Peter Swan

When Finance Minister Mathias Cormann said earlier this month that it was “unfair to rob our children and grandchildren of their opportunities to pay for today’s lifestyle”, he was attacked by economists from all sides of the political spectrum.

Research economist Warwick Smith wrote in The Guardian on January 9: “Repeat after me: the Australian economy is not like a household budget”, and said the Abbott government’s attempt to justify reining in budget deficits on these grounds is one of the “great myths of modern government financing”.

My friend and unreconstructed Keynesian economist Geoff Harcourt accuses the government, on the website The Conversation, of “deficit size fetishism” and denies the “supposed link between [deficits] and the welfare of future generations”.

My colleague Richard Holden denied in The Weekend Australian on January 10 that the national economy is like a household and said it was “misguided” to think that governments, like families, must live within their means.

The government’s difficult task is not helped by economists who believe that any restraint advocated by governments of a persuasion they may not like is pure ideology and that the clear and obvious analogy with household and family budgets has no relevance.

Popular radio personality Alan Jones tells his listeners that governments are subject to the same laws of economics, same resource scarcity, and same need not to waste the taxpayer’s scarce dollar as the families whose tax payments make government possible.

Have he and his listeners been conned, if not Cormanned?

Smith is convinced Jones and his listeners are wrong because “the federal government can create money”. Certainly, some governments have tried to pay their debts by printing money; Zimbabwe’s Robert Mugabe comes to mind. But so can individuals. Every household and family has a perfect legal right to create its own exclusive fiat money, Peter Swan banknotes.

In this sense, you and I are no different to Zimbabwe and Mugabe. My currency and his are rightly rejected as worthless, forcing Zimbabwe to use US dollar denominated currency, as does, effectively, Hong Kong.

The federal government does differ from you and me in one respect, though: it can and does pass laws making Australian banknotes legal tender.

Thus, domestic households have to accept Australian dollar denominated currency and if they purchase federal government debt denominated in Australian dollars they take the risk of its value being eroded by Australian governments when they create inflation.

Australians holding our wartime debt whose wealth was severely depleted by the inflation that occurred during the Korean War-inspired wool boom in the early 1950s experienced this.

Australia is a massive capital importing nation depending almost entirely on foreign rather than domestic savings to fund federal government deficits. These lenders are sufficiently sophisticated not to fall into the domestic inflation trap.

So, much of the borrowing is denominated in American or other global currencies, putting the federal government on a similar basis to the states. Queensland has already lost its AAA credit rating crown. Unless the federal government can balance the budget and pay down debt, it risks following suit.

Printing money simply devalues the Australian dollar, magnifying both the interest and the principal repayment burden.

Harcourt, however, believes it is a fallacy that the federal government needs to balance its budget over the economic cycle. Nor does he believe there is a problem with internal debt as it postpones the need for higher taxes, resulting only in the payment of more interest to Australian lenders.

This he regards as a transfer even though taxpayers and lenders need not be one and the same.

Harcourt believes there may be a case for foreign borrowing to pay for social infrastructure, even though he admits that higher exports will be required to repay the debt. However, this leaves us paying a rising international interest bill just to meet budget outlays into the indefinite future.

Holden argues that the analogy with household budgets is inappropriate because unlike mere mortals, governments live forever. He thinks that families “pay down that debt through prudent spending” only because they want to leave something to their children.

This does not obviate the need for governments to repay debt to prevent the interest burden paid by future generations blowing out beyond their diminishing capacity to pay, with the end of the baby boom generation, the ageing of the population, and collapse in our terms of trade.

Holden points out that “government doesn’t make stuff and it doesn’t create jobs or wealth”. I agree with this pro-market, anti-Keynesian sentiment. With properly enforced property rights in place the private sector can be left to provide social infrastructure such as hospitals and, presumably, toll roads.

The federal government does not need to incur ever-rising deficits and debt to provide law and order and enforce property rights. Hence Holden’s arguments seem to indicate a close analogy between government and household debt.

