Saturday, April 28, 2012

Victoria: Cash tight now, but reform could help

ON TUESDAY the Baillieu government will greet Victorians with either the state's first budget deficit in a generation, or heavy cuts to government spending, or possibly both. That's not its fault: it's just part of what is happening throughout south-eastern Australia as the high dollar and high interest rates flatten the economy.

Juggling the conflicting demands of economic hardliners and Victorian voters will not be easy. While it will not help Treasurer Kim Wells this time, a report this week. however, offers a whiff of reforms in the wind that could give Victoria more revenue to meet future demands for better infrastructure and quality services, at the same time as running a healthy surplus.

Federal Treasurer Wayne Swan released the interim report by former Victorian Labor premier John Brumby, former New South Wales Liberal premier Nick Greiner and Adelaide director and company healer Bruce Carter on how to reform the distribution of the $50 billion a year that the federal government raises from the GST and hands over to the states.

Victorian and NSW premiers have railed against the system of redistributing money to weaker states since the Pharaohs wore nappies. But until now, they got nowhere, because to change it would be a zero-sum game, and the losers would make more waves than the winners. So federal governments just left it to the Commonwealth Grants Commission to be the umpire deciding how much each state will get.

Back in the 1890s, the framers of the constitution envisaged a Commonwealth with limited powers operating alongside self-sufficient states that ran most areas of government activity: education, health, transport, police etc. But they gave the states' main taxes, customs and excise duties to the Commonwealth, and authorised it to make payments to the states of ''financial assistance ? on such terms and conditions as the Parliament thinks fit''.

Gradually the Commonwealth has acquired more and more power, and more and more revenue. The system has kept changing, and the size of those payments has grown massively - as has the amount taken from the bigger states to give to the smaller ones. On average, 50 per cent of state government revenue now comes from the Commonwealth - half through the GST, half through payments for programs such as hospital and school funding.

The GST money is distributed by the Grants Commission, with the goal of giving each state and territory government the same fiscal capacity, regardless of the size of its revenue base or its spending needs. It calculates this by complex estimates of how much revenue a state could raise if it applied the average of all states' taxes, and how much it costs to deliver the average level of services in every state.

In Victoria, it estimates that the state's relatively small size and its people's concentration in Melbourne means government services are cheaper to deliver than in other states - and far cheaper than in the Northern Territory. So Victoria gets less money than its per capita share, and the NT gets far more. On revenue, Western Australia's $4 billion a year of mining royalties puts it in a far stronger position than anyone else, while Tasmania is the weakest.

Ironically, WA was the first state to line up for federal funds, in 1910. For almost a century, its government received more than its per capita share of Commonwealth payments, often far more. But now that mining royalties have made it the main source of funds to subsidise the weaker states, it has begun rocking the boat deliberately to force change to a system that takes its mineral royalties and shares them around with everyone else.

Now that WA and Queensland have joined Victoria and NSW as donor states - WA as a donor on an unprecedented scale - the political balance has changed. For the first time, reform has become possible: indeed, inevitable.

For 2012-13, the Grants Commission has awarded Victoria 8 per cent less GST money than it would get if the funds were distributed to states on a per capita basis. NSW got 5 per cent less than its share, Queensland 1.5 per cent less. But WA was given 45 per cent less, and it forecasts that by 2014-15 it will get only a third of its per capita share. That is politically challenging.

So the Gillard government appointed the first outside review of how the Commonwealth grants are awarded. The presence of Brumby and Greiner on the panel at first raised alarm in the smaller states: in 2002, as Victoria's treasurer, Brumby attacked one Grants Commission finding with the words: ''Victorians are sick of being ripped off by ramshackle, outdated and blatantly unfair funding arrangements.''

Their interim report, however, suggests they were put on the panel because, as smart politicians, they can judge where the best trade-offs lie, and how far reforms can go without forcing WA or the smaller states and territories to try to derail the whole process.

Their interim report is deliberately blurred, specifying directions rather than detail, ruling some options in and others out, and pointedly pressing states to come up with ideas for solving the drawbacks in what they propose. In broad terms, it gives every child a present, and looks for reforms that would smooth the sharp edges off the current system, rather than overthrow it. And that means it could well succeed in delivering real change.

On one hand, it rules out the ambit claim put by Victoria and NSW for the system to be replaced by per capita funding entitlements, with special needs in Tasmania or the NT , for example, to be met by special federal grants. That claim would have given Victoria an extra $1 billion in 2012-13, but cost South Australia a similar sum and cost the NT almost half its budget.

Instead, the panel expresses interest in returning to the former concept of providing each state with ''comparable'' fiscal capacities, rather than identical ones. It points out that no other federation attempts to provide its states with equal resources. In Canada and Germany, they try to roughly equalise revenue capacity, but not spending; in the US, poor states such as West Virginia and Mississippi are left to do their best with what they have. The report hints that it might be better to define an acceptable minimum standard of service, and equalise capacity only up to that level.

It also rejects WA's ambit claims that each state receive at least 75 per cent of its per capita share of GST revenues, and/or that mineral royalties be excluded from the GST calculations. But the panel does agree, if unconvincingly, with the WA/Queensland claim that the cost of providing mining infrastructure is not adequately recognised by the Grants Commission, and asks the states to suggest how to do it.

It also points the way to sensible reforms. Victoria is understandably ropeable that the Grants Commission is taking away almost half the money the federal government gave us to build the new railway through the outer western suburbs (the ''regional rail link''). The panel suggests that big grants for defined ''nationally important infrastructure'' should be either excluded from the process, or included over time, at a reduced rate.

The interim report has defined the contours within which reform is possible. The states will now weigh in with specific proposals for or against the changes suggested, with a final report to be handed to Swan in August or September.

The panel will also have to report back by then on a second reference Swan gave it: asking how he could use the threat of withholding GST money to force the states to accept the tax reforms he wants. Treasurer, that is not a good idea. But that's another issue, for another day.


Wednesday, April 25, 2012

Reserve wrong and must move on

THE Reserve Bank wanted low inflation. Now it's got it. Strip away the statistical static, and for the last three quarters, underlying inflation has been running at 1.8 per cent, the lowest level for almost 50 years.

But in 1963-64 we had the best of both worlds: inflation of 0.9 per cent and growth of 7 per cent. Now we have growth of just 2.5 per cent, and most of it in outback mines. The 80 per cent of the economy not driven by mining is treading water.

This is not what the Reserve forecast. It thought the economy would be booming, and inflation around the top of its target band of 2 to 3 per cent. Instead, mining is booming, the rest of the economy is flat, and since mid-2011, underlying inflation is below the bottom of its target band.

The Reserve made a mess of it. It kept overestimating growth. It kept overestimating inflation. It raised interest rates far too high, and has kept them too high. It has no more excuses. It must now fix the problems it created.

Next week it has two choices. It can cut its losses, fix the problem quickly, and move on to the next page. That means cutting interest rates by at least 0.5 percentage points now, and by more ahead if the economy continues to underperform.

Or, if its priority is to preserve its pride, it could make just the usual cut, of 0.25 percentage points, and go on issuing rosy forecasts as if nothing had gone wrong. That would be irresponsible, but not unlikely.

The economy needs a decisive lift; a small rate cut will not give it. Mortgage rates are now at 2005 levels, appropriate for an economy growing fast. Small business overdraft rates are at late 2007 levels, appropriate for an economy overheating. Now we are slow, and cold. Even a 0.5 percentage point cut assuming the banks pass it on would still leave rates too high.

We've now had three quarters of inflation data since the Bureau of Statistics updated its index weights to reflect actual household spending. In that time, in annualised terms, headline inflation has grown at 0.9 per cent; seasonally adjusted inflation at 0.7 per cent; and underlying inflation (the trimmed mean) at 1.8 per cent.

There were times in the '90s when inflation got as low as that, but only because the index was then dominated by mortgages, so rate cuts also cut inflation. This time prices have been flattened by three things: falling fruit and vegetable prices, the high dollar cutting import prices, and the weak economy cutting retail margins.

Yes, say inflation hawks, but look at the prices of non-tradeable items: up 1 per cent in the March quarter, 3.6 per cent in a year. The Reserve can't relax its grip, because if the dollar falls, these will drag inflation back up.

Relax, hawks. The March-quarter figure is high because it includes the annual rises for health and education fees. The annual data matters. But it shows six items created 80 per cent of net price rises in the past year and not one is an area where prices are sensitive to interest rates.

The six are rents (up 4.4 per cent in the past year), health and medical services (5.1), petrol (5.9), electricity (9.9), private school fees (6.0), and cigarettes (6.3). High interest rates did not stop these prices soaring in 2007-08, or in 2011-12. If you stop to think about why, the reasons should be obvious.

The Reserve has run out of excuses. It was wrong. It needs to cut its losses and move on.


Tuesday, April 24, 2012

Bravo Hockey, for a speech free of cheap hits

JOE Hockey went to London last week to give a speech declaring ''The End of the Age of Entitlement''. Pity he didn't also go to Washington, to listen to the biannual meetings of the International Monetary Fund and the World Bank.

Within 18 months, Hockey is likely to be Australia's next Treasurer. If he is, he will face a very challenging task in reconciling the Coalition's rhetoric and the expectations it has aroused with the limited resources he will have to meet them.

The Coalition's economic policy, we are told, is to cut taxes - cut personal income tax, cut company tax, scrap the carbon tax, scrap the mining tax - while putting the budget back into a fiddle-free surplus, and increasing some spending.

Uh-huh. Labor claims that would require $70 billion of spending cuts over four years - roughly 5 per cent of budget spending - which the Coalition refuses to spell out at this stage. You can understand why, but after Treasury found $11 billion of holes in its 2010 campaign promises, the silence leaves the Coalition's economic team short on credibility.

