The era of privatising government-owned businesses is pretty much
done and dusted, but two governments have dragged their feet, making
opposition to their efforts to complete their privatisation programs a
key issue in the Queensland election last week and the NSW election next
month.
Voters have always disapproved of privatisation, but that
hasn't stopped a lot of it happening. Particularly in recent years,
however, voters' doubts have been fed by the dire predictions of those unions
whose members fear they will be adversely affected. Let private owners
loose and prices to consumers will skyrocket!
So what evidence is there that the prices charged by
privatised businesses are higher than those of government-owned
businesses? And where's the evidence that privatisation is good for the
economy, anyway?
Malcolm Abbott, of Swinburne Business School, and Bruce
Cohen, of the Grattan Institute, have conducted a meta-analysis (a study
of studies) of the effects of privatisation in Australia, published in
the latest issue of the Australian Economic Review.
If you're surprised to learn that most of what could be
privatised already has been, and that most of it happened quite a while
ago, let me quote their facts and figures.
They estimate that the sale prices of all the privatised
businesses since 1987 total $194 billion. The bulk of those sales
occurred in the 1990s. The federal government accounted for just over
half that total, with Victoria taking a quarter and NSW and Queensland 7
per cent each, with South Australia and Western Australia making up the
remaining 8 per cent.
Broken down by industry, communications (mainly Telstra)
accounts for a third of the total proceeds, electricity for a quarter,
financial services (Commonwealth Bank, state banks and state insurance
offices) for 15 per cent, aviation (Qantas, Australian Airlines and many
airports) for 9 per cent, gas for 8 per cent and, among the tiddlers,
gambling (TABs and lotteries) for 2 per cent.
One thing this list proves is that though many people
disapprove of selling off government businesses, once it has happened we
get used to it pretty quickly.
The stated reasons for believing privatisation to be a
"reform" vary. For the Howard government, the attitude was: "Everyone
knows privately owned businesses are better managed than
government-owned, so why not sell our businesses and use the proceeds to
reduce debt?"
A more sophisticated rationale is that deregulating an
industry to foster competition in it is far more important in
encouraging productive efficiency (higher productivity) and better
service to consumers. Once that greater competitive pressure has been
achieved, you might as well sell the business you own and use the
proceeds for some more beneficial purpose.
So what do all the studies tell us about how the great
privatisation experiment has worked out? The evidence is, in the
authors' words, "far from conclusive". Despite the extensive
privatisation that has occurred, only a limited amount of research has
been undertaken.
In the case of government-owned banks, the industry had been
extensively deregulated before they were sold. Their productivity did
improve, but not until long after they had been sold.
And it's hard to know how much this improvement was because
of deregulation and greater competition, rather than privatisation.
I think it's still true that the banks' interest margin -
the gap between what they pay to borrow and what they charge to lend -
is lower than it was before deregulation. I doubt if privatisation has
made much difference to this.
In the case of aviation, the government deregulated its
two-airline policy well before it allowed Qantas to take over Australian
Airlines and then be privatised. I don't think there's much doubt that
domestic air fares have been lower than they would have been had
deregulation not occurred.
The lower international air fares are
explained by privatisation and deregulation in many countries, combined
with the advent of bigger, more cost-effective planes.
The process of deregulating telecommunications, including the
admission of new competitors such as Optus and Vodafone, began long
before the staged privatisation of the former monopolist, Telstra.
I think the sale of Telstra could have been done in a way
that did more to promote competition - no doubt at the cost of a lower
sale price for the monolith - but there's little reason to believe
privatisation has made prices higher than otherwise or reduced
productive efficiency.
Of course, the spread of mobile phones and use of the
internet have transformed the telecom industry. Distance phone calls are
cheaper than they've ever been. Technological advance explains most
of this, but increased competition would have helped.
It's a similar story with electricity. It's the break-up of
the old state-by-state monopolies, the introduction of competition and
the formation of the national wholesale electricity market, much more
than privatisation, that's done most to affect the efficiency of the
industry and the prices we're paying.
Most of us have forgotten the big real price falls achieved
in the 1990s, even before the major reforms took place. The more recent
series of big price rises occurred despite the success of the national
market in holding down wholesale prices.
The rises were caused by failure in the regulation of prices
charged by the privately and publicly owned monopolies responsible for
distributing the power (the "poles and wires"). But this failure has
been corrected and the distribution component of retail prices is likely
to fall now.
Studies suggest that, in competitive markets, whether
businesses are publicly or privately owned makes little difference. It
follows that consumers have little to fear from privatisation in
electricity.
So how would new private owners make room for the profit they
seek if they have little scope for lifting prices? By removing any
remaining overstaffing and workers' perks.
That's why the unions are running scare campaigns about soaring prices.
The trouble with the latest round of state government privatisations is
that those who oppose them do so for the wrong reasons, but their
promoters are also pushing them through for the wrong reasons.
