Five and a half big things Kevin Rudd doesn't understand about the Australian economy

Occasional Paper

1:
The current economic crisis is due to regulatory, and not market, failure

2:
The Premiers' Plan helped Australia escape depression quicker

3:
Our economic boom was much more than just mining and stockmarkets

4:
Other countries have undergone a "building decade", and they didn't work

5:
Greater economic self sufficiency is a recipe for lower growth

And an honourable mention:
Bureaucratic solutions are not the way to engender real jobs and growth

INTRODUCTION

On 25 July 2009 Melbourne-based newspaper The Age and The Sydney Morning Herald (SMH) published a 6,000-word essay by Prime Minister Kevin Rudd on the "Road to Recovery".

In many respects, the issues canvassed by Rudd were nothing new and were expressed in a style similar to that contained in his now infamous essay in The Monthly.  Rudd views current events as a Manichaean struggle between good and evil where free markets give comfort and succour to evil men but doughty and vigilant political leadership can save society from their anti-social tendencies.

Indeed, Rudd's recent essay is reminiscent of those regularly churned out by identities of the political left and sensibly ignored by the vast majority of Australians.

What makes this essay different, however, is the author himself, who wields significant political power managing a federal budget worth almost $282 billion or 24 per cent of GDP (and spending even more than that amount).

Any errors of economic thinking on the Prime Minister's part will be felt by millions of ordinary Australians, not to mention future generations saddled with the long-term consequences of damaging economic interventions.

As The Age essay makes clear, Kevin Rudd's view of the economic landscape is tinged by what American economist Bryan Caplan calls the four biases:

• The "anti-market" bias, or a tendency to underestimate the economic benefits of the market mechanism
• The "pessimistic" bias, or a tendency to overestimate the severity of economic problems and underestimate the (recent) past, present and future performance of the economy
• The "make-work" bias, or a tendency to underestimate the economic benefits of conserving labour
• The "anti-foreign" bias, or a tendency to underestimate the economic benefits of interaction with foreigners (in the marketplace) ⁽¹⁾

Caplan is able to demonstrate how these four biases lead directly to poor policy making.  In particular, they are the reason democracies choose bad policies.  Rudd's essay highlights these biases and we have no doubt that they have lead to the poor economic policy choices that characterise his government.

His anti-market bias is illustrated by his description of the causes of the current economic crisis.  American government policy is the direct cause of the current crisis, yet he persists in blaming some vaguely defined and never explained market failure.

His pessimistic bias is highlighted by his understanding of the Australian experience of the Great Depression, and by his understanding of more recent Australian economic history.  Our prosperity is not simply due to a mining boom, but rather to a generation of hard fought bi-partisan economic reforms.

The notion that government can simply spend money on unproductive construction is evidence of his make-work bias.  This "solution" has a long history of failure despite being given every opportunity to succeed.

The Rudd government is ambivalent to foreign involvement in the economy.  This is despite the overwhelming benefits of trade and foreign investment.  To his credit Rudd is resisting some of the more anti-foreign arguments presented by some elements in the Australian community, yet he continues to promote forms of economic nationalism.

Kevin Rudd's misinformed and biased economic commentary stands in stark contrast to that used by his immediate predecessors Howard, Keating and Hawke in their public statements.

All three former Prime Ministers arguably possessed the highest degree of economic literacy of all post-war Australian leaders.  This in turn was reflected through their policies, including market deregulation, public sector privatisation and freeing up the economy to grow and prosper.

It should be remembered that the current government inherited a $21 billion accrual budget surplus and a negative net debt position to help shield Australia from adverse economic shocks.

Not only does Kevin Rudd disparage the economic record of his predecessors as representing a "neo-liberal" agenda, but his cocktail of budget deficits, public sector debt and prescriptive market regulations all stand to consign Australians to a lower growth future with higher unemployment and interest rates.

Rudd's essay reveals much about his lack of understanding about economic events and their policy implications.  This paper serves to dispel some of the erroneous themes expressed in The Age and SMH essays, taking him to task on five (and a half!) issues raised that need to be corrected for the public record.

#1

THE CURRENT ECONOMIC CRISIS IS DUE TO REGULATORY, AND NOT MARKET, FAILURE

Kevin Rudd has adopted a morality-play approach to the financial crisis.  Yet the current financial crisis can be traced to public policy failures.  These factors include a monetary policy error and the damaging consequences of "social justice" in forming the US Community Reinvestment Act (CRA).

In the late 1980s social justice activists in the US alleged that banks and other financial institutions were discriminating against minorities -- usually African Americans and Hispanics -- in a practice known as "redlining".  In 1989, the US Congress required banks to collect race data on mortgage applicants.

The CRA, originally passed in 1977, requires US banks to serve the entire market and not engage in redlining.  In 1995, the CRA was modified directing regulators to examine how banks and financial institutions met the credit needs of the community.

Effectively banks and financial institutions were directed to lend money to sections of the community they otherwise would not lend to.  The quid pro quo was that banks and financial institutions would be allowed to securitise the loans made under the CRA.

In 1992, the Boston Federal Reserve published a working paper, subsequently published in the prestigious peer-reviewed American Economic Review, which provided empirical evidence showing that banks were discriminating against minorities. ⁽²⁾  It subsequently transpired that the data used in the 1992 Boston Fed paper was deeply and fundamentally flawed.

The definitive study of the Boston Fed report was conducted by Theodore Day and Stan Liebowitz and was published in the 1998 Economic Inquiry -- also a peer reviewed journal. ⁽³⁾  That study found that after correcting the most severe data errors that no evidence of racial discrimination could be found -- banks and other financial institutions had not engaged in redlining.

The damage, however, had been done.  The Boston Fed published a document in 1993 entitled "Closing the gap:  A guide to equal opportunity lending" that is still available on their website. ⁽⁴⁾  On page 13 the document states:

"Even the most determined lending institution will have difficulty cultivating business from minority customers if its underwriting standards contain arbitrary or unreasonable measures of creditworthiness."

The Boston Fed then discusses some of the "arbitrary rules" that banks might apply.  Considerations such as the age, location and condition of the property are "arbitrary".  Banks are advised to review loan obligation ratios and requirements for down payments -- for example, "Policies regarding applicants with no credit history or problem credit history should be reviewed.  Lack of credit history should not be seen as a negative factor."

While the Boston Fed argues that these "recommendations are intended as guidelines" it also sets out legal requirements for compliance in an appendix.  Stan Liebowitz in a recent New York Post op-ed writes:

"Those 'outdated' standards existed to limit defaults.  But bank regulators required the loosened underwriting standards, with approval by politicians and the chattering class. ... It also let community activists intervene at yearly bank reviews, shaking the banks down for large pots of money.  Banks that got poor reviews were punished;  some saw their merger plans frustrated;  others faced direct legal challenges by the Justice Department." ⁽⁵⁾

In their 1998 paper, Day and Liebowitz had written, "The currently fashionable 'flexible' underwriting standards of mortgage lenders may have the unintended consequences of increasing defaults for the 'beneficiaries' of these policies." In 2007 that prediction came true.  In March 2000 the dot.com bubble deflated and the US Federal Reserve lowered interest rates.  Following the terrorist attacks of 9/11 the US Federal Reserve kept interest rates low until 2004 when it started to increase interest rates in rapid incremental steps.  John Taylor of Stanford University has argued that US interest rates were far below what they should have been and this caused over-investment in the housing market and over-pricing of the housing stock:

"During the period from 2003 to 2006 the federal funds rate was well below what experience during the previous two decades of good economic macroeconomic performance -- the Great Moderation -- would have predicted. ... With low money market rates, housing finance was very cheap and attractive -- especially variable rate mortgages with the teasers that many lenders offered.  Housing starts jumped to a 25 year high by the end of 2003 and remained high until the sharp decline began in early 2006." ⁽⁶⁾

Ultimately, the crisis is due to government forcing banks to make loans at unreasonably low rates.  Rather than have some individuals priced out of the market, government intervened and effectively lowered the price ceiling facing those individuals.  This would have been less of a problem had interest rates not being artificially low after 2003.  But when interest rates did fall too low, moral hazard problems arose whereby highly leveraged individuals could speculate in housing using finance from highly leveraged institutions.  The overall lesson to be learned from the current financial crisis is that public policy very often has unforeseen consequences.  This is not a new lesson.  However, when Kevin Rudd is unable or unwilling to heed the lessons of contemporary policy failure, this heightens the risk that harsh lessons will have to be re-learned.

#2

THE PREMIERS' PLAN HELPED AUSTRALIA ESCAPE DEPRESSION QUICKER

Kevin Rudd stated that the policy "alternatives were to do nothing or, worse, effectively replicate the Premiers' Plan of 1931 when governments cut expenditure, thereby compounding the problems created by a private sector already in retreat.  The result, of course, was an economic rout, appalling unemployment and a decade of negligible growth through the 1930s."

The Prime Minister's assertions do not stand up to the evidence.

In 1931, following consultation with leading economists, commonwealth and state governments agreed on a plan to restore Australia's public finances and economic competitiveness.

The plan included the reduction of all "adjustable" government spending by 20 per cent on 1929-30 levels, including all wages, pensions and other welfare payments.  It also encompassed reductions in interest rates and scope for devaluation of the Australian dollar to reduce costs, and restore the confidence, of local industries.

The Premiers' Plan has been reviled by many Australian economists influenced by the Keynesian tradition and also by Labor politicians.  The historical record, however, is very different from the rhetorical record.

To demonstrate the point, we collected GDP per capita data from the authoritative OECD publication The World Economy:  Historical Statistics by Angus Maddison.  We convert the data into index values and plot GDP per capita over the inter-war period 1919 to 1939 for Australia and the United States.

In Australia economic growth slows and begins to decline after the return to the gold standard in 1925 -- the late 1920s were hardly "roaring" for Australia.  The nadir of the Australian Great Depression occurs in 1931 -- overall Australia has a V-shaped depression growth trajectory (Figure 1).

By contrast, the United States recorded a reduction in output of 13 per cent in 1932 with FDR's big-spending New Deal contributing to endemic investor uncertainty and sapping the economic growth potential of that country throughout the 1930s.  This is illustrated by its long, drawn-out U-shaped depression (almost W-shaped after FDR raised taxes).

Figure 1:  GDP per capita, Australia and United States;  1919 to 1939

Source:  OECD The World Economy:  Historical Statistics, Angus Maddison.

Two policy events occurred in 1931:  the Premiers' Plan was adopted and Australia excised its gold standard.  Many economists argue that it was the latter that led to the recovery.  To test that view we also look at GDP per capita for Canada, New Zealand and the United Kingdom -- all members of the former British empire (Figure 2).

Figure 2:  GDP per capita;  Australia, Canada, New Zealand and United Kingdom;  1919 to 1939

Source:  OECD The World Economy:  Historical Statistics, Angus Maddison

It is quite clear that Australia's economic recovery begins before the other countries.  Clearly leaving the gold standard was an important component of recovery, however there is no evidence supporting Rudd's interpretation that adoption of the Premiers' Plan lead to an economic rout.  To the contrary, the Australian economy made a significant recovery by international standards.

