‘Interview with Michael Short, opinion page editor of the Melbourne Age newspaper, published in his column ‘The Zone’

Michael Short: Saul Eslake, welcome to The Zone. Thank you for your time. You have been one of Australia’s leading economists and public policy analysts for a quarter of the century. Ahead of the election, I am using The Zone to examine policy issues, and today we’re going to discuss a couple of key areas, some of them tax-related, but generally under the rubric of what we ought to be talking about at the macroeconomic level. Can we start, please Saul, with an overview of the size of Australia’s government sector? If we listen to the political rhetoric, one might be forgiven for thinking we have a high-taxing, big-spending government. Is that the case really when we compare Australia to other industrialised economies, with, for example other OECD countries?Saul Eslake: By OECD standards we have a relatively small public sector. We are at the bottom end of the 30-odd OECD countries, and only Mexico, Turkey and Chile would have clearly smaller public sectors than ours, and in many senses those are still emerging economies rather than fully advanced economies. Our public sector is about the same size as a proportion of GDP as the US, Japan and Switzerland, and it’s a lot smaller than most European OECD economies and a bit smaller than New Zealand’s.

There are a couple of qualifications to make, though, because those figures come from figures for public spending as a proportion of GDP. First, we do some things through the private sector that in other OECD countries are done in the public sector. The best two examples are compulsory superannuation and private health insurance. If you were to add the spending that households do on those two things to the taxes they pay, then we would be closer to more OECD countries than we are.

The second thing is that, unlike most other OECD countries, we actually export to and compete with many non-OECD countries, particularly in our region. We should not draw exact parallels between ourselves and places like Hong Kong, Singapore, China, Korea and the like – because we have different expectations of government from the people of those countries.

Nonetheless, when we’re looking at the impact that government activities have on the competitiveness of businesses, we at least have to be conscious of the fact that our public sector is bigger and costs proportionately more than countries in the region to whom we sell things and with whom we compete.

MS: We can back to that momentarily, Saul, when we look at the scope we have for change with economic policy. Just as a sort of postscript to that discussion though, as far as I am aware, notwithstanding the perceptions that political leaders might have us grasp, the size of the former coalition government and the current Labour-led minority government is roughly the same in terms of taxing and spending.

SE: It is roughly the same. Government spending is a bit higher as a proportion of GDP now than it was during the final period of the Howard government. Tax as a proportion of GDP is a bit lower than it was in the final term of the Howard government, and of course part of the reconciliation of that apparent discrepancy is that the Coalition was running surpluses, while the present government has been running deficits as of course have most of the states during the last six years.

MS: That is a good segue into the next question I wanted to ask you Saul, because the fiscal debate in recent years has been a little Orwellian, in the sense deficits bad, surpluses good. Should not that debate be a little bit more nuanced? Should it not perhaps take into account the state of the domestic and international economies, and where the cycles are and where the risks are?

SE: Absolutely it should, and I don’t think any credible economist would say anything different.. In the Australian context, a sensible guide to fiscal policy over the medium-to-longer term would be to say that we should aim to run modest budget surpluses on average over the course of the cycle. By modest, I mean something like one or two percentage points of GDP.

I say we need to run surpluses on average over the course of the cycle because we are a nation that needs to borrow from the rest of the world in order to fund a level of investment that, as a proportion of our GDP, is higher than in most other advanced economies, and in circumstances where we as a nation choose to save a bit less than some other economies. In order to attract capital from abroad, we need to be able to borrow – and having a sound public sector financial position is an important part of allowing us to do that relatively cheaply. But here is where the nuances come in – there are two important ones.

First, the appropriate position of the budget at any given point of time depends on where we are in the economic cycle. It is appropriate to run budget deficits when the economy is either in recession or growing at a below-trend pace and unemployment is rising. And it is appropriate to run bigger surpluses than you would seek to do on average over the course of the cycle at the height of booms such as we had in the five years leading up to 2007/08, leading up to the financial crisis.

One of the criticisms I made in the years leadning up to the financial crisis, and where I had a very little company, was that although the Howard Government was running budget surpluses, in my view the surpluses weren’t as big as they should have been, having regard to where we were at the time.

