Address to the Brisbane Club, 11 March 2015

March 11, 2015

Let me begin with the central issue.  Australians live in a prosperous developed nation with high wages and a very high standard of living.[1]  We have a generous social welfare safety net which for the most part is carefully targeted.

While we are an enterprising market economy, progressive income taxes and means testing of virtually all working-age social payments result in much less inequality in after-tax incomes than comparable societies such as the United States or the United Kingdom.[2]

But wages, living standards and social safety nets in developed nations around the world are under pressure – from the need to reduce budget deficits given high levels of debt in many countries, from emerging market competitors to long-established industries, and from ageing workforces.

Australia is no exception.  So in the face of these pressures, how do we maintain our relatively high standard of living? How can we ensure our children and their children will have even greater opportunities and higher incomes than we enjoy?

We secure our future prosperity by embracing the future, not running from it.  By engaging with the world as it is, not as we want it to be or imagine it once was.  By making volatility and change our friend, not our foe.

We secure our future prosperity by being confident and not fearful, innovative and not complacent, and by being thoroughly Australian – disrespectful of authority, lacking in deference, unafraid to call it how we see it if current practice or accepted wisdom are not cutting it.  I am passionately committed to freedom of speech but if I was going to ban one phrase it would be ‘not invented here’.

We secure our future prosperity by telling the unadorned truth about the Budget – by honestly and accurately describing our circumstances, and setting out credible and fair options for bringing outlays and revenue back into balance.

Above all we secure our future prosperity by making sustained economic growth our central objective and ensuring we have a coherent and credible plan for achieving it.  Responsible economic leadership demands nothing less.

We must never forget, however, that economic growth or Budget repair are not goals in themselves but simply means to end.  Growth provides us with higher living standards and greater opportunities to freely to pursue our dreams.  Budget consolidation preserves flexibility and optionality for future generations.

I’ll get back to the Budget shortly but first let’s consider the bigger picture.

Australia in the world

There’s never been a more exciting time to be alive.   The pace of change, supercharged by information and communications technologies, is exhilarating. Every day, “the old order changeth, yielding place to new”.

Yes there are emerging challenges, especially for a medium-sized high-income market economy such as Australia.  But remember, we aren’t a minnow; we possess the 12th largest economy in the world.[3]  We’re creative, we’re innovative, and increasingly we think globally.

We need to be all of this and more, because times of increasing competition and rapid change are as much times of immense opportunity for the quick-witted as they are times of immense risk for the slow and the complacent.

The big engines of change in the world today are economic convergence (catch-up growth in emerging economies whose low skill workforces are now increasingly high skill),  global economic integration (underpinned by the Internet, sophisticated supply chains and logistics, and specialization) and rapid technological change.  Examples of their impact abound: 

●       The Apple iPhone 6 includes components made by 785 suppliers in 31 countries (none of them Australian) and accounts for about 5 per cent of Japan’s exports of electronics.[4]

●       The arrival of AirBNB increased the rooms available to visitors in Australia by about 10,000 without a single brick being laid or Government approval being granted.[5]

●       In calendar 2014 the number of active mobile wireless devices almost certainly passed the number of humans (7.2 billion) on the planet.[6]

Every day more jobs, industries and businesses in Australia become trade-exposed, competing with the rest of the world in a way that was unimaginable a few years ago.  Even in non-traded sectors, technological change is the great disruptor, from newspapers to taxis.

To succeed in this environment individuals and businesses need to be smart and nimble, productive and innovative, creative and global.  They need to see disruption as an opportunity to reach into other markets or become more efficient within our own.

The most advanced and technologically sophisticated economies tend to be very open, highly competitive markets.  Producers are specialized, compete on differentiation, and have intimate knowledge of customer needs.  There are strong linkages between complementary sectors and between businesses and universities, deep pools of skilled workers, executives and investors, and geographic clusters of high-value activity.[7]

These are attributes and characteristics that arise organically, through the behaviour and initiative of firms and individuals and the free operation of open markets, not by design.  They are way beyond the remit of Government – and should be.  An economy of this sort depends upon a dynamic and entrepreneurial culture that encourages innovation and diversity, tolerates risk and failure, and copes easily with uncertainty and ambiguity.

