Interview with Tony Jones

Lateline

Thursday, 12 April 2007

SUBJECTS: Unemployment, Budget, tax, inflation, private equity

JONES:

Peter Costello, thanks for joining us.

TREASURER:

Thanks very much, Tony. 

JONES:

Now unemployment at a 32-year low, down to 4.5 per cent.  Do you now regard 4 per cent as a possible target?

TREASURER:

Well let’s just see how far we can go.  Back in the late 80s, early 90s people thought full employment in Australia would be 6 or 7 per cent.  Then it was thought that maybe you could get it to 5.  Now we have it at 4.5 – let’s see how we can go.  I have no doubt that the Australian economy can create more jobs.  The job creation has been astounding in the last year or so.  The trick of course, Tony is to make sure that the job creation doesn’t come at the risk of inflation because people will always talk about what the rate of unemployment is that doesn’t accelerate inflation and we can get more jobs, I’m sure of that.  What we have to make sure we get more jobs and it doesn’t put pressure on inflation.

JONES:

Very briefly, 4 per cent – realistic or not realistic?

TREASURER:

I would like to see Australia aim for lower than 4.5.  I don’t want to tempt fate by putting a figure on it.  Where we are now used to be called full employment, perhaps we can go further.

JONES:

Alright, you have just mentioned the downside to the boom, that it could be inflationary.  The IMF are obviously worried about that.  They are suggesting the inflation in Australia could lead to further interest rate rises this year.  Do they know something that we don’t?

TREASURER:

No, they don’t.  They are making the point that where you have an economy which has now grown continuously for a decade and a half where you have by world standards low unemployment and by our standards almost unparalleled low unemployment, you start to get wage pressures.  And wage pressures if they are not managed properly can break out in inflation.  This is what has always happened in Australia in the past.  In the 50s when we came off the Korean war wool boom, we had a downturn because inflation was set off.  It happened again in the 80s.  It has always ended badly for Australia.  And so the trick this time is to make sure that our growth does not come at the price of increased general wages which set off inflation which end badly for Australia.  Now we have been successful so far.  We have got a decade or more in relation to economic growth.  But the trick now is to see if we can get another decade out of this expansion.

JONES: 

Of course in an election year, interest rate rises become much more potent politically than at other times.  Is there any way you can use Budget measures to keep down inflation and keep interest rates down?

TREASURER:

The best thing you can do in a Budget to keep pressure off interest rates is to ensure that you do not have a deficit.  In fact, have a surplus.  Let me explain why.  If the Government brings down a deficit Budget then it has to borrow in financial markets to make up the shortfall.  If a government is borrowing, a government is competing in a market with the private sector.  People are trying to borrow the same amount of savings or less savings and interest rates go up.  If a government however, balances or has a surplus budget rather than borrowing, the government is actually contributing to savings.  It is growing the pool of savings, it is not competing against the private sector.  The consequence of that is that the government action is putting a downward pressure on interest rates rather than upward pressure on interest rates.  Now this is why it is so important for Australia that we balance and have a surplus in our Budget.  This is the Government’s contribution to taking pressure off interest rates and in fact exerting downward pressure. 

JONES:

The fear of economists is that this will be a big-spending Budget, the surplus will be low and a big-spending Budget tends to be inflationary and put upward pressure on interest rates.  That is the fear. Can you counter that with this Budget?

TREASURER:

Well as I said, I will be aiming and determined to deliver a Budget which is not only balanced but is in surplus.  That means at the end of the day after the Government has spent every item that it has allocated in the Budget it will not be borrowing, it will be adding to savings.  That means overall the Government will be exerting downward pressure on interest rates rather than upward pressure on interest rates.  Now, there are other levels of government in Australia that will be borrowing in the next financial year.  The fact that they are borrowing means that they are in the market competing with the private sector for a limited pool of savings.  They will be exerting upward pressure on interest rates.  But the Commonwealth won’t be.  We won’t be in the market borrowing in the next year.  We will actually be in the market adding to savings.

JONES:

Well if you are spending you could be adding to inflationary pressures.  As Ken Henry points out in his famous speech, expansionary fiscal policy tends to crowd out private activity, it puts upward pressure on prices which in turn put upward pressure on interest rates.  Will that be your guiding philosophy in this Budget?

