Speeches

ADDRESS TO THE AUSTRALIAN AND NEW ZEALAND SCHOOL OF GOVERNMENT

3rd September 2009

ADDRESS TO THE AUSTRALIAN AND NEW ZEALAND SCHOOL OF GOVERNMENT

RESPONDING TO THE CURRENT RECESSION – MINIMISING RISKS, MAXIMISING OPPORTUNITIES

CANBERRA, 10.30 AM 3 SEPTEMBER 2009

* Check against delivery *

The title of my talk today is “Responding to the Current Recession”.  Right up front I have to say that this illustrates the dangers of committing to a topic well in advance because recent information suggests of course that the worst of the crisis is behind us. And that’s a good thing. It looks increasingly likely that Australia has not entered into recession and it is more certain, following yesterday’s National Accounts which showed strong positive growth. Given the economic circumstances, it is good news.

Let me review the recent developments.

The financial crisis is stabilising.  Fear is receding and investors are becoming less risk averse.

Global equity markets have rebounded solidly since March. 

Corporate credit spreads to the government curve are appropriately narrowing.

And there has been improvement in credit flows. 

Term yields are now rising. 

And the Australian Dollar has rebounded solidly from its lows of late 2008.  The low was under US$0.62 in November 2008.  Now it is trading at around US$0.83. Bear in mind, it was at parity, near parity with the US Dollar prior to the crisis, so in fact Australia, with a flexible dollar, has benefited significantly from that flexibility in its currency.

The global downturn in the real economy also appears to be stabilising and indeed many countries recorded positive growth in the June quarter of this year.  So contrary to what some have suggested, in fact we’re not alone. As a result, supra national organisations such as the IMF and the OECD have been upgrading their growth forecasts for the global economy.  There is a growing view that the global growth recovery may be V-shaped rather than long and drawn out. 

In July the IMF revised up its forecast for world economic growth in 2010 by around half a percent.  And overnight it suggested there would be a further upward revision in its projections, which is good news.

Even better news, one of the key symptoms of the crisis, falling residential house prices in the US and in other countries such as the UK, now appear to be moderating, with signs that the house prices are stabilising. And that’s a good thing, obviously, stabilising rather than falling.

Although the shocks to the global system did not eventuate in Australia, this country has of course been impacted.  It is in the nature of globalised financial markets and economies that a shock in one part of the system will be transmitted to other parts. 

Having said that, the downturn in Australia now looks like being milder than expected.  Indeed, it may be the case that even using the word “recession” to describe the economic slowing in Australia would be overplaying the point. 

In the June quarter Australia recorded growth in GDP of 0.6%.  That followed growth of 0.4% in March.

It now appears the downturn will certainly not be as severe as in 1990/91 and perhaps even less severe than the Asian Economic Crisis. So that means that the forecasts for the immediate future in the Budget of below trend growth for three years, followed by above trend growth in the financial year 2011/12 may be pessimistic. Having said that, we still believe that the massive expectations in the out years are still optimistic. 

The main reason Australia is faring relatively better than our developed country peers is because we entered this downturn in far better shape, from a fiscal and monetary position. Bear this in mind. You know, you expect me to say it, but it’s real - Australia had economic growth of more than four percent when we entered this downturn. We had unemployment of four percent when we entered into this downturn. The Australian Government had money in the bank of net $40 billion. Compare that with other countries entering this downturn with higher unemployment, with governments already running debt to GDP of 40, 50, 60% and bear in mind some of those economies were already staggering.

Secondly, the Australian financial system has been incredibly sound. Our top four banks have entered into the top twelve banks in the world. We didn’t have an IAG, or a Fanny Mae, or a Freddie Mac or a Royal Bank of Scotland. And the reason why we didn’t is because we undertook the Wallis Reforms, which were very difficult. But we undertook those reforms during good times, when it was absolutely necessary to do it.

And I, as Financial Services Minister, introduced the Financial Services Act, the Financial Services Reform Act, which was landmark legislation that helped to prevent Australia from heading down the path of other countries.

