ECONOMIC AGENDA: Cut the deficit while boosting infrastructure
by Patrick J. Byrne
News Weekly, June 7, 2014
Treasurer Joe Hockey could cut his infrastructure budget by $50 billion, while establishing an Infrastructure Finance Corporation to put hundreds of billions into developing the nation’s infrastructure.
The Treasurer’s heavy cuts in the recent federal Budget are aimed at reducing the budget deficit and overall government debt.
It’s proving extremely unpopular, with the ALP well ahead of the government in polling.
Invariably, deep budget cuts will drive up unemployment, which will reduce the government’s tax base while increasing welfare payments to the unemployed.
Many dispute the Australian Bureau of Statistic’s low unemployment figure of 5.8 per cent, because it defines unemployment to include only those people working less than one hours paid work per week.
Roy Morgan polling calculates the average unemployment rate over the last three months at 11.6 per cent.
So, if the government wants to cut the budget, and not create even higher levels of joblessness, it needs to find substantial ways to boost investment in the economy.
Creating an Infrastructure Finance Corporation (IFC) — i.e., a government-backed development bank — for this purpose is not rocket science.
Germany has a dedicated development bank, the Reconstruction Credit Institute (KfW), which in 2013 had a balance sheet equivalent to AUD$648 billion.
An IFC would allow Treasurer Hockey to cut the budget deficit immediately by $50 billion.
It could also help to reduce state and local government deficits, by taking over some of their long-term financing of long-term infrastructure investment.
Mr Hockey argues that government debt robs future generations who will have to pay back the debt through their taxes. However, the reverse argument applies when infrastructure is financed out of the budget. Financing long-term infrastructure from today’s budgets takes from today’s taxpayers, but bequeaths the subsequent assets free to future generations.
When new railroads, ports, airports, water storages and roads are paid for entirely by today’s taxpayers, the future generations using these facilities are getting a free ride.
For the sake of inter-generational equity, long-term infrastructure should be financed using long-term loans. In that way, the future generations benefiting from the asset can share in paying off the cost of the investment.
Currently, the Commonwealth government doesn’t have a way of doing this. Rather, it is planning to finance infrastructure programs from a combination of sources: taxpayers and asset recycling, i.e., selling existing government infrastructure and reinvesting the money in new infrastructure. Their user-pay plans will see the burden fall on current and future users, but that can be a costly means of financing such projects.
So, getting investment in infrastructure right can benefit governments and taxpayers for generations to come.
As a former deputy secretary of the Department of Trade, Colin Teese, pointed out in his most recent article, the Bank of England is the oldest reserve bank in the world. Recently, it devoted two articles in its Quarterly Bulletin (2014, Q1) to explain with great clarity — and to sort out the confusion over — how reserve banks and commercial banks create money.
The Bank of England has declared that it is a myth that banks act simply as intermediaries between savers and borrowers. Neither do they “multiply up” central bank money to create new loans and deposits.
Rather, money is mainly created in two ways.
First, commercial banks create money by making loans to customers. These loans are expunged when borrowers repay their loans.
While commercial banks can create money as loans at will, central banks manage the overall amount of money in circulation.
Reserve banks “manage up” the official interest rate to restrict lending, or “manage down” interest rates to expand commercial bank lending.
The official interest rate is the rate charged by the reserve bank when it settles accounts on a daily basis between the commercial banks.
Currently, the Reserve Bank of Australia (RBA)’s “official rate” is 2.5 per cent. In Japan the official rate is 0.10 per cent; the USA, 0.13 per cent; the Euro Area, 0.25 per cent; and the UK, 0.5 per cent.
Banks then set their commercial interest rate several percentage points above the official rate. So an Australian bank paying the official rate of 2.5 per cent on its settlement account with the RBA, then charges, say, 5.3 to 5.8 per cent on a housing loan.
Secondly, in times of crisis such as the 2007/08 global financial crisis, reserve banks can undertake “quantitative easing”, i.e., using cash to buy government and corporate securities, thereby injecting spending into the economy.
The Bank of England’s model is important for how an Australian Infrastructure Finance Corporation (IFC) could be funded and operated. The IFC could be authorised to create and lend money, just as commercial banks create loans for customers.
Also, because the IFC would only be financing long-term infrastructure projects, the RBA could charge a lower official rate for the IFC than for Australia’s commercial banks, i.e., for the purpose of funding its daily settlements with other banks. It could be set between zero and 0.05 per cent, within the range currently set by reserve banks in Japan, the USA, the UK and in the Euro Area.
Such funding arrangement by the RBA would allow the newly-created IFC to finance infrastructure projects for 30 to 50 years, at low interest rates, spreading the cost across the generations who would benefit from these projects.
This method would allow governments to fund and construct major projects, while retaining in public hands these major assets as they earn a return for the government.
These would be assets on the government’s balance sheet and not liabilities. The more assets the government holds, the more it brings down the government’s net debt.
Further, getting infrastructure investment right “will make a significant contribution to lifting productivity”, according to a report by the Business Council of Australia, done in conjunction with Price Waterhouse Coopers.
The report said that, given “Our population is expected to grow from 23 million to 38 million by 2050 and our cities are set to almost double in size, … productivity growth of at least 1.6 per cent a year will be needed to maintain solid growth in national income.
“Infrastructure is needed to keep pace with these changes, and while private and public investment have risen to historically high levels of about 4 per cent of GDP in the past decade, just maintaining this spending rate for the next 10 years will cost at least $760 billion”, the report said.
Patrick J. Byrne is national vice-president of the National Civic Council. The printed edition of News Weekly contained a shorter version of this article.
 Michael McLeay, Amar Radia and Ryland Thomas, “Money in the modern economy: an introduction”, Bank of England Quarterly Bulletin: Q1, Vol. 54, No. 1 (2014), pages 4–13.
Michael McLeay, Amar Radia and Ryland Thomas, “Money creation in the modern economy”, op. cit., pp.14-27.