OECD wants growth rather than austerity

THE Organisation for Economic Co-operation and Development has urged Europe to shift its economic tack by adopting a growth compact , including interest rate cuts, infrastructure investment, and ultimately, the issuance of eurobonds.

In its half-yearly Economic Outlook, released overnight, the OECD cautiously throws its weight behind the snowballing demands for the European Union to reweight its economic policies to give more priority to growth rather than austerity and low inflation.

Its economic forecasts are heavily qualified, as they rest on the assumption that policy actions will be sufficient to prevent destabilising euro developments, that there will be no major disturbances affecting oil prices, and that disruptive US fiscal consolidation will be avoided .

If those assumptions are right, the OECD estimates GDP growth in 2012 will be 3.1 per cent in Australia, 2.4 per cent in the US, 2 per cent in Japan, 1.6 per cent in the rich world as a whole and -0.1 per cent in the eurozone, ranging from 1.2 per cent in Germany to -5.3 per cent in Greece.

The OECD does not challenge the EU s fiscal compact, which requires EU members to slash their bloated budget deficits to below 3 per cent of GDP by next year, other than to urge that if growth slumps, countries should abandon the targets rather than try to meet them at all costs.

But while noting that prospects for the global economy are somewhat brighter than six months ago , when markets were paralysed with fear of government debt defaults and bank failures, it warns that the risks facing the world are extensive, and primarily on the downside .

The OECD warns that the eurozone crisis is the biggest risk to the global economy and urges the EU to try radical new measures to restore confidence and growth.

In particular, it urges new issues of jointly guaranteed government bonds to refinance Europe s troubled banks, and allow them to write off bad loans. It suggests this could be a step towards the future issuance of eurobonds, which would allow Greece, Ireland, Spain, Italy and other troubled countries to borrow from global markets without prohibitive costs.

France s new President, Francois Hollande, will propose eurobonds tonight at an informal summit of EU leaders called to debate Europe s recession and the crisis of confidence surrounding its banks and government debt.

German Chancellor Angela Merkel firmly opposes any move to centralise debt issuance. Germany s 10-year bond yields have fallen to record lows, just below 1.5 per cent, with widening spreads to other EU members. Yields for French bonds are almost 3 per cent, Italy and Spain close to 6 per cent, and Greece in the 20s. For Germany, a move to eurobonds could be expensive.

An economic think tank based in Paris and financed by its 35 rich and middle-income member governments, including Australia, the OECD is a fringe player in the policy contest now being fought out all over Europe, from national leaders at summit meetings to the voters at the polling booths.

But its endorsement counts for something when new economic policies are in the wind.

Its new report does that, in suggesting that the EU s proposed growth compact includes increased mutualisation of risk by:

Issuing jointly guaranteed government bonds to help recapitalise Europe s banks and encourage them to write off bad loans.

Increasing the resources of the European Investment Bank so it can step up financing new projects in transport, energy and communications infrastructure.

Growth-friendly structural reforms, agreed jointly by a range of countries, to liberalise labour markets and product markets, particularly opening new opportunities for service industries.

An easing of monetary policy by the European Central Bank, in view of the minimal risk of an inflation breakout.

The risk of disruptive policy changes has probably increased, the OECD observes. Against the backdrop of fiscal consolidation, increased inequality, and high and rising unemployment, a sense may be spreading that the burden of the crisis has not been shared fairly.

This risks giving rise to policy upheavals with adverse long-term, and possibly near-term, effects on growth prospects.

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Markets rocked by euro chaos

INVESTORS nervous about Europe and the slowing global economy have wiped $27 billion from the value of Australian shares - as the chairman of BHP Billiton warned that the nation's mining boom was winding down.

Sharemarkets around the world quaked amid growing speculation that Greece would be forced out of the euro bloc, triggering a new bout of global financial instability. In Australia, investors pulled their money out of shares, sending the market on its biggest fall of the year.

By the end of yesterday, the benchmark ASX/S&P200 index had plunged by 101 points to 4165.50. The Australian dollar sank below 99 US cents for the first time this year.

More than $75 billion has now been stripped from the value of Australian shares this month - mostly over Europe concerns, but also because growth in China and India has slowed, easing demand for our mineral exports.

Trade figures released last week imply that imports of capital equipment shrank in the March quarter, and have barely grown in the past six months. This suggests growth in business (mostly mining) investment is slowing sharply.

