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Economic Overview (NER 60)

National Economic Review

National Institute of Economic and Industry Research

No. 60               December 2006

The National Economic Review is published four times each year under the auspices of the Institute’s Academic Board.

The Review contains articles on economic and social issues relevant to Australia. While the Institute endeavours to provide reliable forecasts and believes material published in the Review is accurate it will not be liable for any claim by any party acting on such information.

Editor: Dr A. Scott Lowson

© National Institute of Economic and Industry Research

This journal is subject to copyright. Apart from such purposes as study, research, criticism or review as provided by the Copyright Act no part may be reproduced without the consent in writing of the Institute.

ISSN 0813-9474

Economic overview

Peter Brain, Executive Director, NIEIR

Abstract

In this article Peter Brain assesses the medium term outlook for both the world and Australian economies, including the importance for the latter of public sector demand and immigration as important drivers of growth.

An overview of the medium term outlook for the world and Australian economies

The medium-term outlook for the Australian economy remains shaped by a number of conflicting influences.

On the positive side these include:

  • the strong terms of trade gains which will exert upward pressure on growth, particularly in States such as Western Australia and Queensland.
  • a steady outlook for immigration; and
  • the fact that public sector balance sheets in Australia are very strong.

On the negative side are:

  • the strong downward pressure on discretionary consumption expenditure from the weight of household debt;
  • increased import penetration of final and intermediate manufactured goods, particularly from China, leading to manufacturing closures, namely in New South Wales, Victoria and South Australia; and
  • the current downturn in new dwelling construction, concentrated in 2005-06.

The strong terms of trade gains made over recent years – shown in Figure 5 – are expected to exert strong upward pressure on Australian GDP growth over the next two years. The resource boom will bring higher levels of private business investment, infrastructure development and a higher exchange rate that would have otherwise have been case. This will support higher income growth. Actual expenditures will be concentrated in the resource rich states of Queensland and Western Australia. The developing imbalance in the world economy (US trade and budget deficits, China’s increasing share of world production) will produce a correction by 2009. The question is, how severe this correction will be. A sharp correction has not been factored into this forecast, however, world growth is forecast to weaken in 2009 and 2010, and the terms of trade to fall back significantly.

Whilst the contribution of the household sector to growth will be limited by debt constraint, the state of public sector balance sheets in Australia can increasingly drive growth. The public sector can drive growth by income tax changes, infrastructure spending (which is already occurring in some states) and also debt leverage through public sector partnerships and co-opting the superannuation sector, through their infrastructure funds, to play a direct role in driving growth.

Whilst the increase in the terms of trade will benefit the resource based sectors of the Australian economy, the higher exchange rate and increasing competition from imports have, and will continue to, lead to a downsizing of Australia’s established manufacturing sectors.

The import penetration has been steadily rising in Australia, both in terms of final manufacturing products and intermediate inputs. More and more Australian manufacturers are either shifting their operations overseas or stopping operations and importing products from overseas. Australian established manufacturers in older urban area have also seen a dramatic increase in their land values as a result of the housing boom. The profitability of these operations, under increased import competition, has narrowed against the actual income potential of the land they occupy. The high exchange rate has also blunted Australia’s manufacturing export potential.

Capture1As we have seen over the recent years in Australia, the gains by the commodity based sectors of the economy and the resource based sectors will be partly offset by the downsizing and closure of established manufacturing operations. The established manufacturing sectors are concentrated in New South Wales, Victoria and South Australia.

International outlook

The world economy continued to expand at a rapid pace in 2004 with continued strong growth in the United States, China and East Asia. Economic growth in the Western Europe and Japan also picked up significantly in 2004. World economic growth was around 5 percent in 2004. This follows growth of 4 per cent in 2003 and 3 per cent in 2002. China’s GDP growth rate was around 10 per cent in 2003 and 2004.

In the projections, growth in the Chinese economy is expected to continue at around 8 to 10 per cent level through to 2009. Growth is expected to fall following the Beijing Olympics. Australian commodity exports and prices are expected to weaken at this point, with Australian terms of trade and the exchange rate both falling.

The world economy appears to have passed its cyclical peak growth rate. World economic growth is forecast to weaken slightly over 2005 -06 and 2006-07, partly in response to high oil prices. Growth is still however between 3.5 and 4.0 per cent.

The United States economy, which grew by 4.4 per cent in 2004, is projected to grow by 3.5 per cent in 2005 and 3 per cent in 2006. With continued pressures on US public sector balance sheets, high household and corporate debt levels, growth in the US economy us expected to slow post 2006. The US current account deficit reached around 6.5 per cent of GDP in early 2005. The Federal Reserve has been successively increasing rates since mid-2004, and further rates rises seem likely.

Growth in Japan was 2.7 per cent in 2004 following growth of 1.4 per cent in 2003. Growth in 2005 is projected to be 1.4 per cent and 1.8 per cent in 2006. The fundamental of the Japanese economy definitely improved over the last 18 months, and even the banking sector balance sheets have improved.

World economic growth slows to 3.5 per cent in 2008-09 and then 2.7 per cent in 2009-10, mainly reflecting weaker US economic growth and growth in China contracting to around half current growth rates.

The recent drivers of Australian economic growth

The drivers of Australia’s economic growth over the last decade are now going into reverse. From Figure 2, the household debt service ratio reaches 28 per cent of net disposable income in 2004-05. The debt service ratio is the ratio of interest and repayment of loans to net household income. This is now considerably higher than the peak level that prevailed before the 1991 recession.

In the March quarter 2005, the Australian household debt to disposable income ratio reached 174 per cent as shown in Figure 4. By comparison, the ratio four years earlier in March 2001 stood at 123 per cent. This rate of increase cannot be sustained. Indeed, this rate of increase in the household debt to income ratio is declining, as indicated by Figure 3.

It is not only debt saturation that is leading to a decline in households’ ability to absorb debt. As Figure 3 indicates, there has been a decline in the household net worth to income ratio over the last four quarters, compared to the peak level in March 2004. Household net worth is household financial assets plus market value of housing stock less financial liabilities. The major reason for the decline/stabilisation has been the stabilisation of house prices in the context of further growth in household debt.

The deteriorating household balance sheets are being reflected in the current sluggish growth in retail sales and the current slower growth in household consumption expenditure. As a result, household consumption expenditure is forecast to slow to 2.9 per cent in 2005-06 and remain at between 2.5 and 3.0 per cent per annum till the end of the decade.

Capture2In the May 2005 Budget the Federal Government gave personal income tax cuts equal to 1.0 percentage point of household income. The commencement of severe downward pressure on household expenditures from debt saturation and falling net worth to income ratios (from expected falls in house prices over 2005-06) will either offset the impact of the expenditure enhancing effects of the tax cuts, or will force the additional income from the tax cuts to be saved.Capture4
Capture3The Australian medium-term outlook

Australian GDP growth over 2004-05 was 2.3 per cent, the lowest since 2000- 01. The slowdown in Australian growth over 2004-05 reflects a gradual slowing in private consumption expenditure growth and a small fall in new dwelling investment. Household consumption expenditure and new dwelling investment were drivers of Australia GDP growth over the 2001-02 to 2003-04 peri

High levels of consumption expenditure and rising levels of business investment have lead to sharp increases in imports over the last 3 years. Import growth over the 2002 -03 to 2004-05 period has been averaging around 12 per cent per annum. Imports significantly subtracted from growth in 2004-05.

Australian GDP growth is forecast to accelerate to 2.9 per cent in 2005-06 and 3.5 per cent in 2006-07. Private consumption expenditure and dwelling construction, however, will not be the key drivers of growth. Dwelling approvals have already fallen and private dwelling construction expenditure is expected to fall by 10 per cent in 2005-06. The decline could be more significant depending upon the rate of adjustment by builders in this sector.

The decline in private consumption expenditure growth over the course of 2004-05 confirms the household debt constraint is increasing taking hold. The Federal Government tax cuts announced in 2005 will mostly be absorbed by increases in the household savings ratio. Consumption expenditure growth will fall below that ratio of growth in real household disposable income.

For the next two years Australia’s export performance will be relatively strong.

Australia’s export performance will improve over the next two years. Average export volume growth is expected to be in the vicinity of 5.0 to 6.0 per cent per annum. Export volumes are also expected to be reasonably strong as resource projects commencing over the next year are completed.

The restructuring of the manufacturing sector is adversely affecting exports. As import penetration steadily increases and plants close, exports fall because many of these bigger plants also export. Between 2008 and 2011, given the world outlook, Australia’s export performance looks bleak, unless a significant devaluation occurs.

The Australian dollar is likely to devalue strongly after 2007 or 2008.

Given Australia’s current high terms of trade from the high commodity prices and the likely downward pressure on the US$ over the next one to two years, Australia’s currency, in US$ terms, could well appreciate to the 80 cents range. This will not last. The slowdown in world GDP growth post 2008 will return the Australian current account deficit, as a per cent of GDP, to the 7.0 per cent benchmark. The return of commodity growth to more normal levels will combine with these factors to drive the Australian currency to the 60 to 70 cents range, against the US$. Given the expected devaluation of the US$, this implies a significant weighted average devaluation of the Australian currency. This is 25 per cent by 2010. The weighted average exchange rate returns to close to the low levels of 2001.

Capture6Public sector demand will become a more important driver of Australian growth.

The 2005 round of Government budgets is the forerunner of what is to come. That is, Governments in Australia sustaining growth by using their strong balance sheets to offset the decline in the capacity of the household sector to sustain growth. The State Government’s 2005-06 infrastructure expansion will add 0.5 per cent per annum to Australia’s growth rate over the next two years.

More importantly, Governments are beginning to think long term. The Queensland Government has announced a $55 billion expenditure program, while the New South Wales program is around $20 billion. Over the next 20 years, depending on the PPP (private-public sector partnership) component, Australian Governments could spend between $700 billion and $1 trillion dollars and still maintain acceptable debt to GDP ratios.

The Government sector will take over the role from the household sector in driving total investment.

 Immigration will also become an important driver of growth.

The Federal Government has announced that permanent and long term immigration will be increased by 20,000 to offset Australia’s skill shortages. Over the projection period, immigration will become an important source of growth from a variety of linkages. These include:

  • workplace growth to offset the ageing of the population;
  • direct capital inflows associated with wealthy immigration; and
  • network integration with Asia to sustain Australia’s export performance.

The next movement in interest rates will be downwards.

The downturn in the dwelling cycle has commenced. In the Eastern States the level of approvals are 10 to 20 per cent below the levels that prevailed a year ago. Domestic demand growth is slowing. Interest rates are likely to be lowered at some point in 2006. However, the extent of the downward adjustment is likely to be limited. Inflationary pressures (currently from skill shortages and commodity prices) will be joined by currency devaluation post 2008.

This will keep nominal wages and inflation at near the upper bound of the Reserve Bank of Australia’s (RBA) acceptable range for much of the projection period, despite periods of weak labour market conditions. This will also occur despite downward pressure on low skilled wage rates that will flow from the Federal Government’s industrial relations reforms.

