Where did all the money go?

Glyn Davis
G'day. I'm Glyn Davis and this is the Policy Shop, a place where we think about policy choices and today we ask where did all the money go?

Malcolm Turnbul;
There is nothing more unfair than saddling our children and our grandchildren with mountains of debt that we have created because our generation could not live within its means. If we aren't prepared to make the tough choices today, younger Australians, future generations will be forced to pay back the debt through a combination of higher taxes and a lower quantity or diminished quality of government services, in short through lower living standards than they would otherwise have enjoyed.

Radio presenter
Good luck and God bless you if you want to live in Mosman but if you're going to live in Mosman you’d better have a very good job because you're going to have to spend a lot of money to pay for the house if it's not given to you or you didn't inherit it. And that's just the reality. That's the reality biscuit. Eat it.

Politician
This budget is an economic plan. It's not just another budget. Australians know that our future depends on how well we continue to grow and shape our economy as we transition from the unprecedented mining investment boom to a stronger more diverse new economy.

Commentator
The sportsman in me says no guts no glory and it's time to have some courage, it's time to put ideas and plans and vision forward. To me the name Commonwealth of Australia is losing credibility because fewer and fewer people are experiencing that common wealth.

Glyn Davis
For over a quarter of a century Australia has escaped recession. It's a remarkable achievement, close to a global record. Yet despite continuous growth Australia scrambles to make ends meet. This is the eighth year of a national budget deficit. Treasurer Scott Morrison predicts it will be 2021 before we return to surplus and even this is a contentious forecast since the International Monetary Fund warns of a structural deficit. By 2020 it suggests Commonwealth spending will outstrip economic growth locking in a budget deficit of three per cent or around $50 billion a year if no action is taken.

Yet government as always is constrained. Income from the mining boom has cooled while low interest rates fuel a long and perhaps dangerous housing boom. Tax rises are always unpopular and changes to housing policy may produce some very unhappy losers. Always sobering for a federal government with the majority of only one seat when opposition and cross bench unite.

So with a Federal Budget due on 9 May, why does this wealthy nation find it so hard to balance the books and what economic policies should Australia consider?

Joining us on the line to discuss these questions is Honorary Professorial Fellow at the Melbourne Institute of Applied Economic and Social Research at the University of Melbourne, Professor Judith Sloan.

Judith, welcome to the Policy Shop.

Judith Sloan:
Thank you very much for having me.

Glyn Davis
Also on the line is Australian Laureate Fellow in Economics at the University of Queensland, Professor John Quiggin. John, welcome to the episode.

John Quiggin
Thanks, Glyn.

Glyn Davis
Let's start with the deficit. Judith, a deficit is a deficit, spending more than the government receives, but unlike most of us, government have broader options than simply tightening the belt. They can increase revenue or like some American administrations, they can simply decide that deficits don't matter and load debt onto future generations.

Can we start with this big picture? Where did the money go, what has to happen now and does the deficit matter?

Judith Sloan
I think the first point we have to bear in mind is that virtually every developed economy is running budget deficits and have run budget deficits for some time. In fact if we look at France they last ran a budget surplus in 1974.

We have to see this in context but I think there are reasons why we should be concerned about running a deficit but more importantly we should be concerned about where we're heading in terms of that gap between spending and revenue, particularly in the context of an ageing society.

I think budgetary challenges are alive and well and I guess to a degree will be a test in the forthcoming budget.

Glyn Davis
John, your assessment of the causes and the options open to government?

John Quiggin
Well I suppose obviously the reason we don't have a recession - I won't say obviously but certainly my view and Treasury's view at least [at] the time is because we undertook pretty substantial public spending at the time of the global financial crisis. Now since then we've been going along and you can reasonably argue that's worked its way through the system but we've never really had a boom since then.

I would say, picking up on Judith's point, it's important to remember that the natural position for the budget is a modest deficit. If you want to maintain a stable ratio of government debt to GDP that debt has to grow in line with GDP which means that the average position has to be a small deficit.

Now possibly we're a tiny bit above the deficit we should be at but not in a particularly catastrophic way and of course we're at an incredibly low level of debt to GDP for the Federal Government, below 20 per cent. If you think of a big recession as costing 20 per cent of GDP we could absorb two more recessions and still be within the targets for membership of the European Union.

