Rudd's bandwagon on a roll

According to the Concise Oxford Dictionary, something is "pathetic" if it invokes "pity or sadness or contempt".  Pathetic is the only description that can be applied to the behaviour in recent weeks of Australia's economics profession, business organisations, and the media.

Witnessing the reaction of these groups to the federal government's $42 billion stimulus package, it is impossible to avoid feeling anything other than a mixture of pity, sadness, and contempt.

It's a pity that the country's economists, corporate leaders and journalists have been reduced to little more than cheerleaders for the government.  It's sad that we've come to this.  And there's something a little bit contemptible about the whole thing.

Given the way the country's policy elites have rushed to embrace more government intervention in the economy, more government spending and more government debt, it's as if the 1980s never happened.  And what was the point of the recession we had to have if we have forgotten its lessons?

At least in America, the economics profession was willing to engage in some sort of debate about President Barack Obama's stimulus package.

A few hundred academic economists signed a petition organised by free market think tank the Cato Institute that declared:  "It is a triumph of hope over experience to believe that more government spending will help the US today ... Lower tax rates and a reduction in the burden of government are the best ways of using fiscal policy to boost growth."

Not many academic economists in Australia would be willing (and brave enough) to put their name to something like this.  Only one economist who gave evidence to the Senate inquiry on the package was willing to declare it should be opposed.  There have been a few individuals and associations that stood against the Zeitgeist of recent months but they've been the exception.  Within hours of the stimulus package being announced, business groups were calling for it to be passed.  Anyone who suggested debate, delay or deliberation was scorned as being unpatriotic.

It was automatically assumed that a fresh coat of paint on a school gymnasium was the best way to boost Australia's future productive capacity.  The government didn't even have to bother explaining what was special about the figure of $42 billion.

Presumably business would have been just as pleased to agree to a $32 billion or a $52 billion package.  Nor was the business lobby too concerned by the size of the looming budget deficit or the borrowings required to fund the package.  This sort of lackadaisical attitude is what's responsible for the global financial crisis.

The media's main interest was in reproducing the views of everyone who supported the stimulus package.  There wasn't too much analysis of what the package contained.  The media reported that the Treasury Department endorsed the package as if it were news.  Given that Treasury wrote the package it's hardly surprising that Treasury would endorse it.  This country's press, which prides itself on its willingness to probe and question (and sometimes even harass) anyone in authority, seems content to accept as holy writ the pronouncements of the secretary of the Treasury.

Bizarrely, many in the Canberra press gallery genuinely seemed to believe that if the big-business lobby groups endorsed the package the coalition would automatically fall into line.  The approach of the gallery was along the lines of:  "If everyone who's anyone likes the idea of cash handouts how can the coalition be opposed to the package?"

What media commentators failed to notice was the growing rift between the public positions of the business lobby groups and the opinions of their members.  The Liberal Party, at least nominally, supports free markets.

The business lobby stopped supporting the free market years ago.  Credit must go to the new shadow treasurer, Joe Hockey, who started in the job this week by declaring the obvious truth that "the [free] market has made every Australian richer than they have ever been -- even with this economic downturn".  It's impossible to recall any business leader who in recent months has come close to saying anything like this.

Treasurer Wayne Swan scoffed at Hockey's suggestion and said that Hockey should "go and tell that to those with superannuation who've been hit by the global recession, people in the stockmarket who've seen their shares halve in value as a result of the global recession".  It seems that Swan believes there's some preferable alternative to free markets.  What that alternative is, the Treasurer hasn't yet revealed.

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The unquiet ghost who could yet spook Labor

He's back!  Just when Canberra journalists thought he was forgotten, parliament recommences, the economic debate resumes, Julie Bishop resigns the shadow treasurership, and there he is again, risen from the political grave and haunting the press gallery and the Labor government like Banquo's ghost.

I'm talking, of course, about Peter Costello, who has been everywhere in recent weeks:  Alan Jones, Lateline, Neil Mitchell, ABC radio, CNBC Asia, Sky News and doorsteps outside memorial services.  Add to this his fortnightly columns in the Fairfax press and two well-received parliamentary speeches on Labor's stimulus package and the late and much lamented Liberal minister Peter Howson, and it is no wonder speculation is running hot that the former treasurer might not only hang around to recontest the next election but become the spectre to haunt Malcolm Turnbull indefinitely.  Anyone who claims to know his exact plans is merely guessing.  I speak with the Member for Higgins regularly and I have no idea what he will do.  But I do know three things about Costello that may provide clues about his intentions.

First, his narrative about the Australian economy, culminating in his strong opposition to Labor's $42 billion stimulus package, has a lot going for it.  Start with the stunning statistics that defined his nearly 12-year treasurer-ship from March 1996 to November 2007.  Everything that should be up -- wages, economic growth, the stock market -- was up, while everything that should be down -- unemployment, inflation, interest rates -- was down.  He made the Reserve Bank independent (something Labor opposed) and in 1997, he created a prudential regulatory authority of the financial system (something which the RBA itself strongly opposed, which both the Americans and British curiously lacked, and which the IMF overwhelmingly praised).  Bringing the budget into surplus and eliminating Labor's $96 billion debt, moreover, were obviously achievements.  And unlike Bill Clinton, George W. Bush and the US Congress, Costello did not encourage the subprime lending that precipitated this crisis.  By any reasoning, there is much to praise and little to criticise in terms of what was actually done on Costello's watch.

Although the global financial circumstances have changed since the election, Labor's economic management compares unfavourably with that of the Howard-Costello years.  This is a government that for most of last year championed a tight fiscal and monetary policy to contain some imaginary inflation dragon even as the sluggish global economy was in desperate need of loosening.  Yet the dire warning signs were evident in September 2007 when the US subprime mortgage market collapsed.  As Costello suggested at the time, the Australian economy needed stimulation to weather itself against the coming "financial tsunami".  "Go for Growth", remember, was the Coalition election mantra.

Rudd now sells his spending spree as the only way to protect Australia from the global downturn.  But Costello has been the most effective critic of cash hand-outs and giveaways to Labor pet projects instead of tax cuts and investment on economic infrastructure.  If the economy fails to recover in 12 months' time, Costello will be able to say:  "I told you so".

Second, Costello is the only Liberal with the talent, experience, and parliamentary skills to beat Labor.  I say this not just because of his impressive command of economics and record as treasurer, but also because he oozes that indefinable quality of leadership that the Romans called gravitas.  As Barry Cohen, the former Labor minister and regular contributor to these pages, says of Costello:  "Not only can he be hilariously funny -- an immensely valuable asset when things are tense in parliament -- but he has a great sense of theatre and in full flight can rally the troops from the depths of depression."

He is, moreover, a much more decent person than the press make him out to be.  As treasurer, he sometimes gave the impression of being arrogant and a sook.  He certainly needs to let go of what many people think are his petulant resentments towards John Howard and prove that he is focused on a leadership future, not dwelling on past duels.  And it is true that decency, as Brendan Nelson found out, is a dull blade to take into a knife fight with Kevin Rudd.

Malcolm Turnbull has plenty of strengths, among them his high intelligence and connections in the higher echelons of society.  But he needs to dispel the public's sense that he is part of an introverted elite, a born-to-rule clique which has no understanding or feel for the wider electorate -- and reassure his own backbenchers, who are upset with what they see as his lack of consultation and his willingness to bow to Labor on emissions trading and industrial relations.  Costello does, however, believe in things that are near and dear to the party faithful.

At a time when the public rates Labor as better economic managers than the Coalition, Costello's record stands as a testament to the good old days.  According to Newspoll, Costello was seen as a better economic manager than Wayne Swan by a margin of 53 to 21 on the eve of the 2007 election;  yet within six months, Swan was 14 points higher than the then shadow treasurer Turnbull (40-26).  What was once seen as a major Coalition strength is now a liability (even without Julie Bishop in the shadow treasury portfolio).  That would automatically change if Costello returned to the limelight.  As the economy deteriorates, who can better use Ronald Reagan's devastating line in the 1980 debate against Jimmy Carter:  "Are you better off today than you were four years ago?"

Third, critics in the government and media have noted the Costello revival.  Hardly a Question Time goes by without Kevin Rudd and Wayne Swan taunting Turnbull that the Member for Higgins, with a "lean and hungry look" (Rudd), is "breathing down his neck" (Swan).  Yet one can't help but wonder if all of this teasing won't boomerang in the end.

The Age's Tony Wright -- presumably still guilty over his role in the so-called Brissenden affair in which three journalists leaked an off-the-record discussion with Costello -- recently asked one well-connected Liberal whether he had any thoughts about Costello's new visibility.  "He held up his hands in mock horror and backed away.  But before he scurried off, he winked and whispered, 'Watch this space'."  To which Wright replied, "Oh, we will, we will".

