What Australia should be doing to get financial and cultural benefits from the boom

The financial legacy

I’ve been arguing since around 2005 that Australia should establish some kind of ‘stabilisation fund’ or ‘sovereign wealth fund’ similar (although not identical) to those that exist in countries like Norway or Chile. More recently, more influential authorities such as Glenn Stevens and the OECD have supported this proposition.

An Australian sovereign fund wouldn’t be created out of the revenue from State-owned commodity businesses like Norway’s Staatoil, or Chile’s Codelco. Nor would it be funded solely by specific taxes levied on mining companies (which, as currently envisaged at the Federal level, aren’t going to raise much money anyway – and the money which they are supposed to raise has already been committed to other purposes).

Rather, it should be created from the larger budget surpluses which Australia ought to be running once the mining boom gets into full swing, and after the net debt which has been run up since the onset of the global financial crisis has been paid off – which on the forecasts contained in the most recent Federal budget will be by 2020.

An Australian sovereign wealth fund would provide a means of avoiding what I argued (admittedly without much company at the time) was the mistake made by the Howard Government in its last term in office, and the Rudd Government in its first Budget, of being unwilling to contemplate running budget surpluses of more than the equivalent of 1 per cent of GDP.

That was largely because, having by 2005 paid off the debt inherited from the Keating Government, the Howard Government couldn’t find a politically saleable rationale for continuing to collect much more in tax than it spent, even though that’s what good economic policy required. They were apparently also influenced by the experience of the Kennett Government in Victoria in bequeathing large budget surpluses to the incoming Bracks Labor Government in 1999, which the latter then spent.

However, in ‘giving away’ in the form of income tax cuts or untargeted welfare handouts any revenue which might otherwise have resulted in a forecast budget surplus of more than 1 per cent of GDP, the Howard Government (and the Rudd Government in its first budget) added to domestic demand at a time when the Australian economy was already operating at close to ‘full capacity’ (if not indeed at something over that), and hence fuelled upward pressure on inflation and interest rates.

The present Government’s fiscal strategy, as enunciated in the most recent Budget Papers, says that the disciplines by which the Government regards itself as bound – to divert any unanticipated revenue gains to improving the Budget bottom line (a discipline which has been honoured more in the breach than the observance) and to keep growth in real outlays to less than 2 per cent per annum – only apply until the Budget surplus reaches (yes, you guessed) 1 per cent of GDP – which on the latest forecasts will be in 2016-17.

After which, presumably, the present Government, or whoever is in power after that, will be free to repeat the mistake made by the Howard Government all over again.

A sovereign wealth fund would provide a politically saleable rationale for running budget surpluses of a magnitude – perhaps as much as 3-5 per cent of GDP – that may well be required in order to prevent the present resources boom from ending in the same way that previous ones have done, or to ensure that the burden of preventing that outcome doesn’t rest entirely with the Reserve Bank.

Such a fund would desirably have two key features:

• Very tight rules, similar to those governing the Howard government Future Fund, to defray its unfunded public service pension liability, to prevent governments from touching the capital in (and perhaps also the income from) the fund until the resources boom is ‘over’ according to some objective criterion, such as the terms of trade falling below their 2005 level, or the average for the 20 years to 2005, for at least a full financial year.