Among the problems we face deficits are not really a huge problem. Now of course there's this constant pressure. We want tax cuts, we want expenditure, we want to keep the deficit down. So there's never an easy time for governments but I would say the idea that the deficit is a huge problem is one that was really manufactured for political purposes and of course the opposition, whoever the opposition is, is always happy to carry it on as long as the government's in deficit.

It's not really an out of control problem by any means. Looking at the state of the macro economy which although not in recession has been soft with the end of the mining boom, I would say we're not far from where we ought to be.

Glyn Davis
Okay, I'm not hearing either of you say that you think that's about to change quickly.

Judith, there are other economies in the world with a similar pattern of boom and bust linked to commodity prices and they've responded in different ways. Norway, for example's, prospered from North Sea oil and enjoyed a long period of growth at least until the global financial crisis. Back in 1990 it established a natural petroleum fund taking as taxation a cut of the profits to invest in a future fund, a fund that now stands close to $900 billion.

Australia copied that approach in 2006 with the fund now worth around $127 billion. Are future funds part of the solution, part of the future or is a future fund the wrong way to think about a nation reliant on resources?

Judith Sloan:
Well of course the future fund in this country was not all from mineral resource but was actually the result of the sale of the final tranche of Telstra, the telecommunications giant.

Was it a good idea? I think so. We had a large unfunded liability associated with public servants' superannuation and one way or another they have to be covered so it was I think a reasonable political decision to make.

It's an interesting time though because there are various rules, accounting rules but also rules in relation to whether the fund can now be drawn down at this budget. Up until this time the future fund has been effectively locked up by dint of legislation. I think that was a good idea but the government has certain discretionary decisions to make at this budget including whether it decides to start to draw down the money in the fund.

Now I think there are arguments both for and against and I'd be interested to hear what John has to say but I think there is probably a case for keeping it. It seems to have been a very good investment vehicle and there's actually an argument that there are other funding arrangements that could be added to this fund, perhaps even dare I say it universities.

I think the future fund in medical research has gone in there for example so I think it's a very interesting policy debate.

Glyn Davis
John, are you a fan of future funds and what role should they play in smoothing out commodity price impact on a budget?

John Quiggin
Thanks to a bunch of circumstances we really didn't get a great deal of Commonwealth Government revenue from the mineral boom. The proposed mining tax came in too late and then was bargained down to a point where it raised almost nothing so from a Commonwealth fiscal point of view we haven't had a commodity boom and bust cycle at all except in so far as it feeds into taxable corporate profits, which is not really that much.

Looking at the general principle though, in a situation where the government's net position is very strong by global standards, very low levels of debt, I think it makes sense to use some of the government's borrowing power to invest in higher return assets rather than using the proceeds of something like a privatisation to pay down debt, which would have implied a shift towards - effectively a shift towards lower return.

I think the fund idea does make sense but as I say, we really saw the mining boom go through but it didn't really have as much effect on either the fiscal situation of the government or on the income of the average person than you might think from the figures. It didn't employ that many people. A large amount of the capital came from overseas and therefore obviously had to be serviced so that it made a big impact on GDP and much less of an impact on the actual performance of the economy.

Judith Sloan
But the interesting point is, John, that compared with previous mining booms and we have had quite a few over the years, we didn't really blow it up. I think we have to give ourselves a tick. We didn't particularly blow it up by causing a wages explosion in the mining sector then flowing to the rest of the economy. Because we had a free floating exchange rate we got some equilibration through that mechanism.

We are an economy that is mineral intensive so these things will happen. I think in that sense from a policy point of view this was handled much better than it has been in previous cases.

John Quiggin
It's hard to point to the brilliance of particular individuals to do that but clearly we haven't been too badly served by our leaders and bureaucratic managers.

Glyn Davis
I'd like to explore an aspect of this and that's the question of deficit and debt. This is a recording from Professor Max Corden making a case that Australia should borrow to fund for the future.

Max Corden
What we need to do is to create more jobs to solve that jobs problem in a [unclear] way by government spending more but doing something useful. The most useful thing is actually provide the necessary infrastructure. They have to be planned but then you might say yes but who pays for it? You get into debt. Yes.

