THE TROUBLE WITH FISCAL-DEBT FIXATION Comment on The Let s Kick Joe Fest Is Damaging Australia 1

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1 THE TROUBLE WITH FISCAL-DEBT FIXATION Comment on The Let s Kick Joe Fest Is Damaging Australia 1 This comment on Vanstone s comment is intended to direct attention toward an understanding of the problem, and hence to open the way for solutions, rather than to create another posse to throw sticks and stones at the present posse of Joe Hockey s kickers. Amanda makes notable remarks about the National Commission of Audit Report, to which she was a contributor. But much of the resulting goodwill is lost with the use of hackneyed expressions that have become catchwords for conservative ideology, such as mountain of debt, inter-generational theft, and one that is new to me a rosecoloured-glasses Mary Poppins sort. The last of these does not fit well since the fictional Mary Poppins did not need tinted glasses to alter her perception of reality she used magic and self control to change it. If Joe Hockey had that magic, neither Amanda s comment nor mine would be needed. 2 A fiscal-debt fixation arises from a laser-beam focus on accumulated debt arising from deficits in the fiscal budget to the exclusion of other economic factors that contribute either directly or indirectly to the nation s wealth. All debts, both government and private sector, are assessed on the basis of the capacity to manage the debt, which normally depends on income and wealth. For example, net government debt for Australia, as projected by the International Monetary Fund for the current calendar year, is $254.8 billion. This would sound like a lot if it is to be managed by someone with a household budget of $58,000 per year, which is said to represent a reasonable standard for Australia at the present time. 3 But if we extend the management of the debt to the national level and compare it with the estimated wealth of the nation at the end of this year, the IMF s projected debt for Australia amounts to about 2.9 per cent of total wealth. 4 Should we worry about that amount? Not at the present time, but we should worry if the percentage rises at an increasing rate. This means that horror stories caused by excessive debt are, at the moment, as imaginary as Mary Poppins, and could remain that way if the debt were properly managed. 1 Amanda Vanstone s comment was published in The Age on 8 December Available at: 2 It must be said, in fairness, that Vanstone probably looks upon those who believe Mary Poppins effects are possible are the ones wearing rose-coloured glasses. It is they, according to Vanstone, who have lost touch with reality and fail to see the folly of spending as if there is no tomorrow. It almost certainly applies to some people. 3 Trish Power, A Comfortable Retirement: How Much Super Is Enough, SuperGuide, 27 April Available at: 4 Total wealth for Australia in 2014 is estimated by Credit Suisse to be USD 7,202 and, as noted above, the International Monetary Fund estimated that net government debt would be about AUD billion. Converting these into common currency units using 1 AUD = 0.82 USD gives that percentage stated. Refer to Credit Suisse, Global Wealth Databook 2014, October Available at: and the International Monetary Fund s World Economic Outlook Database, October 2014, can be downloaded at 1

2 Debt management requires us to decrease the debt or increase the amount of wealth for Australia, or both. The last of these is obviously preferable, especially if decisions as to how much and when to decrease the amount of net government debt have an impact on the ability to accumulate national wealth. This is where the laser beam mentality can produce sub-optimal results. We increase the amount of national wealth by investing in activities that are expected to yield a return, which may be a direct monetary gain (profit) or an indirect contribution to wealth through productivity improvements. Place these activities into five categories and call each one a form of capital: 5 natural capital, including natural resources that require investment funds for maintenance purposes; physical capital, including all forms of economic infrastructure (buildings, roads and power supplies) that are needed for the operation of enterprises and for the functioning of society as a whole; financial capital, including financial assets (net of obligations) resulting from foreign trade and from domestic market transactions; human capital, including the skills, knowledge and experience embedded in the citizens of a nation, as well as technology that has not yet become embedded; social capital, including institutions of the state and the non-government organisations that have the principle purpose of providing order, stability and protection for civil society. Each of these forms of capital requires input from governments either through direct control (ownership or in partnership with private sector organisations) or through a regulatory system. Natural capital is viewed as gifts of nature but financial outlays to maintain, protect and preserve them are nevertheless required. This category is particularly critical to inter-generational equity since many varieties of natural resources are nonrenewable. Substantial investment may then be required to ensure that the total stock of this form of capital is not significantly diminished in quantity or quality for future generations. As stated by E Brown Weiss: 6 In Fairness to Future Generations argues that we, the human species, hold the natural environment of our planet in common with all members of our species: past generations, the present generation, and future generations. As members of the present generation, we hold the earth in trust for future generations. At the same time, we are beneficiaries entitled to use and benefit from it. 5 This is an oversimplification; the selected categories are not unique and not all of the relevant activities would fall into the normally accepted definition of capital. See especially the section on the meaning and measurement of capital in Avi J Cohen and G C Harcourt, Whatever Happened to the Cambridge Capital Theory Controversies? Journal of Economic Perspectives, Vol. 17, No. 1 (Winger 2003), pp Available at: 6 Edith Brown Weiss, Our Rights and Obligations to Future Generations for the Environment, American Journal of International Law, Vol. 84, No. 1 (January 1990), pp ). 2