The second important nuance is that whether a budget deficit is “good”, whether public debt is “good “or not, also depends on what the borrowings are used for. There is a world of difference between borrowing to fund recurrent expenditures, which is usually a bad thing, and borrowing to fund capital expenditures or infrastructure, which can be a good thing – indeed can be a very good thing, if the infrastructure spending is well-targeted and rigourously evaluated and meets genuine long-term economic needs.

MS: Let’s head to the policy agenda, but en route let’s just start with looking at a summary, if you will, of what shape the economy is in, and perhaps you could include in there what shape the Australian fiscal situation is in, and the outlook for the Australian economy?

SE: By comparison with most other advanced economies, the Australian economy is still in pretty good shape. We are now more than 22 years out from our last recession. Not only is that the longest period Australia has ever gone without having a recession, but it is probably one of the longest periods any country in the world has ever gone without having a recession.

Our public finances likewise are in good shape by comparison with the major advanced economies, although they are not in as good a shape as some of the smaller advanced economies such as the Nordic ones, or some other commodity exporting nations who have benefited like we have from the decade of very rapid growth in China and the commodity demand that has generated. I’m talking here of economies is like Chile and Peru, which are middle-income or lower-to-middle income developing economies, but like us have also derived a lot of benefits from the commodities boom, and they are big net creditors not net borrowers.

So from that point of view, things are pretty good. We have low inflation, we have low interest rates, and by comparison with most other western economies we have low unemployment, although unemployment is now rising. That state of affairs is the result of a combination of good luck and good management. We have had pretty good economic management over the last 25 years, both at the macro level, in terms of dealing with international and domestic challenges, but also, at least in the late 80s and through the 90s, at the micro level.

We have had good structural reforms that have helped lay the foundations for this extended period of economic growth, including through the financial crisis. We’ve also had quite a bit of good deal of luck, especially by comparison with the previous 80 years. For most of Australia’s history since federation, our terms of trade went down – that is, we got less by way of export income for every given amount that we had to pay for imports. And that was one of the reasons why our per-capita incomes fell relative to those of most other western economies from the end of the Second World War, indeed some would say from about 1900, until they reached their low point in that sense in the late 1980s or the early 1990s.

One of the things that has helped improve our relative economic position has been that from the early 90s and particularly from the early years of the past decade our terms of trade have been rising, up to their peak in 2011, as Chinese economic growth drove up the prices of the things we sell and drove down the prices of many of the things, particularly manufactured goods, that we buy, not only from China but from other producers.

That period is now drawing to a close. Commodity prices, our terms of trade, have been falling since late 2011. We’ve been through the biggest investment boom in our history, and that has accounted, I think, for about a third of our economic growth since mid-2009. That boom I think peaked if not in the second half of last year then is in the process of peaking now. As the mining investment boom draws to a close over the next couple of years, one of the major challenges we face is sustaining the sort of growth we need to prevent the unemployment rate from rising.

And the Reserve Bank and the government have been trying to nurture other sources of growth. Exports of resources products will obviously come pretty naturally off the increased capacity that this investment boom has created, but that certainly won’t creat enough growth, and definitely not enough employment, by its own to fill the hole that will be left by the decline in mining investment.

We need to see faster growth in other components of domestic demand, particularly housing and non-mining business investment, if we are to keep the economy on an even keel and prevent the unemployment rate from rising. That is proving to be a more difficult task than many had assumed, partly because of the persistent strength of the exchange rate.
Even though that has come down by around 11 or 12 cents since the beginning of May, it is still high by historical standards and business is still very uncertain as to whether the recent depreciation will be sustained or continued.

The other traditional instruments of economic policy, like cutting interest rates, are not working in the way that they have done historically – because in the aftermath of the financial crisis, and given the high levels of debt which many households have, they do not want to take on any more debt. They are trying to pay it down more quickly using lower interest rates to help them do that. So we do have a dilemma in that respect. It is also complicated by the fact that for a whole lot of reasons that are too complex to go into here, the budget is not returning to health in the aftermath of the financial crisis as quickly as it has done following other periods of weak economic growth.