Joe
Hockey's 15 per cent incentive payment to encourage "asset recycling" -
selling existing government-owned businesses to fund the building of new
infrastructure - has fallen on receptive pockets in the NSW and
Queensland governments, which are worried about their credit ratings
and, unlike the Victorian government, still have valuable electricity
transmission and distribution businesses to flog off.
The previous, Labor
government in NSW tore itself apart over
electricity privatisation, with the cabinet supporting it but the
powerful public sector unions bitterly opposing it. It wasn't much better with the previous, Labor government in Queensland.
Now
Labor is free of the responsibilities of office, it will be completely
united in its opposition and its unceasing claims that privatisation
will lead to big rises in electricity prices.
Since voters in all
states strongly oppose privatisation, Labor will hope to do well with
this argument at the NSW election in March. But polling also shows
voters are much less opposed when the sale of businesses is linked to
the building of specific new projects.
Labor's counter-argument is
deceptively simple: government-owned businesses act in the best
interests of their customers, whereas privately owned businesses seek to
maximise their profits by raising their prices.
The truth is far
more complicated than that. Whether publicly or privately owned, the
monopoly business that doesn't seek to overcharge its customers has yet
to be discovered by archaeologists. Monopolies that don't seek to
maximise profits usually succumb to overstaffing and overpaying workers
and managers. Why wouldn't they?
The public sector unions understand this full well, which is their real reason for opposing privatisation so vehemently.
They
know that whether or not the private owner succeeds in raising prices,
it will seek to improve its profitability by moving in on union perks
and rorts. They know even Coalition-government owners give them an
easier ride than a private owner would.
So voters would be mugs to believe Labor and its union mates have consumers' best interests at heart.
Unfortunately,
that doesn't mean Coalition privatisers can be trusted to do their best
by customers. The temptation facing all privatising governments is to
seek to maximise the price they get for the asset they're selling.
If
you can't see why that would be a problem, you're helping demonstrate
why privatisations so often fail to deliver their promised benefits.
The
main thing that protects customers from being overcharged is effective
competition between the privatised entity and other businesses.
So
the main way governments seek to inflate the price they get for a
privatised business is to protect it from competition, or otherwise
ensure its ability to overcharge. They tie the hands of the price
regulator in some way, or explicitly guarantee freedom from certain
future sources of competition, or sell the business to some player who
already owns businesses in the industry and so can use the acquisition
to increase the player's pricing power.
The simple truth that
escapes so many privatisation supporters on the non-Labor side is that
privatisation is only worthwhile if it leads to greater competition in
the market. If it doesn't, it will be of little benefit to anyone bar
the new private owners.
When the Keating government privatised
Sydney airport, it guaranteed the purchaser first refusal on control of
any second Sydney airport, thus virtually ensuring that even with two
airports there'd be no competition between them.
When the Kennett
government privatised Victoria's electricity industry in the 1990s it
took care to ensure a wide range of buyers.
But it seems the Baird
government in NSW has no such scruples. It planned to sell Macquarie
Generation, the state's largest power producer, to AGL, one of the
state's three largest power retailers.
The Australian Competition
and Consumer Commission tried to block the deal, judging it would have
resulted in a substantial lessening of competition in the electricity
market. But last week the commission was overruled by the Competition
Tribunal, so the deal is likely to go ahead.
Only a couple of days
earlier, however, the chairman of the commission, Rod Sims, reiterated
his view that "electricity companies have a strong commercial incentive
to have all players vertically integrated ... If electricity retailers
can tie up most of the generation then they can create a stable
oligopoly with high entry barriers and so higher prices and better
returns."
I'd be wary of believing any politician who tried telling you electricity privatisation won't lead to higher prices.
Mike Baird is nothing if not game. His first budget as Premier is a
model of fiscal rectitude - which wins him high marks from people like
me, but makes this a most unusual budget for a politician facing an
election early next year he can no longer be certain of winning easily.
The
budget offers little in the way of tax breaks and few new spending
initiatives, save for more money on child protection, disability
services and homelessness.
Hardly a standard way to buy votes. The
cynical may see this as the reversal of earlier budget cuts that led to
political embarrassment, but I think I see signs of a more tender
conscience - another rare commodity in politics.
A fourth budget
of tight control on spending and steadfast revenue-raising cements the
new Treasurer Andrew Constance's claim to have got the budget back on
track and heading steadily into the land of surplus. If voters are
looking for good managers of the state's finances, this lot is the best
we've seen in a long time.
Of course, Baird is promising to spend
big on a new hospital, highway or rail link near you. That's sounding
more like pre-election vote gathering. But even here he's not planning
to do anything that could possibly endanger the state's much-prized AAA
credit rating.
As his opponents will lose no time in reminding anyone
who has forgotten, almost all the goodies he's promising are dependent
on him raising the money by partially privatising the state's
electricity distribution businesses - a proposal the electorate has so
far found utterly unattractive.
It's also a proposal that caused
bitter division within the previous Labor government. It led to the
demise of a premier and a treasurer, and was ultimately the greatest
single contributor to Labor's ignominious defeat in 2011.
