Published in The Weekend Australian on 19.10.13
DEBT, it seems, is not a dirty word any more. It all changed at the swearing in of the new government. Having relentlessly called on the previous government to stop the debt, the Coalition government is planning to increase it.
Back when the Coalition claimed all debt was bad, several of its senior frontbenchers had declared a Coalition government would never have gone into debt, not even during the global financial crisis. How they would have achieved a surplus when the global recession had stripped an estimated $200 billion off revenue forecasts remains a mystery. If they'd cut spending by a commensurate amount, Australia would still be struggling to crawl out of the hole of a five-year recession.
Now there is good debt and bad debt. In truth, there always was. Good debt arises when governments invest wisely in infrastructure that is expected to yield strong financial or social returns. Good debt arises, too, when an economy falls victim to an external recession, as happened during the GFC, warranting a dose of fiscal stimulus.
Bad debt is accumulated when infrastructure investment is politically driven, offering poor returns to the wider community, and when recurrent government spending is on a long-term trajectory of outgrowing revenue.
Australia experienced an infrastructure drought during the period 1990-2007. State governments, reeling from a political backlash from the collapse of state banks, refused to add to debt by investing in infrastructure. The previous Coalition government considered infrastructure a state responsibility, spending up instead on middle-class welfare while, to its credit, paying down debt.
Labor government borrowings to finance vital infrastructure such as widening the Pacific Highway and an intermodal terminal in Sydney did not constitute bad debt. Indeed, the new government has accepted the case for further investment in Australia's weak and ageing infrastructure. And, having repeatedly claimed that under Labor there was no revenue problem, just too much spending, the Coalition now appreciates some infrastructure spending stimulus will be needed to fill the hole in economic growth being left by the passing of the mining boom's peak.
Treasurer Joe Hockey has floated the idea of upping the scale of the previous Labor government's initiative of offering guarantees on private sector borrowings for selected infrastructure projects. He has reportedly sought the views of international rating agencies on the impact on Australia's AAA rating of substantially increasing the government's contingent liabilities by providing these guarantees on a large scale. In answering, the rating agencies are likely to be mindful of the contribution to the GFC of the reckless behaviour of home lenders Fannie Mae and Freddie Mac and of private banks that, being too big to fail, enjoyed an implicit government guarantee.
Australia's experience with public-private partnerships has been underwhelming. Private forecasts of toll revenues and patronage on transport infrastructure projects have usually been far too rosy. Risk-averse private infrastructure partners will want the public partner to take on as much risk as possible or demand large risk premiums if they are to take it on. Some have succeeded in negotiating high risk-adjusted returns while at the same time shifting most risk to the government.
An alternative way of funding infrastructure that offers commercial returns is to establish an entity run on commercial principles but funded from government borrowings. Investment proposals would be subjected to rigorous cost-benefit analysis. A commercial board would approve only those projects that offered good economic returns.
The debt incurred would not add to the budget bottom line, only to interest payments on government bonds issued. The Coalition government is unlikely to be attracted politically to this funding vehicle, as it is being used for the National Broadband Network. But it could be far more efficient and less risky than any large-scale underwriting of private-sector borrowings.
If it were considered that such ventures could benefit from extra private-sector expertise, experience and discipline, the government-owned commercial entity could invite minority private equity participation.
For those projects that cannot, by their nature, generate a commercial return, such as upgrading the Bruce Highway, conventional debt financing that affects the budget bottom line would continue. With global interest rates at historic lows, there is a strong economic case for accelerating these sorts of projects.
Having thundered about a budget emergency, the Coalition announced its response late in the election campaign: it would improve the budget bottom line by a negligible $1.5bn a year and deliver no further surprises.
Instead of keeping its election promise to pay back the debt, the government should increase debt for wise infrastructure investment while abandoning extravagant new recurrent spending commitments such as the paid parental leave scheme. That's the difference between good and bad debt.