Wayne Swan last week announced that he had finalised details of the Mining Resource Rent Tax (MRRT) following the Government’s industry consultation. Whether or not the MRRT will pass is up in the air. However, the design of the MRRT misses an important opportunity for Australia to take advantage of high commodity prices and a boom in demand from Asia to create a sovereign wealth fund for future times when things may not be so lucky.
The interconnected global economic system is marred by uncertainty arising from the complex natural and human systems that pervade the world in which we live. In this uncertain global system, Australia has been extremely lucky. While other industrialised countries battle with unused capital capacity and high unemployment, Australia has been riding a wave of high commodity prices, coupled with steaming demand for those commodities from emerging Asian economies. As much as contemporary government leaders and corporate interests may wish to claim credit for this economic success, the reality is that simple good fortune has made a decisive contribution to this fecund domestic economic environment.
But past success based on luck is not a predictor of future success based on luck. It is extremely difficult to predict, or model, what the future holds. Good policy is thus about long-term planning, not in a way that presumes what the future holds, but in a way that implicitly recognises the uncertainties inherent in the global economic system. Good policy is also about exploiting the good times in a way that ensures we can cushion the impact of inevitable bad times.
Mere pessimism is not the only thing driving concern that the commodities boom in iron ore, steel and coal markets (to name but a few) is unsustainable. Some economists are now arguing that artificially high prices are being generated by speculative behaviour driven by access to excess liquidity thanks to loose monetary policy in the US. Other analysts contend that there is no speculative bubble and price increases are instead an indication of general inflationary pressures. Yet other economists argue that commodity prices are rising because they are, by their very nature as finite goods, in short supply.
The commodity price bubble could burst, it may not. India and China — two of the largest markets for commodities — may be overheating economies, or they may not. Whatever the analysis, one thing is clear: Australia cannot go on relying on the good fate of commodity demand from India and China, along with ever increasing commodity prices, to perpetually underwrite its ongoing economic prosperity. We should take advantage of our luck and invest the revenue from our commodity boom into an offshore sovereign wealth fund for future times when we may not be so lucky.
There are potentially significant benefits to setting up a sovereign wealth fund that invests in diversified foreign assets. First, diversifying our investment offshore will help protect us from unexpected events that may cause a domestic down-turn. Secondly, the commodities boom may be overheating the Australian economy. In such a time, as RBA Board member and prominent economist, Warwick McKibbin points out, it is wise not to recycle any revenue from the MRRT back into the domestic economy. Offshore investment will also take some of the heat of the domestic economy, and our foreign exchange rate that could be crowding out the competitiveness of non-mining sectors.
However, the creation of a fund that does not invest locally should not be viewed as a substitute for continuing immediate strategic investments that enhance the Australian economy’s global competitiveness.
The voices to set up a sovereign wealth fund are coming from all corners, except, perhaps surprisingly, from the federal government. Business economists including Commonwealth Bank chief executive Ralph Norris, UBS investment banking chief Guy Fowler, and BT Investment Management equity strategist Crispin Murray have recently pointed out that at some point our current booming economic cycle will end and we need to invest in a buffer. McKibbin, whose commentary draws attention to the uncertain nature of the world economy, has been a persistent advocate of a sovereign wealth fund. Even the Greens notionally support this policy. Norway, the United Arab Emirates and Saudi Arabia, all major commodity exporters already invest heavily in off-shore funds each amounting to hundreds of billions of dollars.
The Howard government did establish the Future Fund in 2006. The Fund is now worth an estimated $71 billion but was comprised of a one-off investment with the very limited purpose of funding Australia’s public-sector superannuation liabilities. In fact, much of the surplus achieved under the Howard government was recycled back into the Australian economy through tax cuts, missing the opportunity that budget surpluses provide for saving for bad times. The Rudd government did not do much better; channelling fiscal revenue back into the Australian economy through it’s larger than required stimulus package.
Despite the sound economic arguments to channel MRRT revenue into an offshore fund, it seems that Swan has already slated the revenue to be channelled back into the domestic economy. In his own words, "to invest in infrastructure and to cut the corporate (tax) rate among other things". This is a missed opportunity by the Gillard government to "future proof" Australia, so our children and their children can enjoy the same (or superior) standard of living that we do.
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