The
election next March is shaping as a referendum on electricity
privatisation which Labor, freed from the obligations of office, will
vehemently and gleefully oppose with blood-curdling predictions about
how power prices would rise.
This time, however, Baird has upped
the stakes by giving all of us something to lose in the way of improved
infrastructure. If you want all those goodies you have to vote for him,
not the other lot. But if we vote him back, the privatisation comes too.
He's nothing if not game.
It would be nice to say Baird's
budgetary virtue had been rewarded by a much-improved outlook for the
NSW economy. But state budgets don't have much influence over state
economies.
Sometimes, however, the virtuous can have good luck.
And Baird's luck is looking fine. With the mining investment boom
ending, there has been a changing of the guard between the states. As
Western Australia falls back, NSW takes the lead.
The whole of
federal macro-economic policy is directed at encouraging growth in the
non-mining economy and the non-boom states, making NSW a prime
beneficiary.
The Reserve Bank is holding interest rates
exceptionally low to encourage borrowing and spending, particularly on
housing, and NSW is Exhibit A to show it's working. Baird's budget is
getting its cut, with collections from the tax on property conveyancing
now very high.
After a long period of below-average growth, the
NSW economy is already growing faster than the national average and this
seems likely to continue for at least another few years. That means
better growth in employment and lower unemployment. Not a bad time to
have an election.
There's no subject more likely to stir people up than rising electricity
bills. With prices roughly doubling since 2007, that's hardly
surprising. But why have prices risen so fast? And will they keep
rising?
It has suited various business lobbies and Coalition
politicians - federal and state - to leave people with the impression
the main reason is the carbon tax and the renewable energy target, which
requires that 20 per cent of Australia's electricity come from
renewable energy sources by 2020.
In truth, the price rises
started well before these measures took effect and they explain only a
small part of the increase. Which suggests the politicians will suffer
yet another loss of credibility when eventually (and stupidly) the
carbon tax is abolished and the renewables target is dropped, as seems
on the cards, but power prices don't seem to fall by much.
The
more important reasons were given by Professor Ross Garnaut, of the
University of Melbourne, in a recent speech. Here's my version of his
explanation.
One part of the reason is that more people have been
using renewable energy and this reduced their demand for conventional
electricity from the grid, which is produced mainly by coal-fired
generators, of course.
Apart from all the wind turbines,
governments - federal and state, Coalition and Labor - have offered
incentives to people to incur the significant expense of installing
rooftop solar power systems.
The most generous of these incentive
schemes have been abandoned but, at the same time, the cost of
photovoltaic systems has been falling rapidly, partly because of
advances in technology, partly because more purchasers mean greater
economies of scale.
The most important economic characteristic of
renewable energy is that once you've incurred the high "fixed cost" of
installing a system, the "variable cost" of using the system to produce
more energy is negligible. Sunshine is free. So once you've got a
system, you use it.
A second important part of the reason for
rising power prices is that many businesses and households have reacted
to the rising price by being more economical - less wasteful - in their
use of electricity.
Another factor (one many economists tend to
ignore) is that all the talk about the need to reduce emissions of
carbon dioxide to stop climate change, and all the talk about how much
power we waste, has made more firms and householders waste-conscious.
Some people are being careful in their use of electricity as a
self-interested response to its rising price, while others - including
businesses - are doing it from a sense of duty to society.
By now,
I trust, a big red light is flashing in your head. If people are using
less power from the grid because more of them are collecting their own
and more are reducing their wastage of electricity, doesn't that mean
demand for conventional power is falling?
Indeed it does.
According to figures from the Grattan Institute, since late 2009
electricity demand in eastern Australia has fallen by about 7 per cent.
But
hang on, is this guy saying the price of electricity has gone up
because demand for it has gone down? Isn't it supposed to be the other
way round? Isn't a fall in demand supposed to lead to a fall in the
price?
Well, assuming no change in supply, yes it is. So you're
right to be to be puzzled. The relationship I've described between price
and demand is, as an economist would say, "perverse".
But why?
Because, as Garnaut explains, we've stuffed up the deregulation of the
electricity market. (Moral: as we're being reminded by the plan to
"deregulate" university fees, if you deregulate or privatise without
knowing what you're doing you can make things worse rather than better.)
Before
the reform process began, each state had its own, government-owned
electricity monopoly, with little trade between the states. From the
late 1980s it was decided to break the integrated state monopolies into
their component parts - generation, transmission, distribution and
retailing - and form one big eastern Australian electricity market with
as much competition and as little monopoly as possible.
The power
stations were separated into individual businesses - some of which were
privatised, particularly in Victoria - and made to compete in a highly
sophisticated "national" wholesale market for electricity. Garnaut says
this has worked well, with competition keeping the wholesale price low
in response to the reduced demand.
