Yesterday, Secretary of the Treasury, Martin Parkinson, gave another in a series of speeches that seem designed to give Australia no choices in its current trajectory towards the world’s largest quarry. This is a long speech and I can’t address it all but will take what appears to be its main purpose: trashing any idea of a sovereign wealth fund (SWF).
Parko sets up the discussion thusly:
Given the potential opportunities for our economy arising from the ‘Asian century‘ it is important that policymakers make the right decisions for the long term.
We need to continue policy settings that enhance the flexibility of the economy and improve productivity in a sustainable way.
Fiscal consolidation and efforts to boost public saving will allow for a considerable pipeline of mining investment to be accommodated in an economy close to full capacity. In addition, such actions help to create a policy buffer to
deal with an uncertain global environment, both now and in the future.We also need to ensure the entire community benefits from the once-in-ageneration mining boom. We are, after all, selling a non-renewable resource. If we don‘t use some of the returns to invest in other forms of capital – human, physical and financial – then we risk reducing the value of our national balance sheet in order to support current consumption.
To be clear, it is important that we don’t consume all the benefits today — such actions have characterised previous mining booms. So we need to not only ensure society gets an adequate return from these resources but also that it‘s used to build alternative forms of capital.
One proposal that has been generating considerable attention — including at the recent Tax Forum — has been for Australia to set up a resource-related sovereign wealth fund. Arguments for sovereign wealth funds are typically couched in terms of one of
three broad objectives:
• revenue stabilisation — shielding the budget from revenue volatility caused by swings in commodity prices;
• intergenerational equity — smoothing consumption and/or saving for the future, and imposing discipline on current government expenditure ; and
• limiting the extent of exchange rate appreciation.These are well intentioned and thought-out objectives, and sovereign wealth funds form part of the fiscal frameworks adopted by resource-rich countries such as Chile and Norway.
For example, under the Norwegian system — which is focused towards longterm savings — all petroleum revenues are paid into a sovereign wealth fund, with spending out of the fund limited to the estimated long-run rate of return on the accumulated funds. In contrast the Chilean system — which is focused towards stabilisation — ensures revenues from above-equilibrium copper prices are saved in the sovereign wealth fund, which can be drawn down when prices fall below equilibrium.
The different objectives and aims of the Norwegian and Chilean funds highlight the need for each country to approach the management of their resources endowments based on their own individual circumstance.
Just like Norway and Chile, our circumstances are unique — we need to look at our own economy and at the frameworks we already have in place. It is worth noting that technically Australia already has a sovereign wealth fund in the Future Fund, set up in 2006 to deal with unfunded Commonwealth superannuation liabilities, which has around two thirds of its assets invested offshore.
Further, Australia‘s compulsory superannuation system replicates some, though not all, of the elements of a long-term savings sovereign wealth fund. Established around 25 years ago initially under the Accord wage-setting process, it has transformed the saving and retirement income landscape in Australia.
Such is the size of the system that with total superannuation assets standing at around $1.3 trillion as at the end of 2010, or roughly the same size of the Australian economy, they are not that much smaller than Norway‘s sovereign wealth fund relative to the size of its economy. Similar to the role of a sovereign wealth fund like that in Norway, this stock of financial assets is continuously being built up, managed at arm‘s-length from
government and, given the tax treatment of superannuation savings and government co-contributions, there is a contribution from the annual budget into Australian‘s individual retirement savings accounts.Also similar to a sovereign wealth fund, saving through superannuation can ensure that more of the increased income being spread throughout the economy from Australia‘s resources is invested over a long period of time — rather than being consumed immediately — providing an enduring benefit even if increased incomes and resource revenues prove to be temporary.
The RBA estimates that four fifths of the mining sector is foreign owned. Therefore, four fifths of the dividends of mining go offshore. I’m all for foreign investment and bully for them. But let’s not kid ourselves about this being a ‘fair’ return for Australia’s future generations. There is also the costs of the boom, that the wider export sector must shrink to accommodate it, so there’s not much capital deepening in other sectors and indeed it’s one reason why 96% of corporate profit growth is contained to the ASX8.
The other benefits of the boom are also diminishing. Much of the investment benefits are in the early stages of development so are also temporary. The RBA came clean last week in the SoMP that the LNG boom is doing bugger all for local production because we simply don’t make the inputing goods. So no capital deepening there. No, government royalties and corporate tax revenues are the key redistribution mechanism for future generations.