Governments can lead by example – for example in their own use of IT, or innovation in service delivery.   That’s why we’ve recently established the Digital Transformation Office which will ensure that all frequently performed transactions with Government can be undertaken digitally by 2017.  Remember the public sector is a third of our economy; every gain in productivity not only saves taxpayer dollars but lifts the productivity of every business or citizen interacting with it.

Governments can also contribute by maximising the impact of their spending on enablers that generate positive economic spillovers, such as education and skills, scientific and medical research, and infrastructure with clear, demonstrable economic or social returns.

An education system that encourages excellence but also focuses heavily on ensuring less able students receive the best possible training and skills is a particularly crucial enabler, as it is the less skilled cohorts of the workforce most at risk from a converging global marketplace.  Until now, we have increased Australia’s human capital by pushing a rising share of each age group through school, college and university; as process approaches its limit, it is by only by lifting the quality of education that we can compete.

The currently proposed deregulation of universities, which provides more flexibility and scope for specialisation, is also an important reform given tight linkages between higher education, research and business in countries with highly technologically sophisticated economies.

But in the end the key leadership in building a more diverse, adaptable economy must come from the companies and individuals whose success and achievements bring it into being.

The best contribution governments ultimately make is to get out of the way, except where they enhance rather than constrain the freedom and motivation that drive entrepreneurship and innovation.  Government must help set the table, not determine the menu or cook the meal.

That is why we are repealing Labor’s misconceived laws on employee shares which so disadvantaged start-ups.  It’s why we are repealing volumes of costly or obsolete red tape.  And it is why we are working to return the Budget to balance without tax rises that harm incentives.

The Budget problem

In September 2013 the Coalition Government inherited a Federal Budget that had been heavily in deficit for six years and was projected to remain that way for at least another decade.[8]

The immediate reason for the deterioration from the Budget position left behind by the Howard Government was not difficult to identify.  If we compare Peter Costello’s final budget in 2007-08 to Wayne Swan’s final Budget in 2013-14, we see that over Labor’s six years in office:[9]

●       Spending rose from $272 billion to $411 billion – an increase of $139 billion.

●       Revenue rose from $295 billion to $363 billion – an increase of $68 billion.

So under Labor, for every $1 in new revenue, the Government committed to $2 of new spending.

Dire as the recent past appeared, the near future looked worse.  Labor had committed to several high-profile promises that if delivered would vastly increase outlays over the next decade, with much of their cost conveniently hidden beyond the Budget’s four-year forward estimates window.

Kevin Rudd’s 2010 deal with the states to fund hospitals, Julia Gillard’s 2013 ‘Gonski’ reforms to schools funding, and the National Disabilities Insurance Scheme (NDIS) are the iconic examples. 

According to the Parliamentary Budget Office, these three types of spending will have a joint annual cost of $73 billion by 2023-24 (equal to 14 per cent of total Budget outlays).[10]

However well intentioned the policy goals – and the case for the NDIS, to take one example, is surely compelling – these heroic commitments were made just as a flood tide of revenue from the resources boom was ebbing away.  Now those promises stand out, like ships stuck on the mud, mocking the previous Government’s naivete for making them and our credulity for believing there was enough revenue to pay for it all.

But it wasn’t just new programmes. Spending on existing social payments was also projected to surge, in many cases reflecting wider eligibility, more generous rates or the inclusion of new services.  Consider these forecasts from the Parliamentary Budget Office:[11]

●       In 2003-04, at the start of the resources boom, the age pension cost $18 billion.  Last year we spent $39 billion.  A decade from now the cost of the age pension will be $64 billion.  Yes, there are more elderly Australians – but that is still a huge increase.

●       In 2003-04, the Government spent $1.5 billion on childcare and parental leave.  Last year we spent $7 billion.  A decade from now, we will spend $18 billion.  That twelve-fold increase is despite modest growth in the cohort of children with working parents.