But transmission (high-voltage
power lines) and distribution (local poles and wires to the premises)
are natural monopolies. That is, it's not economic to have more than one
network. So whether these businesses are publicly or privately owned,
the prices they charge have to be regulated to prevent them
overcharging.
Trouble is, Garnaut says, we've done this by fixing
the maximum rate of return the businesses are allowed to earn on the
capital they have invested. Economists have known for 60 years that this
always causes problems because it's so hard to pick the right rate of
return.
If it's too low it leads to underinvestment in the
physical network, causing blackouts. If it's too high, however, it leads
to overinvestment in the network at the expense of business and
household customers.
But as well, when monopoly businesses that
are guaranteed a certain rate of return suffer a loss of demand, the
regulator has to allow them to restore their profitability by raising
their prices.
Another red light flashing? Surely if you keep
responding to a fall in demand by raising prices, this will lead to a
further fall in demand (particularly as the cost of renewable energy
keeps falling) and the whole thing will keep going round and round and
getting worse and worse.
Just so. People in the know call it a
"death spiral". One day soon the regulators of the regulators - aka
federal and state governments - will have to step in and call the
madness to a halt. Until then, prices will keep rising.
I have no sympathy for those who take an ideological approach to the
privatisation of government-owned businesses, whether they support all
selloffs because governments are always inefficient or oppose all
selloffs because the private sector can never be trusted.
No, each proposal should be judged on its merits - with a lot of boxes to be ticked before privatisation is justified.
Even
so, it seems likely we'll see a fair bit of privatisation in coming
days - particularly at the state level - as part of Joe Hockey's efforts
to get his budget back in the black while avoiding having a
contractionary effect on economic activity and, indeed, while ensuring
the economy accelerates to the point where we get unemployment down
again.
What squares this circle is staggered savings in the
recurrent budget combined with increased spending on public
infrastructure. Though it's getting late, a surge in infrastructure
investment would also be a good counter to a possible collapse in mining
investment over coming years.
While only Hockey's former
scaremongering about supposedly soaring federal debt stands in the way
of the feds stepping up their own infrastructure spending, they prefer
it to be done by the states.
Trouble is, those state governments
that haven't already lost their triple-A credit ratings are on the edge
of doing so should their debt grow. In an ideal world, the (discredited)
ratings agencies could be ignored and told to do their worst. But in
our imperfect world it's probably not such a bad thing that politicians
worry so much about their ratings.
So how can the states do a lot
more infrastructure investment without increasing their debt levels? By
privatising existing businesses and reinvesting the proceeds in new
infrastructure. This is what Hockey hopes to encourage.
One
disincentive the states face is that, as well as paying them dividends,
the businesses the states own in effect pay company tax to their state
owners, whereas privatised businesses pay company tax to the feds.
Although
he's yet to spell out the details, Hockey has signalled his willingness
to overcome this disincentive by passing that tax revenue back to the
states.
On the face of it, the prospect of more state
privatisations suffered a setback last week when the ACCC effectively
vetoed the NSW government's plan to sell Macquarie Generation, the
state's largest power producer, to AGL, one of the state's three largest
power retailers. The commission judged that the deal would have
resulted in a substantial lessening of competition in the electricity
market.
This brings us to the first test of whether a proposed
privatisation is in the public interest: it ought to involve an increase
in competition within the relevant market and certainly shouldn't
lessen competition.
Governments should resist the temptation to enhance
the sale price of a business by adding to its pricing power, or sell off
a natural monopoly without adequate regulation of its prices.
So
it's a good thing the commission put its foot down. But, equally, it's a
good thing NSW Treasurer Mike Baird expressed his intention to press on
with plans to build up his privatisation recycling fund, and do so
without selling any asset for less than its "retention value" to state
taxpayers.
This raises the second test to be passed. The stream of
dividends governments receive from the businesses they own (and are
about to forgo) could easily exceed the saving in interest payments to
be made from using the sale proceeds to repay government debt, unless
the sale price is sufficiently high.
This is the main factor
determining the business's retention value. To sell assets for less than
that value is to put ideology ahead of the public interest.
Polling
shows privatisation is greatly disapproved of by voters. But this is
the punters wanting to have their cake and eat it. They demand better
infrastructure, but don't want to pay higher taxes for the privilege,
nor give up government services, nor see government deficits and debt
build up.
Well, they can't have it both ways. And an obvious
compromise is for governments to sell businesses for which there's no
good reason for continued public ownership and use the proceeds to get
on with meeting new needs.
It's notable that polling suggests such
recycling deals attract significantly less voter disapproval. Note to
diehard rationalists: hypothecation is the key to escaping the budget
impasse.
But there's one last test to be passed to make such deals
good economics: the new infrastructure's social benefits have to exceed
its social costs. And public transport projects are more likely to do
that than yet more motorways.