Overall, the outlook over the projection period is one described by the RBA Governor last year. It is a growth outlook for annual Australian GDP growth that “will sometimes have a 2 in front of it and sometimes a 3”.

Capture6 Energy trade

Despite rapidly rising oil prices, rising crude oil and product imports and static domestic crude oil and condensate production, net exports of energy continue to rise. Energy exports are expected to be strong post-2006, mainly due to large expected increases in LNG exports.

Capture7

Economic Overview (NER 58)

National Economic Review  National Institute of Economic and Industry Research   No. 58        September 2005

The National Economic Review is published four times each year under the auspices of the Institute’s  Academic Board.  The Review contains articles on economic and social issues relevant to Australia. While the Institute endeavours to provide reliable forecasts and believes material published in the Review is accurate it will not be liable for any claim by any party acting on such information.

Editor: Dr A. Scott Lowson National Institute of Economic and Industry  Research 

This journal is subject to copyright. Apart from such purposes as study, research, criticism or review as provided by the Copyright Act no part may be reproduced without the consent in writing of the Institute.

 

Economic overview  Peter Brain, Executive Director, NIEIR 

Abstract : Peter Brain assesses the Australian economy and describes alternative scenarios.

Although the GDP growth for 2003-04 was 3.6 per cent, this represented a relatively poor performance.  The GDP growth rate of 3.6 per cent for 2003-04 was the same as earlier projections. However, it represented a relatively poor performance. The reason for this assessment is due to the fact that over 2003-04 the Australian farm sector recovered from the drought. Farm product in 2003-04 grew by 27 per cent, adding 0.7 per cent to GDP growth. However, non-farm GDP grew by 3 per cent for 2003-04 despite a 5.6 per cent private consumption growth which represents the highest rate of growth for a number of years. Moreover, the growth rate of all the private investment components was 6 per cent or greater.  The reason for the relatively poor GDP growth outcome is, firstly, the poor performance of exports and, secondly, the growth in imports. There is a lag between farm production recovery and exports so the growth in exports resulting from the farm recovery will occur in 2004-05.  In 2003-04 imports grew by 13.1 per cent, only slightly below the growth in 2002-03. This represents a growth in import penetration across a wide range of sectors, including clothing, textiles, motor vehicles, chemicals and machinery. Imports represent one quarter of GDP. Hence, a 13.1 per cent import growth rate means that the growth in imports over 2003-04 reduce GDP by 2.5 per cent from what would otherwise have been the case if imports had growth in line with GDP.  Over the last two years in particular, the growth in imports has been a major negative factor in determining  Australia’s growth performance.

Australia’s exports performance has also been poor but will recover over the next three years.

In the few years since 1999-00, the value of Australia’s non-resource based exports has been flat. That is, no change has occurred. This is despite the value of trade in the Asia-Pacific region for non-resource based products growing between 30 and 40 per cent over the past four years.  In 2004-05 exports of goods and services are expected to grow by 5.1 per cent, in part due to the recovery of the farm sector. Exports will also recover over the next two to three years because of the coming on-line of major resource projects that were commenced in 2002 or 2003. The most important of these will be the fourth liquefied natural gas (LNG) train on the North West Shelf. In 2006 the Darwin LNG train will come on-line.

Both the United States and Australian dollars will devalue over the next five years relative to our trading partners. 

Exports may well recover, but without a substantial devaluation of the Australian dollar, import growth will continue to outstrip the growth of exports. With the upswing in the world interest rate cycle now occurring, the continuation of the current growth in imports would lead to an Australian current account deficit of around 7 per cent of GDP. To hold the current account deficit at the 5 per cent level, which is the projection to 2008-09, it is necessary for the Australian dollar to devalue,  in weighted average terms of around 15 per cent over the 2006 to 2009 period. This is built into the projection.  It can be seen from Table 1 that the United States/Australian exchange rate stays relatively unchanged over the projection period. The projection also allows for the outcome that the United States dollar devalues 20 per cent against the Euro, yen and yuan over the projection period. Because Australia maintains parity with the United States dollar, it follows that there is an equivalent devaluation of the Australian dollar against these currencies. The appreciation of the yuan against the United States dollar is also assumed to trigger the appreciation of other Asian currencies against the United States dollar.  It is the devaluation of the Australian dollar that leads to a more subdued growth rate for imports over 2008 and 2009.

The recent evidence is that the downside phase of the dwelling cycle has commenced.

It has long been NIEIR’s contention that the down-phase of the current dwelling cycle would only commence when significant growth in established house prices ceased. By the June quarter 2004, established house prices had stabilised with a fall in established house prices in Sydney offset by more moderate price growth elsewhere. Moreover, the trend in approvals and the financing of dwellings for new construction all point to falls in dwelling construction over the next two years. Over the next two years the cumulative decline in housing construction is projected to be 18 per cent.

The borrow and spend behaviour of households is now reaching its peak. Household balance sheet constraints will be a negative factor for growth for the foreseeable future. 

The ending of the established house price boom will also lead to a curtailment of a key driver of recent Australian economic growth, namely household borrowing to support consumption expenditure.

The growth in established house prices since 1996 resulted in the ratio of household net worth (the value of the housing stock plus financial assets less financial liabilities) increasing from 6 to 7.8 by June 2005 (Figure 2). From Figure 4, this allowed households to borrow to fund a borrowing gap which has reached 15 per cent of disposable income by June quarter 2004. The borrowing gap represents the difference between consumption expenditure and discretionary income. Discretionary income is significantly smaller than household income in the national accounts because it includes superannuation contributions and superannuation interest, which represents income that is not available for current consumption.  From Figure 3, by the June quarter 2004 the build up in debt to fund the borrowing gap (as well as the high level of housing investment) drove the household debt to net disposable income ratio to 163 per cent. In the June quarter 2002 the rate stood at 137 per cent.  From Figure 1, the household debt service ratio now stands at 25 per cent of disposable income, the highest on the historical record.  The combined impact of stable (or falling) house prices, high debt service and debt-income ratios will, at the most optimistic, force households to hold the borrowing gap at around 15 per cent of income. This will force consumption expenditure to grow in line with household disposable income, which in turn will reduce the rate of growth of private consumption expenditure to between 2 and 3 per cent over the medium term.

Even with modest consumption growth, the debt-income/debt-service ratio will continue to rise. A recession is likely at some point before 2010.

If the borrowing gap is held at 15 per cent, the debt-income ratio will still increase by around 7 percentage points per year. By 2009, given the projection in Table 1, the debt to income ratio will reach 200 per cent. If households decide to stabilise their debt-income ratio then the household savings ratio will have to rise to 6 to 8 per cent. Household consumption would most likely fall and the economy would experience a recession, probably a severe recession. However, given the forecast methodology outlined above, this aspect has been translated into a lower trend rate of growth rather than a recession and this aspect makes the low case projection of more interest than the high case projection.

Fiscal stimulus will support the household sector in the short term.  

The position in the short term is not as bleak as the borrowing gap would suggest because of the strong fiscal stimulus being given to the economy. The May 2004 Federal Budget and the election promises of October 2004 will give a stimulus of around 1 per cent per annum to household income over the next two to three years. This will probably be enough to partially offset the constraints of the household debt-service ratio. Beyond 2007, if a severe recession is to be avoided, further significant fiscal stimulus will be required. That is, as the growth in household debt slows, public sector new borrowings will have to increase significantly.

The alternative scenarios

The problem for Australia is that Australia is not the only economy with households with large amounts of illusionary wealth created by housing price bubbles. The same is true in North America, the United Kingdom and some Western European economies. An economy that is an indicator, in terms of a low scenario over the medium term, is the Netherlands. The Netherlands was a fast growing economy over the second half of the 1990s, in part driven by rapid increases in borrowings funding a house prices-wealth creation consumption boom. In 2001, house prices stabilised due to tightening monetary policy. In 2003 the economy was in recession with private consumption falling by 1.5 per cent, the largest fall since World War II.  For the Netherlands the catalyst was tightening European monetary policy over 2000. For Australia the likely trigger for a low scenario is also most likely to be an external shock such as illustrated in Table 2. There are a number of potential shocks with good probabilities of occurring over the next two to five years. They are listed in the Table.

The reason why a transition path from the base to low scenario is likely to be associated with an external catalyst is that there are two factors that would allow policy authorities to keep the economy on the base scenario trajectory despite increasing constraints in growth. These are:

  1. strong public sector balance sheets which would allow fiscal policy to be expansionary for a decade or more;
  2. the potential for Australian nominal interest rates to be lowered by between 1 and 2 percentage points.

This cushion would allow the base scenario to be achieved if the world economy remained supportive.  Unfortunately, because of vulnerable households in a number of major economies, any negative shock to the world economy is likely to trigger the ushering in of a long period of low growth for Australia, in particular, and many parts of the developed world in general. In short, the low scenario, at least to 2012 or thereabouts, does not have a low probability of outcome.  The high scenario assumes the most optimistic outcomes for the world political economy.

Australian energy trade, 2004-10 

ABARE and NIEIR analysis and estimates of Australian energy trade trends are presented below. Over the period there continues to be an energy trade surplus with projected increases in net oil imports being more than offset by coal, natural gas and uranium export increases.  In 2004-05 the trade surplus, at a projected $7.4 billion (NIEIR/ABARE), will be about $2 billion higher than in 2003-04 due to higher thermal coal exports (tonnes, prices) and higher LNG exports.

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Governing the Market: Threats to Australia’s Stability and Security

National Economic Review

National Institute of Economic and Industry Research

No. 64   July 2010

The National Economic Review is published four times each year under the auspices of the Institute’s Academic Board.

The Review contains articles on economic and social issues relevant to Australia. While the Institute endeavours to provide reliable forecasts and believes material published in the Review is accurate it will not be liable for any claim by any party acting on such information.

Editor: Kylie Moreland

National Institute of Economic and Industry Research

This journal is subject to copyright. Apart from such purposes as study, research, criticism or review as provided by the Copyright Act no part may be reproduced without the consent in writing of the relevant Institute.

 

ISSN 0813-9474

Governing the market: Threats to Australia’s stability and security

Peter Brain, Executive Director, NIEIR

 

Abstract

This paper was presented as a lecture in the Senate Occasional Series at Parliament House, Canberra on 8 August and represents an update of ‘The Australian Federation 2001: Political structures and economic policy’, a 2001 Alfred Deakin Lecture. The basic message here is that unless Australia adopts a middle course between the highly successful corporatist state model of development and the extreme neoliberal model that Australia has selected as its development framework, Australia’s internal stability and national security could well be severely degraded over the next two decades. In short, Australia will have to relearn and reapply some strategies and instruments to govern the market.

 

This will involve some restoration of the practices and institutions that were swept away in the name of microeconomic reform over the past two decades. Australia will never be able to match the efficiency of the informal governance structures of corporatist states. For Australia, leadership will have to be provided by its governance institutions in general and parliament in particular.