The unemployment data over the era shows a slow recovery from the depths of the depression.  The argument that employment growth was slow in the 1930s is consistent with the notion of "jobless recoveries".  This phenomenon is hardly unique to that period.

The important thing to notice is that unemployment in Australia falls steadily over the decade after the early 1930s, outperforming the capacity of the New Deal US economy to absorb labour.

Figure 3:  Unemployment rate;  Australia, United Kingdom and United States;  1919 to 1939

Source:  OECD The World Economy:  Historical Statistics, Angus Maddison.

The success of Australia's Premiers' Plan did not go unnoticed at the time.  Even Rudd's economic hero -- John Maynard Keynes -- was inspired to write in the Melbourne Herald in June 1932 that the Plan "saved the economic structure of Australia".

#3

OUR ECONOMIC BOOM WAS MUCH MORE THAN JUST MINING AND STOCKMARKETS

Kevin Rudd claimed that "in the past, Australia relied almost exclusively on the rollercoaster of the boom and bust of the mining sector or the stockmarket."

A cursory examination of ABS national accounts data shows that an increase in gross value-added (a measure of output) was recorded for each major industry, not just mining or financial services, since the trough of the previous business cycle in late 1991 (Table 1).

Table 1:  Industry gross value-added;  chain volume measure

	December 1991	March 1996	December 2007	December 2008	March 2009
Agriculture	4,405	5,143	6,180	7,181	7,525
Mining	13,045	15,721	20,699	21,358	21,315
Manufacturing	19,636	21,948	26,528	25,715	24,871
Electricty gas water	4,533	4,943	5,450	5,664	5,717
Construction	8,068	9,657	19,088	19,847	19,687
Wholesale trade	6,245	8,132	12,196	12,155	11,888
Retail trade	7,961	9,194	14,730	14,876	14,973
Accommodation cafes restaurants	2,865	3,314	5,164	5,047	5,050
Transport storage	6,457	7,869	12,635	12,792	12,597
Communication services	2,007	3,055	6,593	6,592	6,570
Finance insurance	9,880	11,593	20,471	20,405	20,454
Property business services	14,989	18,670	32,376	32,763	31,846
Education	7,864	8,825	10,900	11,060	11,098
Health community services	8,602	10,180	15,667	16,133	16,290
Cultural recreational services	2,276	2,505	4,008	4,126	4,079
Personal other services	2,862	3,309	4,930	5,056	5,063

Excluding government administration and defence.

Source:  ABS, Australian National Accounts:  National
Income, Expenditure and Product, cat. no. 5206.0.

The mining industry's gross value-added as a share of national GDP has trended downwards since the 1990-91 recession and, more recently, since the turn of this century (Figure 4).

Figure 4:  Mining industry gross value-added as a share of GDP;  chain volume measure

Source:  ABS, Australian National Accounts:  National
Income, Expenditure and Product, cat. no. 5206.0.

Similarly Rudd's argument that Australia relied on a rollercoaster stockmarket is unsupported by the evidence.  Stock market values have increased dramatically in recent years (prior to the crisis), yet so too did the economy.  The ratio of stock market capitalisation to GDP for Australia has grown in line with that of the OECD as a whole and with comparable economies (Figure 5).

Immediately prior to the crisis the ratio for Australia was similar to that of the UK and US;  Australia has not been as affected by the crisis as those two countries.  Consequently it is difficult to argue that a stock market boom is the cause of the crisis.

Figure 5:  Market capitalisation;  per cent of GDP

Source:  World Bank Development Indicators.

#4

OTHER COUNTRIES HAVE UNDERGONE A "BUILDING DECADE", AND THEY DIDN'T WORK

In his essay, Kevin Rudd recommends that "Australia must embark upon a Building Decade, implementing a plan of nation-building for the future."

Attempts by other nations to embark on a "building decade" of public infrastructure have been made, and they have failed at every turn.

Between 1992 and 2000, Japan implemented almost a dozen separate stimulus packages emphasising public infrastructure investment.  As explained by economic historian Amity Shlaes, "the spending yielded painfully little for the rest of the economy.  The Nikkei stayed down.  The country's standard of living failed to keep pace with the rest of the world's." ⁽⁷⁾

Shlaes also noted that the Japanese unemployment rate had doubled during the infrastructure boom decade of the 1990s.  At the same time as failing to revive the economy, Japan incurred a substantial public sector debt of a size in excess of its total economy.

The case of the remote western Japanese port of Hamada is instructive.  Almost two decades of government capital works included a "hakomono" (or white elephant) bridge, highway, two-lane bypass, university, prison, children's art museum, sports centre, a "welcome" centre, ski resort and an aquarium featuring three Beluga whales. ⁽⁸⁾

According to a Japanese economist, Toshihiro Ihori, "it is not enough just to hire workers to dig holes and then fill them in again. ... public works get the best results when they create something useful for the future." His economic analysis suggested that the Japanese building decade crowded out valuable private sector investment thus dragging back overall growth in that country.

The Depression-era United States also engaged in a massive capital expenditure program, including the construction of dams throughout the Tennessee Valley, yet low growth and high unemployment persisted during the 1930s.

Less than six per cent of the Rudd government's $42 billion stimulus package in February 2009 was directed to road and rail projects.  Other spending was directed to overpriced school halls and toilet blocks, housing insulation batts, a range of local government boondoggles (such as public iPod docking stations, reshaped creek banks, sheds and eucalypt museums) and plaques designed to "boost confidence". ⁽⁹⁾

A cursory examination of the federal government's stimulus website shows that there are many Hamada works being developed in our own back yard. ⁽¹⁰⁾  Similar to the case of the Japanese port town, it is highly unlikely that our domestic spending escapades, undertaken at taxpayers' expenses, will yield a flow of economic returns sufficient to cover the initial funding.

Until the government provides detailed, independently verifiable evidence that the economic and social benefits of current infrastructure projects exceed their costs, community hesitation to give Kevin Rudd a green light on a "building decade" is well justified.

#5

GREATER ECONOMIC SELF-SUFFICIENCY IS A RECIPE FOR LOWER GROWTH

Kevin Rudd maintains an ambivalent position when it comes to matters of international trade and investment.

To his credit, Rudd is currently resisting the anti-foreign biases of the self-interested trade union movement on a number of fronts.  However, Rudd did stoke their autarkic ambitions by asking in his first speech as Opposition leader in late 2006 "Will we still make things?  Or is that all gone?" and declaring prior to the last election that he wanted Australia to be "a country that actually makes things".

The Rudd government has also not been as welcoming of foreign investment, especially from China, as we might have hoped.

Rudd's essay contains passages that portray cross-border market exchanges in a negative light:

• "if we succeed, we will have built in the decade ahead an Australian economy on rock-solid foundations for the future, rather than one that rests primarily on the shifting sands of international fortune"
• "the government has embarked on long-term economic reform ... rather than cyclical windfalls from mining booms entirely captive to global factors beyond our national control."

Australia has experienced a secular increase in exports, including in manufactured products, over the past two decades (Table 2).  Even despite the slowdown experienced during the March quarter 2009 export values were still double those at the trough of the last growth cycle.

Table 2:  Value of selected merchandise exports;  chain volume measure

	December 1991	March 1996	December 2007	December 2008	March 2009
Rural goods	4,772	5,208	5,769	6,058	6,661
Metal ores	4,752	5,346	10,328	10,138	9,644
Other metals	2,773	3,347	3,915	4,372	4,059
Machinery	661	1,337	2,275	2,315	1,860
Transport equipment	425	668	1,611	1,576	828
Other manufactures	1,344	1,975	4,288	4,311	3,673
Other non-rural goods	867	998	3,384	2,735	2,609
Total goods credits	21,793	26,926	44,501	45,505	42,653

Source:  ABS, Balance of Payments and International Investment
Position, Australia, cat. no. 5302.0;  original series.

The export share of total national output has also increased since the early 1990s (Figure 6).  Despite Rudd's uneasiness Australia is still very much a country that makes things, so much so that it is selling its wares around the world.

Figure 6:  Exports of goods and services as share of GDP;  chain volume measures

Source:  ABS, Australian National Accounts:  National
Income, Expenditure and Product, cat. no. 5206.0;  trend.

If exports stayed at their December quarter 1991 level Australia would have lost about four per cent of GDP or roughly almost $470 for each man, woman and child (March quarter 2009 figures).  This underlines the undeniable fact that exposure to international markets (in other words, less economic self-sufficiency) has delivered economic gains to Australia.

It is true that the absorption of inputs has increased as well.  Despite recent protestations from the trade union movement, this trend is not problematic and has proven to be beneficial for businesses and consumers alike.  The reduction of tariff and other trade barriers by Australia has enabled firms to benefit from the reduced costs of imported capital items and other intermediate goods.  Further, the inflow of cheap imported consumer goods satisfies the economic needs of consumers at home, contributing to our historical low inflation of recent years.

Australia's progressively open economic relationship with the world extends to capital flows, with an inflow of capital from investor interests abroad representing a key driver of our long term economic development.

As my submission to the current Senate inquiry into foreign investment by state-owned entities testified, consideration needs to be given to relaxing Australia's FDI policy to attract more investment in a capital-constrained world. ⁽¹¹⁾  The economic literature has conclusively demonstrated that there exists a positive relationship between trade and investment openness and economic growth. ⁽¹²⁾  This is why it is in Australia's best interests to keep our economic doors open to the world, and not decry the consequences of this policy stance as does our current Prime Minister.

And an honourable mention:

BUREAUCRATIC SOLUTIONS ARE NOT THE WAY TO ENGENDER REAL JOBS AND GROWTH

The Rudd essay is replete with assertions that actions by governments, including through the unaccountable G20 international bureaucracy, are necessary to rescue economies and put them back on a sustained growth path.

As Kevin Rudd himself put it, "as the crisis took hold, responsible governments around the world were forced the step in to stabilise fractured financial markets and to support growth and jobs through unprecedented fiscal stimulus."

Rudd is using Keynesian-style arguments to support an agenda expanding the size of government.  According to the Treasury budget papers, federal general government payments as a share of the economy have jumped from 24 per cent in 2007-08 to almost 29 per cent expected in this financial year -- a massive twenty per cent jump in the amount of federal spending in a short period of time. ⁽¹³⁾

Treasury figures also show that state and local governments are getting in on the act of spending like there's no tomorrow.

While using policy justifications from the post-war Keynesian copybook, it is arguable that Rudd is going down a path that not even John Maynard Keynes would have supported.  After all, Keynes once said that economic performance would be hampered if tax and spending exceeded 25 per cent of GDP. ⁽¹⁴⁾

Since Keynes' time, the empirical literature has conclusively demonstrated a significant and negative relationship between the size of government and economic activity in the long run. ⁽¹⁵⁾

There is no magic pudding or free lunch when it comes to economic management.  Government cannot stimulate an economy without first extracting funds, in the form of taxation or borrowings, from economic agents.

This explains why governments are also not the job-creation machines that Kevin Rudd thinks they are.