Yesterday's fall began as soon as markets opened in the wake of more bad news from Greece. Negotiations to form a new government failed again, forcing a second national election.

New data showed Greece's GDP shrank by 6.2 per cent in the year to March, amid reports that European and German leaders want Greece out of the eurozone, and are ready to risk a market meltdown.

There was a brief rally when new data showed Australian wages growth remains subdued - except in Western Australia, and in mining - but the market started falling again after BHP chairman Jac Nasser said the resources cycle had turned, and that BHP would shelve some of its planned projects.

''The tailwind of high commodity prices has contributed to record growth in the sector and the country,'' Mr Nasser said in Sydney. ''Now we have a period where those tailwinds are moderating, and we expect further easing over time.

''The resources business has always been, and will always be, a cyclical business.''

Asked if BHP still planned to invest $80 billion over the next five years, he responded: ''No.''

In a politically charged speech, Mr Nasser, the Melbourne engineer who became Ford's global chief, called for a new wave of industrial relations reform, saying that in 2011 BHP faced 3200 cases of industrial action in its Queensland coal business alone.

He warned that Australia had become ''one of the higher cost countries of the world''. Its industrial relations environment was deteriorating, governments had hiked mining taxes and royalties, and investors had lost confidence in the future of the global economy.

''Those decisions have repercussions,'' Mr Nasser said. ''At BHP, our choices include in which product ? and in which country we choose to invest.

''Stable tax and appropriate industrial relations frameworks ? we will make progress if we focus on getting these two issues right.''

He censured Treasurer Wayne Swan for his attacks on mining billionaires, and urged him to create ''a stable, predictable and competitive tax framework''.

''I cannot overstate how the level of uncertainty about Australia's tax system is generating negative investor reaction,'' Mr Nasser said. ''I don't think it is good for Australia when global investors question openly whether Australia really wants a globally competitive resources industry.''

But the slide in the dollar is giving relief to thousands of Australian businesses, as it was mostly the dollar's rise that made them (and BHP) high-cost.

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Europe's economic nightmare should worry us

FOR Australia to achieve the government's 3.25 per cent growth forecast, and hence a budget surplus, the global economy will have to remain benign. That really depends on what happens in Europe and, week by week, it looks more unlikely.

Europe is far away, and unless you watch the SBS news it has an unfamiliar cast of characters and issues. But this year it will become more and more important in our lives, so it's worth watching and its scene is changing rapidly. Deficits and debt are one half of Europe's problem. Recession and unemployment are the other. The issue is: which should you tackle first?

German Chancellor Angela Merkel, outgoing French President Nicolas Sarkozy and the European Commission insisted that governments must get their fiscal house in order first, whatever the cost to jobs and growth. And so Europe's governments have locked themselves into a pact to bring their deficits below 3 per cent of GDP by 2013.

But as economists such as Martin Wolf of the Financial Times and Paul Krugman of The New York Times forecast, those austerity measures have led Europe back into recession. So deficit targets have not been met, which requires further austerity measures, which leads to still deeper recession, which . . . well, you get the hang of it.

At the centre of this dilemma is Greece. Through reckless fiscal mismanagement over decades, Greece now has gross government debt of 160 per cent of its GDP (as against 24 per cent in Australia), and an annual interest bill equivalent to almost $100 billion here.

But it is also in an economic depression: its output has fallen by almost 20 per cent, 22 per cent of its workers are unemployed, and an appalling 54 per cent of its young jobseekers.

Which should it tackle first: getting its fiscal house in order, or trying to stimulate growth to provide jobs for its people?

That is what last Sunday's Greek election was about. But in a key complication, no bank will lend to Greece any more. Its only loan sources are the European Union, the European Central Bank and the International Monetary Fund, and (against the IMF's better judgment) they have insisted Greece meet the 2013 fiscal target. Given its economic free fall, that requires it to make another ?11 billion ($A14.2 billion) of spending cuts or revenue hikes: 5 per cent of GDP.

Greece's two main parties had joined forces to try to negotiate a better deal, but failed. The elections saw their combined vote plunge from 77 per cent at the previous election to 32 per cent this time, as voters flocked to parties to the left and right who reject the deal, yet have no realistic alternative. At this stage the elections seem to have left Greece at an impasse, with no viable government, and any new election likely to end in a similar impasse.

