Rethinking tax and income policy practices to make our society more civil

by Eva Cox

There are two good arguments for framing policies to create more civil societies: one is that life will be better for all, the other is that we will feel it is. Democracies should be social systems that distribute the myriad of experiences, resources and relationships fairly and civilly. Effective policy responses to global financial and climate crises require high levels of good will, resilience and generalised trust rather than a culture of fear and self interest. Governments need the trust of voters to make legitimate decisions for the common good, and that depends much more on social well-being than on individual economic circumstances.

Policies that increase social well-being must take into account the quality of our links with those we know, whether at home, at work or in communities, as well encouraging the growth of quality ties with those outside our immediate circle.

Good policy making, whether in the classically social portfolios, on environmental issues, or economic ones, must also be framed by accepted views of the kind of society we want to live in. Setting overarching social priorities would improve both the effectiveness and coherence of public policy making and avoid damaging the social fabric through the application of inappropriate economic models.

This distinction has become necessary because too much policy making by both past and current federal Governments has failed to recognise the limits of economic analysis and applied it willy-nilly to inappropriate areas. Economics is a social science, built on limited assumptions about human behaviours that can usefully explain some but not most behaviours. Good policies need to balance the social purpose of the nation state against the practice of making more money to fund its expenses.

When policy-makers assume that the economy is an end in itself the policies shaped by that assumption can be socially damaging. Whether it’s through the attempt to enforce engagement in economic activities through coercive policies or the implementation of economic policies that increase inequality, the blindness to the social purpose of policy creates social rifts, damages social cohesion, increases anxieties across the board and reduces engagement by those who feel excluded and disrespected.

This chapter looks at two main areas in which flawed assumptions are skewing our policy priorities: the mix of tax and transfer policies that collect and redistribute public dollars, and the suite of measures grouped under the inaccurately named ‘social inclusion’ portfolio.

‘Social inclusion’ should be about more than paid employment

The word ‘social’ features only rarely in current policy agendas, and there is no priority given to this area of policy in election debates. This reflects the dominance of economic over social equity issues reflected in the ‘What does ‘progress’ mean to you?’ chapter of this publication. ¹ It is no surprise, therefore, that the Social Inclusion ² portfolio has ended up having social in its name but not in its mandate or its measures of success. When economic activity is seen as the most important measure of social progress then welfare reform is seen as employment policy, paid parental leave is justified by its contribution to workforce participation and productivity, and the Indigenous closing the gap strategy is too often seen through the lens of jobs. ³ This assumes that the primary aim of social policy is to make all individuals fit a narrow definition of ‘independence’ and that paid work is the most socially useful way that anyone can spend his or her time. It leaves out all questions of social relationships, as well as failing to recognise the importance of cultural connections, social responsibilities and care for country and others.

There are interesting questions being raised internationally on the important role that making time – not just money – plays in increasing social well-being. The New Economics Foundation ⁴ is exploring ‘time banking’ as a way of recognising the non-monetary value of time spent helping others. The Foundation describes the outcome of time-banking programs as ‘a parallel economy, using time as the medium of exchange, putting these forgotten assets to work meeting the forgotten needs, and by doing so making connections between people and rebuilding a sense of trust.’ ⁵

The sharing of paid and unpaid work is part of good parenting and good communities. Full time employment (or over-employment) for some and none for others is not a good basis for dealing with climate change and diminishing resources. However our tax and transfer systems continue to penalise part time workers, particularly those with limited time or paid work capacities, while rewarding the wealthy.

Higher participation and productivity requires a workforce that is comfortable with its non-work roles as well. This means a tax and transfer system that is not clearly linked to the residual Justice Higgins wage earner model, which assumes that an unpaid support system exists for all workers. It must recognise the value of the informal care and cultural sectors to enhance the capacities of communities to manage workplace and other changes.

Better policies for tax and an income security system should involve integrating ideas from successful Indigenous standpoints and some related feminist critiques of current public policies. These marginal viewing points provide useful guides for moving outside the overly influential economic models to a more inclusive social system. Using the failure of western (male) goals for education, health and family functioning in Indigenous communities can contribute to our understanding of how to engage in collective well developed social cultures. Similar, but less obvious, is the need for inclusion of aspects of the social system that have been seen traditionally as female or the private domains of home, care and social cohesion. A system that balances and integrates the social and cultural domains into forms of income support can provide both better social outcomes and economic ones.