3 Governments are placed in the spotlight with regard to physical capital as a result of ownership of infrastructure (about $92 billion as at December ), partnerships with private sector organisations or as regulators. No systematic plan has been undertaken as to the ways and means of preserving the integrity of the nation s infrastructure for future generations. Rather, recent attention has been given to a consideration of selling existing infrastructure assets in order to finance the construction of future infrastructure assets. This focus is of course part of the single-minded pursuit of debt reduction. Selling-to-build activities may indeed contribute substantially to the long-term growth in the nation s wealth for the current and future generations, but that has not yet been determined. The turnover in Australian for financial capital during the financial year was $135 trillion. 8 The major items traded include shares of stock, bonds, money-market instruments and derivatives markets. There are also other markets in the financial system that facilitate the trading of specific financial products, such as electricity derivatives. The turnover of Australian government bonds during the fiscal year cited above was $1.78 trillion, 9 or 1.31 per cent of the total financial market turnover. While the amount of sales and the resulting interest rates on the bonds are taken as important market indicators, the remaining per cent of turnover deserves at least some attention. An assessment by the International Monetary fund in indicated that the Australia s financial system is sound, resilient and well managed, but a number of risks will need to be closely managed and there is room for improvement in the government s own stress testing processes. 11 This is not a substantial problem, but it should not be neglected entirely. Human capital cannot be estimated in summary form; it is the accumulation of many qualitatively different inputs associated with education, training and technological diffusion. Changes in the stock of human capital, and the consequences thereof, can nevertheless be examined periodically, particularly in connection with the assessment framework for all levels of education including technical school training. A recent evaluation by the Organisation of Economic Cooperation and Development is informative: 12 7 Australian Government, Infrastructure Australia, Update Paper: Balance Sheet of Sell to Build, December Available at: e_paper.pdf 8 Australian Financial Markets Association, 2013 Australian Financial Markets Report, unnumbered page before page 1. 9 Ibid, p Australia: Financial System Stability Assessment, IMF Country Report No. 12/308, 26 October Available at: 11 Ibid, p Paulo Santiago, Graham Donaldson, Joan Herman and Claire Shewbridge, OECD Reviews of Evaluation and Assessment in Education: Australia, August 2011, p. 9 (Italics in the quoted portion were added). Available at: 3

4 The overall evaluation and assessment framework appears as highly sophisticated and well conceptualised, especially at its top level (national and systemic levels). However, there is a less clear articulation of ways for the national agenda to generate improvements in classroom practice through the assessment and evaluation procedures which are closer to the place of learning. Moreover, striking the right balance between nationally-dictated policies and ability to meet local needs is a challenge and there is room to improve the integration of the nongovernmental sector. Realising the full potential of the overall evaluation and assessment framework involves establishing strategies to strengthen the linkages to classroom practice. A major step in this direction would be a national reflection about the nature and purpose of evaluation components such as school evaluation, teacher appraisal and student formative assessment within the overall education reform strategy and the best approaches for these evaluation components to improve classroom practices. Similar to the evaluation and assessment framework, the overall education reform strategy for Australia has not been fully articulated, and is apparently unrelated to projections of human capital requirements in the current decade. Inter-generational equity will clearly suffer if educational standards decline and the future stock of human capital subsequently becomes inadequate to capture the opportunities for employment and productivity enhancement in the years ahead. Social capital is difficult to define and impossible to measure. Nevertheless, it comprises an investment in both time and money that should yield at least as much for future generations as it has in the past. Plans to achieve this for some (perhaps most) institutions of the state are non-existent. For example, the legislative branch of all national governments in the Anglo sphere is under severe pressure as a result of rapidly declining confidence in legislatures as major institutions of the state. I have no specific suggestions for a solution, but it would seem obvious that the fiscal-debt fixation is making things worse rather than better. Perhaps all political parties should undergo a comprehensive evaluation of their values and belief systems. Only then can a comprehensive plan emerge and only with such a plan can the economic growth/national debt problems be solved. John Zerby j.zerby@bigpond.com 15 December