Hockey clearly understands this, and his speech set out to tackle it. It will be dismissed by some as another gaffe by a bloke who is likeable but gaffe-prone. A shadow Treasurer implying that he wants to cut welfare entitlements? When the Howard government reaped such an electoral harvest from expanding them?

Abbott quickly told us that Hockey was talking only about Europe, declaring: ''Australia hasn't got there yet, and it's the job of the Coalition to ensure that we never do''. Yesterday Hockey fell in line, as if to put an embarrassing episode to rest.

I hope it doesn't. In London, Hockey gave the kind of speech you wish our political leaders would give, but, with the exception of Malcolm Turnbull, rarely do. It was well-argued, full of ideas, largely bereft of cheap point-scoring, and confronted a real problem that will loom large over Australia and the rest of the West as their populations age.

You can read it on It was not just about Europe - ''Australia has not completely avoided the problems'', Hockey declared, while praising the Future Fund and four Labor initiatives that reformed our retirement system. It summed up powerfully the forces that caused Europe's fiscal problems, and which our governments too must contend with. The key problem, Hockey said, is ''a belief that one person has a right to a good or service that someone else will pay for ? In our collective effort to win votes, political leaders deliberately portray a new spending commitment as if it is coming out of their own personal bank account. Political leaders rarely thank taxpayers for funding the policy.

''The sovereign debt problems we are seeing in Europe and the US today are the outcome of countries wanting a lifestyle they cannot afford, but are quite happy to borrow from others to pay for ? Whether it is defence, law and order, income support, social programs and so on, the outcome is the same. Eventually the piper has to be paid.'' Too true. Witness the culture in our tabloids, talkback, even in letters to The Age, that berates governments for spending too little, taxing too much, and not running a surplus. We forget arithmetic - and we forget that governments don't spend their money, they spend ours. In turn, we receive what that spending buys for us: education, health, a welfare safety net, transport, security. As former US Supreme Court Justice Oliver Wendell Holmes famously put it: ''I like to pay taxes. With them, I buy civilisation.''

Hockey wound up: ''The bottom line is that our communities need to make a tough decision. We cannot choose both higher entitlements and lower taxes. We must make a decision one way or the other. We can take more and more of our citizen's money and spend it for them, or we can take less of it and rationalise government services.''

Hockey chose the latter. ''We must rebuild fiscal discipline. Budget surpluses must be restored, ideally until the debt is repaid.'' He urged increasing the pension age, means-testing ''all government-funded pensions and other such payments'', making superannuation compulsory, requiring user co-payments for some government services, citing health care - and eliminating public debt.

You don't have to accept all his argument or prescriptions (particularly the last) to find them refreshing to read. At last, here is a politician talking frankly in public about the real difficulties policymakers face. Wayne Swan would be a far more effective Treasurer if he did the same.

But Swan was in Washington, where he too performed a PB: giving a speech to the IMF that did not boast that Australia is doing better than any of them (perhaps because IMF data shows it isn't).

Ideally, Hockey should have gone with him, to absorb the IMF's key message: give growth and jobs priority now, and allow time to get budgets into surplus over the medium term. IMF data shows Australia has very little debt by global standards - and Hockey knows that half our economy is in or close to recession.

Why doesn't the Coalition back the IMF's message, and oppose Labor's plan to force the budget into surplus by slashing spending and raising revenues? Hockey's speech implies one reason: they're fiscal hardliners. But is it also a cynical tactic, to close off Swan's options so the ensuing economic pain costs Labor votes?



17 APRlL 2012, LONDON


I wish to thank my friends at the Institute of Economic Affairs for the opportunity to discuss an issue that has been the source of much debate in this forum for sometime….that is, the end of an era of popular universal entitlement.

There is nothing much new in the debate other than the fact that action has now been forced on governments as a result of the recent financial crisis. Years of warnings have been ignored but the reality can no longer be avoided.

Despite an ageing population and a higher standard of living than that enjoyed by our children, western democracies in particular have been reluctant to wind back universal access to payments and entitlements from the state.

As we have already witnessed, it is not popular to take entitlements away from millions of voters in countries with frequent elections.

It is ironic that the entitlement system seems to be most obvious and prevalent in some of the most democratic societies. Most undemocratic nations are simply unable to afford the largesse of universal entitlement systems.

So, ultimately the fiscal impact of popular programs must be brought to account no matter what the political values of the government are or how popular a spending program may be.

Let me put it to you this way: The Age of Entitlement is over.

We should not take this as cause for despair. It is our market based economies which have forced this change on unwilling participants.

What we have seen is that the market is mandating policy changes that common sense and years of lectures from small government advocates have failed to achieve.

And we have subsequently witnessed over the last twelve months a raging battle. This has been a battle between the fiscal reality of paying for what you spend, set against the expectation of majority public opinion that each generation will receive the same or increased support from the state than their forebears.

The entitlements bestowed on tens of millions of people by successive governments, fuelled by short-term electoral cycles and the politics of outbidding your opponents is, in essence, undermining our ability to ensure democracy, fair representation and economic sustainability for future generations.

Perhaps we could re-apply noted British philosopher, AC Grayling’s words on liberty to our debate by declaring that we may record that the age of entitlement might have passed its best point, “after so brief a period of flourishing…”

And flourish it did.

Government spending on a range of social programs including education, health, housing, subsidised transport, social safety nets and retirement benefits has reached extraordinary levels as a percentage of GDP.

However an inadequate level of revenue has forced nations into levels of indebtedness that, in an age of slowing growth and ageing population, are simply unsustainable.

The social contract between government and its citizens needs to be urgently and significantly redefined. The reality is that we cannot have greater government services and more government involvement in our lives coupled with significantly lower taxation.

As a community we need to redefine the responsibility of government and its citizens to provide for themselves, both during their working lives and into retirement.

As part of this process, we must emphasise that government spending should be funded from revenue rather than by borrowing from future generations in whatever form that may take.

The Problem

Entitlement is a concept that corrodes the very heart of the process of free enterprise that drives our economies.

All of us would agree that there are some basic community entitlements. For generations we have all sought to define those basic rights.

For example, in the United States constitution the founding fathers determined that citizens are entitled to life, liberty and the pursuit of happiness.

You will remember it was Margaret Thatcher who interpreted community entitlements as the right for our children to “grow tall and some taller than others if they have the ability in them to do so”.1

This broader and timeless conservative definition of our end game lays down some foundations for the role of government.

Equality of opportunity rather than equality of outcome is my preferred model for contemporary society.

Thankfully the modern capitalist economy is centred around the satisfaction of personal wants and needs. Commercial transactions are at the core of the system. And it is a simple and proven formula for willing buyers to engage with willing sellers. If we want a product or service we go and buy it with the dividend from the fruits of our own labour. The producer is happy and the customer is satisfied.

The problem arises however when there is a belief that one person has a right to a good or service that someone else will pay for. It is this sense of entitlement that afflicts not only individuals but also entire societies. And governments are to blame for portraying taxpayer’s money as something removed from the labour of another person.

In our collective effort to win votes, political leaders deliberately portray a new spending commitment as if it is coming out of their own personal bank account. Political leaders rarely thank taxpayers for their funding of the policy.

To pay for all these good policy initiatives, governments have taken the easy option and borrowed money from that mysterious and amorphous group defined as “bondholders”.

We all know this is simply a case of borrowing money from the taxpayers of tomorrow for spending initiatives of today. Of course I say with irony, it gets even better when some governments borrow more money to pay the interest on current debt so existing taxpayers and voters will never notice the pain. This is the public sector equivalent of those much maligned ponzi schemes.

The sovereign debt problems we are seeing in Europe and the US today are the outcome of countries wanting a lifestyle they cannot afford but are quite happy to borrow from others to pay for.

Of course in recent months in some countries in Europe the “borrowings” have turned into permanent transfers of wealth as those countries have become unable – or unwilling – to repay the loans.

Richer countries are either writing off the debt of poorer countries or they are subsidising the debt repayments with sophisticated transfer payments.

As a parent I want to give my children everything they wish for.

As a democratically elected legislator I want to give my constituents everything they wish for.

The hardest task in life is to say NO to someone you care about.

So perhaps what we are witnessing is a chronic failure of the democratic process.

A weak government tends to give its citizens everything they wish for. A strong government has the will to say NO!

Being profligate is easy and politically popular in the short term, particularly when the political cost of raising sufficient revenue is avoided by resorting to debt.

But painless revenue makes for reckless spending.

Whether it is defence, law and order, income support, social programs and so on, the outcome is the same. Eventually the piper has to be paid.

Since World War 2 western communities have enjoyed prosperity that has exceeded all expectations. This has been fuelled by innovation, materialism, globalisation, free trade and debt.

Of course these are not malevolent developments. Rather they are the lauded natural outcomes of a free and successful society.

Moreover these initiatives, which have fuelled a massive improvement in global economic productivity, have driven the age of prosperity. Arguably this has delivered the most dramatic improvement in the material quality of life since the beginning of humanity.

In effect the rapid rise in private prosperity has been matched with demands for an equal improvement in state provided prosperity.

This is understandable. We all want the best available health care, the best education, the best pharmaceuticals and so on.

The difference is that the handbrake on private demand is income.

Unless a consumer can borrow money, it is their income and wealth which determines whether they can buy a new television or renovate the family home.

But for governments with seemingly unlimited capacity to borrow money, that handbrake on expenditure is not real.

While the Keynesian model of Government-led stimulus during the inevitable downturns in the economic cycle is well documented, governments who have turned on the fiscal tap seem completely incapable of turning it off when the cycle turns upwards.

So we have witnessed a continual over-commitment in many countries, funded by the lure of cheap and easily obtainable debt.

It is a problem which is not new. We might think by now we would have learnt the lessons. But clearly that is not the case.

