The truth behind the mid-year budget update

Wow. Under Scott Morrison’s inspired leadership, the budget is almost back to surplus and the economy is ticking over nicely. And having brought home the bacon, Santa ScoMo can deliver our reward, scattering little presents from now until the election.

It’s a lovely thought, but the truth is less heroic. An old saying would assess the position outlined in the midyear budget update as: good things come to those who wait. Or, franker: better late than never.

To be boasting about how much better the budget balance is looking is a bit rich, coming from a government that, five long years ago, talked its way into government by claiming we faced a "budget emergency" of debt and deficit that only the Liberals could fix because they had good economic management in their DNA.

After the disastrous political reception to its first budget in 2014, the government made no further serious attempt to reduce the budget deficit, instead quietly resolving to wait until the passage of time caused the economy to strengthen and tax collections to recover.

That’s where it finds itself now. Tax collections have strengthened in the past year or so because heavy infrastructure spending by the state governments and the rollout of the national disability insurance scheme have boosted employment and the number of people paying income tax.

As well, company tax collections are stronger because export prices have recovered a bit, businesses have finally used up their deductions from accumulated losses incurred during the downturn, and because the crackdown on multinational tax avoidance initiated by the previous government is paying off.

Even so, the government’s net public debt has doubled from the $175 billion it inherited in September 2013 to $355 billion this October.

Initially, the government resolved not to cut taxes until the budget was back to significant surplus. Malcolm Turnbull ditched that in his first budget and the government has proposed tax cuts in every budget since.

Had it held the line it could have been back to actual (rather than foreshadowed) surplus today. And it could have shown us a net debt that had already fallen a little, rather than telling us its projections see the debt peaking in June next year.

The first politician to show us a projected return to surplus in the next few years was Julia Gillard in 2010. Since then, the Coalition has had to revise down its own projections countless times. We’ve learnt the hard way not to believe any budget number that’s not an "actual".

The Coalition’s budgetary performance has been ordinary in all respects bar one: over the five years to June 2017, it limited the average real growth in its spending to 1.5 per cent a year.

Very few governments can better that restraint – certainly not the previous Labor government which, despite all the dodgy figures Wayne Swan showed us at the time, ended up with real spending growth averaging 5 per cent a year.

As for Morrison’s claims about how well the economy’s doing, Josh Frydenberg has had to revise down the budget’s forecasts for growth in wages and the economy.

With luck the economy will keep growing reasonably strongly in the coming year or two, but only if it negotiates the housing downturn without mishap and only if wages return to reasonable growth.

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ACCC wins watchdog of the year, as others lick their wounds

It’s been an infamous year for Australia’s economic regulators. Most ended it with their lack of vigilance exposed, their reputations battered and their ears stinging from judicial rebuke.

The biggest loser is the Australian Securities and Investments Commission, followed by the Australian Prudential Regulation Authority. But the mismanagement of the national electricity market became more apparent. And neither the Reserve Bank nor Treasury emerged unscathed.

Just one regulator had a good year, the Australian Competition and Consumer Commission. It worked hard, discharging its duties with vigour and initiative, taking on powerful business interests, seeking and being granted hugely increased maximum penalties, and fighting to make up for the negligence of its fellow regulators.

As the others have been found wanting, its role has been expanded. And as next year we see the government’s response to this year’s seemingly endless revelations of regulatory failure, it’s role may well be further widened. That’s what tends to happen when rival regulators’ failures become apparent.

It’s been a watershed year. From now on, life will never be the same for regulators found wanting under the microscope of public scrutiny.

Much of that scrutiny came from the banking royal commission, of course. Its interim report in September criticised ASIC for "rarely" going to court "to seek public denunciation of and punishment for misconduct," and being too accommodative when negotiating penalties with the companies it polices.

APRA faced criticism for a "lack of action" in response to widespread misbehaviour in superannuation, including cases where thousands of members were kept in higher fee accounts, rather than being moved into no-frills MySuper products.

But the royal commission wasn’t the only critic of economic regulators this year. I’ve said plenty elsewhere about the failure of the national electricity market’s three (and now four) official operators and regulators to prevent the massive blowout in retail power prices.

One of the many things the Turnbull government did in its vain attempt to fend off pressure for a royal commission was to get the Productivity Commission to report on competition in the financial sector.

The commission confirmed competition in banking was weak and made one eye-opening revelation: part of the problem was that, in their concern to ensure the stability of the banking system, APRA and the Reserve Bank weren’t too worried about ensuring this did as little as possible to inhibit price competition between the big banks.

The commission noted that when APRA had imposed limits on new interest-only lending, it and the Reserve had looked the other way while all four big banks used this as an excuse to jack up interest rates on new and existing interest-only loans.