5 ANNEX: NET GOVERNMENT DEBT AND OTHER DATA IN DETAIL Net debt is calculated as gross debt minus financial assets that can easily be converted into cash to reduce the debt if and when desired. They include monetary gold and statutory drawing rights, currency and deposits, debt securities, loans, insurance, pension, and standardised guarantee schemes. The data for the following analysis were obtained from the most recent database of the International Monetary Fund (IMF), which is available online at: The normal practice is to express the net debt as a ratio of gross domestic product (GDP) in order to facilitate international comparisons, as well as comparisons over time, with the ratio interpreted as the total net debt relative to the nation s annual output. 13 This is shown in Chart 1 for Australia, Canada and the United Kingdom. The percentages for 2014 to 2019 are estimated by the IMF from information supplied by the treasury departments of the respective governments. They are of course based upon assumptions concerning future events for which current trends comprise the only reasonable basis for projection. These trends can change substantially within any calendar year, leading to revisions by the IMF staff Chart 1: Net Government Debt Per cent of gross domestic product Keating Howard Rudd/Gillard Abbott Australia Canada United Kingdom Source: IMF, World Economic Outlook Database, October Gross domestic product is used rather than wealth since the latter estimates are taken as less reliable for international comparisons. 14 The Commonwealth Treasurer reported in the recent Mid-Year Economic and Fiscal Outlook that the new forecast for the fiscal deficit for the current financial year is $40.4 billion, or $10.6 billion worse then the May budget prediction. The next IMF projections will therefore be altered accordingly. The test for the nation s economic managers is to initiate actions now that result is a lower deficit and a greater-than-forecast level of economic growth. The MYEFO is available at: 5

6 The chart on the previous page indicates that Australia s ratio of net debt to GDP was expected to peak at 16.9 per cent in 2016 and that is less than the highest ratio of 23.2 per cent attained during the Keating period in (Note that the chart places the value at the mid-year point, but it applies to the debt accumulated during the entire year.) The chart shows clearly that the net debt ratio rose in the years that the Labor Party formed government, and fell while the Coalition was in power. It would appear that Labor governments comprised the bigger spenders, and this is examined in greater detail with Chart 2 on the next page. Before leaving Chart 1, a comparison with Canada and the United Kingdom is informative. Compared to the red and green lines in the chart, Australia s net debt ratio more closely resembles two mole hills than mountains. The net debt ratio was moderately high for the UK when the financial crisis occurred (38.3 per cent in 2007) and rose to 61.9 in 2007, several months before David Cameron formed a governing coalition of his Conservative Party with the Liberal Democrats. The ratio continued to rise and was expected (again in October) to peak at 84.8 per cent of GDP in Canada experienced a relatively high net debt ratio of 71.9 per cent in 1995, well above Keating s highest of 33.5 per cent in The Canadian prime minister from November 1993 to December 2003 was Jean Chrétien, who inherited the debt from the Trudeau and Mulroney eras. 15 Chrétien s finance minister was Paul Martin, and he became prime minister of Canada in Martin initiated an austerity program early in the period with substantial reductions in military spending. The task of reducing the net debt ratio during the second half of the Howard period was facilitated for both Australia and Canada by the increased exports from the respective mining sectors. This is highlighted for Canada by the substantial drop in general government total expenditures, as a ratio of GDP, as shown in red in Chart 2, until Per cent of gross domestic product Chart 2: General Government Total Expenditure Keating Howard Rudd/Gillard Abbot Australia Canada United Kingdom 15 A useful summary of the economic and political conditions during Chretien s prime ministership is available in Wikipedia at 6

