The Future Fund

This column was published by the Fin in early April and appears here as a matter of record – and invitation for comment.

Peter Costello told us that he would relentlessly attack the oppositionâs $2.7 billion raid on the future fund for broadband investment. And he did, doggedly raising the issue in parliament every sitting day last week. But the future fund is an unconvincing policy. And Costelloâs criticisms of the opposition are misleading.

The first thing to say about the future fund is that it is unnecessary. Before it was established last year, commonwealth unfunded superannuation liabilities were $95 billion. These are to be met over forty years. For 2005-06, they required less than $2.5 billion: one per cent of the commonwealth governmentâs cash expenses. This was entirely within the budgetâs capacity.

Unfunded liabilities stem from defined benefit retirement schemes many of which have been closed to new members. The commonwealth estimates that a peak liability of $140 billion will occur around 2020. There is no concern that the cash required – again to be met over the following four decades – would be unmanageable.

But the future fund was never about superannuation or the intergenerational issues canvassed in yesterdayâs report. It is a device – a jam jar – invented to justify Costelloâs multi-billion dollar budget surpluses. Putting these surpluses into a fund with a seductive label dampens pressures for higher spending or tax cuts. Too many untrained commentators think that jam jars are useful because they think that what is good for household budgets is good for governments.

The second point is that it is a shame that the commonwealth has nothing better to do with surpluses than to invest them in David Jones and Woolworths or, more interesting, in Tabcorp, Gunns Timber or other securities which many Australians class as unethical investments.

Some economists want Costello to invest surpluses in a taxation system that reduces the disincentive for those thinking of moving from welfare to work. Others argue for more infrastructure or for skills creation. If the government cannot identify needs which have a higher priority – and a higher return – than the shares to be acquired by the future fund, it is myopic. Even re-buying government office blocks would be a better deal.

Then there are the attacks of economic irresponsibility. Last Wednesday, Costello likened Laborâs plan to a theft of employeeâs savings, âThere have been a lot of demands in Australia for government employeesâ superannuation to be protected. The member for Lilley [the shadow treasurer, Wayne Swan] has been a persistent demander that the superannuation savings of employees be locked up in the future fund and not raidedâ. But that was mischievous; the boring truth is that the future fundâs assets are comprised of government taxes and assets; they are not employee savings.

Costello also equated his fund with state superannuation funds. He argued that state governments would not dare raid their superannuation funds in the way federal Labor would take from the future fund. But state and federal funds are not the same.

Like the commonwealth, the NSW government has unfunded superannuation liabilities. And like the commonwealth, NSW has injected lump sums to reduce these liabilities. (Its contributions once attracted significant commonwealth tax advantages.) But unlike the commonwealthâs allocations, those made by NSW reduced the stateâs budget surplus and reduced its superannuation liabilities. The way the commonwealth has structured its future fund – remember, Costelloâs prime goal is to record budget surpluses – contributions to the fund do not reduce the commonwealthâs surplus and do not offset commonwealth superannuation liabilities. Whatever might happen in 2020, the future fund is not funding superannuation liabilities.

Another issue, one which Labor should study, is the budgetary impact of drawing from the future fund. According to the concepts used by the Australian Bureau of Statistics, meeting expenses from the capital of the future fund (even for superannuation) would be treated as a cash borrowing (a reduction of savings), and this can only occur in times of cash deficits. And any investment of fund capital for policy reasons – as Labor proposes – would be classed as a purchase of non-financial assets, reducing the commonwealthâs cash surplus. Not a great start for Laborâs fiscal reputation.

Although Costelloâs future fund has some positive elements, be entirely sceptical about his glorious defence of it. And do not believe the desperate mistruths used in his attacks on the opposition.

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flute
14 years ago

I think that’s a pretty fair assessment, though not quite damning enough. The future fund is an incredibly stupid economic idea, that is, using revenue generated by production today be stashed under the bed for tomorrow instead of investing in future growth. It probably stems from the massive cuts in the first Howard term, and the bracket creep that has put the average rate of tax way above what it was in 96. Instead of riding the economic cycle, the slash and burn has lead to a ridiculous surplus and created an economic problem that needed to be hidden, as the article says, in a jam jar. Again, the article is correct about the accrual of liability over time, and not a one time bill of gazillions some time in the future. If you’re going to account for $100bn of debt now, you should also account for estimated future revenue over the same period, clearly a complete bloody nonsense.

Fred Argy
Fred Argy
14 years ago

I don’t normally jump to the defense of Costello but there really was some logic in setting up the Future Fund – not to pay for super (a silly notion) but (as Tony Harris says) to put away his budget surpluses (as public debt levels were getting dangerously close to zero).

