The Crest of the Commonwealth of Australia Treasury Portfolio Ministers
Picture of Wayne Swan

Wayne Swan

Deputy Prime Minister and Treasurer

3 December 2007 - 27 June 2013

30 October 2008

NO.042

Addtress to the
Per Capita Policy Conference

Brisbane

30 October 2008

Can I acknowledge the Rt Hon Patricia Hewitt MP; Olaf Cramme, Director of the Policy Network; Professor Bruce Muirhead from the Eidos Institute; and our friends from the Queensland Government.

Ladies and gentlemen, it is a genuine pleasure to be associated with Australia's newest think tank, Per Capita.

During my visit to Washington in October, I had the privilege of visiting and addressing the Brookings Institute, which I know many of you consider a model for Per Capita. My visit gave me the opportunity to reflect on the different role that think tanks have played in the policy process here and in the States.

Australia has a history of relying heavily on advice and ideas from within government. Governments, of course, generate good ideas. But think tanks have capacity for unconstrained, nimble, entrepreneurial movement which government cannot always replicate.

New ideas can take hold very quickly because developing good ideas is the institution's core business, allowing staff and contributors to dwell over key questions in great depth.

Per Capita has got the right people in place, in David Hetherington and Michael Cooney. Michael I know personally, and consider a friend. He combines intellectual horsepower with an understanding of how the game is played in Canberra.

Having the right people is an important predictor of future impact. Another barometer is the capacity to raise the right issue at the right moment. On this measure, Per Capita's future is bright.

Because there could not be a more appropriate time for us to be discussing the role of markets than in the context of the challenge leveled by the global financial crisis.

The Global Crisis and the Role of Markets

The global financial crisis has brought debates about the effectiveness and morality of markets from academic journals to the front pages of daily papers around the world.

On opinion pages and in the blogosphere, commentators are locked in debate about whether the global financial crisis is a necessary part of functioning capitalism or spells the end of the free market - or at least the end of the emphasis on free markets we've had since the Reagan and Thatcher revolutions of the late 1970s and early 1980s.

British economist Anatole Kaletsky argues in Prospect that the current crisis is one of a series which, far from an indictment of capitalism's instability, are in fact "testament to its extraordinary resilience." "Capitalism will recover", he predicts, "as it always has in the past."

Meanwhile, others have sounded capitalism's death knell. Ruth Sunderland writes in the Observer that the crisis is an opportunity to "slay the myth of the omnipotent market", and Madeleine Bunting argues in the Guardian that we are witnessing the collapse of an "absurd economic orthodoxy". This is a healthy debate.

As a former academic, I must admit it's refreshing to see our citizens discussing the fundamental moral and economic issues at stake in the theories of the Keynesian and Austrian schools of economics.

But the wiser commentators and economists - and I'm taking about those on the spectrum between The Australian's Alan Woods and the New York Times' Paul Krugman - have given a less reactionary, more contemplative reading.

Sometimes, in the face of upheaval, it feels safe to bunker down without facing the other challenges swirling around us. But another lesson of the crisis is that if we see systemic challenges to our prosperity, we must address them bravely, and decisively.

That's why, despite the current environment, we're continuing on with our reform agenda. We're making the big changes that will build a more productive and fairer Australia. We're not taking our eye off the long-term - not for one moment.

As Treasurer, I'm effectively Minister for Markets. And I've always been a believer in the right type of markets - not those that reward greed, but those that create incentives and efficiencies and, ultimately, benefits for average working Australians.

And I believe this crisis spells the end of a certain type of market: the totally unrestrained and poorly regulated market that even its chief architect, former US Federal Reserve Chairman Alan Greenspan, has now admitted was seriously flawed.

The world financial system entered a crisis not because it was a market but because it was a poorly designed and laxly regulated one. Greed ruled. And poorly designed markets were vulnerable to abuse, unnecessarily unstable and, ultimately, ineffective.

Let me offer a quick analogy: in the early years of aviation, aircraft designers discovered that it was possible to design an aeroplane that was so stable that an almost complete novice could fly it safely.

It would rise ever so gently from take off, cruise along in a straight line, bank and turn slowly and predictably, and float back down gently to the runway. The problem was that was all it could do.

Designers then realised that they could make much more high performance aircraft with more powerful engines, smaller wing area and reduced drag, but it came at the price of calculated instability. Such aircraft could perform amazing aerobatics, but were prone to hit the ground in alarming numbers, in an era before parachutes were perfected. Designers pushed the boundaries, eventually producing high performance aeroplanes that were so unstable that they were almost as dangerous to their own pilots as they were to the enemy.