Both must be prudently managed and debt levels kept in check so as not to destroy the bequest motive (households) and to prevent interest payments alone absorbing the limited capacity to raise revenue (governments).

None of these three advocates for essentially unlimited public debt has in my estimation made the case, or even shown how it is possible, without a breakdown of society. The bailout crisis in Greece is a case in point. The analogy between government and household budgets remains intact.

Peter Swan is professor of finance at UNSW Business School. A version of this post appeared in The Australian.

Jerry Parwada

The debate about a national exam for financial planners misses the point that there is already a benchmark for professional standards for the profession.

Universities across Australia offer undergraduate qualifications in financial planning.  Some, such as UNSW, offer a master of financial planning. In fact, the Business School at UNSW was the first among the Group of 8 universities to offer the course when it began three years ago.

While the focus of the present political debate is around the need for an exam at all, I suggest the Australian Securities and Investments Commission (ASIC) take advice from universities and other neutral bodies that do not have a vested interest.

Evidently, ASIC is not the body to ensure that a national exam reflects state-of-the-art financial issues and industry practice. Nor can it keep up to date (or deliver) the examination content and training required to meet minimum professional standards.

To this end, it should do two things – establish an education council (spearheaded by universities and with significant industry participation) and hold a summit to seek input from across industry and education providers into the training systems required.

The federal government (and ASIC) should avoid pandering to the market. The present debate is polarised by vested interests and taking place in a poisoned atmosphere where the industry is controlled by the big planning groups and players lacking higher qualifications are resisting professionalisation.

Financial planners with a university master’s degree that focuses on longer-term planning will ensure a higher level of professionalism.

As individuals, financial planners need to decide if they will make a long-term investment in higher qualifications or pander to the short-termism that is the practice across much of the existing industry.

That future is coming. It might not be today or tomorrow, but it is definitely coming. Investors are becoming more savvy, markets more attuned to international best practice and there are massive amounts of assets under management, mainly because of compulsory superannuation.

This makes the outcome of this debate a significant economic issue for Australia – it is no longer about just convincing mum and dad investors to seek financial advice for their retirement. It is about an investment management industry that is about the fourth-largest in the world (behind the US, UK and Japan) – a behemoth that needs professional advisers that add value and not just feed from the lucrative fee trough.

In the long term, a parallel system could operate, with graduate and postgraduate qualifications sitting alongside a requirement for national entry exam. This would be similar to what already occurs elsewhere in the financial services industry where upwardly mobile professionals complete a CFA exam but often also undertake a master of finance.

In Australia, we also need a comprehensive register of financial planners so that we complement advances in adviser training to improve standards in the industry. This literally means nobody without ASIC recognition via the register hangs a shingle and starts advising clients.

Potential investors should be able to check the bona fides of their financial planner – not via ASIC’s simple RG146 list which was considered sufficient in the past. Ideally, financial planners would be required to disclose not only qualifications and history but also their institutional affiliations and any past professional and criminal misdemeanours. Without this, I would question the efficacy of having a national exam at all.

Universities deliver fundamental education and many have steadfastly resisted coming up with training courses that feed into the current sales-based financial planning culture that infects much of the industry.

Under the spectre of deregulation of higher education fees and the present market spotlight on financial planner education standards, many universities offering financial planning qualifications have or will be approached by organisations wanting to make a quick buck.

Some are not even course providers themselves but want to act as brokers, trying to convince universities to downgrade standards or offer excessive exemptions and credit for years of experience alone or lower-level previous qualifications.

The present system of training financial planners is tainted and higher education providers should resist being used to rubber-stamp these failed systems (retrospectively) to give them credence. There is no point to be used merely as a branding mechanism where credibility is obtained by an affiliation with a respected university.

Jerry Parwada is an associate professor of finance and head of the school of banking and finance at UNSW Business School.

