Prompted by the exchange between Gruen and Gittins on NSW privatisation, I asked myself a much broader and pertinent question: what should be the proper role of government in the allocation of capital in Australia?
At the two ideological extremes, the answer is simple.
The interventionist Left says that governments have an obligation to correct deficiencies in economic infrastructure such as in roads, ports and railways; build up the stock of human capital, such as public health, education, housing, employment programs; protect our natural environment; safeguard or improve the quality of our living and working conditions; and ensure that every citizen gets an equal opportunity to succeed, irrespective of the circumstances of their birth and upbringing (the much beloved level playing field). These five long term societal goals require massive economic, social and environmental investment over time and this job cannot be left to private commercial markets which do not have regard for wider social and economic externalities. So government involvement is necessary to achieve the desired goals. If in the process it crowds out or discourages some private sector activities, then so be it. That’s what the public say they want.
At the libertarian end of the ideological spectrum, the argument is that while the goals outlined above might be desirable, so too are other goals such as individual freedom of choice. So, they say, governments need to defer some of the goals i.e. achieve them over a longer time period, while some goals should be left to private capital markets to fix up (perhaps with a bit of subsidization at the margin). Governments should largely stay out of capital allocation decisions as their direct involvement would mean higher taxes, with their serious disincentive and distorting effects; higher interest rates; undisciplined execution (they stress the many examples of government failure in design or implementation) and slower economic growth.
Most economists do not adopt either of these two extreme positions. In fact their stance tends to be agnostic
Mainstream economists refuse to generalize about
– the relative importance of market and government failure;
– the relative merits of public over private goods;
– the intrinsic superiority of the private sector as an owner-manager of infrastructure relative to governments;
– the effects of higher taxes;
– the economic superiority of private debt over public debt;
– the impact deficits might have on interest rates or its consequences for economic growth; or
– the precise state of public opinion on taxes, government spending and public borrowing.
These economists prefer to look at each investment proposal on its merit that is, they like to examine, case by case, how benefits and costs stack up, what might be the optimal method of financing the investment and the optimal role of governments and private markets in risk-management, design, construction and operation.
Adoption by governments of such an agnostic stance is only plausible if the fiscal stance of governments is flexible and responsive i.e. if there is no investment straightjacket in the public sector. Unfortunately, this is exactly what we had under Howard, where it did not matter much because of the gushing revenue from the resources boom. And it is what we look like having under Rudd, where it will matter greatly in the more restricted revenue outlook.
The Rudd Government has in effected adopted the libertarian stance on fiscal policy. It has virtually frozen its capacity to invest on a sustained basis by promising (in the election run-up) that, over the business cycle
the budget will be balanced or in surplus i.e. there shall be no net government borrowing (no increase in public debt), so all government expenditure, whether of a recurrent or capital nature, must be more than fully paid for out of ongoing revenue (mainly taxes); and
the tax burden will remain constant or fall relative to national income, thus severely constraining the ability to use revenue to pay for economic and social investment.
This extreme form of fiscal conservatism may have helped Rudd win the elections but it will make it very difficult for him to deliver a strong report card on his education, health and infrastructure goals. It will also force it to adopt infrastructure financing options that are economically less efficient than borrowing and denying Australians a genuine, well informed choice on the appropriate balance between public and private goods.
The structural fiscal goals are not as rigid at the state level but, under our lopsided federal system, it is the Federal Government that has the largest and fastest growing revenue base and the greatest capacity to borrow. So it is the federal fiscal stance that will be crucial for the achievement of the Rudd vision. Yet Rudd’s libertarian stance has left him little or no room for manoeuvre.
Sadly and ironically, an opportunity might open up for Rudd if (as I fear) the economy stumbles badly in 2009. This will then require both a fiscal and monetary stimulus and, with advance planning, this could give Rudd the chance to implement short-gestation infrastructure spending and indulge in some one-off social and environmental investment initiatives. But there must be an easier way for a government to pursue its vision of a fair and productive society. It involves keeping an open mind and an open-ended policy on borrowing and taxes over the economic cycle.