My point of course it that our goal can't simply be performance at any price - it doesn't matter how high you fly if you finish your journey plummeting towards the earth with no parachute.

The goal of market design, like that of aircraft design, is to find the optimal design which will deliver enduring solutions to sometimes intractable problems. Our task is to find a way of designing markets that can serve the public without blunting the incentives that enable them to allocate resources effectively and generate prosperity.

So as a government, we've taken heed of two messages from the current crisis.

First, markets are a powerful and valuable tool to harness human ingenuity, creativity and innovation. But we must think clearly and carefully about how they are designed to ensure that markets achieve outcomes that are beneficial to Australians. Markets that work for the community, not against them.

Second, while sometimes in the face of upheaval it feels safe to bunker down without facing the other challenges swirling around us, the current crisis means that if we see systemic challenges to our prosperity, we must address them bravely, and decisively. That's why despite the crisis, despite the upheaval going on around us, we're continuing on with our reform agenda. Big changes, to build a more competitive, more modern, more productive future economy.

Those big changes relate to three areas of reform. Areas which - if we get the design of the markets in question right - will help change Australia. In each, market design and market principles are the critical tools which will direct the power of competition and innovation towards solving the economic and social problems we confront. These areas are climate change, the overlay of the tax-transfer system on our labour market, and Modern Federalism.

Climate Change

As Treasurer, I know that no issue better exemplifies both the consequences of market failure and the importance of astute market design than climate change.

The market has failed to price the impact of carbon on our economy. The consequence is dangerous climate change - which threatens to slow economic growth and imperil our way of life.

But just because a problem stems from the market, it does not mean that we should limit the role that the market can play in resolving it. And so it is with climate change.

A well-designed market can break the link between emissions and economic growth by putting a price on carbon to reflect the true cost of economic activity.

This is the central goal of the Government's Carbon Pollution Reduction Scheme. The Scheme will place a limit on the amount of emissions which can be pumped into the atmosphere - and the Government will issue permits up to the level of the limit. This will put a price on our greenhouse gas emissions - so that the market takes account of their impact on the economy, and so that Australia moves towards a low carbon future.

Designing the Carbon Pollution Reduction Scheme - that is, designing a carbon market - is a challenging task. Trust me, I know. The design of the Carbon Pollution Reduction Scheme is something that the Prime Minister, Penny Wong and I grapple with intently and frequently. But new evidence which has just come in suggests we are heading in the right direction.

Later today, the Minister for Climate Change and I will officially launch the long-awaited Treasury report on climate change mitigation modelling. This is a landmark event.

The Treasury has conducted one of the largest, most complex and most rigorous economic modelling projects ever undertaken in Australia, to investigate the potential economic impacts of reducing emissions over the medium- and long-term. It's been a huge task, but it means that we will make decisions about climate change better informed about the likely impacts than almost any country around the world.

The modelling tells us important things about Australia's transition to a low carbon economic future. It proves that:

  • Australia can reduce emissions and continue to grow economically;
  • Acting earlier will be cheaper; and
  • With a global carbon constraint, many of our key industries will become more, not less, competitive.

Let me elaborate on each of these.

First, the Treasury modelling proves that a well-designed carbon market will break the link between economic growth and emissions output by increasing our economy's carbon efficiency. With efficient emissions pricing, Australia can reduce the emissions intensity of GDP rather than its actual GDP. That means we will be able to produce more for every tonne of emissions we generate as a nation. The report shows that by 2050, the emission intensity of the Australian economy will be reduced to a quarter of 2005 levels.

Second, the modelling proves that the longer we delay, the more expensive responding to climate change will become. Delay could encourage build-up of emissions-intensive capital stock that will later become a significant liability.

In contrast, early action allows individuals and firms to plan their adjustment pathways and better manage changes in skills acquisition and capital stocks. Acting early is particularly important if countries implement emissions reduction schemes in stages - which at this stage, is a likely outcome.

The economies that defer emission pricing become relatively more emissions-intensive, so when an emission price is eventually introduced, they face greater costs, particularly because global investment is redirected to early movers.

The modelling suggests that, by 2050, GDP costs for economies that act early are 15 per cent lower than countries that wait for the world to act together. The message is clear: acting early is an economic imperative.

Third, the modelling shows that while all producers will face falling global demand for emissions-intensive goods and services, some of Australia's emissions-intensive trade-exposed sectors, such as coal, are likely to become more competitive, and increase their share of global trade.

And others like steel and iron ore will remain just as competitive as they are now. This is because Australian production of these goods is less emissions-intensive than it is elsewhere, and in a market-based setting, the most energy-efficient producer will, all else being equal, also be the least-cost producer.

