l e c t r i c i t y u t i l i t i e s are in more of a com petitive environment than has previously been imagined. If s ta tu to ry a u th o r itie s carrying out commercial a c t i v i t i e s in accordance with the above p rin c ip le s are removed from Loan Council r e s tr i c ti o n s on borrowing, i t follow s th a t they should also forgo government guaran tees. This would re s u lt in the market fu rth e r re in fo rc in g the need for such a u th o r itie s to exercise fin a n c ia l d is c ip lin e. It is my view th a t i f the foregoing measures were adopted i t would lead to more e ffe c tiv e and e f f ic ie n t fin a n c ia l management by s ta tu to ry a u th o r itie s. Short-term p o litic a l and other influ en ces on th e ir d ecisio n making would be minim ised. The s ta tu to ry a u th o r itie s would be able to adopt fin a n c ia l management s tr a te g ie s more com patible with th e ir role and needs. O verall the community would be b e tte r served

55 IV GOVERNMENT DEBT AND THE CAPITAL MARKET* J.K. Bain In recent years, the dominant trends in the Australian capital market have included the following: (a) Interest rates have moved to historically high levels both in nominal and real terms. (b) The influence of financial trends abroad on domestic financial conditions has strengthened further. (c) Average maturities of borrowings have shortened dramatically both for the government sector and the non-government sector. (d) Government borrowing has been a dominant influence in the capital market. The concern of this paper is with the form and implications of government borrowing. However, the several major trends noted above are closely interrelated; trends in government borrowing need to be considered in this broader setting. Government Borrowing: Some Facts Government debt is issued for several purposes: (a) To enable the government sector to finance its annual deficit. (b) (c) (d) (e) To meet the within-year financing requirement of the government sector. To refinance maturing debt. To maintain an appropriate spread of maturities. As an aid to monetary policy. Figure IV-1 shows the deficits of the government sector (divided into Commonwealth Government and semi-government sectors) over recent years. The main points are these: (a) The borrowing requirement of the Commonwealth Government sector rose very sharply in (to 4.1 per cent of Gross Domestic Product (GDP) from 0.7 per cent in ). It then remained above 3.5 per cent of GDP until , but it has since declined markedly. Some parts of this paper draw on material from a letter sent jointly by The Australian Bank and Bain & Company in 1981 to governments and to the Campbell Committee

56 (b) (c) The borrowing requirem ent of lo c a l and semi-government a u th o r itie s has increased s te a d ily over recen t y ears, from around 1 per cent of GDP in the e a rly 1970s to around 2 per cent today. In a g g reg ate, borrowing by the government se c to r rose from under 2 per cent of GDP in and to 6 per cent in ; i t has since eased m ainly because of the red u ctio n in the d e f i c i t of the Commonwealth Government. The consequence of th i s run of d e f i c i t s is th a t the volume of go ernment s e c u r itie s outstan d in g has increased s i g n if i c a n tl y, as is shown in F.gure IV-2. This fig u re shows o u tstanding debt by the major se c to rs of go ernm ent; a d is tin c tio n is drawn between debt dom iciled in A u stra lia and th a t (om iciled abroad. The main fe a tu re s of th is fig u re a re : (a) Since the advent of the larg e Commonwealth d e f i c i t s in 1974 Commonwealth s e c u r iti e s o u tstanding in A u stra lia have ris e n from $14 b i l li o n to $28 b i l l i o n. (b) (c) With Commonwealth borrowing offsh o re to a s s i s t the balance if payments, Commonwealth debt abroad rose sh arp ly between 197' and O utstanding s e c u r itie s of lo c a l and semi-government borrowe s have increased from $6.5 b i l li o n in 1974 to $19 b il li o n in The average m a tu rity of government debt o u tstan d in g has d eclined sh arp ly in recen t y ears. For the Commonwealth Government, the average m atur.ty of dom estic debt (but excluding T reasury b i l l s ) is shown in Figure IV-3 In 1970 the average m atu rity was 126 months and in 1974 i t was 137 m ontls; i t is now 65 months. The combined e f f e c t of the la rg e d e f i c i t s and of.he shortening in average m a tu ritie s is th a t a very s u b s ta n tia l amount o: debt now m atures each y ear. Table IV-1 looks a t m a tu ritie s over th is and the next year of Commonwealth bonds and of conventional semi-government s e c u r t i e s. The inform ation on government debt o u tstan d in g presented in Figures IV-1 and IV-2 r e l a te s to annual fig u re s. There is also a s u b s ta n tia l swiig in the volume of the s e c u r itie s of the Commonwealth Government w ith in each /e a r. This m ainly r e f le c t s the sharp w ith in -y ear turnaround in the Commonwealth budget. About 80 per cent of p ro v isio n a l taxes i s c o lle c te d in la te M arch/april and about 50 per cent of company tax es is c o lle c te d in Miy; as a r e s u l t, the accounts of the Commonwealth Government swing sharply berween the f i r s t three q u a rte rs of the fin a n c ia l year (la rg e d e f i c i t s ) to the Jm e q u a rte r (la rg e s u rp lu s e s ). Figure IV-4 i l l u s t r a t e s the ex te n t of s e is o n a lity in the budget d e f i c i t of the Commonwealth in recen t y ears. As mentioned e a r l i e r, sa le s of Commonwealth s e c u r iti e s r e f le c t tie c u rre n t financing needs of the Commonwealth Government plus the need to refin an ce m aturing s e c u r iti e s ; in some y e a rs, the m onetary a u th o r itie s also s e ll Commonwealth s e c u r itie s as a means of c o n tain in g money growth or of 'mopping up' some p a rt of the li q u id i ty generated from o ther sources ( e.g. from balance of payments su rp lu se s ). For m onetary po licy purposes, i d is ti n c ti o n is o fte n made between s a le s of Commonwealth s e c u r itie s to nonbank groups and those to banks on the grounds th a t n et s a le s of Commonwealth s e c u r itie s to non-bank groups help to co n tain growth in the money supply, w hile n et s a le s to banks (R eserve Bank or tra d in g banks) are s t i l l associated w ith growth in money. This d is tin c tio n should not be pushed too far. (For example, some h o ldings of Commonwealth s e c u r iti e s by non-banks are very clo se s u b s titu te s fo r money; a ls o, should banks buy a government se c u rity from the p riv a te se c to r in stea d o f making a loan to the p riv a te s e c to r, the money - 46-

57 supply is unchanged.) Nonetheless, the distinction is still often a useful one, and monetary policy considerations are important in the overall bond selling task. Does the Large Government Borrowing Requirement Matter? This brief outline of the main facts highlights more than anything else the sharp increase in borrowings by the government sector over the past decade. The causes are complex. Governments have taken on new functions and there has been rapid expansion of some existing activities. Also, their larger deficits have reflected the slowing in the rate of economic growth: government revenues fall off when economic activity weakens; government spending (e.g. on unemployment benefits) increases; and governments look to a larger deficit as a means of giving some stimulus to the economy. Indeed, to some commentators, the larger deficits of the public sector are not a cause for concern. The view is taken that deficits are merely a symptom of a weaker level of economic activity; to some commentators, the government deficits should be made even larger as a way of stimulating the economy. As part of this view, it has been argued that the relevant measure of the deficit is not the recorded deficit but what the deficit would be were the economy to be operating at full employment (or at least at a high employment level of output). On these grounds, a number of academic commentators have argued that fiscal policy has in fact been too restrictive. From my viewpoint as a market practitioner, I do not agree with those who argue that we should be relaxed about continuation of large - and even enlarged - deficits by the government sector. In brief: (a) It is the observed deficit of the government sector which has to be financed, not some hypothetical deficit. Markets have been exceedingly apprehensive about financing the large government deficits over recent years; these financing requirements have put upward pressure on interest rates. Australia's experience is not unique: in fact, current experience in the U.S.A. underlines the concern of financial markets with the need to absorb and to finance large government deficits year after year. (b) One reason why large government deficits worry markets is that government borrowers are generally far less interestsensitive than private borrowers. Once its borrowing requirement for the year ahead is decided on, the government sector will generally go ahead with that borrowing come what may - i.e. no matter how far interest rates must rise. The private sector - and particularly borrowing for housing - is far more sensitive to changes in interest rates; it will suffer more when competition for funds is keen. (c) Markets are also concerned about a large borrowing requirement by the Commonwealth Government because some part at least of the budget deficit can be monetised - i.e. funded by Reserve Bank. The initial effect of such a move might be to reduce pressures in financial markets. But the beneficial effects are very short-lived and at the cost of giving rise to concern about worsening inflation and a subsequent increase in interest rates both because of that inflation and because policy will subsequently have to be tightened

58 Of co u rse, none of th i s i s to suggest th a t the government sector o v e ra ll should balance i t s budget every year; i t is simply to suggest th a t, when th e government borrowing requirem ent is not kept w ith in reasonable l i n i t s, strong upward pressu res w ill emerge on in t e r e s t ra te s and fin a n c ia l markets w ill be s tra in e d. For th is reaso n, the e f f o r ts of the Commonwealth Goveriment to reduce i t s budget d e f i c i t are to be commended from the point of view of e f f e c ts in the c a p ita l market (though i t s e f f o r ts in have been thw arted, to an e x te n t, by e x te rn a l f a c to r s, by the re f u s a l of the Senate to pass the sa le s tax b i l l s and by the strong growth in s a la r ie s in the defence fo rces and the public s e rv ic e s ). To d a te, the borrowing program of lo c a l and semi-government a u th o r itie s has continued to expand, to a point where the semi-government borrowing program has become a major in flu en ce in the c a p ita l m arket. F u rth e r, these comments should not be taken as arguing fcr a cutback in c a p ita l expenditure by the government s e c to r. Indeed, government c a p ita l expenditure has been squeezed a good d eal over recen t years as governments have sought to find a d d itio n a l reso u rces to meet the s u b s ta n tia l growth in th e i r re c u rre n t spending. There is a case fo r an expansion in government c a p ita l expenditure - but th is should m ainly be financed by goverrment re c u rre n t income, including r e a l i s t i c charges fo r government se rv ic e s. Even w ith these d is c ip l in e s, government borrowing w ill remain a m ajor force in the c a p ita l market and we now tu rn to look a t arrangements fo r m arketing government s e c u r iti e s. Markets fo r Goverrment S e c u ritie s: E xistin g Arrangements C u rren tly, Commonwealth s e c u r itie s are issued to the market by way of the ta p /te n d e r system introduced d u ring T reasury notes are issued via a weekly te n d e r. Each F riday, the Reserve Bank announces the q u a n tity and m a tu rity d ate of the n o tes a v a ila tle for ten d er on Wednesday of the follow ing week. The siz e of the tender i s based m ainly on li q u id i ty c o n sid e ra tio n s. Tenders are lodged on the subsequent Wednesday and the Reserve Bank r e p lie s the same day. Notes are taken up over the follow ing week. There is an a c tiv e secondary market in Treasury notes and in a d d itio n, as a form of standby, n o tes of 90 days or le s s to m a tu rity can be rediscounted w ith the Reserve Bank a t a published rediscount r a te. Commonwealth bonds are c u rre n tly marketed by way of a tap issue v ia the Reserve Bank. The a u th o r itie s nominate a s ta te d amount of a p a rtic u la r issu e which w ill be a v a ila b le over an in d e f in ite period u n ti l the issu e is fu lly subscribed or is closed fo r some o th e r reason. The a u th o r itie s can vary the p ric e on a tap issue on o ff e r b u t, in f a c t, p ric e s of tap stock have not v aried much. There is an a c tiv e secondary market in Commonwealth bonds, a l l issu e s of which are li s t e d on the A u stra lia n A ssociated Stock Exchanges. The a u th o r itie s are c u rr e n tly co n sid erin g rep lacin g the tap system by a ten d er; the proposed tender system is believed to d i f f e r from th at employed with T reasury n o tes. I should also mention A u stralian Savings Bonds (Aussie Bonds) which are on continuous sale to the public a t y ie ld s which are v aried from time to tim e. These s e c u r itie s have a maximum term of 7 y e a rs and provide fo r redemption a t one m onth's n o tic e (a t a pen alty ra te i f encashed ea rly in the l i f e of the bond). The maximum holding of these s e c u r iti e s is $200,000 by any one b e n e fic ia l i n t e r e s t. For the la rg e r sem-v-government a u th o r itie s (th o se who borrow more than $1.2 m illio n in a given fin a n c ia l y e a r), aggregate borrowings for the year are set by the Loan Council along w ith the a llo c a tio n s fo r each State and the terms and co n d itio n s of the borrow ings. For the sm aller a u th o r it ie s, 48

