Lack of clarity on due diligence for GBR Foundation grant is a major concern

Today’s Courier-Mail includes opposing opinion pieces on the Turnbull government’s controversial $444 million grant to the Great Barrier Reef Foundation, which according to the author of the first opinion piece, Foundation Managing Director Anna Marsden, is the “lead charity” for the reef. The opposing opinion piece by Simon Black of Greenpeace Australia summarises the legitimate concerns that have been expressed over the wisdom of granting so much money without a tender process to a small not-for-profit, one which at the time had around six full-time and five part-time employees. Black reminds us that Foundation MD Anna Marsden once compared the grant to winning lotto. While the government rightly observes that it isn’t the first government that has granted such a large amount of money without a competitive process, that of course doesn’t excuse it. It is akin to the young child’s defence that whatever he or she did is OK because Jack or Sally did it also.

Moreover, I am particularly concerned that the grant appears to have been inserted into the budget process late in the day, and was not subjected to several months of scrutiny from central agencies (Treasury, Finance, Prime Minister and Cabinet) and Expenditure Review Committee ministers. A strong giveaway of the lack of appropriate scrutiny given to the grant is the obfuscation in the answers provided in the Senate Budget Estimates hearings in May. NSW Senator Jenny McAllister asked very pertinent questions of Finance Minister Cormann at Estimates, which the minister had to take on notice (see Question on Notice 23 May 2018):

Senator McALLISTER: I might pick up on some of those issues around the payment to the Great Barrier Reef Foundation. When was Finance first consulted on the proposal?
Senator Cormann: This is a proposal that is part of the budget process. I’m quite happy to take on notice consideration of the date as to when this was first considered. But you would, of course, appreciate that, consistent with convention, I’m not going to be at liberty to reveal the content of cabinet deliberations or deliberations of cabinet subcommittees.
Senator McALLISTER: Would it first have been brought to the Department of Finance’s attention before Christmas, as part of the portfolio budget submission?

McAllister was rightly trying to determine whether the grant would have been subjected to several months of rigorous scrutiny, or due diligence you may say, that many other budget proposals would have been subjected to. The answer eventually provided to the question Minister Cormann took on notice wasn’t illuminating:

It is a longstanding practice not to disclose information about the operation and business of the Cabinet, including details of matters that may have been raised in meetings of the Cabinet, as to do so could potentially reveal the deliberations of the Cabinet, which are confidential.

This was a disappointing response, especially considering government ministers and staffers regularly brief journalists on matters considered by the Cabinet (e.g. see this AFR report). It is the positions taken by ministers on Cabinet matters that are rightly confidential, to ensure ministers can debate vigorously in the Cabinet. With the possible exception of some national security issues, there is a strong public interest in knowing what matters are considered by Cabinet and when they are considered.

Since that question-on-notice response was provided, some important information regarding the timing of the development of the $444 million grant has been provided by Minister Frydenberg, particularly that the grant was discussed with the Foundation over the period 9 April to 22 April, following agreement from ERC, which was first presented with the idea of a “partnership” with the Foundation in March  (see this Guardian Australia report). It certainly appears that the development of the grant was rushed. Further information on the process underlying the awarding of the grant would be highly desirable.

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Is the Dutton Park high-rise high school really necessary?

David Gillespie, Brisbane State High School Council Chairman (and author of Free Schools and Sweet Poison) gave a terrific interview on the 612 ABC Brisbane Breakfast program (at 2:18:50) yesterday morning. He argued State High’s over-enrollment problem is due to the education department’s failure to ensure only students living in the school catchment (or who have obtained a place via selective entry) attend the school. There are many State High students who have at one time lived in the catchment—e.g. if their parents briefly rented a property in the catchment—but no longer do so. Because State High achieves such excellent academic results, largely because it offers many places to gifted students outside the catchment, many families move into the catchment area, often temporarily, so their children can enroll by right and avoid the competitive selection process. The result is a school that has reached its capacity, with a school population of over 3,000 students.

I agree with David Gillespie that the proposed new high school at Dutton Park, which is intended to take some of the load off State High, is probably unnecessary at present. It is not justified by population growth. It would be better to fix the policy failure underlying over-enrollment at State High than to build a new high school. Indeed, Gillespie questioned whether parents would actually send their children to the new Dutton Park high school, as they are already driving past reasonably good state high schools to take their children to State High. It could end up a white elephant. I was happy to hear Gillespie’s views as I have previously questioned why the Brisbane inner city area is receiving the largest amount of state education department CAPEX (see my state budget CAPEX post and chart below).