It recommended that a “consumer champion” be appointed to join APRA, ASIC, Treasury and the Reserve on the co-ordinating Council of Financial Regulators. No prize for guessing the ACCC was the champion the commission had in mind. Nor for reading between the lines that the commission suspected the Reserve and Treasury had been “captured” by the bankers they were supposed to be regulating.

The ACCC has done what little it could over the years to oppose the misregulation and oligopolisation of the national electricity market, and its reports this year revealed what went wrong.

Last week it acted on three fronts. Its preliminary report on digital platforms took on Google and Facebook, greatly expanding our understanding of the questionable ways they operate and working on ways they could be regulated.

ACCC boss Rod Sims has long worried publicly about the state governments privatising their electricity businesses and ports in ways that maximised their sale price by inhibiting price competition. The banker-led Baird-Berejiklian government in NSW is the worst offender.

Last week Sims announced the ACCC was taking the Botany port operator to court, alleging its agreement with the NSW government is anti-competitive and illegal.

And last week the ACCC released its final report on factors influencing residential mortgage prices, commissioned at a time when the banks were threatening to pass the new “major bank levy” straight on to their customers.

The report covered similar territory to the earlier Productivity Commission report, noting again the way the banks had used APRA’s move on interest-only loans as an opportunity for “synchronised pricing”.

But the ACCC’s analysis of pricing dynamics in an oligopolistic market like banking revealed far more realism (and advanced economics) than the Productivity Commission’s trademark introductory textbook neo-classicism. The more I see, the more I like.

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Trump's mad trade war has a hidden logic

Simple economics tells us Donald Trump’s stated reasons for starting a trade war with China make no sense. But more advanced economics tells us it’s no surprise he’s 'P’d off' over China’s economic rise.

Trump complains that the United States buys more from China than China buys from the US, meaning his country runs a trade deficit with China. He sees this as an obvious injustice and a sign China is cheating.

But economics teaches that bilateral trade imbalances are natural and normal, the inevitable consequence of countries’ differing “comparative advantage”. (Australia’s strength is rural and mineral commodities, for instance, whereas China’s is manufacturing.)

What matters is a country’s trade with all its trading partners. But, even here, economics teaches it’s not necessarily bad for a country to run an overall trade (or, strictly, current account) deficit.

Why not? Because a country runs a current account deficit when its investment in new homes, business equipment and public infrastructure exceeds its ability to fund this investment with its own saving by households, companies and governments, thus requiring it to call on the saving of foreigners.

Conversely, a country runs a current account surplus when it saves more each year than it needs to fund that year’s investment spending, thus allowing it to lend some of its saving to foreigners.

Because some countries (such as China, Germany) save more than their profitable investment opportunities can take up, they run current account surpluses most years.

On the other side of the coin are countries (the US, Australia) that have more profitable investment opportunities than their savings can cover, so they run current account deficits most years.

Put the two groups together and – at least in theory – the world’s annual saving flows to the most profitable investment opportunities to be found on the planet, thus leaving everyone in the world better off.

But a deputy secretary of the Department of Prime Minister and Cabinet, Dr David Gruen, noted in a recent speech that, at a more advanced level of analysis, some of the recent tension over trade is a consequence of the strong and sustained growth of Asian economies, including China.

“As economies in our region have grown and moved up the value-added chain, they have increasingly competed with more entrenched, influential and valuable industries in advanced countries [such as the US],” Gruen says.

When rapidly developing countries embrace some new technology, the consequent increase in their productivity constitutes an increase in their real income (because they’re producing more output per unit of input).

This should also help raise the income of the developed countries with which they trade, since the rich guys are usually getting access to imports that are cheaper than they can produce themselves.

“While some advanced-country industries [and their workers] have undoubtedly been harmed by a rising Asia-Pacific, a rising Asia-Pacific has also meant more demand for other goods and services from advanced countries [as the developing countries spend some of their higher income on imports from the rich world],” Gruen says.

So better technology and increased trade between the rich and poor countries don’t reduce the real incomes of the advanced countries, but they are likely to change the distribution of income.

More income is likely to flow to the owners of capital and to highly skilled workers, while some lower skilled workers’ real incomes stagnate or fall.

“Such disruption is likely to continue as technology makes it easier to trade services across borders, and economies in the Asia-Pacific become increasingly sophisticated. Some of these newly threatened advanced-economy jobs rely on intellectual property or skills premiums, providing an economic rent worth protecting.

“It is no surprise that the generally open-trade stance of those in places like Silicon Valley sits alongside [Trump’s] demand for strong enforcement of intellectual property rights,” Gruen says.