59 borrowings are controlled by State governments, who ensure that terms and conditions are generally similar to those set by the Loan Council. However, Loan Council approval is not required for borrowings of a short-term or temporary nature; these are generally under the promissory note type of issue. Semi-government authorities can raise funds either by public loans or private loans. Public issues are underwritten by brokers and institutions within the maximum interest rates and placement fees set by the Loan Council; the tendering for semi-government loans is a fiercely competitive part of the financial market. In , public issues provided about half of total borrowings of semi-government authorities (for very large authorities, the figure was three-quarters). By contrast, a decade ago, public issues provided only about one-tenth of funds of semi-government authorities. The increase in the importance of public subscriptions is a reflection both of the much enlarged scale of individual raisings (which are now often larger than can be absorbed by a particular lender) and of the efforts made by underwriters to extend the range of investors in public issues of semigovernment bodies and to introduce initiatives in the underwriting and marketing of these securities, e.g. registry facilities transferring inscribed stock to all major States of the Commonwealth and organised secondary market support. In 1978, a new category of approved borrowings by semi-governments - infrastructure borrowing - was introduced. Infrastructure borrowing is related to specific projects for which the semi-government authority has approval to borrow in addition to the normal allocation. When such funds cannot be raised on satisfactory terms in domestic markets, the borrowings can be arranged as private issues in overseas financial markets. Table IV-2 shows the borrowing program over the last decade for larger State authorities, Commonwealth authorities (Telecom, Northern Territory, etc.) and smaller authorities. The figures for aggregate borrowings exclude refinancing of maturities. The infrastructure program is shown separately. Maximum interest rates on semi-government bonds are set as a margin over Commonwealth bonds of comparable maturity. The margin can be varied in the light of market conditions and, in fact, was widened in August However, in general, the margin has not been varied very frequently. On public issues of semi-government securities the minimum maturity is four years; no maximum term is set. With average maturities throughout the Australian capital market having shortened a good deal in recent years, the four-year minimum on public borrowing by semi-government bodies has on occasion limited support for these securities. Maximum placement fees are also set. Currently, these are 1.25 per cent on securities of four to less than five years; 1.5 per cent on five to less than seven years; 2 per cent on seven to less than 15 years; and 2.5 per cent on loans of 15 years and beyond. Terms and conditions are also strictly controlled for private loans. On private loans, a maximum interest rate is set as a margin above the interest rate on public issues. There is a relatively active secondary market in semi-government securities; the market is conducted by brokers and merchant banks through direct negotiation with institutions and also through dealings on the floor of the Australian Associated Stock Exchanges. The depth of the secondary market varies substantially between the large and small authorities. Turnover in the secondary market has increased in recent years for a number of the better-known semi-government issues. The most widely-traded stock is - 49-

60 th a t of Telecom, an a u th o rity which has taken sp e c ia l ste p s to broaden the secondary market in i t s s e c u r itie s. These comments have re la te d to the issu e of public debt in A u s tra lia. The Commonwealth Government borrows abroad from time to time p rin c ip a lly to support the balance of payments. Such borrow ings were a t high le v e ls in and are again being stepped up. Semi-government a u th o r it ie s do not go abroad with conventional issu e s of bonds. Markets fo r Commonwealth S e c u ritie s: A C ritiq u e Arrangements fo r m arketing Treasury notes have g e n e ra lly worked very w ell. The q u a n titie s for the weekly tender have u su a lly been w ell-chosen; y ie ld s on T reasury notes have been responsive to market p re s su re s; and the flow of inform ation has g e n e ra lly been adequate. But the tap system for m arketing Commonwealth bonds has not worked w ell. These shortcomings are recognised in the c u rre n t move of the Loan Council to consider what form a tender system for the issu e of Commonwealth bonds might take. The major shortcom ings of the tap system, as we see them, are summarised below: (a) (b) (c) (d) Y ields on tap is su e s are not s u f f ic i e n tl y re la te d to y ie ld s on Commonwealth bonds in the secondary m arket. There is unnecessary u n c e rta in ty in the bond market about the a u th o r it ie s ' in te n tio n s concerning the purpose of and ta r g e t for i t s s a le s of bonds. The tap system has not been conducive to the developm ent of a wider market in Commonwealth bonds. The margin between y ie ld s on bonds and those on semigovernment s e c u r itie s has not been fle x ib le enough to cope w ith changes in market c o n d itio n s; and the fo u r-y ear minimum on conventional borrowings is unduly r e s t r i c t i v e. The f i r s t c r itic is m r e la te s to the i n f l e x i b i l i t y o f o f f i c i a l y ie ld s. For in s ta n c e, from August 1980 to the end of 1980 y ie ld s on tap is su e s were not v a rie d, notw ithstanding su b s ta n tia l in creases in y ie ld s in the secondary m arket. Tap y ield s were ra ise d la te in 1980 and again in January 1981 (follow ing which for a time s a le s of bonds v ia tap is su e s picked up) but from January 1981 to July 1981 they were again unchanged even though y ield s in the secondary market varied sh arp ly. Again, tap y ie ld s were not varied between la te 1981 and A pril 1982 (except for a sm all - alm ost m in iscu le - adjustm ent on 2 February 1982) d esp ite siz e a b le changes in secondary m arket y ie ld s. The tap system was meant to make o f f i c i a l y ie ld s more responsive to market p ressu res and to d e p o litic is e in te r e s t r a te s. In th is re g a rd, i t has fa ile d to ta lly. Figure IV-5 and Table IV-3 i l l u s t r a t e th is p o in t. Ralated to th is has been the absence of publicly-announced ta r g e ts for sa le s of Commonwealth bonds. The a u th o r itie s have not informed m arkets as to the volume of bonds they wish to s e ll each year (or each q u a r te r ). There is even u n c e rta in ty in the market as to the ro le for sa le s of Commonwealth bonds. That confusion is whether the prim ary ro le for sa le s of bonds over any period is debt management, monetary p o licy or l i q u i d i t y management. In fa c t s a le s of bonds are expected to serve a l l the purposes mentioned e a r l i e r, but m arkets are l e f t guessing as to the main purpose of the b o n d -sellin g - 50-

61 program and as to the amount of Commonwealth bonds which w ill have to be absorbed. The a u th o r itie s w ill d o u b tle ss counter w ith the claim th a t th e ir s a le s of bonds serve a m u ltip lic ity of purposes and th a t the in flu en ces on li q u id i ty are so u n p red ictab le th a t they could not hope to sp ecify th e ir b o n d -sellin g task even th ree months ahead. But our view from the m arket-place is th a t the m arket fo r government s e c u r iti e s would be improved were in v e s to rs to be aware of the sin g le main purpose for s a le s of bonds by the a u th o r itie s - which should be debt management. The a u th o r itie s might s e t q u a n tity ta r g e ts fo r th e i r s a le s of bonds for th is purpose. The monetary a u th o r it ie s ' ta sk of m onetary management and li q u i d i t y management would then p rim a rily be conducted v ia sa le s of T reasury n o tes and v ia the Reserve Bank's sa le s of bonds not c lo s e ly re la te d to those in the secondary m arket. F in a lly, the e x is tin g tap system has not provided an in cen tiv e for i n s t i t u t i o n s and d e a le rs to develop and broaden the market in Commonwealth bonds as they have in T reasury n o tes and semi-government s e c u r itie s. There is a w idespread view in the m arket th a t the tap system, as i t is operated in A u s tr a lia, would permit the a u th o r itie s to s e l l in s u b s ta n tia l volume ag ain st any d e a le rs who sought to make a m arket. The experience in October/November 1981, when the a u th o r itie s sold a s u b s ta n tia l volume of tap stock ($1.4 b il li o n in the two months) ra th e r than tu rn o ff the tap and thus c re a te a s c a r c ity value in these bonds is a case in p o in t. As I have said befo re: ' i t i s not the tap ; i t is how you tu rn i t o ff th a t m a tte r s '. A lso, the y ie ld curve on bonds has o fte n been f l a t and unchanging; th is has fu rth e r in h ib ite d the making of a m arket in Commonwealth bonds. The tap system has given no in c e n tiv e for in s t i t u t i o n s and d e a le rs to seek out p o te n tia l in v e s to rs in Commonwealth bonds and to encourage a widening in holdings of th e i r s e c u r iti e s. Not s u r p r is in g ly, th e r e fo re, the base of holdings of Commonwealth bonds has remained narrow. Only a r e s tr i c te d range of in v e s to rs holds Commonwealth bonds as an investm ent (but a widening range of in v e sto rs is holding semi-government s e c u r i t i e s ). As a consequence, the m a rk e ta b ility of Commonwealth bonds is r e s tr i c te d and, p o te n tia lly a t l e a s t, the market is su b je c t to stro n g er p ressu res than i t needs to be. There are tim es when Telecom s e c u r itie s are e a s ie r to market than bonds. The main need, as we see i t, i s fo r the a u th o r itie s to become p r ic e - ta k ers and not pvic-e-maker8 in the bond m arket. C ontrol over the volume of s a le s of Commonwealth bonds could be e sta b lis h e d w ith an in c e n tiv e for d e a le rs and i n s ti tu t io n s to develop the m arket. This view has received support from the Campbell Committee. That Committee said i t 'p r e f e r s a system where the Government determ ines how much i t wants to borrow and the in t e r e s t ra te is c le a rly determ ined by the m arket - the tender system is o bviously such a sy stem '. The Committee also said th a t, w hile i t is co n cep tu ally p o ssib le th a t the b e n e fits of a tender system could be achieved w ith a more fle x ib le tap system, ' i t would req u ire an a b i l i t y by the a u th o r itie s to determ ine and a w illin g n e ss to match market ra te s which may be d i f f i c u l t to achieve in p r a c t ic e '.^ T his leav e s open the q u estio n of the p re fe rre d form of the te n d e r. One means would be for the a u th o r it ie s to announce a q u a n tity ta rg e t for sa le s of Commonwealth bonds, say over the follow ing six weeks or th ree months. The q u a n tity of Commonwealth bonds to be sold would be determ ined w ith referen ce to the size of the budget d e f i c i t plus m a tu ritie s plus p ro v isio n of some A u stralian Financial System, F in al Report of the Committee of In q u iry, A u stra lia n Government P ublishing S ervice, C anberra, 1981, paras 9.18 and