Capital spend by region for top 5 portfolios

Gillespie argues the solution is cracking down on enrollment rorting, so only children currently living in the catchment or who qualify for academic or sporting reasons can attend State High. I would suggest we instead apply economic principles. Having a large number of students wanting to attend State High shouldn’t be viewed as a problem, but as an opportunity. The state education department is missing out on an opportunity to raise revenue and to manage demand for places at the school at the same time. I expect it could raise parental contributions to State High to levels similar to private schools (e.g. $20K+ p.a. for Brisbane Grammar) for many families no longer living in the catchment. We know that parents value highly the ability to send their children to State High and this lifts house prices in the area (see my post Property market shows parents are willing to pay for high performing state schools).

Imposing additional fees on out-of-catchment students would help manage demand and could help finance the augmentation and refurbishment of infrastructure at the school. It would very likely be more efficient and cost-effective to manage the demand at State High through higher fees, possibly using some of the additional revenue to refurbish and expand some existing school facilities, than to build a new high school at Dutton Park.

To an economist, this seems like such an obvious solution, but there would no doubt be resistance to it on the grounds of fairness. I would respond that the current system is not necessarily fair. Those students lucky enough to secure a place at State High will receive a superior education to those at many other state high schools. If, as I expect, parents are willing to pay handsomely for the right to send their children to State High, why couldn’t they make an additional contribution to the cost of their children’s education, which could allow some funding to be re-directed to disadvantaged schools? Also, under the current system, taxpayers will have to fund the construction of a new high-rise high school at Dutton Park, at a likely cost of around $70-80 million (based on the budget estimate of the cost of the Fortitude Valley High School of $73 million). These funds may be better spent on poorly performing schools in outer metropolitan Brisbane or in regional Queensland.

On school funding issues, also see my posts:

Excellent proposal for school funding reform from ISQ head David Robertson

Qld private independent schools saving taxpayers $1 billion per annum

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CIS Ideas post on government size & economic growth paper by Makin et al.

I spent an enjoyable week visiting the Centre for Independent Studies in Sydney, and while there I was roped into drafting a short post for their regular Friday Ideas email. My post was on a recent conference paper by Griffith Economics Professor Tony Makin, my ESA Qld management committee colleague Julian Pearce, and Griffith econometrician Shyama Ratnasiri on the optimal size of government in Australia:

Cut government share of the economy

Here’s an extract from the post:

Prior to the Whitlam government of 1972-75, total Commonwealth, state and territory government spending in Australia was around 25% of GDP. In the four decades since the Whitlam government, it has been around 35%.

There is no question it would be good for the economy and taxpayers to reduce this burden.

The CIS has previously set a realistic target of reducing government spending to 30% of GDP, as part of its TARGET30 campaign. A new economic research paper presented at the recent 2018 Conference of Economists provides fresh support for this objective.

In The Optimal Size of Government in Australia, Makin, Pearce and Ratnasiri estimated the optimal size of government in Australia is around 31%. This represents the level that maximises economic growth.

The 2018 Australian Conference of Economists paper by Makin and co-authors (still to be peer reviewed and containing only preliminary results I should note) can be downloaded at this link:

The Optimal Size of Government in Australia

Note that local government spending (which I forgot to mention in my summary) is included in the figures referred to above.

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The Andrew Leigh-Sinclair Davidson company tax debate

In March, there was extensive media coverage (e.g. in the Guardian Australia) of shadow assistant treasurer Andrew Leigh’s company tax research which found companies paying lower effective company tax rates (i.e. actual tax paid/profits) did not create more jobs than those paying higher effective tax rates, and may actually create fewer jobs. The research paper was published in Economic Analysis and Policy (EAP), the online journal of the Economic Society of Australia (QLD) of which I’m Vice President, although this is a personal comment on my part, and I am not on the editorial committee of EAP.

I am very pleased that RMIT’s Sinclair Davidson has converted his critique of Andrew Leigh’s paper, originally published at Catallaxy Files, into a submission to EAP. Davidson’s paper has been published along with a reply by Andrew Leigh, which in my view doesn’t effectively counter the major criticism Davidson makes, that Leigh has used a mis-specified econometric model. The abstract of Sinclair Davidson’s comment is:

The paper presents a critique of the recent paper published in this Journal by Dr Andrew Leigh (Do firms that pay less company tax create more jobs? Volume 59, September 2018, Pages 25–28). Besides the model misspecification, omitted results and data availability bias of the regression used to inform the overall results, there are no controls for confounding factors that influence the effective marginal tax rate. These omissions are detrimental to the validity of the paper. This paper seeks to illuminate the sources of those errors and argues that the paper is sufficiently flawed that no weight should be given to its analysis when considering the potential consequences of a company tax rate cut.