Governments are hoping that the "seen" outcomes of its spending spike, such as the hastily laid construction sites and the feel-good photo opportunities, will lead to tangible growth.  But it is more likely that the "unseen" misallocation of resources and destruction of economic value from wasteful expenditure will render harm to current and future generations.

The latest Kevin Rudd essay once again illustrates the Prime Minister's lack of understanding of why economies have come unstuck, as they have done in recent months, and what sort of policy strategies are required to get markets investing, producing and employing again.

Ideas do indeed have consequences.  Until such time that the Prime Minister gets the intellectual basics right on the economy, average Australians are likely to continue feeling the pain of the government's economic mismanagement.

---

ENDNOTES

1.  Bryan Caplan, 2007, The Myth of the Rational Voter:  Why Democracies Choose Bad Policies, Princeton University Press, Princeton.

2.  Munnell, A., Tootell, G., Browne, L., Mceneaney, J., 1996, "Mortgage Lending In Boston:  Interpreting HMDA Data", American Economic Review (March):  2–54.

3.  Theodore Day and Stan J. Liebowitz, 1998, "Mortgage Lending to Minorities:  Where's The Bias?", Economic Inquiry (January):  1–27.

4.  http://www.bos.frb.org/commdev/commaff/closingt.pdf

5.  Stan Libowitz, 2008, "The real scandal:  How feds invited the mortgage mess", New York Post, http://www.nypost.com/seven/02052008/postopinion/opedcolumnists/the_real_scandal_243911.htm.  An academic version of the op-ed is available;  Stan Liebowitz, forthcoming, "Anatomy of a train wreck:  Causes of the mortgage meltdown", In Benjamin Powell and Randall Holcomb (eds), Housing America:  Building out of a Crisis, Transaction Publishers.

6.  John Taylor, 2007, "Housing and Monetary Policy", Presentation to Symposium on Housing, Housing Finance, and Monetary Policy, NBER Working Paper, http://www.nber.org/papers/w13682.

7.  Amity Shlaes, 2008, "The Perils of a Cement Tsunami", The Washington Post, 10 December.

8.  Martin Fackler, 2009, "Japan's Big-Works Stimulus Is Lesson", The New York Times, 5 February.

9.  ABC Insiders, 2009, "Mark Arbib discusses stimulus spending", 5 July, http://www.abc.net.au/insiders/content/2009/s2617057.htm.

10.  See http://www.economicstimulusplan.gov.au/pages/default.aspx.

11.  Sinclair Davidson, Julie Novak and Tim Wilson, 2009, Submission to the Senate inquiry into investment by State-owned entities, http://www.aph.gov.au/senate/committee/economics_ctte/firb_09/submissions/sub32.pdf.

12.  Joshua A. Byrge and Michael R. Pakko, 2006, "Freedom, Trade and Growth", International Economic Trends, Federal Reserve Bank of St. Louis, http://research.stlouisfed.org/publications/iet/20061101/cover.pdf.

13.  Commonwealth of Australia, 2009, Budget Strategy and Outlook 2009-10, Budget Paper No. 1, Canberra.

14.  Quoted in Vito Tanzi and Ludger Schuknecht, 2000, Public Spending in the 20th Century:  A Global Perspective, Cambridge University Press, Cambridge.

15.  Tanzi and Schuknecht, Ibid;  Daniel J. Mitchell, 2005, "The Impact of Government Spending on Economic Growth", Heritage Foundation Backgrounder no. 1831;  Dennis C. Mueller, 2003, Public Choice III, Cambridge University Press, Cambridge.

Mere words won't save free trade

Despite Labor's posturing;  the evidence is mounting that the party's free-trade credibility is weakening.  Last month, the NSW government introduced budgetary measures giving local industry preference in major projects.  Foreign Minister Stephen Smith said the commonwealth wouldn't be following suit.

Yet on Tuesday, Industry Minister Kim Carr released his "Boosting Australian Industry Participation" policy that requires tenderers for government work to outline their use of Australian suppliers in every bid.  Carr's policy may not be all-out protectionism, but it is by stealth, by requiring tenderers to declare their suppliers and suggesting bids that don't use local industry will be subject to hazing.  Even the Australian Industry Group is backing Carr's latest plan, claiming it will "boost" local industry.

The announcement was made to appease the union movement, which wants "Buy Australian" provisions in government procurement, and to stop a fight on the ALP National Conference floor this weekend.

In a bid to affirm his free-trade credentials, Victorian Premier John Brumby said recently he "strongly opposed" the NSW regime.  "If you want more growth opportunities in the future, more job opportunities in the future, the answer to that is not to put up trade barriers," he said.

But Brumby isn't practising what he preaches.  In November, similar measures to give local producers a 10 per cent advantage for Victorian government projects were introduced.  The measures appear to be in breach of Australia's obligations under its free-trade agreement with the United States.

And in the ALP's draft national platform to be debated this weekend is consideration of whether "appropriate mechanisms are introduced to prevent environmental dumping".  That's code for supporting an Australian carbon tariff.  The only clear saviour in the government is Trade Minister Simon Crean, who is prepared to rail against any protectionist sentiment from the union movement or inside the government.

Over the past 30 years, Australia has benefited enormously from a bipartisan consensus supporting free trade.  Australia is a free-trade country because it serves our economic interests.  We cannot produce everything, and if we try the cost would be so outrageous it would reduce our bang for buck.

But recent action coupled with reducing migrant intakes earlier this year, suggest the government espouses open markets and borders but behind closed doors is turning the clock back.

Prime Minister Kevin Rudd said last year he had "a low tolerance threshold for importation" in relation to goods purchased with government stimulus money.

Rudd has previously argued that protectionism "brought on the Great Depression" and "throws a spear at the heart of the economy because so much of our jobs, so many of our jobs are generated by the trading sector of the economy".  He clearly understands the cost of protectionism, but it hasn't prompted him to stop the current course being set.  But to stop it and Australia's consensus for free-trade from crumbling, Labor needs more than words -- it needs uniform action to support free trade.

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Palin is not the new Pauline

Here we go again.  Sarah Palin's recent decision to resign as governor of Alaska has provided more ammunition for late-night comedians and left-wing partisans all across the world.  Airhead, lightweight, ditz, simpleton -- all of these barbs were levelled at last year's Republican vice-presidential candidate, and having resurfaced they are bound to proliferate in the run-up to the 2012 US presidential election.

The last time I can recall this degree of condescension among the keepers of left-liberal received wisdom was in Australia during the mid-to-late 1990s.  Pauline Hanson was as much of a hate figure in the staff cafeterias at Fairfax and the ABC as Palin is in the editorial offices of The Guardian and The New York Times.

At first glance, the outgoing Alaskan governor and the former One Nation leader have a lot in common.  They are the most divisive figures in recent American and Australian history;  there was almost no middle ground between those who have loved them and those who believe they were the devil incarnate.  Both are right-wing populists who activated hot-button issues in American and Australian politics:  for Palin, it's abortion and gun rights;  for Hanson, it was immigration and protectionism.  Both have lacked policy detail and philosophical substance in their political outlooks.  Both had their fair share of scandals, bad interviews and self-pitying monologues.  Both are attractive mothers (Palin has five children while Hanson has four).  Both arrived on the political scene from relative obscurity;  Palin was a small-town mayor and governor of a sparsely populated and faraway state, while Hanson was a fish-and-chip shop owner and disendorsed Liberal candidate for a federal seat in Queensland.

Both have been mocked and marked as apostates by the high priests and priestesses of their nation's media establishment.  Indeed, try going on the ABC's Q&A and say even nuanced things about Hanson or Palin, as I did about the latter last year.  You will see the audience wailing and whining like a Greek chorus because Palin, like Hanson, is a boo-word in Western politics, shorthand for ignoramus, reactionary and xenophobe.

But that's where the similarities end.  For Hanson and Palin are very different political figures.  Hanson was a protectionist and agrarian socialist who opposed virtually all market-oriented economic reforms;  Palin is a fiscal conservative, free trader and genuine reformer.  Hanson embraced race-based policies, epitomised by her repugnant views on Asian immigration;  no evidence suggests that Palin has flirted with racism.  Hanson has always been a marginalised character Down Under;  Palin still stands a chance of being the GOP nominee in 2012.  Hanson represented the peculiar Australian historical circumstances of her time;  Palin reflects the conservative political mood of a significant segment of working- and lower-middle-class folks in Middle America.

But just as Hanson did not represent the future of Australia, nor does Palin indicate a guide post for the US.

Hansonism, far from posing a threat to our democratic way of life, represented a protest vote against decades of dramatic economic and social change.  And while it was as much a reaction against Paul Keating's rights-based cultural agenda as an isolationist backlash against our integration with Asia, comparable movements had developed in New Zealand, North America and Western Europe.  This was hardly surprising, since every nation that undergoes a process of rapid change and modernisation has experienced a similar reaction to the dislocation and, as Joseph Schumpeter famously put it, creative destruction resulted.

And yet for all the criticism that John Howard had bowed to the Queensland populist during his almost 12 years in power, and for all the talk that Hansonism has undermined the social fabric of Australia, the political landscape does not bear One Nation's imprint.  On a wide range of issues -- from legal immigration to Asian engagement to economic reform -- Hanson failed to change the direction of Australia.  Today we maintain a large-scale, non-discriminatory immigration policy, we are very much engaged with both south and north Asia, and on economics Hanson's agenda contained a greater overlap with the protectionist and interventionist Left than the latter ever liked to admit.

In the US, Palin's appeal to certain electoral groups has little to do with the same historical factors that helped explain the rise of Hanson here.  Palin, perhaps more than any other political figure since George Wallace, exposed the age-old tension between populism and elitism in American public life, and her candidacy represented red meat for cultural populists and a lightning rod for the Joe Six-Packs who detest intellectual elites.  However plausible such qualities may be on the campaign stump, they are diminished by Palin's lack of policy substance, philosophical rigour and political experience.  Besides, a genuine presidential campaign requires the articulation of a broader vision for American families, freedom, prosperity and American security.

In fact, Hanson's equivalent in the US was more likely Pat Buchanan.  The former Nixon-Reagan adviser who ran in the Republican presidential primaries in the 1990s was admittedly a smarter, more sophisticated and better-read firebrand than Hanson.  But they nonetheless represented similar moods and causes.  Indeed, Hansonism was Old Australia just as Buchananism was Old America.  Opposition to globalisation and economic rationalism and support for a protectionist trade policy and restricted, discriminatory immigration levels reflected the conventional wisdom in post-war Australia and America.  And just as Buchanan's campaign failed to register with the feelings of the great mass of American voters, so did Hanson's agenda of racial divisiveness and economic isolationism eventually collapse.

As her latest campaign to re-enter Queensland politics earlier this year showed, Hanson is damaged goods and finished politically.  But Palin is not out yet, notwithstanding the many doubts among even leading conservative columnists such as George Will, David Brooks and Peggy Noonan.  The consensus among these leading lights of the US Right is that Republicans are playing with fire if they assume Palin is their warrior princess in shining armour.

So Palin is no Pauline.  Still, these two firebrands do share one overriding trait:  they represent the dead end of American and Australian politics.