TREASURER:

Well that is quite right.  If you so spend that you have to borrow, you start crowding out the private sector.  There is only a limited pool of savings in Australia.  If the Government comes in and it says, “Well, we’ll borrow a couple of billion,” the private sector is already out there as we know borrowing tens of billions, then the government is coming into the market competing for those savings driving interest rates up.  What I intend to do is have the Government adding to the savings so that when the private sector makes a call on those savings, the Government is not there bidding prices up, the Government is actually increasing the supply of savings which is putting pressure downwards.

JONES:

Yes, but it is also a question of Government spending and the amount of the savings is going to be critical here.  As Ken Henry points out, “In present fiscal circumstances there is a temptation to think that problems can be solved by government spending.”  That is what he is worried about, that is the warning that came out of that speech.  Have you taken that into account in formulating the Budget?

TREASURER:

Well of course I take that into account, Tony.  I have delivered more balanced Budgets than any Treasurer in Australian history.  So, of course, I have taken that into account.  Nine of the last 11 Budgets have been surpluses.  It is my intention to deliver another.  And this is why incidentally when you see people arrive in Canberra demanding more money that the Commonwealth has to take a hard line.  Who is going to be demanding more money, demanding expansionary fiscal policy in Canberra in the next 24 hours?  Eight Labor States, Premiers and Chief Ministers.  Who is going to be coming to Canberra in the next 24 hours demanding more Government spending?

JONES:

And who, that is a good rhetorical question, but who is going to be coming to your office demanding more spending between now and the election?  Many of your Ministers and many of the people that they represent are going to be asking for big-spending Budgets or a big-spending Budget that will get them out of a political problem.  The question is, will you turn a deaf ear to that because what Ken Henry is saying is that would be expansionary and cause upward pressure on interest rates?

TREASURER:

Well of course, over the next month just as over the last several years every lobby group in Australia will be coming to my office asking for more spending.  Every single lobby group in Australia.  I don’t think Tony I have ever had anyone come into my office who hasn’t asked for more spending.

JONES:

But this is an election year, to be fair, that is the point.  That is the point that Ken Henry is making.  In an election year these pressures become much more dangerous, the temptations for Treasurers and governments which want to save themselves from electoral defeat, become much more compelling.

TREASURER:

Well let me make this point, Tony.  Every lobby group in Australia wants more spending.  Every council does, every State Government does.  Most media outlets do by the way.  They see a need in the community and they campaign for more spending.  Don’t think this is new.  Don’t think this is the first time it has happened.  But I have been doing this for a bit of time now.  The important thing is to prioritise, to engage in that spending which is important and will add to overall economic growth, whilst making sure that at the end of the day, you can finance all of the activities and add to savings.  Now that is not easy.  Nobody ever said it was easy.  I have never said it was easy.  As a Treasurer you have got to be prepared to make the right decisions and sometimes you have pressure even from colleagues.  But that is the way I approach these things.  The record speaks for itself and I think that when you see the Budget it will be appropriately balanced for the economic situation. 

JONES:

Do you agree with Ken Henry’s assessment that “both the probability and the cost of policy error in the current environment is especially high,” and is that, are you worried, for example, that tax cuts could be expansionary, put upward pressure on interest rates?

TREASURER:

Well the possibility of error is always there and the point Tony, is you can’t afford much error.  A 1 per cent error on a Federal Budget is over $2 billion.  You are dealing with big sums here.  The margin for error is very fine and I’m very conscious of that.  And that is why in the lead-up to the Budget we will be doing everything we can to minimise it.

JONES:

Could tax cuts be expansionary fiscal policy?

TREASURER:

Well the one thing I will say for tax cuts as opposed to expenditures is that by and large tax cuts are generally pro-growth.  If you have a choice between spending some more money or cutting taxes by the same amount by and large, cutting tax is pro-growth.  They are good things for the economy.  They generally give more incentive for work.  They generally increase economic growth.  Now, some spending can do that but we also know some spending can be wasted.  That is clear.  Governments don’t always get it right.  Now, the important thing in a Budget is to have a balance so that you are keeping your tax burden as low as possible whilst engaging in well-targeted and well-directed spending.  And the overall outcome’s got to be such that you are adding to savings in the current climate.  We were able to cut taxes in last year’s Budget, very significant cuts in taxes in last year’s Budget, an instalment of which is still to come into effect on 1 July with our superannuation tax cuts.  That was very consistent with good economic policy.  We have shown that we can do it.  We will go into this Budget again prioritising all measures to ensure that they are consistent with good economic policy. 