The government is repeatedly finding that its estimates of revenue have proved too optimistic, and they are having to implement a series of measures on both the revenue and spending side of their budgets to meet the commitments they have previously given to return the budget to balance and eventually to surplus. All of those decisions can have, and in some cases have had, negative impacts on economic growth and employment at a time when both have been fragile.

MS: And that takes us back as a good example to the point we were talking about a moment ago about the lack of sophistication in the fiscal debate. Had those commitments not been made, and they were made for political reasons, the government would have more flexibility to deal with the situation your answer is setting up and where we’re moving now, which is what ought the policy agenda be in light of the shape of the Australian economy you have described and the outlook you have pointed to. Let’s start with housing, because you brought that up as one of the things the reserve bank and the government would like to see stepping up to take over some of the weight that has been carried by the investment phase of the mining boom. But before we look at the broader housing situation, can we look at negative gearing, Saul, as something that is in need of change, that should be on the policy agenda, something that is perhaps an example of the first law of public policy, which is that the pig with its snout deepest in the trough squeals loudest when you try to pull it out? Last time somebody tried to do something about negative gearing there was a god-awful row and things didn’t go well. But before we look at the history of negative gearing, can you please just describe what negative gearing is, how it works, how much money is involved and how many people are involved?

SE: Negative gearing is a term that you actually have to explain when talking to foreigners, because to them the idea that an investor would deliberately incur a loss – that is, in the case of a property investment, to borrow so much to fund the investment that the interest on the borrowings exceeds the rental income on the investment. – seems incomprehensible.

You have to explain to a foreigner why on earth anyone would do that. And the answer, of course, is because the Australian tax system makes that an eminently sensible thing for an investor to do. What negative gearing allows people to do is to convert income that would otherwise be taxed at their ordinary marginal rate, which for high-income investors would be 45% plus the Medicare levy, and, by having interest exceed the running income that that investment produces, in effect reducing their tax payable now with a view to having the income produced by the property being taxed as a capital gain when it is eventually sold, at half the taxpayer’s marginal rate.

So there are actually two benefits for an investor out of this. One is the deferral of tax obligations – and money that you have to pay in X years time is clearly worth less than money you might have had to pay now. The second thing is the halving of the tax that you would have otherwise have paid on that income now. So it is a double-edged benefit. The benefits of negative gearing to investors were certainly enhanced by the Howard Government’s 1999 decision, supported at the time by the Labor opposition, to halve the rate of capital gains tax.

That turned negative gearing from what had long been a vehicle for deferring tax into one that was useful for both deferring and reducing the total amount of tax paid. And it is not surprising that in the years following the halving of the capital gains tax rate, the number of Australian taxpayers availing themselves of these provisions jumped to more than 15% of all Australian taxpayers – that is, well over 1 million people. That of course is one of the reasons why neither side of politics wants to touch or talk about this.

Those 15% or so of Australian taxpayers vote, and they would probably vote against any government that gave any hint that they would be thinking of winding back these provisions. Yet, as I say, with the exception of New Zealand, there is no other OECD country of which I am aware that allows what we call negative gearing. In the United States, for example, if you borrowed to fund an investment property you can write off the interest that you incur against the rental income up to the amount of that rental income. Any excess, if you have any, is carried forward as a deduction against the capital gains tax that you ultimately pay. And far fewer Americans are investors in rental property than is the case in this country. And that is also true of most other countries apart from us and New Zealand.

MS: So what is the rationale? Why on earth would you introduce negative gearing in the first place?

SE: I don’t think it ever was consciously introduced; it was just a characteristic of our income tax system that evolved over time. If you borrowed money, that was a tax deduction against your income: and at some point, I don’t know when, probably going back into the 1960s or 1970s, smart accountants figured out that this was a way initially of deferring tax, and then post the 1999 halving of the capital gains tax rate, of reducing it outright. Advocates of negative gearing say that this is an important policy instrument for encouraging investment in rental housing.

MS: Is it?