Then there's Kerry-Anne Walsh.  In her appearance on Sky News's PM Agenda recently, the Sydney Sun Herald columnist and former ABC Labor union staffer, indulged in the press galley's wonderful talent for hypocrisy.  Last year when Costello was "doing nothing" on the backbench, she complained he hindered the Liberal party and should just go;  this month when he has been speaking out and contributing to policy, she complained, well, he hindered the Liberal party and should just go.  Walsh is one of many journalists to write off what she calls the "irrelevant" Costello.

But one of the greatest advantages in politics is to be underestimated.  When he launched his bestselling memoirs last September, Costello was dismissed as yesterday's man by the press, yet he keeps hanging around.  Don't be surprised if he confounds the experts yet again.

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Bring on the acid bath

Australian public debate is usually sober and routine.  Policies are proposed, criticised and eventually watered down.  One person calls another person a "neo-liberal" and everybody goes home at a quarter past five.

So when novelist Peter Carey claims that a technical legislative change affecting the publishing industry will encourage the growth of "a new species that can swim in acid", it is at least an entertaining break from the normal banalities.

The Productivity Commission is investigating the removal of the ban on parallel importing, which makes it illegal to import for sale any book that has already been published in Australia.  It seems that any proposal to lift this ban is like kryptonite straight to the groin of Australia's publishing fraternity.

If the ban is lifted, Carey imagines a very bleak future:  "long-term devastation" and "cultural self-suicide";  Australian book editors will be "reduced to nothing, to become marketers and publicists for Paris Hilton".  And according to Carey, treacherous -- and apparently acid-resistant -- global retailers will take over.  They plan to rob Aussie publishers "blind".

Also chiming in, Tim Winton was slightly less surreal but more poetic, predicting a "great bitterness" would wash through the Australian literary community.

And Matthew Reilly, whose books have sold more than 4 million copies, compared the possible influx of popular books if the ban is lifted to the introduction of McDonald's.

Our novelists are adopting a whole new strategy into debate over microeconomic reform:  emotional blackmail.  As a general rule, if a law needs a lot of exceptions to avoid being idiotic, it's probably not a very good law.  And there are a lot of exceptions to the ban on parallel importing.

To ensure Australian readers aren't shut out of the worldwide book market altogether, if a new book hasn't found an Australian publisher within 30 days, importers are free to bring it in.  Other regulatory exceptions ensure that overseas travellers don't get arrested for bringing in the Dan Brown novel they picked up at Heathrow, and that booksellers aren't jailed for ordering books that are out of stock in Australia.

The hardest thing in retail is trying to figure out how much consumers are willing to pay for your product.

Australians might be willing to pay a relatively high price for books, but for the less affluent Indian market, authors and publishers might have to sell at a lower price.  Clever capitalists try to segment their market as much as possible -- rich people pay more, poor people pay less.

So if parallel importing is legalised, Winton, Carey and a lot of publishers are worried that bookshops will be able to import those cheaper copies.

Well, hey -- cheaper books for everyone!  And if authors really want to keep selling their books at different prices in different markets, they should be able to use private contracts to prevent their own retailers from undercutting them.  Like all protectionist laws, the ban on parallel importing privileges producers over the consumers they are supposed to serve -- novelists no more deserve to be insulated from competition and consumer demand than farmers, computer programmers or line workers.

In an era where everything is available on the internet, segmenting a market is getting harder and harder.  Over time, the whole issue of parallel importing may become obsolete -- call it the Amazon effect.  The debate shows how much Australian cultural producers have made it appear that our culture is only possible with government protection.

But strong and vibrant culture doesn't usually come from a bureaucratically orchestrated jumble of subsidies, regulations and writers' workshops.  Culture shouldn't need a legislative umbrella to protect it.

Peter Carey may believe that parallel importing will silence Australian authors, but there's something anachronistic and nationalist about the crusade to encourage specifically Australian voices, Australian stories and Australian images.  It is peculiar that while we might believe that modern Australia is a cultural collage of backgrounds and value systems, culture warriors on both sides of politics are not able to admit that this makes the deliberate encouragement of a uniquely Australian culture a sham.  Many Australian Muslims might find Islamic authors published overseas more personally enriching than Tim Winton's descriptions of surf in Western Australia.

Unique voices will continue to find their way in a marketplace no matter how globalised that marketplace is -- globalisation may spread McDonald's outlets across the world, but it also makes far-away Peruvian cultural products easily accessible to punters in Narre Warren.

Yet Australia's cultural legislation protects and subsidises authors with the aim of constructing some sort of universal story that can be shared by the 21 million people living within the territorial limits of Australia.  Apart from being futile, this attitude imagines that Australia is a solitary island, rather than deeply integrated in cultures spanning the globe.

Culture evolves in the wild, battered and shaped by the elements, and by the pressure of competitors.  It is more likely to stagnate or starve when protected in an artificial environment.  The more Australian authors have to compete, the more rewarding our cultures will become.

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Crisis Gloom Equals Climate Boon

Last year Federal Minister for Climate Change and Water, Penny Wong, was telling Australians that the drought in the Murray-Darling was a consequence of global warming.  It was our fault because of green house gas (GHG) emissions including from Australians' general over-consumption and wasteful affluent lifestyles.

Indeed, predictions for the entire planet have been dire, with pleas, including from the Secretary-General, Ban Ki-moon, that we must change our ways and drastically cut our carbon dioxide emissions or we will lose not only the Murray-Darling, but the Great Barrier Reef, Kakadu and snow from the High Country.

This year, with the financial crisis resulting in a general slowdown, there is a lot less "stuff" being produced, built, and moved about in Australia, and also in the US and China.

This must translate into fewer GHG emissions.  Furthermore, if, as many environmentalists suggest, the path of righteousness is to live as frugally as possible, less "stuff" is good news.

But instead of seeing the economic bad news, as good news for the environment, the Australian government has been handing out money with the Prime Minister, Kevin Rudd, begging first pensioners, and now the rest of us, to spend, spend, spend.

My mother is planning to do the right thing and buy a dishwasher with the cheque she received from the government just before Christmas.

All she perhaps needs to do now, in terms of following government advice, is stop serving beef at her dinner parties.

Government climate change adviser, Ross Garnaut, was suggesting we should ditch cattle for kangaroos to reduce methane emissions.

If Mum did this, when she stacked that dishwasher after her next party she could perhaps be happy in the knowledge the meat she had served was from a low emissions source.

But should government on the one hand be suggesting low emission sources of food, and on the other suggesting Australians buy more "stuff"?

The reality is that you cannot have it both ways.

Given available sources of energy, economic activity and emissions are directly related.

The Federal government cannot be determined to maintain domestic growth above two percent, on the one hand, while at the same time telling us we are destroying the environment with our emissions.

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Investment key to free trade

Martin Feil's criticism of the Australia-US Free Trade Agreement (Trade millstone around Australia's neck, 10/02) ignores its real gains.  Feil argues that to assess the FTA, you only need "look at the numbers".  According to him, a nominal increase in our deficit of goods and services trade of $4.41 billion with the US is proof of a failed FTA.  But the deficit is in his numbers -- they show only half the picture.

The FTA covers almost all sectors of both economies, from trade in goods and services to government procurement, intellectual property and investment.  Assessing the gains of the FTA by goods and services trade ignores the real success of the FTA -- promoting investment.

The AUSFTA came into effect on January 1, 2005.  ABS data shows that in the 2005 calendar year, US investment in Australia was $325.3 billion.  By the end of 2006, it was lifted to $362.8 billion.  And by the end of 2007, it had risen to $445.9 billion, or an increase of $120.6 billion since 2005.

Arguing that the FTA is a failure because of an increased annual deficit of $4.41 billion in goods and services trade against an increase in total investment of $120.6 billion in only three years is absurd.

Growing investment matters.  In February 2004, former chairman of the General Agreement on Tariffs and Trade (predecessor of the World Trade Organisation), Alan Oxley, opined in The Age that "in today's world, investment is as important for growth as trade ... (because it) is the vehicle that delivers new technology".

Modern industry is heavily dependent on sophisticated technology to help business achieve increasing levels of productivity.  But that technology need not be developed in Australia.  Similarly, technical expertise can also be an important business import.

Instead of assessing the dividends of the entire agreement, Feil's criticisms smacks of discredited mercantilism.  And in doing so, he ignores these dynamic gains from free trade.

Australia's prosperity doesn't rely solely on ever-increasing exports.  Imports help Australian businesses grow by providing cheaper or more advanced inputs, and in doing so make our businesses more competitive.

Free trade also provides economic benefits because it maximises the return consumers and producers can get from the allocation of scarce resources -- or put simply, buying more with less.  And with the remainder, they are free to use excess capital to invest or buy other goods and services.

But that doesn't mean that the results of the FTA are perfect and there isn't room for reform.

During the passage of the enabling legislation for the FTA, then opposition leader Mark Latham introduced amendments to the Therapeutic Goods Act that have harmed Australia's investment potential.  Latham's amendments included provisions requiring patent holders to determine whether they had a "reasonable prospect of success" before seeking to enforce their property rights in court.  If the court deemed they didn't, they could be exposed to a $10 million fine.  Meanwhile, a mischievous patent infringer could only be fined $110,000.