●       In 2003-04, the Government spent $8 billion on Medicare.  Last year we spent $19 billion.  A decade from now, we will spend $34 billion.

How did spending rise so quickly, with even larger increases in prospect?  Why did Labor commit to costly new programs plainly beyond the capacity of the Budget to support without large tax increases?

How is it the International Monetary Fund, echoing our own Treasury,  judges we currently have a structural Budget deficit – that is, a deficit after adjusting to remove the effects of the economic cycle – of $48 billion or 3 per cent of GDP despite our having avoided recession during the GFC and enjoying our most sustained period of favourable terms of trade in history?

Essentially, because from 2003-04 to 2013-14 the Budget received an unprecedented windfall of roughly $460 billion, mostly on the revenue side, during the initial phase of the resources boom.[12]  Spending and tax cut commitments rose rapidly, at first in line with the windfall, and and then under Labor in excess of it.

Treasurer Wayne Swan, speaking a language just steps away from the angry class warfare of a century earlier, condemned ‘greedy billionaires’ and extolled the merits of new spending initiatives to ‘spread the benefits of the boom’ (forgetting the exchange rate had already done this).  A complacent optimism had washed over us like a comforting warm bath.

Unlike all previous booms this boom was going to persist.[13]  The Budget mused about prosperity underwritten by resources for ‘an extended period of time’.[14]  This time would be different.

Except that it wasn’t.

The nearly half-trillion dollar Budget windfall from the decade-long commodity price rally proved temporary, like all such windfalls, and ended emphatically with dramatic slumps in coal prices in 2013 and iron ore prices in 2014.  But as Chris Richardson at Deloitte Access Economics points out, the commitments governments made during this period to income tax cuts or increased expenditure, all premised on revenues no longer being collected, are permanent.

Or as the Secretary to the Treasury, John Fraser, said recently, echoing his predecessor: 

The reality is that Australia has spent its way to a structural budget problem. Government payments are growing faster than government revenues and without action, this trend will continue.[15]

So we’ve been living beyond our means, and since 2008-09 we’ve been borrowing to fund the shortfall.  Far from tightening our belts, however, under Labor we made grand plans to live even further beyond our means in the near future.

The inevitable result is debt.  When the Howard Government lost office the Federal Government had $45 billion of cash at the bank (equal to 4 per cent of GDP).  Seven years later, we are in net debt to the tune of $245 billion (or 14 per cent of GDP).[16]

If we allow this situation to continue we will put the security of every family and every business at risk.  The deficits continue, our debt and interest payments balloon - and all this at historically low interest rates. What happens when rates rise again, as they assuredly will?

When the global financial crisis struck in 2008 the fact that we had no net Government debt gave Labor virtually unlimited flexibility to respond with stimulus spending.  How will we be placed if there is another GFC-like episode but we have accumulated a mountain of public debt?

Labor’s position is that our debt is low compared to other advanced economies. What isn’t stated is that high debt levels are one reason those economies suffered during the GFC and have experienced so anaemic a recovery since.  Nor does it recognise that Australia is not like Europe or the US – we are a small economy dependent upon imported capital and exposed to massive external shocks.

Demographic change heightens these risks, as Treasury’s latest Intergenerational Report makes clear.  We know that as our population ages there will be fewer and fewer workers to support a swelling number of retirees.  Today there are 4.5 Australians aged 15 to 64 for each person aged 65 and over. In 2035 that ratio will be 3.2, and by 2055 it will be just  2.7.[17]  And it was 7.1 in 1970.

We know claims on pensions, aged care and health services are going to grow.  We could and should prepare by living within our means today.  But instead we are doing the opposite, passing onto our children not just the expense of supporting an army of retired baby boomers but also the cost of servicing the debt we ran up because we ignored the financial realities of our times.

Treasurer Joe Hockey’s  2014-15 Budget attempted to address these trends.  Evidently by doing so it disappointed many in the community.