SE: Well, it certainly has encouraged people to invest in rental housing, because, as I said, over 15 percent of Australian taxpayers are doing it. But what it has not been is an effective instrument for increasing the supply of housing, which would be a legitimate policy objective. The problem is that around 92% of geared property investors buy an established property, as opposed to around 72% of owner-occupiers who buy an established property.

To put it the other way round, only 8% of investors buy a new property – that is, add to the supply of housing – as opposed to something like 24% to 28% of owner-occupiers. So negatively geared investors enjoy tax breaks, which of course are funded by higher taxes on the rest of us indirectly, in order to compete with would-be owner-occupiers to drive up the price of established housing. If negative gearing was making a useful contribution to the supply of rental housing then we should have higher vacancy rates than we do.

And the comparison here with the United States, which I have just explained does not have negative gearing is instructive. At least since the mid-1980s, the US rental vacancy rate has never been below 5%. In Australia, which has always had negative gearing and which has been more attractive to investors since 1999, the rental vacancy rate has never been above 5%.

Since the halving of the capital gains tax rate, the rental vacancy rate in most Australian cities has been less than 3%, which of course is reflected in rising rents. Advocates of negative gearing would say that if you abolished negative gearing then investors would dump their properties on the market and that would lead to a drying up in the rental market. But think that through: if investors dumped their properties on the market, who would buy them?

The answer is, people who had been struggling to buy properties to live in themselves, but had been unable to do so in part because of the subsidised competition they had been facing from landlords. So what you would have is an equal drop in the supply of rental housing and the demand for rental housing because more people would be able to become owner-occupiers. Indeed it is hard to think of anything that would do more to make it easier for people, especially young people who want to buy their own property, than to abolish negative gearing.

MS: And you’re saying, if I read you rightly earlier, that the reason that it hasn’t been abolished is primarily political, rather than fundamental – that is there are too many snouts in the trough. It would create a political backlash and nobody has the guts to do that.

SE: Yes, indeed. That is absolutely right.

MS: Okay, if you had the political will, and in light of the broader macroeconomic need to have housing and other bits of the economy come through as the mining investment boom peaks, what would you do to fix negative gearing?

SB: In the housing space, probably the only politically acceptable compromise you could make would be to abolish negative gearing for any new investors, and at least that would forestall the risk of a backlash from those who would perceive, not entirely without justification, that the government was adversely affecting them. So you would not be at adversely affecting those who had entered into these arrangements in good faith.

MS: And it is an absolute tenet of public policy that retrospectivity is bad. So, you would not do that, anyway.

SP: You would not necessarily be making people pay taxes in respect of things they had done in the past, but, as I see it, if you abolished negative gearing for all properties today you would be making those who have got negatively geared properties pay more tax from this day forward. There is not much difference in principle in my view from that and making people who smoke pay 50% more in cigarette excises, which the government is proposing to do.

So I personally would not see an injustice in abolishing negative gearing for all investors. But I am not the one whose votes are at risk, so I would say an acceptable compromise ought to be to abolish negative entirely for any new investors, and maybe to reduce the capital gains tax discount and therefore in effect the offset to excess interest relative to rental income, as recommended by the Henry Review, say from 50% to 40%. That would be an acceptable compromise. But that is only part of a broader set of policy changes that are needed in housing.

MS: Okay, so go on with that. What should happen with housing?

SE: To see what ought to happen you have to recognise what has been wrong. Housing policy has been an area of conspicuous serial failure for more than 50 years. Since the early 1960s, what governments – federal, state and local – have effectively done has been to inflate the demand for housing, not only through negative gearing, which inflates the demand for investment properties, but also through things like the first home-owner grants and their successors, which have also inflated the demand for housing, especially since 2000 when the Howard government reintroduced them and allowed them to be used for purchases of established properties, supposedly as compensation for the introduction of the GST, even though the GST did not apply to established properties.