Dale Boccabella and Kathrin Bain

Under Australian law, changes to the GST are said to be not permitted unless the states agree to the changes. In reality, the GST lock-in mechanism is legally meaningless and unenforceable, though it may still hold political weight.

Section 11 of the A New Tax System (Managing the GST Rate and Base) Act 1999 provides that:

“the rate of the GST, and the GST base, are not to be changed unless each State agrees to the change”.

Similarly, section 1-3 of the GST Act states that:

“the Parliament acknowledges that the Commonwealth will maintain the rate and base of the GST in accordance with the Agreement on Principles for the Reform of Commonwealth-State Financial Relations endorsed at the Special Premiers’ Conference in Canberra on 13 November 1998”.

These legislative provisions and the Intergovernmental Agreement are referred to as the GST lock-in mechanism.

The legislative GST lock-in mechanism is contained in Commonwealth pieces of legislation. Despite the fact that the GST revenue collected is distributed to the states, these pieces of legislation are not Acts of state parliaments. Accordingly, it is the legislative power of the Commonwealth that is relevant when determining whether the GST rate and base can be modified contrary to the lock-in mechanism – that is, without state agreement.

The Commonwealth Constitution grants the Commonwealth Parliament the right to make laws in respect to taxation. Section 1 of the Constitution states:

“the legislative power of the Commonwealth shall be vested in a Federal Parliament, which shall consist of the Queen, a Senate, and a House of Representatives”.

There is no mention of any other body (for example, state governments) having any power in relation to Commonwealth law-making.

The current GST lock-in mechanism is in conflict with section 1 of the Constitution, (which vests the legislative power of the Commonwealth solely in the Commonwealth Parliament) because it purports to grant a veto power to the states in regard to the GST, and is therefore constitutionally invalid.

In order for a GST lock-in mechanism to be valid, section 1 of the Constitution would need to be amended to include a grant to the states of a veto power over Commonwealth GST legislation. Such constitutional change could only be achieved by way of referendum.

In spite of the above, the Commonwealth government has a signed agreement (the Intergovernmental Agreement) with the states that contains the lock-in mechanism. Since the legislative provisions are invalid, does such an agreement provide an alternate avenue for enforcement of the lock-in mechanism? It depends whether the government has the authority to enter into such an agreement.

The key factor in addressing this is whether the executive under the Constitution (that is. the government) has the authority to enter into such an agreement.

Section 61 of the Constitution gives the government the power (and effective responsibility) to implement and maintain the Constitution and the laws of the Commonwealth. The GST lock-in part of the Intergovernmental Agreement is attempting to circumvent a central pillar of the Constitution – that is, the sovereignty of the legislative branch of the Commonwealth government – by granting a veto power over certain areas of its legislative competence to the states.

If the High Court enforced the GST lock-in mechanism, it would be sanctioning a change to the Constitution without requiring use of the referendum process (that is, contravening the Constitution rather than maintaining it). The High Court will not do that.

Overall, neither the legislation nor the Intergovernmental Agreement would legally prevent the Commonwealth government from changing the GST rate or base. However, this does not mean that the Commonwealth government won’t seek the approval of the states before making any such changes.

Laureate professor Cheryl Saunders has stated: “Agreements that have no legal effect either as contracts or through legislation, nevertheless may be significant as a form of ‘soft law’, effectively guiding executive action, often complementing the operation of legislation and sometimes affecting the interests of third parties.”

Indeed, consulting the states has been the practice in regard to the numerous amendments to the GST since its introduction. From a political point of view, the Commonwealth government of the day would need to consider the inevitable community backlash it would receive if changes were made to the GST despite state opposition.

Therefore, while the GST lock-in mechanism is unenforceable, the Commonwealth government (regardless of political party) may still feel obliged to comply with it. It must also be remembered that the Senate is a central part of the Commonwealth Parliament, and therefore must approve any legislation passed by the House of Representatives before it becomes law.

Dale Boccabella is an associate professor and Kathrin Bain is a lecturer in the school of taxation and business law at UNSW Business School. Solicitor Bruce Gordon also contributed to this article. A version of this post has appeared on The Conversation.

