Carbon tax will stoke inflation and hurt productivity

Inflation and productivity are the terrible twins of Australia's economic policy.

The eurozone remains in crisis, with frantic attempts to stave off the falling dominoes of sovereign debt default. The latest news from Washington suggests the US may avoid a "financial Armageddon" but there is a lot of work needed to produce a viable long-term deficit reduction plan to limit exploding US government debt.

China is grappling with serious inflation and may by accident, or design, reduce its growth, at least for a time, to an extent that hurts Australia's terms of trade.

The Reserve Bank should not alter interest rates while global uncertainty is high. But goods and services inflation for the June quarter was again in excess of expectations and the mining boom is on track to make inflation worse. RBA governor Glenn Stevens has drawn attention to the way Australia's productivity performance has stalled. Strong inflation and stalled productivity are the key twins of economic policy. As with any twins, there can be interactions between them, for good or ill.

Stalled productivity creates inflation as cost pressures do not get offset by rising productivity. And if cost pressures rise, as they must as the mining boom gathers strength, inflation will become a larger problem. The many costs of inflation work against productivity, creating a vicious cycle of rising inflation and falling productivity, with stagflation the inevitable outcome. Sensible reform of industrial relations could help break this ugly cycle, but this will not be seen from the Gillard government, whose predecessor Labor government so enthusiastically re-regulated the labour markets.

Instead, what is on offer in the name of reform is a great big new carbon tax, intended to reduce CO2 emissions in the supposedly most efficient manner. Australia's economists almost to a man support this tax, arguing that it is efficient by definition in its supposed use of a price mechanism. The fault in this logic is that no other country has such a system.

A tax of $23 a tonne for the CO2 emissions of Australia's 500 greatest polluters will severely handicap Australia's most productive industries. Production, jobs and emissions will be shifted offshore to countries and competitor producers less concerned than the Australian government about the supposed costs of greenhouse gas emissions.

This is action guaranteed to reduce the productivity of Australian industry, increasing the strength of the stagflationary forces already evident.

As the Productivity Commission noted in its recent report to the government, "no country currently imposes an economy-wide tax on greenhouse gas emissions or has in place an economy-wide ETS". What is more, the same PC report noted that Australia's current policies, both in terms of effort to reduce emissions and in terms of abatement achieved, place us around mid-range among the countries analysed, rather than falling behind as the government claims.

This was despite the government omitting, from the selection of countries it asked the PC to examine, key competitors such as Indonesia, South Africa, Russia and Brazil, none of whom are acting on climate change.

As noted in the speech by Tony Abbott at the Economic and Social Outlook Conference in Melbourne on July 1, other countries are rapidly increasing emissions and moving away from putting in place economy-wide emission trading schemes. For example, the US has abandoned all moves towards a national cap-and-trade scheme; and at the same time as our 5 per cent emissions-reduction target would see us cut annual CO2 by around 50 million tonnes per annum by 2020, relative to current levels, China is projected (on the government's own figures from Ross Garnaut) to increase its emissions by over 100 times as much (over 5000 Mtpa), on top of an increase 50 times as large that has already happened over the five years to 2009. The silence of most economists at the conference in response to Abbott's speech was noticeable and deeply disturbing.

This effect of getting ahead of the world will be exacerbated by the uses to which the tax will be put. One use will be to pay officials to administer what is sure to be a complicated money-go-round, clearly unproductive.