It also reflects the fact that Australia has also been the beneficiary of the most generous terms of trade in history.  As of today, the terms of trade are favourable to this government than the day we lost government in 2007.

And of course the demand for our commodities, a significant issue in itself, continued as China ran a massive fiscal stimulus and that was to our benefit because the purchasing of, for example, iron ore was at record prices. And it continued, it continued to flow through even into this year.

And together with the floating exchange rate, when the Australian dollar went from near parity with the US down to around 60c, it actually buffered us at the appropriate time from the economic downturn.

So they are significant reasons to start with, and of course I’ll say more about it, the government’s response. And we have questioned the government’s response and we have been consistent in that.

The government response to the global crisis was to embark on what we describe as a massive and in parts wasteful spending spree. This financial year, under this government, the ratio of government spending to GDP is forecast to be 28.6%, the highest since World War II - 28.6%. By the end of the forward estimates, June 2013, the ratio will be 26.4%, 26.4% in 2013.

That is 2.5% higher than in the last year of the Coalition government. We left them with 24% of GDP government expenditure and they’ve taken it up to over 28%, and in four years’ time they’re still going to be a full 2.5% higher than when we lost government. And, bear this in mind, the government has forecast that economic growth in 2013 will be strongly above trend!

And this spending spree will last for a number of years.  Since the 2008 Budget, this government has made new, additional policy decisions involving expenditure of over $106 billion over the forward estimates period - $106 billion of new, additional expenditure since the 2008 Budget. So when we talk about fiscal stimulus, and they might be referring to around $12 billion in December last year, $42 billion earlier this year, it ignores the fact that the total of economic stimulus initiatives since the 2008 Budget is over $106 billion, and 40% of that is going to be spent after the 1^st of July next year. After the 1^st of July next year, 40% of new, additional expenditure kicks in. That’s when interest rates are projected to be on the rise. 

The problem is not just that the government’s spending is extraordinarily large by Australian standards, it is also large on an international scale. OECD data show that Australia’s stimulus package was the third biggest of the OECD countries, with spending equivalent to 5.4% of GDP.  Only the United States and Korea had larger packages, and they were in a far, far deeper situation.  In terms of the balance between spending and tax cuts, Australia had the second highest reliance on spending at 4.1% GDP, second only to Japan at 4.2% of GDP.

Now because of this massive spending program under Labor, the Australian fiscal position has sharply deteriorated.  The government has delivered a fiscal policy which involves:

·         Budget deficits from 2008  to at least 2013 – seven years of deficits

·         Peak gross debt in June 2014 of $315 billion

·         A gross interest bill in 2013-14 of at least $12.5billion.

So, have no doubt – this is the biggest spending government since World War II. Our concern is that the trajectory continues, it continues until 2013 and we don’t have any estimates beyond, because that’s as far as it goes in the Budget Papers. What is the risk? The risk is that it appears that even though we are now having a much more mild than anticipated downturn, the government is not prepared to wind back its program.

Continued emergency spending is no longer required.  We have repeatedly called on the government to reduce the stimulus it is pumping into the economy.  We didn’t say “have no stimulus”, we never said that. We actually offered alternatives all the way. But we said they are spending too much money, and the danger is that it’s going to have a negative impact on the economy as Australia continues to grow.

It will firstly push interest rates to a higher level than they should be at. There is no doubt about that, and monetary policy has played a key role in the recovery, there is no doubt about that. Bear in mind, and I’ll talk a little more about this later, Australia’s cut in interest rates has been more dramatic than in any other country in the developed world, apart from New Zealand – 425 basis points cut. And the big issue in Australia, compared to the US and other jurisdictions, is that most Australians have variable interest rates so as the RBA states because of the transmission rate, the flow-through to borrowers is immediate. So for many Australian households when there is a reduction or increase in interest rates it flows through directly to the bottom line. And that’s why we were able to survive the economic downturn.