JONES:

It is not as if you couldn’t afford a big-spending Government.  You would be aware of Alan Mitchell’s analysis in the Fin Review.  He says you can reach back into the 2006-07 cash surplus and spend up to $12 billion as long as you spend it by June 30 of this year.  Is he right?

TREASURER:

Well if you went out and spent $12 billion, you would wipe $12 billion off your bottom line and $12 billion off Australia’s savings.  Last year I brought down a Budget designed to have a surplus.  A surplus of about 1 per cent of GDP.  The idea of that was to add to savings, to take pressure off interest rates.  Now, if you went out between now and then and spent $10 billion, I have no doubt that would put a lot of pressure on the financial markets.  Can you afford to do it?  No.  No, not if you don’t want a result like that.  You can’t afford to do that because it is important as I said earlier, to balance your Budget and to add to savings.  That is to have a surplus.  And I have targeted over recent years surpluses of around 1 per cent.  I think that has been consistent with good growth.  It has been consistent with improving the financial position of the Commonwealth.  I think it has been consistent with monetary policy.  That is my policy.  That is the policy I followed last year and if anybody went out and decided that they could spend $12 billion they would break that policy, they would break our fiscal credentials.  They would probably break the reputation of Australia in financial markets.

JONES:

Peter Costello, we will move on.  You gave a speech a few weeks ago warning of the dangers for Australia in private equity boom that is happening at the moment.  Now the IMF is also warning of increased risks associated with the rapid growth in private equity and leverage buyouts.  How serious do you think those risks are?

TREASURER:

Nobody quite knows at the moment where this current bout will end.  I have had discussions here in the UK about private equity where the number of bids and the number of companies affected is far greater than Australia.  In fact probably London is the capital of the world for these private equity buyouts.  So far, so good in England.  But these companies do borrow very heavily.  The banks that lend the money then generally speaking on-sell some of that borrowing, some of the risk.  Some of it goes into derivatives.  And so you can’t be sure at any one particular moment where all of the risk falls.  So you can’t be sure at any particular moment that if the company gets into trouble where the risk in the system will turn up.  And that is what you are looking for in a situation here, to minimise the risk in the financial system of a very big collapse or a fallout from one of these deals gone wrong.  Regulators around the world, the FSA here in London has done a big report, we are having this looked at in Australia by our Council of Financial Regulators.  It will be an issue at the IMF meeting which I’m on my way to at the moment.  Regulators will have to try to get a grip on where the ultimate risk of these borrowings falls in order to make sure that they can stress test financial systems and make sure that there is no risk emerging.

JONES:

Are Australian companies particularly vulnerable because the money all comes from overseas?  Vulnerable to any kind of international shock in the markets?

TREASURER:

Well the good thing about the money coming from overseas is that our own financial institutions are not exposed.  So that if one of these deals ran into trouble and there was a default, you wouldn’t have an Australian institution coming under risk.  That is actually a good thing.  Now, the fact that the money comes from overseas and then is spread generally between overseas borrowers does mean that international risk will play a big factor for these companies.  That if their lenders are in another jurisdiction then an event in that jurisdiction could actually trigger repercussions back in Australia.  So they have to be very, very careful not just about Australian conditions and Australian conditions will be the least of their worries, because Australia has been pretty carefully managed at the moment.  They will have to be very careful about conditions in the United States and in other countries where the lenders and where the risk from the borrowing ultimately lies.

JONES:

Did any of these concerns give you pause as you deliberated on whether or not to approve the Qantas takeover bid?

TREASURER:

I thought about it very carefully.  I mean there is the systemic issue.  There is then the tax issue and I have issued a warning about that recently.  Australia is not going to allow these companies to load debt in Australia with thin capitalisation.  I have given a warning about that.  Then, of course, there were the service issues as to the services that Qantas would actually deliver.  And I went through that pretty carefully with the APA partners and we got various undertakings in relation to that to protect the Australian public. 

JONES:

Peter Costello, we are out of time, we appreciate you have got to get off to your flight.  But we thank you very much for taking the time to come and talk to us today.  Hopefully we will be able to do it again when you get back to the country.

TREASURER:

Thank you very much, Tony.