And, although the rich world is better off with free trade, as technology continues to bring down natural barriers to trade in sectors previously considered “non-tradeable” – particularly services – politically influential opposition to free and open trade is likely to continue, he says.

But there’s a second implication of the economic rise of Asia I bet you haven’t thought of. “It makes less sense for the largest economy in the world to bear the costs of maintaining an open trading system as its economy becomes a relatively smaller share of global output.

“Free trade is a 'public good' – we all benefit from it, but each country has an incentive to shift the cost of maintaining it to others.

“The United States shouldered that burden when it was the world’s largest economy. When you are half the global economy you tend to benefit wherever in the world trade is occurring.

“The logic of [it] continuing to do so is now less compelling. The rules-based [trading] system, including the World Trade Organisation, emerged at a time when the US was the dominant global superpower."

Small or medium-sized economies with limited bargaining power in global markets (such as us) are better off with free trade – even when other countries are being protectionist. Why? Because protecting a few of your industries against imports hurts the rest of your industries more than it hurts the countries whose imports you don’t take.

But that’s not always true for large economies with significant market power, such as the US. They can sometimes use tariffs to drive down the prices other countries charge them for imports.

How? Their market is so lucrative the country supplying the imports absorbs some of the cost of the tariff to keep its retail prices competitive. The lower price of imports across the docks improves the big country’s terms of trade, increasing its real income.

Get it? The US has less to lose from an outbreak of protectionism than do smaller countries like us. That’s why the rest of us have to put more effort into preserving and abiding by the WTO’s “rules-based system” and Trump isn’t quite the madman he seems.

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Privatisation has been a disaster in many cases

If you’ve always doubted the sense of privatising government-owned businesses, vindication is now flowing thick and fast. In many – but not all - cases it’s turned out to be bad idea. One that’s costing consumers a pretty penny. Unscrambling the egg, however, is proving a frustrating and painful process.

Many people feared that if private businesses were allowed to buy government businesses, the first thing they’d do would be to jack up their prices. Politicians and supposed experts told them not to worry. Sorry, experts wrong, doubting punters right.

In some cases, the businesses privatised were natural monopolies – electricity transmission and distribution networks, and geographic monopolies, such as federally owned airports and state-owned ports.

It the case of the electricity networks, the experts told us not to worry. The prices the private owners are allowed to charge would be tightly regulated. Wrong. In no time the monopolists found ways to rort the system.

One of Scott Morrison’s biggest problems at the coming federal election is voter anger over the huge increase in electricity prices and his government’s limited progress in getting them back down.

Morrison was so rattled he made the most un-Liberal-like threat to use a “big stick” to force the three big companies that have come to dominate the national electricity market to be broken up if they didn’t cut their prices before the election.

He’s since had to replace his big stick with a small one – suggesting he won’t get far in lowering power prices.

The blowout in power prices is the direct result of a decision to take five state-owned electricity generation, transmission and retailing monopolies and turn them into a national electricity market of competing privatised businesses.

But although the feds are now carrying the can for this giant national stuff-up, it was all the doing of the state governments who did the privatising.

How did they get is so badly wrong? They sabotaged it. While you and I were being told not to worry – that vigorous competition would prevent the businesses from raising their prices unduly – the state governments were busy selling their businesses to the highest bidders.

The highest bidders turned out to be companies putting together a vertically integrated business of power stations at the bottom and power retailers at the top. In some cases, governments tightened reliability standards in a way they knew would make it easier for potential purchasers to game the price regulation rules.

If you wonder why parking is so expensive at airports – and catching a taxi home comes with an extra fee – it’s because the Keating government privatised these geographic monopolies without price controls.

With the state governments’ privatisation of their ports, some private lessees have been allowed to fatten their profits in ways too diffuse for us to see how we’re being got at.

For scheming behaviour by premiers and treasurers, there’s no case more appalling than the way the NSW government privatised its ports of Botany, Port Kembla and Newcastle.

Botany is the state’s one big container port, with Port Kembla specialising in bulk commodities and Newcastle the biggest coal port in the world.

In 2013, Botany and Kembla were leased to a single operator and the sale price was enhanced by a “confidential” agreement that the state government would compensate the operator for each additional container handled by the Newcastle port beyond a minimal level.

The Newcastle port was leased to a separate operator with a confidential agreement requiring it to compensate the government – to the tune of about $100 a box, it’s said - for any money it has to pay the other operator if Newcastle increases its handling of containers.

Trouble is, five years on, this deal the public wasn’t supposed to know about is a classic “seemed like a good idea at the time”. Newcastle’s future as a coal port is all decline (the more so if the Adani mine in Queensland goes ahead), but it’s well placed to diversify by building a big new, state-of-the art container terminal.