What all those things – and stamp duty concessions for first-time buyers and the like – have done has been to inflate the demand for housing, particularly for established housing. And therefore it has driven up prices. Meanwhile, state and local government planning policies have restricted increases in the supply of housing – by making it more difficult to do high-density conversions; by mandating higher standards of infrastructure and housing provision, which inevitably dries up the price; by putting additional charges, particularly in New South Wales and to a lesser extent Queensland, on developers to pay for suburban infrastructure of a higher standard than used to exist, which in turn has prompted the developers to build a smaller number of more expensive houses so that they can recover those infrastructure charges from the people who buy their products.

Good policy would have if not reduced the demand for housing then at least sought to increase the supply of it, but what we’ve had is a combination of policies that have inflated the demand for housing and reduced the supply of it. The inevitable result has been that we have had an increase in house prices and a decline in homeownership rates, which is exactly the opposite of what governments of all persuasion say they have been seeking to achieve. So what we ought to be seeking to do is have policies that at least don’t artificially inflate the demand for housing but instead focus on increasing the supply of housing.

Now, if we look back further than the past 50 years, the most successful housing policies Australia has ever had were policies pursued from the late 1940s until the early 1960s, whereby the federal government borrowed at relatively low interest rates in order to lend to state housing authorities to build houses of two types. One was for houses for rent to people whose incomes were so low that would never be able to get housing finance and become homeowners, but they also lent to the States to build houses for sale on reasonably concessional terms to people whose incomes were high enough to allow them to become homeowners, but not high enough really to allow them to get finance from banks in circumstances where bank finance for housing was restricted by a whole lot of other government regulatory settings.

I would not advocate in today’s world that state housing authorities or any government build the sort of housing estates that they did on the urban fringe, away from jobs and social infrastructure in the way that they did then. That caused all sorts of other social problems. But I think it would be much more effective if instead of doing the things they do – first homeowner grants, stamp duty concessions, negative gearing and the like – governments used the funds that they use in those ways that make the problem worse, and instead worked with private-sector developers to build suitable housing for rent or sale to people who can’t afford to look after themselves without some form of assistance.

MS: And then you basically remove all of the other distortions for the people who can look after themselves?

SE: Correct.

MS: And you allow the market to work?

SB: Yes, and allow the market to work. And the emphasis of policy really ought to be on increasing the supply of affordable housing. Government does not have to do that itself. That is not what I am advocating. But government funds could certainly be used to assist that process, and if what you are doing is taking government funds that are currently having a negative impact on people’s ability to buy their own homes or on their ability to rent homes or on the supply of housing and use those in ways that boost the supply of housing, particularly affordable housing, then I think you’re doing an awful lot of good.

MS: And public-private partnership model has been well established in the Australian economy and you’re talking something and analogous to that.

SE: Yes. The scheme that works best as far as I’m aware is the Keystart scheme in Western Australia, which is in a sense a sort of shared equity model. It does have both income tests and house price tests on it that focus the public funds on those in most genuine need.

And there is a clawback for the public investment when the property is sold; the public sector gets a return on the funds that it has invested. And why the Western Australian scheme has not been picked up by other states is one of the mysteries of Australian public policy, or why the federal government does not get involved in a similar way is one of the mysteries of public policy.

MS: Let’s move on to some of the other areas, if not mysteries, of public policy. We’re running out of time and I want to open it up to you to look at a broader macroeconomic agenda – the things that you think we ought to be seeing discussed in terms of change and policy initiative ahead of the election. Can we start with another area of the taxation system, in the context of that earlier discussion about having some room relative to move on policy and that we should not be shackled by fear of deficits and that sort of thing. So, should the GST be raised as part of an overall improvement of the efficiency and effectiveness of the taxation system?

SE: What I would like to see in the first instance would be a broadening of the base of the GST. When the GST was set up, you will remember that the Coalition initially wanted to tax all food and in order to get support from the Democrats in the Senate they had to back away from taxing what became known as basic food.

That was supposedly a measure that was pro the poor. In fact, as the Henry Review showed, the top 20% of households in income distribution spend about five times as much on GST-free food as the bottom 20% of the income distribution, so it is perverse. And in fact upper-income groups spend a higher proportion of their incomes on all of the categories that are exempt from the GST, except for health.