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Rudd, Depressions and the lessons of history

These days much of our historical understanding is informed by American popular culture.  So it is quite understandable that many Australians would think that the American experience of the Great Depression is the Australian experience.  We might even believe that FDR and John Maynard Keynes saved the world from economic stagnation.

In his latest essay Prime Minister Kevin Rudd certainly gives that impression.  He claims that "Australia has sought to learn some lessons of recessions past" and describes the actions his government has taken to stave off recession.

Just as many would argue that the Great Depression was a hang-over from the roaring 20s, Rudd now argues that the current Great Recession is a hang-over from the growth of the last generation.  As if economic growth itself is somehow bad.  But I don't want to quibble with the prime minister's opinions -- I want to fact-check his statements.

His third paragraph is particularly troubling.

The alternatives [to the stimulus packages] were to do nothing or, worse, effectively replicate the Premiers' Plan of 1931 when governments cut expenditure, thereby compounding the problems created by a private sector already in retreat.  The result, of course, was an economic rout, appalling unemployment and a decade of negligible growth through the 1930s.

It is here that Rudd shows his complete ignorance of Australian economic history -- as opposed to a populist understanding of American history.  The Premiers' Plan certainly did not lead to an economic rout;  it did lead to a political rout.  The ALP government was subsequently flung out of office.

To demonstrate the point I have collected GDP per capita data from the authoritative OECD publication The World Economy:  Historical Statistics by Angus Maddison.  In the picture above I show index values for GDP per capita for the inter-war years 1919 to 1939 for Australia and the United States.  As can be seen economic growth in Australia slows down after the return to the gold standard in 1925 -- the late 1920s were hardly roaring in Australia.  The nadir of the Australian Great Depression occurs in 1931 -- overall Australia has a V-shaped Great Depression.  The US has a long, hard U-shaped depression (almost W-shaped depression after FDR raised taxes).

Two things happened in 1931:  Australia went off the gold standard and the Premiers' Plan was adopted.  Contra Rudd, the economic consequences of these events did not result in an economic rout, appalling unemployment, or negligible growth.  Rather the economy made a massive recovery and unemployment began falling.

The Australian economy was already fragile from inappropriate monetary policy when global conditions declined, and only began improving once monetary policy was changed and government maintained fiscal responsibility.  In the current great recession, monetary policy was also a problem before the Reserve Bank of Australia quickly lowered rates.  Yet rather than maintain prudent and conservative fiscal policy, the Rudd government has done the exact opposite, claiming to have learned lessons from past recessions.

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Green baptists lead to bootleg

The renewable energy bill now before the Senate proposes that 20 per cent of electricity be derived from renewable sources.

This would offer no advantage to Australia while crippling the competitiveness of our energy supply.  Based on the cost premium required for wind, the least uncompetitive available renewable source, and the bill's penalty costs on electricity retailers, the proposal requires energy at double the cost of commercial sources.

On average this would raise the average cost of generated electricity by 10 per cent and impose a deadweight loss on the economy of $1.8 billion per year.

Should the wider cap-and-trade emission trading scheme also be introduced, the 20 per cent renewable requirement will not even bring about a net reduction in carbon emissions.

With the ETS, it would merely change the composition of that reduction, making its achievement more expensive.

Ten years ago Australia developed the world's most competitive and lowest-cost electricity supply.  This was brought about by energy deregulation and privatisation.

Combined with the creation of the National Electricity Market and Australia's natural advantages in energy sources this has produced immense value to the nation's competitiveness across the range of industries.

The seeds to progressively dismantling this asset started with the 1997 Mandatory Renewable Energy Target.  Though ostensibly designed to require 2 per cent of electricity to be generated by subsidised renewables, this now requires more than 4 per cent from these sources and the new bill would boost that to 20 per cent.

Though the MRET scheme was never a good idea, unlike in 1997 it can no longer be credibly argued that, given time, wind generated electricity will be competitive with conventional fossil fuels.

These regulatory measures mean that instead of ensuring that the lowest cost energy dominates the market and putting pressure on all sources to reduce their prices, we are requiring the use of high-cost energy sources.

The resultant damage is compounded by imposing a tax on energy in the form of the ETS which would markedly increase costs.

Together the two measures will undermine the benefits we have gained from our low-cost energy and the political and regulatory institutions that allowed it to percolate though the economy.

At least with the ETS it may be argued that we have a tax with revenues directed back to those the political powers deem to be most worthy of extra subsidies (or cushioning the blow to firms whose corporate viability is exposed).

But with the mandatory renewable agenda all we have is a high-cost energy source.

This is imposed on the consumer by a form of tax, the revenues from which are directed back to the suppliers of the intrinsically uncompetitive energy sources.

Evidence from overseas shows that any jobs created as a result of the forced requirement to use mandatory renewables come at a cost in excess of $200,000 each.

Moreover, Spain's experience indicates for each subsidised job created, there are 2.2 jobs lost.

Mandatory renewables are promoted by an archetypical combination of "Baptists and bootleggers".  When Baptists call for a ban on alcohol sales on Sundays, it's the bootleggers who benefit.

The bootleggers -- those with commercial interests in wind farms and other high-cost renewables -- like the protectionist lobby before them, point to visible developments in facilities built on the back of the economic distortions they seek.

But the damage of acceding to the special pleading for high-cost electricity is much greater than was the case with the introduction of external tariff protection.

Unlike manufacturing facilities previously made possible by restraining import competition, wind farms no longer have any pretensions of being the nursery for an infant industry that will mature into genuine world competitive and productive activities.

Moreover, in making a poor use of our resources, they are sapping the nation's competitiveness on a much greater scale because of the all-pervasive nature of electricity within the economy.

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The long and winding road

With Road to Recovery, Kevin Rudd has once again offered his views on where we came from, where we are and where we are going.  Once again he is exposing his own individualistic views on how economies tick and how he is the man to make the tick louder and more enduring.

Basking in some indicators that suggest the economy has ridden out the global financial crisis, as a result of his spendthrift measures, he wants to moving into what he hopes will be a new austerity driven path to sustainability.

He starts his new essay with a repeat of a howler that featured in his first Essay.  He argues that Roosevelt was the one who got it right in the thirties with a massive shoveling of money into the US economy.  The fact is that US gross domestic product per capita in 1938 was still below the 1929 level and net investment was down 15 per cent.  The deficit-cutting UK and Australia fared better and saw their economies grow by over 10 per cent in the same period.  Other economies also saw lower unemployment than the US.  The wage boosting Roosevelt's policies brought US jobless in 1938 to 19 per cent compared with a rather better level of 9 per cent in this country where, like in others, wages were reduced in line with the lower level of real income.

And contrary to the Treasury view on which he based his spendathon, he no longer sees the economy roaring back to life.  Instead he adopts his own version of a Churchillian blood, sweat and tears stance in offering us negative investment, higher interest rates and growing unemployment.

He also sheets home the blame for the current crisis to the "corporate cowboys".  Not for our Mr. Rudd is a cause of the crisis the lax US monetary policy so carefully demonstrated by Stanford economist John Taylor.  Nor does he show an understanding of the US housing policy with government requirements on the banks to lend to people who would otherwise be classed as high risk and the collapse in financial confidence this triggered.

In a dismal lack of familiarity with history he considers it is only through actions like those he has taken that the green shoots he says are evident have been allowed to germinate.  The current world downturn is one of a couple of dozen over the past two centuries, ranging in severity from the Great Depression to that in 2000 when US unemployment peaked at under 7 per cent.  All of them have been caused by excess, and doubtless Mr. Rudd's corporate cowboys have figured.  So, ominously for his analysis, have faulty government policies.

Mr. Rudd, as a man who has had no exposure to work outside of government, is astounded that anyone could consider the cure for recessions does not lie with government.  In the light of his misreading of the causes and progression of the Great Depression, this is hardly surprising.

Evoking the language used to describe terrorism he calls those who do not share his big government agenda and faith in government controls over the economy as "market fundamentalists".  His own views are, naturally enough, those of the "responsible centre".

Mr. Rudd attaches much of blame to "cheap savings" from the Far East.  It is true that the US was borrowing an inordinate amount from the high saving nations like China and Japan (and, though he neglects to say so, Australia was doing even more of this).  He urges all developed countries to start saving more -- heroic words from a man who has been the prime plunderer of domestic savings, diverting them to consumers in an attempt to kick start the economy.  And he gratuitously advises the developing nations, who he says are saving too much of their income, to stop doing so and spend the money instead on welfare.  To China he is saying, "Cannibalise your savings and start spending for today rather than trying to catch up to western living standards".

In a breathtaking statement of misinformation on his own policies, he says, "Seventy per cent of the total direct investment under the strategy has gone to infrastructure".  He is actually only talking about a small amount of the money (which includes the back-of-the-envelope impulsive decision to spend $43 billion on the National Broadband Network).  And even the spending he claims as infrastructure can hardly be said to contribute to his much vaunted productivity enhancing expenditure.  In fact of the $42 billion Nation Building package only the $2.2 billion allocated to roads and rail is productive infrastructure.  Doubtless much of the rest -- including increased welfare housing, Pink Batts, school toilet blocks -- is worthwhile expenditure but it is difficult to see it delivering a productivity return.

Mr. Rudd thinks that in taking taxpayers money he prevented economic collapse.  He now wants to pay back the future's funding that he so ruthlessly raided.

In what is clearly part of a long CV for the position as UN Secretary General, Mr Rudd urges global coordination.  The G20 (which many will recall, was the group about which Mr. Rudd claimed G.W. Bush was totally ignorant) is given a lofty role.  The IMF is to be transformed into a kinder, more loving institution that will be more indulgent to the debtor nations (in an attempt to get them to spend more and save less!).  At least he no longer sees a sudden economic upsurge along the lines of the Treasury modeling.  Instead he sees "mountains of debt" (to which he joyfully has contributed) as a "drag on global growth for a long time".

Mr Rudd claims he will now start winding down the size of government.  He says that expenditure growth will be held to less than 2 per cent per annum.  That is a pipe dream for any ALP Government.  In any event over the next two years and probably beyond, two per cent growth in government spending will exceed the aggregate growth in national income.  He claims $55 billion in savings over the past two budgets -- yet oddly enough in spite of all those phantom savings budget expenditure has mushroomed!

One area of taxation, the "Carbon Pollution Reduction Scheme", is not mentioned as such.  This new carbon tax will provide $10 billion in new revenues that will escalate annually.  Revenues from the carbon tax can be constantly raided to bring home the electoral bacon.  The problem Mr. Rudd, is the carbon tax will drastically undermine the capacity of the economy to produce.  It may raise revenue but it will impoverish the economy as it does so.

As the Prime Minister says, we have to make tough choices.  One is between a big spending high taxing windbag with a slender grasp of economic history, and the other guy, whoever that might be.

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Gambling in a Free Society

Presentation to the RSL & Services Clubs National Conference
27 July, 2009

Gambling is a pastime that has brought pleasure to free citizens through most of recorded history.