Richard Holden

The Australian dollar (AUD) is a curious currency. It is the fifth most traded in the world and it gyrates pretty wildly – having traded below US48c cents and above US110c in the decade or so from mid 2001 to 2011.

And to listen to the financial press – or the governor of the Reserve Bank of Australia (RBA) – it would seem to determine our economic fortunes more than almost anything else. No wonder we are obsessed with it.

What then, does 2015 hold for the AUD, and by implication the nation? That’s the sort of question I generally try to avoid answering – in the spirit of Nobel prize-winning physicist Niels Bohr and baseball legend Yogi Berra, who are both credited with the some version of the aphorism: “It’s tough to make predictions, especially about the future.”

But our currency has become so central to debates about everything from unemployment to interest rates to deficits that I can’t avoid throwing caution to the wind and, in homage to US president Harry Truman, doing my best impersonation of a “one-handed economist”.

Truman reportedly once said: “Give me a one-handed economist! All my economists say, ‘On the one hand … on the other’.”

Here’s a good question for you. What determines the level of the Aussie dollar: (a) our terms of trade; (b) the difference between interest rates in Australia and abroad; (c) global investor sentiment; (d) whatever five hedge fund managers in Greenwich, Connecticut, say it’s worth; or (e) all of the above?

I’m going with (e) all of the above. That fact makes it pretty hard to pinpoint an exact level of the AUD at any point. But it is fair to say most of those factors point to an exchange rate on the weaker side of what we’ve been used to during the past few years. The prices of what we export versus what we import (the terms of trade) have been weakening, putting downward pressure on the AUD.

The US Federal Reserve has been scaling back its bond-buying program (“quantitative easing”) and the US economy grew very strongly in the last quarter, increasing the chances of an interest rate rise in 2015 or 2016. And RBA governor Glenn Stevens may not be predisposed to a cut in Australian rates (in no small part because of the weakening AUD) but the fragile economy, rising unemployment, and low inflation hardly point to a rate hike.

So, from a present level of about US82c, the AUD is probably not going to spend much time above US85c and could spend a fair bit below US80c – maybe below US75c.

When the AUD falls, our exports become cheaper for the foreigners who buy them. Their US dollar, pound, yen or euro buys more Australian dollars and hence more of our “stuff”. This increases their demand for our exports. This is good news for exporters such as the mining, education and tourism sectors.

Much less emphasised are the costs of a weaker AUD. In a piece in this publication late last year, I suggested that our economy has changed a fair bit from the circa-1990 version that benefited from a lower dollar.

We buy more from overseas than we did – both consumers via the internet and increasing trade, and producers in terms of equipment and other business inputs. And a lot of the stuff we do buy has no close domestic substitutes.

In information technology and electronics, particularly, we buy a lot of important things from overseas that we can’t just “not buy” and we certainly can’t get locally. When the Aussie dollar falls these purchases cost more, and they have spillover effects on our productivity.

A weaker AUD makes consumers poorer and business less productive. And that matters a lot more than it used to – and, dare I say it, a lot more than whatever dynamic stochastic general equilibrium model the RBA is presently using seems to tell them.

It looks like the AUD will be relatively weak in 2015, at least compared with recent history. A number of people think that’s a good thing. I don’t. The puts and takes I mentioned above are basically a wash. The kicker is how it affects policy.

I think the RBA materially overestimates the benefits of a lower AUD – so much so that it seems as if the lower dollar has scuppered the chance of a 50 basis points rate cut this year. That was the reaction of futures markets to Stevens’s comments about the AUD and interest rates late last year.

With low inflation, a weakening mining sector, uncomfortably high unemployment and political uncertainty, a couple of 25 basis point cuts would be a great thing for the economy.

Too bad that the bank puts so much weight on the currency – and too bad that it looks likely to be weak in 2015.