But the story has just taken a new twist. Merkel became the most powerful person in Europe, largely because the German public supported austerity, and the opposition Social Democrats had not opposed it until now. But on Sunday, in the Ruhr valley state of North Rhine Westphalia, Germany's biggest, her Christian Democrats were hammered in a state election fought on the issue of austerity, their vote falling to just 26 per cent.

Germany has not suffered the austerity seen in Greece, Spain or Ireland. But German voters objected to council swimming pools being closed as an economy measure. The west is weary of paying endless subsidies to east Germany. And Social Democrat Premier Hannelore Kraft won a personal vote that makes her a potential challenger to Merkel at 2013's federal election.

The trend in German state elections is startling. Since the last federal election, 10 of the 16 German states have gone to the polls: the Christian Democrats have won just two states while being dumped from office in four. They and their partner, the Free Democrats, have shrunk from 515 seats to 399, compared with 590 seats won by the Social Democrats and the Greens.

The crisis in Europe has now seen governments fall in 19 of the 27 EU members, including Britain, France, Italy, Spain and the Netherlands. Tonight Francois Hollande takes office as president of France, then flies to Berlin for dinner with Merkel. Hollande has been ambivalent about whether he wants to rewrite the EU fiscal pact, or just add a growth package to it, by increasing investment. Whatever his goal, he might find Merkel more receptive now.

But even if Hollande can reconcile the contradictions of his campaign promises to meet the deficit reduction targets while increasing spending, there is no good way out for Greece. No Greek government is likely to carry out the spending cuts the European Union requires. Too bad, says European Commission President Jose Manuel Barroso, we won't change the rules for you. And if the EU keeps its hard line, there will be a new financial crisis.

Greece would run out of money to pay public servants. It would have to exit the euro, default on its debts, and bring back a cheap drachma. Markets would speculate on defaults by other countries in strife: Spain, Portugal, Ireland. IMF chief Christine Lagarde warns that this could see a slump worse than the panic of 2008.

A crisis in Europe would convulse trade and financial markets. Australia's banks could face a crisis in rolling over loans. Our dollar would sink. Investments would be put on hold. All bets would be off.

Keep your eye on Europe.

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Swan's song to be in the key of austerity

ON SUNDAY, the Greeks had their say on austerity budgets. In 2009, 78 per cent voted for Pasok (Labor) or New Democracy (Liberals). Now the two are in coalition, and on Sunday, their combined vote fell to 33 per cent. Some swing: 45 per cent.

But austerity there will be: we will find out some of that tonight, some in the days and weeks ahead. And if Labor is not already in enough electoral strife, tonight's budget is a big gamble, with the potential to put it in even deeper strife.

To put it simply, this budget aims to turn a deficit of $40 billion or so this financial year into a surplus of $1 billion or so next year at a time when, other than mining, the economy is going either sideways or down.

The government has been releasing good news before the budget, to make sure it gets noticed. But the bottom line is that in 2012-13, the government will pull more than $40 billion out of Australia's economy, either by spending less, taxing more, or both.

It doesn't have to do that. There is no pressure from markets or voters for Australia to run a budget surplus. Money is flooding in to buy government bonds. And an Essential Research poll found just 12 per cent of us want to get the budget into surplus in 2012-13.

But the government had promised before the 2010 election that the budget would be in surplus in 2012-13. At the time it thought the economy would be growing at 4 per cent by now and adding 250,000 jobs a year.

Sadly, that was another forecast that went wrong. But after Julia Gillard has taken so much flak for breaking her promise on the carbon tax, Labor decided the budget had to go into a surplus in 2012-13, whatever the economic cost.

The outgoing Greek government made a similar choice, under duress from its European partners. Greece has 24 per cent unemployment and an economy that has shrunk 20 per cent in four years. Yet the budget deal imposed by the EU requires Greece in 2013 to run a sizeable "primary" surplus that is, a surplus of revenue over all spending except interest bills.

That will require huge budget cuts. So two-thirds of Greeks voted for parties to the left and right of the big two, in protest. Since the far left and far right can't agree, the centre will probably keep governing but will demand changes to the deal.

So will France, where Socialist Francois Hollande dethroned President Nicolas Sarkozy, after campaigning to replace deficit reduction with growth as Europe's central goal. "Europe is watching us," he said. "Austerity isn't inevitable. My mission now is to give European construction a growth dimension."