62 o ff s e t to o th er in flu en ces on li q u id i ty. There are several ways in which th is q u a n tity of bonds could then be sold. One would be to have a com petitive un d erw ritten tender and fo r the successful ten d erer then to market th a t volume of bonds. As w ith semi-government issu e s a t p re se n t, in d iv id u al tendering groups could be expected to include those w ith marketing s k i l l s as w ell as those w ith some cap acity to absorb s e c u r itie s. A lso, as with semi-government is su e s a t p re s e n t, the successfu l underw riting panel would have a strong in cen tiv e to develop and to widen the market in these s e c u r iti e s. This is a m ajor b e n e fit of an underw ritten arrangem ent. But there seems to be concern th a t such an arrangement would lim it the volume of bonds a v a ila b le to those not involved in the tender. Opinions w ill d i f f e r on how su b s ta n tia l a problem th is i s. My own view is th a t the su ccessful ten d erer in a co m p etitiv ely u n d erw ritten tender would g en erally have an in cen tiv e to make paper a v a ila b le to n o n -ten d erers. Indeed, he would g e n e ra lly be keen to find in v e s to rs to take up paper. But i f fu rth e r reassurance is re q u ire d, the arrangement fo r m arketing bonds could be stru c tu re d such th a t the public would always be ab le to subscribe a t p ar, as with semi-government s e c u r iti e s. (For in s ta n c e, the system could be one where a tender is held every six weeks or th ree months fo r a pre-announced amount of bonds of sta te d m a tu ritie s ; where the stock is a v a ila b le a t coupon ra te s to a l l in v e s to rs who so apply; and where the su ccessful tenderer takes the amount of stock not subscribed by the p u b lic.) A number of v a ria tio n s on such a form of a tender could be considered. They have in common th a t there is a ro le for u n d erw riters in the market for Commonwealth bonds who in an extrem ely co m p etitive system would have an in c e n tiv e :. to quote the low est p o ssib le in te r e s t r a te ; and. to develop a market in government s e c u r itie s. Two asp ects of a tender system - whatever form i t takes - should be brought out e x p lic itly :. Y ields on Commonwealth bonds would be more f le x ib le (though not n e c e s s a rily higher) than they have been. But th is is n ecessary, and indeed in e v ita b le, i f the a u th o r itie s are to achieve b e tte r c o n tro l on the q u a n titie s of bonds they are to s e l l. As w e ll, the s e ttin g of o f f i c i a l y ie ld s would be taken out of the p o li ti c a l arena. T hat, too, would help to s e t t l e m arkets.. The public d is c lo su re of a ta rg e t would give the a u th o r itie s le s s scope in the short term to vary th e ir sa le s of bonds, say because of an unexpected s h if t in the balance of payments. However, the a u th o r itie s would s t i l l have scope to ad ju st the size of the T reasury note tender and buy or s e l l very sh o rtdated government s e c u r itie s from the secondary m arket. I t i s also in te re s tin g to note th a t A u stra lia is one of the few in d u s tria l c o u n trie s th a t does not allow and encourage the s h o r t-s e llin g of the s e c u r itie s of i t s c e n tra l government. The r a tio n a le behind s h o r t-s e llin g is th a t i t immediately allow s the market to e s ta b lis h a market p rice across the e n tire y ield curve and consequently lead s to improved m a rk e ta b ility fo r the relev an t s e c u r itie s. As Commonwealth s e c u r itie s are homogeneous in a l l re s p e c ts, unlike semi-government or corporate d eb t, they are id e a lly su ited to market-making and hence s h o r t-s e llin g. The follow ing b e n e fits flow to the government from the establishm ent and encouragement of s h o r t-s e llin g : - 52-

63 . the establishm ent of market-makers who in turn w ill look to develop a customer base for the d is tr ib u tio n of such s e c u r iti e s, thus enlarging the u ltim ate market for the governm ent;. improved m a rk e ta b ility a t a l l po in ts of the y ield curve;. the e a r l ie r re co g n itio n of tru e market y ie ld s for a ll po in ts of the y ield curve. Overseas m arkets have developed some s trin g e n t ru le s on s h o r t-s e llin g which ensure th a t larg e market d is to r tio n s are avoided and cornering is c o n tr o lle d. My comments so fa r have re la te d to T reasury n o tes and conventional bonds. Another shortcoming of the m arketing of Commonwealth s e c u r itie s is th at y ie ld s on A u stralian Savings Bonds (ASBs) have o ften not been co m petitive. Indeed, in recent months there have been su b s ta n tia l net red u ctions in h o ldings o f ASBs (see Table IV -3). The cum ulative d eclin e in the nine months to March i s $470 m illio n. That i s, th is instrum ent has not played i t s part in financing the governm ent's borrowing requirem ent: what should have been a fle x ib le and (a t tim es) com petitive instrum ent h as, because of the i n f l e x i b i l i t y of i t s y ie ld, become a deadweight for the monetary a u th o r itie s. If ASB ra te s had been perm itted by the Loan Council to remain co m p etitiv e, the net ra is in g s from th is source might w ell have reached $200 m illio n as compared with the red u ctio n of $470 m illio n re fe rre d to above. This p o ssib le increase of $670 m illio n would have played an im portant p art in the governm ent's o v erall program. As the tap issu e s are not designed to a t t r a c t su b scrip tio n from in d iv id u al in v e s to rs and the ASBs were o ffe rin g ra te s w ell below the m arket, the government r e a lly has had no access to p riv a te savings over th is lengthy p erio d. We recognise the s e n s iti v it y of housing in te r e s t ra te s to the ASB ra te but we see need for more fle x ib le use of the ASB i f other instrum ents fo r government borrowing are not to carry too heavy a load. Markets fo r Semi-Government S e c u r itie s : A C ritique In c o n tra st to arrangements for m arketing Commonwealth s e c u r itie s, the siz e of the program for new (conventional) ra is in g s by semi-government s e c u r itie s is reasonably w ell known to the market and there is some incentive for u n d erw riters to develop the market in these s e c u r itie s. R eflecting th is l a t t e r in flu en ce, holdings of semi-government s e c u r itie s have widened over recen t y e a rs, as is shown in Table IV 4. Note, p a r tic u la r ly, the increase in holdings of the a l l o ther s e c to r, i. e. persons, co rp o ra tio n s, fin a n c ia l i n s ti tu t io n s not elsew here included and overseas in v e s to rs. A lready, a s u b s ta n tia l part of semi government s e c u r itie s is marketed to non c a p tiv e s ; as a r e s u lt the a b o litio n or m od ificatio n of cap tiv e arrangem ents recommended by the Campbell Committee w ill probably not do much to push up in te r e s t ra te s on semi-government s e c u r itie s. N onetheless, arrangem ents for marketing semi-government s e c u r itie s have not kept pace e ith e r with trends in p riv ate fin a n c ia l m arkets (w ith which semi-government s e c u r itie s are in close com petition) or with the su b s ta n tia l growth in the borrowing requirem ent of semi-government a u th o r itie s. F i r s t, there is only lim ited inform ation a v a ila b le on the aggregate borrowing requirem ent of semi-government a u th o r itie s. The Loan Council announces a program fo r conventional borrowings but there are also refin an cin g s of e x istin g loans (and l i t t l e inform ation is a v a ila b le on - 53-

64 m a tu r itie s of p riv a te lo a n s ), lev erag e le a s in g, s u p p lie r c r e d its and sh o rtterm borrow ings. One arrangem ent which would a s s i s t m arkets would be fo r th e re to be an announcement o f the to ta l borrowing requirem ent of semigovernment a u th o r it ie s and fo r in form ation to be published on m a tu r itie s. A lte r n a tiv e ly, th ere i s m e rit in the proposal of the Campbell Report th a t co m m ercially-oriented semi-government a u th o r it ie s borrow on th e ir own name and w ithout borrowing l i m i ts or c e ilin g s or in t e r e s t r a te s se t by the Loan C ouncil. Such an arrangem ent would impose f u l l commercial d is c ip lin e on th ese semi-government borrow ers. Secondly, and more im m ediate, th e re is need fo r g re a te r f l e x i b i l i t y between y ie ld s on Commonwealth s e c u r itie s and maximum y ie ld s on semigovernment is s u e s. U nless the margin s e ttin g the maximum re tu rn on semigovernment s e c u r itie s i s made more f l e x ib l e, th ere could be tim es over which r e l a t i v e support fo r the bond m arkets and the semi-government market changes sh a rp ly. This increased f l e x i b i l i t y could be achieved in any one of sev eral ways, e.g. by more freq u en t adjustm ent of the margin or by a b o litio n of any form al c e ilin g on semi-government s e c u r iti e s and determ ining i n t e r e s t ra te s by market com p etitio n. T h ird ly, some sm all semi-government bodies have very lim ite d public support for th e ir s e c u r itie s as w ell as very lim ite d secondary m arkets fo r t h e i r s e c u r iti e s. By c o n tr a s t, the m ajor semi-government a u th o r it ie s can tap a n a tio n a l market for th e i r public is su e s and have a more developed secondary m ark et. In coming y e a rs, su c c e ssfu l m arketing of the s e c u r iti e s of the sm aller a u th o r itie s may prove d i f f i c u l t v is - a - v is the is su e s of the la r g e r a u th o r it ie s un less a hig h er re tu rn is paid. F o u rth ly, th e re is a need for g re a te r f l e x i b i l i t y in the m a tu rity of semi-government is s u e s. When the m arkets were defined for the issu e of semigovernment s e c u r iti e s, c a p tiv e market arrangem ents were a more powerful in flu e n c e than can be the case today. A lso, the c a p tiv e s had an a p p e tite fo r lo n g -d ated m a tu ritie s and a t tim es th a t a p p e tite exceeded the s e c u r iti e s a v a ila b le to the m arket. Those days have gone. The borrowing program i s much la r g e r and fin a n c ia l m arkets are so co m p etitiv e th a t th e re i s lim ite d scope to re ly on c a p tiv e m arket arrangem ents. Because p erm issib le m a tu ritie s have not v a rie d, one of the la r g e s t borrowing se c to rs in the A u stra lia n economy is s t i l l r e s tr i c te d to the medium to long-term dom estic fixed i n t e r e s t debt m arkets. Conclusion Several points emerge from th is d is c u ssio n : (a ) The s u b s ta n tia l borrowing requirem ent of the pu b lic secto r has put upward p ressu re on in t e r e s t r a te s and has n e c e ss ita te d changes in arrangem ents for m arketing government s e c u r iti e s. ( b) The tap system fo r s e llin g Commonwealth bonds, introduced in A pril 1980, has not worked w ell: y ie ld s have not been responsive to market fo rc e s; the market is concerned th a t the a u th o r itie s w ill flood the market with bonds whenever the bond market r a l l i e s ; and th e re is no in c e n tiv e fo r in s ti tu t io n s or o th e rs to make a market in bonds. (c) The a u th o r itie s have under review the in tro d u c tio n of a tender for sa le s of Commonwealth bonds. A ten d er can take many d if f e r e n t form s. I t is to be hoped th a t the system chosen provides fo r: - 54-