This government, by refusing to tighten fiscal policy - even though gradually a number of commentators are joining with the Coalition in continuing to call for the government to slow down on the spending spree - the government refusing to tighten fiscal policy is going to have a negative impact on the economic recovery.  

Indeed, the Reserve Bank is flagging now that it will increase interest rates, and certainly the markets are factoring in a rise in interest rates of at least 150 basis points by the middle of next year. And the question is why would the Reserve Bank, with still mild economic growth, why would it be racing to increase interest rates when they are already among the highest in the world, at 3%. Why would they be racing to do it? Because there is so much stimulus being rolled out from a fiscal perspective. Why would the Reserve Bank want to make it harder to access money?

The first interest rate rise is expected to come before the end of this year, and some commentators are now flagging it as early as next month. The Reserve Bank has signalled it will raise interest rates to what they call “normal levels”, somewhere around 5.5-6% by the end of 2011.  That will add at least 3% to current mortgage and business interest rates. 

That translates to increased interest payments of $9000 a year on a $300,000 mortgage, a very large increase in after-tax money. I might add that a lot of business people have told me that they didn’t get the full benefit of the 425 basis point reduction in interest rates, in fact many of them said they had a reduction of around 1% in the interest rate on business overdraft accounts and so on, but you can be rest assured that the banks will increase them on the way up.

The second effect is that the higher interest rates will push up the value of the Australian dollar, higher than what it would have been.  And this will of course hurt Australia’s export industries.  It will reduce the Australian dollar revenue from overseas sales.  It will increase the cost of Australian exports on overseas markets, making them less competitive at exactly the wrong time.  And it will constrain investment in Australia’s export sector. And one of the industries that I was previously responsible for, the tourism industry, knows this better than most.

Thirdly, the government’s uninterrupted spending binge will need to be financed through continued heavy borrowings in the domestic and international capital markets.  We believe that this runs the very real danger of leaving insufficient funds for private borrowers, by “crowding out” the private sector.  This will mean home owners will find it more difficult to purchase or renovate their homes.  And businesses, particularly small businesses, will find it more difficult to borrow to invest to grow their businesses and to create jobs.

And I just want to make this point as an aside. Large business can always raise capital on the markets, small business can’t do that. In the last economic downturn in the early 1990s, there were probably around half a million small businesses in Australia. Today there are over two and a half million. Those two and a half million small businesses can’t go to the capital markets, to the ASX, they can’t go and raise additional capital. Often they are putting their own homes on the line for credit finance. They can’t access money like big business.

Various supranational bodies have over recent months issued warnings on the potential costs of continued deficit spending.  A cautionary note was most recently issued by the Chief Economist of the IMF, who said, and I quote:

“As large deficits continue, debt sustainability comes increasingly into question.  And with this comes the risk of higher long-term interest rates, both because of anticipated crowding out of private borrowers by government borrowers and because of a higher risk of default.”

And I’m watching China in that regard very carefully, where there has been a massive expansion of credit and now there is quite an argument about a contraction of credit and the risk of defaults.

It is our contention that this government has put the budget into deep structural deficit, and this is supported by estimates of the structural budget balance in the May Budget Paper No 1.

Budgets which are structurally in balance can be repaired through the operation of the economic cycle.  Such balanced budgets will be in deficit in times of weak economic activity and will return to surplus, and repay debt, in times of above-trend economic activity.

But budgets which are structurally in deficit – that is, where the deficit in the down times has been larger than required by the cycle, as this Government’s Budget certainly is – are much more difficult to repair.  In such cases the budget can only be brought back to surplus, and the debt repaid, through a conscious tightening of policy.

Tightening fiscal policy can be only achieved through three mechanisms. 

It can be achieved through reducing spending. As I have already noted, this government seems reluctant to take any hard decisions to cut spending. 

The problem can be tackled through asset sales. You know what, there’s not that much left to sell. Although I do issue a word of caution about Australia Post going into insurance but that’s for another time.