Richard Holden is a professor of economics at UNSW Business School. A version of this post appeared on The Conversation.

Richard Holden

Like it or not, a fair chunk of Australian political chatter this year is going to be about how to manage the economy – and about budget deficits in particular. Politicians need to find a narrative that resonates with the public when talking about any issue, and with economics it’s both particularly tricky and important. Just ask Treasurer Joe Hockey.

Though tempting, traditional analogies about the national economy are misleading at best, and downright wrong at worst.

The most popular narrative about economic management is to compare government finances to household finances. “Families all over Australia balance their budgets and live within their means — and so must the government.” It sounds sensible and it resonates with many people. But it’s completely misguided.

The big difference between government and household finances is that households have a finite life (because their members do). At the end of that life something will be left behind: ideally some net assets, like a property without a mortgage attached. The desire that many of us have to leave a bequest to, say, our children is a powerful force. It leads us to try to accumulate wealth.

Typically, we take on debt early in our lives: often a mortgage to buy a house or loans to pay for tertiary education. Taking on debt to purchase housing is rationally shifting consumption forward in our lives, and investing in education increases our earning capacity. But the bequest motive compels us to pay down that debt through prudent spending.

All good, but nothing like what the government faces. The government never dies (even when one political party leaves office) and it doesn’t have anything to leave behind. And that’s the fundamental difference between it and a household.

What about business, then? Surely that’s like government. After all, isn’t the government just one big “corporation”?

Actually, no. Businesses, in principle, can live forever – even if they’re taken over or merge. So that’s not the key difference between business and government.

And notice that most businesses have a positive level of debt permanently. That’s precisely because good businesses have attractive investments to make, can borrow at lower rates than the expected returns on those investments, and expect to be around for a long time.

So even if government was just like business it wouldn’t justify this “pay back the debt and stop paying interest” nonsense the present Coalition government keeps peddling. Subtext (with apologies to Simon & Garfunkel): “Where have you gone Pete Costello, a nation turns its lonely eyes to you?”

The big difference between business and government is that business gets told what its preferences are. Consumers decide what they like and how much they will pay for it.

Of course, businesses can innovate, develop completely new products, and educate consumers. But ultimately businesses take inputs at market prices and convert them, as efficiently as possible, into outputs that someone wants to buy, also at a market price. This creates jobs and wealth.

That’s not to say any of it is easy. It’s just very different from what government does. Government doesn’t make stuff and it doesn’t create jobs or wealth.

What then, if anything, should government do? The answer lies in the fact that markets are great, except when they’re not. And it’s in the “not” part where government has a vital role that no one else can play.

Government can make sure markets work better by ensuring that true price signals are sent and information is freely available. If there is a social harm that isn’t factored into market prices and behaviour, then the government should tax it. For example, cigarettes are taxed because smokers cause pollution and impose costs on the healthcare system. Cigarette taxes cause the price of cigarettes to reflect part of this “social cost”.

So, too, with social goods. Philanthropy is subsidised through tax deductions because people don’t typically factor in the social benefit of such gifts.

Similarly, when markets are plagued by sellers with private information – like sellers of used cars who know whether their car is a “lemon” – they tend to unravel. I, as a buyer, rationally assume the worst about the seller’s car which means good sellers drop out of the market, leaving only lemons behind.

The same adverse selection phenomenon happens in unfettered markets for all sorts of goods and services: from health insurance to stockmarkets. In these situations, government can play a vital role in stopping markets from breaking down through sensible disclosure requirements and incentives for good sellers not to drop out of the market.

Running government finances isn’t like running a household, nor a business. Not even a little bit. It’s much more like being a car mechanic. The “vehicle” that does all the work is markets. But, just like a car, to run smoothly markets need to send and receive the right signals and information. And getting that right is a job only government can do.

So, Mr Hockey, in 2015 I hope you metaphorically don overalls, rather than suits or aprons.

Richard Holden is a professor of economics at UNSW Business School. A version of this post appeared in The Australian.