I'm suggesting that given the world interest rates are so low and there is a need for the infrastructure and we should borrow for it. Then you might say that's terrible. Why do you think borrowing is terrible? Borrowing is terrible because it creates a liability for the future but the companies borrow and they create a liability for themselves. How do they justify it? Because they use the funds to create assets.

In other words you create assets to balance the liabilities and if it's well managed then the assets will be worth eventually as much or more than the liabilities you incurred. Governments should spend more not on anything but on useful things. It's the optimal thing to do because the demand for these assets will go up with the growth of the population.

Glyn Davis
Judith, the Federal Government's expenditure has exceeded revenue in every fiscal year since 2008 and indeed in 21 of the last 35 fiscal years. How do you respond to Max's argument about the important role of debt and therefore the inevitability of some form of deficit?

Judith Sloan
It is also worth having the debate about what is good investment. The trouble is that there are clearly different points of view about what are desirable spendings on infrastructure and it just very quickly becomes political. I don't necessarily follow in every state what's happening but I think of - is it WestConnex in Sydney? That seems to be a highly contentious form of infrastructure spending and then there was the highway spending in Perth again.

It might be that we need to have the debate about the pros and cons of particular spending items but that clearly is an issue.

John Quiggin
One of the problems with a debt obsession is that we get dodgy methods of financing infrastructure and many of the supposedly privately financed infrastructure investments fall into this category that they've been motivated by a desire to get debt off the books. In genuine economic terms they don't reduce debt because there's an obligation there that has to be paid but the cosmetics of it make it appear as if debt's lower.

I think the point that Max Corden's making is with interest rates as low as they are borrowing directly and financing infrastructure, provided that the investment itself is economically sound, is a lot more sensible than trying to distort the investment in order to be able to package it as a privately financed proposal. Which was very much the case with investments before the global financial crisis.

One of the benefits of the global financial crisis I guess has been that some of these more dodgy proposals have been unable to be financed because investors have become more cautious about so-called innovative financial structures.

Judith Sloan
I think running economic policy is really like being a juggler with a lot of balls to tell you the truth. I think there is a really important issue about foreign investment both equity and direct investment because I'm not sure this government is actually as welcoming to foreign investment as previous governments had been, including Labor governments. I think particularly in terms of the National Party influence on the rules in relation to agriculture and agribusinesses.

We have to remind ourselves that we are a country that has always been partly dependent on foreign investment flows in fact to fund the current account deficit. I think that is an area in policy terms that's very important to watch.

Glyn Davis
John, I'm turning now to housing policy and you've argued that Australian public policy makes housing as unaffordable as possible. What did you mean by this?

John Quiggin
I think if you look at the rhetoric of most politicians, certainly of the government, what you'll see is that out of one side of their mouth they say they want housing to be affordable, that is house prices to be lower. On the other side any measure they don't like they'll attack as bringing house prices down. You can find the statements easily from the current government. They both want higher house prices and lower house prices.

When you look at which motive dominates in policy it's clearly to protect the house prices of existing home owners. That's deeply embedded in policy in things like the exemption of owner occupied land from land tax but it's also reflected in the resistance of the government to any measure that would stop the combination of negative gearing and concessional treatment of capital gains.

Negative gearing gets a bit of a bad rap but it's really the fact that you can accumulate tax losses and then collect them back as lightly taxed profits that's the problem and is fairly specific to housing.

What we see is the interest of home owners who want house prices to be high that has always been politically dominant as against the interests of particularly those who would like to buy houses and the interests of renters.

Glyn Davis
Very interesting isn't it now that less than half the population are house owners whether that equation will change.

John Quiggin
Well in a sense the whole policy is now collapsing in on itself because retirement income policy depends heavily on the assumption that nearly everybody will retire with a mortgage free home of their own.

Glyn Davis
Judith, federal tax policy in the form of negative gearing and capital gains rates affects housing prices and many people have argued these should be the focus of government attention but you've suggested elsewhere that migration is an important issue here. You've called for a reduction of permanent immigration to Australia by half I think, arguing that competition from new permanent residents in Sydney and Melbourne in particular are driving up prices in those cities.

Judith Sloan
We have to remember that budgets are two parts marketing and one part policy so there will I think be a substantial statement in relation to housing affordability. Essentially in the long run house price is determined by supply but in the short run they're not. It seems to me that at least giving the Melbourne and Sydney housing markets a bit of a breather by reducing the permanent immigration intake by perhaps not as much as 50 per cent but a number to be chosen by politicians is not such a bad thing.