Introduction

In my 2001 ‘Alfred Deakin Lecture’ I set out to:

(i)            explain why Australia in the 1980s had adopted the extreme neoliberal (or the economic rationalists) model as its development framework; and

(ii)           discuss some likely consequences of that choice.

Put simply, under the neoliberal model the state plays a largely passive role, with many of the key decisions determining the direction and quality of Australia’s economic development and its social consequences being left to the market. The explanation for why Australia adopted the model was, in part, attributed to the relatively weak state of Australia’s parliamentary institutions as a representative democracy and strong executive. This is not to say that the Australian system does not produce good outcomes for many decisions. The problem is that for some key strategic decisions the tendency is to select simple, easy to market solutions for economic and social problems that reflect the capacity, interests and vision of the political leadership group. More complex solutions that require the input of the broader political community and the design of new governance structures that may lie beyond the control of strongly established, including bureaucratic interests, tend to be eliminated at an early stage.

The likely consequences for the future noted in the 2001 lecture include:

(i)            increasing wealth/income inequalities;

(ii)           increasing foreign ownership and a narrow based economy;

(iii)          no solution to Australia’s high current account deficit and foreign debt;

(iv)         financial instability as a result of the capacity of the financial sector to expand debt to whatever level was in its interest; and

(v)          a vulnerability to negative economic shocks and a poor capacity to respond, which is now an important issue in the context of a likely carbon price shock.

The focus of this paper is to elaborate on the likely consequences of the adoption of the neoliberal model for Australia.

The Corporatist state model

The neoliberal approach focuses on market conduct and structures on the assumption that if market conduct and structure are appropriate then optimal outcomes will be achieved. Whatever outcomes are achieved through market forces will in the main, by definition, be optimal.

Corporatist states tend to approach development from the reverse direction. Objectives are specified in terms of social, political, security, export and industry output/cost targets. The means are then designed to mobilise whatever is necessary to achieve the defined objectives in the minimum time subject to global resource constraints and global as well as local market forces. The strategies of corporatist states to achieve objectives involve reducing the risks to the institutions (governance and commercial) charged with the responsibility of ensuring the objectives are achieved by:

(i)            building large scale enterprises to dominate markets and supply chains, reaping maximum economies of scale and scope, and reducing market risk to a minimum;

(iii)          ensuring that all necessary resources in terms of finance, skills and technology are available for the task;

(iv)         ensuring that any other domestic or foreign organisation cannot impede the performance of the chosen organisation(s) for the task; and

(v)          relying on regulation rather than the price mechanism.

An early Corporatist state, Germany grew by 12 per cent per annum between 1933 and 1937, with the unemployment rate cut from a third back to full employment, while most developed economies had an inferior performance though not necessarily by much. What is important is not whether a more neoliberal approach would have been more effective, but the approach was different and it seemed to work. It changed history.

The North Asian countries took note of the German strategies and applied them post war with astonishing results. One nation’s experience, South Korea’s, is miraculous. In 1961, South Korea had an annual income of US$82 per person or less than half that of

 

Ghana at the time. Today, it is one of the wealthiest countries in the world. It took the UK two centuries and the United States one and a half centuries to achieve a similar result (Chang, 2008). More importantly Korea, Taiwan, and Singapore continue to maintain per capita GDP growth rates well beyond the level achieved by other countries with a similar high level of per capita income.

In this context there are three categories of corporatist states:

(i)            The social market model of Western Europe with democratic institutions where policy institutions rely on codified statute and regulations with some reliance on non-parliamentary governance bodies representing stakeholder interests.

(ii)           The corporatist state model of Singapore, Korea, Japan and Taiwan which may or may not have effective democratic institutions but where the governance is non-transparent relying on networks between governments, bureaucracy and businesses with decisions made in the interests of the collective irrespective of codified statutes and regulations. The penalties for non-compliance are exclusion from social networks and business supply chains with severe consequences for social standing and material advancement.

(iii)        The extreme authoritarian models of Germany/Italy in the 1930s and Russia and China today, where along with social and commercial exclusion, violence (i.e. loss of property, liberty and in the extreme cases life) is a penalty for non-compliance. The extreme authoritarian model has an impenetrable informal governance structure.

 

The Germans showed in the 1930s that the arrest of an individual for economic treason when it was clearly understood that the real crime was the import of product instead of using the favoured domestic supplier was a very effective form of industry policy, which did away with the need for costly tariffs, subsidies or other financial inducements. In this context, it is interesting to note that the criteria applied in determining what foreign enterprises can and cannot currently do in China is expressed in terms of largely undefined parameters based on the concept of national economic security. Many countries aspire to the status of corporatist states. Few, however, have the capacity to reach the desired status. On this criteria the classification of Russia as a corporatist state is problematic.

China: Where to?

Of high importance to Australia’s national interest is how China will evolve. Neoliberals tend to assume that it will evolve into a market-based economy.

China is not going to be transformed into a neoliberal market economy. Instead, it may well transform itself into perhaps the most efficient corporatist state model of all time with, over the next two to three decades:

(i)            A large number of its state-owned (or indirectly controlled) enterprises (70 per cent of business assets are still under direct government control) becoming the largest companies in the world, dominating the control of capacity in many industries.

(ii)           A Communist Party that will grow rapidly and in influence on the basis of generating individual material advancement that will also provide an informal governance framework that will be simply impenetrable. No matter what the codified statutes, China will have a machinery of governance capable of doing the opposite on non-transparent command. In this context, who owns the enterprises will be irrelevant.

The Chinese see large-scale foreign investment in China mainly as a short-term strategy to:

(i)            introduce new technologies, management expertise and new skills generation; and

(ii)           construct distribution systems to the world economy,  in the shortest possible time.

It is likely as their own enterprises are built up to reach world competitiveness, the assets of foreign enterprises that directly compete with and are of no strategic value if left independent to a mandated Chinese enterprise will be taken over by a combination of intimidation (as per the Russian approach to BP and Shell assets in oil and gas sites), financial incentives and frustration, of which the recent creation of Communist Party control of Trade Union cells in foreign enterprises will be a useful tool. At worst foreign enterprises exiting China may find that they will lose a significant proportion of non-Chinese assets and intellectual property and, in the extreme, the entire enterprise.

The only major uncertainty about China is the extent to which extreme nationalism will become a hallmark of its external relations similar to what occurred in Germany in late 1930s. The recent signs in this regard are not encouraging. There are signs that strong nationalism is taking root among the young with the state having the capacity, like Germany, to manufacture outpourings of mass nationalism triggered by suitable incidents. The optimists assume that massive environmental problems and widening inequalities will trigger a move, at worst, towards the social market model. The pessimists contend that threats to the legitimacy of the elite in the context of severe resource and environmental constraints will result in the sustained administration of the drug of extreme nationalism and the rectification of past injustices at the hands of the West. To quote Robert Kagan (2008) in his recent assessment of China:

If East Asia today resembles late-nineteenth-and early-twentieth-century Europe, … a comparatively minor incident could infuriate the Chinese and lead them to choose war, despite their reluctance. It would be comforting to imagine that this will all dissipate as China grows richer and more confident, but history suggests that as China grows more confident it will grow less, not more, tolerant of the obstacles in its path. The Chinese themselves have few illusions on this score. They believe this great strategic rivalry will only ‘increase with the ascension of Chinese power.

All that has to be done is to assume, as is the case here, that China behaves no worse that the United States as a global power or no worse than the Western European powers behaved towards China in the 19th century to arrive at the conclusion that a difficult period for Australia lies ahead. This is returned too below.

The governance riddle

The riddle is that the leadership of corporatist states is even more politically exclusive and dominated by existing bureaucratic and commercial interests than is the case in Australia. Yet these states, because of a combination of history, culture, ethnic homogeneity, strength of nationalism, genes, a common view of economic competition as warfare by other means, requiring the nation to be on a permanent war footing, or whatever, are capable of delivering high performance sustainable outcomes on a long-term basis. My only answer to this riddle for Australia, based on observed Western European outcomes, is that the appropriate response to the corporatist states is not to emulate them in political structures and conduct, but to achieve similar outcomes by strengthening the institutions of representative democracy. That is, governance and the institutions of governance are important. This is in contrast to the neoliberal view that governance is relatively unimportant.

What  is  the  focus  here  is  in  regard  to  some  of Australia’s current and future economic problems, how would a corporatist state solution differ from the actual or likely neoliberal solution.

Monetary policy

The 2001 lecture I pointed to the Australian neoliberal ‘privatised’ monetary policy regime where no intermediate target for credit growth was set as is the case for the monetary policy of the European Union. Provided CPI inflation is within the desired bounds then debt accumulation could be at whatever level the market was willing to absorb. For the European Central Bank (ECB) inflation in the long run is a monetary phenomena and any credit growth on a sustained basis in excess of desired nominal GDP growth will result in undesirable inflation. In Australia credit growth in excess of desired nominal GDP growth is taken as a sign of a healthy economy. For the ECB monetary growth should be little more than desired nominal GDP growth.

 

As Table 1 indicates, the ECB has achieved its objective since 1996, while in Australia the growth in M3 relative to nominal GDP has been 28 per cent. This does not seem much but, as will be outlined below, the consequences for long-run economic and social stability will be very large.

Over the years I have criticised the Australian approach to money policy as irresponsible. That is, I have agreed with the ECB view provided inflation is defined as including established asset prices (shares, dwellings) as well as newly produced goods and services.

Therefore, sustained credit growth in excess of desired nominal GDP growth will:

 

(i)            increases the vulnerability of the economy to negative shocks by encouraging borrowing for

(ii)           create an increasing proportion of households in ‘serf’ status by forcing households to pay high debt service/rent payments as a proportion of income over an extensive period of their life cycle;

(iii)          lead to house prices (and rents) putting home ownership beyond the reach of an increasing proportion of the population and

(iv)         easy short-term growth diverting energy and attention from the constant resource mobilisation effort required for long-run sustainable growth.

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The excess monetary growth for Australia drove the build-up in asset values (Figure 1) which encouraged households to borrow and spend (Figure 2). Figure 2 shows the precipice the Australian economy is now sitting on. Non-dwelling investment borrowings by households over the last half decade have increased from 5 per cent of income to currently around 15 per cent. If only a third of this is used to support consumption, then a repeat of the 1991 experience of household borrowings for non-dwelling investment turning negative would cause the household savings ratio increasing by 5–7 percentage points, plunging the economy into the severest recession since the depression. In the context of Figure 2, the current (August 2008) dilemma facing the Reserve Bank of Australia (RBA) is self evident. Although inflation is 1.5 per cent per annum above the 3 per cent upper bound of acceptable outcomes, the RBA can either maintain tight monetary control and risk a severe recession, or abandon tight monetary policy and risk the return of longer-term unsatisfactory inflation, thereby simply postponing the day of reckoning to greater pain down the track.