The surpluses were generally justified as in the last few years the Australian economy has been operating very close to full employment (as Ken Henry reminds us) and it is sound contra-cyclical policy to run surpluses in these circumstances. (I know the argument about the high level of under-utilisation of labour but it applies mainly to unskilled workers)

The new money going into the Fund must be applied to financial assets because to apply them to non-financial assets would stimulate aggregate demand and thus breach the counter-cyclical objective.

All this is not to say that I want governments to run cash surpluses on average over the business cycle. On the contrary, I believe that over the long term if governments want to invest direct in capital infrastructure spending they should borrow or draw on the Fund. But that is a structural long term argument. Given the stage of the cycle in the last few years, a responsible government had no choice but to run surpluses. And it was sensible to put the money into the Future Fund for that purpose (forgetting the super nonsense).

Tony, I agree that if an ALP government raided the Fund and spent it directly on physical infrastructure it would be equivalent to a reduction in the annual surplus. The ALP were able to get around this problem with the Broadband project because the investment is indirect. It involves setting up a separate entity in partnership with private groups and the government buying shares in that entity. If this entity were to deliver a commercial return (comparable to what it is now getting from Telstra), it would have no effect on the underlying budget deficit or on the Future Fund

Nicholas Gruen
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Nicholas Gruen(@nicholas-gruen)
14 years ago

I don’t agree with these kinds of attacks on the future fund. Running surpluses makes sense at a time of booming commodity prices. Costello was going to pay down the debt further but that would have liquidated the bond market which generates a lot of benefits for the Australian economy in terms of risk management.

So what’s his option? Apart from the accounting quibbles – and they are it seems to be quibbles – it seems pretty obvious that there needs to be somewhere to stash money – a jam jar if you like. But this jam jar earns returns.

Further it earns returns that are higher than the returns foregone in keeping the bond market open. So the Govt is – shock – going into debt to inveset in assets that earn a higher return than it has to pay bond holders. That’s what companies do and what individuals do.

Of course, like companies and like individuals, borrowing to invest shouldn’t be done indefinitely. It should be done until the costs (in increasing the risk you bear) outweighs the rewards (in higher expected returns). This is what a well run company or individual would do – weigh up the risks and returns and make a decision on how to run it’s balance sheet accordingly.

It seems only governments should run their balance sheet as a residual rather than as the outcome of some process where risk and return are considered and deliberated upon and chosen as wisely as they can be chosen.

The ALP is arguing (if I understand their case correctly or have put it in its best light) that it accepts some of this logic but thinks there are higher value uses of the investment funds – or some of them than investing at arms lenght in commercial enterprises. Maybe – but their first choice of a project, subsidising internet movies – is unprepossessing.

Furthermore, arguing that certain things will be treated in a certain way for accounting purposes should not lead us to change our behaviour if it’s just an artifact of the accounting. It should lead us to changing our accounting – or to putting footnotes in the accounts saying ‘this figure is misleading being an artifact of the particular accounting standards we’re using here.’

crocodile
crocodile
14 years ago

If the future fund was supposed to be set up purely for unfunded super entitlements why can’t the money simply be deposited into each member’s personal super account tomorrow and let the fund managers carry on with the business of fund managing.

Tony Harris
14 years ago

Accounting principles are meant to catch and portray reality. There is a difference between setting up Costello’s future fund and funding superannuation – and we should not dismiss the differences as quibbles.

If Costello really wanted to fund superannuation, he would have transferred the funds to the commonwealth’s pre-existing superannuation fund established to invest employee monies and to pay pensions. This is what everyone else does. But it would have reduced the general government surplus, something Costello objects to for presentational reasons.

So, should the government be running a surplus? It adds to national savings and takes pressure of capacity constraints. Is there a better way to add to savings and reducing pressure on capacity constraints? That is the real question.

Buying company shares on the market has a positive impact on investment sums, but there are better ways of adding to capacity, I think.

And when the time comes to liquidate the fund and pay pensions, that will be a dissaving. Is there a macro-economic difference between the government dissaving by selling its shares or by borrowing?

Nicholas Gruen
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Nicholas Gruen(@nicholas-gruen)
14 years ago

Tony, I think I agree with your points. I guess I’m pretty inured to the lying that goes on. There’s no doubt the fund is not being accounted for precisely as it’s being described. But I’m afraid I do regard a fair bit of it as quibbling or at least as less important than the question of whether a govt can build assets – and borrow to do so – which I see as a worthwhile idea (indeed something that every other sector does if it thinks it makes sense for it.)