Latham's changes are arguably in breach of the FTA.  And such an extreme has diminished the incentive for US pharmaceutical companies to conduct research and development and manufacturing operations in Australia.  Any reform should include amending Latham's amendments.

But the biggest loss to Australia's national interest results from inconsistency between our FTA with the US and Australia's other FTAs.

In theory and fact, the boon from the AUSFTA was in the investment chapter.  Under the FTA, US investments don't need to be screened by the Foreign Investment Review Board unless they are above $913 million.

Yet, non-US investors have a screening once a substantial investment hits as little as $100 million.

Australia also has FTAs with New Zealand, Chile, Thailand and Singapore.  But these countries don't enjoy equivalent privileged treatment.  And the cost is being borne by Australia's economic potential.

When completed, the AUSFTA was hailed as a "living agreement" that would deliver significant dividends in the long term.

The evidence shows that Australia is enjoying the gains.  But it should cement the gains from free trade with all countries, not just the US, by completing the work the AUSFTA started.

And that means revising the Latham amendments and unilaterally harmonising and liberalising barriers to all investment into Australia.

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Tinseltown ideology reflects our cultural obsessions

It's no surprise that when Hollywood decided to remake the 1951 sci-fi classic The Day the Earth Stood Still for modern audiences, the theme would change from nuclear war to the now much more popular fear of environmental collapse.  There is a long tradition of movies with political messages.

But the strikingly different approach of each film speaks volumes about a shift in green philosophy of the last few years.  It is apparently now unremarkable to believe that humanity should be sacrificed at the altar of Gaia.

The plot of both The Day the Earth Stood Still films is very simple -- an alien named "Klaatu" visits Earth to teach humanity a lesson about its bad ways.

In the 1951 film, Klaatu is a sort of Christ-like figure, whose extraterrestrial intervention into human affairs brings about an age of peace.  This original Klaatu is a charming alien who firmly but gently convinces mankind to abandon politics and warfare.  Humanity obediently pulls back from the nuclear precipice.  Peace and good times are then had by all.

In 2009, the filmmakers have changed Klaatu into a dictatorial environmentalist with a penchant for genocide.  Keanu Reeves plays a Klaatu who fairly quickly decides that all humans need to be immediately eliminated for the sake of the earth.  The new film is sort of like an episode of Doctor Who where the Daleks are the good guys.

Indeed, the alien civilisations of 2009 appear to be everything that the alien civilisations of 1951 were trying to stop.  When the 1951 Klaatu steps out of his space ship, he immediately states that he has come to visit the earth "in peace and with good will".  By contrast, it seems that Keanu Reeves steps out of his space ship only to briefly survey the species he plans to destroy.  This film has to be one of the most deeply anti-human movies in a long time.

So what does it say about our collective mental health that, when we try to imagine a "good" race of aliens, we also imagine that they would want to systematically slaughter us?  If we're lucky, the next bunch of extraterrestrial visitors will bring us the anti-depressants we so obviously need.

The extraordinary ideological change between the original The Day the Earth Stood Still and its remake shows how mainstream apocalyptic environmentalism has become.  Obviously, the vast majority of those who care for the environment also think that the human race is probably worth keeping alive.  But what was, just a few years ago, the harmless spluttering of Malthusian academics certain that the Earth needs to halve its population, is now being repackaged approvingly as infotainment.

Movies have always both reflected and distorted our cultural obsessions.  Filmmakers aren't stupid -- they want movies to sell to as wide an audience as possible, so they try to mimic as best they can the attitudes and interests of the population at large.

But at the same time, the political views of most filmmakers hardly reflect the political views of that audience.  You could shove the number of conservatives and libertarians in Hollywood into a small Prius, and still have enough room for their pets, or their guns -- or whatever profit-loving, environment-hating, worker-oppressing things they like to carry around with them.

So every year, Hollywood produces a couple of films that are little more than vehicles for Tinseltown's latest trendy ideology.  Last year's otherwise charming Wall-E depicted humanity as not just destructive, but also morbidly obese morons encased in hover-chairs.  And the global warming disaster movie The Day After Tomorrow implied that the world was just one bonfire away from a climate implosion.

Presumably the next iteration of Godzilla will be born because of an aggregate global temperate change of 3 degrees spread over a century.

Of course, if you're too quick to jump at the latest popular cause, it's easy to make mistakes.  Hollywood can get it spectacularly wrong.  Remember the overpopulation crisis of the 1970s?  A steady stream of films like Logan's Run, Soylent Green, The Last Child, and Z.P.G. (which stood for the environmental movement's aim of "zero population growth") tried to popularise the bizarre idea that the amount of people the world had in 1978 was exactly the maximum population the world could hold.

But despite Hollywood's best efforts at convincing us not to, we kept on breeding.  At the time of writing, we have not yet had to resort to turning our dead into basic foodstuffs.

For decades, the film industry churned out films about the need for love, peace and just generally getting along.  What made them stop?  Bring back the original, kindly Klaatu, who wants to help humanity, not destroy it.

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Remarks to the Senate Finance and Public Administration Committee Inquiry into the Nation Building and Jobs Plan

Given the short period of time that I have to speak to the Senate, I begin by presenting my conclusions on the package and then discuss the reasons behind my views and also present some alternative policy prescriptions that, in my opinion, would better serve the objectives of the proposed package.

RECOMMENDATIONS

In summary, it is my view that the Senate should reject the fiscal stimulus package in its current format.

• The package contains a lot of spending and little actual stimulus.
• The proposed spending is poor quality expenditure of Federal funding.
• Discretionary fiscal policy has a poor track record of success.
• While the government needs to respond to the current economic downturn in a timely manner, there is no urgent need to rush the package.  Rather, a better quality package should be designed and implemented.

WHAT SHOULD BE DONE?

• Government policy should establish conditions whereby living standards can improve.
• Fiscal policy should be prudent and conservative.  That implies balanced budgets, and low taxes.
• Public debt should be used sparingly, if at all.
• Government should target Ken Henry's 3Ps when making policy.  Participation, Productivity and Population.
• Government should also consider Glenn Stevens' advice -- a good project last year is probably still a good project, whereas a bad project last year remains a bad project now.  "Shovel ready" is not now, nor has it ever been, an appropriate criteria for public spending.

To the extent that the federal government wishes to pursue an activist fiscal policy it should target tax cuts.  In particular, the federal government should consider payroll tax relief and a GST holiday.  In both instances the federal government would have to compensate the States and Territories.  (Alternatively, the federal government could reinstate the aspirational tax cuts promised at the last election.)

• The federal government should buy out the payroll tax liability that firms bear.
• This reduces an existing tax on employment.
• This reduces disincentives to reemploy workers when the economy recovers.
• This temporarily stabilises the finances of State and Territory governments during the crisis.  It is they who are primarily responsible for education and health expenditure.
• This policy is not as expensive as it may first sound:
• Individuals who keep their jobs continue to pay income tax.
• Individuals who keep their jobs do not receive unemployment benefits.
• It is important to remember that the payroll tax is regressive -- this policy would benefit low-income earners more than high income earners.
• The GST holiday would consist of leaving the GST rate unchanged at 10 percent, but not requiring firms to pay the GST revenue to the ATO for a period of, say, one quarter.
• This has the effect of temporarily increasing the profitability of firms but not distorting prices (in the long run the GST amount would be competed away, but this would reduce the tax wedge between consumers and firms leading to increased activity).
• It also leaves the GST rate unchanged and does not necessitate further rate rises in the future.
• This would allow some firms to lower their prices by the GST rate, if they chose.
• This policy could be adopted in conjunction with the payroll tax cut, or as a substitute for those firms not liable for payroll tax.

OBJECTIONS TO THE PROPOSED POLICY

1. SPENDING MULTIPLIERS ARE LOW.

Fiscal stimulus can be defined as the situation where government borrows money and then spends it, with the expectation that the debt will be repaid out of future tax receipts.

Whether or not fiscal policy can be used to stimulate the economy revolves around the size of so-called multipliers.  The multiplier is the ratio of GDP generated by the stimulus to the expenditure of the stimulus.  Multipliers can be thought of as being "bang for buck".

Professor Gregory Mankiw of Harvard University, former Chairman of the Council of Economic Advisors to President George W. Bush and leading economics textbook writer has compared the size of the multiplier for spending increases relative to the size of the multiplier for tax cuts in the United States.  Writing in the New York Times he summarised the empirical evidence for spending versus tax cuts, and finds that tax cuts have a far greater bang for buck. ⁽¹⁾

It is important to note that there is a discrepancy between theory and empirical evidence.  In theory, the impact of spending should be greater than tax cuts.  In practice, however, careful economic studies find that tax cuts have bigger bang for buck.  In fact, the tax cut multiplier is twice the size of the spending multiplier.

