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John Quiggin

Public debt a useful instrument

John Quiggin Australian Financial Review

8 June 2006

In public debate, two steps forward for one step back is probably the most that can be hoped for, and that’s what we’ve seen in the recent debate over infrastructure policy.

One big step forward has been the long-overdue recognition by state governments that public debt is a useful instrument of policy, not a sign of economic and moral failure.

The Cross City Tunnel fiasco, and the mishandling of upfront cash payments, seems finally to have discredited the idea that there is a free lunch available from public–private partnerships. However the deal is packaged, it is impossible to deliver public infrastructure without taking on, or assigning to the travelling public, the associated liability to bear the cost.

As the NSW government is now finding out, it is easier to wrap such a package up than it is to unwrap it when it turns out not to deliver the goods. Unless the contracts with the Cross City Tunnel consortium are simply repudiated, as Opposition Leader Peter Debnam has suggested, it is likely that substantial compensation payments will be needed to extricate taxpayers from their commitments. And, as former NSW premier Jack Lang could tell Debnam, repudiation is a high-risk option. This is a case where reliance on debt finance would have been far more sensible.

The other big issue of the past week, Snowy Hydro, was more of a mixed bag. The ultimate decision was the right one because, as Bob Officer observed in the Australian Financial Review, no one had given any serious thought to the way in which Snowy Hydro’s poorly specified water rights would be sorted out in relation to the National Water Initiative.

But the debate surrounding the proposal revealed the continuing appeal of the ‘pot of gold’ theory of asset sales, notably to the advocates of the sale, many of whom regard themselves as economic rationalists. When the deal fell over, commentators referred to the loss of a ‘war chest’ the Bracks government might have used to fight the forthcoming election campaign. The very terminology is redolent of the eighteenth century ideology of mercantilism, definitively refuted by Adam Smith in The Wealth of Nations.

The mercantilists believed that governments should try to pile up gold, for example by promoting exports and discouraging imports, and that the resulting hoard would provide finance for fighting wars (the main activity of governments at that time). Smith pointed out that what mattered was not access to a pile of cash, but the productive capacity of the assets on which the government could draw, through taxation or direct ownership. His analysis is just as relevant today.

Other supporters of the proposal, including the state governments concerned, complained about the government having capital ‘locked up’ in Snowy Hydro that could be used to fund schools and hospitals. This is nonsense. Snowy Hydro is an income-generating asset. Assuming that its market value is equal to the value of future returns, its sale would make no difference to the net worth of its owners.

In practice, the absurd restrictions on shareholdings imposed by the political process would probably have meant that the sale price was below market value. Such a fire sale would have made schools and hospitals less affordable, not more.

What matters here is not cash flow or debt, but the net worth of the public sector as a whole, and the balance between long-term inflows of revenue and requirements for expenditure and debt service.

There is a place in public finance for both debt and equity. Similarly, there is a place in infrastructure for a range of ownership structures, including full public ownership, private ownership and various mixtures of the two.

The appropriate balance depends on many different factors, including regulatory frameworks, the willingness or otherwise of private investors to bear equity risk and the capacity of governments to manage long-term contractual relationships. We will do a better job in striking this balance when the obsession with reducing debt is replaced with a careful analysis of the fiscal position as a whole.

The debate over the last couple of weeks has shown some progress in understanding of these issues, but it has also demonstrated the continued power of fallacious arguments about debt. Still, two steps forward and one back is better than no movement at all.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

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