It was a similar story even in Germany, Europe's success story. In the northern state of Schleswig-Holstein, Chancellor Angela Merkel's coalition was swept from power in a swing of 7.5 per cent: the third state it has lost in a year or so.

In Europe, austerity is going out. In Australia, it's coming in.

Don't worry, the Treasurer tells us: the budget forecasts that even with $40 billion taken out of the economy, we'll still grow by 3.25 per cent. Yes, but the last accurate budget forecast was in 2007. And the last time he forecast growth of 3.25 per cent, we got just 2 per cent. If that happens this time, it will mean boom in outback mines offset by recession in the south-east. That is the risk tonight.

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COLUMN: Surplus to requirements

PAUL Romer, one of the founders of what economists called new growth theory, used to pose a question which has deep implications, going well beyond economics.

Suppose all the world's stock of structures and equipment remained, Romer mused, but our knowledge of how to create them was wiped out. Then imagine a scenario B, in which all our structures and equipment were wiped out, yet our knowledge of how to build them remained. In the long term, which scenario would leave us better off?

The answer, clearly, is the second. It is the power of knowledge, of human intelligence, our ability to think, learn and create, that is the most valuable asset of any society. Far from knowledge being a limited store, as Western thinkers once assumed, Romer argued that it is virtually unlimited. What leads to growth is the ability to imagine, to think through conflicting propositions, to invent a better solution to problems than the one we inherited.

If only humans always did so. But in the real world, the innovative idea is so often dismissed as heresy. People don't think through conflicting propositions, but rely on prejudice or loyalty to a simple idea. To embrace a better understanding of complex events means discarding an old one. And often those old ideas are convenient ones for us to believe. Often they are in our financial or political interests or come from deep ideological convictions. Mere objective reasoning can find it impossible to break through.

Australia offers plenty of examples in which prejudices block our ears to better ways of doing things. But the riots in Athens over the past week, and the long standoff over how to reduce Greece's public debt, are a dramatic illustration - on an issue with huge implications for the world, and us - of how hard leaders and the public find it to accept ideas and solutions which clash with long-held, convenient prejudices.

Yesterday, Greek MPs voted 199-74 to endorse the latest austerity package negotiated last week by the leaders of the two main parties, slashing the minimum wage to ?560 (roughly $A700) a month, and making deep cuts to pensions and government spending across the board. It is forecast to cost 150,000 jobs over the next three years. That's what they were rioting about.

But the MPs' vote was just another reprieve. Even if the next Greek government implements the package in full, which many doubt, it would deepen the crisis, not solve it. The package dictated by the European Union won't work, for reasons that have been made clear repeatedly, but not accepted. The crisis will return; the worst of it could still be ahead.

On both sides, comfy old prejudices are keeping minds closed to challenging ideas, innovative thinking, and better solutions.

The rioters illustrate why the rest of Europe doesn't trust Greece any more. They symbolise the refusal of Greeks to take collective responsibility for the crisis into which Greece has thrown the Continent, and which might take a decade to resolve. Year after year, the Greek government, on a huge scale, spent money it did not have, employed people it did not need, bought votes with lavish pensions, allowed its people to dodge paying taxes, and then lied to the EU and the world about its financial position.

Even before the crisis, after a decade of boom for the Greek economy, Greece was secretly running the biggest deficit in the advanced world, equivalent to roughly $80 billion a year in Australia. If that's how you run the business in good times, then the bad times are going to be awful. And so they were. No bank would lend to Greece any more; only aid from the IMF and the EU has saved it from bankruptcy. But in the end, bankruptcy might be inevitable.

The EU has lent on the banks to write off half their debts to Greece; but led by the German government, it wants to enforce deep austerity in Greece to start paying back the other half. Unemployment in Greece is already almost 20 per cent, and would get much worse if these budget cuts are implemented; yet the Greek government would then be running a surplus on its primary balance - that is, excluding its debt payments.

I have deep admiration for Germany's economic achievements, which are little understood by politicians or economists here. But it is an illusion to think that countries can cut their way out of trouble as deep as this, unless they can devalue their currency to make them more competitive. Greece can't do that, because it's locked into the euro. Even in Britain, outside the euro zone, the Cameron government's deep spending cuts have pushed the country back into recession - and Britain started from a far better position than Greece.

