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Australia needs some kind of sovereign wealth fund

By Saul Eslake - posted Friday, 4 March 2011


One of the Howard Government's proudest boasts was that it 'paid off' the debt it inherited from its predecessor. Having come to office with Australian government net debt at $96bn, equivalent to 18% of GDP (not an especially large figure by international standards, but high in terms of Australian experience), by the time it left office the Australian government had become a net creditor to the tune of over $30bn. This bequest allowed the Rudd Government to engineer one of the industrialized world's largest fiscal stimulus packages (relative to the size of our economy) during the global financial crisis, without raising any of the questions about the longer-term sustainability of our public finances which are now bedeviling governments throughout the industrialized world.

The Howard Government turned the Commonwealth's net debt position around by a combination of running 'underlying' budget surpluses in all but two of the years for which it was in office, and asset sales (principally, shares in Telstra). However, once it had, in its oft-repeated words, 'paid off Labor's debts', it struggled to find a politically saleable rationale for continuing to run large budget surpluses. Peter Costello established the Future Fund in 2006, to defray the unfunded liability accumulated by previous Australian governments in respect of public service and defence force pensions; but, however foresighted that decision was, it was hardly likely to excite the average voter.

As a result, during its last few years in office, the Howard Government adopted an informal principle that whenever the budget surplus looked set to exceed 1% of GDP, it 'gave away' the excess in the form of income tax cuts and increased in a wide range of un-means tested cash hand-outs. By my reckoning, from the 2004 Budget until it lost office, the Howard Government 'gave away' $67bn of the $77bn which favourable economic developments (principally, those associated with the first phase of the resources boom) would otherwise have added to the budget surplus.

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Now while that's a lot less than the amounts which the Rudd Government 'gave away' during its first term in office, the Howard Government was presiding over a booming economy, one operating at close to 'full capacity' and one in which inflationary pressures were becoming more pronounced. In those circumstances, the Howard Government should have run larger budget surpluses than it did. But lacking a political rationale for doing so, its repeated 'give-aways' added to overall domestic spending (as households spent the vast bulk of the tax cuts and cash handouts which the Howard Government gave them), and hence put additional upward pressure on inflation and interest rates.

Now that the 'resources boom' is officially back, and seems likely to be around for quite some time (at least 15 years, according to the Treasury's principal forecaster, David Gruen), the Howard Government's experience is likely to become relevant once again.

Although the Gillard Government is still running a budget deficit, it is determined to return the budget to surplus by 2012-13, come hell or (as we have seen over the past month) high water, and thereafter to begin paying down the debt accumulated since the onset of the global financial crisis by running budget surpluses of .. you guessed it, roughly 1% of GDP. In the most recent promulgation of its medium-term fiscal strategy, the Mid-Year Economic and Fiscal Outlook released last November, the Government pledged to retain 'a 2% cap on real spending growth, on average, until surpluses are at least 1% of GDP', a position which it expects to have attained by the 2016-17 financial year.

In other words, the Government is saying that, from 2016-17, it will make the same policy mistake as the Howard Government did in essentially similar economic circumstances, namely, a fully-employed economy experiencing an on-going resources boom and in which the risks to inflation are clearly tilted to the upside.

The best way of preventing whoever is in office at this time (it is, after all, two elections away) from repeating the Howard Government's mistake is to establish some form of 'national fund' into which the Government can divert whatever additional revenue comes its way. Such a fund – call it a 'sovereign wealth fund' if you like, although I am sure someone could come up with a better name – would provide a politically saleable rationale for running the 'considerably larger budget surpluses' which, as Reserve Bank Governor Glenn Stevens suggested in a speech last November and hinted at again last week, whoever is in government at the time should be prepared to run 'in the upswings of future cycles'.

Such a fund could include specific accounts not only for investment in higher education institutions and hospitals (which the Howard Government established in its last budget, and which the Rudd Government subsequently depleted along with its own 'Building Australia Fund'), but also accounts for pre-paying some of the costs associated with the ageing of the population; for funding productivity-enhancing infrastructure investment; for tackling, with funds sufficient to the task, entrenched areas of Indigenous disadvantage; for 'drought-proofing' and, to the extent it's possible, 'natural disaster proofing' the nation; for funding investment in low carbon emission technologies; and for other purposes that require expenditures over long periods of time.

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A fund such as this would be quite different from the sovereign wealth funds established by Norway, Chile or the oil-producing nations of the Middle East, which accumulate a large share of the revenues accruing to state-owned companies and seek to hold most if not all of the resulting assets offshore, in part to minimize the upward pressure on their exchange rates that would occur in all of the revenues were brought onshore. The Australian Government (thankfully) doesn't own any of the companies operating at the 'coal face' of the mining boom; and it is (properly) not seeking to 'hold down' the exchange rate for the Australian dollar in order to shield other trade-exposed sectors of the economy from some of the side-effects of the resources boom.

Rather, an Australian 'sovereign wealth fund' would be more like those established by Singapore or China to invest the massive foreign exchange reserves which they have accumulated as a result of the large surpluses they have maintained on the current accounts of their balances of payments over many years. It could be managed by the custodians of the existing Future Fund who have done such an excellent job since its inception in 2006.

An Australian 'sovereign wealth fund' would also provide the most feasible means of ensuring that the current generation of Australians, who just happen to be occupying this country at a time when more people (in China and India) are undergoing the process of urbanization and industrialization that at any other time in human history, leave a substantial proportion of the wealth which will accrue to this country as a result of that accident of timing to future generations of Australians, rather than spending it all on themselves. A politician who can't sell that promise isn't worthy of election to office.

It's a little known secret that Australia established one of the world's first sovereign wealth funds – for its then colony Nauru, in 1968. Sadly for Nauru, that fund – which twenty years ago had US$800mn in it, or US$200,000 for each of Nauru's citizens at that time – has been almost entirely depleted by corruption and mismanagement. Australia could, and should, do better.

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This article was first published in the business pages of the Melbourne Age, Wednesday March 2, 2011.



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About the Author

Saul Eslake worked as an economist in the Australian financial markets for 25 years, including as Chief Economist at McIntosh Securities (a stockbroking firm) in the late 1980s, Chief Economist (International) at National Mutual Funds Management in the early 1990s, and as Chief Economist at the Australia & New Zealand Banking Group (ANZ) from 1995 to 2009. Since leaving ANZ in August 2009 Saul has had a part-time role as Director of the Productivity Growth Program at the Grattan Institute, a non-aligned policy ‘think tank’ affiliated with Melbourne University, and more recently also as an Advisor in PricewaterhouseCoopers’ economics practice. The views expressed are his own.

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