Nov

25

PM’s get out of jail card

November 25, 2009 | 4 Comments | Sam Wylie

Here is the text of my opinion piece in The Age today. 

The events of the GFC have snookered the Rudd Government.  The RBA is now raising interest rates to suppress resurgent inflation, but most the Government’s $95 billion stimulus package is still in the pipeline and cannot easily be reversed.  The Prime Minister and Treasurer have lost control of events, as monetary policy (interest rates) and fiscal policy (government spending) pull in opposite directions.  But they are not completely trapped – there is a way out.

The Government’s political problem is that rates will quite possibly rise month by month all the way through to the next election.  The RBA is likely to do 25 basis point increases, and 12 of those (minus January) gives a cash rate of 6.25% at the beginning of December 2010.  the RBA Governor Glenn Stevens in recent speeches, and the RBA Board in the October meeting minutes, have made it very clear that the inflation resulting from the resources boom that began in 2002, is unfinished business.  The RBA also wants to dampen house price growth. 

The cash rate was at 7.25% as recently as early September 2008, just 14 months ago, and a return to those levels is what it will take to contain inflation, especially given the level of fiscal stimulus still to come.  

The Prime Minister’s dilemma is that voters understand the connection between fiscal excess and interest rate increases.  Every passing month will put the GFC further back in the rear vision mirror and bring another rate rise.  The infrastructure spending components of the stimulus package are locked in, and the Rudd Government has not demonstrated the appetite for tough choices needed to cut spending heavily in the next budget, or any budget.  Rates are going up and the electorate will blame the Government. 

The PM’s get-out-of-jail card is compulsory superannuation.  The Government could introduce legislation to increase compulsory super contributions by 1% each year from 2010-2012 to take the level from 9% to 12%.  That increase would extract the government from its political dilemma and solve a range of major economic problems facing Australia. 

First, it would reduce the need for interest rate rises.  Prices are rising because aggregate demand it too high in the face of capacity constraints.  Increased super contributions would reduce aggregate demand and increase the supply the capital needed to expand capacity.  Superannuation savings, because of their long investment timeframe, are ideal for funding capacity expansion.

The Treasurer would argue for caution in tackling the GFC.  A relapse in global growth is a real danger.  But that makes the flexibility of a labour market approach to the problem all the more compelling.  The 1% annual increase in super in each year could be conditioned upon unemployment not rising above 7%, or some other level.

Second, a 9% to 12% rise would increase national saving.  Australia’s saving rate will soon move to centre stage when the Third Intergenerational report is released by the Treasury Department.  The need to increase current savings to smooth our transition to an older population, with fewer workers per retiree, will be highlighted.  A superannuation contribution increase would directly address the demographic problem of the ageing of Australia.

The intergenerational report will be followed by the Henry Tax Inquiry report which will suggest tax changes to increase savings rates.  But Henry’s hands have been tied in this matter by the PM’s promise not to increase the GST.  Increasing super contributions is the only other credible way of increasing the proportion of national income that is saved. 

Our low savings rate gives Australia a high current account deficit.  Westpac’s CEO, Gail Kelly, recently questioned whether funding the current account deficit through ever increasing bank borrowing in off-shore bond markets is sustainable, and many observers share her doubts.  Ms Kelly recommended that measures be taken to stimulate growth in bank deposits, but increased saving through superannuation would have the same stabilising effect.

Third, the time for action on increased superannuation contributions is now.  The peculiar circumstances of the GFC have given us a one off chance to get from 9% to 12%.  The GFC spawned a massive stimulus package, that was justified at the time of its conception, but is now the problem and not the solution.  The stimulus package cannot be easily reversed but it can be used to provide the aggregate demand needed for the transition from 9% to 12%.  If not now, then will it be an opportune time for this crucial change?

The pressing need for an increase in compulsory super contributions is widely accepted.  Over two thirds of the electorate believe that 9% super contributions are not enough to generate an adequate retirement income, according the recent poll conducted for the Association of Superannuation Funds of Australia.  That puts the Prime Minister is in the happy position of having a policy option that fixes a range of serious economic problems, solves his political dilemma and is seen as necessary by the electorate.  Let’s hope the PM plays his get-out-of-jail card soon.


Comments

4 Responses to “PM’s get out of jail card”

  1. kme on November 26th, 2009 10:30 am

    I agree that super contributions should be higher – however it’s not quite true that adjusting the GST is the only way the taxation change could encourage saving.
    The other way would be to discount (as with the CGT discount) or remove entirely tax paid on interest from savings.
    Currently a term deposit paying 7%pa is effectively only returning 4%pa, because the rest goes in tax.  That (combined with the preferential treatment of capital gains) creates an incentive to borrow-and-buy rather than save.

  2. Chris on November 26th, 2009 10:32 am

    I don’t disagree. Higher savings levels are definitely something to work towards.

    On the negative side of things, compulsory increases in superannuation would fuel potential asset price bubbles in property and the share market.

    Savings levels are low. Too low. But increases in the CAD are just as dependent on changes in the investment conditions in Australia. Over the past ten years, Australia has shown itself to be relatively micro-efficient and macro-stable, with a comparative advantage in mineral production. This has had a huge impact on investment.

    Increases in saving will close the  gap, but eliminating a CAD would signal a dramatic change in the underlying structure of the Australian economy.

    Also, we would get the inevitable, tedious and economically irrelevant political argument about whether employers or employees should stump up the cash.

  3. Zippy on November 27th, 2009 3:46 am

    We just finihed a review on Australia Super where we pretty much slam it.
    I’d be interested in your thoughts Sam
    http://www.zippy.com.au/super-aint-so-super-part-1/2009/11/

  4. Alan on November 27th, 2009 11:02 am

    I tend to agree with Chris’s comments about the possibility of fuelling asset price bubbles — this statement in the article,
    ” Increased super contributions would reduce aggregate demand and increase the supply the capital needed to expand capacity.”
    seems to assume that the additional super funds would be directed to productive uses. However, this is not necessarily the case.
    That said, I agree with the point that super funds are appropriate for funding measures to boost capacity.