Which is precisely why many smart folk are calling for an SWF, because the private sector isn’t. Back to Parko:
So what is driving the calls for Australia to adopt a sovereign wealth fund? While well-motivated intentions lie behind the calls for a sovereign wealth fund, closer examination suggests different commentators are actually seeking to achieve markedly different outcomes.
Some, for example, are trying to achieve a greater share of the returns from the mining boom going to society via a broad sovereign wealth fund. Others want these returns to be held and used in ways that increase investments in human and physical capital over decades — hypothecated wealth or endowment funds. That is, long term savings or sustainability roles.
And occasionally, it is suggested the sovereign wealth fund should be held offshore to ease pressure on the exchange rate and on the non-mining sectors of the economy.
So let‘s consider a couple of these issues in the Australian context.
Long-term savings and sustainability
As Norway has demonstrated, a sovereign wealth fund can be effective in helping to achieve long-term savings and sustainability. The sustainability approach behind Norway‘s sovereign wealth fund involves building up a stock of financial assets over an extended period of time, and then using the earnings from these financial assets to supplement the annual budget, while preserving the principal value of the fund for the long term. In building up this fund, Norway has converted some of the revenue from the sale of its oil into a stock of financial assets.Importantly, Norway is able to receive an appropriate return from the extraction of its natural resources that is sufficient for it to ensure that these non-renewable resources are able to provide income for generations into the future.
So the issue is not so much the existence of the sovereign wealth fund per se as an appropriate sharing of the returns from its resources and a commitment to long-term income smoothing.
See above. Back:
Exchange rate sterilisation
Can a sovereign wealth fund materially limit the resulting exchange rate appreciation from the mining boom by investing in foreign assets? Firstly, it is important to note that the exchange rate is an important agent in the longer-term structural adjustment process. That allows us to benefit from this once in a century increase to our national wealth. In seeking to artificially adjust the level of the exchange rate, we would, in effect, be aiming to undo such structural adjustment — potentially holding us back from benefiting from this higher wealth. Further, as I highlighted earlier, the appreciation in the exchange rate is important in spreading the gains from the boom across the economy.However, if we still wanted to limit the appreciation in the dollar, could we? The Australian dollar is a considerable player in the global monetary system —we have the fifth most traded currency in the world. One way of gauging the underlying demand for Australian dollars is the sum of our current account receipts and gross financial inflows — this amounted to around $445 billion in 2010-11.
Investing surpluses of, say, 1 per cent of GDP in foreign assets would amount to around $14 billion per year in current dollars.
Therefore, it is unlikely that purely investing in foreign assets alone would have any lasting significant impact on the exchange rate.
Sovereign wealth funds and fiscal policy
A key point to note about sovereign wealth funds is that the issue is not just about the establishment of a fund per se — a sovereign wealth fund is just like a bank account — but its combination with different fiscal strategies.The act of paying down net debt out of future surpluses is identical to accumulating financial assets in a sovereign wealth fund. It has the same effect on the government‘s balance sheet and the level of public saving.
Efforts to reduce government net debt should be the immediate focus – whether this is done by reducing gross debt on issue, or maintaining gross debt but building up financial assets, in a sovereign wealth fund, is an important but second order issue.
Credible medium-term fiscal strategy can effectively guide budget policy outside of mining boom conditions. Accompanied by a firm understanding of how a mining boom is impacting on revenue, including ensuring an appropriate return from the extraction of these resources, such strategies can perform a similar role in the current environment.
I am not suggesting that a sovereign wealth fund is not without merit, just that we should be clear about the role that it can and should play. Given the time that will be required to reduce net debt, we have time to consider further the merits of a sovereign wealth fund – our first priority needs to remain fiscal consolidation.
I’ve taken these last two together because I have the same objection to both. That is, both take the status quo and use it to corral the discussion about the effects and possibilities of an SWF. My idea for an SWF is to boost revenues first through a big, fat mining tax. Big enough to slow the mining boom a smidgen, hence the possible impacts on the dollar are much larger. So too are the effects on industrial diversity. So too are the effects on government revenues and the potential to go beyond paying down debt.
In that light, I just have one question for Captain Parko. If talk of an SWF is all so unnecessary and we’re already capturing a righteous slice of the boom, why did your predecessor propose a resource rent tax that aimed to collect $100 billion more for the government over the next decade?