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The RBA has only itself to blame for this as it is simply the result of a decade of irresponsible monetary policy. It knew of the ECB approach, but showed no intellectual leadership and simply went along with the short-term political objective of maintaining the financing of the new aspirational society. Indeed, a good case can be made that Australia’s low inflation rate over the decade to 2006 was in spite of, not because of, the RBA. Its only effective task over this period was to ensure that financial structural disequilibrium did not occur. It failed. Ultimately, Parliament will be held responsible for delegating without appropriate guidelines a core governance responsibility to unelected officials.

 

 

Towards debt serfdom

What if Australia escapes the current policy difficulty and interest rates start to come down within a year or so? The current undersupply of housing (a shortage of around 150,000 units by 2010) is increasing rents and when interest rates come down will trigger a rapid rise in dwelling prices as many try to escape rental status. In other words, the 2003–2007 cycle will be repeated with a further increase in the proportion of households that could be classified as ‘serfs’ risking longer-run social stability.

The origins of serfdom in Russia were based on the need to keep labour fixed in place because of the excess supply of land relative to labour, with high marginal physical product of labour resulting from the large territorial gains from conquest with small populations. Market forces would have driven wages to very high levels. Various tactics were tried to constrain labour mobility, such as finding replacement labour before a peasant could move. One tactic was for the landlord (the farmer of the day) to willingly lend to peasants all that was needed and more (e.g. implements, livestock and fencing): another unfortunate linking of readily available finance with an emerging aspirational society. Droughts, wars and plagues would force more lending until peasants were hopelessly in debt. This debt serfdom facilitated legislated serfdom, with the peasant tied to the land with the requirement of up to 3 days a week work for the landlord. As other family members could work on the serf’s allocated land or in the cash economy, modern serfdom ‘status’ will be taken here to arise when households pay over 35 per cent of income in debt service and rent.

The recent Australian history of the more than doubling of the household debt to income ratio since the mid-1990s is well known. However, there is little recognition of what this might mean at the micro level. Both Tables 2 and 3 clearly spell this out. It means less homes in fully-owned status and more households paying more than 35 per cent of income in rent and debt service costs. In terms of mortgage households, the 2008 estimate of the share of households paying more than 35 per cent of income in debt service costs is 23 per cent due to interest rate rises since June 2006. It should be kept in mind that from the 2006 Census, those households paying more than 35 per cent of income in debt service costs were paying an average debt service cost of just under 50 per cent of income. That is, the living standard of a household with no debt would, on average, be twice that of the average household of serf status, despite both households having the same income.

By 2018, on current conservative trends (an increase in the household debt to income of 30 per cent from current levels and interest rates declining from current levels), it is estimated that at least 22 per cent of households will be paying more than 35 per cent of income in debt service and rent costs, or a doubling since 1996 levels. This excludes the high debt of fully-owned households. It might be claimed that the use of the concept of ‘serf’ status in the modern context is over the top as households can eventually escape debt status and Russian serfdom was intergenerational. I would counter argue that, in fact, the intergenerational aspect of serfdom is de facto also emerging in modern times.

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The movement towards neoliberal solutions in education and health means that access to quality services is determined by household circumstances. The greater the number of households in serf status, the more likely the serf status will be passed on to their children as a result of underinvestment in social capital complemented by increasing resort to reverse mortgages, allowing a lifetime of high debt service costs with little or no inheritance for children. This is consistent with findings from the United States vis-à-vis Sweden. For the United States, the correlation coefficient between status of parents and children is approximately 0.5, while for high taxing equal opportunity education/health service across Sweden, it is 0.2 (Bjorklund and M. Jantti, 1997). The irony is that the United States is a society that is approaching as rigid an intergenerational class structure as what prevailed in Europe in the 18th and 19th centuries which, in part, forced the migration to the United States.

The likelihood is that if something radical is not done, there will be a high degree of intergenerational correlation in serf status. This will leave Australia with an unenviable choice around 2030 of either a severe one-off tax on wealth to ‘emancipate’ the serfs, or suppression of the serf class to maintain social stability. In any case, a society in 2018, characterised by the results given in Table 3, will be a very grumpy place. Economists have discovered that after national per capita income is greater than US$20,000, happiness is a function of relative incomes not absolute incomes. The greater the serf class, the greater the inequality of discretionary income and the greater the unhappiness.

Housing affordability

One of the core solutions to arrest the march towards a serf society is to significantly increase housing affordability for first home buyers. In this regard, the case of Germany is important because German house prices in nominal terms are only a little more than what was the case a decade earlier and have fallen in real terms. In other parts of Europe, such as Italy, house prices have doubled, so that although ECB tight monetary policy has helped, it is a necessary not a sufficient condition for maintaining high levels of housing affordability. For Australia, over the same period the increase in house prices has been a little under 180 per cent. You would think that current German housing market policies would be at the top of the agenda for all Australian governments.

Corporatist state-type housing solutions have been followed in Austria and Germany for decades. These are called social partnerships. These policies are aimed at coordinating and accommodating conflicting interests between landlords, tenants, financial institutions and government. One core feature is risk shifting from the private sector to the state.

In terms of the rental market, the features of the German housing market are:

(i)            long-term contracts of 3–10 years for tenants;

(ii)           defined rules for rent increases (e.g. consumer price indexing);

(iii)          housing benefit support based on monthly income for both renters and owner-occupiers;

(iv)         strong public sector housing construction with municipal housing construction providing approximately 10–15 per cent of housing stock.

In terms of dwelling construction and the supply of housing, direct subsidisation of housing construction at the state level takes into account the regional housing market situation. Construction support is allocated to housing companies, housing associations and individual builders on application, via, for example, preferential interest loans, grants, guarantees/securities and provision of land.

Direct financial support comes from Federal Government/state financial institutions. The focus of loans is on:

(i)            housing stock renovation;

(ii)           CO2 reduction retrofitting;

(iii)          rental new housing construction; and

(iv)         low interest loans for the construction or purchase of owner-occupier housing.

The CO2 Building Renovation Program of 25 billion Euro was introduced in 2008 for the modernising of heating systems and the energy efficiency optimisation of building shells for both renters and owner-occupiers. In addition, regulation makes it difficult to borrow more than 60 per cent of house value, with German lenders reluctant to allow mortgage top ups if a home increases in value. The overarching German objective is to ensure that the supply of houses runs well ahead of demand.

In an unequal society, increasing housing affordability and equal opportunity for housing affordability can only come from one strategy; namely, through rationing of opportunities by rationing of finance and a very targeted list of incentives. This is how the market was governed to allow Australia to solve its last major housing crisis after World War II. Each state had different strategies. Victoria rationed credit via the State Savings Bank, while New South Wales (which lost its Saving Bank in the Depression) focussed on public sector housing construction. There were many other niche instruments that have been swept away over the past 20 years under the mantra that the market will solve everything. However, the Federal Government has introduced new supply-side measures. What is clear about housing policies is that they have to be comprehensive to stop ‘leakage’ into house prices if they are to achieve the delivery of affordable housing to those who need it.

Telecommunications

If the corporatist states are as good as I am inferring in economic development, then it would be expected that they would be well ahead in the provision of quality telecommunications infrastructure. This is the case. By mid-2008, the average download speed was 61 Mbps in Japan, 45 Mbps in South Korea, 18 Mbps in Sweden, 17 Mbps in France and 1.9 Mbps in the United States.

Eighty per cent of households in Japan can connect to a fibre network at a speed of 100 mlps, 30 times the average speed in the United States. Australia is 30–50 per cent below United States levels. Australia has announced a supply-side initiative to improve the situation, but the past delay in trying to incorporate market forces into the process will mean that like electricity to Timbucktoo, Australia will get there but only when quality telecommunications is a competitive necessity and no longer a competitive advantage. The image of Australia being a technological laggard is not a good one in terms of attracting investment. The same approach in many other economic aspects has and will cost Australia dearly.

Greenhouse gas abatement policies

There is no better example of this than the approach to greenhouse gas abatement policies (GGAP). The design of GGAP regimes currently being undertaken in Australia is proceeding along strict neoliberal lines. The central touchstone is that the market is the most efficient platform for engineering the appropriate changes. All the government has to do is to set an emissions cap and the resulting price changes will miraculously allow the emissions objective to be achieved. Quoting from the ‘Carbon Pollution Reduction Scheme Green Paper’ (2008, p. 12):

There are two distinct elements of a cap and trade scheme – the cap itself and the ability to trade. The cap achieves the environmental outcome of reducing greenhouse gas pollution. The act of capping emissions creates a carbon price. The ability to trade ensures that emissions are reduced at the lowest possible cost.

Let’s consider by illustration a segment of the adjustment effort, mainly the electricity sector. Assume that a target is set to reduce total emissions by 20 per cent below 2005 levels, which would represent a (EU 2020 target) 223 million tonne reduction from a 2020 business-as-usual level in 2020. Of the 223 million tonnes, a large part of the reduction would need to come from the electricity sector. Around 91 million tonnes would need to come from replacing approximately 11,000 MW from coal fired plants. To do this, the price of carbon would need to (on NIEIR and ACIL-Tasman estimates) quickly ramp up to around $55/tonne by 2020, based on the long-run marginal cost of alternative supply in order to achieve the long-run marginal costs of a combined cycle gas turbine plant in combination with the mandated Federal renewables target.

A corporatist state would immediately conclude that the Australian market of independent generators independently bidding for supply would not be successful, even if the $55 CO2 price were achieved. The market will not react because to achieve the target, approximately $50 billion would have to be spent on generators, gas development, pipeline and transmission investment. In an unfettered market environment, the risks would simply be too great.

The risks would include:

(i)            Existing supplier risk. Yes, the asset value of existing brown and black coal plant would be reduced by over 90 per cent. However, bankruptcy would merely mean that the new owners would be willing to supply some of the market at short-run marginal cost, which might require an additional $20–25 a tonne in CO2 price (i.e. $80/tonne) to reduce the risk. If they continued their pre-emissions trading scheme output, the cap would not be attained.

(ii)           Technology risk. Electricity generation technologies are rapidly changing. At any point in time, technological change may well reduce the real long-run marginal cost by 20–50 per cent in 10 year’s time. Few are going to build a $2 billion plant today that could become obsolete shortly after it becomes operational.

(iii)          Regulatory risk. If a $60–80/tonne CO2 price results in excessive economic damage, the CO2 price will be lowered and cap attainment strictly regulated, for example, by applying a mandatory gas target, as is now applied in Queensland. Without a compensation guarantee of future prices, few will risk large investment funds.

(iv)         Gas supply risk. Yes, long-term contracts for gas supply will be negotiated with existing suppliers. However, at any time, gas discoveries could result in suppliers willing to supply long-term gas at a fraction of current prices, especially if the location were remote from existing gas distribution infrastructure or the global LNG market were oversupplied.