It has the land, it could build a single ship-rail-road interchange and its port is deep enough to take the next generation of much bigger container ships that will otherwise be accommodated by only one other Australian port, Brisbane.

But the confidential deal makes a container port in Newcastle uneconomic.

Meanwhile, routing all the state’s inward and outward container movements through Botany is a crazy idea. It’s a long way from the Moorebank intermodal terminal, meaning a huge amount of heavy trucks lumbering through Sydney.

New modelling by AlphaBeta economic consultants for the Port of Newcastle claims a new container terminal would allow businesses in the northern part of the state to divert about 16 per cent of the state’s two-way container traffic through Newcastle, cutting their freight distance by 40 per cent, putting competitive pressure on Botany’s container handling prices, taking many trucks off Sydney roads, boosting the NSW economy and cutting the freight costs hidden in the prices consumers pay.

On Monday the Australian Competition and Consumer Commission announced it was taking the Botany operator to court, alleging its agreement with the NSW government is anti-competitive and illegal.

Just another skirmish in what will be a long-running battle to undo the not-so-unintended consequences of privatisation.

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Budget Office finds the bigger picture is looking OK

There’s a weakness in the way we think about the government and its effects on the economy that economists and politicians usually don’t see. We draw macro conclusions from micro data because we forget the need for what accountants call “consolidation”.

The problem arises because we keep forgetting that the responsibility for governing Australia is divided between the federal government and eight state and territory governments – not to mention any amount of local councils.

Yet most of us focus only on the federal government’s budget when we want to know what’s happening at the “macro” (national or economy-wide) level, and on our own state government’s budget when we when want to know what’s happening at the “micro” (individual component) level.

Because we think – correctly – that responsibility for managing the macro economy rests with the federal government, and also that the feds’ budget is one of their main instruments for influencing the economy, we study the federal budget in great detail and forget that the eight state budgets also have big economic effects.

It’s when you remember this that you realise the federal budget is micro (part of the total picture) not macro (the whole picture).

We’re bamboozled by the existence of different legal entities, each producing their own accounting statements, even though the economy – a common market between eight states and territories – recognises no legal barriers between its components.

Sometimes this causes us to mislead ourselves, other times it gives the politicians from each level of government much scope for misleading us.

For instance, a federal treasurer bent on showing that our public debt isn’t high by international standards, shows us a graph which compares our federal public debt with other countries’ total public debt.

Similarly, a premier whose state is growing faster than others will claim all the credit. If it’s growing more slowly than the national average, they’ll find some reason to blame it on the feds.

Although it’s true that each state has a different combination of industries, and some states are a bit better governed than others, because Australia is a common market the greatest influence on the economic performance of any state is usually the performance of all the other states.

And, at any point in time, the government whose policies are having the greatest influence on a particular “state economy” is usually the federal government.

It’s partly because we focus on bits of the national economy rather than the whole that politicians – federal and state – put so much effort into shifting costs to the other level of government. (The bigger reason, of course, is that it saves them money.)

Or appears to. A less-remarked flaw in Tony Abbott’s reviled first budget in 2014 was that much of its cost savings involved shifting unchanged costs to other budgets: massive cuts in grants to the states for public schools and hospitals. Abbott’s successors have been backpedalling on those supposed savings ever since.

By contrast, most big listed companies consist of a group of many (mainly wholly-owned) separate legal entities. This is why company law has long required them to publish their financial statements on a “consolidated” basis.


When you combine the accounts of, say, 20 companies into one, you have to eliminate the overlap between them, ensuring nothing’s counted more than once. Money transferred between subsidiaries “washes out”.

The closest we come to a consolidated financial statement for our nine governments – showing us the full picture - is the federal Parliamentary Budget Office’s recent innovation of an annual “national fiscal outlook” using the nine governments’ latest budgets. The report for 2018-19 was published last week.

It’s not a full consolidation because it doesn’t show us total government spending by function. So it doesn’t correct the misperception that spending is dominated by social security payments.

Combine federal and state spending and you see the big ones are health and education.

Because the states use accrual accounting, whereas the feds keep the focus on cash accounting, a federal budget balance can’t be compared with a state budget balance.

Putting them on the same accrual basis (but taking government projections at face value), the consolidated budget balance (the "net operating balance") reached zero last financial year and over this and the next four years is projected to reach a surplus of $46 billion.

Consolidated annual net capital investment is projected to peak at $32 billion this financial year and fall to $28 billion by 2021-22 (though this misses the feds' creative accounting on new airports and inland railways).

Consolidated net public debt is projected to grow by $51 billion to $414 billion in June 2022.

Even so, by then our consolidated net public debt should be about 20 per cent of gross domestic product, compared with Britain’s 75 per cent and America’s 80 per cent.

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