65 (i) the necessary f l e x i b i l i t y in y ie ld s; ( i i ) a ro le for market-makers; ( i i i ) inform ation on the scale of the bond s e llin g program. (d) (e) The tender system for m arketing Treasury notes has worked w ell. However, because of the d if fe rin g c h a r a c te r is tic s of Treasury notes and bonds, th is system could not re a d ily be extended to the sale of bonds. Arrangements for m arketing semi-government s e c u r itie s have provided for a s u b s ta n tia l widening in the market for these s e c u r itie s. Given the scale of prospective borrowings by semi-government a u th o r it ie s, fu rth e r changes in arrangements for m arketing these s e c u r itie s are re q u ire d. - g re a te r f l e x i b i l i t y in the margin between in te r e s t ra te s on bonds and those on semi-government s e c u r itie s ; - f l e x i b i l i t y in the y ie ld s on d if fe re n t issu e s of semigovernment s e c u r itie s ; - g re a te r f l e x i b i l i t y in the m atu rity stru c tu re of semigovernment s e c u r itie s. (f ) F in a lly, the A u stralian Savings Bond has been badly l e f t behind by market ra te s of in te r e s t. Indeed, th a t se c u rity is now uncom petitive w ith ra te s a v a ila b le to small in v e s to rs on a wide range of instrum ents. This is the s ta rk e s t (but not the only) example of the heavy p o li ti c a l influence on o f f i c i a l in te r e s t ra te s in A u stra lia. The cost of such influence is i n s t a b i l i t y in the volume of government s e c u r itie s sold; in tu rn, such i n s t a b i l i t y eventually adds to upward pressu res on in te r e s t r a te s

66 Figure IV-1 PUBLIC SECTOR DEFICIT AS PERCENTAGE OF GROSS DOMESTIC PRODUCT, to per cent Total State and --- Local Commonwealt Year Figure IV-2 $ million 25,000 GOVERNMENT SECURITIES ON ISSUE, Commonwealth, Domicile in Australia 20,000 15,000.oca! & Semi-Governmen Australia and Overseas 10,000 5,000 Commonwealth, Domicile«Overseas Year - 56-

67 Figure IV-3 AVERAGE MATURITY OF COMMONWEALTH GOVERNMENT SECURITIES, (EXCLUDES SAVINGS BONDS) Months Year Figure IV-4 CUMULATIVE DOMESTIC DEFICIT OF COMMONWEALTH GOVERNMENT $ million June July Aug Sept Oct Nov Dec Jan Feb Apr May Jun e - 57-

68 F ig u re IV-5 c en t YIELDS ON COMMONWEALTH BONDS Y ears to M a tu rity A p ril A p ril Ja n u a ry 1982 X Tap on 19 and 29 A p ril AUSTRALIA: T able IV-1 GOVERNMENT FINANCE $ b i l l i o n ( e s t. ) ( e s t. ) Commonwealth: Budget d e f i c i t M a tu r itie s of bonds Sem i-g overnm ent: New Borrowings M a tu r itie s o f la rg e a u t h o r i t i e s

69 CO ical AND SEMI-GOVERNMENT AUTHORITIES - LOAN COUNCIL APPROVED BORROWINGS( a ) ($ m i l l i o n ) S 5 rh *H cfl 3 *-i o O 1h H o CO CO CO CO CO i i I i i <0 1-1 H CO 04 4 J > CO 4-1 -H O 0 0 CO 14 c 4-J O r4 t o O H o co co <u 1 l 1 i 1 0) 8 to G G ON CM CO ^ H r-h O» 1 o CM O ^ OO 0 0 O O -H o o -H ^ r-no 4 3 to to to H H H CNJ O J CM CO 0) o 14 O 4 3 O 4-1 c o cnj 1 1 I < r cnj CM CO I l l vd r^. r 1 CO 04 * 0 5 M tu r-h CO CM T3 4 3 S 1 l 1 *H co u 3 CO o co QJ >H X CO CO i i t i i J M 0) J-i CO r-h *h <d ctf 4-J > c 8 1 T J 6 g o M O 03 O g 4-4 -H O CO CO O <0 Q. - I 1-c cfl <0 O CO r-4 O <0 <H i-3 rh CO 14 G i n 04 e x nj 0 0 <U G 5 T3 0 0 <U (3 to CM CM a 2 T 3 O 01 -H 1-1 O 10 >1 S 14 C O tfl 0) 0) r l r l U <U V4 i i i i i O CM >> o o CO 4 3 O U 44 O o o o o 4 c o o o en m o o UO 0 > vo o CNJ 4 rh 0 0 CM rn vo io CM CO O ( J O >4-1 O - t s O 0) -H!4H Ö0 -CO- CM CO CO ^ uouo to to o i 14 OO a g S H *" O CO U 14 s 'S 00 CO o o o e 4 3 Ih U MH r-h < ) O O LO o r-h In. CM 'S h vo On ON On ON G O 4 J c a. o CO CO 1-4 CO O ' rh CM CM CM CM 4 3 G -H cx 4-1 co to CO i-3. ^ S rh g O eg i-h G cb O o O G S o 55 'S CO rh <D CO «H CD 4J *H C M o o 1 5 O 3 O co s m o o o < f c o ^ cm rn s f m o cnj c o ^ Gv G nc7n O'* G r~h r H * H * H r-h n ^ h o IN CM NO ON 0 0 CNJ CNJ CM n n co on o N 1%IN fn n vo in co g rn rn i r^> in. O ' O n O n ON O ' -H * H r-h r-h r-h so <T o <r S *-HCM o p 0 0 o p o o o c o G -rl CO n 3 </> 14 o tu H S O O In U 4 3 4H 3 to O r-h 0 0 CO a s a s r-h r-h 3 8 g o rs 4 3 Source: Reserve Bank B u lle tin, S y d n e y, Novembe - 59-

70 T a b l e IV -3 SALES OF COMMONWEALTH GOVERNMENT SEC U R IT IE S, T ap S a l e o f T r e a s u r y N o te s A u s t r a l i a n B o n d s ( E x c l u d i n g N e t S a l e s S a v i n g s B o n d s R e s e r v e B a n k ) N et S a l e s $ m i l l i o n 1981 J u l y A u g u s t S e p te m b e r Oc t o b e r N ovem ber D e c e m b e r J a n u a r y F e b r u a r y M a rc h T able IV-4 LOCAL AND SML-GOVERMENT SECURITIES - MAJOR HOLDERS AS AT 30 JU1E ($ m ill ion) Savings berks 1,961 2,150 2,437 2,830 3,285 3,894 4,461 4,880 5,340 5,752 6,118 T rading banks L ife in su ran ce ,061 1,177 1,264 l,a 33(p) companies P uhlic pension 1,103 1,200 1,177 1,245 1, ,583 1,768 1,953 2,210 2,540(p) funds P riv a te pension (p) fu rd s G eneral in su ran ce 1% ,642 1,902 2,232(p) companies Ftermanent b u ild in g s o c ie tie s (p) A uthorised d e a le rs and money m arket H I (p) c o rp o ra tio n s A ll o th e rs 1,269 1,283 1,408 1,311 1,360 1,378 1,761 2,323 2,660 3,809 4,891(p) T o tal 5,425 5,910 6,454 6,891 7,603 8,585 10,121 11,701 13,689 16,154 18,619(p) Note: (p ) P relim in ary Ebunxt: RzeeJVe Bank BuLZotmy F in an cial Flow A ccoints Supplem ent, an n eal. 60