I agree with Davidson’s conclusion. Indeed, as Judith Sloan pointed out in the Australian, it does not make sense to relate jobs created to the effective tax rate paid by companies in the way Andrew Leigh did, because the effective tax rate can differ from the statutory rate (i.e. 30% for large companies) for a variety of reasons, some of which would affect employment growth. So it would not be possible to say there was a one-way causal relationship going from the effective tax rate to jobs growth. A firm could have a low effective tax rate and low or negative employment growth for the same underlying reason (e.g. a previously poor financial position which means it can now take advantage of previous tax losses, but which would still make it reluctant to hire workers). In her Australian article, Judith Sloan was alluding to the fact the effective company tax rate is endogenous, which makes it perilous to estimate a relationship between the effective tax rate and employment growth. Judith Sloan noted in her Australian article:

What Leigh doesn’t seem to understand is that there is a variety of reasons why companies pay an effective tax rate below the statutory one.

Take mining companies that have made large investments. These companies will bring the cost of these investments to book over a long period of time, bringing down the rate of company tax they pay. You would also expect the number of jobs in those companies to be lower after the investment has been completed.

Andrew Leigh attempted to respond to one of Sinclair Davidson’s criticisms in his reply by including average profits in the regression equation. But econometric theory tells us this alone would not deal with the fundamental endogeneity problem that has probably given Andrew Leigh a biased and meaningless equation.

Andrew Leigh knows well the challenge of estimating causal relationships based on historical data from uncontrolled experiments, and it’s why he rightly advocates the analysis of natural experiments (e.g. in his work on the impact of the baby bonus on the timing of births) or the use of randomised controlled trials for policy evaluation. His EAP article should have been clearer about its limitations. In summary, Andrew Leigh’s findings are of questionable value to the policy debate over cutting the company tax rate.

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Economics of second best in energy policy

Australia’s energy policy is such a confusing mess that the Australian’s economics editor Judith Sloan actually supports the ACCC’s dubious call (in its Electricity Pricing Inquiry Final Report) for the Australian Government to act as a buyer of last resort for electricity, to help energy companies secure finance for new generation capacity. In her latest opinion piece, Sloan observes:

The one interesting recommendation of the ACCC’s report is that the government should operate a program to contract for low fixed-price generation capacity — around $45 to $50 per MWh — for the later years of new projects. These projects would in effect be sponsored by large industrial and commercial users but would be underwritten by the government.

Now, as reported in today’s Australian, the federal government is considering this proposal. Influential ministers, such as Queensland’s own Matt Canavan, see it as a way to support the construction of new high efficiency, low emission (HELE) coal-fired power stations.

Such industry assistance could only be justified as the economics of second best: using one market distortion to correct the economic problems caused by other distortions. To me, it looks like bad policy. We would be better off fixing the distortions which caused the mess in the first place, including public ownership of generation capacity and costly environmental schemes such as the premium solar feed-in tariff (44c/kWh in Queensland) and Small-scale Renewable Energy Scheme (SRES).

Much of the policy action needs to occur at the state level, in Queensland in particular. For example, we need to break up our price gouging power generators CS Energy and Stanwell and ideally privatise them, as recommended by the ACCC.

I would prefer we fix our current energy policy settings before the Australian Government commits to underwriting new generation capacity, taking a significant contingent liability on its balance sheet, the risk it will have to prop up unviable HELE coal-fired power plants in the future. This contingent liability would crystalise if substantial global action to reduce greenhouse gas emissions were agreed and followed through with in future decades.

I should say the ACCC deserves a high distinction for producing such a comprehensive analysis of electricity pricing in Australia and for generally sensible recommendations. But its proposal for government underwriting of new energy generation is not one of them. The ACCC is trying to correct one set of distortions by introducing a new one. This seems like folly to me.

accc_electricity_report

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A question you could ask RBA Deputy Governor Guy Debelle at ESA Qld business lunch on 22 August

Ten years after the 2008 financial crisis, economists are still debating whether the policy response at the time was excessive or insufficient (e.g. the excellent recent Macro Musings podcast with Larry Ball on the Lehman collapse) and whether banking needs further reform. In the UK and continental Europe, radical reforms to finance are being contemplated, including by veteran Financial Times columnist Martin Wolf, who last month wrote in support of the radical Vollgeld proposal put to a referendum in Switzerland (see Why the Swiss should vote for “Vollgeld”, which is behind a paywall, sorry).