A Tale of Two Systems

In September last year I travelled to Hong Kong – a city of 7 million2 - which sits at the edge of the Pearl River Delta - home to over 100 million additional residents. As a Special Administrative Region, Hong Kong is now serving as a conduit between China and its global trading partners, particularly those with business directly to the north.

So even though its destiny has changed, Hong Kong continues to maintain its own currency, laws and Parliament but is now totally wed at the hip to Beijing.

Without a social safety net, Hong Kong offers its citizens a top personal income tax rate of 17% and corporate tax rates of 16.5%. Unemployment is a low 3.4%3, inflation 4.7%4 and the growth rate still respectable at over 4%5. Government debt is moderate6 and although there is still poverty, the family unit is very much intact and social welfare is largely unknown.

The system there is that you work hard, your parents look after the kids, you look after your grandkids and you save as you work for 40 years to fund your retirement. The society is focused on making sure people can look after themselves well into old age.

The concept of filial piety, from the Confucian classic Xiao Jing, is thriving today right across Asia. It is also the very best and most enduring guide for community and social infrastructure.

The Hong Kong experience is not unusual in Asia. Characteristics such as low inflation, low unemployment, modest government debt, minimal unfunded benefits and entitlements, and significant growth are powering a whole range of emerging markets and developing an Asian middle class that will grow to some two and a half billion people by 20307.

The sense of government entitlement in these countries is low. You get what you work for. Your tax payments are not excessive and there is an enormous incentive to work harder and earn more if you want to.

By western standards this highly constrained public safety net may, at times, seem brutal. But it works and it is financially sustainable.

Contrast this with what we find in Europe, the UK and the USA.

All of them have enormous entitlement systems spanning education, health, income support, retirement benefits, unemployment benefits and so on. Some countries are more generous than others and in many instances the recipients of the largest amount of unfunded entitlements are former employees of the Government.

In all these areas people are enjoying benefits which are not paid for by them, but paid for by someone else – either the taxes of those who are working and producing income, or future generations who are going to be left to pay the debt used to pay for these services.

Despite tax rates much higher than in Hong Kong, government revenue in these economies still falls well short of meeting current government spending initiatives.

The difference is made up by the public sector borrowing money. And more often than not we are borrowing money from people such as the citizens of Hong Kong.

You would have to say that this is a flawed formula. For western democracies the party is over.

Our most deeply exposed western economies can no longer continue to accumulate debt without constraint. The ongoing credit crisis in Europe seems a very long way from resolution. Ultimately, spending on entitlements becomes a structural problem for fiscal policy.

In the United States for example, the excess of government expenditure over receipts is enormous. The Government has $15 trillion of Federal gross debt and it’s going up by $1.5 trillion a year because expenditure is $6.2 trillion a year and receipts $4.8 trillion8. Obviously with interest rates at near zero levels the cost of debt is limited but sooner or later it must end in tears.

So why is it that western nations are so deeply indebted and so tragically unfunded when it comes to meeting their future obligations in the face of an ageing demographic and longer life expectancies?

Both sides of the western political spectrum are to blame.

As the electoral pendulum has swung between socialist and conservative sides of politics, the socialist governments, often winning electoral success thanks to the funding from unions, have created a huge array of entitlements for selected classes of individuals, particularly and ironically employees of government and members of unions.

These entitlements have now begun to hang like a millstone around the neck of governments, mortgaging the economic future of many Western nations and their enterprises for generations to come.

I will give you a classic example. In Boston USA, there’s a certain former police captain who retired aged 55 some 20 years ago after a 32 year career on the force. During that period he managed to contribute some $73,000 to his defined benefit pension plan, a plan which gives you a percentage of your salary for life when you retire. On retirement he started receiving 100% of his retirement salary, namely $55,000.

He is now 75, which means he has collected some $1.1 million in benefits. And it looks like he’ll live until he’s at least 90 or even older, so that’s almost another $1.0 million over 15 years. It’s more than he earned in 32 years and he contributed just $73,000 to help pay for it. Either taxpayers pay the bill or the government has to borrow to pay for the entitlement.

When the electoral pendulum swings, conservative governments have come in promising to fix the problem but in most instances have just trimmed around the edges without addressing the real problem of the growing entitlement burden.

And the greatest Catch 22 of modern democratic politics is that socialist governments are blindly wedded to increases in expenditure while conservative governments are blindly wedded to not increasing taxes. So once the cycle of economic growth comes to its inevitable end, the problem is exacerbated.

Perhaps the real problem is the exuberant excesses of politicians who do not seem to understand or care about the fact that like a household, a nation needs to balance its budget over time and needs to make sure it can cover its future commitments.

This has already reached dangerous levels with some OECD countries like France spending close to 30% of their GDP on public social expenditure.

Other countries get by with much less. Korea only spends 10% of GDP on public social expenditure with Australia at 16% of GDP, the USA at 20% and the United Kingdom at 23%.9

The bottom line is that our communities need to make a tough decision. We cannot choose both higher entitlements and lower taxes. We must make a decision one way or the other. We can take more and more of our citizen’s money and spend it for them, or we can take less of it and rationalise government services.

But it is a decision that must be made …and soon.

This challenge is compounding in scale as an ageing population in many industrialised countries is making even further demands on the entitlement system.

Europe for example, has the highest proportion of over 60s of any region in the world. And while 22% of the population in Europe is currently over 60, this number is forecast to rise to 35% by 2050.

Plans for the future of Europe have assumed strong economic growth, but it is highly uncertain how growth will be achieved as the fiscal burden associated with rising health and aged care costs, as well as a generous pension scheme, continues to grow.

According to a study commissioned by the European Central Bank10, 19 EU countries had almost 30 trillion Euros of unfunded entitlement obligations for their existing populations. Of this 30 trillion Euros, France has liabilities of 6.7 trillion and Germany 7.6 trillion.

These liabilities will continue to grow without significant reform. And, by the way, I don’t see how a debate in France about lowering the retirement age from 62 to 60 will help address these challenges.

A lower level of entitlement means countries are free to allow business and individuals to be successful. It reduces taxation, meaning individuals spend less of their time working for the state, and more of their time working for themselves and their family.

An economy that impedes individual ambition - whether through higher taxation, the lack of opportunity in employment, or restricted social mobility - is one that enforces the barriers of class, rather than reduces them.

Governments should ensure that the actions they take will leave their citizens better off because, naturally, that will reduce the desire for ‘entitlements’. The role of government must be to help people to the starting line, while accepting that some will then run faster than others.

Everyone should know that they grow up in a country where it is possible, through hard work and diligence, to achieve their dreams.

Naturally the Americans call this the American Dream, but it is similarly played out across the globe, including in emerging economies in Asia.

The Australian Experience

As the child of a father who came to Australia in 1948 as a refugee from Palestine and built himself into a successful businessman, I know that being successful in Australia is not the product of belonging to rich and prosperous families, but rather is the result of hard work and diligence.

In fact those stories are most often repeated in countries without extreme interventionist governments. For example, over 80 per cent of the millionaires in the United States are the first generation in their family to be millionaires.

But Australia has had its fair share of irresponsible governments. In 1996 the incoming conservative government inherited a budget in a weakened state. The previous Labor administration had racked up a succession of budget deficits and $96bn of net debt, about 17% of GDP. (I know that figure is not large by the current experience of most countries in Europe, but trust me, the repayment task was a challenge.)

It took nine years of budget surpluses and asset sales to repay the debt. That is three election cycles in Australia.

It took another two years of hard fiscal rectitude to build up a stock of net assets equivalent to 4% of GDP. In total that is a long period of sustained fiscal austerity.

Australia has not completely avoided the problems of other western democracies because it still has a lot of spending by government which many voters see as their entitlement.

However, over the years there have been a number of key decisions to reduce spending to manageable levels.

Australia has sought to reduce the burden on government of providing aged pensions through a compulsory system of savings for retirement. Retirees must rely first on the benefits they have accumulated rather than on government income support. And retirement benefits to government employees and politicians are no longer provided on a defined benefit basis but on a contributions basis so they only get back the principal and earnings on what they have put in.

The government is also gradually raising the age at which government benefits can be accessed, from 60 to 67 for women and from 65 to 67 for men from 1 July 2023.

Most importantly, the net government assets of $45 billion arduously built up by the previous conservative government were set aside into a Future Fund. The funds cannot be touched by the government for everyday expenditure. Rather, the fund can only be accessed to pay for the previously unfunded entitlements of federal public servants so as to reduce the burden on taxpayers.

That was an initiative of great foresight. It is, if you like, Australia’s sovereign wealth fund with the explicit purpose of boosting the sustainability of the budget through time.

The Road Back

So where do we go from here?

There is really only one solution in the long term, and that is for countries to live within their means.

We must rebuild fiscal discipline. Budget surpluses must be restored, ideally until the debt is repaid.

This can only be achieved by cutting spending or by raising taxes. And given the general acceptance that the increased drag from higher taxes would compromise economic growth, the clear mandate is to lower expenditure.

This is lovely rhetoric but to actually do it needs some very harsh political and social decisions.

To be bold, I have some suggestions.

The first is that people need to work longer before they access retirement benefits. When the age pension was introduced in Australia at age 65, life expectancy was 55. Today life expectancy is in the 80’s.

So you can understand how I was shocked to hear that one of the policy promises of one of the main French Presidential Election candidates, Fran├žois Hollande, is to bring the official retirement age back down to 60 from 62.

Second, there have to be universal compulsory retirement schemes into which employees and employers must contribute so that after a man or woman has worked for 40 or more years they have set aside an amount that can provide them with a reasonable income for a further 15-20 years at least.

Defined benefit schemes need to be phased out worldwide, including in Australia, whether they are for public servants or private sector employees. In addition, all government funded pensions and other such payments must be means tested so that people who do not need them do not get them.

Third, there needs to be clear thinking about which services should be provided by governments and whether government funded services should be entirely free or have some affordable co payment. Many will argue that certain government services should be free and universal but the problem with any free good is that it will be overconsumed and underappreciated.