I say to free citizens because it is a striking fact, and certainly no coincidence, that authoritarian governments of both Left and Right are quick to ban gambling.  The latest example of this phenomenon is Putin's Russia where, in an example of ever increasing authoritarianism, sweeping new restrictions on the gaming industry came into effect on 1 July forcing casinos and poker machines halls across Russia to close.

Fortunately, in a democracy like Australia such comprehensive restrictions are unlikely, but punters and industry alike need to remain vigilant to protect their rights; rights which are constantly being assailed by a range of critics proposing ever greater restrictions on gamblers.

Now, increasing restrictions on the right to gamble are not new in Australia.  The late 19th century and early 20th century was an era which saw increasing regulation of a range of activities including shop trading hours, the serving of alcohol and gambling.

In relation to alcohol, the temperance movement's influence climaxed in the First World War, with the imposition of 6 o'clock closing, the introduction of local preference provisions and bans on the employment of barmaids.  Amusingly, many barmaids were re-employed during the Second World War, prompting some wags to suggest that stopping them working was essential to defeating the Kaiser, and encouraging them to work was essential to defeating Hitler.

With gambling, the same era saw ever more strenuous efforts by governments to close down any off-track betting on horseracing, whether by SP bookmakers or, most famously, with John Wren's tote.  Wren's most recent biographer, James Griffen, highlights just how much hypocrisy was involved in the pursuit of Wren's gambling operations.  Politicians, and other guardians of community welfare, claimed it as their duty to save working class gamblers from themselves, yet there was never any similar push to stop similarly "illegal" gambling in city clubs.  It should also be noted that Wren's tote was operated in an honest manner, and gave a better return to punters than its rivals.

Fortunately, the period from the 1950s to the 1990s saw a progressive liberalisation of many areas of Australia's economy and society.  In regards to gambling, there were reforms such as the introduction of legal off-course wagering through TABs and legalising poker machines, beginning in NSW in 1956.

It is no coincidence that the most prominent individual opponents of poker machines nationally today come from the states such as Victoria and South Australia, which did not introduce pokies until the 1990s and also have strong non-conformist traditions.

These days even the non-conformist religious ministers tend not to use religion directly in their argument against pokies, instead relying on more humanist grounds.  However, it is an intriguing question as to why anti-gambling activists tend to single out the pokies.  It cannot be because of rates of return to punters, because punters get more back from pokies than they do from wagering and vastly more than they do from buying lottery tickets.  Perhaps, like the woman who in the 1980s wrote to The Age opposing a proposal to sell Tattslotto tickets in TABs on the grounds that she did not believe Tatslotto should be associated with gambling, some types of gambling are more socially acceptable than others.

One is inclined to suggest that there is a strong class element here.  The chattering classes look down on pokies players and patronisingly feel that pokies players must be dupes for even wanting to gamble in this way.  Combine this with a media always keen to run bad news stories and one has a difficult scenario for anyone trying to defend either the gaming industry or its customers.

Just last week, the latest figures for gaming turnover in Victoria were reported with screaming headlines about gaming "losses".  It is important to consider this use of language.  If I spend money on a lousy meal, a disappointing film, or in going to watch my football team lose, nobody says I have "lost" the money, yet if I choose gambling as my form of entertainment it is said that I have "lost", rather than "spent" the money.

Opponents of increased diversity of gambling options tend to argue, as one critic did, that "those of us who have the good of the nation at heart feel there are sufficient facilities for gambling already."  It sounds like a quote from an anti-gambling activist today, but is in fact from Rev Gordon Powell in 1948.  He was opposing an increase in the number of trots meetings in Melbourne.

The argument that there are already enough venues for gambling is a bit akin to those who do not drink coffee thinking that there are already enough coffee shops in many trendy inner urban shopping streets.  The difference is that non-coffee drinkers rarely have the same patronising and superior mindset as elements of the non-gamblers.

Of course, much of the anti-pokies rhetoric places a large proportion of the blame on state governments, which are allegedly so beholden to taxation on gambling.  This line of argument formed part of the Howard Government attack on the states and Prime Minister, Kevin Rudd has also criticised state Labor governments for relying too heavily on the revenue.

Considering that gambling taxes make up a bit over 3 per cent of state revenue for gambling as a whole, or 2 per cent for gaming machines, it is hardly undue reliance, when compared to property and payroll taxes.  Of course, an easy way to reduce their "reliance" would be by the states cutting the rates of gambling taxes, but I am not sure if this obvious way of reducing "reliance" is what the gambling critics have in mind.  Ensuring punters get back a higher percentage of their turnover would seem a laudable aim, especially as gambling taxes tend to be regressive, but not apparently to the anti-gambling zealots.

This view that state governments have some sort of vested interest in promoting gambling has contributed to the trend of all levels of government feeling the urge to play a role in gambling policy.

At the federal level, the most obvious manifestation of this is the Productivity Commission's Gambling Inquiry.  The Commission's 1999 report has provided the basis for many of the subsequent debates and arguments about gambling in this country.  At last count, the Commission's current Inquiry had received 252 submissions and it is pleasing to see so many sensible ones.  Anyone wanting to see some of the key arguments should look at the submissions from RSL & Services Clubs, Clubs Australia and myself.  It is also good to see so many submissions from individual clubs, highlighting what they contribute to their local communities, both in economic and social terms.

Key elements of the debate will no doubt continue to relate to the prevalence of problem gamblers and the percentage of gambling "losses" which come from problem gamblers.  All reputable studies are showing a downward trend in the prevalence of problem gambling and hopefully the Productivity Commission will recognise this and put an end to some of the more exaggerated claims of the anti-gambling lobby.

Even if we accept, for the time being, the 1999 figure on the prevalence of problem gambling, it still means that 98 per cent of those who gamble in Australia are not problem gamblers.  It seems unfair to impose unnecessarily onerous restrictions on such an overwhelming majority to protect the minority, especially if there is minimal evidence that the restrictions will actually help the problem gamblers.

One current such proposal, banning ATMs in gambling facilities, would cause significant inconvenience to users, not just of gaming facilities, but of all other food and entertainment within venues.  As so many in the industry have pointed out, is it really a good idea to send patrons out of the secure location of a club or hotel, down to an ATM at a bank in a deserted main street?

It is also important to continually rebut some of the more exaggerated claims of the opponents of gambling.  One of their most commonly cited claims relates to the impact on families.  Interestingly, a 2006 Relationships Australia survey placed gambling 22nd of 24 possible factors "negatively influencing relationship with partner", with a score of just 3 per cent.  Six times as many people had relationship problems due to disputes over housework and three times as many complained about the "influence of in laws".  So while pokie critics stress about poker machine spin rates, perhaps they could do more good if they worried about in-law visitation rates.

As well as the Commonwealth involvement, local government has also begun interfering with gambling.  In some jurisdictions state governments have given local government the power to object to new developments which include poker machines, but rather than using this power with discretion, some councillors in municipalities such as Logan in SE Queensland are trying to ban new pokies all together.

Not to be outdone, the mayor of Moreland Council, in the northern suburbs of Melbourne, recently proposed doubling the rates paid by gaming venues in his municipality.  Singling out pokies leaves many other businesses paying rates at the standard level in Moreland, businesses such as brothels, tattoo parlours, tobacconists and pawn shops, all of whom at least some citizens might consider to be as socially damaging as the local pokies venue.

As the President of the Waverley RSL in Victoria so eloquently commented in his club's newsletter last year:

It is unfortunate that many in the community (particularly in local government) do not have an understanding of the crucial role that RSL sub-branches play in the service of volunteer hours and support to the aged and needy within their communities.

Another unfortunate aspect of the debate about gaming being focused solely on issues of problem gambling is that it has crowded out debate about very important topics, such as the new industry structure in Victoria from 2012, the impact that internet-based gambling will have on all traditional forms of gambling, and the preferential treatment of casinos.

Nobody denies that there is a risk attached to gambling, and that gambling addiction has caused significant problems for individuals and families.  The gaming industry, with clubs at the forefront, has implemented significant measures over the past decade to reduce the risk of harm.

As with almost any other human activity, gambling will always carry a risk but, in a healthy democratic society, the assessment of risk is something that is best left to adult individuals, rather than the state.  Ultimately, the right of individuals to spend their own money as they choose, including on gambling, is fundamental to a free, open society.

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Big switch will overload electricity industry

Regulations to reduce carbon emissions in Australia would massively increase business costs and seriously disrupt electricity supplies.  They would also ruin the nation's major electricity generation businesses.

Australia, especially Victoria, has the world's most competitive electricity supply industry, thanks to deregulation and privatisation reforms.

Since they were sold, Victoria's power stations have lowered costs, including by shedding four fifths of their previous workforces and reducing maintenance downtime.  Households and industry have benefited with cheap power prices.

Canberra's Carbon Pollution Reduction Scheme (CPRS), imposes an increasingly stringent annual cap on permitted emissions.  Its goal is to bring carbon emissions down to 20 per cent of today's levels.  The cap on emissions has a fall-back tax at $57 per tonne of carbon dioxide, an imposition equivalent to 1½ times Victoria's current market price for electricity.

The CPRS has two painful implications.

The first is that it eradicates coal based electricity.  And yet we have no source of power to replace coal.  Gas, though lighter in its carbon emissions, cannot offer a long term solution in the context of the planned reduction levels and is more expensive.  Nuclear is carbon free but has been demonised out of consideration and anyway is twice the cost of coal based electricity.  The various renewable options would bring unreliability and require massive permanent subsidies.

The second implication is that the targeted carbon reductions under the CPRS very quickly bankrupt Victoria's electricity generation industry.

Canberra's carbon tax proposal leaves Australian generation businesses far more vulnerable than their counterparts in the US and Europe.  That's because Penny Wong's plans allocate only 4 per cent of total allowable emissions free to existing electricity generation businesses.  The US bill provides 35 per cent of total emissions free to generators.

Because brown coal has more emissions than black coal it is the first casualty of the CPRS carbon tax.  According to confidential information prepared by Ernst and Young, the present proposals would reduce the worth of Victoria's Latrobe Valley generators from their current $7.9 billion to $2 billion.

That Sword of Damocles hanging over generators' heads creates difficulties in their loan refinancing, even without the global financial meltdown.  Moreover, the higher risks of looming bankruptcy mean the businesses will avoid throwing good money after bad and stint on maintenance.  This foreshadows earlier supply problems than Canberra bargained for.

The generation businesses are looking for more free carbon credits.  A trebling of currently proposed free credits would preserve their balance sheets.  But, though this would silence shareholder outrage, it would do nothing to ensure future electricity supplies.

Canberra cannot meet its goals on carbon emission reductions, unless it forces the closure of coal based electricity generation.  This supplies 80 per cent of Australia's electricity.

Governments hope that forcing up electricity prices will bring a dramatic reduction in energy usage that leave us little worse off and that we will also see sudden stunning technological breakthroughs.  These pious wishes are in contrast to the certainty that carbon emission restraint policies will destroy the magnificent electricity supply industry that has been developed in Victoria and Australia generally.

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Four pillars fickleness

Australia's four major banks want to have it both ways.  The banks happily accept government regulations like the deposit guarantee, which gives them a significant competitive advantage over their smaller rivals.