71 V GOVERNMENT BORROWING IN THE CONTEXT OF MONETARY POLICY AND THE CAPITAL MARKET D.N. Sanders Debt Management and Monetary P o licy T his sem inar b rin g s to g e th e r c o n tr ib u tio n s from p u b lic s e c to r borro w ers and a p r o f e s s io n a l s p e c i a l i s t in the m arket fo r t h e i r s e c u r i t i e s. In such company a c e n t r a l banker i s som ething of a m iddle man. The R eserve Bank has c o n s id e ra b le i n t e r e s t in governm ent b o rrow ing. We do not c a r r y th e r e s p o n s i b i l i t y fo r p u b lic d eb t management but we have an a d v iso ry and agency r o le and have a good d e a l to do w ith th e m echanics o f the issu e and s e r v ic in g o f th e d e b t. We have a g r e a t co n cern th a t d e b t management should be sound, in th e sense th a t i t sh o u ld : cover the g o v e rn m e n t's n e ed s; be a t lo w est c o s t, tak e n over th e y e a rs ; a c h ie v e a spread o f m a t u r i t i e s which is not too v u ln e ra b le a t tim e o f m arket w eakness; and be as f a r as p o s s ib le a f a c to r of s t a b i l i t y and e f f i c ie n c y in th e m ark e t. We see th e s e m a tte r s from the v iew p o in t o f o u r s t a tu t o r y r e s p o n s i b i l i t y f o r m onetary p o lic y. What I would re g ard as sound d eb t management i s of g r e a t a s s i s t a n c e to the achievem ent o f s a t i s f a c t o r y m onetary c o n d itio n s. Some i n t e r p r e t a t i o n s could su g g est th a t th e d eb t management o b je c tiv e of low borrow ing c o s t could c o n f l i c t w ith good m onetary p o lic y. E s s e n t ia l ly any such c o n f l i c t would l i e in seek in g to a ch iev e low borrow ing c o s ts by m o n etisin g the d e b t through borrow ing from the c e n t r a l b an k, le a v in g the c e n tr a l bank to fin d ways to o f f s e t the m onetary ex p an sio n which r e s u l te d. In A u s tr a l ia, o u r T rea su ry b i l l issu e a t non-m arket term s has lin g e r e d on as an a n a c h r o n is tic r e l i c of th a t l in e of th o u g h t. E x p erien ce has shown th a t such a c o n f l i c t can n o t be su s ta in e d fo r any le n g th of tim e. I f the c e n tr a l bank can n o t o f f s e t the m o n e tis a tio n, i n f l a t i o n e n su e s. Then i n t e r e s t r a te s r i s e and governm ents a ls o come under community p re s s u re to mend m a tte r s. M arkets and com m unities have le a rn e d a g r e a t d e a l about t h i s p ro c ess in re c e n t y e a rs and th e tim e betw een seeking through m o n e tis a tio n to a ch iev e low er borrow ing c o s ts and h aving to pay h ig h e r borrow ing c o s ts has c o n tra c te d g r e a t l y. There can be no enduring s u b s ta n t ia l c o n f l i c t of i n t e r e s t between good d e b t management and good m onetary p o lic y. The R eserve Bank i s a buyer and s e l l e r of governm ent s e c u r i t i e s, usin g them as the v e h ic le fo r tr a n s a c tio n s w ith the p r iv a te s e c to r. With a le s s e n in g r e li a n c e on a tte m p ts a t r e g u la tio n of th e f i n a n c ia l sy s te m 's a c t i v i t i e s, o u r use o f m arket o p e r a tio n s in s e c u r i t i e s has been in c re a s in g and is l i k e l y to in c re a s e f u r th e r in the f u t u r e. There i s no dom estic a s s e t which is b e t t e r su ite d fo r m arket o p e r a tio n s than Commonwealth Government s e c u r i t i e s. We need to be a b le to d e a l in s e c u r i t i e s in a tim e ly fa sh io n a t need and in volum e. There is no o th e r homogeneous paper o f com parable s e c u r ity a v a i l a b l e. Supply o f governm ent s e c u r i t i e s i s u s u a lly ample (som etim es o v e r-a m p le ), alth o u g h a t tim es we may not have q u ite th e p a tte r n of p o r t f o li o we would wish (th o se n o n -m ark etab le T re a su ry b i l l s a re u s e le s s fo r t h is p u rp o se ). To lo o k a t i t a n o th e r way, im b alan ces in th e g o v e rn m e n t's a c c o u n ts a re a m ajor in f lu e n c e on the a v a i l a b i l i t y o f cash to th e p r iv a te s e c to r. I t sta n d s to re aso n t h a t, to the e x te n t th a t t h i s e f f e c t i s n o t co u n tered s u f f i c i e n t l y by p rim ary d e b t o p e r a tio n s o f th e governm ent, i t should be c o u n tered by R eserve Bank s a le s and p u rc h ase s o f Commonwealth p a p er

72 At tim es some people would wish us out of the market - i t is commonly our lo t to be the messenger who brings the bad news. Some contend we should be in i t more, a t le a s t a t tim es and in ways of th e ir choosing. G enerally, we o ff e r some g ains to the m arket through arrangem ents made w ith au th o rised d e a le rs in government p ap er, f a c i l i t i e s to b ro k e rs, and our general background c o n trib u tio n to m a rk e ta b ility. The job th a t co n fro n ts m onetary p o lic y depends im p o rtan tly on the success of the Commonwealth Government in i t s debt management. If i t is financing i t s needs from the market a t r e a l i s t i c y ie ld s, a major p o ss ib le d istu rb an ce to m onetary co n d itio n s is removed. There can be o th er d is tu rb a n c e s, some of which, fo r example from the balance of payments, can be m ajor. But in handling a l l of th e s e, the problems and the ten sio n s are lessened i f the government is ob tain in g i t s finance from the market on r e a l i s t i c term s. If i t is n o t, then the Reserve Bank is l e f t to co n cen trate more on o th er areas of the m arket, or to the f r u s tr a tio n of attem pting by re g u la tio n to r e s tr a i n expansion w hile the p rice sig n a l induces everyone to want to expand. Good debt management is not the end of the is su e s which can a ris e from government borrowing. The siz e o f government expenditure and of the borrowing requirem ent can ra is e q u estio n s about the p o s s ib il it y of crowding out the p riv a te se c to r in the c a p ita l m arket. That is a f a i r l y complex is s u e. Government D e fic its and Borrowing Requirements With th a t background of c re d e n tia ls and c o n te x t, l e t me tu rn to Mr B ain s very in te r e s tin g paper on government debt as seen by a p ro fe ssio n a l w ith experience of substance in th is and o th er areas of the c a p it a l m arket. In th is paper I w ill not attem pt to address a l l the m a tte rs ra ise d by Mr Bain - many would, in any c a se, evoke no comment from me. However, h is paper d ir e c ts our a tte n tio n to the la rg e and growing volume of government debt o u ts ta n d in g, a ris in g from the run of government d e f i c i t s p a r tic u la r ly sin ce the m id-1970s. I would lik e to give a b i t wider p ersp ectiv e to th i s m a tte r. With in f la t io n, most d o lla r aggregates have ris e n apace over the l a s t decade o r so. We should bear th a t in mind. For example, taking the fig u re s o f government s e c u r iti e s on issu e used by Mr Bain in Figure IV -2, th e i r to t a l as a percentage of g ro ss dom estic product (GDP) has v aried as follow s: Percentage of GDP The to ta l f e l l 21 percentage p o in ts over th a t period. Commonwealth dom estic issu e s f e l l from 38 per cent of GDP to 21i per c e n t. Commonwealth overseas issu e s f e l l from 5 per cent to 3i per cent and lo c a l and semigovernment is su e s f e l l from 16 per cent to 14 per c e n t. This audience w ill not be su rp rised to le a rn th a t the p ic tu re of l i t t l e n et change between 1976 and 1981 concealed a f a l l of 4 i percentage p o in ts in Commonwealth dom estic is s u e s, a r is e of 1 p o in ts in Commonwealth overseas is s u e s and a r is e of 2 j percentage p o in ts in lo c a l and semi-government is s u e s. In in te rp re tin g these d ata we need to remember th a t not a l l financing is included - notable - 62-

73 om issions are le a s in g, su p p lie r c re d it and sho rt-term paper issued by semigovernment a u th o r itie s. Let us take another b a s is of comparison. Aggregate public se c to r debt as shown in Figure IV-2 was as larg e as 48 per cent of the a s s e ts of fin a n c ia l in s ti tu t io n s in I t f e l l to an equ iv alen t of 32i per cent of those a s s e ts in 1976, rose to 34 per cent in 1979 and f e l l to 29i per cent in These s o r ts of p e rsp ectiv es are u sefu l to guard ag a in st exaggerating our p ro b lem s., But they do not dem onstrate th a t th ere are no problems. Even i f the problems look a l i t t l e more m anageable, they s t i l l need to be managed. What I have said does not d e tr a c t from the force of Mr B ain 's concern about la rg e d e f i c i t s and high borrowing requirem ents. His p o in ts, th a t government borrow ers can o ften stand the pace of growing in t e r e s t c o sts longer than p riv a te borrow ers and th a t p o li ti c a l s e n s iti v it y to high in t e r e s t ra te s can lead to a tem ptation to m onetise la r g e r d e f i c i t s and cause in f la t io n, are w ell taken. The Shortening Maturity o f Commonwealth Debt The Bain paper also shows th a t the Commonwealth's debt has shortened through a halving of the average m atu rity in the l a s t decade. This was a period of in f la tio n which posed d i f f i c u l t judgments fo r a l l is su e rs of d eb t. Although the p resent m a tu rity of Commonwealth debt is not too bad by some stan d ard s, I share the unease about th is shorten in g. On the one hand, i t can be argued th a t so long as reasonable- f i s c a l and monetary p o lic ie s are in place and there are not massive amounts of new debt being issued each year - and provided the Commonwealth o ffe rs com petitive y ie ld s - big ro llo v e rs are not in them selves n e c e ss a rily a cause for g re a t concern. A fter a l l, the m aturing of debt tends to provide the wherewithal necessary fo r a su ccessful conversion program. On the o th er hand, any borrower who is h eav ily r e l ia n t on sh o rt-term debt has a p o te n tia l market v u ln e r a b ility to every sh o rt-ru n flu c tu a tio n in h is own circum stances and to every sh o rt-ru n flu c tu a tio n in the fin a n c ia l m arkets. Viewed in th is l i g h t, the trend toward shortening of Commonwealth debt (and, indeed, of debt in gen eral) is d is q u ie tin g. The task of handling the m a tu ritie s and reversing the trend w ill be g re a tly eased i f the to ta l of debt o u tstanding is not r is in g much through government d e f i c i t s. Of co urse, there is a ro le for sh o rt-term Commonwealth d eb t. One aspect of th a t ro le I would lik e to see much reduced a r is e s from the s e a s o n a lity of Commonwealth Government fin an cin g. This is asso ciate d with ta x a tio n arrangem ents, w ith perhaps h a lf of the seasonal outflow and re tu rn of funds a sso ciate d w ith the co n cen tratio n of p ro v isio n a l tax payments. The Reserve Bank has always been anxious to reduce th is seasonal flu c tu a tio n and to do i t at source ra th e r than through some cosmetic which s t i l l leaves unchanged the la rg e swings in funds flowing between public se c to r and p riv a te s e c to r. Market Uncertainty and V o la tility Seasonal flu c tu a tio n s in li q u id i ty impose v arious c o sts on the fin a n c ia l community, such as more u n c e rta in ty and v o l a t i l i t y facing fin a n c ia l managers and those who have to form and to implement monetary p o lic y. These c o sts can be q u ite high. There is another cost also - th a t of financing the seasonal d e f i c i t through Treasury n o te s. On a quick c a lc u la tio n, i f the Commonwealth - 63-