So it would be a sensible reform in my view to broaden the base of the GST to include most of the things that are currently exempt from it – health might still be an exception – to compensate those at the bottom end of the income scale for the impact it has on their finances, as the Howard Government did when it was introduced, and as the Gillard Government did with the carbon tax, and then use the revenue generated by that to address the increasing difficulties the states are having funding education and health, which are primarily their responsibilities, and/or to allow them to abolish many of the nuisance taxes that have a bigger deadweight cost in terms of compliance and so forth than the revenue which they raise.

Here I am talking about things like insurance taxes. I would put raising the rate of the GST as a second-order issue compared with broadening the base. When you look at both sides of politics and their attitude to this, it is odd. If you look at the coalition, which has pledged black and blue not to increase the rate of tax; they introduced it in the first place. Their conservative counterparts in New Zealand have twice at least been prepared to increase it as part of a trade-off for reducing rates of personal income tax. And no one in New Zealand seems to have seriously objected to that. The last Labour Government in New Zealand did not reverse the increase in the rate of GST that had been implemented by its National predecessor.

From the ALP’s point of view, it is intriguing that all of the Labor Party’s fraternal colleagues in Western Europe have been perfectly happy to preside over GST rates that everywhere in Europe are at least double the rate of GST that we have here in Australia. And to European social democratic parties, the VAT, as they usually call the GST, has been what they see as an equitable way of paying for the modern European welfare state.

Now, it may well be that the rates they have of over 20% still are not high enough to pay for the welfare state as it now exists in Europe, and that is a problem for them. But I don’t think that increasing the rate of GST, if broadening the base does not give you enough revenue, has any serious economic obstacles. There may be political ones. One change that I would be trenchantly opposed to, one which I would not even call ‘reform’, is the demands made by the New South Wales and Western Australian Governments in particular for changes to the way in which the GST is carved up.

I note that the Business Council of Australia has also been supporting this. I think the formula administered by the Grants Commission under which the GST is carved up among the States has actually served the country pretty well. Now you might think I am a Tasmanian so of course I am going to say that, but I think one of the good things about Australia is that the income gaps between, say, Tasmania and Western Australia are vastly smaller than the gaps between say Mississippi and Connecticut in the United States, between Newfoundland and Alberta in Canada, or between some of the places in eastern and western Germany.

One of the reasons for that is that we have mechanisms for redistributing income between rich and poor states that actually work pretty well. You might say the formula is too complex and not sufficiently transparent, and I agree with that and there is scope for reform there, but the ‘horizontal equalization’ principles on which the revenue from the GST is carved up is one aspect of the GST system that I would not want to see changed.

MS: Within the context of tax reform to make it more equitable and more efficient and more effective, as you’ve just discussed, would you see room for that total tax take to tick up a bit to take into account the need to create space for policies on the spending side that you think might make the world a better place?

SE: I wouldn’t necessarily be an advocate of that, but I think it ought to be an option. To take a recent example, the Gillard Government increased the Medicare levy to pay for the disability insurance scheme. I supported that before it was announced as well as afterwards. I think that was a reasonable thing to do, and I think the opinion polls suggest that the public will support an increase in taxation that is clearly marked to fund spending which they also support.

And so would I, although I think it is problematic that the Government has increased the Medicare levy four years before the disability insurance scheme is due to start and is banking that interim four years as a way of reducing the deficit. I think that is a bit shifty. Again, with other taxes, I would prefer to see a broadening of the base considered first before we look at increasing rates. So we talked about negative gearing as being one example of a loophole in the income tax base that could usefully be closed. Our income tax system is riddled with discriminatory treatment or favourable treatment of particular groups.

For example, I can see no compelling economic reason why income from capital gains – that is, income from speculating – should be taxed at half the rate of income from working. I can see no economic reason why income earned by people over 65 should be taxed at a lower rate than income of people under 65 – especially as people in the latter group are supporting children, which most people over 65 have ceased to do. I can see no reason why people should be allowed to use trusts to reduce the amount of income tax that they would otherwise pay, even if you accept that trusts have legitimate uses for other reasons. But they should not be used to reduce tax.