• Professor Valerie A. Ramey, at the University of California, San Diego estimates that each dollar of government spending increases GDP by $1.4. ⁽²⁾
• Christina D. Romer -- now Chairman of the Council of Economic Advisors to President Barrack Obama -- and David H. Romer, at the University of California, Berkeley, estimates that a dollar of tax cuts raises GDP by $3. ⁽³⁾

Professor Mankiw -- a new-Keynesian economist and author of one of the leading economics textbooks -- summarises his argument as follows: ⁽⁴⁾

Do not be intellectually bound by the textbook Keynesian model.  Be prepared to recognize that the world is vastly more complicated than the one we describe in [Economics 101].  In particular, empirical studies that do not impose the restrictions of Keynesian theory suggest that you might get more bang for the buck with tax cuts than spending hikes.

The Federal Government proposes a lot of spending and no tax cuts in its Fiscal Stimulus package.  Based on empirical work, as opposed to theoretical expectations, the stimulus effects will be low.  Furthermore, based on the arguments by Michael Knox, in last Thursday's Australian Financial Review, "Rudd pays top dollar to buy time", the multiplier in the Fiscal Stimulus package will be even lower than usual. ⁽⁵⁾

Professor John H. Cochrane, of the University of Chicago, has summarised the argument for stimulus spending as follows: ⁽⁶⁾

The classic argument for fiscal stimulus presumes that the central cause of our current economic problems is this:  We, the people and our government, are not doing nearly enough borrowing and spending on consumer goods.  The government must step in force us all to borrow and spend more.  This diagnosis is tragically comic once said aloud.

It is easy to "Australianise" this comment, "Australians have not been borrowing and spending enough on alcohol, pokies and tobacco and there are not nearly enough plasma televisions around.  The government should borrow and spend more to ensure that more consumer spending occurs".  I invite Senators to read that statement out loud and wonder whether it sounds plausible or responsible.  The fundamental problem with a lot of spending stimulus packages is that it consists of government spending a dollar, any dollar, on any project.

Professor Robert Barro of Harvard University has undertaken some empirical studies of the long run effects of government consumption and investment on economic growth.  Barro (1991) finds that the ratio of real government consumption expenditures to real GDP had a negative association with investment and economic growth, and that there is no statistically significant evidence of a positive relationship between public investment and economic growth. Barro and Sala-i-Martin (2003) find a similar negative relationship between non-defence, non-capital educational government consumption and real per capita GDP growth. Barro, R. (1991) "Economic Growth in a Cross Section of Countries," Quarterly Journal of Economics, 106(2):  402-443. Barro, R. and Sala-i-Martin, X. (2003) Economic Growth, Second Edition, Cambridge, MA:  MIT Press.

In an article in the Australian Financial Review ("IMF favours spending over tax cuts as fuel for Growth", Monday 9 February 2008, pg. 4), the IMF is reported as having indicated that "Spending measures are likely to be more effective" than tax cuts "particularly if they are not targeted to credit-constrained consumers".  Comments like this seem to indicate that spending multipliers are likely to be higher than tax multipliers.  This view contradicts the evidence I have referred to above.  To investigate this anomaly, I tracked down the IMF documentation and also the sources the IMF refers to as evidence for their argument. The publication that the Australian Financial Review refers to reports that multipliers were used in the IMF analysis but do not report individual country multipliers.  Here the spending multipliers are greater than the tax multipliers. (7) The IMF document in turn refers to two other IMF publications. (8), (9)  Neither of these publications provides numerical estimates for either spending or tax multipliers, but they do refer to an unpublished 2004 paper by Professor Roberto Perotti (updated in 2006). (10) The Perotti paper does estimate government consumption and government investment multipliers for 5 OECD economies including Australia.  It does not calculate tax multipliers.  The important point to note, however, is that the Australian multipliers tend to be low relative to the other 4 economies (Canada, Germany, UK and US). The IMF analysis therefore is not based on empirical evidence, but rather on theoretical grounds.

2. WHAT DOES WORK?

Andrew Mountford, of the University of London, and Harald Uhlig, of the University of Chicago, have just had a working paper published by the prestigious National Bureau of Economic Research (NBER) that analyses three types of policy scenario:

1. a deficit financed spending increase,
2. a balanced budget spending increase, and
3. a deficit financed tax cut.

In their analysis they find that deficit financed tax cuts have the greatest stimulatory effect -- although they emphasise that they do not necessarily endorse these types of cuts.  They also find that tax multipliers are much higher than spending multipliers.

In particular they find the deficit spending multipliers are higher than tax multipliers in the first quarter only.  Over time the tax multiplier has a maximum value of 5.33 while the maximum value of the spending multiplier is 0.65.  Further, they find that the spending multipliers are insignificant after two years. ⁽¹¹⁾

3. WHEN STIMULI DO WORK.

Professor Kevin M. Murphy, of the University of Chicago, has set out a simple analysis of when a stimulus will add value. ⁽¹²⁾  Stimuli are likely to work when the economic value of the output from the stimulus is greater than the costs of the inputs and deadweight losses.

• The economic returns of federal investment in school halls etc. are likely to be low.
• This makes very little, if any, contribution to productivity, participation or population.
• This is primarily expenditure that should occur at the local level.  This expenditure rewards State and Territory governments for past neglect of school infrastructure needs and re-enforces perverse incentives.
• It is possible that a properly designed scheme could see federal funding that augments local community and State funding, but this should not be primarily funded at federal level.
• The economic returns of home insulation are likely to be low.
• Are there really under-utilised resources in the home insulation sector?
• Are the skills developed in this sector generic or specific?  What will happen to workers after all homes have been insulated?
• How will this policy interact with the Climate Change Policy?
• To the extent that this policy is useful and valuable, an open question, it is better that it be considered as part of the Climate Change policy.
• The economic returns to a $950 hand-out based on having been a taxpayer in 2007-08 are likely to be low.
• This is a retrospective tax refund that cannot lead people to change their behaviour -- i.e. it has no incentive effects.
• Consequently, this money has no impact on productivity, participation or population.

Rather than undertake low value adding investment and expenditure, the government -- if it really wants to invest in infrastructure -- should consider assets that will contribute to greater economic growth as the economy recovers and consequently become (partially) self-financing.

• While the economic benefits of the Fiscal Package are low, the costs are likely to be high.
• The project choices are rushed and more likely to be less efficient.
• The objective to spend more money faster is likely to lead to poor project choice.
• Public sector spending tends to be less efficient than private spending anyway.
• The Fiscal Stimulus is funded by public debt.
• Public debt is associated with intergenerational burdens.
• Public debt has a history of rising very rapidly to high levels.
• Public debt is associated with irresponsible fiscal behaviour.
• Public debt implies that future taxes will be higher than they otherwise would have been.

4. OTHER OBJECTIONS.

• The government is not doing nothing!
• The RBA, an operationally independent arm of government, has lowered rates by 4 percent over six months.
• The "automatic stabilisers" are operating to put money into the economy already.
• Spending versus saving is a false dichotomy.
• Keynesian strategies are less likely to work in small, open economies.
• Economists tend to over-estimate the benefits of fiscal policy.

5. FURTHER INQUIRY

It also needs to be pointed out that Australia has just experienced a catastrophic failure in economic policy making.  While the root causes of the current economic crises are non-Australian, nonetheless both the Treasury and the Reserve Bank of Australia failed to anticipate the impact of the crisis which commenced in mid-2007.  The government has already spent $10.4 billion in a previous stimulus package and now proposes to spend an additional $42 billion.  An inquiry into how and why the official economic government agencies failed to warn or forecast the local impact of the crisis needs to be undertaken.

---

ENDNOTES

1.  http://tinyurl.com/cj5zdl

2.  http://econ.ucsd.edu/~vramey/research/IdentifyingGovt.pdf

3.  http://www.econ.berkeley.edu/~cromer/RomerDraft307.pdf

4.  http://gregmankiw.blogspot.com/2008/12/spending-and-tax-multipliers.html

5.  Michael Knox, "Rudd pays top dollar to buy time", Australian Financial Review, Thursday 5 February 2009, pg. 63.

6.  http://faculty.chicagobooth.edu/john.cochrane/research/Papers/fiscal2.htm

7.  http://www.imf.org/external/np/g20/pdf/020509.pdf

8.  http://www.imf.org/external/pubs/ft/weo/2008/02/index.htm

9.  http://www.imf.org/external/pubs/ft/spn/2008/spn0801.pdf

10.  http://papers.ssrn.com/sol3/papers.cfm?abstract_id=637190

11.  http://www.nber.org/papers/w14551

12.  http://faculty.chicagobooth.edu/brian.barry/igm/Evaluating_the_fiscal_stimulus.pdf

I was wrong on the surge in Iraq

Whether it was worth doing remains highly doubtful, and how it will end remains to be seen.  But it looks as if the US is achieving some kind of success in Iraq.  That is quite a mouthful from someone who strongly opposed the war from the outset.