A number of its most important measures, which would have generated savings over the forward estimates of more than $25 billion, have been unable to secure support from the Senate cross benches and have been abandoned or modified.

It is in no way correct to say that the 2014-15 Budget was a failure.  Many measures, amounting to a net saving over the forward estimates of $16 billion, have been passed.  But we clearly haven’t been able to achieve the degree of fiscal repair and reform that was and is needed.

Why have the Budget measures been such a battle?  At a mechanical, political level the answer is that Labor, the Greens and others in the Senate refuse to support them.  That is their right.

But it is to Labor’s enduring shame that as custodians of the Budget during a period when almost three quarters of the resources boom revenue windfall flooded in, they turned a starting point of $45 billion of cash into $245 billion in net debt by the time they left office.  In opposition, they then proceeded to block $25 billion of savings (including $5 billion they themselves originally proposed) while cynically and irresponsibly declining to offer a single alternative measure until the past week when they unveiled, perhaps predictably, a plan for higher taxes.

In the past fortnight, for the first time since the 2013 election, shadow treasurer Chris Bowen and assistant shadow treasurer Andrew Leigh have at least acknowledged there is a Budget deficit problem and promised an alternative plan.  We will see if they deliver.  The acid test will be whether Labor proposes a constructive alternative in the Budget-in-reply.

I hope they do.  We need an evidence-based, spin-free, fair dinkum debate about the Budget position and what we should do to fix it.  This May the spotlight will be on Bill Shorten and Chris Bowen as much as it is on Tony Abbott and Joe Hockey.

The more fundamental problem the 2014-15 Budget faced was that the public was not persuaded tough measures were necessary in the first place.

We – and I include myself and every member of the Government in this criticism – did not do a good enough job in explaining the scale of the fiscal problem the nation faces, and the urgency of taking corrective action.

In addition there was a deeply felt sense in much of the community that our proposed Budget measures were unfair to people on lower incomes when taken as a whole.

In my view the failure to effectively make the case for Budget repair was our biggest misstep, because it was a threshold we never crossed.

Once you’ve explained an issue often enough that people understand there is a genuine problem and “something” must be done, you can have an intelligent discussion about what that something might be - and just as importantly, your opponents will face public pressure to come up with their own “something” if they are not prepared to support yours.

But at least we have learned our lesson.  The Intergenerational Report released last week by Joe Hockey provides a solid platform from which to reboot the Budget debate, and educate the public about the need for action.

Economic management is how governments are judged

It is important for the Coalition to make progress on the Budget and economic reform.  In Australia, governments delivering good economic and fiscal outcomes are very rarely ejected.  John Howard’s defeat in November 2007 (at the hands of a self-professed fellow economic conservative who turned out to be anything but) is a striking exception.

Governments judged to be inept economic managers or presiding over recessions (even recessions caused by global events) on the other hand seldom survive the next election.[18]

At the heart of this issue is confidence. It is critical that the public have confidence economic management is in safe and competent hands.  That means policies need to be carefully thought through, painstakingly explained and be robust enough to withstand rigorous policy debate.

As I have said many times, the time for spin and slogans is over.  The Australian people want all of us in public life to respect them, by laying out the challenges we face clearly and accurately,  not insulting them with exaggeration or oversimplification.  They expect us to debate the options for dealing with problems honestly, transparently and with open minds.

This type of debate is a crucial element in allowing reform to be successfully achieved without exorbitant costs from compensating losers.  It’s how it generally was achieved in the so-called reform era between 1983 and 2007.

While the sequence varies from issue to issue, the case for a difficult reform typically involves: 

●       Highlighting a problem and clearly and repeatedly explaining the need for reform.

●       Calculating the costs of inaction.

●       Setting out the various options for change.

●       Discussing their respective merits and disadvantages.

●       Choosing the best option and devising a plan to implement it.

●       Identifying losers from change and to the extent possible assisting them to adjust.

Two examples of reform: the NBN and Australia Post

Let me briefly describe two instances of how I’ve followed this approach in my own portfolio, starting with the National Broadband Network.