Vollgeld would have prevented banks from lending out money acquired from depositors on a long-term basis to households or businesses. Instead, the banks would need to hold all the depositors’ money in reserve, in case depositors all wanted to withdraw all their money at once. This would certainly make the system safer, and would prevent banking panics and bank runs, but it would sharply increase the cost of borrowing, unless say the central bank stepped in as a lender to households and businesses, which appears to have been part of the Vollgeld plan. In my view, the Swiss were eminently sensible in rejecting this radical proposal, with 76 percent voting against it at the referendum last month.

That said, I acknowledge the 2008 financial crisis highlighted the too-big-to-fail problem with major financial institutions, which means government bailouts appear inevitable in times of financial crisis, and it is widely agreed this problem has not yet been fixed. So I’m pleased there is extensive debate about banking regulations, even if I disagree with many of the radical proposals.

Incidentally, one of the most interesting proposals for large-scale reform of banking has come from Australian economist Nicholas Gruen, who I work with from time-to-time on consulting projects. Gruen would have the RBA take deposits from households just as it takes deposits from banks. The RBA would also lend money to households against safe collateral (e.g. a home, but only up to 60 percent of its value). The justification advanced appears to be that the provision of bank accounts and payment services could soon solely be done electronically, and could be a natural monopoly which may be best placed in a central bank. As Martin Wolf, who referred to Nicholas Gruen’s proposal in his FT article on Vollgeld, noted:

“The technological reasons for branch banking are, after all, perishing quickly.”

Note that Gruen has posted a letter he wrote to the FT on his proposal at Club Troppo:

My letter to the Financial Times: All finance requires is an upgrade for the internet age

It would be good to know what the RBA thinks about proposals to reform the financial system along the lines of Vollgeld or the Gruen proposal. Fortuitously, for those of us in Brisbane, there is the opportunity to ask a very senior RBA official about these proposals at an upcoming lunch.

The Economic Society of Australia (QLD), of which I’m one of the Vice Presidents, is privileged to be hosting a lunch at the Hilton Hotel, Brisbane on 22 August featuring RBA Deputy Governor Guy Debelle:

ESA Qld Business Lunch – Guy Debelle, Deputy Governor of the Reserve Bank of Australia

There are still tickets available, and I would encourage you to attend if you can. The RBA typically does not announce the topics of its upcoming speeches, but there is no doubt the Deputy Governor’s address will be on an important economic issue and will attract much media and market interest.

guy-debelle

RBA Deputy Governor Guy Debelle

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My comments in Morningstar article on Australia’s “27-year economic winning streak”

One frequently quoted economic fact I think is a bit dubious is that Australia has had a record breaking expansion of 27 years. Although Australia avoided a technical recession (by not having two successive quarters of declining real GDP) during the financial crisis, we nonetheless had a significant downturn which saw the unemployment rate climb from a low of 4.0% in August 2008, the month before the Lehman Brothers collapse in September, to 5.9% in June 2009. Furthermore, Australia had a significant contraction in Real Gross Domestic Income in the first half of 2009 (see chart below), due in part to falls in commodity prices during the financial crisis.*

Given my concerns about the robustness of the 27-year economic expansion claim for Australia, I’m grateful to Brisbane-based freelance journalist Anthony Fensom for quoting me in his latest article for Morningstar on Australia’s economic record: Australia’s economic record outscoring rivals but for how long?** Here are some relevant quotes from the article:

…economist Gene Tunny warns that Australia’s economic sunshine will not last forever.

“Eventually there will be a downturn; it’s just the nature of the business cycle. We’ve learned that you can’t fine tune your economy to never have a downturn – that’s impossible,” he says.

Tunny, principal of Adept Economics, notes the impact of population growth on supporting Australia’s economy, unlike other advanced economies. He also notes the nation suffered an “income recession” during the GFC.

“Based on the data, we’ve grown every year, but it’s not as if we haven’t had any downturns – we haven’t completely eliminated the business cycle,” he says.

While Tunny notes the concerns around Australia’s high level of household debt and the risk of a global trade war or other geopolitical shock, he says conditions remain generally positive amid synchronised global growth.

Incidentally, I had an enjoyable chat with 612 ABC Brisbane’s Steve Austin last year on my experience in the Treasury during the worst days of the financial crisis in late 2008 and early 2009:

Interview with ABC Radio’s Steve Austin on “The time Australia’s Treasury almost ran out of money”

realgdigrowth

*Given the major impact changes in commodity prices now have on business conditions and government budgets in Australia, in my view we need to supplement GDP, which effectively measures the volume of production, with measures such as Real Gross Domestic Income which measures “the purchasing power of the total incomes generated by domestic production”, according to the ABS definition.

**Unfortunately, the link I originally had to this article no longer works. I’m trying to obtain a new one, but the article may be behind a paywall.

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