I’ve been working up to it for some years in these talks, but today I think I’m finally in a
position to pronounce the Death of Economics. Last week’s decision to postpone
indefinitely the privatisation of Telstra has removed the fig leaf covering the Howard
Government’s loss of commitment to further micro-economic reform. It’s equally true
that the satisfactory state of the economy has allowed concerns about macro-economics
to recede. The economy is now on automatic pilot and it won’t return to top priority until
the next recession – which I’m not expecting any time soon. The most significant
development for politics and policy this year – and thus the most significant influence
over the outlook for politics and policy in the coming year – is the way the events of
October 12 have moved concerns about defence and domestic security to the forefront of
the public’s mind and to the top of the Howard Government’s agenda. The public was
greatly disturbed by the Bali bombings and is very worried about the possibility of a
terrorist attack on our shores. You and I may not be terribly conscious of this growing
crisis atmosphere, but the politicians are in no doubt about it.
The chief political consequence of the terrorist threat has been to complete John
Howard’s personal dominance of the political scene. All incumbent governments around
the world have benefited from the post-September 11 climate of uncertainty, but John
Winston Howard has shown himself particularly well suited to the role of ‘wartime
leader’. He won many plaudits for the way he comforted the Bali bereaved; in general,
he’s said all the right things and rarely said the wrong thing.
The chief policy consequence of the terrorist threat has been to shift defence and
domestic security to the top of the Government’s preoccupations and thereby complete
the eclipse of micro-economic reform. Howard made that crystal clear in his recent
CEDA speech: ‘Mounting a strong, focused and resolute defence of Australia and our
national interests is the most critical continuing challenge that we face. Not since the
early 1960s have we faced a more complex and uncertain region. Some trends,
particularly the emergence of terrorism, clearly run deeply counter to our interests. And
Australia’s national security will therefore require the highest priority and continuous
review by the Government.’ So the dominance of economics in the political debate has
passed and, for the first time in about 30 years, defence and foreign affairs are the main
game.
Now, before we move on, I want to be clear that to freely acknowledge John Howard’s
political success is not to approve of the way he has come by it. To say that he’s the most
successful politician of his generation is also to say he’s the most cynical politician of his
generation. Howard is a walking political calculator. He couldn’t kiss his granny without
the political implications of the act flashing across his mind as he did so. And it’s a long
times since we’ve had a prime minister more uninhibited by ethical concerns in his
efforts to garner the xenophobic vote. We were reminded of that when, in response to
Fred Nile’s bigoted and idiotic suggestion about preventing women from wearing the
chador, he failed to immediately dissociate himself, but slipped into his old Pauline
Hanson soft-shoe shuffle, observing that Nile ‘speaks for the views of a lot of people’.
That was a dog-whistle to people who hate the ‘towel-heads’.
The Liberal leadership
John Howard now has almost total, personal dominance of the federal political scene. He
has the electorate eating out of his hand and is reigning, like a head of state, above the
political fray. He has completely wrong-footed, overawed and demoralised the Labor
Opposition. And he has total dominance over his own party. You’d never imagine this
was the same man who, not so long ago, so many punters were contemptuously referring
to as Little Johnny. I should add that he’s also enjoying a media that’s unquestioning and
complacent, where it isn’t belligerently defensive of his every move. So after he reaches
his 64th birthday in July, it would be the perfect time for him to retire.
I’m not really joking. All former prime ministers are obsessed by just one thing: how
they’ll be remembered by history. And Howard knows that all political leaders are
remembered by the manner of their going. History is littered with prime ministers who
clung on past their time, had to be pushed out and so diminished their reputations. But
quit while you’re riding high and your good reputation is assured. This is why I believe
Howard fully intended to retire next year, just as soon as he’d pipped Malcolm Fraser’s
seven year term as PM.
There’s just one thing wrong with this analysis, however: if you’re riding high, why on
earth would you quit? The kind of person who has what it takes to climb the greasy pole
as far as prime minister, and cling tenaciously to the job despite all the blows, is simply
not the kind of person who knows when to call it quits. That’s why so few PMs have left
at a time of their own choosing. So, though they say Howard is tireder than he looks, I
won’t be surprised if he decides to stay on after all. The temptation to stay on and enjoy
the adulation would be huge. Howard will have many self-serving people around him
urging him to stay on – he even has callers on talkback radio urging him to stay. And he
has the perfect excuse: I promised the people I’d see them through the crisis and I just
couldn’t desert my post at my country’s hour of need (cue the violins).
But note this: should Howard decide to stay, it means he has to stay for another three
years ie until he’s 67. Why? Because he couldn’t get through another election campaign
without making another commitment to stay for the best part of two years into the new
term before handing over to his successor. And what would Peter Costello do about all
this? Nothing. He’d be deeply unhappy, of course, but he’d be a long way from having
the numbers in the party room and he lacks the courage to make an issue of it.
The Labor leadership
Turning to the Opposition, it’s been completely outmanoeuvred by Howard and lives in
fear of him. He can make his criticisms of it stick with the electorate, but it can’t make its
criticisms of him stick. Part of its problem is that the media have no enthusiasm for
holding the government to account. Howard has stolen much of Labor’s foreigner-fearing
blue-collar base. It’s efforts to retain that base by saying ‘me too’ to his populist policies
on asylum seekers don’t have much effect – except to alienate Labor’s educated, middleclass,
socially progressive base – which is switching its first-preferences to the Greens to
register its disapproval of Labor’s pandering to redneck intolerance.