74 had been able closely to match its income and outgo over the course of the year, its reduced indebtedness would have produced lower borrowing costs, assessed at the cost of Treasury note finance, of over $250 million in and over $300 million in That would be a perfect score; even falling short of that, there is plenty of room for improvement. While on the question of market uncertainty and volatility, I should mention the effects over quite short periods of mismatching of payments. For instance, could monthly tax sharing payments to States be aligned more closely with the flow of tax receipts, thereby offsetting the disruptive effects of the separate flows on the money markets? Again, on 30 June in recent years, large intergovernmental payments have produced acute stringency in the money markets. Yet on the very next day sizable payments have been made in the opposite direction. Is there scope for rationalisation? While market operators cope professionally with these fluctuations, they are pretty unproductive and may be avoidable. Arrangements for Issuing Debt On the question of issuing debt, the Treasury note tender is seen as a success. I believe that success owes a lot to good work by the specialists in the Reserve Bank who make their own assessments, consult leading members of the market and consult with their counterparts in Treasury in order to form a decision on the amount of the weekly issue. However, fundamental to that good work being rewarded by a successful operation is that it has been a 'hands-off' operation so far as government is concerned. Mr Bain is unenthusiastic about the tap system, on a number of grounds. He mentions specifically an absence of flexibility and realism in tap yields. Certainly, the tap system for bonds has not displayed the characteristics of a 'hands-off' operation. Mr Bain does not, as I understand it, rate highly the likelihood that a tap system with its inherent 'price-making' quality could approach the effectiveness of a 'price-taking' system such as the tender. Reasonably high hopes were held for the tap system on its introduction. It was seen as providing more flexibility and greater precision in debt management; reducing speculation previously associated with cash loan results; reducing the instability sometimes occasioned in capital markets by unusually large and concentrated loan raisings; and providing a pretty continuously operating takeaway service for bond buyers. The Campbell Committee thought bond tenders would be better and the Loan Council is preparing to have a look at the matter. Although the decision does not lie with the Reserve Bank, it would be inappropriate for me to enter the lists with judgments about the merits of different systems. It is fair to say that the Reserve Bank has no difficulty with a tender system. However, fundamentally, effective bond selling requires willingness to meet the market. That is more than a matter of mechanism, but mechanism may nevertheless be important. Mr Bain favours a tender restricted to syndicated bids for the full amount of the issue, as opposed to other varieties of tender such as a tender open to all bidders for such amounts as they wish to subscribe. You may be wondering why syndicates cannot compete satisfactorily in an open tender. On the face of it, they either get the whole issue at the price they think appropriate or get part of the issue at the price they think appropriate and which is the lowest (or equal lowest) in the tender

75 The Market's Information Heeds Much of the d is c u ssio n about tap and tender systems tu rn s on la c k of inform ation about the a u th o r it ie s ' in te n tio n s concerning the purpose of and the ta rg e t fo r sa le o f bonds. I am responsive to the need to have inform ation a v a ila b le to the m arket. Care has to be taken in assessin g the m e rits of every impassioned c a ll by the market to re v e a l a l l about the a u th o r it ie s ' s itu a tio n in some m a tte r; wider in t e r e s t s have to be considered. I doubt th a t the market needs a l l the inform ation th a t some people sometimes say i t needs. However, th e re can be advantage to a l l concerned in making known what can be made known w ith reason able co n fid en ce. The market n a tu r a lly w ishes to reduce the amount of u n c e rta in ty i t fa c e s. I t is not fly in g b lin d. I t knows the reasons for issu in g d eb t. Research o rg a n isa tio n s in the market know the size of the borrowing requirem ent, know the p a tte rn o f m a tu r itie s, know the lin e s of monetary policy and keep i t under review su b je c t to the seasonal swings I discussed e a r l i e r. They do not know the u n fo reseeab le any b e tte r than I do. That is an inescapable u n c e rta in ty. I t is a t th i s sta g e th a t a c re a tiv e ten sio n a r is e s between the market on the one hand and the debt managers and the Reserve Bank on the o th e r. The market would lik e to have from the debt managers a c le a r ly la id out bond s e llin g program and, along w ith th a t, a negative pledge from the debt managers and the Reserve Bank concerning o th er sa le s of bonds. This goes fu rth e r than those p a r t ie s, in conscience and w ith regard to th e ir s ta tu to ry r e s p o n s i b i l i t i e s, have believed they can go. Although I see m erit in aiming to follow p o lic ie s which do not add to the m a rk e t's d i f f i c u l t i e s, I am slow to undertake to observe c e rta in ru le s no m atter what change in economic and fin a n c ia l circum stance ev en tu ates. Given th a t debt management and market o p eratio n s are p o lic y in stru m e n ts, a n eg ativ e pledge ag ain st v a ria tio n s in th e ir use for p o licy purposes has obvious d i f f i c u l t i e s for policy-m akers. There is reason to ask w hether, in some of the more extreme p re s e n ta tio n s on th i s m atter th a t are heard from the market from time to tim e, th ere i s not an element of seeking the u n a tta in a b le. Those p re s e n ta tio n s seem to ask th a t, when the un fo reseeab le o ccu rs, i t be d e a lt with in a way which leaves the bond market u n a ffe c te d. This would seem to assume th a t a p a rt of the c a p ita l market can be in su la te d from a s u b s ta n tia l change in the economic or fin a n c ia l news. Such extreme p re s e n ta tio n s must be questioned. The market is not so segmented. What happens in one area bears on o th ers and d is ru p tio n, i f se rio u s enough to th re a te n the p re v a ilin g tenor of the fin a n c ia l s i tu a t io n, w ill tend to s p i l l over from the sectio n of the market in which i t occurs to o th er s e c tio n s. At the end of the day, the c a p ita l and money m arkets are lin k ed and the judgment about whether or not some investm ent is a good investm ent must be made in a co n tex t of necessary u n c e rta in ty. That said, l e t us not lose sig h t of the point th a t the market b e n e fits g re a tly from as much c e r ta in ty as i t can g e t. Good debt management r e l ie s on an e f f ic i e n t m arket and th e re fo re has an in t e r e s t in giving as much c e rta in ty and in form ation as i t can, reasonable and c o n fid e n tly. SemirGovernment Borrowing On semi-government borrow ing, I claim no g re a t e x p e rtise but o ffe r a few comments. Good inform ation in th is area has become more im portant because, as we have seen, the borrowing demands of lo c a l and semi-government - 65-

76 a u th o r itie s are r i s in g. Increased borrowing demand has been such t h a t, d e sp ite a l l the work put in by brokers and i n s ti tu t io n s in the com petitive new issu e market and d e sp ite an in crease in the l a s t couple of years in the margin above Commonwealth bond y ield o ffered in new is s u e s, increased amounts have had to be ra ise d o ffsh o re. These developm ents are making g re a te r demands on the fin a n c ia l e x p e rtise of semi-government a u th o r itie s. They now have to face questions such as w hether, when they borrow fo re ig n cu rrency, they can arrange a s u ita b le hedge or can be assured of a cash flow which can be v aried i f necessary w ith the value of the fo reig n currency. I t is im portant to us a l l th a t these a u th o r itie s be well-managed fin a n c ia lly. Not a l l the im portunings they receive w ill have th e ir in t e r e s t s a t h e a r t. There is a r is k th a t th e ir governm ent-guaranteed s ta tu s may be seen as s u f f ic ie n tly a t t r a c t iv e by some len d ers as to dim inish the need for c r i t i c a l exam ination. There have been ra th e r more in stan ces around the world of com plaisant lending by fin a n c ie rs than would j u s t i f y rely in g too re a d ily on th e ir judgments about the b est in t e r e s t s of semi-government borrow ers. The Campbell Committee had a thought about t h i s. In measured d is c u ssio n, which recognised p o ssib le d i f f i c u l t i e s, i t recommended the id e n tify in g of ' commercial' lo c a l and semi-government a u th o r itie s which would not be su b ject to the Loan Council and would not be guaranteed by the government. I have not yet been able to put th is concept to g eth er in my mind. I a p p re c ia te the thought th a t th ere could be advantages in such a u th o r itie s borrowing on a tr u ly commercial b a s is. I t is the 'a f t e r s ' th a t concern me. I f a p riv a te commercial borrower f a i l s, the prudent lender can have recourse to sa le of the bu sin ess as a whole or of p a rtic u la r a s s e ts to recoup some of the funds advanced. What would happen in the case of f a ilu r e of a non-guaranteed commercial s ta tu to ry a u th o rity? Would government step in a f t e r a l l, d e featin g the purpose of the exercise? Could the b u siness be sold to the h ig h e st bidder and move in to the p riv a te sector? These m a tte rs bear on a couple of p o in ts ra ise d in e a r l ie r papers. One was about the r e la tiv e c a p a c itie s of p riv a te e n te r p ris e s and public e n te r p ris e s to make good investm ent d e c is io n s. If we assume eq u ally good d e c is io n s, th ere remains the question of how m istakes are d e a lt w ith. I th in k th a t the p riv a te se c to r g e n e ra lly would close out the d isap p o in tin g p ro je c t e a r l i e r. Ownership can also be re le v a n t to c o n sid eratio n of fo reig n borrow ing. If an o v erseas-fin an ced p riv a te p ro je c t f a i l s, the fo reig n lender lo s e s. If a governmental p ro je c t f a i l s, the n atio n s t i l l has to pay the fo reig n lender although no increased cap acity to pay has re su lte d from the fin an cin g. Standing back a l i t t l e fu rth e r from the d iscu ssio n about commercial semigovernment a u th o r it ie s, a t some stage the case for having them tre a te d lik e p riv a te b u sin esses r a is e s the question whether i t would be b e tte r th a t they were p riv a te b u sin esses. Indeed, the concept r a is e s p re tty deep is s u e s. One o ther p o in t. The argument has been put fo r giving more o p p o rtu n ity for lo c a l and semi-government a u th o r itie s to borrow sh o rt. I was a b it su rp rised a t th is because th e ir sh o rt borrowing seems on casual observ atio n to have been in creasin g a good d e a l. I have drawn out the dangers in h eren t in the shortening of d e b t. The disadvantages a tta c h in g to shortening of debt are lik e ly to be more worrisome fo r lo c a l and semi-government a u th o r itie s than fo r the Commonwealth. I t would be d e s ira b le th a t, when longer-term finance is d i f f i c u l t to g et or u n a ttra c tiv e ly d e a r, a lo t of thought be given to in creasin g cash flow or reviewing expenditure ra th e r than simply sh o rtening the d ebt

77 Conclusion This seminar has brought out the importance of government borrowing and has provided an opportunity to identify and discuss problems and concerns from varying points of view. That is valuable. I commend Mr Bain's paper for its important contribution to that process. At the market end of the process, he represents the real world rather than the wished-for world. Coming to terms with that real world is basic to successful debt management