But when the government then demands something in return, like having the banks pass on interest rate cuts, the banks loudly demand that politicians stop telling them how to run their business.

Given that bankers make their living by making loans and then (hopefully) having those loans paid back with interest, it's surprising they forget a basic rule of human interaction.  When someone gives you something, usually you have to give something in return.  So it is with government.  Favours from government come with strings attached.

Westpac Banking Corp boss Gail Kelly warned this week of regulatory "overkill" of the finance industry in the wake of the global financial crisis.  Kelly spoke of the risk of "unintended consequences" as "lots more red tape" and "lots more paperwork" will make credit more expensive.

In fact the problem with the Rudd government's proposed national consumer credit code is not just that it will make credit more expensive, the code will actually stop some people from getting credit in the first place.  Under the "responsible lending" requirements, banks will be prohibited from lending to borrowers at risk of not being able to pay back the loan.

So we've come full circle.  In the United States in 1977 the Community Reinvestment Act said that banks must lend to people on low incomes.  Thirty years later, in response ot the global financial crisis, here in Australia the government introduces laws that say that banks must not lend to people on low incomes.  On most accounts the Community Reinvestment Act had at least some role to play in creating the conditions of the global financial crisis.  Hopefully, our local efforts will not have the same catastrophic consequences as occurred in America.

There's no reason to think that Australian politicians are any better than those in America at second-guessing the commercial decisions of banks and the personal decisions of borrowers.  It doesn't look like politicians have learned their lesson.  Probably because it is not a lesson they want to learn.  Politicians simply can't help themselves from interfering with banks, in exactly the same way as they can't stop themselves telling telecommunications companies what services to offer and how much to charge for those services.

The same goes for the government guaranteeing bank deposits.  Given the circumstances of the time when it was introduced, perhaps the policy was justified.  But we're nearly 12 months on from the panic of "October days" last year.  The need for the guarantee has passed.  So far the main effect of the guarantee has been to all but kill the competition the banks faced from non-guaranteed investments.

Gail Kelly was right, of course, when she talked about the unintended consequences of the new credit regulations.  Hopefully, in the future there'll be more bank executives wishing to speak up on this and other issues.  For the regulatory onslaught has begun and is likely to continue for some years yet.

However, as significant as the proposed credit code is, far more important at the moment are regulations governing the deposit guarantee and the edifice of the four pillars policy.  The unintended consequences of these regulations are enormous and affect the entire financial sector.  Perhaps it's not surprising that Kelly didn't venture an opinion on these other regulations given she's the boss of one of the banks that benefits from them.

When a politician stands up at a press conference and attacks the big banks for their supposedly "excessive" profits, no journalist ever points out that the size of those profits are a result of decisions made by government.

The four pillars policy was conjured up by Paul Keating in 1990, and John Howard and Kevin Rudd maintained it.  A few months ago former Reserve Banks of Australia governer Ian Macfarlane commented that "ironically" the policy prevented Australia's banks from taking the sort of risks that US and European banks undertook, because Australian banks didn't need to fear being taken over and so didn't need to be constantly increasing their revenue.

Given that the four pillars policy was intended to promote competition by preventing four big banks from turning into two even bigger banks, the actual outcome of the policy is ironic indeed.  So much for the claim that politicians have any idea about the consequences of the regulations they make.

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The ACCC is failing to rein in the cartels

Australian business leaders woke up yesterday morning to an extraordinary outburst from a public servant.  The Australian Financial Review published a threatening and patronising opinion piece penned by Graeme Samuel.  Mr Samuel is the Chairman of the ACCC -- a government regulatory body that has in the last 18 months been responsible for policies such as FuelWatch and GroceryWatch.  In 2005 the ACCC admitted, in court, to fabricating evidence leading to charges being dropped in a price fixing case.  The existing CartelWatch policy has been ramped up with criminal sanctions applying to cartels after Friday.

It is entirely appropriate that Mr Samuel take the time and effort to explain the law to business.  Yet it is not at all clear that patronising, threatening and thuggish commentary is appropriate.  Mr Samuel explains:

Let me make it very simple -- if you don't want the risk of going to jail, don't get involved in illegal cartels.  This is the only advice lawyers will need to provide their clients.

There you go -- just don't do it.  That is all very well and good, except the problem is that business is not entirely clear what an "illegal cartel" comprises.  In other words, Mr Samuel's advice is next to useless.  For example, there has been some doubt as to whether franchise agreements constitute cartel-like behaviour.  The bottom line is that this op-ed is not aimed at business, but rather at his political masters and anti-business constituencies.

The problem with the ACCC is that it has absolutely no accountability for its primary functions.  These functions are spelt out in its name;  competition and consumers.  While the ACCC often speaks about competition and consumers, there is no evidence that supports the notion that it does anything at all to promote either of these two things.  Consider, for example, competition;  prices in a competitive market should be lower than prices in a monopolistic or oligopolistic market.  Yet, we know that following the ACCC prosecution of Visy that prices rose and didn't fall.

So how exactly did the ACCC actions promote either competition or consumers?  We know for example that the Petrol Commissioner was investigating Coles and Woolworths to discover whether their petrol discounts of up to 40c per litre were legal.  How does lowering prices to consumers make them worse off?

To be sure, the ACCC may claim that they are merely enforcing the law as it stands.  But why should consumers, taxpayers and voters accept at face value that the ACCC, or any other government agency, performs its stated functions well?  Audits and accountability need to be put in place, and not just tick-a-box accountability either.  When alleging cartel behaviour the ACCC should have to nominate how and when consumers will benefit from lower prices and increased competition.

The Auditor-General should have to verify that the process and outcomes that the ACCC nominated have in fact occurred.  If those outcomes have not transpired the injured parties should have an action for damages against the Commonwealth.  As it currently stands, the ACCC operates an all care and no responsibility system of law enforcement.

This is a change from how law-enforcement normally operates but would go a long way to creating a level playing field whereby the ACCC cannot simply engage in trial by media and trial by fishing expedition, but would have to exercise far more caution in future than it has in the past.

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The Costs to Australia of Renewable Energy

Submission to the Senate on the proposed 20 per cent energy requirement

KEY POINTS

The proposed renewable requirement would markedly raise the price of electricity:

• imposing a direct cost on the economy of $1.8 billion annually;
• increasing consumers' costs and reducing industry competitiveness;
• causing far more jobs to be lost than the subsidised jobs created.

INTRODUCTION AND SUMMARY

The Commonwealth Government's proposal to require 20 per cent of electricity to be derived from renewable sources offers Australia no advantage to while crippling the competitiveness of its energy supply.  It raises the average cost of generated electricity by 10 per cent, imposing a deadweight loss on the economy of $1.8 billion per year.

If the proposed Emission Trading Scheme (ETS) is also introduced, the 20 per cent renewable requirement will not even bring a net reduction in carbon emissions.  It would merely change the composition of that reduction, making it more expensive.

Ten years ago, with the National Electricity Market Australia had developed the world's lowest cost electricity supply industry.  This stemmed from deregulation and privatization combined with Australia's natural advantages in energy sources.  The outcome was of immense value to the nation's economic competitiveness.  We are progressively dismantling this asset.  Instead of facilitating the use of low cost energy, government regulations are increasingly subsidising high cost energy sources.

The proposed ETS tax would compound these adverse effects.  But, at least revenues from the ETS are to be directed back to people and institutions the government deems to be most needy or meritorious.  By contrast, the mandatory renewable requirements impose a hidden tax on the consumer, the revenues from which are given to the suppliers of intrinsically uncompetitive renewable energy sources.

Evidence from overseas shows that any jobs created from a forced requirement to use mandatory renewables come at a cost in excess of $200,000 each.  Moreover, Spain's experience indicates for each subsidised job created, there are 2.2 jobs lost.

Mandatory renewables are promoted by a classic combination of "Baptists and bootleggers".  The bootleggers, those with commercial interests in wind farms and other high cost renewables, like the protectionist lobby before them, point to visible developments in facilities built on the back of the economic distortions they seek.

But the damage from imposing high cost electricity is much greater than was the case with external tariff protection because of electricity's ubiquitous presence throughout the economy.  Moreover, unlike manufacturing facilities previously made possible by restraining import competition, wind farms and other renewable technologies can make no credible claims of being nurseries for infant industries that will mature into productive activities.

AUSTRALIA'S PROPOSED 20 PER CENT
RENEWABLE TARGET IN CONTEXT

TYPES OF AUSTRALIAN EMISSION REDUCTION MEASURES

The renewable target is being addressed at the same time as other measures which focus upon emission reductions.  Chief among these is the cap-and-trade scheme incorporating a carbon tax, and a range of budgetary expenditures by the Commonwealth and State Governments.  In all, there are five classesof programs designed to reduce Australian emission levels:

• direct funding from the budget for incentives to reduce emissions;
• the regulatory price based cap-and-trade proposal;
• requirements for specific amounts of renewable energy to be incorporated in the electricity that retailers supply to the consumer;
• funding promotional measures designed to encourage consumers voluntarily to reduce their emission levels;  and
• requiring businesses to incur expenditures through energy audits with a view to their discovering new means of saving energy or justifying reasons why such savings are not being made.

The last two classes are not further addressed in this paper.

GOVERNMENT BUDGETARY EXPENDITURE

The Commonwealth Government is spending considerable public funds on measures to foster lower energy use.  As there is no shortage of energy per se that normal price developments do not signal, these sums can be designated as focussed upon the objective of reducing greenhouse gas emissions.

During the current financial year some $2.6 billion is identified in the Department of the Environment (DoE) budget.  Among these are the "Clean Energy Initiative" and the "Climate Change Action Fund".

The Department of Climate Change (DCC) elects not to include some of the DoE measures as directed at climate change and therefore publishes a lower costing (just over $1 billion).  Excluded from the DCC summation is important expenditures on home insulation and low emission assistance for renters which have over $1.4 billion budgeted in the current year and 2010/11.  These formed part of the fiscal package designed to avert the effects of the global financial crisis on Australia.

Aside from their emission abating functions, a rationale for these expenditures is "market failure" to produce the goods and services that consumers generally want.  While it is possible that all classes of the $2.6 billion of expenditures undertaken by government on our individual behalves represent our best interests, such spending choices have seldom proven to be optimal in the past.  Governments have long histories of promoting particular industry sectors through tariffs and subsidies but such "winner picking" is now generally considered to have been misplaced.

In the case of energy industries, the widespread belief 30 years ago that there was a looming energy supply crisis brought government subsidies and regulations that were designed to pressure decision takers into making energy savings they would not have willingly made.  Though there are benefits in energy savings, these are rarely costless and usually have a negative worth when they involve capital expenditures with a zero or very low payback.

THE EMISSION TRADING SYSTEM (E.T.S.)

The ETS incorporated within the Carbon Pollution Reduction Scheme is the only one of listed classes of abatement policy that is an "economic instrument" in the accepted definition of the term.  Economic instruments are almost universally considered to be more efficient than deterministic command-and-control measures which mandate specific solutions.  Regulations that specify particular technologies or types of technologies fail to make use of the power of markets to discover the lowest cost ways of meeting the goal.