One option a corporatist state would readily implement would be to combine all the generators into a single body. The arithmetic is simple. Under the present structure of independent suppliers, a $55/tonne carbon price would result in costs per megawatt hour increasing from $45–$50 to approximately $90, or around 80 per cent of the wholesale price. If these costs could be spread over the entire capacity, as would be the case under a single entity, then the wholesale price increase could be limited to 20 per cent, or approximately 7 per cent for the price increase at the retail level, which would represent a minor irritant.

However, there would be further short-term savings. The price increases would be phased in as plants were completed. In terms of cost savings, the strict neoliberal approach to the current Australian situation would result in cumulative CO2 price costs of anywhere between a minimum of $110 billion and $150 billion being imposed on the economy between now and 2020 to allow for market instability and required risk margins, without any guarantee that much of the required capacity would be completed by 2020.

The corporatist state would allow a guaranteed outcome for total cumulative electricity costs increases of between $15 billion and $20 billion. All other risks are reduced to zero by allowing a monopoly. It is this logic that explains why the electricity sector was nationalised in Australia in the first half of the 20th century as state after state gave up trying to induce the required supply response at the right price from an albeit regulated private electricity sector.

A good corporatist state that did not want to renationalise the generating industry in Australia would sit down with the generators and hammer out an agreement for ownership change, exit arrangements on reasonable terms, and a regulatory environment that delivered an outcome in line with the old nationalised model where the private sector could still play a part. The current Queensland model for encouraging the use of gas in electricity generation would be a good place to start. The ultimate model would probably resemble this model and the model used by Victoria to run its train system.

The Garnaut recommendation to ignore private sector losses is not the right way to go. Governments are going to have to rely on the private sector (albeit with substantial risk shifting to the public sector) to undertake a substantial portion of the hundreds of billions of expenditures needed for greenhouse gas reduction.

Any rational corporatist state approach to CO2 reduction would place the emissions trading system at the end point, not at the beginning, in policy design. It would work out all the possible regulatory, technology and mandatory market incentives (by directly paying tradesmen to retrofit dwellings with insulation, solar panels, gas etc.), with the carbon price then set in terms of financing requirements and long-term strategic direction. A corporatist state would laugh off the suggestions of the neoliberals that Australia needs a high CO2 price for energy efficiency. Yes, there is some low lying fruit, but this isn’t the main game. Australia makes little equipment, so energy efficiency gains will depend on how overseas suppliers respond to the world carbon price. Accelerated depreciation allowances, tied investment allowances and energy efficiency performance regulation would be far more efficient in encouraging speedy adjustment. High carbon prices by themselves would simply result, in many cases, in plant shutdowns when they reached the end of their commercial life.

If the Treasury modelling into carbon prices simply assumes that the market operates optimally with ‘near perfect’ substitution between factors of production, then it should be immediately thrown into the bin. In this context, one of the best things the Federal Parliament could do for climate change is to give back to the states their income tax base set in line with their responsibilities so they can build the necessary transport infrastructure and urban design to minimise the CO2 content of connectiveness. The situation is now reaching an extreme position, where an increasing number of households in major metropolitan areas will not have the time and/or financial incomes to reach their place of work on a regular basis. The Federal Parliament must stop the practice of spending what should be State resources on income tax cuts to enhance its short-term election prospects.

Finally, in relation to climate change, if the implication of Figure 3 is correct, then by 2012 the Intergovernmental Panel on Climate Change may well revise the sea level rise up by 2100 to 10–20 metres in the same way that predictions of an ice free summer Arctic have been quickly brought forward from 100 years time to the near term. The 2–4°C predicted rise in global temperatures, even with substantial emission reduction success, would still result in rises in the sea level of tens of metres. This would require a response to reduce CO2 in the atmosphere back to the 1990 level of 350 parts per million, which would, in turn, require a near zero emissions target by 2050. This would necessitate drastic action, but the tools of the corporatist state could enable it to be done, albeit with no increase in living standards (consumption per capita) for decades.

 

National security

In the 2001 lecture I gently suggested that to protect the national interest and economic sovereignty it was desirable to bring foreign investment decisions under more parliamentary control and not leave them to an effectively unaccountable body. This course of action has become more urgent. There is no national interest in allowing major customers (i.e. Chinese enterprises) to control Australian resources. The objective here is simply to transfer value from Australia to China to enhance international competitiveness and real incomes. The concept of sending tax inspectors to Beijing to politely ask to see the books of what will be the biggest companies in the world owned by a potentially hostile country to try and recoup billions of lost tax revenue is laughable.

A good case can be made that Australia is heading towards a classic ‘banana republic’ status. The phrase ‘banana republic’ was invented to describe a country like Honduras, where foreign interests (United States) controlled the region producing the principle Honduras exports (bananas) and all supporting infrastructure. The region was run like a private chiefdom in which companies kept order, and crushed labour dissent using their own security forces or, when necessary, by calling in United States troops, who then established military bases in the country. The irony is that the aim of preventing Australia from becoming a banana republic (Paul Keating, 1986) was one reason for adopting the extreme neoliberal model. It wouldn’t be the first time that a policy shift achieved the reverse of what was intended. In this context, for Parliament not to take back control of foreign investment decisions could well be seen from the hindsight of 2030 as pure treason. The immediate task is to reduce Chinese foreign investment in Australian mineral resources to zero.

When doing this, Parliament could usefully abolish the Productivity Commission and replace it with a body directly under Parliamentary control, focussed on protecting Australia’s economic and political sovereignty. The Productivity Commission can do good work but, unfortunately, its ideological blinkers can result in it unintentionally operating as a fifth column within government, reinforcing those private and foreign messages and demands that have and will undermine the national interest. This is an intolerable situation.

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United States and Australian security

Whether the above can occur depends in part on the speed of the relative decline of the United States relative to China. Over the next decades, Australian security very much depends on the relative decline in political economy strength of the United States being as slow as possible so as to allow the region to develop balanced multipolar counterweight power centres in which Australia can enhance its security. Unfortunately, trends in this regard are not optimistic. The United States seems to have gotten itself into an unstable political cycle, where the Republicans have been hell bent on exhausting the Federal treasury (largely for the benefit of their own constituency) so there are few resources available to correct some of the United States fundamental problems (not all that dissimilar to Australia). This, when coupled with established interests being able to influence both parties for changed regulation, removal of regulation and less regulatory oversight for the enormous benefit of a few and the eventual misery of many does not bode well for a political response that will arrest the United States’ relative decline.

In this context, not surprising, is the outcome that during the Bush administration three-quarters of the economic gains went to the top 1 per cent of taxpayers (The Economist, 2008). To sustain its economic strength and to combat climate change, the United States, like Australia, requires a redistribution of resources from consumption to investment. The magnitude of such a change can probably only be done with very strong political leadership that, in relatively normal times, would only effectively come from a leader from the right; that is, a Republican such as Teddy Roosevelt. This avoids the charge of class warfare. For a Democrat leader to engineer this outcome would require a massive economic or security crisis, as per Franklin Roosevelt. This might, of course, occur, but the probability is that the United States will continue to experience destabilising political cycles that will sap its economic and political strength.

The point may well be reached sooner than any of us think when the United States will have to decide, as Britain had to in 1902 with the Anglo–Japanese treaty, what its strategic interests were and what had to be let go. That is, the United States will have to decide what will remain in its sphere of interest and what will have to be conceded to, for example, China and India. As Australia becomes more vital to the Chinese economy, and the greater the Chinese investment in Australia, the more likely, irrespective of history, culture and tradition, that the United States will have to decide that Australia can no longer be justified as being a member of its sphere of influence.

From this perspective, the faster Australia can diversify its trade and the stake of countries in Australia, the greater the ability Australia will have to protect its effective sovereignty. This gives industry policy a strategic security status, which is common to most corporatist states.

Industry policy

The record of Australian industry policy has been appalling. As Table 4 indicates, the relative fall in Australia’s non-mining merchandise exports has accelerated over the past decade, which would be expected given the Coalition Government’s downgrading of industry policy. Australian service exports in real terms have been virtually stagnant since 2000. The resort to trade agreements will not be successful. NIEIR investigated the impact of the trade agreements to the end of 2007, including the United States Free Trade Agreement, and found the effect to be small, in terms of manufacturing (NIEIR, 2008). They might have been successful 20 years ago, but now

Australia’s trading relationships are being massively overshadowed by the growth of Asia and Latin America. The neoliberal policy focus is largely irrelevant. The concept of an Australia–China free trade agreement is an oxymoron.

To succeed in the future, Australia will have to integrate itself into the informal networks of Asia, using whatever levers it has to lift the glass ceiling applying to Australia as set by informal governance structures. These levers would include defence relationships, foreign investment in Australia, ethnic networks operating from Australia, cultural affinity and the strategic foreign investment in selected countries. For success, this requires a coordinated effort from many.

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Conclusion

The outlook over the next 20 years has to be approached with a sense of pessimism. Left unabated, current trends suggest that Australia will be facing increasing external pressure, coupled with internal economic malaise and a growing feeling that political institutions are not working. The most recent period that is likely to be similar to the future is the mid-1970s. The mid-1970s was characterised by a combination of intense Cold War pressure and economic meltdown from an energy crisis. The mid-1970s was a strange time, with coups, quasi coups and attempted coups in a number of places, including the UK, where the early stages of an attempted coup centred on Lord Mountbatten. The attempted coup was terminated by the resignation of the British Prime Minister of the day, Harold Wilson (Freedland, 2006).

To avoid similar circumstances prevailing, Parliament’s role is clear. It must put in place institutions and policies that will govern the market in such a way that the current and future challenges are controlled, stemmed and defeated. A large percentage of the population could have a very poor long-term expectation of the future, and this time around Australia could be without powerful friends. To effectively combat the three challenges of climate change, external security and internal stability, the requirement is for the adoption and maintenance of a semi-wartime footing in policy focus and implementation.

 

 

References

Australian Government  (2008),  Carbon  Pollution Reduction      Scheme   Green   Paper,   July,   p.   12, Department of Climate Change.

Bjorklund A., and M. Jantti (1997), Intergenerational mobility in Sweden compared to the United States,

American Economic Review, Volume 87 See Also The Economist, Even higher society even harder to ascend, 29 December 2004.

Chang, H-J. (2008), Bad Samaritans: The Myth of Free Trade and   the   Recent   History   of   Capitalism, Bloomsberg Press, NY.

Freedland, J.  (2006),  The  Wilson  Plot  was  our Watergate, The Guardian, 15 March 2006.

Kagan, R. (2008), The Return of History and the End of Dreams, Alfred A. Knopp, New York.

NIEIR (2008), An Evaluation of the Impact of Australian Free Trade Agreements to the End of 2007, for the AMWU, 9 April.

The Economist (2008), 1 August, p. 43.

The Economic Impact of Public Events

National Economic Review

National Institute of Economic and Industry Research 

No. 67 November 2012

The National Economic Review is published four times each year under the auspices of the Institute’s Academic Board.