78 VI MEASURES OF PUBLIC SECTOR BORROWING AND INDEBTEDNESS J.P. McAuley This comment i s addressed to the im portance of having a v a ila b le su ita b le measures of the o v e ra ll impact of public secto r fin a n c ia l o p eratio n s on c a p ita l m arkets and the economy. This m atter has a bearing on the question whether borrowing by 'com m ercial' public a u th o r itie s should be e n tir e ly removed from su rv e illa n c e by the Loan Council. N et B orrow ing a rd N et D ebt There is a need for co n sisten cy and p recisio n in the d e fin itio n s of public secto r net borrowing and net debt i f th e ir impact on c a p ita l m arkets is to be fu lly understood. The public s e c to r 's annual net borrowing is the excess of i t s to t a l (c u rre n t plus c a p ita l) expenditure over c u rre n t re c e ip ts. Net borrowing is also measured by the excess of borrowing through the issue of s e c u r itie s or o th er loan ra is in g over lending to o ther s e c to rs. In c o n s is te n t fa sh io n, the net debt of the public secto r rep resen ts the o utstanding accum ulation a t a given d ate of a ll past annual net borrowing. I t thus com prises to t a l l i a b i l i t i e s le s s fin a n c ia l a s s e ts, the l a t t e r including loans made to o th er s e c to rs, s e c u r itie s and cash held. Net borrowing in th is sense corresponds to the term used in the Reserve Bank's flow -of-funds s t a t i s t i c s and c o n tra s ts with the accounting d e f i c i t. This is the cause of some confusion because the Commonwealth Budget d e f i c i t, as defined in Budget Papers and A u stralian Bureau of S t a t is ti c s (ABS) p u b lic a tio n s, is augmented by n et advances to o ther se c to rs. On the o th er hand, the d e f i c i t s of S tate and lo c a l a u th o r itie s in ABS p u b lic a tio n s are not reduced by the in c lu sio n of n e t advances from the Commonwealth as c u rre n t re c e ip ts. To be c o n s is te n t in p rin c ip le and to provide the most meaningful measure of public se c to r indeb ted n ess, i t would be p referab le to follow the Reserve Bank's p ra c tic e of in cluding advances to or from other secto rs as financing item s. Net advances are p a r tic u la r ly im portant in a fed eral system. In the context of government p o lic ie s concerned with balancing the Commonwealth Budget or keeping the d e f i c i t as low as p o ssib le i t is unreasonable to have repayable advances made to o th er se c to rs exaggerate the out-o f-b alan ce p o s itio n. Of c o u rse, fo r the public se c to r as a whole, in tra -p u b lic se c to r advances co n so lid ate to zero, leaving only net advances from the public to the p riv a te and overseas s e c to rs as a financing (neg ativ e borrowing) item and as an o ff s e t to the public s e c to r 's borrowing from the p riv a te and overseas s e c to rs. To be r e a l i s t i c, indebtedness needs to be defined and measured on net b a sis; to ta l g ro ss l i a b i l i t i e s alone are q u ite u n sa tisfa c to ry as a measure of public se c to r ind eb ted n ess. L i a b i l i t i e s may increase continuously but the serv icin g burden may w ell have equal o f f s e ts from fin a n c ia l a ss e ts accum ulating p a r i p a s s u. I t is thus the net debt which is m eaningful. Although fig u res for public secto r annual net borrowing are av ailab le from published s t a t i s t i c s, o f f i c i a l estim ates of accumulated net debt outstanding are not published a t a l l. They a re, however, capable of being - 69-

79 c a lc u la te d and have been estim ated from C e n tre 's Research Monograph No 34.* 1927 onwards by the w rite r in the Both annual net borrowing and accum ulated net debt are thus a v a ila b le an n ually for each su b -se c to r w ith in the t o t a l pu b lic se c to r. T his means th a t i t is p o ssib le to a s c e r ta in the d i s t r i b u ti o n of public indebtedness by categ o ry of public a u th o r ity. The r a tio of n et debt to g ro ss dom estic product (GDP) provides a b e tt e r in d ic a tio n of tren d s than the h ig h ly v a ria b le r a t i o of annual n e t borrowing (o r government d e f i c i t s ) to GDP. Changes in A u stra lia n P ublic S ecto r Indebtedness During the post-w ar p e rio d, the n et debt of the public se c to r ( t o t a l l i a b i l i t i e s le s s fin a n c ia l a s s e ts ) a c tu a lly f e l l r e la tiv e to GDP u n til T h e re a fte r, the r a t io began to r i s e, but the in crease was a tt r i b u ta b l e w holly to the Commonwealth s e c to r, w ith the r a t io s of S tate and lo c a l n et debt to GDP continuing to f a l l. The in c re a se in the Commonwealth r a t io was due p a rtly to heavy n et borrowing by Telecom and o th er Commonwealth non-budget a u th o r itie s and p a r tly to the Commonwealth Government's own budget d e f i c i t s since P ressure on c a p ita l m arkets for funds during the past ten y ears or so has thus come m ainly from the Commonwealth s e c to r, ra th e r than from S tate and lo c a l a u t h o r i t i e s. The r a tio of Commonwealth n et debt to GDP rem ains h igher than a t any tim e since the 1950s, w hile the r a t io for S tate and lo c a l governments in to t a l i s le s s than o n e -h a lf of the le v e l of the 1950s. The Commonwealth Budget s e c to r, which was a p a r t ic u l a r ly heavy borrower in the la t e r 1970s, by 1981 had run down most of the n et su rp lu s (excess of fin a n c ia l a s s e ts over l i a b i l i t i e s ) which i t had accum ulated since World War I I. These h is to r i c a l tre n d s o f the r a t io of public se c to r n et debt to GDP and i t s d is tr i b u ti o n by type of public a u th o r ity need to be taken in to account in a sse ssin g the e x te n t of the demands of the public se c to r on the n a tio n 's c a p ita l m arkets and on reso u rces in the economy g e n e ra lly. F actors In flu e n c in g High I n te r e s t R ite s W hilst the public s e c t o r 's r a t io of n et debt to GDP has increased by comparison w ith the mid-1970s and to th is e x te n t has added to pressure on c a p ita l m arkets, i t i s d o ubtful whether th is has had more than a m arginal in flu en ce on in t e r e s t r a t e s, in c re a se s in which have been more a tt r i b u ta b l e to such fa c to rs as: (a) (b) the in flu en ce of high r a te s o v erseas; in v e s to rs ' ex p e c ta tio n s about co n tinuing in f la tio n and th e ir demands for hig h er in t e r e s t to compensate fo r in f la t io n and for the r i s k of fu tu re in c re a se s in in t e r e s t ra te s ; The S tru c tu re o f A u stra lia n P ublic D ebt, D istrib u te d by ANU P ress, C anberra,

80 (c) the p a r t i a l d e re g u la tio n of bank in t e r e s t r a t e s and the p a r t ia l fre e in g of some c a p tiv e m arkets; and (d) the sh o rten in g of average m a tu r itie s of public s e c u r iti e s. Borrowing by Corrmercial Public A uthorities With re s p e c t to the q u estio n of the removal of the borrowing of commercial pu b lic a u th o r it ie s from the s u rv e illa n c e of the Loan C ouncil, an im portant m a tte r fo r c o n sid e ra tio n is the li k e ly e f f e c t on c a p ita l m arkets and in t e r e s t r a t e s. An a ss o c ia te d m atter i s the proposal of the Campbell Committee th a t borrowing by o th e r (non-com m ercial) lo c a l and semi-government a u th o r it ie s be su b je c t to Loan Council su rv e illa n c e only in re s p e c t of the volume of annual borrow ing, not c o n d itio n s. Such a system would place g re a te r re lia n c e on the use of r e s tr a i n ts imposed by m arket a p p ra is a l of the p r i o r i t i e s of pu b lic se c to r borrow ing. The outcome of th i s would probably be th a t the stro n g e r commercial a u th o r it ie s would command more and weaker a u th o r it ie s le s s borrow ing. Such a system would be li k e l y to r e s u lt in somewhat g re a te r crowding out of p riv a te s e c to r borrow ing, and th i s would have to be balanced a g a in s t any increased measure of f in a n c ia l r e s p o n s ib ility imposed on the p u b lic a u th o r it ie s

81 V II CONCLUDING COMMENTARY P. G roenew egen The Role o f P ublic S ecto r Borrowing Mr S c o t t ' s h i s t o r i c a l a c c o u n t o f a t t i t u d e s by e c o n o m is ts to p u b lic b o rro w in g m u st be q u e s tio n e d in a num ber o f r e s p e c t s. Up to and i n c lu d in g th e tim e o f Adam S m i t h,* g o v ern m en t b o rro w in g was u n d e r ta k e n f o r e x t r a o r d i n a r y e x p e n d i t u r e s o n ly ( a l t h o u g h in 1 8 th c e n tu r y E n g la n d, war was h a r d l y an e x t r a o r d i n a r y e v e n t ). S in k in g fund r e q u ir e m e n ts w ere d i s c u s s e d from th e e a r l y 1 8 th c e n t u r y o n w a rd s. B orrow ing f o r r e p r o d u c ti v e w orks w ere n o t r e a l l y a d m itte d by S m ith, who b e l i e v e d in th e u s e r pays p r i n c i p l e f o r r o a d s and b r i d g e s a s w e ll a s f o r e d u c a t i o n. T h is a t t i t u d e ch an g ed d u r in g th e 1 9 th c e n t u r y, when a second c r i t e r i o n f o r w a r ra n te d p u b l i c b o rro w in g was in tr o d u c e d. T h is was b o rro w in g f o r r e p r o d u c t i v e p u b l i c w o rk s, w h ich w ere s e l f f i n a n c i n g and t h e r e f o r e a u t o m a t i c a l l y p ro v id e d f o r a m o r t i s a t i o n o f th e d e b t. T h is was th e p o s i t i o n in th e l i t e r a t u r e from J. S. M ill ( i f n o t e a r l i e r ) to B a s ta b le and P ig o u. The t h i r d c h a n g e came w ith th e s, when p u b l i c d e b t came to be r e g a r d e d a s s e l f f i n a n c i n g i f used to s u p p o r t p u b lic w orks w h ich c r e a t e d em p loym ent. K eynes d e v e lo p e d t h i s id e a w ith H en d erso n in , and Meade and Kahn ( i n th e l a t t e r ' s fam ous m u l t i p l i e r a r t i c l e ) w orked o u t th e m a th e m a tic s. T h is a l s o le d to d e v e lo p m e n ts in th e t h e o r y o f th e i n t e r - g e n e r a t i o n a l t r a n s f e r o f th e b u rd e n o f th e p u b lic d e b t. I t was a rg u e d t h a t o n ly e x t e r n a l d e b t b u r d e n s c o u ld be t r a n s f e r r e d to th e f u t u r e, th e b u rd e n o f d o m e s tic d e b t b e in g b o rn e by th e p r e s e n t g e n e r a t i o n ( a l t h o u g h th e t r a n s f e r pay m en ts o f i n t e r e s t and th e ta x r e v e n u e s r e q u i r e d to pay f o r them had d i s t r i b u t i o n a l e f f e c t s w h ich c o u ld i n f l u e n c e c a p i t a l a c c u m u la tio n and t h r i f t ). T h is q u e s t io n o f i n t e r - g e n e r a t i o n a l b u r d e n s i n r e l a t i o n to extern al d e b t h a s im p o r ta n t i m p l i c a t i o n s f o r f e d e r a t i o n s and r e g i o n a l o r l o c a l b o r ro w in g, w here b o rro w in g by one r e g i o n in a n o th e r r e g i o n can be t r e a t e d a s e x t e r n a l d e b t. In th e p o s t- w a r p e r i o d, K e y n e s ia n a n a l y s i s h a s b e e n c h a lle n g e d by B u c h a n a n.^ T h is c h a l l e n g e was c o n c e rn e d w ith th e q u e s t io n o f i n t e r - g e n e r a t i o n a l b u rd e n t r a n s f e r s, and r a i s e d com plex t h e o r e t i c a l i s s u e s w hich h a v e n o t y e t b e e n s e t t l e d a f t e r w e ll o v e r a d e c a d e o f d e b a te.-^ A n o th e r c h a l l e n g e r e s u l t e d from th e c r i t i c i s m o f c o m p e n s a to ry f in a n c e in s i t u a t i o n s o f ' s t a g f l a t i o n ' by m o n e t a r i s t s and o t h e r s ; an i n t e r e s t i n g v ie w i s p ro v id e d by Jo h n S to n e in h i s 1979 p a p e r on th e B udget d e f i c i t. ^ A gain i n my v ie w t h e s e i s s u e s h a v e n o t b een f u l l y s e t t l e d, s i n c e c o u n t r i e s l i k e Ja p a n h av e l a r g e d e f i c i t s r e l a t i v e to g r o s s d o m e s tic p r o d u c t (GDP) ( i n f a c t J a p a n h a s 1 The Wealth o f N a tion s, ( ), Book V, C h a p te r 3, Random H o u se, I n c., New Y o rk, ^ P ublic P rin c ip le s o f the Public D ebt, I r w i n, Homewood, I l l i n o i s, ^ T h ese a r e su m m arise d w ith r e f e r e n c e s in my t e x t, Public Finance in A u stra lia : Theory and P ra c tic e, P r e n t i c e H a ll o f A u s t r a l i a P ty L t d., S y d n ey, , C h a p te r 7. ^ C e n tr e f o r A p p lie d Econom ic R e s e a rc h a t th e U n i v e r s i t y o f New S o u th W a le s, R e s e a rc h P a p e r No. 7, S y d n ey, , pp