For example, in Australia, health services are partly funded through compulsory levies, paid either to the government or to private health insurers.

Across the Western world we have saddled our nations and our children with a debt burden that is simply unsustainable. It is time for strong political and economic leadership to clean up this mess properly, not with a series of band aids and political spin but with genuine economic and social reform.

The age of unlimited and unfunded entitlement to government services and income support is over. It’s as over in Greece as it is in Italy, in Spain, and in the USA.

There also needs to be a rethinking of government borrowing. Some might argue that some low level of debt is not a bad thing. I believe that is a dangerous proposition. Once some level of debt is accepted it becomes too tempting to opt for just a little more. Pretty soon a little debt becomes a big problem.

Also, there is a significant cost to servicing debt. Even in Australia, where net debt as a percentage of GDP is lower than in Europe, interest costs on net debt are approaching $7 billion a year. That is enough to build 7 new teaching hospitals every year.

The message is that every dollar of debt has an opportunity cost.

Another aspect of the problem is that credit is no longer easily accessible for the private sector or the public sector.

And the credit market no longer automatically favours the public sector. Ironically more and more sovereigns are seen as a greater credit risk than many international companies. I would think the experience of the past few years has been something of a reality check. Lenders now know that even today advanced western economies can default on their debts.

In today’s global financial system it is the financial markets, both domestic and international, which impose fiscal discipline on countries. A country which is viewed as approaching its safe limit for debt will find it increasingly difficult to borrow additional funds at an affordable rate. Eventually the capital markets will close.

We are now in an era where lenders are much more wary about credit risk. I view this as a healthy development.

Lenders have a more active role to play in policing public policy and ensuring that countries do not exceed their capacity to service and repay debt.

This is playing out most dramatically in Europe where the European Commission and the European Central Bank are either directly or indirectly heavily influencing public policy in Greece, Italy, Spain and Portugal to name a few.

It is also worth noting that the system of regulation of banks and other deposit taking institutions is artificially boosting demand for sovereign credits with mandated liquidity requirements generally emphasising a prominent role for government securities.

Governments have been too prepared to exploit the resultant lower borrowing costs.

And whilst securities issued by sovereigns have traditionally been viewed as the safest and most liquid assets, I am not sure that it is still the view of investors in Europe today.

Concluding Comments

The road back to fiscal sustainability will not be easy.

It will involve reducing the provision of so called “free” government services to those who feel they are entitled to receive them.

It will involve reducing government spending to be lower than government revenue for a long time.

It is likely to result in a lowering of the standard of living for whole societies as they learn to live within their means.

The political challenge will be to convince the electorate of the need for fiscal pain and to ensure that the burden is equally shared.

Already in the UK and parts of Europe we have seen the social unrest that can result when fiscal austerity bites.

But the alternative is unthinkable.

The Western world cannot continue on its current path of borrowing to fund its excessive lifestyle. The problem of fiscal sustainability will only get worse.

Eventually lenders will cry enough is enough and turn off the credit tap. And when that happens the economic, financial, social and political dislocations are likely to be catastrophic.

The Western world is at the most important economic cross road in its history - Governments must accept their responsibilities to fiscal discipline and the prudent use of their citizens hard earned monies, or they need to accept that the demise of western economies will be forced upon them in a dramatic, unpredictable and possibly violent way.

Adam Smith’s free hand is perfectly capable of forming a fist to punish nations who ignore the fundamental rules. Unfortunately I think Adam’s down at the gym right now and in training for one almighty whack.

Restoring fiscal credibility will be hard. But it is essential we learn to live within our means.

The Age of Entitlement should never have been allowed to become a fiscal nightmare. But now that it has, Governments around the world must reign in their excesses and learn to live within their means. All of our futures depend on it.

[1] Speech to the Institute of Socio Economic Studies “Let Our Children Grow Tall” September 15, 1975

[2] World Bank

[3] February 2012

[4] ibid

[5] GDP year to Q3 2011

[6]Gross debt of 33.8% GDP in 2011, IMF World Economic Outlook Database, September 2011

[7] Can the Asian Middle Class Come of Age?, Homi Kharas, The Brookings Institution, 12 June 2011

[8] IMF, World Economic Outlook, September 2011

[9] OECD Social Expenditure Database, estimates for 2012

[10] Pension obligations of government employer pension schemes and social security pension schemes established in EU countries, Final Report, European Central Bank, January 2009


TIM Colebatch forgets to mention that Joe Hockey voted against means testing the private health insurance rebate, which will stop workers on low incomes subsidising the health insurance of wealthy people. He doesn't mention Mr Hockey's Rolls-Royce paid parental leave scheme that provides massively higher benefits for wealthy Australians than it does for Australians on average incomes. Nor does he mention that Mr Hockey will jack up tax rates for companies and small businesses, while giving a huge tax break to people like Clive Palmer and Gina Rinehart. Further, it was very strange there was no criticism of Mr Hockey's calls for massive cuts to spending on the social safety net.

Treasurer Wayne Swan, Canberra, ACT


Saturday, April 21, 2012

The aged care package explained

HOW can a government that has locked itself in a fiscal straitjacket conjure up $3.7 billion of new funding for aged care? Simple: it hasn't.

Strip away the spin, and you find that in budget terms, there is just $285 million of new funding over the next four years.

That's no bad thing, if it means the $14 billion a year the government spends on aged care will be spent more efficiently, or better targeted to meet the most urgent needs.

These reforms will increase funding to allow older Australians to be cared for at home, to meet the real costs of dementia, and to pay aged-care workers a decent wage.

Importantly, they end the tenuous distinction between high-care and low-care places between hostels and nursing homes, in the old lingo and offer a choice of payment options that appears fair to patients and providers alike.

But this will be paid for mostly by redirecting money from existing programs. Canberra will pay nursing homes more for each aged-care patient, but cut the planned growth in nursing home beds. It will make better-off patients pay more, and make taxpayers put in a bit more.

The new programs will cost $2.2 billion over four years, most of it after the main changes take effect in July 2014. To make it sound bigger, Julia Gillard added a fifth year of spending ($1.5 billion in 2016-17), but that will not be in the budget.

Roughly 75 per cent would be paid for by taking money from existing programs for nursing homes, home care, aged care advice, etc. Some of that will be redirected to new programs, some to old ones in new wrappers.

Most of it would come from one saving: $1.1 billion over four years from "refining" the Aged Care Funding Instrument, the system of 65 classifications that determines how much nursing homes are paid for each patient.

Audits have found that some homes are overcharging taxpayers by classifying patients as more disabled than they are. It is unclear how widespread this practice is or how the government would change the rules, or, as Anglicare's executive director Kasy Chambers warned, whether it can save so much.

Of the rest, $257 million will come from tighter means tests on funding for residents in home care or residential care.

Those with incomes and/or assets above the threshold for the full pension will pay fees on a sliding scale up to maximums of $10,000 a year for home care and $25,000 a year for residential care.


Friday, April 20, 2012

Melbourne's unemployment rate 6.2 per cent

MELBOURNE and Tasmania are taking the brunt of rising unemployment. Melbourne's raw unemployment rate has shot up from 4.5 per cent to 6.2 per cent in a year.

Bureau of Statistics figures show Melbourne suffered most of the sharp rise in Victoria's unemployment in the year to March. It does not publish seasonally adjusted figures for cities, but if it did, Melbourne's seasonally adjusted unemployment would have risen from 4.1 per cent to 5.8 per cent.

Only Tasmania took a bigger hit. Even using quarterly averages to smooth out the volatile monthly data, its unemployment rate climbed from 6.2 per cent to 7.4 per cent. The National Australia Bank survey found business conditions in Tasmania are by far the worst in the country.

Regional Victoria also took a hit in the past year, but only half as severe as Melbourne. Unemployment rose a bit in Sydney, but no other big city went backwards, and unemployment fell sharply in regional Western Australia, to be just 2.4 per cent in the outback, mining's home.

Australia's economy is likely to get increasingly bipolar over the next year, as federal and state budget cuts and the high dollar hurt the south-east, while the mining states are propelled ahead by the mining boom.

New figures show seasonally adjusted imports shot up 11 per cent in March, almost entirely in oil and machinery. Nearly all the growth in imports in the past year was in WA, where imports almost doubled, whereas imports into Victoria fell.

The NAB's quarterly business survey tells a similar story. Confidence and activity are running high in the west, but spluttering along in most states, and falling fast in Tasmania.

Nationwide, slightly more companies predict good times than bad times for the June quarter with a firmer balance predicting good times over the next year. Trading and profits are expected to improve, though with little growth in jobs.

But NAB points out that companies expected similar gains in the March quarter, yet ended up disappointed. The survey findings suggest that job growth in the next year, as in the past year, will be mostly in WA and Queensland.

Manufacturing is the most depressed sector. Half the mining companies surveyed expect to lift employment in the current quarter, and none plan to cut jobs. But only 10 per cent of manufacturers plan to increase hiring, while 29 per cent are planning job cuts.

Manufacturing plants are working at only 75 per cent of capacity, and 43 per cent of manufacturers say profits are poor.


Thursday, April 19, 2012

Memo Australians: The IMF dos not agree with you

THE International Monetary Fund has set Australia a challenge. If it is right, in 2012 we will experience the third-fastest economic growth of the 34 rich countries.

This will be at the same time as a fiscal tightening 2? times more severe than in Europe, and a sharp fall in our export prices. If we achieve that, it will be heroic, not to say improbable.

Essentially, the IMF has backed Treasury's forecasts - Australia has a history of getting upset if it doesn't - but the absence of any commentary on Australia in the 400 pages of reports released this week is hardly a ringing endorsement.

It predicts that Australia will grow by 3 per cent this year, and 3.5 per cent next year and thereafter. Inflation will stay within the Reserve Bank's target band.