With the NBN the first thing we threw out was ideology, lies and spin.  We told the truth about the project - with an independent Strategic Review completed three months after the September 2013 election, by publishing weekly rollout statistics, through requiring the company to provide detailed quarterly financial and operational reports.  In short we made NBN Co as open and accountable as a publicly listed company.

Only a few weeks ago the company published the true costs per premises of the NBN fibre to the premises rollout to date.  These costs were not $2200 - $2500 as was claimed by the former Labor Government in April 2013, but $3600.  When you take into account the capitalised costs of leasing ducts and pits (as one should) the total rose to $4300.  The increase from 2013 wasn’t a trifling misunderstanding.  Extra costs of that order add up to real money for a project serving roughly 10 million premises.

At the outset we explained our approach on the NBN was going to be pragmatic, focussed on delivering households the broadband they want and were willing to pay for.  Rather than engaging in theological debates about fibre versus copper versus other technologies, we would free the company to use whichever access technology enabled it to finish the job as quickly and cheaply as possible.  Most end users accept this approach - and are happy to forgo Labor’s fibre nirvana in favour of high speed broadband deployed sooner and costing less.

Let me turn to Australia Post. Its letters business has lost $1.5 billion since 2008.  The decline reflects high fixed costs and fewer and fewer letters being sent.  Losses on letters have overwhelmed profits on parcels.  If nothing is done the business will need about $6.6 billion of subsidies from the Budget over the next decade.[19]

Regrettably, prior to September 2013   Australia Post’s problems had been quietly kicked into the long grass.  Upon becoming Minister I asked Post’s CEO and Chairman to lay out the truth about its letters business in public, loudly and repeatedly and they did so.  We retained an independent firm, BCG, to verify the scale of its problems.  We engaged with employees, their unions, franchisees and customers both large and small.

So last week when we announced radical changes (stamp prices to rise to $1.00 and delivery times to slow down by two days) there was broad acceptance, despite the pain involved. 

The problem had been explained and, it seems, understood.  The concerns of stakeholders (employees, Licensed Post Offices and consumers, especially in the bush) were considered and addressed.  Our reform proposal had been flagged for months, nobody had come up with a better mousetrap, and so with regrets all around just about everyone involved accepted that the alternatives were even more painful, while this way, Australia Post does have a viable future.

With the right groundwork, reform is still possible. 

This is as true for the Budget as anything else.

[1] Organisation for Economic Cooperation and Development (OECD) online statistics show the average wage in Australia in 2013 was $US50,400 – 4th highest in the 34-member OECD.  The highest average wage in 2013 was $US56,300, in the US.  The UN Human Development Index, a measure of quality of life, ranked Australia 2nd in 2014, behind only Norway.  United Nations Development Program – ‘Human Development Report 2014’ – p.160.

[2] Prof. Peter Whiteford of the Social Policy Research Centre at UNSW notes the combination of progressive taxes and targeted benefits results in a large reduction in inequality from a modest welfare budget: “For each dollar of spending on benefits our system reduces income inequality by about 50 per cent more than the United States, Denmark or Norway, twice as much as Korea, two and a half times as much as Japan or Italy, and three times as much as France.”

[3] International Monetary Fund – ‘World Economic Outlook Database’ – Oct 2014.  In 2014 Australia’s GDP at market exchange rates was $US1.5 trillion.

[5] Robert Upe & Lane Sainty, Sydney Morning Herald  – ‘Tourists Find There’s Something in the AirBNB’ – 8 Feb 2014.

[7] The Business Council of Australia commissioned a paper from McKinsey & Co in 2014 that presents priorities and structural reform proposals to foster the development of a more sophisticated economy, and lift he global competitiveness of sectors where Australian firms have the potential to be internationally successful.  Like other similar research, the paper notes that many sectors of the Australian economy (particularly those which aren’t or until recently hadn’t been trade-exposed) are nowhere near internationally competitive at the present time.  McKinsey & Co for BCA – ‘Building Australia’s Comparative Advantages’– Jul 2014.