So Costello likes to call it the Future Fund, likes to pretent it’s about super liabilities when it’s not. So lets call it the ‘dead lucky, once in a generation windfall fund’. The Norwegians have one of those built from North Sea oil and gas windfalls and it makes their govt sector the biggest saving govt sector in the OECD. This isn’t necessarily good from first principles. You can argue that in a textbook sense they should save less. But when so much in the political culture leans in the other direction, I think it’s a worthwhile thing to do in a dangerous world.

observa
observa
14 years ago

“The second point is that it is a shame that the commonwealth has nothing better to do with surpluses than to invest them in David Jones and Woolworths or, more interesting, in Tabcorp, Gunns Timber or other securities which many Australians class as unethical investments.

Some economists want Costello to invest surpluses in a taxation system that reduces the disincentive for those thinking of moving from welfare to work. Others argue for more infrastructure or for skills creation. If the government cannot identify needs which have a higher priority – and a higher return – than the shares to be acquired by the future fund, it is myopic. Even re-buying government office blocks would be a better deal.”

Yes it’s a shame that previous Govts and their profligate economic advisers saw fit to put public servants’ super on the general taxpayers’ credit card so to to speak, especially when the sun never set on their bulging numbers, but now it’s setting on the youthful taxpayers to foot the bill with interest. Then we wouldn’t have devious fellows twisting words to continue more of the same profligacy. Having trouble finding the most logical gilt edged investment for the FF are we Tony? Let’s see we we could stick it so it wouldn’t be a tempting sticky jam jar shal we? Sell the shares and put them with open market Treasury Bond raisings to buy out the our PS Super liability eh? That would be the simplest gilt edged riskless investment for taxpayer assetts and would immediately establish the true opportunity cost of what Rudd and Co are proposing with broadband rollouts and the like. Then if they want to borrow more, rather than reduce our truly transparent debt and interest, as well as pump that additional spending into a highly employed economy at the top of the resources boom, we could judge that on its true merits. But then that’s what’s effectively happening with plans to dip into the FF anyway, although with a bit of smoke and mirrors you can pretend it’s not.

Patrick
Patrick
14 years ago

I think the ethical investments point is absurd – probably more Australians regard either government as a fundamentally inethical investor than even know who those companies are (or at least, in the case of Tabcorp, that they are listed).

But governments buying shares is kinda ridiculous in the present market – if there is one thing no sharemarket today needs it is more money. I agree with Observa that the money has to go into welfare and tax reform – by which latter I mean cuts – which is also the most sensible ‘modern Keynesian’ approach to the happy part of the cycle. By that I mean that in reality, surpluses are wasteful and prone to being squandered – so better put the money into people’s pockets.

See also the comments re ‘industry policy for the capital markets and finance industry’.

Fred Argy
Fred Argy
14 years ago

Tony, I am not sure what you mean when you ask if there is a “better way (than running a surplus) of reducing pressure on capacity constraints”.

In the short term, to reduce demand pressures, governments must run a surplus and the surplus must be invested in financial assets or in re-buying old office blocs if you like. The surplus cannot be invested in NEW infrastructure like roads or broadband.

That is the short term cyclical reality. However in slacker economic conditions (when unemployment is rising), governments should invest in new infrastructure because it will boost employment and help build up productive capacity in the long term. This policy could lead to a cash deficit on average over the business cycle as a whole. If it does, so what?

In brief: the fiscal rule should be to continue to run surpluses now but borrow net over the business cycle as a whole. Costello has got the first part of the rule right but he (like Rudd it seems) is stubbornly refusing to contemplate a structural rise in public debt over time. That is where the fiscal problem lies, even though it might seem academic just at the moment.

observa
observa
14 years ago

Forgive the naivety, but was there any restriction on the FF investing in Microsoft, Sony or Nokia perchance and if so why not? As for ethical investments, according to the James Hardie retrospective, witch hunt mindset, anyone working in the carbon industries should down tools right now. My view- until ‘we’ via our governments decide some activity is unethical and hence illegal, it’s all ethical investment. Anything less is a social copout.

observa
observa
14 years ago

‘…if so why not?’ ahh yer know what I mean

tony harris
tony harris
14 years ago

Fred,
I’m not sure that using the surplus to buy Coles or Woolwoths shares (or exisitng government buildings) does ease capacity constraints. It assumes the sellers in the private sector use the proceeds from their sale to the commonwealth without adding to capacity costraints. By buying these assets, the cmmonwealth would increase asset values but probably moderate interest rates. Everything is at the margin, of course.
If budget surpluses were deposited with the Reserve Bank and the surpluses were steralised, the argument for them in these buoyant conditions would be stronger.
The one advantage of the future fund is that it better aligns or matches commonwealth assets (future fund investments)with commonwealth liabilities (unfunded defined benefits).
Tony Harris