82 the la r g e s t among OECD c o u n trie s) combined with r e l a ti v e ly few problems w ith in f la tio n and unemployment. There seems to be more to th i s issu e than a s im p lis tic a s s o c ia tio n between d e f i c i t s and in f la t io n r a t e s. Of relevance in th is c o n te x t, a ls o, is K ald o r's econom etric study which does not find any strong s t a t i s t i c a l re la tio n s h ip between the public se c to r borrowing requirem ent and money supply for the U nited Kingdom.^ Borrowing fo r N ational Development In commenting on Mr H ie ls c h e r's p aper, I f i r s t endorse h is remarks about the complementary n atu re of public investm ent arvd p riv a te investm ent. If th e re are lesso n s to be learned from economic h is to r y, th i s i s su re ly one of them, as P ro fesso r N.G. B u tlin so c le a rly dem onstrated in h is a n a ly s is of the com plem entarity which c h a ra c te rise d A u stra lia n public and p riv a te investm ent in te r r e la tio n s h ip s between 1860 and 1890.^ Secondly, I support Mr H ie ls c h e r s remarks about the dangers which ris in g in t e r e s t payments pose fo r governments in r e la tio n to th e i r re c u rre n t ex p en d itu res. H ielscher mentioned a fig u re of 10 per cent of C onsolidated Revenue, which is alread y very high although le s s than the p ro portion reached during the Great D epression. In th is co n tex t P ro fesso r Kenneth Boulding re c e n tly re fe rre d to the p o s s ib il it y th a t, in the United S ta te s, in t e r e s t payments as a pro p o rtio n of c u rre n t ex penditure may soon be g re a te r than w elfare spending in the form of cash b e n e fits. In re sp e c t of public a u th o r ity spending as a whole, th i s is also w ith in the realm of p o s s ib il it y for A u s tra lia. However, I am su rp rised at Mr H ie ls c h e r's statem ent th a t the purpose of Commonwealth borrowing is r e s tr i c te d to macro-economic po licy o b je c tiv e s, presumably through debt management and a sso c ia te d monetary p o lic y. This ignores Commonwealth borrowing fo r defence purposes, which is accorded sp e c ia l treatm ent by the Loan Council and which c u rr e n tly accounts fo r a s u b s ta n tia l part the d iffe re n c e between the to t a l Commonwealth Budget d e f i c i t and i t s domestic Budget d e f i c i t. Secondly, i t ig nores Commonwealth borrowing for development purposes, which since has la r g e ly been undertaken by non-budget a u th o r itie s such as Telecom and the P o stal Commission. The H ielscher paper also id e n tif ie d two im portant is su e s re la te d to public borrowing which ra is e a wide spectrum of d i f f i c u l t side is s u e s. These are the q u estio n s of ta x a tio n versus borrowing and of ap p ro p riate pu b lic u t i l i t y p ric in g p o lic ie s. The l a t t e r r a is e s d is tr i b u ti o n a l issu e s of co n sid erab le im portance. F inancial Planning in P ublic E n terp rises Mr H u rley 's paper was of co n sid erab le in t e r e s t because i t provided a p r a c t i t i o n e r 's view of the problem of public borrowing from a d if f e r e n t Cambridge Journal o f Economics, Vol. 5, No. 1, March N.G. B u tlin, In vestm en t in A u stra lia n Economic Development , Cambridge U n iv ersity P ress, Cambridge, At a symposium held during the 52nd ANZAAS C ongress, Macquarie U n iv ersity, Sydney, May

83 p e rs p e c tiv e from th a t of the H ie lscher and Bain papers. Although Mr Hurley appeared to support Mr H ie ls c h e r 's co n ten tio n on the com plem entarity of public and p riv a te investm ent, he also argued, or appeared to argue, th a t public investm ent is in f e r io r in some re s p e c ts to p riv a te e n te rp ris e (th e p o in t seems to be a sso ciate d w ith the tr ic k y d e f in itio n s of o p tim a lity and e f f ic ie n c y, which are very d i f f i c u l t to handle in a n o n -p e rfe c tly com petitive framework). In th a t co ntext Hurley re fe rre d to a n o tio n of com petitive n e u tr a li ty, which has been given con sid erab le im portance by the Campbell Committee of In q u iry in to the A u stralian F in an cial System. This notio n cannot be taken very se rio u sly because i t s u ffe rs from many th e o r e tic a l d i f f i c u l t i e s and many m isunderstandings about the n atu re of public e n te r p ris e s (which the Committee in v a ria b ly wished to tr e a t as i f they were c a p i t a l i s t commercial e n te r p r is e s ). The s u b s ta n tia l d iffe re n c e s between public and p riv a te e n te rp ris e s influ en ce a v a rie ty of m atters re la tin g to public investm ent and borrowing. Public Sector Borrowing and the Capital Market My main concern w ith re sp e c t to Mr B ain 's paper r e la te s to the underlying th eo ry, p a r t ic u l a r ly h is excessive and o p tim is tic f a i th in the e ff ic ie n c y consequences of f r e e, com petitive m arkets. One issue is the qu estio n of the size of the Budget d e f i c i t and i t s economic e f f e c ts. R elative to GDP, A u s tr a lia 's d e f i c i t is now q u ite low. I t is much lower than th a t of Japan, for example, yet Japanese in t e r e s t ra te s are lower and Ja p a n 's economic performance is su p e rio r to th a t of A u s tra lia. Furtherm ore, Mr B ain 's comments on the f u l l employment Budget concept, although most ap p ro p riate from the f in a n c ia l point of view, tend to suggest th a t th is concept has l i t t l e to o f f e r. This is not the case. Among o th er th in g s, i t provides one index of the c o st of the s u b s ta n tia l unemployment which A u stra lia has experienced since The most in t e r e s tin g aspect of the Bain paper is i t s f a i th in the e q u ilib r a tin g p o te n tia l of com petitive unregulated fin a n c ia l m arkets, which flows from the arguments about the re tu rn on A u stra lia n Savings Bonds (ASBs) being too low and u n a ttra c tiv e r e la tiv e to re tu rn s on close s u b s titu te s such as b u ild in g s o c ie ty d e p o sits and cash management t r u s t s. What happens when the ASB r a te is raised? When the f i r s t s e rie s was issued in 1976, we saw one p o ssib le answ er. Other ra te s responded ra p id ly and the Savings Bond ra te was reduced. The old d i f f e r e n t i a l s were th e re fo re quickly re sto re d but in te r e s t ra te s moved up in the p ro cess, w ith no re a l economic b e n e fits but with serio u s d is tr i b u ti o n a l consequences. Under c e rta in assum ptions, which in clude a r e l a t i v e l y in t e r e s t - e l a s t i c saving fu n ctio n and perhaps a r e l a ti v e ly i n t e r e s t - e l a s t i c demand fu n ction fo r c e rta in types of fin a n c ia l a s s e ts, an eq u ilib riu m p o sitio n can be shown to e x is t which c le a rs a l l the fin a n c ia l m arkets sim ultaneously. Such a p o sitio n also assumes p a in le ss and alm ost in sta n ta n e o u s adjustm ent c o sts fo r the p a r tic ip a n ts, which in m arkets such as those fo r housing finance are never re a lis e d in p ra c tic e. The im p lic it acceptance of th is th e o r e tic a l framework w ithout the many concessions req u ired to make i t apply to the A u stralian s itu a tio n is one of the major w eaknesses of the Report of the Campbell Committee

84 Public Sector Borrowing in Australia edited by R.L. Mathews T h is b o o k c o n s id e rs a num ber of recent developm ents and issues affecting A u s tra lia n p u b lic se c to r borrowing, including: criteria for borrowing; the present and future role of the Australian Loan Council; the relationship between public sector borrowing requirements and public debt management, the role of the Reserve Bank with respect to the relationship between government borrowing operations, monetary policy and the marketing of Commonwealth securities; and the role of the market in meeting the borrowing requirements of different levels of govern m en t and d iffe re n t kinds o f p u b lic authorities. Individual chapters are presented from the perspective of a State Treasury, a State commercial and semigovernment authority, a market practitioner the Reserve Bank and a State Dank. RL. Mathews is Director of the Centre for Research on Federal Financial Relations in the Australian National University. He is also a member of the Com monwealth Grants Commission. Distributed by ANU Press PO Box 4 Canberra ACT 2600 Australia Designed by ANU Graphic Design ISBN