Seventy per cent of these migrants go to Melbourne and Sydney and the point is I think that both housing supply and infrastructure just can't keep up with that rate. Australia's population is growing by about 1.8 per cent per year. That's over double the OECD average so we really do have some issues in relation to population pressures.

Glyn Davis
John, I'm just interested in pursuing another aspect and then taking it back to migration and that's about an ageing population. One in five Australians will be 65 or over by 2040. Clearly one of the implications of reducing our migrant intake is about the balance of the population.

There was a very interesting Productivity Commission report last year called Migrant Intake in Australia and it argued – quite an unexpected argument - that targeting younger migrants with desired skills in effect allows Australia to steal the investment of other countries and shore up against an ageing population.

Is this a moral argument, an economic argument and what should it mean in policy terms?

John Quiggin
Well before we get to that I just want to say the whole idea of an ageing population is misconceived. It's based on economic categories that are out of date. The fact that a certain number of Australians will be over 65 by 2040 is scarcely relevant when the retirement age is going to be above 65 well before that. If you look at the ABS they're producing so-called dependency ratios which look at the ratio of people aged 15 to 64 to the population as a whole, which implies the typical life course should be to leave school at 15, work in a factory for 50 years and then go on the pension.

The whole idea of an ageing population is a nonsense. What we're talking about is how we organise the fact that we aren't dying as fast as we used to, which is a benefit not a cost. The continued framing of this problem in the way it has been framed I think is just utterly mistaken.

Glyn Davis
If I take it as a cost the cost to the budget of aged care and ageing, that is of looking after our current aged people, is $13 billion a year. It's estimated to grow by 7.5 per cent a year every year over the next 10 years which is a rate of growth that will start to impose very significant costs on the Federal Budget and we're hoping Generation X and Y will foot the bill.

How do we address this concern about the consequences of a different profile in our population?

John Quiggin
We should have had the ageing population after World War II. The first alarms about it were put in then. We had a particular demographic structure which can't be sustained indefinitely of a very small older generation associated with the baby bust of between 1930 and 1946 and a much larger generation in the productive years.

Now that's going to go away but it's essentially a once off story. Once that very small generation dies we'll have essentially a rectangular age distribution. It isn't the chronic problem it has. It's the fact that we cashed in the demographic dividend from the period when the Baby Boomers were in their most productive years. That dividend will eventually run out.

Judith Sloan
If we go back to the issue of the impact of immigration on the age structure of the population, what the Productivity Commission is saying is that it can have a marginal impact. Of course migrants themselves age so essentially they would argue that this is an inappropriate linking of policy and target.

I think it raises a very interesting issue about the moral case for immigration. Now we're inclined to think of what are the economic benefits of immigration for Australia and we know that we want younger workers. We actually prefer them to be trained because then the cost of the training has been borne by them privately and/or the country from which they've come. That's great but we might want to look at what are the economic costs to the sending country.

It's sort of fallen out of favour. It was quite a fashionable thing to think about I'd say 20 years ago.

Glyn Davis
It was.

Judith Sloan
We thought about it a lot in the context of health care workers. There would be nurses from Ghana going to the UK when there was a crying need for more nurses in Ghana and the like. It's something that has rather fallen away.

If we look at where most of our migrants come from, still a lot from the UK but China and India are now the dominant sources. I guess we seemingly don't really care about the impact of them losing young and highly skilled workers to a developed country.

Glyn Davis
Just pushing that a bit further and coming on this ageing issue. One of the points is of course if you target migration policy to an age distribution you want, you have to enforce that with very strong restrictions on family reunion and particularly on young people, young migrants bringing their elderly parents out to Australia to look after them. Even though they're coming from societies with very weak public retirement income systems where the assumption is precisely that sons in particular will take care of their parents in their old age.

There really is a significant human cost. Having brought people out we're effectively treating them as second class citizens indefinitely by these kinds of restrictions. I think as countries like Britain in particular really try and tighten up but we're seeing the same things here, we're really seeing quite large social cost being imposed by the attempt to squeeze the maximum economic benefit out of migration.