But these are the facts:  Coalition military and Iraqi civilian casualties are down significantly.  The level of violence is the lowest in six years.  Iraq's economic growth levels are today nearly one-third higher than under Saddam Hussein.  The Sadrist militia and other Shia militant groups have been halted.  The Sunni Arabs who once formed the heart of the Iraqi insurgency are among the most steadfast coalition allies in the battle against al-Qa'ida.  The sectarian civil war has ended.

Local politics, meanwhile, is embracing the complicated but exhilarating quality of a functioning democracy.  At the weekend, Iraqis voted in largely violence-free elections for local representatives, many of whom were secular candidates, in a turnout that varied from about 40 per cent in two provinces of Baghdad to 75 per cent in some Kurdish areas in the north.  More than 14,000 candidates competed for 440 seats in 14 of Iraq's 18 provinces.

All of this amounts to remarkable progress for a nation that only six years ago was ruled by one of the world's most bloodthirsty tyrants.

Now I've long believed the Iraq invasion was unnecessary.  The incompetence of president George W. Bush, and in particular the neo-conservative architects of this misbegotten venture -- which has cost the US dearly in not just blood and treasure but also prestige and credibility -- merely adds underlining and an exclamation point.  Any threat that Saddam posed could have been dealt with via the tried and tested policy of containment (UN sanctions, naval blockade, no-fly zone).  And no direct operational links existed between his secularist regime and the fundamentalist al-Qa'ida terrorists responsible for 9/11 and Bali.

But, like many critics, I also believed that democracy was not an export commodity, especially in a part of the world that has had very little experience of the rule of law and market economics.  With Iraq, an artificial construct from the remnants of the Ottoman Empire, we sceptics even doubted whether there was such a thing as a single nation.  With the mess-in-potamia, we argued, it was better to cut and run than keep digging in a hole.

That was back then, two years ago when the Iraq Survey Group, among other distinguished policy thinkers, called for a phased withdrawal of US troops from an Iraq rapidly spiralling out of control.  Yet the Iraq that confronts us today is not the one announced in the program and shown in the reviews since Saddam's downfall.  Indeed, things are looking much more promising than anyone had the right to expect.

So what happened?  In the face of overwhelming opposition among even his own military and civilian advisers, not to mention the American people, Bush did not follow the script.  He instead announced a surge of 20,000 US troops into Baghdad and 4000 marines to Anbar province in the country's west.

The result:  dramatically declining casualty rates for both US military and Iraqi civilians.  According to Michael O'Hanlon, a one-time adviser to Hillary Clinton, the number of Iraqi war dead last November was 500 whereas it was 3475 in November 2006, precisely one month before the surge was announced.  Ditto US military casualties.  That same month, 69 Americans died in Iraq;  in November 2008, 12 did.  Other factors, such as militant Shia cleric Moqtada al-Sadr's call on his army to suspend attacks against US troops, are also responsible for the staggering drop in violence.  But as Peter Beinart, one of Washington's leading liberal pundits, argued recently:  "If Iraq overall represents a massive stain on Bush's record, his decision to increase America's troop presence in late 2006 now looks like his finest hour."

To be sure, the war is far from over, and there will be risks and uncertainty involved as Uncle Sam's boot starts to leave the ground within the next two years.  Will, for instance, those age-old ethnic and tribal tensions resurface?  Will a Shia majority regime consolidate a new Iraqi state or will de facto partition result in three regions, ruled by Kurds in the north, Shi'ites in the south and a Sunni Arab centre?  And will, as US General David Petraeus has warned, the security gains from the US troop surge in Baghdad remain "fragile and reversible"?

All good questions.  But for now, as the largely violence-free weekend elections demonstrated, the situation on the ground has improved dramatically.  Too bad many opponents of the war won't concede that simple fact.

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Rudd's plan a dead weight on the future

On Monday, Prime Minister Kevin Rudd told a news conference the government would "move heaven and earth" to support the economy.

That's a tall order, even for a practicing Christian, but the Prime Minister says this is what he's trying to do.

Recession has seen Australia's annual tax revenues sagging by more than $30 billion.

Even so, Mr Rudd has now committed more than $80 billion of taxpayers funds -- almost 10 per cent of our national income -- in give-aways, subsidies and spend-a-thons.

These are designed to re-ignite the economy which he says has been strangled by "free market fundamentalism, extreme capitalism and excessive greed".

Mr Rudd's measures involve taking money from future generations and from private investors -- most of whom won't realise that their pockets are being picked -- and giving it to people who will notice and be grateful.

There is a naive belief that this robbery of Peter will give Paul funds to spend, thereby kick-starting the economy.

Doubtless this belief is reinforced by hopes that the recipients will be grateful and reward Labor with another term of office.

Mr Rudd would, however, also harbour fears that a year from now with a recession deepening, voters might start to ask if the Government knows what it is doing.

Some people might even begin to wonder whether the bail-outs and give-aways might have been harmful.

They would be right -- the government's policy settings spell disaster.

If governments spend taxation money or borrowings on infrastructure -- roads, rail, dams, ports etc -- the spending brings a return.

That return means increased productivity and higher incomes, which allow loans to be repaid without damaging future living standards.

The return from government infrastructure spending is highest when the infrastructure is in greatest need of repair or expansion.

So it is especially valuable after a war, for a newly populated area or in a region where new activities are planned.

Though less valuable when decent facilities are in place, as in Australia, government-financed infrastructure spending may still be worthwhile.

But there is very little of this in the Rudd packages.

Of the $80 billion in spending, only $3.6 billion is for roads and investment support, spending which offers a fighting chance of providing a return to the future generations who are paying for it.

The rest -- 95 per cent of the total -- is for low-return social infrastructure like school refurbishments, to rescue superannuation funds' shopping centre investments, and as gifts to those on low and middle incomes.

In this context, the Rudd packages have to be recognised for what they are -- a deadweight cost to the future which will offer negligible improvements in the economy's productivity.

The Prime Minister has said he wants to rescue capitalism from the extremes of the free market.

Unfortunately his prescription for doing so is an orgy of government spending that would cause even his illustrious predecessor, Gough Whitlam, to blush.

Whitlam too thought he could spend Australia out of a world recession.

That experiment ended in tears for the Australian community, and so will Mr Rudd's.

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Rudd's rush is unseemly

In the past few days we've learnt that Kevin Rudd doesn't much like what he calls "free-market fundamentalism".  It seems, though, that the Prime Minister doesn't have too many qualms about crony capitalism or perfunctory parliamentary processes.

Trying to work out what the Prime Minister believes in is these days a difficult task.  As a few dozen political commentators have pointed out, the sentiments expressed by Rudd in his 7700-word essay in The Monthly are quite different from what he was saying a few months ago.  And his sentiments are different from those of his ministers.

He argues in his essay that the Liberal Party is the party of "anti-regulation".  This sits a little uncomfortably with the remarks of his Treasurer, who on numerous occasions has praised the quality of Australia's system of financial regulation.  It is a system that Labor inherited from John Howard and Peter Costello.

Given the country's economic condition, trying to decipher the Prime Minister's cryptic utterances is a less urgent task than assessing the merits of his government's policies.

A fortnight ago we had the spectacle of the federal government dragooning Australia's four major banks into a rescue package for commercial property developers.

Picking and choosing which industries the government will spend taxpayers' money bailing out is a perilous undertaking at the best of times.  Taxpayers might, with some justification, be somewhat skeptical about the motivations behind the rescue package.

The fact that trade union-aligned superannuation funds have substantial investments in commercial property may not have crossed the minds of ministers when they decided to offer government loans to property developers.  And it may be a complete coincidence that the sector of the construction industry that was rescued has a unionised workforce, while residential property, which is largely non-union, was not rescued.

The Prime Minister's demand on Wednesday that the Senate authorise $42 billion of spending within 48 hours of the government's announcement would be laughable if only it were a laughing matter.  The problem is that he was serious.  For the 11 years of the Howard government Labor made much of the need for the Senate to operate as a house of review and as a check on untrammelled executive authority.  It's taken a year for Labor to change its tune.

The government's excuse for rushing the legislation through the parliament is that the global economic crisis is serious and it requires a timely response.  Yes, the global economic crisis is serious, and, yes, it does require a timely response.  Recovery will not be imperilled by having a few days of thoughtful analysis and debate.  A few days of delay will also help the government find the typos.  According to Bob Brown, a defence housing program worth $252 million appears as a $2.42 billion program in the legislation.  Maybe the Greens serve a purpose after all.

Labor seems to believe that avoiding a recession is a question of acting within hours.  Maybe you can run a political campaign according to the news cycle, but that's no way to run an economy.

It was predictable that those lobby groups in thrall to the government would welcome the stimulus package.