Labor is convinced it could do a lot better with Costello as PM so, should Howard decide
to stay on, it will be a further blow to Simon Crean – assuming he survives long enough
to be hit. Crean’s case is terminal. The recent outbreak of muttering and manoeuvring
against him is no media beat-up – it never is. In such cases the gallery is always reacting
to what it’s being told off-the-record by plotters and disaffected backbenchers. In this
case, the rumblings were prompted by the Newspoll finding that, even among Labor
voters, only 26 per cent preferred Crean as leader, while 44 per cent still hankered after a
proven loser like Kim Beazley. But here’s the point: it’s hard to think of a previous
occasion when a leader has suffered such public destabilisation and yet survived. No,
Crean will be out of the job before next year is over – probably long before it’s over.
He’ll be succeeded by Wayne Swan – who’ll be no better. Mark Latham has little support
within the caucus and is considered unstable. Which is a pity because (apart from the
Left’s Lindsay Tanner – who doesn’t have the numbers) Latham is one of the few
contenders who has what I consider to be the bedrock qualification for high office: he
wants the job because he has policies he deeply believes in and wants to implement
because he’s convinced they’d make the world a better place. All the rest of them are men
who want the job because they want the job, and don’t have a deeply held belief to bless
themselves with. That’s Crean’s problem and it’s also Swan’s problem.
The remarkable federal/state dichotomy
It’s important not to overlook the present remarkable federal/state dichotomy. At the
federal level, the Libs are all-conquering and Labor is in utter, hopeless disarray. At the
state level, however, Labor holds all eight state and territory governments and most of the
Liberal oppositions are in terrible shape. Amazing. You can imagine how much the
federal Libs would like to break that drought, and how anxious Labor is to hold the state
line. And with the Libs so hopelessly routed in Victoria, the focus now turns to the NSW
election in late March. Here the Carr Government will be trying to jump the hurdle Jeff
Kennett couldn’t make: to win a third term - with its various weaknesses and failures well
known to the electorate and an accumulation of niggles on 101 issues. I’m told Labor is
quite worried about the possibility of losing, while the Libs are hopeful of progress with
such a young, intelligent and attractive candidate as John Brogden. And here’s the point:
federally, nether side will be rocking the boat before the NSW election. So, Crean is safe
from challenge until after the NSW election. And that election was one of the factors in
the Howard Government suddenly going cold on the sale of Telstra – Brogden and his
National Party mates don’t need any further problems with country seats, thank you.
Howard’s policy agenda
That’s enough about politics; let’s move on to policy matters and let’s look at the items
the Howard Government has on its agenda. The big point of Howard’s recent CEDA
speech was to demonstrate how busy he is on the policy front by laying out the cabinet’s
recently determined list of ‘longer-term strategic objectives’. There were no fewer than
nine of them. Let’s go through them quickly and see what they add up to. Howard
stressed that, apart from the first, they were in no particular order – ‘they all have a
special importance of their own’ ie no particular importance.
First is, as you’d expect, ‘the twin dangers of rising international terrorism and the
proliferation of weapons of mass destruction’ and these are ‘clearly . . . more fundamental
than any of the others’.
Second is ‘balancing work and family life’. It’s clear Howard has a quite narrow
conception of this issue: he thinks it’s all about mothers having ‘choice’ over whether or
not to stay at home full-time with their young children. He seems to be working on a rejig
of the Government’s many and various family payments. This could be announced in
association with the next election – which is probably the only context in which the
Government would be likely to pick up the moderately expensive proposal for taxpayerfunded
paid maternity leave.
Third is ‘demography’ and the ageing of the population. On this Mr Howard will
continue preaching about the need for people to avoid early retirement – he may get
around to taking measures to affect the incentives and disincentives. There’s little sign of
any policies aimed at raising fertility.
The fourth ‘strategic objective’ is ‘science and innovation’. All very worthy – doesn’t
seem to amount to much.
Fifth is education. Here Brendan Nelson is working on further reforms to university
funding, and has won the vice-chancellors’ agreement to a scheme which will allow them
to take in more full-fee paying students and also charge fees in excess of HECS if they
think the market will bear it. Problem eased with little or no extra cost to the budget.
Sixth is ‘sustainable environment’. This means pressing on with water reform, with the
Commonwealth’s incentive payments to the states under national competition policy
being diverted to this purpose. Also under this heading is Mr Howard’s remarkable policy
of insisting that our greenhouse gas emissions target under Kyoto will be met easily and
at no cost to the economy, while also insisting that actually to sign the Kyoto agreement
would do our economy incalculable economic damage.
Seventh is ‘energy’ where Mr Howard is developing ‘a strategic plan for Australia’s
long-term energy policy’. Wow.