The assertions proved by the modelling all point to one conclusion: the Carbon Pollution Reduction Scheme is a pro-growth, pro-competitiveness strategy for the Australian economy. It shows that a market-based solution allows us to tackle climate change in a way that's affordable for families and pensioners and promotes growth and competitiveness. By using a well-designed, market-based solution, we win on the environment, we win on competitive industry, we win on growth.

Distributional policy and the Labour Market

Climate change is an issue which we're becoming accustomed to hearing about in the context of microeconomics and market design.

But to give you a flavour of how ideas about market are relevant to a diverse range of policy areas, I'd like to switch tracks, and speak about the labour market.In particular, I'd like to speak about how the tax and transfer system can shape the incentives that underpin the functioning of that market.

Designing an efficient labour market, which fairly rewards the efforts of Australian workers - is an issue to which many of you will know that I have devoted a fair amount of my public life, including large tracts of my book, Postcodes: The Splintering of a Nation.

In making the decision about whether to participate in the labour market or not, Australians, like most people, are guided by how well they will be rewarded for their efforts.

But, like most governments, we make two important interventions which can significantly alter the returns to work.

First, we tax. We step into the transaction between the employer and the employee, and we collect part of the money.

Of course, we do this so that we can provide public goods - community safety through the police and defence forces, opportunity through the education system and wellbeing through the healthcare system. But we also do it so that we can redistribute income - which is the second way in which the government intervenes.

To help those who are less well-off, the Government provides support through the transfer system.

But to do it fairly, we ensure that as a recipient's income goes up, the amount of transfer payments he or she receives goes down.

The interaction of these two actions - taxing on the one hand, and redistributing on the other - can lead to unintended consequences.

Let me put my point to you using a couple of practical examples. In Australia, a mum with two primary school aged children, who is supported by a primary income earner earning $58,000, might earn $280 a week in a part-time role.

This particular mother earns less than $15,000 a year, yet if she takes on an extra shift at work, then through the combination of taxes and a reduction in benefits she will lose 35 per cent of her additional pay. Even more striking is the fact that a person in the same situation who earns $770 a week could lose 65 per cent of each additional dollar earned.

Of course, high effective marginal tax rates and muted labour market signals are not a uniquely Australian phenomena.

For example, Harvard economists, and former economic advisers to President Clinton, Dean Elwood and Jeff Liebman, have passionately written about a kind of "middle class parent penalty"- referring to circumstances in the US labour market where moderate income families face marginal tax rates higher than their richer neighbours.

But while the phenomenon of blunted labour market signals is universal it does represent a special sort of challenge for progressives. That challenge is for us to continue to stand by the redistributive benefits of transfer programs, but yet at the same time to design policy in such a way that there remains strong incentives for people to participate in the labour market. It is a challenge which holds profound significance for our future economic and social well being.

By 2047 one quarter of this country's population will be over 64 - almost double the figure today. This ageing of our population will create pressures on public services and resources.

The smaller domestic labour pool will also have significant implications for economic growth, with real per capita GDP growth to slow to an average of 1.6 per cent a year - compared with 2.1 per cent during the past 40 years. So it is vital that we remove blockages in our labour market, by fixing the problems with our current tax and transfer system. There is general agreement on this matter.

Yet no Australian Government in the last 50 years has seriously sat down to do a clear, comprehensive think about our tax and transfer system. That is why in our first Budget the Rudd Government announced that an independent review panel, chaired by the Secretary to the Treasury, will undertake a comprehensive review of the tax system - and as part of that provide options untangling the complex disincentives which sit at its centre.

If we get our design of the tax and transfer system right, we will have a labour market which encourages people to work, save and invest. It will be a market that operates fairly, treats those in similar circumstances equally and demands more support for those in need from those who can afford to pay it. And a market which gets the incentives right to encourage fair participation in the labour force, and rewards effort and enterprise.

Commonwealth-State Relations

I want to move now to my final reflection on market design, that is, our reforms to Australian federalism.

Coordinating the efforts of the Commonwealth, the six State and two Territory Governments is a problem that has plagued Australia since federation.

I'm passionate, and the Government is passionate, about getting it right. Because so many of the most critical challenges facing Australia straddle State and Commonwealth responsibilities.

We cannot provide a 21st Century education system without cooperation between state and federal governments.

We cannot address problems of indigenous disadvantage, or provide good quality healthcare for all Australians, or ensure we have the infrastructure required to build prosperity for the next generation, without harnessing the energies and capabilities of all Australian governments.

In part, the existing problems associated with federalism are a consequence of how our system has developed.