Human nature: we’re just not that simple

These and other policy mistakes can be traced to flawed but deeply ingrained assumptions about human nature:

• Classical economics assumes that humans are rational self-interested individuals, so all that’s needed for good policy is to get the price incentives right. The logical consequence is that those who make the ‘wrong’ choices should suffer the consequences. This assumption triggers a contradictory conservative desire to enforce ‘good’ behaviour and avoid the costs of deviance.
• This assumption creates policies to make people self supporting and assumes that if they don’t have jobs, it is because they have problems: they’re lazy, or maybe have other personal flaws. Therefore, at best, they may need treatment for lack of skills or for personal or group health or character flaws.  The implication is that government needs to change, pressure or punish them until they get a job.

This approach ignores systemic bias: the inequalities of how societies allocate resources and opportunities. Instead it assumes individual problems with fitting in. It is an approach which denies the fact that there is such a thing as unequal power in society.

Being part of fractured, unequal, untrusting societies is stressful even for those who benefit from inequality and more so for those at the bottom of the pile. Increases in income don’t automatically lead to better social outcomes, as has recently been shown in the work of Michael Marmot, Richard Wilkinson and others. ⁶Their meticulous research finds that equality levels are better indicators of the quality of life than average per capita GDP.

The explanation for this finding is that well-being rests more in perceptions rather than the direct material impact of inequalities. Other recent research shows that humans mix emotions with reasons in assessing quality of life, and in particular that there is a gut reaction to unfairness, however defined. ⁷ Therefore people’s perception of their societies as unfair can affect well-being overall and undermine the sense of agency required for society to function well and for people to be willing to contribute to the common good.

Governments need to make policies that help society become more civil. Individuals exist within a network of relationships – individuals’ happiness does not only depend on their own circumstances, but on their relationships with those around them. The quality of a society rests on the ways in which it values the connections between people – not just on the sum of their individual well-being.

When social inclusion becomes social exclusion policy

The government’s social inclusion policy is a major indicator of its social agenda, despite the policy being relatively low profile and having few budget items. This policy area states that its aspirations are ‘reducing disadvantage, increasing social, civic and economic participation and developing a greater voice, combined with greater responsibility’. This may sound relatively broad but the actual priorities are much narrower, as indicated in their documentation of the issues on their webpage – and the programs they fund for implementation. ⁸

The delivery model for welfare payments puts many conditions on recipients which are designed to push them into certain activities and make them employable. ⁹ So it assumes that the major faults lie with the excluded, whether as individuals or in some type of community. Therefore the current government view of its own role is to provide remedial services, coercively if necessary, to ensure that the people involved move into approved slots in the economy. The way to show success is to become employed, or at least be obviously preparing for employment. The message is clear. People are only valued and included if they are self-supporting members of the paid workforce.

This area was part of the current Prime Minister’s portfolio and her various statements about the importance of hard work and the emphasis on finding people jobs as the way ahead suggests the deep embedding of these assumptions in the newly-elected Gillard Government. The Coalition already signalled its views when in government by its Welfare to Work policies, which have continued under Labor.¹⁰

Evidence-less policy – unfair and ineffective

These approaches to what is seen as individual, or at best community, dysfunction fail to take into account the findings of Marmot et al. Their research seriously suggests we need to look at whether high levels of social dysfunction, as is seen within some Indigenous communities and other poorly functioning outsider groups, may derive from the loss of a sense of agency because of perceived systemic unfairness.¹¹

The Northern Territory Intervention and the more recent expansion of its income management scheme to other working age recipients is the wrong response to long-term despair as it focuses on fitting ‘flawed’ individuals into an existing social system without recognising the flaws in the system itself.  This is despite the lack of evidence that such strategies work.¹²

There is no recognition that many of those who end up on Newstart may be excluded because of prejudice or inappropriate workplace demands. Nor does the current system recognise the difficulties single parents face in finding jobs that fit in with care, let alone dealing with employer prejudices against them, as shown in research I and others did for the New South Wales Department of Women. ¹³

Not only is such policy making seen as unfair, it does not work. The experience of the original compulsory income quarantining of 50 per cent of government payments in the 73 communities has produced no evidence that it has improved life and reduced risks in these communities. However, it is being extended to the rest of the Northern Territory and de-racialised under claims that it will restore fractured families.¹⁴ This demonstrates an official conviction that income control results in positive behaviour change that overpowers evidence, reason and logic.

By pressuring all those out of paid work into jobs, without regard for their other responsibilities, the time for care of others is limited. This may sometimes reduce direct government spending, but at what social cost?