7 Source: IMF, World Economicc Outlook Database, October 2014 As noted previously, the net debt ratio increased in Australia with Labor governments and decreased with Coalition governments. But the Keating and Rudd/Gillard governments did not spend substantially more out of current GDP then the Howard and Abbott governments, with the latter being based on October 2014 projections. The period averages are shown on the next page, with yearly values shown on Chart 3: Keating Howard Rudd/Gillardd Abbott (projected) per cent of GDP per cent of GDP per cent of GDP per cent of GDP Per cent of gross domestic product Keating Chart 3: General Government Revenue Howard Rudd/Gillard Australia Canada United Kingdom Abbott This is not consistent with the conservative s catchwords and phrases: reckless spending, spending more than necessary, spending as if there is no tomorrow. But that cannot be correct, some might say; everyone knows that Labor governments spend more. Yes, they often did, but not in the Keating years and only slightly more than in the Rudd/Gillard years. But it does not add up, the conservatives are likely to say; how can the debt ratio increase without reducing spending? The answer is obvious. Government revenuee could be falling and thus bring down the government s fiscal balance. That balance was in deficit for all of the Keating years and for the first of the Howard years as seen from Chart 4. Depicted below are the average fiscal balances for the four periods as a per cent of GDP: Keating Howard Rudd/Gillard Abbott (projected) Australia Canada UK

8 Per cent of gross domestic product Chart 4: Government Fiscal Balance Australia Canada United Kingdom An important point to notice from Chart 3, and from the period averages, is that the pattern of deficits and surplusses was much the same for Australia, Canada and the UK. The reason should again be clear: we live in a globalised world so economic growth rates of many of the OECD countries move in tandem. It is not sufficient to focus on only one of the three things that influence the net governement debt ratio. (These three things are: government expenditures, government revenue and gross domestic product, with the last being in the denominator of the resulting percentage.) All three should be considered, together with the way each relates to the others. This is not intended to suggest that government spending is unimportant in the assessment of fiscal responsibility. The UK represents a useful case in determining when increased spending may be inappropriate. It can be seen from Chart 2 that general government total expenditures increased from 34.7 per cent of GDP in 2000 to 39.8 per cent of GDP to From Chart 3, revenue fell slightly during the period, producing fiscal deficits immediately before the GFC occurred. This, together with other factors, 16 contributed to a substantially poorer fiscal balance in 2009, compared to Canada and Australia. The question as to how much the Rudd government overspent in its economic stimulus cannot be accurately determined since we cannot construct a series of parallel universes to measure it. The most we can do is look at average increases in government expenditures from, say 2006 to Other intervals of time could be used but this allows the use of 2006 as a base year before concerns of an impending crisis were experienced. Most of the advanced economies (as classified by the International Monetary Fund) completed 16 There are reasons to believe that government borrowing during the period prior to the GFC may have crowded out private investment. See Tejvan Pettinge, Government Spending under Labour at: Those reasons ceased to exist with the GFC when private sector investment fell sharply. 8

9 expenditure for their fiscal stimulus in 2008, but some continued into Choosing the latter as the terminal point allows these to be included. The arithmetic mean of the differences between the general government total expenditure as a per cent of GDP for the 32 advanced economies that increased their expenditure during the period was 5.24 percentage points. The largest difference was observed for Iceland with percentage points. The difference for Australia was 3.28 percentage points, well below the mean, and with a ranking of 44 from the largest. The objective of the increased spending among the advanced countries was to prevent an economic recession, or at least to reduce as much as possible the loss of economic growth as a result of the crisis conditions. The average difference between the annual growth rate of real gross domestic product between 2007 and 2009 is The smallest loss in GDP was experienced by Korea with 0.84 percentage points. The difference for Australia is 3.56, which ranks 5th after Korea. It is likely that the fiscal stimulus for Australia could have been managed more effectively and with less waste. But with a substantially smaller stimulus expenditure as a percent of GDP, compared to other advanced nations, and with a significantly smaller loss in GDP growth during the period, it seems unlikely that many other advanced countries did better. These comparisons for the GFC period reveal myths that continue to be perpetuated, and those myths are blocking the task of improving economic conditions in Australia now. They encourage everyone to dwell excessively on the past, to believe what they want to believe because that is easier, to ignore anything that conflicts with beliefs established in the past because doing otherwise creates disorientation, and to become even narrower in perspective because it is safer. It is unlikely that this comment will cause these myths to suddenly disappear, but hopefully it might begin to process of questioning why we have a tendency to cling to ideas and concepts that do not fit in with changing circumstances. 9