Monday, 25 October 2010

Ponzi Government?

It was pleasing to see the burgeoning discussion of the problems confronting the State being attempted in the article Ponzi Government HERE.

But a lot of the assertions were either wrong or exaggerated.

To start with the title of the article is misleading. The current cash flow problems of the State Sector in no way resemble a Ponzi scheme.

A Ponzi scheme is best defined (from the ASIC site) as a scheme whereby “the promoter promises investors a very high return on their investment and says it is secure. Part of the money deposited by early investors is then used to pay their first dividend cheques or interest. The victims are more than happy to get high dividends. These schemes only require a few people in their early stages to be successful. The swindler continues paying them dividends for a couple of months until they are more comfortable with their investments, and decide to invest more”.

To liken the State’s problems to Great Southern and Bernie Madoff is not helpful.

The claim that “there is currently no money in the pension fund and all those contributions made over the years from the income of those employed and their employers have been ‘borrowed’ by the government for other purposes” is simply wrong. The Government has not borrowed any amounts set aside in any pension fund.

There is a widespread misunderstanding of how unfunded defined benefit (DB) schemes work. Most existed prior to the advent of the compulsory superannuation guarantee system. When the SG system was introduced employers whose employees were members of DB schemes were not required to make additional contributions if their existing level of support was sufficient to cover any SG requirements. Which it was in the case of the State DB schemes.
In order to cushion the cash flow effects of paying the employer share of benefits out of current income (currently about $170 million pa and which will probably peak at about $400 million pa in the next 15 to 20 years) the Government has been trying to set aside amounts to help meet future payments, not paying them to the Super Fund but rather setting them aside in a special deposit a/c known as the SPA a/c. It is these funds that the Government is using via a system of internal borrowings or IOUs as Ruth Forrest described them. Quite a sensible move if the amount can be repaid. But over the last year and over the period of the forward estimates the amounts being ‘borrowed’ are alarmingly high; almost $700 million in total.

But to describe the system of internal borrowings as “a criminal act and (elsewhere) the perpetrators would be behind bars” is simply silly. It will cause serious cash flow problems but it not near enough to prompt labels of bankruptcy.
Baseless assertions were also made that unlimited access to credit has caused the State’s problems and that the system of internal borrowings is analogous to the basis of the subprime crisis. I struggle to follow that line.

I also noticed one respondent to the article had a free kick at Keynesians’ supposed addiction to debt. My reading of the Treasurer’s Annual Financial Report for 2009/10 indicated total State Sector borrowings fell by $900 million over the last year. Total State borrowings were $800 million less than the figure flagged as the Estimated Outcomes in the 2010/11 budget. This is because Tascorp paid off a lump of debt late in the year from its cash reserves. I’m surprised that an analysis of the State’s debt situation overlooked this event.
Wage costs form the biggest component of outlays for the General Government sector. The figure of 53% of the current budget for the General Government sector is about right, but the figure of 70% in 5 years’ time must have come from the Book of Random Numbers. In P&L terms wage costs as a % of revenue will rise to about 56% in 2013/14. For the overall State Sector wage costs will rise about 1% over 4 years to 40% in 2013/14. Of concern, but not a reason for hysteria.

As soon as a rise in wage costs is revealed, Ronnie Reagan supporters trot out their recipes for reform. Cut the deadweight of Government, cut taxes free up the economy, let the invisible hand chart a path to Nirvana.

For a long time it was difficult to convince some people that the service sector was not just deadweight to primary and secondary industries and that it actually contributed to the economy. But the myth remains that “the larger proportion (of the public service)... adds little or nothing into the economy”. Their output is included in Gross State Product and measures of State productivity. It’s a matter of spending in the right areas not a simple matter that private outlays will automatically produce a better result than public outlays. It’s nonsense to pluck a figure of 20% as a desirable reduction for wage costs. There’s no such correct % for wage costs. Getting the optimum mix for health spending for instance could lead to higher GSP and higher productivity.
And that’s what we need to work on, greater participation and greater productivity whilst managing our cash flow. The latter task is becoming harder.

All 3 political parties have given tacit support to running down our cash reserves. It is only slowly dawning on the community what has happened.
But they all voted for the big spend on March 20. Regardless of the outcome of that poll the Budget bottom line would be the same. Pointing the finger at Mr Aird is pointless. The Greens also sit at the Cabinet table. As for the Shadow Treasurer, he is yet to apply his intellect to understanding our problems let alone postulating a solution, if his public utterances are any guide.

Yet there are continued calls for tax reductions, land tax and payroll tax, for more concessions, for GBE prices to be capped. The begging queue has no shortage of self interested accomplices.
Next year’s Tax Review will reveal how much people are seriously prepared to address our problems.

We are not bankrupt, or insolvent to use the more correct word. The Government has been severely remiss in not fully disclosing the rundown of our cash reserves and the long term effects. The Opposition parties have been mute and complicit.
The system of internal borrowings of available cash has got out of hand in the last year and will remain so over the period of the forward estimates.

The General Government sector has impending cash flow problems. But the broader State Sector is more stable with a more solid cash flow provided of course they don’t keep repeating some of the mistakes of 2009/10.
A better understanding and less hysteria might assist.

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