Prices for coal and iron ore, our two biggest exports, will plunge 25 per cent over 2012 and 2013, sending our current account deficit back up again.

The IMF does not say Australia "will outperform every other major advanced economy in the world", as Julia Gillard and Wayne Swan wrongly claimed yesterday.

The IMF does not endorse Australia's bipartisan policy of pushing the budget into surplus in 2012-13, regardless of the effect of growth.

It implies the opposite: its board of directors and its chief economist, Olivier Blanchard, urge low-debt countries (such as Australia) to "reconsider the pace of consolidation" and rely on "automatic stabilisers" growth-lifting revenues and cutting welfare bills to "reduce deficits over time".

Two key points. The IMF's forecasts are just forecasts. Two years ago, it forecast Australia to grow 3.5 per cent in 2011. A year ago, it cut that to 3 per cent.

The real outcome, as Tony Abbott notes, was growth of just 2 per cent. Its forecasts rarely differ significantly from Treasury's: it doesn't work that way.

What matters in the IMF's World Economic Outlook is not what it says about Australia but what it says about the world. And that is very true this time.

For the world economy, it is hopeful, but not confident. It forecasts growth to be a subdued 3.5 per cent this year, rising to 4 per cent in 2013. But Blanchard depicts the global scene as "uneasy calm: one has the feeling that at any moment things could get very bad again".

The IMF sees three main risks. The biggest is Europe's fragile repair job last December. While the progress is encouraging, it says, the problems remain unsolved, and excessive fiscal tightening risks another collapse, potentially breaking the eurozone apart. If that happens, it warns, the financial cataclysm could make 2008 look good.

Second, an attack on Iran might blow global oil prices sky-high, taking the "fragile" recovery with them.

And third, to fix their balance sheets, Europe's stressed banks might impose a credit crunch that would send a shockwave around the world even here.

Blanchard says the top priority is "to durably increase growth and decrease unemployment" in advanced economies.

"We think that wherever it is possible, automatic stabilisers should be left to play," he said. "This is a remark about Spain, and other countries as well."

Are you listening, Treasurer? Prime Minister? Opposition Leader?


Tuesday, April 17, 2012

Construction costs too high to build things

FOR me, the penny dropped in the 2010 state election campaign. John Brumby pledged to replace the level crossing at St Albans with an underpass. Treasury put the cost at $165 million - for one underpass.

Melbourne has 175 level crossings. Most are on main roads. Andrew McLeod, former CEO of the Committee for Melbourne, warned that unless they go underground, the inevitable expansion of peak-hour train services in future will shut down those roads in peak hours. And 175 times $165 million is almost $30 billion.

Melbourne's population has doubled in the past 50 years, and is on track to double again in the next 50. To house it, we will need to build more than a million new dwellings. If they are to be, as the Grattan Institute puts it, ''the housing we'd choose'', most will be apartments, units and semi-detached homes in existing suburbs. We will build up.

If such a city is to be liveable, it will need to build a metro. It will need new freeways, wider roads and new infrastructure of all kinds. We will have to build, build, build.

But how can we build all this if it costs $165 million to replace one level crossing? Our construction costs, according to the Business Council of Australia, are now 40 per cent higher than those in the US, let alone in Asia. Construction costs in the past decade grew twice as fast as inflation.

Folks, we have a big problem. As Premier Ted Baillieu put it last week: ''Escalating construction costs are pricing us out of infrastructure.''

We pay for the infrastructure. We suffer if the housing we'd choose is unaffordable, or is not built because it would cost more than buyers can afford to pay, or if the infrastructure we need is not built because it costs too much.

We suffer if building costs are out of control. That is why we should welcome the Baillieu government's moves to try to bring them under control.

Two weeks ago, it introduced a construction code for state projects, aimed at achieving ''behavioural change on Victorian building sites'', and stamping out the union rorts that made the Wonthaggi desal plant a $700 million loser for its builders.

The code requires builders with state contracts to enforce the law on right of entry and freedom of association, and ban strike pay and over-award payments. Nigel Hadgkiss, former deputy head of the Australian Building and Construction Commission (ABCC), will head a team enforcing it.

Last week, Baillieu got Julia Gillard to agree to a Productivity Commission inquiry into why Australia's construction costs are so high. Former ACTU president Martin Ferguson, now Minister for Resources and Energy, recently voiced alarm over Australia's declining construction productivity and ''significant cost increases'', including a 24 per cent slump in productivity at one firm.

No one pretends that there is only one problem to fix. But one problem must be fixed if infrastructure and medium-rise housing are to be affordable.

The culture of Victorian building sites must become productive - and not, as at Wonthaggi, one of extorting wages and perks that are out of line with those of the workers who pay the bill.

Construction consultants Napier and Blakeley report that on building sites general labourers cost $75 an hour - including overheads - and high-value tradesmen $85 an hour. They work 36-hour weeks, receive 26 rostered days off on top of normal leave, and when it's wet or hot, they walk off on full pay. And they've just won a pay rise of 27 per cent over four years - with no trade-off to lift productivity.

Why do builders give in? John Lloyd, former head of the ABCC, now with the Institute of Public Affairs, says it's partly the nature of the industry, and partly that some builders hope that it will secure workplace harmony - often in vain.

''Contractors bear the risk and face the penalties if a project goes over schedule,'' Lloyd says. ''They operate on small margins, so they become vulnerable to industrial action and delays.'' In the short term, it's in their interests to give in.

What sort of industrial action? Industry sources say it includes go-slows, raising phoney concerns about safety, interrupting concrete pours, even sabotage. Once a contractor has been burnt by these tactics, the hint of a repeat can induce compliance.

Developers say the ABCC, set up by the Howard government with sweeping powers, brought countervailing power to building sites. ''The unions pulled their heads in,'' says one. ''And since they faced heavy penalties, contractors became more frightened of the ABCC than of the unions.''

But Gillard is replacing the commission as watchdog with what Master Builders chief Brian Welch calls ''a chihuahua brigade'' from Fair Work Australia, with neutered powers.

The state ALP's industrial relations spokesman, Tim Pallas, says he is not convinced there is a problem with the culture on building sites, and if there were, it should be dealt with by an industry roundtable to try to win consensus.

But there is no consensus. Lloyd says the solution is to keep a cop on the beat for 15 years, until union leaders accept that the old ways won't work. This will be a long war.


Saturday, April 14, 2012

A budget surplus Swan won't wear

THE OECD has told Wayne Swan how to get his budget back into surplus. Indeed, it has told him how he could run a $100 billion surplus if he wants one. But there's a catch most of its suggestions would be political dynamite.

They include scrapping tax breaks for superannuation and for owner-occupied housing. An emissions trading scheme with a target of a 20 per cent cut from 1990 levels and no compensation. A GST imposed on food, healthcare and financial services.

But in a new report to its 35 member countries, Fiscal Consolidation: how much, how fast, and by what means?, the IMF does not call on Mr Swan to do any of this in 2012-13. It says fiscal tightening must take account of economic growth in "a consolidation strategy that could be implemented flexibly, capable of adjusting the speed and intensity as new information becomes available".

International Monetary Fund chief Christine Lagarde gave the same advice overnight in a speech in Washington, urging countries that "have the flexibility to reconsider the pace of deficit reduction this year, to limit the harm to growth.

"We need more confidence and demand," Ms Lagarde said. "The immediate focus of policies must therefore be to support growth where it is still weak.

"Let me be clear: in many countries, especially in the advanced economies, fiscal adjustment is essential. But the pace of adjustment matters."

The OECD report finds Australia has the lowest government debt of any of the 28 rich countries studied. Gross debt is a bit over 20 per cent of GDP here, compared with almost 100 per cent in the United States and more than 200 per cent in Japan.

The main thrust of the OECD report is to warn countries to adopt medium to long-term plans to get their debt back below 50 per cent of GDP, to give them the flexibility to handle crises at the same time as dealing with the costs of ageing populations.

Even Australia, it warns, will need to tighten its budget to cope with the healthcare, aged care and pension costs as its population ages. An IMF report earlier this week reported that the life expectancy of 60-year-olds in Australia is increasing at the rate of nine years every half-century.

The IMF suggests six reforms it estimates could improve federal and state budget bottom lines by 8.9 per cent of GDP, or roughly $138 billion a year. But few appear politically feasible. They include:

Cut the greenhouse gas emissions target to 20 per cent below 1990 levels, driving up emissions permit prices, with no compensation (saving: $65 billion a year).

Scrap tax breaks for superannuation and owner-occupied housing ($42 billion).

Extend the GST to food, healthcare and financial services ($9 billion).

Tighten eligibility for family benefits ($8 billion), and find savings in healthcare ($8 billion) and schools ($6 billion).


WTO tips growth to struggle

IN ANOTHER sign that the world is in for a rough year, the World Trade Organisation estimates that exports globally will grow just 3.7 per cent in 2012 barely a third of their long-term average growth rate.

WTO director-general Pascal Lamy said the WTO has also cut its preliminary estimate of export growth in 2011 from 5.8 per cent to 5 per cent, and expressed concern at "a steady trickle of restrictive trade measures" being adopted.

"The world economy and trade remain fragile. The downside risks remain high," Mr Lamy said. "We are not yet out of the woods."

China's growth slowdown follows a similar development in India, now Australia's fourth-biggest export market. Official estimates put India's growth in the year to March at 6.9 per cent, the lowest in three years.

New figures show India's industrial production grew just 4.1 per cent in the year to February, amid weakening export demand and rising interest rates. As in China, India's central bank is expected to cut interest rates to revive growth.


Gillard caves to states. Green tape deal

JULIA Gillard has given some ground to win agreement from the premiers to cut green tape, specifying when Canberra will intervene in approvals rather than leave a broad definition of "high risk" projects.