The Review contains articles on economic and social issues relevant to Australia. While the Institute endeavours to provide reliable forecasts and believes material published in the Review is accurate it will not be liable for any claim by any party acting on such information.

Editor: Kylie Moreland

© National Institute of Economic and Industry

Research

This journal is subject to copyright. Apart from such purposes as study, research, criticism or review as provided by the Copyright Act no part may be reproduced without the consent in writing of the relevant Institute.

ISSN 0813-9474
The economic impact of public events

Ian Manning, Deputy Executive Director, NIEIR

Abstract

The present paper examines a small and ill-defined area of government–private sector interaction: the organisation of public events. In particular, events that receive subventions from the public purse and that draw patrons from outside as well as within the subsidising jurisdiction are considered. Neoclassical economics asserts that economic policy should concentrate on leaving decisions to markets. As applied to the analysis of events, the neoclassical policy recommendation is for reliance on user charges except where there are non-economic reasons for free or subsidised provision. However, NIEIR’s analysis of event provision shows that this recommendation relies on assumptions that have not applied in most parts of Australia over the past 30 years. Instead, subventions to events that increase tourist visitation can increase incomes and employment. Thus, the case for subventions becomes one of priority against other expenditures, preferably exercised in the context of a coherent strategy for the future.

 Mixed economies and government– private sector interaction

When the United States went into ideological overdrive following the end of the Cold War, it let loose a wave of propaganda for market economics. Soviet central planning and government ownership of business enterprise were discredited. Economies should, therefore, be reformed to the opposite extreme, with government curtailed to providing law and order and all else left to the private sector. Some of the most effective propaganda involved the promotion of sophisticated neoclassical economic modelling, which purported to show that a completely privatised economy delivered the best of all worlds. In countries dominated by the American way of thinking, this modelling became the standard by which economic policies were assessed. Its intended target was not the Soviet-style centrally-planned state but the mixed economies inherited largely from the wave of socialist reforms that followed the Second World War.

In Australia’s case, it was conveniently forgotten that the economy had been mixed ever since the 19th-century colonies found that private enterprise was unable to provide them with the infrastructure they required. For the most part, academics and treasuries influenced by the neoclassical wave of thought deliberately assumed away the insights of Keynes’s generation, which supported mixed economies. One of these was the finding that markets are generally ‘imperfect’, which is a polite way of saying that they cannot be relied upon to generate an optimum allocation of resources as described by neoclassical theory. This is not to claim that government action can be relied on to improve matters: far from it. However, there are occasions when governments have opportunities to increase employment and incomes. It is arguable that they should be on the lookout for such opportunities and take advantage of them when they arise.

Since its foundation in 1984, NIEIR has remembered the findings of the economists of Keynes’s generation and, accordingly, has stood apart from the neoclassical economic models favoured by the American economic evangelists. The intellectual problem with the neoclassical models is their high level of abstraction and the plethora of assumptions, many of which contribute directly to their pro-market findings. It should not be surprising that when attempts are made to apply them to policy problems, highly abstract models can generate misleading results. It is inevitable that economic models should simplify the intricacies of the mixed economy in which governments, privately-owned business and non-profit organisations have basically complementary tasks but can sometimes be in (necessarily imperfect) competition, but important that the simplifications capture the major causes and effects rather than being assumed from ideological principle.

The commitment to the vision of a purely private market economy has diverted attention from the realities of government–private sector interaction. These differ industry by industry. Although all industries rely on government for the enforcement of contracts and property rights, the dependence of the mining sector on the administration of exploration and mining licences differs from the dependence of the finance sector on the administration of debtors’ and creditors’ rights and its ultimate dependence on government as lender of last resort. Again, there is general reliance on governments for the provision of an educated workforce but skill requirements are frequently industry-specific. Despite the targeting of government-provided physical infrastructure in privatisation campaigns, one major industry, road transport, is, to this day, completely dependent on infrastructure owned and managed by the three levels of government. Others depend on infrastructure that is to various degrees government provided, guaranteed or assisted. The mixed economy refuses to go away.

 

Event organisation as an activity

This article looks at a small and ill-defined area of government–private sector interaction: the organisation of public events. In particular, the paper considers events that receive subventions from the public purse and that draw patrons from outside as well as within the subsidising jurisdiction. Public events in this sense include sporting, cultural and business-oriented events, such as trade fairs. The event may be as brief as a few hours or last for a season and may take place on a single site or a range of sites. Events can be organised by government agencies, non-profit organisations or commercial businesses. Event organisation includes the production and marketing of the event itself and the coordination of a range of suppliers, including (in various proportions) venues, entertainment, security, accommodation and transport.

The production of events is not recognised as an industry in standard industrial classifications. If anything, it would be a subsector of tourism, which again is not recognised as an industry in the standard classifications, although the Australian Bureau of Statistics (ABS) has a definition of the sector and from time to time releases statistics about it. Persons employed putting on events may be classified as working in sport, the arts, business services, religion or,if all else fails, in entertainment not elsewhere classified.

An important distinction is that between events themselves and associated economic activity. Although accommodation, meals and transport may be arranged as part of an event, they are provided by recognisable related industries. There is also a distinction between events and event venues, sometimes expressed as arm’s length transactions (the event organiser hires the venue). However, events are frequently organised by venue operators while, in the opposite direction, organisations that are primarily event promoters may branch out into venue ownership. In the closely-related field of tourist attractions, venue and events may coalesce.

 

The predilection for user charges

Economic theory distinguishes between excludable and non-excludable events. The latter, exemplified by street parades and fireworks displays, are conducted in public spaces where it is impractical to charge for entry and where, indeed, some of the attendees may be unwilling witnesses rather than beneficiaries. Because it is not possible to charge attendees directly, the source of finance preferred in neoclassical economics, user charges, is not available and non-excludable events must, therefore, be financed from sources such as public culture and recreation budgets, business advertising budgets or the demonstration budgets of groups wishing to apply political pressure. Neoclassical economics allows that where governments finance a non-excludable event, they cannot be faulted for failure to impose user charges, although (as with all government expenditure) their priorities may be criticised.

Excludable events are those where it is practical to charge entry fees. The neoclassical principle is that both the event and the venue should be financed from user charges or, if available, by the use of voluntary labour. However, it is common practice for governments to contribute to the staging of excludable public events, sometimes by way of direct subventions, sometimes through more limited assistance (e.g. for marketing) and quite frequently by contributing to the infrastructure cost of venues. These contributions are contrary to neoclassical principle, but have been defended in two major ways.

A government may decide that an excludable event has such merit as a community occasionthat entry should be free, an approach often taken for events with educational, cultural or commemorative content. Short of this, it may decide that the event should be available at subsidised prices, either through a subsidy paid to the event provider or indirectly through venue subsidisation. A great many arts events fall in this category.

It may be argued that the event generates spin-offs for businesses that justify the subvention. In the extreme case, it may even be argued that the addition to business activity generates increased tax revenue such that the subsidising government actually gets its money back.

The first of these arguments is not particularly amenable to economic analysis because the benefits can only be measured indirectly. This is the domain of cost–benefit analysis, which specialises in the imputation of market-derived values to costs and benefits that are not directly valued by market transactions. Sometimes reasonably satisfactory surrogates are available, but sometimes they are not: for example, it has proved very difficult to put a market value on biodiversity. Where such values are important, difficult decisions have to be made as to how to evaluate mixed bags of market, near-market and distant-from-market values. In some studies, particularly those with environmental costs and benefits, NIEIR has included non-market costs and benefits, but other studies have concentrated on the second, purely economic effects of events. This may be termed economic impact analysis, as distinct from cost– benefit analysis, and concentrates on effects on employment and incomes.

Approaches to economic impact assessment

The economic impact of subventions to events can be estimated by economic modelling. Assessment using neoclassical models produces predictable results: events are assumed to absorb resources that would otherwise be employed in other types of production and, therefore, have negligible overall effects. Given the underlying assumption that the economy is subdivided, without remainder, into a series of perfectly-competitive price-equilibriated markets and is therefore fully employed, this result is inevitable. There is no need to have recourse to models if these assumptions are made, except to identify which areas of production contract in order to expand the production of events.

The position is rather different if the industries impacted by the event have spare capacity. This requires that markets be imperfectly competitive, including that production can be marginally increased without affecting price. A typical case would be a chef who does not increase prices just because his or her restaurant achieves 95 per cent occupancy for a night or two. Whether or not production can be increased without affecting prices is a practical matter, and cannot be solved by assumption. NIEIR has frequently been contracted to estimate the economic impact of events where it can be argued that the concerned industries have spare capacity and production is, for a range of capacity utilisation, demand-determined. The institute has evaluated both events where the existence of spin-off benefits is the primary defence of a subsidy and events whose primary justification is cultural or educational but where spin-off benefits are welcome and help to justify the subvention. Impacts may be calculated in advance (as part of advice as to whether the event should be supported) or in arrears (as part of an audit process and also for reference in deciding future applications). Either way, the calculation requires a comparison of two scenarios: a scenario in which the event is held (in the ex-post case what actually happened) and a scenario in which the event is not held. The impact of the event is estimated by differencing the scenarios.

The construction of formal scenarios requires both geographic and time definitions. These are adopted primarily according to client requirements but might also reflect data availability. The geographic area impacted may be limited to the immediate surrounds of the venue(s) but may be expanded to include their Local Government Area (LGA), the state or the whole country, while time definitions may include the run-up to the event, the event itself and its lasting effects. NIEIR can match these definitions to its datasets and models and, hence, provide assessments at the LGA, state and national levels (the sub-LGA level generally requires additional data collection) and for time periods defined by quarters (with the peak day or week a possibility subject to additional data collection).

Because the argument for subsidisation from spin-offs is expressed in economic terms, it is appropriate to measure the impact of the event by the addition to gross income obtained by differencing a scenario that includes the event and one which does not. (Gross income, in this context, means cash income before deduction of depreciation.) Some clients are also very interested in benefits in terms of employment generation and governments are sometimes interested in estimates of the amount of additional tax revenue generated by the event. The benefits thus calculated can be related to the size of the subvention and different subventions can then be compared for effectiveness and (with a little further modelling) can also be compared with the benefits of equivalent tax cuts.

Measuring benefits in terms of changes to income and employment does not provide a full cost–benefit analysis. Two elements are missing:

  • assessment of additional external benefits, such as the educational value of the event or environmental benefits; and
  • assessment of additional external costs, such as environmental costs and alternative leisure foregone to participate in, or work for, the event.

The simplest approach to these costs and benefits is to limit assessment to market values. This approach is regularly accused of ignoring much that is relevant. However, attempts to be all-inclusive can end up giving excessive weight to shadowy and elusive effects. NIEIR prefers to err on the market-value side but includes major external costs and benefits where it assesses them as relevant and assessable.