MS: On that, just to interrupt, the trust one is an interesting one: you’ve got a lot of very wealthy Australian families using family trusts to split income and put it into superannuation funds for trustafarians to use to minimise their tax and to take it out tax-free at the other end. Do you think that is a fair situation?

SB: No I don’t. I think one of the worst tax policy decisions of the last decade, and there are a lot of contenders for this title, was the decision to abolish, or to free of tax entirely, superannuation payments to people over the age of 60. In a relatively short number of years I am going to benefit from that, but I still think it is a bad decision that has no sensible or credible economic foundation. It might have been popular, it obviously was, but that does not make it right.

In the case of trusts, I am not querying their use by rich people or indeed anyone else, to shield assets from vengeful ex-spouses or mad uncles or indigent children, or to ensure an orderly transfer of assets, particularly with farming families from one generation to the next; but I don’t accept that those arrangements should be able to be used to reduce tax in the way that they so often are.

And as I understand it, Australia has far more trusts per head of population or per thousand dollars of GDP than almost any other country in the western world. It’s another example of the many loopholes that we have in our tax system, and I would like to see those loopholes closed before we start contemplating increases in rates of tax.

That said, it may be at the end of the day, having regard to what people want and what people expect as the population ages, that we might have to ask ourselves whether some of the tax cuts that we had during the property and commodities boom in the last five years of the coalition government – whether all of those are actually sustainable.

MS: We’re very much out of time and there are a couple more questions I want to ask that I ask everybody in The Zone. But just a final one on the policy agenda: do you want to put on the record or on the agenda some other key policy areas that you think are ready for change?

SE: Australia does face a risk of a major downturn when the mining investment boom finally comes to an end in two or three year’s time. To me the logical way of minimising that risk would be for governments to be planning now to undertake the sort of infrastructure spending that would not only employ people who have hitherto been employed in mining investment projects, but would help to set up the industries of the future and to address deficiencies in our economic and social infrastructure that have built up over the last 30 years or so.

And the way to do that in the economic context we’re facing is if the federal government were to construct its budget the way the states too, by drawing a distinction between the operating budget and the capital budget. They should be aiming to return the operating budget to surplus, and doing that will involve taking some decisions on both the revenue and expenditure side that could be harmful to economic growth in the short term but nonetheless have to be done.

The way to offset that would be to be willing to run deficits on the capital account to fund some of the infrastructure spending that I think is necessary, not only to make up for past inadequacies of infrastructure spending but also to provide the support the economy will need as the mining investment boom comes to an end.

MS: On that, that would mean therefore having the budget structured that way we would be borrowing, the government would be borrowing, to fund infrastructure investment, which is probably the best and fairest and most efficient way to find intergenerational assets like that?

SE: Yes. I’m not saying all infrastructure should be 100% debt-funded, because the current generation of taxpayers will benefit from new infrastructure ideally and so they should make some contribution to it, so some of it should be paid for out of operating surpluses.

MS: But we should not be having this terrible fear of debt? Australia does not have a pet problem, does it?

SE: No we don’t, no we don’t. Jennifer Westacott, the head of the Business Council, put this very sensibly about six months ago when she said Australia doesn’t have a debt problem but we do have a budget management problem. And solving the budget management problem does require the federal government to be running a so-called operating or current-account surplus.

But that does not mean we should be worried about running a deficit on the capital account to fund infrastructure spending. It is interesting that we tend to have this view that when it comes to government the federal government is the font of all wisdom and the states are dills or indigent children who need to be managed by Mamma in Canberra. At least when it comes to budgets, for a long time the state governments have been running both more transparent and more commercially realistic budget frameworks the feds have done, and this is one area where the feds could learn from the states to the benefit of all.

MS: Okay, just to finish on the agenda: is there anything else you would like to see and think ought to be debated in the election?

SE: The other big issue, and one that business has been pushing – sometimes out of self interest, but there is a national interest to it as well – is addressing the deterioration in Australia’s productivity performance since the turn of the century. As any economist will tell you, over long periods of time productivity growth is about the only sustainable source of improvement in people’s living standards, and apart from falling commodity prices, the other reason why we went backwards relative to other countries for most of the post-war period was because our productivity performance was so poor relative to other western and emerging economies.