Glyn Davis
Judith, I'd like to come back to the housing package you mentioned is likely to appear in the budget. I'm just keen to get a sense of what the policy choices are. Germany for example has a negative gearing arrangement quite like Australia and yet house prices have been very stable there. This seems to reflect investment in housing stock by regional government and social housing and sometimes outright regulation to prevent housing inflation.

I'm wondering what you're expecting in the package but also importantly what you think governments should be contemplating.

Judith Sloan
Well up to a point I think the Federal Government is making a mistake in a sense of getting out the banners and saying we're going to do something because I think a lot of the levers in respect of housing affordability are not the gift of the Federal Government but are actually much more the gift of state governments and indeed even local governments.

The Treasurer Scott Morrison was clearly emphasising the rental market. The rental market in this country is very cottage-like. It's a cottage industry. They're basically mum and dad investors by and large. You don't see the sort of consolidation of rental providers that you do in places like Germany and America for example.

I think Morrison may end up surprising us a little bit in terms of the initiatives in respect of rental accommodation because it is a reasonably high proportion of the population that currently rent and a much higher proportion of younger people who rent. It would be good I think to see some growing sophistication of that sector.

Glyn Davis
I'd like to seek your views about inequality and its role in these debates. The past year of course has seen dramatic realignments of conventional wisdom about politics in Britain, perhaps in France, certainly in the United States. What began perhaps as social criticism from the left, think of the Occupy Movement or Thomas Piketty's arguments about the accumulation of wealth by the few seems to have become a revolt against the status quo from a populist right with a strong swing to nationalism.

These changes have provoked fierce debate in international policy literature about whether rising inequality is a factor in political change. It's not a debate that's surfaced as much in Australia even perhaps if it simmers in arguments about house pricing and concerns about immigration.

Judith, how much should we read current political trends as a consequence of inequality, perceived or real?

Judith Sloan
The issue of inequality in Australia is different in part because the degree of inequality in this country is less than overseas and the rate of change has been less. I think that there is a very important issue in Australia which is the distinction between the big cities and the regional areas or the rural and regional areas.

I think if you look at some of the analysis about voting patterns you really are seeing I think a marked distinction in terms of what are the things that matter to the people in these regions and rural areas as opposed to particularly inner city areas.

There probably is a further distinction in terms of inner city and outer suburban areas too. Economic geography's really gone terribly out of fashion.

Glyn Davis
John, one policy solution to addressing income inequality that's gained much attention after trials in Finland and elsewhere is the universal basic income but not everyone is convinced. The economist and Labor MP Andrew Leigh for example is a harsh critic of the proposal, noting the significant rises in taxes which would be required to fund such a scheme.

How plausible do you find the idea of a universal basic income and would it address inequality?

John Quiggin
I'm certainly on record as a supporter of a universal basic income as a long run goal but I have a lot of sympathy with the kind of criticism Andrew makes. That is that if you look at the most popular versions to start with a quite small payment given to everybody and then hopefully gradually increase this to a point where it could be called a basic income.

In my view that's not what's been done with the things like the Finnish experiments and so forth but it is what was done in Alaska with some money they got from oil revenues I guess.

I don't see that as getting you very far. So I think I would link this back to the question of for the last 30 or 40 years we've been pushing and pushing harsher and harsher attempts to get unemployed people back to work in an economy which is increasingly demanding in terms of the kind of skills you need to work. I think one solution to that is to reverse that kind of trend and instead take a broader view of the kinds of contributions people might make to society.

What that would imply is making the basic income, the kind of support we give to unemployed people more broadly available and increasing the range of contributions people could make that were seen as deserving of such an income.

Glyn Davis
Judith, any sympathy for the idea of a universal basic income?

Judith Sloan
It would be a very radical change in Australia because we have a highly targeted welfare system. A lot of people think that that's a good thing so it's highly redistributive, monies and assistance flows to those most in need.

One of the arguments in favour of having a universal basic income is that you eliminate all the vast compliance costs associated with establishing cut-off points and taper rates and the gaming that goes on for people to fit into certain categories in order to receive certain benefits.

I hear that. I hear that in theory but I think the likelihood is that it's just a bridge too far. Perhaps Wayne Swan is associated with running a kind of project on inequality generally in some of these issues but I think the more productive policy debate would be - I would be particularly interested in how we reduce some of these compliance costs in this gaming that goes on because our welfare system has become extraordinarily complicated.