The agreement to streamline approvals for economic developments in environmentally sensitive locations came at a Council of Australian Governments meeting in Canberra, which despite opening with hostility and political posturing, ticked off a skills package worth $1.75 billion and a national partnership on mental health.

Yesterday's COAG also included the vindication of a 15-month campaign for an inquiry into soaring construction costs by Victorian Premier Ted Baillieu.

COAG asked the heads of federal and state treasuries to report in a month with an analysis of the issue, with a view to possibly referring it to the Productivity Commission. "Reality has prevailed," Mr Baillieu told The Saturday Age. "Momentum is building now. The Business Council produced estimates yesterday that the costs of construction are 40 per cent higher in Australia than in the US. Our paper estimated that they have escalated at twice the rate of inflation over the past 10 years.

"Escalating construction costs are pricing us out of infrastructure. When a grade separation is costing $250 million to $300 million, then it's a huge cost. We've got to get to all the factors that have gone into these escalating costs."

Victoria is, however, continuing to hold out against a national system of occupational health and safety laws viewing the proposal as harmful to business. Going into the talks, the Queensland and New South Wales premiers were threatening to scuttle Julia Gillard's proposal, endorsed by business leaders, for less cumbersome environmental approvals.

But despite the fighting words including a demand from Campbell Newman to approve developments in Queensland's World Heritage areas they agreed after a relatively minor concession from Ms Gillard.

Thursday's proposal gave Canberra final approvals for developments in World Heritage areas and "high risk" projects. Yesterday's amended proposal said the Commonwealth would approve in World Heritage areas, and all "nuclear actions, defence development, and developments affecting Commonwealth waters".

COAG discussed Canberra's proposal for a national disability insurance scheme and the premiers also emerged with a specific time frame for the release of a report on the future carve-up of GST revenues.

The meeting agreed the document would be released before the May 8 budget.


Friday, April 13, 2012

In the jobs zig-zag, the zigs are getting bigger

AN UNEXPECTEDLY large rebound in jobs has helped NSW reach a record level of employment in March, and cut the headline unemployment rate below 5 per cent for the first time in a year.
In another sign that the state is moving on from its sluggishness over the past decade, seasonally adjusted employment rose for the third month in a row in March, and has now retraced all its 2011 losses.

Seasonally adjusted employment climbed 19,100, mostly in part-time jobs, but with a net 7800 gain in full-time jobs. Unemployment dived from 5.1 per cent to 4.8 per cent.

The Australian dollar soared almost a cent yesterday, and financial markets became less certain about another interest rate cut after the seasonally adjusted figures nationally traced a spectacular zag to last month's zig, with a gain of 44,000 jobs.

It was the fourth month in a row that the figures followed a zigzag pattern, falling and rebounding. But the rebounds have been bigger than the falls, and in March, seasonally adjusted employment climbed to a record of just under 11.5 million Australians in work.

Unemployment remained at 5.2 per cent, with thousands of people coming off the sidelines to look for work. Over the past year, most of the growth in the adult population has been among people who are neither employed nor unemployed, just not looking for work.

But economists pointed out the zigzag pattern of recent months suggests the figures could give a misleading impression, with no certainty that the rise in March will be sustained.

The Bureau of Statistics points to its trend figures, which smooth out the zigs and zags. They show slow growth in employment, with just 25,000 jobs added in the past six months, enough to employ only a fraction of the 118,500 growth in the working age population.

The rebound in NSW is sustained on the trend measure. Even after taking out zigs and zags, the state has added 25,000 full-time jobs in the past six months. While total employment grew just 6000, unemployment fell from 5.4 per cent to 5 per cent.

Western Australia remains the jobs dynamo, after a year in which the amount spent on mining investment climbed more than the entire growth in gross domestic product. In the past six months, the trend figures estimate Western Australia has added 31,000 jobs, while Victoria has lost 23,500.

NSW has now overtaken Victoria as the best-performing state in the south-east, with the first buds of a housing recovery, new mining investment and exports, and solid consumer spending insulating it from the slump in the rest of the south-east.

The state Treasurer, Mike Baird, gave the figures a cautious welcome. "While the current environment is an ongoing challenge ... it's pleasing to see that total employment rose 19,100," he said. "This puts us second to Western Australia in jobs growth.

"However, significant economic uncertainty remains, and we expect that this will put further pressure on jobs over the coming year."


Jobs. Bad for Victoria, better elsewhere

VICTORIA'S economic slump has touched a new low, with seasonally adjusted unemployment rising to 5.8 per cent, its highest level for two-and-a-half years, despite a rebound in jobs.
With the state's industries punished by the high dollar, the Bureau of Statistics estimates that in seasonally adjusted terms, Victoria has lost 50,000 full-time jobs in the past year.

Unemployment soared from 4.4 per cent in March, 2011 to 5.8 per cent now. Victoria now has the highest unemployment rate on the mainland; a year ago it was the second lowest behind Western Australia. The high dollar is stripping back its manufacturing, tourism, export and education sectors, while high interest rates have subdued housing activity and consumer spending.

But the pain could get worse, after an unexpectedly large rebound in employment nationally. The Australian dollar soared almost a cent after yesterday's figures came out, as financial markets abandoned their earlier certainty about another interest rate cut.

The seasonally adjusted figures nationally showed a spectacular zag after last month's zig, adding 44,000 jobs. It was the fourth month in a row that the figures have followed a zigzag pattern: falling, rebounding.

But the rebounds have been bigger than the falls, and in March, seasonally adjusted employment climbed to a new record of just under 11.5 million people in work. Unemployment remained at 5.2 per cent.

State Treasurer Kim Wells said the rise in unemployment was "disappointing", but pointed out that seasonally adjusted jobs in Victoria grew by 11,000 in March, wiping out the fall in February. He said the rise in unemployment in Victoria would not deter the government from delivering a surplus of at least $100 million.

"We are committed to our fiscal targets and our economic objects," Mr Wells said.

He also confirmed the government will announce new infrastructure spending in the budget. He gave no details, but said a freeway linking the western suburbs with EastLink was the government's top priority.

Opposition Leader Daniel Andrews called on Premier Ted Baillieu to develop a plan to keep people in work. "These are not numbers," Mr Andrews said. "These are families. These are workers who have lost their jobs."

Australian Industry Group Victorian director Tim Piper suggested the state government consider abandoning its pledge to deliver a budget surplus of at least $100 million.

Mr Piper said unemployment in NSW is now 4.8 per cent, a full percentage point lower than in Victoria. "Something needs to be done to stimulate investment in the community, create confidence and to make companies feel like they can be generating some new business," he said.

The data excited the markets. The dollar soared 0.85? in five hours, to $US1.0391 at the close of local trading. The S&P/ASX200 index rose 34 points.

But the zigzag pattern of recent months also means there is no certainty that the rise in March will be sustained. The Bureau of Statistics' preferred trend measure, which smooths out the zigs and zags, shows the nation added just 25,000 jobs in the past six months.

Western Australia added 42,300 jobs in the year to March, Victoria lost 28,200.


Thursday, April 12, 2012

We keep living longer than we think we will - IMF

LIFE expectancy of 60-year-olds in Australia is increasing at the rate of nine years every half-century, threatening to overwhelm the sustainability of pension schemes and retirement funds, the International Monetary Fund has warned.

The IMF is urging governments to lift the pension age in line with rising longevity and allow retirement funds to reduce retirees' benefits to match the income available.

In an early chapter from its latest Global Financial Stability report, to be released next week, the IMF points out that in just 20 years, life expectancy in the West, including Australia, has risen by three years more than was forecast at the time.

While this "has obvious benefits", the IMF says, it also has less obvious costs and they could be massive.

"Unexpected longevity, while clearly beneficial for individuals and society as a whole, is a financial risk for governments and defined-benefit pension providers, who will have to pay out more in social security benefits and pensions than expected," it warns.

"It may also be a financial risk to individuals, who could run out of retirement resources themselves.

"If individuals [by 2050] live three years longer than expected in line with underestimations in the past the already large costs of ageing could increase by another 50 per cent, representing an additional cost of 50 per cent of GDP in advanced economies."

In Australia, that could mean that by 2050, an average 60-year-old could expect to live into his or her 90s. Back in 1970, men that age were expected to live only to 75.

The cost of public services rises sharply with age. People over 65 occupy half the beds in public hospitals, although they form just an eighth of the population. People aged 75 to 84 visit the doctor three times more than those aged 45 to 54, and run up five times more pharmaceutical bills.

The older people are, the more likely they are to be on the pension and ultimately, in a nursing home.

Official forecasts keep underestimating actual growth in life expectancy because they assume the rapid growth in longevity will level off. But the IMF points out that in fact it never has. Medical advances such as treatments for AIDS and some cancers keep raising life expectancy, even for 80-year-olds.

With the number of retirees now growing rapidly, further rapid growth in longevity could overwhelm public and private retirement funds.

Looking at US pension funds, the IMF found that if life expectancy rises an extra three years, it would increase their liabilities by 9 per cent without a matching rise in assets, capsizing their balance sheets.

It urges governments to:

. Lift the pension age to match lifespans, putting a cap on time people spend in retirement. Australia plans to increase the pension age, but only from 65 to 67, and only after 2017.

. Give pension and retirement income funds the ability to reduce defined benefits if longevity rises faster than expected. Germany, Japan and other Western countries have already reformed their pension schemes this way.

. Introduce mechanisms to allow retirement funds to transfer their "longevity risk" to other financial institutions, as a kind of insurance.


Wednesday, April 11, 2012

Commodities outlook bleak - IMF

THE International Monetary Fund has forecast a significant fall in commodity prices over 2012-13, with a risk that an unstable global economy could drag them down even further.

Releasing two chapters from next week's World Economic Outlook, which will publish its new forecasts for global economic growth, the IMF warns that in the near term, and perhaps the long term, commodity prices are likely to slump rather than to hold to present levels.