[8] Commonwealth of Australia – ‘Mid-Year Economic & Fiscal Outlook 2013-14’ – Dec 2013, pp.3-4.  The projected deficits assumed real spending would continue to rise at its annual rate of 3.7 per cent of recent years, not stay within the 2 per cent rule imposed (but not followed) by the former Labor government.   The post-election Commission of Audit came to broadly the same conclusion: Commission of Audit – ‘Towards Responsible Government: Report of the National Commission of Audit, Phase One’ – Feb 2014, p.x.

[9] Commonwealth of Australia – ‘Mid-Year Economic & Fiscal Outlook 2014-15’ – Dec 2014, p.266.

[10] The Parliamentary Budget Office (PBO) is an independent fiscal agency that provides advice to MPs. It is independent of Government and responsible to Parliament.  The NDIS cost $0.3 billion in 2013-14 but is forecast by the PBO to grow to $25 billion by 2023-24 (and over its first ten years require $149 billion).  Extra Commonwealth funding promised  in 2010 for public hospitals and in 2013 for schools (both traditionally largely paid for by the states) is harder to identify, since both were partly offset by cuts to existing programs, but hospital funding is projected to rise from $14 to $24 billion and schools funding from $13 to $24 billion over the same 2013-14 to 2023-24 decade. PBO – ‘Projections of Government Spending Over the Medium Term’ – Feb 2014, p.38.

[11]  PBO – ‘Projections of Government Spending Over the Medium Term’ – Feb 2014, p.38.

[12] Deloitte Access Economics – ‘Budget Monitor: Temporary Boom, Permanent Promises’ – Nov 2014, p.iii. According to the Deloitte Access Economics data:

a.        About $130 billion or 27 per cent of the windfall was received by the Budget between 2003-04 and 2007-08 under the Howard Government (which ran Budget surpluses of $75 billion over those five fiscal years and at no point recorded a structural Budget deficit according to the Parliamentary Budget Office).

b.       About $330 billion or 73 per cent of the windfall accrued to the Budget between 2008-09 and 2013-14 under the Rudd and Gillard Governments (which had the GFC to deal with, but ran six successive structural Budget deficits totalling $241 billion).

[13] The first phase of the boom (from 2003-04 to about 2013-14) involved record commodity prices, which lifted the exchange rate and terms of trade, greatly adding to Australian incomes and spending power.  The second phase (from 2005-16 to about 2017-18) will see about $500 billion or so invested in resources and energy production capacity (mostly for iron ore, coal and LNG).  This investment phase is now gradually subsiding.  A third phase – higher output and export volumes – is getting underway and should continue for decades.  Whether Australia benefits to the maximum extent from the production phase depends on competitiveness, however, as the sellers’ market in commodities is over.  Buyers can pick and choose, and given devaluations in Indonesia, Brazil and Canada, Australian producers face a more demanding environment.

[14] Commonwealth of Australia – ‘2006-07 Budget Paper No. 1’ – 9 May 2006, p.4-10.

[15] John Fraser, Secretary of the Treasury – ‘Australia’s Economic Policy Challenges’ – Speech to CEDA, 27 Feb 2015.

[16] Commonwealth of Australia – ‘Mid-Year Economic & Fiscal Outlook 2014-15’ – Dec 2014, p.266.

[17] Commonwealth of Australia – ‘2015 Intergenerational Report’ – p.99.

[18] Even Sir Robert Menzies, our longest serving Prime Minister, nearly lost office twice following economic missteps:

a.        High inflation in the wake of the Korean War commodities boom prompted a tough Budget in 1951, which successfully curbed price rises but caused a downturn and higher unemployment over the next two or three years.  Menzies hung on at the May 1954 election despite a Labor primary vote of 50.7 per cent.

b.       In 1960-61 another outbreak of inflation led to a so-called ‘horror budget’ with tax increases and spending cuts, and a squeeze on bank lending.  Menzies was again narrowly returned at the December 1961 election, this time overcoming a Labor primary vote of 50.5 per cent.

[19] Boston Consulting Group, 2014.

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