The fact that the package did little to reduce the costs of doing business and little to encourage firms to retain existing staff or hire new staff didn't seem to bother the business lobby.  Also predictable is that the business lobby will do what Treasurer Wayne Swan is urging it to do and tell Opposition Leader Malcolm Turnbull to reverse his decision to block the package.  Once upon a time the business lobby worried about government debt and budget deficits.  Turnbull should ignore the business lobby.

The stimulus package is about short term politics;  it is not about long-term recovery.  Put simply, if the government is going to blow the budget, then at least the money should be spent on something useful.

Encouraging more consumer spending with cash handouts will do nothing to make the economy more productive.

Worse, it perpetuates the middle-class tax and welfare churn.  More money for school maintenance provides politicians with photo opportunities, but it doesn't address the central issue in education, which is how to improve the quality of our teachers.

From the time Rudd became opposition leader in December 2006, his strategy was to have an economic policy as close to the coalition's as possible.  Rudd has abandoned that strategy.  The phony war between Labor and the coalition is now over.

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The case against hand-outs; The rescue plan

In Australia's great Keynesian giveaway debate, much pontificating turns on whether it is better to provide hand-outs or tax cuts.

Though tax cuts have certain superiorities (and are marvellous in combination with spending cuts), the short answer is neither of the above.

Assuming increased spending is to be funded in some way -- that is other than having the Reserve Bank simply print money -- increasing the deficit either by tax cuts or hand-outs means tapping funds from overseas or from domestic savers.

Whether debt is covered from domestic or overseas funders, it has to be repaid, and if it is simply spent on consumption, future real income levels will be reduced.

Tapping overseas savers is hardly the correct solution for Australia since, as Kevin Rudd pointed out in his infamous global financial crisis essay, foreign debt has increased rapidly since the Hawke-Keating governments.  And unlike classically described foreign borrowings, Australians' increased overseas indebtedness has not been used to augment domestic savings but has, in fact, replaced those savings.

Our increased debt has, in short, simply been spent on consumption.

Government borrowing from domestic resources cannibalises the funds available for productivity-enhancing private investments.  It therefore disadvantages firms hoping to tap into savings to shore up their finances or to expand.

The rationale for raiding savings for tax cuts or hand-outs is that this will shift expenditure patterns to those who are more likely to consume and that the increased consumption will ignite a new cycle of investment and growth.

But shifting money between different classes of people is less likely to resurrect growth than leaving things as they are.  After all, it is not as though savings are simply being hoarded and not finding their way into the economy at large.  Savings are held in financial institutions and attract interest rates.  The financial institutions have to re-lend those savings, thereby re-injecting them into the economy.

Those advocating deficit financing are punting on the money assuming greater power if it is given to those it hopes are spendthrifts.  Aside from undermining the incentive to prudence, there is no evidence that this will work.  Indeed, Rudd's first $10.4 billion hand-out totally failed to restart the economic locomotive.

These considerations overshadow the debate about hand-outs versus tax cuts.

Hand-outs are particularly noxious, however, because they give people something for doing nothing.  Income tax cuts have the merit of reducing the fiscal burden on working men and women.  They bring a diminished siphoning-off of the money that people have earned and, as Wayne Swan pointed out in last May's budget, in lightening the load, tax cuts provide incentives for people to work harder.  But hand-outs are likely to discourage work.

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Slaves to Keynes saddle us with debt

Economist John Maynard Keynes once famously said practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.

If the way in which governments have been spending and borrowing is any guide, Kevin Rudd and his band of mostly Labor premiers are slaves of the defunct Keynes.

Aggregating the key variables of commonwealth, state and territory budgets creates what could be called a federation budget and it is a rather scary beast.

About the middle of last year, governments were projecting a collective federation surplus of $26.2 billion for 2008/09, equivalent to more than 2 per cent of gross domestic product.

Six months later, it is projected that governments will descend into an aggregate $22.1 billion deficit, a staggering $48 billion deterioration in the budget bottom line.

And it gets worse.  The federation budget is expected to deteriorate in the following two to three years, with the collective governmental deficit increasing to $32.8 billion in 2009/10, $31 billion in 2010/11 and $23.1 billion in 2011/12.

Consistent with a slowing economy, there will be a reduction in revenue growth over the next four years from 4.4 per cent average annual growth, as originally forecast, to 3.9 per cent.  This means an implied cut in revenues of almost $50 billion.

When both sides of the ledger are examined it is clear that the real culprit behind the enormous expected federation budget deficits will be rampant Keynesian pump-priming.

In this financial year alone, expenses are projected to be revised upwards across the federation by $35.4 billion.  This spending growth exceeds changes in governments' revenue by a factor of eight.  Over the next four years, federation expenditure will increase by $97 billion.

The deteriorating federation budget shows the preparedness of our governments to throw taxpayer money about to stave off a recession.  Since the most recent federal and state budgets, the Rudd Government has churned over $50 billion from taxpayers to encourage the very same taxpayers to spend up.

From cash gifts for families, pensioners and potential first-home buyers to corporate welfare bailouts, precious few have been left untouched by the Government's spending bonanza.

A key element of the federal Government's spending strategy is to prod the other partners of the federation, the states and territories, to follow its profligate lead.  This week the state and territory premiers and chief ministers trekked to Canberra, cap in hand, for a slice of the latest $42 billion spending spree.

The states are looking for more funding for schools, housing, community infrastructure and roads.  So, expect a new school or road coming near you, financed by the federal Government and delivered by the states.

However, with every government rushing to spend the outcomes are likely to rank poorly on value for money criteria.

The states, through either own revenue, commonwealth grants or borrowed funds, have announced their own raft of new spending:  everything from replacing house carpets to bailing out film studios, causing significant damage to their own financial positions.

A looming structural problem in the federation budgets is the spiral in government net debt.  Excluding Queensland, which has no net debt, general government debt is expected to rise from $27.3 billion this financial year to $84.6 billion in 2011/12, an increase of 210 per cent.

In simple terms, governments are looking to dole out money today in the vain hope of buffering against a global recession, with taxpayers to pay it all back, with interest costs, later.

The problem with this debt strategy is that, in a tighter international credit market, the collective shift of all Australian governments toward borrowing is likely to push up long-term interest rates.

And therein lies the real damage of Keynesian-inspired government budgeting.

Governments collectively think that churning money from one group to another will magically boost the economy.  It won't.  Other defunct ideas, such as the need to spend, regardless of quality, and borrowing, irrespective of the long-term consequences, also seem to be prevailing in the halls of power.

We would be far better off if we turned our backs on Keynes and looked to tax reform and economic deregulation policies that have been the foundation of our prosperity over the past 30 years, to prepare ourselves for the next phase of growth.

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The fall of a civilisation, or just a "torn country"

About a year after his devastating 1996 election defeat, Paul Keating remarked:  "Over the course of a long political career, you get accused of many unflattering things.  But I have to say that the most spectacular of all the charges against me came from ..."

Guess who?  Newspaper columnist Paddy McGuinness, attacking Keating's big picture of Asia, republicanism and reconciliation?  Liberal senator Michael Baume, relentlessly putting the case against Keating?  Or prime minister John Howard, lobbing another grenade in the culture wars?  No, it was Samuel Huntington, the distinguished Harvard academic, who died recently at the age of 81.

The former Labor prime minister was responding to Huntington's clash of civilisations thesis, first posited in an article in Foreign Affairs magazine in 1993 then three years later in a book entitled The Clash of Civilisations and the Remaking of World Order.  The fundamental source of conflict in the post-Cold War world, he argued, would not be ideological or economic, but cultural.

Intriguingly, Australian newspaper coverage of Huntington since his death has glossed over the stoush between the American intellectual and the Labor politician.  Yet the incident provides a revealing insight into how Keating and Howard defined their leaderships and their nation's place in the world.

According to Keating, Huntington accused him of "precipitating the fall of a civilisation".  In fact, the doyen of political science suggested that, among other things, the policy favoured by Keating's government of converting Australia from being Western to being "part of Asia" was not only doomed to fail, but highly dangerous.  It would, Huntington argued, end up weakening Australia's cultural ties with our traditional and culturally compatible Western friends, while struggling to make us acceptable to the Confucian and Islamic countries to our north.

Australia, in Huntington's phrase, would become a "torn country".  But unlike Turkey, Russia and Mexico, whose leaders wanted "to make their countries members of the West but whose history, culture and traditions are non-Western", Australia, if Huntington's thesis were vindicated, would provide the first example of a historically fully Western country in which a significant section of the elite advocated a move to membership of another, non-Western civilisation.  Better for Australia, he suggested, to define itself as a Pacific country and align itself with the US "whose values of the Declaration of Independence accord far more with Australian values than do those of any Asian country".

Keating complained he was misunderstood regarding whether Australia should become part of Asia and shed its Western cultural character.  He was probably right.  Still, many of the opinion-forming elite in Australia were enthusiastic in their misunderstanding.  And, as Howard warned, Keating's pronouncements coincided with a "perpetual seminar about our national identity" and an "extraordinary period of navel-gazing" in the 1990s about Australia's place in the world.