Eighth is ‘rural and regional policy’ where the Government has ‘important and enduring
priorities’ including a national response to the drought. Obviously, no post-Hanson
government could have a list of priorities that didn’t include the magic word RARA.
Ninth is ‘transport policy’ – which also doesn’t seem to amount to much.
Looking at this agenda you’d have to say it’s not wildly impressive. This is not a
government with a host of major reforms it’s bursting to get on with. This list is not one
of ‘longer-term strategic objectives’ as Mr Howard so grandly puts it, it’s just an ordinary
old to-do list that any government could rustle up at any time. It’s not about Reform with
a capital R so much as running repairs and the oiling of squeaky wheels. It’s the agenda
of a government that knows it’s expected to look busy. You’ll note that, though many
items on the list are matters a reformist government would want to do big things about,
few are the sort of matters you’d think of as ‘micro-economic reform’. There’s little that
involves reducing government intervention or increasing competition. Indeed, it’s clear
the National Competition Council is being wound up and Graeme Samuel moved on to
the ACCC. The era of micro reform has finished.
You’ll notice that one glaring omission from the nine-point agenda is health. Clearly,
there’s no sign of any grand plan for the reform of health-care funding. But the present
funding arrangements aren’t working well and Mr Howard won’t be able to avoid more
patch-ups. He’ll have to do something next year to try to turn around the decline in bulk
billing – which I’m sure is annoying GPs and patients in equal measure – particularly in
RARAland. Less acute but more chronic is the problem the recent IMF staff report drew
attention to: the moral hazard arising from the elimination of out-of-pocket payments for
many people with private health insurance. There’s simply too much scope for overservicing
by specialists – in an area that’s even more heavily subsidised by the taxpayer
than it was.
Telstra and the bond market
You wouldn’t forgive me if I failed to say something about Telstra and the end of the
bond market. A lot of business economists have been reluctant to be seen coming out in
support of the retention of government intervention that contributes to their own
livelihoods. But I think I’ve found the right form of words to overcome the problem: we
could certainly live without a bond market if there was a good reason to, but there isn’t.
So what’s to be gained by killing it off? Nothing. Australia doesn’t have, and never has
had, a problem with an excessive public debt to GDP ratio. Last week I heard the
Chancellor of the Exchequer boasting that Britain had one of the lowest public debt ratios
in the world: 31 per cent. With our federal ratio already a mere 5 per cent, there is simply
no economic reason to want to get it to zero. It’s obvious that Peter Costello’s ambitions
are purely political: he wants to be able to boast that he’s paid off ‘every last cent’ of
‘Labor’s debt’. He dreams of being able to use this as the ultimate proof of the Libs’
impeccable economic management and a reminder of Labor’s appalling mismanagement.
The more spotty his record becomes on the maintenance of budget surpluses, the more he
emphasises debt reduction. It’s become clear, however, that the goal of literally paying
off ‘every last cent’ is unattainable. Telstra isn’t worth that much and the foreseeable
underlying cash surpluses won’t be big enough. With the indefinite deferral of the
Government’s plans to sell the rest of Telstra, the threat of the bond market being wiped
out has passed, but a subtler threat remains: that further smaller-scale debt redemptions
will fatally wound the bond market (in terms of critical mass) without actually killing it
off. Were this to happen it would be a great pity because it would mean that, for no good
reason, we’d incurred many of the losses canvassed in the debate. Presumably, the market
would become moribund. To me, the strongest argument in favour of preserving an active
market is that, sooner or later, the budget will return to deficit and the government will
need to issue bonds to cover it. It would be galling to find we had to run to the expense of
reviving a bond market we’d allowed to expire purely through lack of foresight.
Costello’s blinkers may prevent him from seeing this – just as the Bush Administration
and its Republican supporters’ lust for income-tax cuts blinded them to the obvious
implausibility of those happy projections showing the US budget remaining in surplus for
as far as the eye could see – but it should be clear enough to the rest of us. I wouldn’t be
surprised to see the federal budget return to modest deficit within the next year or two.
The notion that we’ve entered an era of permanent surplus is the product of ignorance or
hubris.
Let me just say something about the deferral of the Telstra sale. One point to note is that,
though the notional sale has been pushed back to the 2004-05 financial year, the next
election is due in November/December 2004 and it’s hard to see the Government wanting
to stir up controversy about Telstra’s ownership before the election. So we’re talking
about the actual sale of the first tranche some time in late 2005 at the earliest. Even by
then I wouldn’t be confident Telstra’s share price would be much higher than it is today.
It certainly could take many years to get back to anything like $7.40 – you only get one
dot.com bubble in your life. I believe Howard, Costello and the Government generally
have had a lot of ego riding on completing the privatisation of Telstra. So I’m not
convinced they’ve indefinitely deferred the sale primarily because they believe the
company is worth infinitely more than its present share price. No, I think they’ve decided
that proceeding with the sale is all too hard politically – getting it past the Nats, getting
the numbers in the Senate, wearing the flack in rural electorates. And, because they see
privatising Telstra as a major micro reform – up there with the GST – I see their decision
to put Telstra on the backburner as strong confirmation of their loss of interest in micro
reform. John Howard has simply moved on.