Is there a better solution? Yes, and IMF managing director Christine Lagarde outlined it last month in a speech in Berlin. Her speech was all nuance, but to paraphrase: timing matters. Yes, getting budget deficits under control is critical, but so is avoiding a deep, self-perpetuating slump. Don't cut current budgets so deeply that you drive the country into recession. Rather, protect your sources of growth, and push through big, long-term reforms that will make your budgets sustainable into the future.

Her message should reverberate here in Australia. It is not getting the budget back into surplus in 2012-13 that matters; events in Europe could make that impossible. As Treasury has shown, the long-term threat to the budget is from an ageing society. We should bite the bullet on this: phase out incentives to early retirement now, and start lifting the pension age, before the baby boomers retire. Timing matters.

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Greek lesson in the perils of overspending

THE fatal riots in Athens reflect the vast gulf in how the Greek financial crisis is seen at home, and in the world. Greeks, by and large, are outraged by the cuts and reforms thrust on them by their government, the European Community and the International Monetary Fund. "It's not fair!" they insist. "Why are they doing this to us?"

To outsiders, it's all too clear. Greece has been living beyond its means for years, borrowing heavily from the rest of the world and, until recently, fudging its books to hide the reality. The financial markets no longer trust it, and will not lend to it or roll over debt, except at prohibitive prices. That's what happens when you push your luck too far.

The facts are simple. Last year, Greece ran a budget deficit equivalent to 13.5 per cent of its gross domestic product (compared with 4.1 per cent in Australia). Its gross public debt was 115 per cent of GDP (as against 16 per cent in Australia), and rising rapidly. And the banks would not lend more.

How did it get there? Take its pension system. Greeks can retire early on a lifetime pension equivalent to 80 per cent of their final salary, and indexed to match wage growth. They receive 14 months a year of pension payments, with bonuses at Christmas and Easter. The OECD estimates that some Greeks actually receive more on the pension than they did when they were working.

In Germany, which underwent bruising pension reforms in the mid-2000s and now finds itself unwillingly funding 30 per cent of the EU's bailout for Greece, top-selling tabloid Bild went to town. "Why do we have to pay Greece's luxury pensions?" its front-page headline demanded last week, alongside a photo of an elderly Greek pensioner it said was paid $A5000 a month.

Greece, it told readers, is "the land of bankrupts and luxury pensions, tax dodgers and rip-offs. It's a country where the authorities use satellites to search for houses with swimming pools, in order to send the owners a tax bill." It reported that Greeks on average paid almost $A2000 a year in bribes, and shops routinely refused to provide tax receipts for purchases.

And that is part of the story. Greece joined the European Union, joined the euro, but never became part of that northern European culture in which officials, taxpayers and citizens obey the law because they see the state as theirs. In Greece, tax evasion and corruption are rife. Transparency International's annual index finds investors rate it the most corrupt country in the developed world, worse even than Saudi Arabia and Ghana.

And change is not coming easy. American-born Prime Minister George Papandreou, elected last October, has taken a series of courageous decisions to admit the true state of Greece's finances, and impose cuts and reforms across the board to reduce the deficit from 13.5 per cent of GDP to 3 per cent within three years.

Pensions have been frozen, and in some cases cut. Early retirement has been abolished. The public sector will hire no new staff in 2010, except for essential positions. Some 10,000 qualified applicants have been turned away. From 2011, hiring will resume, but only at the rate of one public servant hired for every five who leave. Contract employees will be terminated, overtime payments have been cut by 30 per cent, bonus payments and salaries have been cut, and public sector wages reduced overall by 10 per cent in the government itself and by 13 per cent in its enterprises.

But Greeks have rebelled, with a poll finding 51 per cent vowing to fight the cuts. At one end of society, the Athens rioters demand that the rich should pay, not them. At the other, London real estate agents Knight Frank report that 6 per cent of all purchases of London properties for more than £2 million ($A3.2 million) in recent months have been by Greeks shipping their money out of the country.

The biggest risk is that nervous markets are now losing confidence in the other heavily indebted, high-deficit countries of western Europe. Spain, Portugal and Ireland form the new frontline of countries that could be forced to replay the Greek tragedy.

It's a great case study for fiscal prudence.

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