They had the McClure Report quite some time ago which seems to be yet another report that has gathered dust. But there is I think a really strong case for at least trying to rationalise the different welfare payments and to simplify the conditions attached to them so people don't feel so confused or so incentivised to try and get into one category rather than another.

Glyn Davis
Let's close by returning to the key policy dilemma which is why a wealthy country sometimes struggles to address economic challenges.

In his recent book Dog Days: Australia after the Boom Professor Ross Garnaut points to a sort of Gresham's law of electoral competition over policy. In this view that bad policy ideas drive out the good because if one party offers something with economic benefit but obvious losers the other side mobilises fierce resistance to change.

Without leadership, argued Professor Garnaut, we face gridlock. The miracle is not the decade or so of success or reform he dates from 1983 but the fact that it happened at all. Since then he concludes it's been business as usual for Australian politics and public policy.

Judith, are you persuaded by this analysis?

Judith Sloan
I think I am. I think we hoped that the period from let's say 1983 to maybe 2000 with the GFC was to become the new norm where there was a degree of bipartisan support for good economic policy and for reform.

I now think that period was the aberration and really since then it's been business as usual. It really has become I think quite depressing in terms of what little has been achieved in terms of economic reform and how we seem to just go around in circles with a tremendous amount of opposition be it the Liberal Party in opposition or the Labor Party in opposition.

I think one of the sad things is that there is quite a common view that the only way that that cycle will be broken is if we hit some sort of crisis, some economic crisis that will lead to knocking of heads together in some sense.

I'm not sure I see a crisis coming around the bend anyway so I think we'll be muddling on.

Glyn Davis
John, a brief golden period?

John Quiggin
No, I guess I see the whole reform period as oversold. There were some good measures undertaken but I think the net benefits globally and in Australia were largely undermined by financial deregulation mishandled that gave us the huge recession of the 1990s. As Judith says, the period of reform ended around about 2000 and productivity growth was already slowing then and hasn't really done anything since.

I think if we look at why we are in a relatively good position in my view it's that we've managed macro policy successfully since then. We haven't had a recession which turns out in my view to have much bigger benefits than these kind of reforms.

My further point is the way in which those reforms are framed and winners and losers and so forth reflects a particular set of reforms some of which were needed in the context of the 1970s and 1980s but are really irrelevant to the policy challenges we face in the future with for example the huge developments in the Internet, the technological changes and the way in which they influence work and so forth. I really think that it's as much the fixation of the political class on that period, late 20th century, that's a problem as the dysfunctionality of the system.

Glyn Davis
Judith, in closing, what should be central to the forthcoming Federal Budget?

Judith Sloan
I think this is quite an important budget in terms of where the government is. It's their first budget having been narrowly elected. I think there will be some very deliberate effort to look as though they're fiscally responsible. They will I think try and lock in when the budget is likely to return to surplus. They'll have to make some big calls in terms of future movements in commodity prices particularly in relation to the iron ore price.

I think we will continue to be in a bit of a policy morass that we have found ourselves in for quite some years.

Glyn Davis
John, what would you like to see as the priorities for Treasurer Morrison on 9 May?

John Quiggin
Well really I think the crucial, crucial goal of fiscal policy should be to avoid recessions and in the current Australian context the risks for that mainly come from international developments, from things like Brexit, the Trump Administration, always the possibility of something going badly wrong in China. I'd like to see evidence that the government is prepared with a plan to handle a sudden unanticipated downturn caused by something like a breakdown of the financial system arising from Brexit.

Glyn Davis
It's been my great pleasure today to talk with two notable Australian economists, Honorary Professorial Fellow at the Melbourne Institute of Applied Economic and Social Research at the University of Melbourne, Professor Judith Sloan.

Thank you, Judith.

Judith Sloan
It was a pleasure, Glyn.

Glyn Davis
And Australian Laureate Fellow in Economics at the University of Queensland, Professor John Quiggin.

Thank you, John.

John Quiggin
Thank you for having me.

Glyn Davis
I'm Glyn Davis and thank you for being part of the conversation.

Voice over
The Policy Shop is produced by Eoin Hahessy with audio engineering by Gavin Nebauer. Research is by Ruby Schwartz and Paul Gray. Copyright University of Melbourne 2017.