Monetary policy
I should now turn to fiscal policy, but I know you’re not interested in it, so let’s go
straight to monetary policy. I want to start the way Ian Macfarlane starts his
parliamentary testimony: by reviewing the forecasts he made last time. This time last year
I observed that the Fed might have more easing to come and, if it did, the Reserve would
ease a little more, too. This was much more pessimistic than the markets’ thinking at the
time, so I predicted that ‘most of you guys will spend most of next year anticipating a rise
in rates that never eventuates’. Now, as most of you would remember, once it became
clear that the Reserve intended to begin tightening in May, I wrote a Monday column in
which I ate humble pie and admitted I’d got that forecast wrong. At this late stage,
however, I’d like to regurgitate some of that pie and say that, by the end of the year, I’m
not as wrong as I thought I was in May. I was out on the Reserve, but only to the tune of
50 basis points. And I was right in thinking the Fed was more likely to cut than to tighten,
even if the easing came at the opposite end of the year to what I thought. So, in a different
way to what I was expecting, I think I was reasonably right in predicting that most of you
would spend most of this year expecting rate rises that didn’t happen. Certainly, it took
people like John Edwards (to whom I’d apologised in May) a long time after June to
realise there were no more tightenings to come. In fact, the Reserve lost its appetite for
tightenings as soon as it realised there was a growing chance the Fed would resume
easing.
What does this post mortem prove? Nothing – other than that I can wriggle on the hook
as well as the best of them. But I do think that, looking back over the year, the Reserve
has been consistently more worried about the state of the US and world economies than
most business economists have. And that’s true even though there was that period in
April-May-June when the Reserve said it was pleasantly surprised by the stronger state of
the world economy. It soon changed its mind back again – sooner than a lot of you guys.
Over the past two years – going back to Greenspan’s first, surprise easing on January 3
last year – the US financial markets have been consistently over-optimistic, and that’s
rubbed off on our markets and our economists. It’s true that the net fall in share prices
and bond yields over that period reveals the US markets to be a lot less optimistic today
than they were at the start. But, as the Reserve argued in the November SOMP, it seems
pretty clear that the US markets remain more optimistic than they should be – ie that Wall
Street may have further to fall. The one bloke who merits an honourable exception to all
this is, of course, Rory the Wonderboy. I rehash all this to make my first substantive
point: I believe we’re likely to see the same phenomenon in the coming year: markets and
economists in the US and here being consistently more optimistic about the outlook for
the US and world economies than both the Fed and the Reserve. Every time you’re
tempted by the thought that the US is looking up, remember two things. First, Europe is
in worse state than the Yanks. It has a debilitating structural problem: the euro and its
policy regime is seriously flawed and is slowly squeezing the life out of the German
economy. Second, if, as seems possible, the Japanese are finally stirring themselves to
tackle their structural (banking) problems, that will make their economy weaker before it
makes it stronger. I repeat: the most likely second-guessers’ error I foresee in the coming
year is to be more optimistic about the strength of the world economy than the policy
makers.
The other useful lesson I think we can draw from this year’s experience is that, these
days, central banks in general and ours in particular change the direction of policy a lot
sooner and more often than they used to. Consider the record: we had our Reserve
tightening four or five times through 2000, then, last year, after a pause of just six
months, easing six times between February and December. It then paused just five
months before starting to tighten again, telegraphing its intention to raise rates by 125 to
175 basis points - but, in the event, halting after just 50. It’s now done nothing for six
months. It may be that this yoyo-like behaviour is a product of times in which currents
and crosscurrents are especially hard to read, but I suspect it has a fair bit to do with the
present extremely pre-emptive approach to the conduct of policy. The pre-emptive
approach makes central banks more dependent on forecasts and, as we all know, our
forecasts frequently prove astray.
Which brings me to my call. Starting with the Fed, I think it could end up doing more.
Certainly – and as I said last year – it will regard the whole of the remaining 125 basis
points as available to be used if necessary. With some small possibility of deflation, I
don’t expect it to be erring on the side of overconfidence. Turning to the Reserve, I don’t
believe that, at this stage, it has any clear expectation of what it will do with rates over
the coming year – except that it expects to be doing nothing for quite a few months yet. If
rates are shifted some time next year, it could be in either direction: up if it’s clear the US
and world economies are recovering satisfactorily and it’s clear the domestic economy
still has a lot of steam left in it; but down if the outlook for the world economy has
deteriorated further and the domestic economy is losing momentum. Of course, should
the world economy get weaker while we stayed strong, I’d expect the Reserve to continue
sitting on its hands. If this call doesn’t strike you as particularly courageous I’m sorry, but
it’s about as definite as I think it’s sensible to be.