In evaluating events, it is not common to spend much effort on environmental effects. This is because few events have the primary purpose of generating environmental benefits and for most of them environmental costs are incidental. There is a substantial literature on environmental costs and benefits and defensible conventional values are available for many environmental costs, such as noise and carbon emissions. If these are considered significant they can be included in the assessment.

When events have educational value, it is theoretically desirable to include a value for this benefit. Various methodologies have been suggested, such as estimates of the cost of providing the same education by alternate means or estimates of the capital value of the addition to earning power resulting from the education. Educational and entertainment values are sometimes hard to distinguish, and attempts have been made to tie them down by surveys of willingness to pay over and above the actual admission charge and documentation of how much people have spent travelling to the event. These types of evaluation can quickly become subjective. Similar arguments apply to health effects.

A category of cost sometimes put forward is the cost of leisure foregone by people who work as a result of the event, to which one might add alternative leisure foregone by those who attend the event. As with all allocations of time, the basic point is simple: if people didn’t do one thing, they would do something else. The problem is that evaluation is necessarily subjective. Take the case of those who forgo leisure to work. At one extreme, the foregone leisure may have been, for example, a family occasion that the worker would much rather have attended but forgoes in order to retain a reputation for reliability with his or her employer. At the other extreme, the foregone ‘leisure’ may have been moping around for want of anything better to do or money to do it with. In this latter case, hours worked are not a cost but rather bring the benefit of approved social participation. The cost of ‘reservation wages’ is further discussed below.

Event assessment methodology

A decision to concentrate on income generation as the measurable benefit of subventions to events has the great advantage of bringing assessment into the realm covered by the National Accounts and, hence, of economic models based on the National Accounts. Thus, additional income resolves into additions to wage and salary income and gross profits within the selected geographic area. Remembering that the income and expenditure sides of the National Accounts are, by definition, equal in aggregate, the increases in gross income are conveniently measured as net additions to expenditure. There are two dimensions to this: direct expenditures that would not have taken place in the absence of the event (with an offset for direct expenditures curtailed by the event) and indirect expenditures that arise as a multiplier result of the direct expenditures.

Direct expenditures for the geographic area that includes the event venue comprise, primarily, expenditures to the area by visitors who came to attend the event and also, pro rata, expenditures by people who visited partly because of the event and partly for other reasons. There may be other additions: for example, a trade fair will generally receive additional income from the local expenditures of out-of-region exhibitors and may generate income from additional sales of local products, while the accommodation and other expenditures of a visiting sporting team, its officials and visiting media may be offset against the share of the gate revenue that the team takes home.

Sources of information on the direct impact vary from event to event. Subject to judgements as to relevance, NIEIR has used the following sources.

Surveys of attendees are conducted face-to-face at the event. All attendees are asked their age and gender and, depending on the study, they may be asked about their marital status, number of dependent children, occupation, household income and ticket type. Where events run for multiple days or cover multiple venues, the questionnaires cover days and places of attendance. After asking normal place of residence, local attendees (those who live in the geographic area or region defined for impact assessment) are asked their expenditure at and associated with the event, whether they would have travelled elsewhere to attend a similar event had the event not been held locally and whether they ran down savings to attend. Visitors from outside the region are asked whether the event is a major or merely contributing reason for their visit, their expenditure associated with the event (including its broad composition) and the means of transport and type of accommodation employed. Data are also collected on satisfaction with the event and the likelihood of attendance at subsequent similar events, but these data are for market research purposes and do not affect the assessment of benefits.

Similar data may be collected from event participants themselves. At trade fairs these include exhibitors and buyers, at sporting events the competitors and visiting officials and at cultural events the performers. However, for sporting and cultural events, information from the organisers may be substituted for direct interviews with participants.

At trade fairs, locally-based exhibitors may be asked to estimate the value of additional sales generated at the event. It is admitted that such estimates are necessarily approximate, if only because sales concluded after the event can only be anticipated.

Information provided by the venue owner and the event organiser and their subcontractors generally includes the event budget (particularly cash flows into and out of the region) and total patronage (so that survey data may be expanded to total coverage).
Interviewers are supervised and endeavour to question a random selection of attendees. Participant data may, however, be collected by distribution and later collection of forms. Data are compared to the results for other events as a check on validity and also to dimension particular events in relation to others in the same region.

Although local visitors are asked various questions for market research purposes, their only contribution to the economic analysis is the amount they spend financed by reductions in savings or by forgoing travel outside the region. All other spending is, by their own admission, financed at the expense of other local expenditures and, hence, does not alter demand within the region.

Greater attention is paid to visitors from outside the region. The number of net additional visitors from outside the region (typically interstate and overseas) who would not have come apart from the event is estimated, as is the number of visitors who extended their visit because of the event. The resulting addition to visitor days is estimated along with the number of bed-days of additional accommodation, by accommodation type. (Overseas visitors tend to stay in hotels or backpacker hostels, but interstate visitors frequently stay with relatives or in a caravan.) Crucially, an estimate is made of additional expenditure in the region, divided into: event entry fees and other revenue to the event organiser or venue; meals, food and drinks; entertainment; accommodation; transport; additional sales by local businesses resulting from trade fair or similar exposure (if any); and other.
The estimate thus prepared may be termed the addition to the exports of the region promoting the event. The estimates will vary according to geographic definition: as the geographic boundary is broadened from local through state to national, a higher proportion of expenditure becomes local and exports diminish.

None of this has proved particularly controversial. It is the next step that brings out the difference between neoclassical and post-Keynesian approaches.
Neoclassical assumptions to minimise assessed impact
We must first dispose of the neoclassical trump card, known technically as the reservation wage. The underlying assumption is full employment, meaning that all people who want paid employment are at work for precisely their desired number of hours. In these circumstances, increases in employment are not possible without increases in wage rates. People who take on work as a result of the increase in wage rates are accordingly giving up leisure to the value of the previous wage rate (because by the full employment assumption they would have worked at the previous wage had they not valued their leisure more highly). Therefore, the benefits of any additional employment are negligible. However, it has been noted that the value of leisure foregone is highly subjective and can even be negative, and will argue below that the full employment assumption is questionable. Reservation wages are irrelevant when the focus is on income and employment, and even in a strict cost–benefit context their value is highly debatable.

We now turn to the main point at issue, which is the valuation of expenditures curtailed by the event: expenditures which would have been made in the absence of the event but are not made due to the event. As already noted, the neoclassical analysis depends on the assumption of full employment and means that curtailed expenditures are similar to event-generated expenditures. Two variants of the neoclassical story have been proposed, both of which depend on labour being fully employed.

One story runs as follows. An event transfers expenditure from the regions of visitor origin to the region holding the event. In all regions, labour is fully employed. Increased expenditure in the region holding the event causes wage rates there to rise, while reduced expenditure in the regions of visitor origin causes wage rates there to fall. These changes in wage rates precipitate a flow of labour from the regions of origin to the region of the event. The transfer of expenditure is matched by a transfer of labour. This prediction is easily tested in practice. For no event that NIEIR has examined has there been any evidence that the required changes to wage rates have taken place or that the event has been staffed (either directly or indirectly) by labour migrating from the visitors’ home states.

A more plausible version of the neoclassical story runs as follows. As in the first neoclassical story, visitor spending raises the demand for labour in the region that holds the event and workers can only be attracted to provide for the demand by offering increases in wages. However, in this story, the response to the increased wages comes not from different geographical regions, but from the effect of the increased wage rates in reducing profitability in all other local industries. These industries sack employees who promptly transfer to the industries serving the increased visitor demand. The net effect on employment and the total value of output depends on price responses, but it is normally claimed that they more or less balance out: the increase in production to meet the increase in visitor demand is countered by a decrease in local production. Thus, a subvention to an event, even when it increases income earned from outside the region, does not increase net income except perhaps marginally where the price responses fail to balance out.

In theory, similar reasoning could be applied to capital capacity. Neoclassical economics includes the concept of the ‘short run’, defined as a period in which capital capacity cannot be altered. Because events are ephemeral, this would appear to be the relevant assumption. If capital capacity is fully employed, no changes in real output can take place in the short run and the capital capacity required to service visitor expenditure can only be made available by shifting it from alternative production, the same result as for labour.

Realistic assumptions

The neoclassical analysis depends heavily on two assumptions:

  • labour supply is very nearly fixed, although labour can be found to service additional demand at the cost of transferring it from alternative production and/or from valued leisure; and
  • capital is fixed, although capital can be found to service additional demand at the cost of transferring it from alternative production (although this is the strict neoclassical position, some analysts assume that capital utilisation can vary and put the weight of their analysis on the labour supply assumption).

Whether or not capital capacity is assumed to be fixed, the operative assumption is that marginal costs are rising and translate into rising supply curves, not only in the industries serving visitor demand but generally. This assumption is made on purely theoretical grounds, without any investigation of labour market conditions applying in the area affected by the event at the time of the event. NIEIR does not contend that this assumption is always irrelevant: there can be times and places where additions to demand in one industry raise wage rates generally, and, more frequently, where they raise wage rates for particular skills; similarly, there can be times and places where additions to demand in one industry run slap into infrastructure or other capacity constraints. For example, mining booms raise wage rates generally in the remote mining regions and specifically for particular mining-related and construction skills, where they increase wage rates not only in the boom zones but across whole countries and, indeed, worldwide. Mining booms also crash against capital capacity constraints in the mining industry and for related transport, energy and water infrastructure. But is this universally true for events?

The obvious capacity constraint affecting events concerns venues. However, unlike mining booms, events are planned in advance with meticulous attention to venue availability. Only in the case of very large events, such as the Olympic Games, is venue availability a potentially limiting factor. Impact analysis for very large events is complicated by the need to evaluate the costs of the resulting planned construction program and to assess the benefits of the resulting assets after the event has taken place. Most events that NIEIR has been called upon to evaluate utilise existing venues. Where this is the case, the opportunity cost of the venue is reasonably represented by arm’s length venue hire charges. NIEIR includes these with the costs of staging the event.

Having dealt with venue and staging costs, the major question concerns the capacity of the local economy to service the addition to visitor expenditure, where visitors are defined as people coming from outside the region in which the venue is located. Judging by the composition of additions to demand revealed by the surveys conducted by NIEIR at events, these additions to demand chiefly concern accommodation, restaurants and other eateries, entertainment (not only the entertainment provided by the event itself) and transport. Except for the additions to transport demand, the additions are concentrated near the event venue.

The additions to expenditure on entertainment and private motor vehicle transport caused by a typical event (in size up to a Commonwealth Games or a papal visit) are minor in relation to total demand, even at the LGA level, and are likely to be within existing capacity: a few extra seats are sold and the average delay in the queue to pay the cashier at the petrol station increases by a minute or less.