This was a time, remember, when Keating was calling for Australia to cease being a "branch office of empire", become a republic and aim for "enmeshment" in Asia.  Australia, he insisted, "cannot represent itself to the world as a multicultural society, engage in Asia, make that link and make it persuasively while in some way, at least in constitutional terms, remaining a derivative society".  As Huntington pointed out, Keating complained that Australia had suffered untold years of "anglophilia and torpor" and warned that continued association with Britain would be "debilitating to our national culture, our economic future and our destiny in Asia and the Pacific".

Keating's defenders have since insisted that all this was merely rhetoric, that Keating was every bit as committed to our Western allies as he was to Asian engagement, and that the substance of Keating's foreign policy was little different not only from his predecessors Gough Whitlam, Malcolm Fraser and Bob Hawke, but also his successors Howard and Kevin Rudd.

But the Asian elite -- political and diplomatic figures alike -- certainly took Keating's rhetoric seriously enough.  So seriously, in fact, that they regarded his language as representing a major departure from orthodox Canberra policy.  How else to explain the fact, which Huntington documented in his book, that many Asian figures -- and not just Malaysian prime minister Dr Mahathir -- went to great lengths to pour scorn on Keating's big picture?

Would Huntington have described Australia as a "torn country" during the Howard and Rudd eras?  I doubt it.  Put simply, Keating put more stress on Asia than his successors and predecessors.  John Howard, a Western values man, was also a strong proponent of increasing Australian bilateral ties to East Asian nations, but he never over-emphasised his commitment to Asian engagement in the way that Keating did.

Howard signed Australia's record trade deal with China in 2002.  He led one of only two nations to support all three financial bailouts of Thailand, South Korea and Indonesia during the 1997 economic crisis.  And he led Asian democracies to protect helpless East Timorese from brutal attack by the Indonesian military in 1999.

Keating lambasted Howard over the intervention.  But as one regional newspaper editorialised at the time:  "While Mr Keating never stopped spouting slogans about Australia being part of Asia, only with the intervention in East Timor has Australia met and passed a real test of being a great Asian neighbour".

Indeed, Keating's talk was cheap.  But it nevertheless gave the widely held impression that he wanted to make Australia part of the East.  Howard, on the other hand, was never in any doubt about Australia's liberal identity and Western cultural heritage.  Today he recalls how Huntington's analysis revealed something about the "foolish, destructive and introspective" debate the nation was having about itself in the mid-1990s.

"If Huntington were to write again in 2008," Howard remarked a few months before the Harvard academic died, "such a description would be unthinkable.  There is nothing 'torn' or 'indecisive' about Australia's place in the world.  We are seen as a strong exemplar of Western civilisation:  a nation that has managed to sit at that unique intersection of not only history and geography, but of culture and political belief.  We have always had very strong links with North America and we have built profound, enduring and everlasting links with our friends and neighbours in the Asia-Pacific region.  And that is how it should always be.  This nation should never have been prodded to choose in some way between its history and its geography."

I suspect Huntington would be saying Amen to that.

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Very little gain, lots of long-term pain

Australia's second pump-priming stimulus announced yesterday will prove every bit as wasteful as last October's $10.4 billion package.  Predictably, the failure of the first stimulus merely brought Keynesian deficit adherents to claim that things would have been much worse without it, or that it was insufficient for the job.

Now we have a new package valued at $42 billion over four years.  This includes $12.7 billion in handouts to the less well-off.  And it comes on top of bank guarantees and a $30 billion fund to bail out shopping centres.

The stimulatory measures address a downturn that is the culmination of a decade or more of lax monetary policy in Australia and overseas.  This easy credit policy has fed a cancerous growth of lending for assets that are vastly overvalued.

The fundamental distortions in the economy have brought people to recognise a fall in the real value of their savings.  Coupled with this is the collapse of demand for our main exports.  Looming economic collapse has brought the government to promote increased consumption by diverting funds from those who have saved to those it thinks will consume.  The aim is to lift demand and jump-start a cycle of investment and growth.

Such pump priming will only retard recovery and leave a painful legacy of debt to be serviced.  Unwinding the misallocation resulting from monetary mismanagement will inevitably bring hardship, but the current measures are exacerbating the damage.

As governments themselves have few resources, pump priming can work in one of three ways:  it can divert "idle" savings into consumption;  it can expand the amount of money and trick people into increased spending by making them think they are richer than they are;  or it can draw resources from foreign lenders.

Financing deficit spending with government bonds reallocates savings to personal consumption.  But "idle" savings do not exist and the policy simply denies resources to private investors.  And many businesses like Qantas are showing that they have a desperate need to tap into savings, if only to rebuild the greatly reduced value of their assets.

The second alternative, printing money, is the approach that got us to where we are.  It means inflation, and at its worst the runaway inflation experienced by Germany 90 years ago and by Zimbabwe today.

Lifting consumption by borrowing funds from overseas has the merit of leaving a legacy only on future generations.  But borrowings are for investment and not for consumption.  In any event, Australia already has excessive overseas borrowings.  Measured by the deficit on the balance of payments current account, over the past eight years overseas borrowings have averaged 5 per cent of GDP, equivalent to a quarter of the nation's gross savings.  And while it is beneficial to supplement domestic with foreign savings in order to allow more investment for faster growth, Australia's growth has been unspectacular and is now in reverse.  The capital imports have been used to finance domestic consumption and not to create additional wealth.

The new package has a larger infrastructure component than that announced in October, offering prospects that the spending might lift future income levels and capacities to repay the debt.  But the specific measures are geared to projects with low returns -- public housing, schools, community centres and solar heating.

Lower official interest rates were also announced yesterday.  Notwithstanding the Reserve Bank's culpability in the downturn, yesterday's interest-rate cut seems appropriate since, on published aggregates, recent monetary growth does not appear to be excessive.

Assuming the government is forswearing the printing presses, it must be intending to finance its deficit by borrowing.  Not only does this cannibalise funds that would otherwise go to rebuilding the economy, but budget deficits projected for the next four years indicate no exit plan to pay back the borrowings.

This new package will provide only a short-term boost to consumption.  Since fundamental imbalances remain, the boomlet will peter out.  The economy will then, at worst, start experiencing rapid inflation or, at best, result in the sort of economic stagnation that Japan suffered throughout the 1990s when it followed similar policies now being pursued by the Rudd government.

What is needed is a renewed focus on reducing government waste.  This would allow increased scope for people to rebuild their savings and attract them to productivity enhancing investments.

Unfortunately, however, we are seeing the Rudd government's energies squandered in desperately thrashing around the prison in which it finds itself, instead of building an escape tunnel.

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Rudd throws out the baby

One of the enduring questions about Prime Minister Kevin Rudd, and his philosophical position on economics, is now being answered.

As little as six months ago, there were still uncertainties about Rudd's views.  Was he really the "economic conservative", committed to lower taxes, budget surpluses and economic reform, that he painted himself before last election?  Or an "economic interventionist" who believed that Howard and Costello created an economic "brutopia" and that financiers developed global "extreme capitalism"?

Kevin Rudd's latest 7700-word essay on the economy (published in The Monthly magazine) reinforces the idea that perhaps he is an economic interventionist, and not a conservative, after all.

In it he calls for a new era of "social capitalism" to wipe away a 30-year epoch of unrestrained "free-market neo-liberalism".  To achieve this, Rudd believes that governments should impose new market regulations, embrace Keynesian fiscal pump-priming and increase public investment.

If anything, Rudd is keeping to his word about getting his Government more involved in the nation's economic affairs.  Late last year, a Government bank deposit guarantee was put in place, followed by "nation-building" infrastructure spending, a $10.4billion cash spree for families, pensioners and first-home buyers, and bail-outs of car makers and child-care centres.

Even though Rudd has a clear distaste for the free market, his essay begrudgingly states that it should "not be thrown out with the bathwater".  Yet this is exactly what his Government is doing.

The bank deposit guarantee distorted financial markets by freezing deposits in non-bank institutions.  The $10.4billion stimulus package failed to boost retail spending as much as hoped at first, with many people pocketing the money as savings.

The problem with the ill-defined social capitalist approach is that it encourages governments to interfere even more with the economy.  Last month the Government proposed an arrangement with the big banks that in effect would bail out existing commercial properties.

It has now announced a whopping $42 billion nation-building and jobs plan, spraying everyone with cash today to be financed by debt obligations tomorrow.  Included in the package are spending initiatives devoted to low-return infrastructure projects such as schools, social housing and home retrofitting.  The Government also plans to boost welfare entitlements, paradoxically in aid of "supporting jobs now".

The price to pay for this return to Keynesian pump priming is a persistent budget deficit, expected to be in the order of $22.5 billion for 2008-09 and increasing thereafter.

The Prime Minister's least favourite economist, Friedrich Hayek, explained more than 60 years ago that governments are largely incapable of planning the economy in micro-level detail.