Economic instruments use taxes or quantitative goals to allow the objectives to be met most cheaply.

Taxes and quantitative limits both bring additional costs.  These are passed on in prices and cause consumers to reduce their demand for the product incorporating the targeted constituent.  This effect on gross demand is complemented by further abatement resulting from supply switching;  with the ETS, that means from the fuels that are high in carbon emissions relative to the energy they produce, to those that are lower in carbon emissions.

The supply switching effect is transmitted differently by a tax as opposed to a quantitative limit.  With a tax, supply switching is achieved by the charge's greater direct cost on the supplies that use the taxed component most intensively.

With a tradeable rights approach, owners of the outputs that use the taxed component most intensively have an incentive to switch their production profiles or sell the emission rights to others who have a more favourable input profile.  This indirectly increases the cost of the products that use the targeted input most intensively, causing it to be substituted by products where the targeted input is less intensively present.  In both cases the switching between product classes reduces the average rate of tax per unit of product.

The switching process is readily seen with electricity generated by gas rather than coal.  The former has only half of the latter's rate of carbon dioxide emissions per unit of electricity.  As a result, the impost on electricity generated by gas is only half of that on coal based electricity and gas will improve its competitiveness because it faces a lesser impost and will increase its market share, thereby reducing aggregate emissions for a specific level of electricity generated.

The degree to which the price increase brings a demand reduction rather than a switch in types of supply depends on a number of factors.  Importantly, these include the relative ease by which carbon intensive energy supplies can be substituted and the responsiveness of consumers to higher prices.

Economic instruments therefore pursue the goals by one of two routes.  The first involves setting a rate of tax per unit of emission and allowing the quantity to be determined by the market.  The second sets a quantity and allows the market to set the price.  Normally, whether a tax or a quantity is the parameter that is set, the government will have in mind a likely outcome that is acceptable in terms of the reciprocal factor.

Like other countries, Australia has opted to introduce an Emissions Trading System.  Emission rights are to be sold with some given away to particular users who are judged likely to suffer excessive costs from the higher impost they would be required to bear.  As evidenced by the Queensland Premier's call on 15 July for special treatment for the State's "gassy" mines, should the scheme become operational, there are likely to be considerable refinements to it.

As with most ETS schemes, that of Australia incorporates a fall back price at which the government will make unlimited permits available.  That price for Australia is proposed to be $10 per tonne of CO₂-e in the first year and an indexed $40 per tonne of CO₂-e in subsequent years ($57 in after-tax terms).

MANDATORY REQUIREMENTS ON ELECTRICITY USAGE

ADVICE OFFERED ON MANDATORY REQUIREMENTS

The Productivity Commission (PC) in its submission to Garnaut ⁽¹⁾ expressed its strong reservations about the merits of mandatory incorporation of specific technologies in its usual understated and measured manner.  It did so in referring to the MRET scheme for promoting renewables.  The PC's conclusions were

"with an effective ETS in place, the MRET would:

• not achieve any additional abatement but impose additional costs
• most likely lead to higher electricity prices
• provide a signal that lobbying for government support for certain technologies and industries over others could be successful."

The PC examined many claims where a measure other than a price mechanism like the ETS might be supplemented by other regulatory arrangements and concluded that none of these were persuasive.  For example it might be argued that there is an asymmetry of information between the market and those more knowledgeable of future trends in government.  However, such claims have seldom in the past been born out and considerable costs have been incurred by taxpayers or through regulatory measures in supporting particular industries or technologies that turned out to be blind alleys or inappropriate for Australia.

As the PC argued, an MRET scheme in conjunction with renewable targets would have no effect on the aggregate level of emissions since these are set by the ETS scheme.  At best, it could lead to a zero net cost but only if the approach to emission reductions were to follow the renewable route completely on the basis that other reduction approaches, like substituting gas for coal as a generation fuel, were higher cost.

Other rationales for an MRET scheme have included the greater degree of self sufficiency it offers and that it supports an infant industry.

The self sufficiency case is seldom of merit in an inter-dependent world and, in any event, is irrelevant to Australia which is a net energy exporter and certainly has no shortage of local low cost coal and gas supplies suitable for electricity generation.

Support for an infant industry is often the refuge of the politico-economic scoundrel.  In Victoria the state scheme was promoted as the harbinger and catalyst of a whole raft of new industries particularly involving the manufacture of high technology blades.  The outcome is discussed below.

CURRENT AUSTRALIAN SCHEMES

The Mandatory Renewable Energy Target (MRET) From relatively modest beginnings there has been a considerable escalation in subsidies to renewable energy.  When Prime Minister John Howard announced the proposal to introduce a scheme in 1997 he said it was for an additional 2 per cent of electricity that was to come from "renewable or specified waste energy".  Although an additional 2 per cent by 2010, on the basis of the consumption that year of some 250,000 GWH would have been 5,000 MWh, the MRET target was reinterpreted and almost doubled to be 9,500 GWH.

A review of the scheme in 2004 (the Tambling Review) recommended it be increased to 20,000 GWh by 2020.  In June 2004 the Commonwealth announced that it did not believe expanding the target was economically justified and that it did not intend to increase the requirement.

NSW NGAC

The NSW Government introduced its NSW Greenhouse Gas Abatement Certificates (NGAC) scheme in 2003 which set a benchmark for emission standards of 7.27 tonnes of CO₂ per head.  On top of the Commonwealth MRET scheme, based on business-as-usual estimates of market growth and carbon intensity of electricity generation, an additional 19% of electricity in NSW must be derived from low carbon emitting sources.

Queensland GEC

Queensland has its 13 per cent GEC scheme under which 13 per cent of the non-exempt load must be derived from gas based electricity generation.  The exempt load is 9,000 GWh hence, after also deducting for loss factors in transmission and distribution, the requirement covered 75 per cent of the 2005 load.

Victoria's VRET

Victorian Premier Bracks in November 2005 argued that there was a, "lack of national leadership" by the Federal Government in not increasing the MRET scheme from the 9500 GWh target set for 2010 and said this, "is costing Victoria – economically and environmentally -- and cannot be allowed to continue." Mr Bracks argued, "Victoria's aim to facilitate the development of up to 1000 megawatts of wind energy by 2006 represents $2 billion worth of capital investment.  Then there are the jobs and the other economic spinoffs that accompany such a significant outlay".  The VRET scheme requires an additional 3,274 GWh of eligible renewable electricity by 2016.  It was expected to create "up to 2,000 new jobs, most of them in regional Victoria".  An indexed $43 penalty is imposed on shortfalls in a regulated entity's obligations.

At the time of the initial discussions of mandatory requirements for renewables, many among the wind farm lobby were confident that eventually wind would prove competitive with fossil fuels even without a subsidy.  That view was even shared by many climate sceptics for example in 1995 in The Skeptical Environmentalist, Bjorn Lomborg noted how windmills' productivity had improved, and "In the long run they will undoubtedly become competitive and even cheaper (than fossil fuel plants)". ⁽²⁾  No reputable authority would claim that today.  Indeed, anticipating a continued lack of competitiveness in the economics of renewable energy, the 20 per cent renewable proposal increases the after tax fall-back price from the MRET's $57 to $93 per MWh.

The Victorian scheme's hopes for new cutting edge businesses manufacturing blades and other components have been highly disappointing.  Thus the Pacific Hydro wind farms were to be the springboard for a Vestas blade factory in Portland, and were expected to generate 400 direct and indirect positions according to the sponsor, by mid 2006.  In spite of extensive State and Federal subsidies the project folded.

Victorian Industry Minister Theo Theophanous blamed the Commonwealth for failing to invest in renewable energy, "The reason why Vestas has been unable to continue its operations in Portland is very squarely and directly as a result of the Federal Government's refusal to extend its renewable energy scheme to allow the industry to expand," he said on the ABC. ⁽³⁾

This was rejected by then Commonwealth Minister Ian Macfarlane who argued, "Our Government has provided through the MRET scheme some $5.5 to $6 billion in terms of assistance to the renewable energy sector".  Mr Macfarlane added, "In particular with Vestas, [we] have provided them with tax relief over the last two years of around $10 million to ensure they are able to be competitive with the turbines they do produce." ⁽⁴⁾

Victorian Energy Minister Theophanous also announced the Victorian Wind Energy Network central to which was to be a blade manufacturing facility by Bolwell Corporation at Ararat.  This too folded in spite of extensive government support.

THE SPANISH EXPERIMENT WITH RENEWABLES

The Spanish experience with solar and wind power subsidies has been more far-reaching in relation to the market's size than that seen anywhere else. ⁽⁵⁾  Spain embarked upon a vigorous subsidy program which was intensified following the election of a new Socialist Government under Prime Minister Zapatero in 2004.  By 2008, electricity production was as shown in Table 1.

Table 1 Spain electricity generation share

Energy Source	Per cent
Combustible	64
Nuclear	20
Hydro	7
Wind and solar	9

Source OECD;  http://www.swivel.com/data_columns/show/10362480?value=Spain

Wind and other exotic renewables had shown a rapid increase in market share and claimed to be at 11 per cent in the first half of 2009.

However, as demonstrated by the work of Gabriel Calzada Alvarez and his researchers, the outcome has contributed to an economic disaster in Spain.  At 18.1 per cent Spain's unemployment rate is currently the highest in the OECD area, whereas previously it was close to the average.  That regrettable outcome is not solely related to the Spanish Government's aggressive pursuit of wind power investment but this was most certainly a significant factor.

Installed renewable power was targeted at 20,155 MW in 2010 – threefold Victoria's brown coal generation capacity and similar to Australia's entire black coal generation capacity.  At the end of 2008 over 15,000 MW of wind and 4,000 MW of solar photovoltaic capacity had been installed.

A second objective was to have 20 per cent of electricity consumption from renewable sources.  Including hydro-electricity, renewable energy was close to that figure in 2008.

The issue that Alvarez addresses is the cost and consequences of that seemingly successful performance.

In the case of wind power there is a complex remuneration system (which actually encourages the installation of under-sized units).  In 2008 the average cost of wind exceeded the pool price by 59 per cent.  In the case of solar the increase was far greater at sixfold.

Alvarez models the effect of these cost increases on jobs throughout the economy.  He concludes that though the stimulus to renewables has resulted in increased jobs, especially in construction, the increased cost of electricity has resulted in 2.2 jobs being lost for every job created.  He also estimates the cost of each "green" job was €571,000 and the cost of each wind industry job €1 million.

In terms of industry, Alvarez points to several high profile relocations of firms from Spain in response to the higher costs of energy.  These include Hoeschst, Sidenor, Ferroatlantica and the stainless steel company Acerinox (which relocated its production to the USA and South Africa).