It also dismisses the case for sovereign wealth funds to invest revenues from commodity exports, saying the money would deliver a bigger return if it were invested in physical and social infrastructure to lift future productivity.

"The weak global economic outlook suggests that commodity prices are unlikely to increase at the pace of the past decade," the IMF says. "In fact, under the baseline World Economic Outlook projections, commodity prices are forecast to decline somewhat during 2012-13. Sizeable downside risks to global growth also pose risks of further downward adjustment in commodity prices."

The IMF's January update cut its forecast of global growth in 2012 from 4 per cent to 3.3 per cent, and in 2013 from 4.5 per cent to 3.9 per cent. Its latest comments suggest next week's revised forecasts will be similar.

They come as China yesterday reported a return to trade surplus in March, largely because its annual import growth fell to just 5.3 per cent. Imports of iron ore, for which Australia is its largest supplier, fell 9.1 per cent from a year ago.

The Bureau of Statistics reported last week that Australia's earnings from mineral exports had fallen by 17.5 per cent in the past six months, from $17.3 billion in August to $14.3 billion in February.

The Reserve Bank's commodity price index also peaked in August, and was down by almost 10 per cent in March.

Unlike Australia's Treasury and the Reserve Bank, the IMF is not convinced that commodity prices will stay high. It warns that long-term prices are "even more unpredictable", and their future direction has "unusually high uncertainty". It urges governments to take "a cautious approach ... building buffers to address cyclical volatility".

Governments earning revenue windfalls from commodity exports, it says, should adopt counter-cyclical policies: stash away windfalls and increase taxes in boom years to keep the economy on an even keel, then spend the windfalls and cut taxes when the boom goes bust.

It is unimpressed by the case for sovereign wealth funds, particularly those (such as China's) that invest in foreign government bonds offering low returns. It urges governments instead to direct the revenues from commodity booms into investment at home to lift productivity.

"Changes in public investment expenditures give the strongest output effect, by raising private sector productivity (for instance, via improvements in education, health and infrastructure), and subsequently by increasing private capital, labour and corporate incomes and consumption," it says.

Another essay from the Outlook, on household debt, says that when highly-geared housing booms go bust, falling house prices explain only about 25 per cent of the consequent slump in consumer spending.

The bigger impact, the IMF says, comes from going from a period of rapidly growing household debt to one of stable or declining leverage. That is why housing busts after years of rising debt are the most severe.

Its insight helps explain why the growth in consumer spending in Australia has slowed far more than was expected.


Tuesday, April 10, 2012

The least-damaging way of achieving a surplus

DAVID Stockman had a problem. A gung-ho young Republican congressman and fiscal hawk, he had been recruited by the new president, Ronald Reagan, to be his budget director. But while he thought their goal was to cut taxes and spending and put the budget back in surplus, he discovered his boss had other ideas.

Reagan wanted to slash marginal tax rates, especially on wealthy Americans, believing this would launch a ''supply side'' avalanche of growth. But he wasn't keen on spending cuts, and nor was Congress. And to get inflation under control, Federal Reserve chief Paul Volcker had hiked interest rates to levels that would soon drive the country into recession. The budget deficit was set to explode - on Reagan's watch.

Stockman plugged the gap by employing two old friends: Rosy Scenario and the Magic Asterisk. He forecast 5 per cent growth (Rosy Scenario); that made the budget numbers look much better. And he claimed billions of dollars of savings from spending cuts to be specified later (the Magic Asterisk).

Of course, neither was real. In 1982, the US economy instead went backwards by 2 per cent. The unspecified spending cuts were never implemented. Within two years, the US budget deficit had almost trebled.

Wayne Swan must have been studying Stockman's memoir of those years, The Triumph of Politics. Swan has already introduced a mild form of the Magic Asterisk, cutting $800 million from departmental budgets next year as an ''efficiency dividend'', to be delivered by cuts to be specified later. And now he is being seen with Rosy Scenario, telling us Treasury will forecast ''growth around trend'' in 2012-13, even after the government has pulled $40 billion of budget cuts out of a weakening economy.

Trend growth used to be seen as 3.25 to 3.5 per cent a year. But it's been shrinking for a while - 3 per cent is the average over the past decade - and given that spending until the GFC was inflated by a build-up of debt, which won't be repeated, and that population and productivity growth have both fallen, 3 per cent is probably the best benchmark for the future.

The budget cuts, at face value, would take 2.6 per cent of GDP out of the economy. But you may be surprised to know that the federal government transfers more money for others (households and states) to spend than it spends itself. When those transfers are cut, or when our taxes rise, we will replace part of that by saving less and spending more ourselves. So the net impact of the cuts will be less than 2.6 per cent of GDP.

Suppose the net effect of getting the budget into surplus is to cut GDP by 1.5 per cent. For growth to still end up at 3 per cent, that implies that growth without the budget cuts would have been 4.5 per cent. That is double our present growth rate. How on earth could we get there from here?

Well, we could try to reduce the three headwinds that have reduced the non-mining economy to a standstill: the excessively high dollar, excessively high interest rates and excessively large federal and state budget cuts. In particular, we could make the budget surplus a medium-term target, instead of one to be achieved in 2012-13, however weak the economy.

Obviously, budget surpluses are good things. But the central question is: given the weak state of the non-mining economy, would Labor be budgeting for a budget surplus now if it hadn't already promised one? The answer, clearly, is no.

The most responsible course is for the government to back down. A budget surplus in 2012-13 is less important than avoiding a recession in most of Australia.

But if the government remains bent on making the budget papers its 5000-page suicide note, what is the least damaging way it could meet its target? Three goals, perhaps four, stand out:

. The main problem for the economy is the dollar, which has been pushed 50 per cent above its 1985-2005 average by high mineral prices, high interest rates and global fears about Europe. Lowering it should be the prime goal of policy.

The budget's influence is limited, but its diesel fuel tax rebate is a very large tax subsidy on the use of fuel by the mining industry. It is inconsistent with Australia's stated opposition to fuel subsidies. And Treasury arguments that we should not tax business inputs are inconsistent with the taxes it levies on workers and imported equipment, which are also business inputs.

. The budget cuts will hit mostly in the south-eastern states, where 70 per cent of Australians live and economic activity is at a standstill. Reviving activity in the south-east must be a priority. Swan has already pulled two years' funding for infrastructure projects into 2011-12, and has budgeted nothing for them in 2012-13. He should instead step up investment in projects in the south-east, such as Melbourne's regional rail link and the Western Ring Road upgrade.

. A Labor government ought to have it in its DNA to protect the most vulnerable Australians. Sadly, this one doesn't. It has allowed the unemployment benefit to sink well below the poverty line; and that is heartless, when most people on benefits are unemployed for more than a year. It should bite the bullet and spend the $600 million that welfare groups say it will cost to lift the dole for single people by $50 a week. It will all be spent, and that will stimulate activity. To pay for it, cut tax breaks and create a more level playing field.

. Last, the more phoney spending cuts the government makes, the better. Opposition finance spokesman Andrew Robb has shown that eight budget fiddles have already moved $6.2 billion of spending out of 2012-13. Well, the more of them, the better. At least they do no harm to the economy; real spending cuts will hurt.


Thursday, April 5, 2012

Memo Treasurer: We're not the toast of the G20

Treasurer Wayne Swan is out thumping his chest about Europe. First, he warns us that if we don't have a budget surplus in 2012-13, we could end up like Europe. Second, he tells us that Australia is a standout in the world economy, the envy of the world.

On Sunday, the Treas ascribed Spain's 23.6 per cent unemployment rate to lax fiscal discipline before the global financial crisis. Then yesterday, he confided that at the coming G20 meeting in Washington, ''there's not too many finance ministers ? who wouldn't trade places with Australia in a heartbeat''.

We keep hearing this, but is it true? Was Spain's collapse due to lax fiscal policy? Is Australia the country everyone else wants to be?

Take fiscal policy first. This is Swan last Sunday in his weekly economic note: ''If the events in Europe over the past 18 months teach us anything, it's the importance of budget discipline. Many governments ignored the necessary economic reforms over a long period, allowing their spending to blow out and their budgets to become unsustainable. We see the consequences of this today in the region's sovereign debt crisis.

''The failure to maintain fiscal discipline has undermined confidence and economic growth across Europe. This has led to lengthening jobless queues and unemployment rates that are two, three and even four times our own. In Spain, for instance, the jobless rate is nearly 23 per cent. Australia's continued strict budget discipline is our best defence against this uncertain global outlook.''

But hang on, Treas: did no one tell you that before the global financial crisis Spain was running even bigger budget surpluses than Peter Costello: 2 per cent of GDP in 2006, 1.9 per cent in 2007? Or that from 1996, Spanish governments of both sides more than halved its net debt: GDP ratio, from 60 per cent of GDP to 26.5 per cent?

Spain's crash was not due to a lack of budget discipline. It was brought on mostly by the collapse of a huge real estate boom, which has now turned into a savage bust.

That combined with all the factors that have sent Europe into recession: the big losses of European banks lending into US sub-prime housing and other risky markets; the contagion effects from Greece; and the vicious circle of falling asset prices, falling spending, falling employment and falling incomes and revenue, which is now becoming a vortex dragging it down towards a long depression.

Housing prices have slumped 22 per cent from their peak and are forecast to fall by 12 to 14 per cent more this year. Standard & Poor's forecasts that by Christmas, 25 per cent of Spanish home owners will have negative equity, owing more than their property is worth.

What's the lesson? Avoid booms. They tend to bust in damaging ways. But in Australia, officials are cheering on a mining investment boom, which one day will also bust, spreading its fallout all over our economy.

Spain's new conservative government plans to emulate Swan. On Tuesday it presented a budget that aims to cut the deficit next year from 8.5 per cent of GDP to 5.3 per cent.