There has been some improvement in productivity over the last 18 months to two years it would seem, and that tells you that industrial relations isn’t the only barrier to improvements in productivity, because this has happened under an industrial relations regime of which business has been particularly critical. What I actually think it tells you is that productivity is improving in the last two years because for the first time since the late 1990s businesses are actually been trying to improve productivity.

But among the things governments could do to assist that process would be to go back to looking at more productivity enhancing structural reforms, and there are still plenty of areas of the Australian economy that have long been sheltered from competition, both domestically and from abroad. My own strongly held view is that the obsession Australians have had over last 12 years with security in all its forms has had a cost in terms of productivity.

I’m not only talking about so-called national security and all the stupid things that happen at airports and the vast expansion of money spent on surveillance of individuals ,companies and others. The obsession with energy security for example has had a price in terms of rising electricity prices and over-investment in transmission networks. The obsession with water security has had a price in terms of wasteful investment on desalination plants that are not being used.

MS: And that hurts productivity because it is a misallocation of resources?

SB: Yes, it is a misallocation of resources. The government insistence on propping up failing firms and industries has an adverse impact on productivity because it maintains the use of labour and capital in poorly performing activities when they could be released to more productive ones. So there are all those things they need to do, but a lot of that improvement in productivity has to come from companies trying to do it.

Infrastructure also plays a role in that. Education and skills acquisition plays a role in that. Competition policy plays a role in that. Science and technology policy plays a role in that. Doing real things as opposed to chanting ideological slogans to boost productivity is the other big thing I think ought to be on the policy agenda between now and the election and beyond.

MS: What motivates you, Saul? Why do you do what you do?

SE: A lot of what I do I do because my employers pay me to do it. That is, to interpret economic statistics to help my employer and its clients or customers to make better business and investment decisions. But, more broadly than that, why I talk and write about things that other economists in my type of business don’t always is because I guess I believe following from James Tobin, I think it was, I think economics can be used for the betterment of mankind.

There is a lot of evidence to show that good economic policy can make a major contribution to improving people’s lives. Conversely, bad economic policy is often at the root of falling living standards. I have just come back from a week in Madagascar, for example, which is the sixth-poorest country in the world. Madagascar is a country that has people of a similar background to Indonesia and Malaysia, countries that have been reasonably successful over the last 40 years in lifting living standards and a country which has topography and a geology that is a lot like Australia.

It ought to have a resource base, but it is the sixth-poorest country in the world, partly because it has had over 50 years of really bad government and bad economic policy, and while that is an extreme example but has limited relevance to Australia, it does talk to me in a personal way since I have just been there and illustrates how good economic policy can make people’s lives better.

At the margin – since I am not a doctor, I am not saving peoples lives, I’m not an artist, I’m not leaving anything that adds to the cultural endowment of the nation – maybe in a small way I’m trying to make a contribution to society.

MS: The final question to everyone in The Zone, Saul, is what is the hardest thing you have ever had to do, at least that you are able to talk about here? It is not a professional question nor necessarily a personal one; answer it any way you can.

SE: I would say the hardest thing I have had to do is sack people who don’t deserve to be sacked, in order to meet headcount reduction targets that have been dictated by other people. I think that is the most unpleasant thing that I have ever had to do – terminate people’s careers. Having said that, sometimes that opens up opportunities for people, and at least on a couple of occasions when I’ve been required to sack people who I didn’t think needed to lose their jobs I have been able to help them find other jobs.

But I think that is often the most unpleasant thing that I have had to do and it is one of the reasons, and it’s not the only reasonable by no means the most important reason, but it’s one of the reasons why I have never wanted to go on to more senior roles in organisations than the one I’ve had. I have never wanted to be a manager.

MS: It also ties in with your previous answer, which was based on a sentiment of decency.

SE: Yes.

MS: Saul, we have gone way over time, and I thank you so much for your time. I enjoyed talking to you, and I hope some of these ideas get a hearing during the election. Thank you.

SE: So do I. Thank you, Michael.