In light of this, Hayek said, governments would spend and regulate more and more to fix up the unintended consequences of their failed policies.  The ultimate consequence of these actions would be the dilution of economic freedoms in other words, throwing the market baby out with the economic bathwater.

The other problem is that the PM justifies his pro-government philosophy by opposing a "free market" which has never actually existed, at least in modern times.

Governments have been extensively involved in economic affairs over the past century.  For example, corporate entities including those in the financial sector are hamstrung by regulations such as corporate reporting and accountancy standards, credit codes and guidelines issued by regulators.

Enforcement issues and changes in interpretations of existing laws by government authorities add to the endemic "regime uncertainties" of not knowing when or how governments will interfere next.

The Prime Minister has developed an intellectual straw man of free market "fundamentalism" to divert attention from his failed interventions and create a climate for more of the same.  This is not the approach befitting a once self-avowed economic conservative.

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Ease the squeeze on power utilities

Setting prices for "natural monopolies" like electricity lines, water pipes and gas distribution networks has developed as a relatively mechanistic procedure.

In Australia, we have several such price setting bodies, the most important of which is the Australian Energy Regulator (AER).  Invariably the price reviews are conducted with wide hearings where the businesses seek as high a price as possible and user groups seek the opposite.  Voluminous reports are produced rehearsing all the arguments canvassed by different interests.  In the main, over the past decade, this has required a lowering of the current price.

The regulator's decision invariably brings a cacophony of protests from the owners who claim they'll be ruined by the new price.  Usually the regulator pares back the price reduction somewhat in its final decision but this still leaves the businesses grumbling that their capital investment program will be jeopardised and that consumers as well as their shareholders will suffer.

But in almost every case, the businesses have remained profitable and the networks' performances have steadily improved.  To some degree this is a result of interest rates progressively falling over recent years and allowing unanticipated cost savings.  Nonetheless, regulators have been conditioned to regard earlier protests as the businesses crying wolf.  They have therefore steadily reduced the prices that may be charged by critically scrutinising claims of necessary investment expenditures and paring back the capital costs the businesses claim they must incur.

In general, partly due to previously falling interest rates, the scepticism about firms' intended capital expenditures has been proven correct.  There have however been exceptions.  Thus, the disastrous blackouts that were experienced in Queensland in 2004 were largely due to the regulator squeezing the revenues and spending of the two (government owned) electricity distribution businesses.

The relatively uncontroversial assessment of the prices gas and electricity utilities should charge disappears when the economy experiences a radical change.  Such is the situation at present.  In the past the authorities would assess how much debt and how much equity each of the utilities required and apply well known premiums over the risk-free rates.

But those premiums over the risk free rate have suddenly changed.  In its latest price reset, the AER is fixing rates for the period from 2010-2019.  The proposed rate of return for the equity component is 8.1% based on a premium cost at 4.8% above the Commonwealth bond rate.  While such a risk premium was reasonable two years ago and may again be reasonable two years from now, it is clearly inappropriate at present.  One energy infrastructure business, Envestra, is presently in the process of raising more equity at what it estimates to be a yield equivalent of 18%.

The AER price setting is in the accordance with the methodology specified by its legislation.  But unless the regulator uses greater finance-setting flexibility the level of investment in the energy networks will fall dramatically.

Energy firms' difficulties in raising money without the benefit of a government guarantee are amplified by the various government financial market interventions.  Each guarantee or preferential treatment to sectors in distress imposes additional costs on those that are not so favoured.  The $30 billion government backed borrowing facility to bail out shopping centres cannibalises the funding resources that is available to areas like electricity lines and gas pipelines.

One bonus of providing reduced incentives for electricity transmission lines is that it may force some useful economies.  Major candidate areas for outlay savings are the grid links to the highly inefficient and poorly located wind farms, which would be forced to incur their own network costs.  Doubtless governments, which have nailed their colours to the wind industry mast, will see such an outcome differently.

Rather more significant for the economy as a whole is that the reduced incentive to invest, which for some businesses becomes a financial impossibility, will have an effect on the maintenance of the existing system.  Especially around Melbourne, the gas and electricity system is 40 and 50 years old and in many areas nearing the end of its life.  Replacement is necessary to prevent power outages.

As with other ventures that don't have the benefit of a government guarantee the cost of funds for electricity and gas networks has risen markedly.  Where their prices are regulated either they must be added to the ever lengthening list of businesses that are supported by the government's credit rating or they must be given approval to raise prices to cover their increased costs of funds.

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The bail-out disease

If pop psychology has taught us anything, it has taught us that individuals go through five stages of grief -- denial, anger, bargaining, depression and acceptance.

Governments do, too.  Presented with the biggest economic crisis in 50 years, the Federal Government first tried to ignore it and then angrily blamed it on greedy capitalists.  Now having reached the bargaining stage, Canberra has convinced itself that it can fix the crisis if it applies just the right sort of stimulus and bails out just the right sort of companies.

Already the number of industries being prepared for bail-outs is large.  Car dealers have been bailed out.  Commercial property investors look to be bailed out.  Banks are being bailed out with the fluffy blanket of a government guarantee.  Deputy Prime Minister Julia Gillard appears to have spent the past few months moonlighting as the liquidator for a chain of child-care centres.  Now the dairy industry wants a bail-out, presumably because of the importance of marinated fetta to economic growth.

We could also add to that list the car industry, but I'm not sure that we can blame the global financial crisis for that -- propping up this sector with piles of cash and legislative favours is sort of an Australian tradition.  We were probably going to do it anyway.

All of these are dwarfed by the strong possibility that the Federal Government will have to eventually bail out the state of NSW.  Collectively, the NSW Government is far worse than the most reckless, hard-partying, due-diligence-ignoring Wall Street CEO.  When NSW inevitably goes into receivership, its citizen-shareholders will wish they could sue.

Seriously, who isn't eligible for a bail-out?  Your guess is as good as anybody's.  None of the traditional policy justifications for propping up failing companies -- whether you agree with them or not -- seem to apply to our great bail-out bonanza.

For example, child-care organisations are clearly not "too big to fail".  Car dealers are clearly not "too important to fail".  If there is a formula governing which industries are eligible for a government bail-out, it sure is an obscure one.

But the sad reality is that the decision about which companies deserve a bail-out -- and which companies should join whale oil merchants and abacus makers in the cemetery of dead businesses -- is entirely arbitrary, dependent only on the political winds in Canberra.

So there's a certain hypocrisy about a Government that on the one hand is deeply concerned about the influence of lobbyists and donations on the political process, and on the other is making it more and more attractive for businesses to seek political favours.  Own a company?  You'd be stupid not to try for a guarantee, or a loan, or any other trick that transfers money from the Government to you.  Bail-out lotto is a surprisingly easy game to win, and it offers big prizes.

Of course, bail-outs are extraordinarily unfair to those who aren't on their pleasant receiving end.  Shareholder capitalism should be pretty simple.  People bet their money in the market on businesses that they think might be a good thing.  They profit when they are correct and lose when they aren't.  The companies that make bad decisions, or make products that no one wants to buy, fail.  And the good ones survive.

While government bail-outs are no doubt well-intentioned -- nobody likes to see companies collapse and jobs disappear -- they dramatically alter this basic formula.  They undermine the certainty that is so important to economic confidence -- investors have no idea how the Government will react to a business heading south.  Bail-outs mean that people aren't financially punished for their bad financial decisions.  They keep companies afloat that probably should sink -- if your business model isn't working, do something else with your time.

And bail-outs are expensive.  There's no clearer example of corporate welfare than the Government taking money from taxpayers and adding it to the revenue spreadsheets of Australia's biggest businesses.  Bail-outs are paid for by everybody, but they're not available to everybody.

Does anybody doubt that if the Government was presented with the imminent collapse of Ansett that it would have quickly ponied up the cash?  At the time, the Howard government resisted the howls of Ansett executives and the unions and let Ansett die the death it deserved.  Nearly a decade later, flights have never been cheaper and it is safe to assume that most of those who were laid off at the time have been able to find work in a more productive enterprise.

The political eagerness to bail out failing companies just reveals that they -- like a lot of us -- don't quite understand what is going wrong with our economy.

It's actually a bit misleading to describe our economic woes as a crisis.

If anything deserves that title, it was the asset bubble that was burst in the crash last year.

All the downsizing and unemployment that we face over the next year is not the crisis, it is the correction.

So when the Government tries to stimulate the economy with big spending and tries to resuscitate dying companies, it isn't resisting the crisis, it's resisting the correction.  And preventing the economy from healing itself isn't doing Australians any favours.

Things fail.  Napoleon failed to conquer Russia.  Baz Luhrmann's Australia failed to be the next Titanic.  And companies fail.  In fact, building a successful business is an extremely hard thing to do.

The sooner we get to the last stage of grief -- acceptance -- the quicker our economy is going to recover.

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