Bloomberg reports that ministries' spending will be reduced by 17 per cent on average, with the foreign ministry cut by 54 per cent. Income tax and property tax rates have been hiked. But we saw in the 1930s that fiscal austerity in these conditions simply deepens the downturn.

Yes, there was fiscal indiscipline in Europe before the global financial crisis, but mostly by neglect. Greece was a Third World example of fraud, recklessness and incompetence, but it was unique.

IMF data shows that in 2007, of governments in 18 rich European countries, five (all in Scandinavia) were net lenders. Four, including Spain and Ireland, had brought their debt:GDP ratio to relatively low levels, between 10 and 26 per cent. (Ireland, too, was the victim of a property boom going bust.)

Eight others, ranging from Britain (38 per cent) to Italy (87 per cent), were guilty of fiscal complacency. Some stayed in deficit throughout the good years. Germany and France repeatedly breached the EU's Maastricht budgetary rules, which they themselves had written. Portugal, another crisis state, was among the offenders. And lastly, Greece was in a class of its own.

And how does Australia compare? The IMF figures show that, far from being a world leader in fiscal discipline, in 2007 our surplus ranked only 16th of the 34 rich countries as a share of GDP. Last year, we ranked 18th. That's no standout effort.

On the economic front, we are doing better than most European countries, worse than most Asian ones. Last year, our growth rate of 2.1 per cent put us just equal 13th of the 34 rich countries.

Around the G20 table, Swan will find that 13 of his 19 counterparts can boast higher growth than him. They include South Korea (3.6), Germany (3.0) and Canada (2.5), as well as all 10 developing countries.

Australia ranks better on unemployment, but even there, our 5.2 per cent rate is just the ninth best of the 34 rich countries.

Surely we lead in something? Yes: the OECD estimates our growth in unit labour costs last year was the highest in the Western world, at 5.9 per cent.

Maybe the Treasurer can wear that gold medal in Washington.


Tuesday, April 3, 2012

Budget cuts will bring on recession

The government has revealed that with growth at just 2.5 per cent, it will reject calls for tough budget cuts, raise spending in areas that need stimulus, and extend its deadline to put the budget back in surplus to 2015-16. You didn't hear that?

LAST week was budget week. The government revealed that with growth at just 2.5 per cent, it will reject calls for tough budget cuts, raise spending in areas that need stimulus, and extend its deadline to put the budget back in surplus to 2015-16.

You didn't hear that? Perhaps that's because that budget was in Canada: the country and economy most like Australia, but at the other end of the world. Facing similar problems, it has come up with a very different solution.

Canada is run by conservatives. Prime Minister Stephen Harper's government is the closest thing the world has to the Howard government. Finance Minister Jim Flaherty is a tough, no-nonsense social conservative who earned his fiscal spurs by shutting down the tax break for trusts. In his budget speech, along with familiar rhetoric - ''Canada has outperformed most other industrial countries … Our net debt to GDP remains the lowest in G7, by far'' - he anticipated the criticisms from the right for not cutting more from spending:

''We remain concerned about the number of Canadians out of work … Because of our government's responsible choices, we can eliminate the deficit through commonsense, moderate restraint. We have no need to resort to drastic cuts … We have no need to undertake radical austerity measures … The savings we have identified are moderate, less than 2 per cent of federal program spending.''

I suspect John Howard, were he still in power here, would do the same. And I suspect Tony Abbott, were he in power, would do much the same - whatever he says from opposition.

Take New Zealand: the other country most like Australia, except that its mines are forests and sheep farms. On Sunday NZ Prime Minister John Key declared he will stick to his timetable to get the budget back in surplus in 2014-15. Key, too, is from the conservative side.

Canada and New Zealand do not lack shock jocks and right-wing ideologues demanding a budget surplus ASAP. Rather, as economist Saul Eslake of Merrill Lynch Australia puts it, Labor's leaders are afraid of being seen as being another fiscally irresponsible Labor government:

''Labor craves the approval of the financial markets in a way the Liberals don't need to,'' Eslake says. ''Labor has to show that it can govern responsibly. The Liberals don't.''

It is the only plausible explanation for the tragedy we are about to experience. Next month Julia Gillard and Wayne Swan will give us a budget that will probably send most of Australia into recession.

In one year, we will go from a deficit of 2.5 per cent of GDP or more, to a surplus. By a mix of revenue rises and spending cuts, Labor will pull 2.6 per cent of GDP out of the economy. That is 2½ times the fiscal contraction imposed by the Hawke government in 1986-87, or the Howard government in 1996-97. It is the stuff recessions are made of.

Why do it? Because Labor has pinned its credibility to its pledge to deliver a budget surplus in 2012-13. The promise it made in 2009 has become a mantra, repeated 1000 times over, and to be delivered regardless of economic conditions.

In 2009, Treasury had assumed that by now the economy would be booming, and the government would pass the baton to the private sector to take Australia on. It projected economic growth in 2011-12 and 2012-13 of 4.5 per cent, each year. It projected almost 600,000 new jobs. Would the private sector be ready to take the baton? You bet.

Now 2012-13 is almost here. Growth is just 2.5 per cent, with most of that in outback mines. In south-eastern Australia, except mining areas, activity is weak. Much of the country is close to recession. Job growth has stopped. Retailing is flat, manufacturing is weak, housing in free fall. The high dollar is slowly strangling trade-exposed sectors; high interest rates are cramping the rest.

Is the private sector ready to take the baton? Into these headwinds? No way.

But it won't be that bad, we're told. Treasury points to an IMF study last year of 173 serious ''fiscal policy changes'' in Western countries in the past 35 years. The study, Expansionary Austerity: New International Evidence, found that, on average, budget savings equivalent to 1 per cent of GDP will lower GDP itself by 0.62 per cent after two years. The penalty rises with bigger savings, but more slowly, with each percentage point of extra budget savings cutting GDP by 0.5 per cent.

Assume that our budget savings will be 2.6 per cent of GDP. On the IMF average, that would cut 1.4 percentage points from GDP growth by mid-2014. If you assume that we would otherwise grow at our trend rate of 3 per cent a year, that would still give us growth of 2.3 per cent.

But no: the detail of the IMF study suggests Australia's budget cuts will intensify the divide between mining and the rest. It implies that over two years, domestic demand would shrink by 2.75 per cent. There would be gains in net exports, but the regions and sectors hurting now would hurt much more. And the IMF found the damage was twice as big when the country is seen as low risk - as Australia is. This implies that over two years, we face a loss of almost 3 per cent of GDP, and 5 to 6 per cent of domestic demand.

The study cited to play down the risks of Swan's strategy in fact shows how high they are for the non-mining states and sectors. Which is more important: keeping a promise or keeping us out of recession?

WAYNE SWAN April 4, 2012

MUCH has been said in recent days about why the government is returning the budget to surplus in 2012-13.

That's only natural and indeed it's very important we have a strong debate about our economy.

Recent opinion pieces by The Age's economics editor, Tim Colebatch, have claimed returning the budget to surplus would put the economy at risk.

Mr Colebatch is a highly respected observer of the economy and I always read his opinions with great interest, however, on this occasion he ignores some crucial facts, which help explain why delivering a surplus is such a vital economic imperative.

But first, some context. In the face of the worst global meltdown in about 80 years, the government stepped in to support demand, protect jobs and keep the doors of business open. This ensured our economy did not go into recession, virtually the only developed economy not to.

Our response to the crisis underpinned growth in our economy, which is now more than 7 per cent larger than it was pre-GFC. Not only have some advanced economies not even returned to their pre-crisis output level but some are again going backwards after contracting in the December quarter.

With solid growth, healthy public finances, low inflation and low unemployment, we are already the envy of many other advanced economies.

In a couple of weeks I'll be attending my 20th G20 meeting and I can confidently say there's not too many finance ministers around that table who wouldn't trade places with Australia in a heartbeat. Just as it was right to step in and support demand when it was needed, it is right to step back and provide space for the private sector to grow and that is what we have been doing.

Indeed, it's exactly because our economy is moving back towards trend growth that returning to surplus is the responsible course for fiscal policy.

Crucially and this is what Mr Colebatch overlooks the Treasury forecasts for growth in the next financial year already take into account that the budget will return to surplus.

Obviously, our consolidation has a dampening impact on growth but this is offset by the strengthening growth in the private sector.

In other words, the Treasury's forecasts of growth around trend are based on our announced policy setting including our commitment to return the budget to surplus.

The most constructive contribution fiscal policy can make to a patchwork economy with uneven growth across sectors is to move the budget back to surplus. When setting interest rates, the Reserve Bank takes into account all the economic influences on monetary policy, including the stance of fiscal policy.

Moving the budget back to surplus in 2012-13 also ensures we're not adding to price pressures in the economy, providing monetary policy with maximum possible flexibility to respond to economic developments.

It is Australia's best defence in these times of global economic uncertainty. When asked about the government's plan to return the budget to surplus in 2012-13, the deputy director of the IMF's research department, Jorg Decressin, said: "Where you have these strong investment plans in the pipeline, where the growth prospects are still quite good, this strikes me as appropriate."

We are now one of only eight countries to be awarded the coveted AAA status with a stable outlook by all three major credit rating agencies.

This is the first time in Australia's history this has been achieved and has been repeatedly described as partly a result of our strict fiscal policy.

It didn't happen under Howard and Costello, despite what the Liberals would like you to believe. Returning the budget to surplus also allows us to make the investments our country and our community need for the future.

In more general terms, any government must decide its policy setting on the basis of its best assessment of the state of the economy and our economic prospects.

Yes, we face challenges such as those flowing from a high dollar, but with probably the strongest economy in the developed world, I'll stand by our record and our assessments of the economy so far.

I'm an optimist about our country and I firmly believe it's a very bright outlook as we stand at the start of this Asian century, as long as we're up to the task of continuing our record of responsible economic management and embracing the vast opportunities that lie before us.