As many of you know, the challenges tossed up by the last Century - Depression, World Wars, globalisation - saw the Commonwealth assume legislative and financial functions of government that once belonged to the States.

But, as someone who used to lecture on federalism, and now as Treasurer, I am convinced that an even greater part of the problem is that the design of Commonwealth-State financial relations has not been approached with good market principles in mind.

The financial relationship between the Commonwealth and the States is, in many respects a market of exchange: the Commonwealth provides the States with the proceeds of the GST and over $33 billion of payments for specific purposes, and in return the Commonwealth expects the States to deliver a range of services - in areas such as health, education and disability.

However, in dealing with the States, the Commonwealth has never properly conceived of this relationship in market terms. Instead the Commonwealth has created a stifling bureaucratic structure, which ultimately led to a focus on process, and mediocre policy outcomes.

As the years have passed, the Commonwealth has insisted on more and more prescriptive requirements in exchange for necessary funding, shackling the States and reducing their capacity to innovate and tailor solutions to their local communities.

Under the Howard Government, this 'command and control' model was taken to new levels of pettiness and populism - like their insistence that every school fly the flag before they receive funding.

It is this kind of ill-conceived market design which has led the Rudd Government to recast the Commonwealth-State financial relationship in a more modern mould.

Where our predecessors stifled innovation and undermined public accountability, we will do just the opposite.

First, in a significant break with the past, we are committed to using incentives to drive reform at the state level.

Under the new modern federalism, the Commonwealth will enter into incentive arrangements with the States - or National Partnership payments - to deliver key economic and social reforms. National Partnership payments will reward those States which best deliver the services and outcomes to their citizens, and not reward those that don't.

For example, using National Partnership payments, we will set out to provide new resources to schools in low socioeconomic status communities. Providing extra resources to our most disadvantaged schools via incentive payments will spur long run growth - and spread opportunity across the community.

Second, we will use information to drive better accountability. We will independently measure how the States perform across agreed indicators, and we'll provide that information to the public - allowing the community to make better judgements, and keep state governments accountable.

I have every confidence that these market driven changes will help us build a more productive national economy, and deliver better services to all Australians.

Again in the area of schools, Julia Gillard is using the new framework to work with the States to introduce school-level reporting of test score results. As many of you will know, there is strong empirical evidence to suggest that in a high-information environment, underperforming schools are forced to lift their game, as they face the incentive to keep up with similar but better performing schools in their area.

And so, with the new design of Commonwealth-State relations, there will be more accountability across all of Australia's schools - and hopefully better educational outcomes to match.

Now, of course, big hurdles still lie along the road to reforming Commonwealth-State Relations.

The States and the Commonwealth are yet to agree on a few pretty important matters.

But I think Anna - and all the State Governments - would agree that in redesigning Commonwealth-State relations using a more market-driven framework, Australia is now on the path to getting federalism right, after almost a century of trying.

Conclusion

Thank you again for having me here today. Let me leave you with a couple of thoughts.

On the eve of the collapse of the Soviet Union, Mikhail Gorbachev noted that "the market is not an invention of capitalism...It is an invention of civilization." Of course, he was right.

'Markets' are a function of society - not of political ideology. They are an organising device, which, depending on how they function, can solve immense problems or create them.

And in responding to public policy problems, we ought not be guided by extremes - heavy handed regulation on the one hand, and unfettered, unbridled markets on the other. We must keep this in mind when we consider the range of responses to the global financial crisis.

There has rarely been a time of greater need to harness the motivation and energy, the innovation and creativity, of clever people, who are committed to the public good. And markets - properly designed and well regulated - are the best means of harnessing these forces.

And in developing those markets, in applying them to the challenges we face, we should be guided by evidence - evidence which points to the best way to design key markets which will shape our collective future.

When creatively constructed and informed by evidence, markets can provide a path to a new generation of prosperity for the mums and dads and pensioners of Australia.

In the case of climate change, the evidence from the Treasury climate change mitigation modelling is clear: a market-based solution, introduced early, will allow Australia to reduce its emissions while still growing its economy.

In tax, the evidence points to a problem of design which needs to be addressed in the interests of working people, and the nation more broadly.

And when it comes to Commonwealth-States relations, the problems of the recent past shine a revealing light on just what principles ought to determine the way our federation should and will operate in the future.

I believe that if we are guided by the evidence, and design markets well, then our citizens, governments, organisations and businesses will use their resourcefulness, their ingenuity and their creativity, to rise to the challenge of solving the biggest problems facing Australia.

And that's also where Per Capita fits in - providing Australian policymakers with fresh evidence and new, progressive ideas. We'll be listening closely.

Thank you.