Events can impose significant demand on local public transport. However, the transport authorities have the great advantage of fairly accurate estimates of likely demand and have shown themselves capable of marshalling their resources to meet the demand. Similarly, large events generate surges in air traffic, but the airlines have sophisticated demand management systems in place. If a surge in traffic is anticipated, their first step is to withdraw discount fares and the second is to schedule additional flights. If these flights require aircraft placement flights in the contrary direction the airlines may offer discounted fares to take people away from the event rather than to it. Additional flights are usually provided from reserve capacity in the existing fleet, including flying at unattractive times of day, and are manned from existing personnel resources. The increase in the demand for air transport that results from an event does not, therefore, withdraw labour from other industries. However, there may be an offset to the increase in demand from attendees at events from two sources:

Travellers who would have visited the event location in the absence of the event but who are put off by the increased fares (a group that also includes travellers who are put off by increased accommodation charges). Not all of these potential visitors are completely put off; some (helpfully) reschedule.

Residents of the event location who are persuaded to leave the area, either by discount airfares or simply to avoid being at home when the event is held. Once again, these departures may be opportunistic and merely rescheduled departures that would have taken place in any case.

For events significant enough to affect airfares, NIEIR estimates the offset to demand.

A stronger case can be made that events strain capacity in the hospitality industries: accommodation, restaurants and related services. Any event that is worth assessing will cause an increase in local demand for hospitality services sufficient to raise the demand for labour in these industries. The additional demand is met from two main sources:

  • the offer of additional hours of work, either to existing part-time employees or to persons otherwise not in employment, at standard rates of pay; and
  • the offer of additional hours of work at enhanced rates of pay.

Where additional employment is taken, at standard rates of pay, by people who would otherwise be in paid work there is no reason why rates of pay in other industries should be affected or that labour should be withdrawn from these industries. Whether or not labour can be recruited to an event on this basis is a matter of practical observation. The evidence that it can be includes the following:

The hospitality industries rely heavily on part-time workers. There is ABS evidence that, for most Australian locations and for most times since the end of full employment in the 1970s, many part-time workers desire additional hours at the going rate of pay.

The hospitality industries also rely quite heavily on low-skilled and semi-skilled workers. There is ABS evidence that, for most Australian locations and for most times since the end of full employment in the 1970s, many persons are available who would be happy to work at the going rate of pay were more jobs available at these levels of skill. Such workers include many more than those who are unemployed as officially defined. The surveys confirm the presence of significant numbers of people who do not meet the official definition of unemployment in terms of work search but who would, nevertheless, happily take on paid employment were it offered to them. We may also note that Australian labour-force participation rates are below those of many OECD countries, which would indicate the presence of potential employees to take jobs made available.

This said, some employers may prefer to meet the extra demand by raising wage rates. The obvious strategy is to employ existing staff on overtime, which raises costs in the hospitality industries but does not threaten to withdraw labour from other industries. If the increased costs are passed on in terms of increased prices there may, however, be a small offset to real demand in the form of reduced patronage by local residents who have to pay more to eat out.

Finally, demand may be met by the neoclassical mechanism of offering higher wage rates to attract workers who are already employed. In view of the excess supply of low and medium skill workers, increased wage rates are likely to be offered only to skilled personnel such as chefs. The point here is that hospitality skills are industry-specific; an increase in wage rates for skilled hospitality personnel cannot be guaranteed to generalise across all industry as required by the neoclassical hypothesis. However, as with overtime, there is a possibility of increased prices in hospitality reducing the real incomes of local residents and, hence, their real expenditures.

It can be concluded that an increased demand for labour in hospitality is unlikely to generalise to general increases in wages affecting all industries unless the region concerned is closer to full employment than has been the case in most Australian regions over the past three decades.

The position is similar with capital capacity. Event organisers generally organise hospitality at the same time as they organise the event and hospitality providers have shown themselves capable of a flexible response, much like the public transport providers and airlines. Hospitality providers customarily work with a level of excess capacity and also use flexible pricing. This means that a lack of discount accommodation reduces casual visitation during the event, although some of this is rescheduled. NIEIR makes an allowance for visitors who would have visited but for the event, deducting their estimated expenditures from those of the visitors who come because of the event.

For significant events occurring in the capital cities, it is possible to check whether an event was associated with price increases in the hospitality sector. The relevant indicator is the relationship between the price index for hospitality and the consumer price index in general. For several reasons it is expected that hospitality prices will trend upwards more rapidly than consumer prices: productivity increases in services are generally less than in manufactured goods; there is no competition from low-priced merchandise imports; and the hedonic price adjustment for information technology slows the rate of increase of the general index. Given these expectations, price increases for hospitality have been low and have not corresponded with surges in the demand for hospitality: indeed, the reverse has been the case, and periods of high increase in demand have tended to be associated with low increases in prices, as would occur if hospitality were an industry subject to increasing returns to scale.

It is argued by NIEIR that the supply of labour and capital to the hospitality industry in response to events has been cordoned off from the supply to other industries in most Australian locations at most times during the past three decades. This conclusion applies even in places like seasonal tourist resorts because the resorts draw on labour from the nearby cities or from sources such as young overseas tourists with 2-year work permits. If this is the case, additions to demand translate directly into increases in income. The offsets that neoclassical analysis assumes are, indeed, possible, but under typical conditions do not apply.

 

Multiplier effects

The stage is then set for multiplier effects. In traditional Keynesian fashion, an increase in demand generates an increase in incomes, the spending of which generates a further round of increased demand. The process continues subject to ‘leakages’, in the form of savings and capacity constraints, although we have checked the hospitality industry and noted that these are unlikely, and in conditions of generally less than full employment they are not particularly likely in other industries. However, it is admitted that skill supply and capital capacity constraints apply in some places at certain times, and when they do they limit multiplier effects as surely as leakage into imports.

NIEIR models these multiplier effects using:

  • input–output tables, concentrating first on income generation in industries that supply the hospitality industry and then in second and subsequent rounds being more general;
  • data on industry employee characteristics, to determine the kinds of household into which the additional incomes will flow, again concentrating on the hospitality industry in the first round;
  • data on the characteristics of households receiving capital incomes;
  • household expenditure patterns, to determine the directions of spending of households with increased incomes; and
  • data on commuting patterns and trade matrices, to determine the locations of spending.

The results of this analysis are directly contrary to the neoclassical analysis. Instead of the initial increase in export demand being whittled away by reductions in production in other industries, it is expanded by increases in demand for the products of those industries. The result is that public subventions to events that attract visitor expenditure from outside a region generally benefit the region, the exception being where they hit capacity constraints. The returns to public expenditure can be attractively high, although there is no guarantee: NIEIR has come across events that have failed to attract non-local visitors and where the economic impact has been negative. Subventions to such events may still be justified on cultural or other grounds, but not on grounds that the events generate income or employment.
Should generally positive returns guarantee priority in public budgets?

The finding that, under present circumstances of less than full employment, events are often effective means of translating public funds into employment increases is good news for event organisers but less to the taste of those in Treasuries whose unenviable but worthy task is to balance the public budget and to ensure that public spending yields value for money. Rather than rely on spurious neoclassical arguments that event subsidies cannot, by assumption, yield positive economic impacts, Treasuries would do better to rely on the following arguments.

First, the assessment that a subvention to an event yields increases in income and employment does not give the event an absolute claim on government funds. Technically speaking, the rate of return on each event should be compared with the rates of return on the following: subventions to other events; other government expenditures; tax cuts; and increasing government saving. These comparisons depend on the macroeconomic circumstances of the day and also rely on similar assessments being available for alternative government expenditures. Needless to say, this is a rather tall order, but the principle remains that governments have the unenviable task of deciding the relative urgency of different expenditures. Although rates of return are helpful in determining priorities, they do not do away with the necessity to choose.

A second argument sees event promotion as a zero-sum competitive game between the Australian states. According to this view, event promotion is as pernicious as local preference in awarding manufacturing contracts and it simply encourages inefficiency. This argument is incomplete in that it fails to recognise that events increase national exports as well as interstate exports; competition by states to stage events is not a zero-sum game. Competition between places goes beyond competition for the tourist dollar; it is, in part, competition for identity and recognition. Success in such competition brings intangible benefits to residents, which have not so far been mentioned in the analysis. Turning to a visitor point of view, competition between cities and towns increases the range of visitor experiences available: efficiency arguments that assume that events are homogenous miss the point of this type of competition. Also note that the Australian states not only compete for interstate tourism, but combine to promote international tourism. There may be a point where competitive tourism promotion by the Australian incurs diminishing returns but it is unlikely that this point lies at zero expenditure.

Third, events are not the only ‘industry’ to benefit from public support. For example, subventions for events and capital investment in venues are small compared to government expenditures on road construction and maintenance. Both provide direct consumption benefits to citizens and both generate benefits to private businesses. This is the exact point of calculating the income generation benefits from different forms of public expenditure. Instead of assuming benefits away, as they do when they adopt the neoclassical assumptions, Treasuries should compare the benefits of alternative spending patterns and adjust their spending accordingly.

Fourth, the benefits from event subventions need to be placed in the context of general macroeconomic policy, which in Australia for several decades has favoured the generation of demand by the encouragement of bank lending, and, more specifically, the encouragement of mortgage lending to households. The Commonwealth was so anxious to pursue this policy that it was unwilling to increase real taxes and limited government borrowing, thus limiting the flow of funds available for event subventions and for all other forms of government spending. The tragedy pointed out in recent State of the Regions reports was that the policy of high mortgage lending has failed to generate either full employment or affordable housing, the ultimate culprit being the constrained supply of accessible urban land, which is partly due to the constraints to government investment required to create an enhanced supply.

This brings us back to the question of constraints more generally. While it is argued here that there are no constraints that prevent the operation of income multipliers arising from visitor expenditure, there may be constraints at a more general macroeconomic level.

As described in the National Economic Review as far back as June 1987, Australia suffers from a number of serious macroeconomic constraints:

  • a public sector constraint – broadly, the unwillingness to pay sufficient taxes to finance desirable public expenditure, particularly public investment;
  • various capital capacity constraints, including shortages of highly specialised skills and an inability to make the public investments required to alleviate these shortages, and various infrastructure inadequacies arising again from low public investment; and
  • a balance of payments constraint, arising from reliance on an exchange rate that has failed to settle at rates justified by the economic fundamentals coupled with industry policies that pay insufficient attention to investment in export industries – not merely the mining industry, but industries that are capable of generating jobs that match the skills available.

In view of these constraints, the high benefit–cost ratios commonly observed for subventions to events should be assessed in the context of a long-term strategy for Australian economic development. Event assessments are but a tiny part of the analysis required to develop and implement such a strategy.

 

Conclusion
Neoclassical economics purports to show that economic policy should concentrate on leaving decisions to markets. As applied to the analysis of events, the neoclassical policy recommendation is for reliance on user charges except where there are non-economic reasons for free or subsidised provision.

NIEIR’s analysis of event provision shows that this recommendation relies on assumptions that have not applied in most parts of Australia over the past 30 years. Instead, subventions to events that increase tourist visitation can increase incomes and employment. Thus, the case for subventions becomes one of priority against other expenditures, preferably exercised in the context of a coherent strategy for the future.