Or the budget can be repaired through higher taxes.  A government can raise additional revenue by increasing tax rates or introducing new taxes.  Additional revenue can be raised through stealth by removing tax breaks and benefits, therefore widening the tax base.

I have a strong suspicion that this government is planning to introduce new taxes or to increase tax rates to help fund the spending spree. Now why would I say that, you say? Why would I say that? Well, let’s see. Federal Labor has been here before.  Labor governments increased the corporate tax rate in 1987-88 and again in 1995-96 to help tackle debt, which had risen to high levels as a result of irresponsible spending.

And in this episode, since the 2008 Budget, this government has introduced new revenue raising measures such as:

·         An increase in the luxury car tax from 25% to 33%

·         Changes to employee share schemes

·         Removal of concessions on fringe benefit taxes

·         Changes to the depreciation period for computer software

·         The denying for individuals of tax deductions for a whole range of different things

·         Tightening of the exemption for foreign employment income.

And you know what, I didn’t even mention alcopops!

The Coalition has asked this government to come clean on its tax plans, and currently it’s hiding behind the Henry Review.  “Let’s wait until the Henry Review is completed”, the Treasurer has said. He has added that it’s a big broad-ranging review. It’s so big and broad-ranging that we’re not allowed to have a look at the GST, so big and broad-ranging that we’re going to exclude some super taxes, which would seem to suggest that its political motivations are greater than its economic motivations.

On this point I will again quote the Chief Economist of the IMF, Olivier Blanchard, who said in a recent article:

“In nearly all countries, the costs of the crisis have added to the fiscal burden, and higher taxation is inevitable.”

We believe that higher taxation is not inevitable. The Coalition does not believe higher taxation is inevitable, in fact, it could be avoided through responsible pruning of spending.  But we do agree that higher taxation will be the recourse of lazy Labor governments.

This government’s response to this downturn involves persistent deficits, rising debt, higher interest rates, a higher exchange rate, the crowding out of private sector borrowers from the capital markets, and higher taxes.  The Coalition does in fact offer an alternative strategy. 

Our strategy is aimed at facilitating the best possible climate for private business investment. 

Our strategy is aimed at achieving the lowest possible interest rates. 

Our strategy is aimed at minimising the government’s demands on the capital markets.

Our strategy is aimed at keeping taxes as low as possible.

And the cornerstone of our strategy is to try to get the Budget back into surplus as soon as possible. We achieved that in office, when we were last in office.

And of course, we’ve already undertaken in Opposition a root and branch examination of all areas of government spending with the aim of finding savings in as many areas as possible.

I note again that the government is conducting a review through the Henry Review of its tax system, and we will look forward to the outcomes of that.

From our perspective, you should always look to improve productivity. Productivity is the end result of many factors.  It is primarily the product of private sector business decisions as companies strive in an environment by producing more with less.  Governments can assist this process by:

·         Ensuring that public infrastructure meets the needs of a modern economy and is efficient – roads, rail, ports, utilities, telecommunications, the legal system and so on.

·         Lowering the cost of capital.  The Government should not be competing with the private sector for scarce capital, especially as the economy begins to grow.

·         Minimising the drag from Government.  The cost of complying with Government regulations and taxation must be minimised.  Part of this process in Australia is achieving uniformity nation wide in regulation. The government deserves some credit for announcing the program, starting the program but we wait to see any outcomes.

·         Promoting competitive markets.  Barriers to competition must be removed and I’ve offered a viable, credible alternative to the government, a proposition to the government to get the RMBS and the CMBS markets going so that there could be more competition in banking. But so far the proposal has fallen on deaf ears in Canberra.

This policy program would promote strong private sector investment. It must invite growth in the economy and a return to full employment. It must seize the opportunities that are available as the world begins to grow again, as it inevitably will. And what we offer, now and into the future, will be focussed on making enterprise front and centre of an enterprising economy, not replacing it with the heavy hand of government.

Thank you very much.

[ends]