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The Case Against (Another) Australian Sovereign Wealth Fund

As if the Future Fund were not bad enough, there are those (really just Paul Cleary, who thinks Australia is like Timor Leste, where he spent too much time) who argue that Australia should establish another sovereign wealth fund as a revenue stabilisation fund to smooth out the budgetary implications of terms of trade shocks. In yesterday’s speech to ABE, Treasury Secretary Ken Henry argued against the idea, while pretending not to:

I don’t want to pre-empt a debate on these matters. But I will make a few observations.

First, if the revenue surge is regarded as likely to be long-lived, the alternative of tax cuts – permitting the private sector to make its own saving and investment decisions – should always be considered first.

Second, of the various objectives, the proposition that a sovereign wealth fund can be used to impose discipline on government spending is most problematic. Sovereign wealth funds that have been in place around the world have not been as effective in imposing spending discipline as many seem to believe. IMF research has found that there is no statistical evidence that such funds impose any effective expenditure restraint.6 Even if rules are put in place to restrict access to the fund, in the absence of liquidity constraints, a government that wants to finance an increase in current spending can borrow against the security of the fund. Money is, after all, fungible.

Third, stabilisation, consumption smoothing and exchange rate sterilisation are not dependent upon having a sovereign wealth fund. That is to say, these objectives could just as well be achieved within the context of the overall budget strategy.

Fiscal stabilisation can be achieved without drawing on a sovereign wealth fund, as demonstrated in Australia’s response to the global financial crisis and international recession.

Consumption smoothing can alternatively be achieved in the Australian context by investments in human capital and high quality public infrastructure or through contributions to individuals’ superannuation accounts.

And a country experiencing large gross flows, both inward and outward, of both equity and debt, doesn’t have to take an explicit decision to invest the proceeds of fiscal surpluses in foreign assets in order that those surpluses put downward pressure on the nominal exchange rate. That is, using budget surpluses to repay debt, or even to purchase another financial asset domestically, would have the same effect.

posted on 18 May 2010 by skirchner in Economics, Fiscal Policy

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He also made some promising remarks just before those on running fiscal policy in response to a terms of trade shock:

“For reasons given earlier, since it is likely that a substantial part of the increased income flowing from our elevated terms of trade will be sustained for some time, the persistent accumulation of surpluses in our case would likely be quite prolonged.

“Persistent budget surpluses imply tax rates that are structurally higher than they need to be to finance current spending. And taxes can affect long run growth. The size of the tax-induced welfare loss depends on the choice of tax base and its structure.

“If high inefficient taxes are maintained and a structural surplus is depleted through higher spending, there is the potential for a second set of deadweight costs — on the spending side. Especially as an economy approaches full capacity, it is important to keep in mind that the case for a government spending initiative has to confront both the opportunity cost of the proposed initiative – whether there is an alternative initiative of higher quality – and the cost of holding tax rates higher than they might otherwise be.”

Posted by .(JavaScript must be enabled to view this email address)  on  05/19  at  08:16 PM


“Especially as an economy approaches full capacity, it is important to keep in mind that the case for a government spending initiative has to confront both the opportunity cost of the proposed initiative – whether there is an alternative initiative of higher quality – and the cost of holding tax rates higher than they might otherwise be.”

This is true regardless of where you are in the business cycle. He just made the case against fiscal stimulus.

Posted by skirchner  on  05/19  at  10:35 PM



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