Spain's experience, though involving higher costs than others, has not been unique.  Indeed, according to the Rhine-Westphalia Institute for Economic Research, "Each of the 35,000 solar jobs in Germany, for instance, is subsidized to the tune of €130,000." ⁽⁶⁾

EFFICIENCY OF DIFFERENT ELECTRICITY SOURCES

COSTS BASED ON AUSTRALIAN EXPERIENCE AND ESTIMATES

In Australia, South Australia is home to most of the wind generation installed and under consideration.  This is due to the state having the most advantageous wind conditions and because its pool prices tend to be a little higher than those of most other states (as a result of its reduced availability of coal).

Some 326 MW of wind generation is installed or planned around Lake Bonney in the state's south west and much of the rest is planned near existing transmission lines north of Adelaide.  Capacity factors average around 27 per cent.

South Australia's Electricity Supply Industry Planning Council (ESIPC), now incorporated within the Australian Energy Market Operator (AEMO), estimated that the state has 880 MW of wind generation projects "advanced" with 295 MW considered close to commitment. ⁽⁷⁾  That approaches one third of the state's capacity and though, because of wind's unreliability, it would never supply that share of electricity, in 2008/9 it contributed 14 per cent of supply.

Work conducted for ESIPC by KPMG estimated future supplies as follows.

KPMG's forecasts show SA's wind capacity rising from 740 MW in 2008-09 to 2,162 MW in 2012-13, without any allowance being made for an extension of the RET target to 45,000 GWh by 2030.

ESIPC also demonstrates one of the outcomes of Australia's National Electricity Market's "energy only" approach to pricing.  The pool price received closely approximates the worth of the energy.  Because of the unreliability of wind energy, it tends not to be available at the highest priced occasions – sometimes because it is at full capacity already, often because high price events coincide with no or excessive wind.  As a result, wind tends to attract a lower average price than more flexible forms of generation.  In the first half of this year wind's average price was $48.56 per MWh, some 53 per cent below the $74.26 per MWh received by other South Australian generators.

Table 2 below illustrates the different prices over recent years.

Table 2:  South Australian pool prices for wind and other generated electricity

Year	Volume Weighted Price for Wind Generators		Volume Weighted Price for Other SA Generators
	Full Year ($/MWh)	Summer ($/MWh)	Full Year ($/MWh)	Summer ($/MWh)
2004-05	NA	NA	39.25	32.62
2005-06	32.57	39.59	43.91	67.50
2006-07	49.69	51.55	58.71	67.21
2007-08	63.31	63.94	102.01	149.92
2008-09*	48.56	91.80	74.26	165.28

Source ESIPC

In addition to this, the priority in scheduling of most wind generation tends to distort the costs of other generators by forcing them to back off at periods when they would otherwise be operating, thus increasing the average costs of supply for these units.

The increased wind generation availability also has a cost in terms of networks, which need to be upgraded to carry the increased wind based electricity output that is available at times that are propitious for its generation.  This essentially means designing a network to carry less average power than is the case with a network carrying output solely from conventional fossil fuelled power stations.  Those costs are likely to be carried by consumers in general under the "regulatory test" applied for new transmission investment.

Based on data prepared by Carbon Market Economics for AEMO, the costs of wind are currently around $93 per MWh. ⁽⁸⁾

AEMO also has considerable detail prepared annually by ACIL Tasman on the costs of other generators.  Excluding carbon costs, in real 2009/10 dollars, these vary from around $47 per MWh for conventional black and brown coal generators to a little over $50 per MWh for gas, $70-80 for black and brown coal incorporating carbon capture and storage, ⁽⁹⁾ and around $100 for nuclear.  These costs for the coal based generators are inflated by the high world demand for new power stations on the back of very rapid growth in China and appear to have declined somewhat in 2009.

The carbon capture and storage costs (incorporated in the "IGCC black CCS_SWNSW" row below) are speculative and are likely to be in excess of those incorporated into the modelling.

Table 3 illustrates comparative costs.

Table 3:  Comparative generation costs

	2010	2012	2014	2016	2018	2020
CCGT (WC)_SWQ	55.63	50.41	50.55	50.66	52.14	52.57
SC BLACK (AC)_CQ	52.78	50.71	49.35	48.78	48.35	47.94
SC BLACK (AC)_NCEN	51.85	49.86	48.62	48.13	47.78	47.43
SC BROWN (WC)_LV	50.22	48.33	47.33	47.04	46.88	46.72
IGCC BLACK CCS_SWNSW	97.24	89.65	84.12	79.96	76.09	72.87
USC CCS BROWN (WC)_LV	82.94	77.35	74.59	73.16	71.80	70.87
Nuclear_NSA	101.41	100.62	99.85	99.09	98.33	97.58

Source:  AEMO/ACIL Tasman

Wind costs with the proposed $65 per MWh government penalty (an after tax penalty of $93) are below fossil fuel generated electricity costs and assure the use of wind to the degree stipulated.  This would remain true even though wind generators' inflexibilities mean they earn less on the spot market than controllable generators.

Unlike nuclear, where future efficiency improvements are likely, wind is now a mature technology, which has shown asymptotically lower costs which are now close to the their maximum.

A popular model, the Vestas V80, uses a rotor 80 meters in diameter and has a generator rating at 1.8 MW.  Set at a wind design point rating of 7 metres per second, on a site that averages this wind speed, it delivers a capacity factor of just under 30 per cent.  This approaches the practical maximum achievable which several authorities suggest is around 35 per cent and indicates that there are few technological improvements to be had with the design of wind turbines that will lower their costs. ⁽¹⁰⁾

THE COSTS OF THE 20 PER CENT RENEWABLE PROPOSAL

Using wind as the least cost renewable option, additional costs fall within three components:

• The premium required for wind over the least cost energy supply of $46 per MWh ($93 less $47 for coal)
• The costs of the additional back-up for wind supply.  Wind's reliability according to AEMO is only 7 per cent.  In order to ensure the system is maintained, fast start (gas) back-up plant is required.  The most market-oriented means of establishing the cost of this is to use the $300 base cap traded through the over-the-counter market, which gives traders the certainty that they can avoid losses in the event of their supply not performing.  The price of the $300 cap varies between $11 and $15 per MWh, with the averageat $12. ⁽¹¹⁾
• Additional costs stemming from the increased transmission likely to be required as a result of the lower average flow of electricity from wind sites.  In marginal cost terms this is likely to be low since the wind farms locate in areas where transmission is amply available.  Where new lines need to be built or existing lines reinforced, the costs do become significant.  However for the purpose of this analysis these costs are not included.

The premium costs per MWh for wind are therefore estimated at $58 ($58,000 per GWh).  In order to reach 45,000 GWh, this premium would need to be applied to the non-commercial (mainly hydro) part of renewable energy supply stipulated in the Bill.  The commercial component is about 14,000 GWh, hence the cost would apply to 31,000 GWh and amount to $1,800 million per annum in 2020, ⁽¹²⁾ with this rising in subsequent years in line with the 20 per cent target.  The cost of the renewable option is not greatly dissimilar from substituting nuclear for coal of $1,580 million, though nuclear might show considerable cost reductions, perhaps amounting to 40 per cent. ⁽¹³⁾

In addition to these costs there would be consequential magnification effects.

Offsetting this, in the context of an ETS, the expanded MRET would entail some reductions in the cost of the ETS (100 per cent in the unlikely event that the renewables were the lowest cost option).  The PC reported that the cost of specifying renewables was double that of a more market-oriented approach, findings the PC noted were similar to those by consultancy projects conducted by Access Economics and CRA.

CONCLUDING COMMENTS

There can be few other cases in the history of modern economies where governments have taken action deliberately to increase the costs of production in their economies on the scale being contemplated with the Renewable Energy proposal.  In the past, those societies that have rejected lower costs have been condemned to economic decline and in many cases a loss of sovereignty.  Historically, such was the fate of the Ottoman Empire and a looming repetition of this in the case of China was observed by key nineteenth century Japanese politicians.  This led to the Meiji Restoration with the recognition that Japan needed to aggressively accept the least costly production methods of the western world or become a backward, foreign controlled state.

The issue of renewable certificates under the Carbon Pollution Reduction Scheme Bill (2009) introduces a variable tax on generators, with the rate dependent on their emissions per unit of energy supplied.  An indexed emission cost of $40 per unit -- $57 in after tax terms -- (following $10 per unit in the first year) would increase the costs for a brown coal generator by 150 per cent and more than double those of a black coal generator.

Specifying a particular form of technology rather than leaving the market to select the lowest cost option will invariably result in additional costs.  The proposed 20 per cent renewable target for electricity would impose a considerable burden on the Australian consumer and on the nation's industry.  As a stand-alone policy, a 20 per cent renewable target means substituting existing sources of electricity by others that are far more expensive.  Windmills are the least cost means of supplying renewable energy in the absence of the availability of large scale hydro.  These entail a premium that is roughly double the cost of commercially available coal based electricity.

In those respects, a 20 per cent renewable requirement would mean the equivalent of a tax on non-renewable electricity supplies to raise the sums necessary to allow wind to be viable.  That amounts to a tax of $1,800 million on the consumer with the sums raised hypothecated back to the builders and owners of windmills.  In terms of the impost on energy consumers, as renewables are over twice the costs of conventional sources and apply to a fifth of total supply, the tax is equivalent to something in excess of 10 per cent of the total generation costs.

The 20 per cent renewable proposal in the Renewable Energy Bills involves intentionally increasing consumers' expenditures and deliberately reducing the competitiveness of productive activities by raising their input costs.  In doing so, because the ETS proposal is to control total Australian emissions, the 20 per cent proposal will contribute nothing to the goal of emission reductions that it ostensibly pursues.  It would simply re-arrange the aggregate nature of emission reductions, while imposing additional costs.

---

ENDNOTES

1.  What Role for Policies to Supplement an Emissions Trading Scheme?  May 2008

2.  The Skeptical Environmentalist, by Bjørn Lomborg, Cambridge University Press, p. 134.

3.  http://www.news.com.au/heraldsun/story/0,21985,22287835-662,00.html

4.  http://www.abc.net.au/news/newsitems/200608/s1723948.htm

5.  Denmark has a considerable amount of wind installed but is fully electrically integrated with the rest of Europe

6.  http://online.wsj.com/article/SB122937766062908297.html

7.  http://www.esipc.sa.gov.au/webdata/resources/files/Public_Forum_presentation_Final.pdf

8.  See http://www.aemo.com.au/planning/419-0032.pdf

9.  The stated costs for this are highly speculative and at the present juncture optimistic.

10.  Under Betz Law, a wind turbine can never convert more than 59 per cent of the wind flowing past it into energy.  This is further reduced by mechanical losses and the fact that the turbine only reaches its 59 per cent maximum at a specific "design point".  The Betz limit is not directly factored into the turbine rating.

11.  Personal communications with electricity traders, though a price can be estimated from the d-cypha site.

12.  This cost may be reduced by renewables featuring less uncompetitive sources like bagasse (which have limited availability) and, if the practice is allowed to continue, by Snowy and Hydro Tasmania manipulating the scheme by oscillating their production from year to year so that every second year they produce above baseline.  It would be increased to the degree that solar panels (with a cost over fourfold that of wind) fulfil part of the 20 per cent quota.

13.  The Economic Future of Nuclear Power, a study conducted at the University of Chicago, August 2004