Changes are needed

Recognising the socially useful activities requires an equitable tax and transfer system to redress the cultural and gendered divide between activities that are publicly recognised or not. This becomes a problem when payments are income tested on joint incomes, which unfairly penalises the lower income earner, as recognised in the Henry Review, or by intersections of tax and welfare payments. ¹⁵

Indigenous societies value the activities of engaging with kin, sharing stories, caring for country, ceremony and traditions, as highly as earning money. Similarly, most unpaid activities within other communities, households and family are overlooked despite being essential to wider social functioning. The way that public policy undervalues the costs of our social obligations for care and social maintenance can be particularly harmful to the more vulnerable, less resourced people who have to cope with difference and change.

Ken Henry, in the Tax Review ¹⁶ and in other speeches, showed his awareness of social and ethical issues involved in taxing and spending designs. The design of tax and transfer payments can be powerful affirmations of what a society values and what it condemns. The distinction is best illustrated by the attitudes of the media, public opinion and in policy making towards ‘entitlements’ to tax cuts and concessions compared to the moralistic, controlling and downright mean attitudes to ‘welfare’ payments. Yet $100 paid under either system costs the public the same amount.

Therefore, any examination of these major policy areas needs to define its principles and purposes. The overview of the Henry Report starts with the following claim in the letter to the Treasurer: ‘The Report presents a vision of a future tax and transfer system that would position Australia to deal with the demographic, social, economic and environmental challenges of the 21^st Century and would enhance community wellbeing.’

Note the word social is there as it is in an earlier Australia Council of Social Service (ACOSS) speech where Henry was quite explicit about his aims in the Review.

‘I chose the title of this speech — ‘how much inequity should we allow?’ — for a couple of reasons. For a start, it is mildly provocative, which I thought might help pique your interest. The instinctive response of many to the question would be to answer — none; a just society would not tolerate any inequity. Of course, beyond this instinctive reaction things get complicated. I will return to this later.

Secondly, I selected this title because I consider this to be one of the most significant choices society faces. Indeed, the question assumes inequity is a social choice. And it is. Leaving fairness solely to the market to determine should be unacceptable to a civilised society. Societies will choose how much inequity they allow according to the institutions, norms, laws, policies and programs they adopt.’ ¹⁷

The following recommendations and principles follow his stated intentions with more emphasis on the social than he was able to do. Therefore a tax/transfer system, in what it collects and redistributes, should affirm what is seen as socially as well as individually valued.

Principles for change

This involves setting up principles for long term changes to policies that:

• Recognise engagement in social as well as economic activities needs to be on the government’s agenda when setting the criteria for funding and taxing.
• Policies need to balance earning income through producing goods and services for money with the many other aspects of life which warrant public encouragement and support.
• This should include the full gamut of useful social roles, some paid and many unpaid, some formalised but others informal. Public recognition should encourage appropriate engagement with personal wellbeing, the needs of others and the common good.
• Payments, tax imposts, concessions and rebates need to contribute to the overall progressiveness of the system, or at least be justifiable as fair.
• Systems changes need to recognise diverse cultural values and be gender neutral.
• This may involve reviewing the units of payment to deal with the clash between taxing individual incomes and transfer payments that assume interdependence and shared resources.
• New de facto legitimation also carry problems as transfer payments can assume  that co-habiters may be responsible for each other, even if they deny this
• The gap between pensions and benefits needs to be decreased or abolished to recognise minimum income needs are related to workforce participation.
• The tax/transfer system should be based on assumptions that people, in general, will be prepared to take responsibility for their income needs if the wider social system treats them fairly.

Specific policy proposals

• Stop the extension of income management in the Northern Territory and possibly other disadvantaged areas in Australia as it permanently shifts the basis of income support from facilitative to punitive, particularly for parents.
• Where communities require income management, they should be offered the option of voluntary community based packages of income management and allied support services or in response to individual or household behavioural triggers.
• Return all sole parents income recipients with children under 12 to the parenting payment rates and conditions to ensure that they have enough basic income
• Urgently review the payment levels of Newstart and other benefits and raise it to an adequate base payment.

Reforming the broader system – mainly from the Henry Review

• Establish an independent tribunal to set and maintain payment levels to remove the decisions from populist political pressures with a brief to establish a basic income support level for all.
• Design categorical income supplementation and support programs that recognise needs for financial support for both the direct costs of children, and the costs of reduced access to paid work and the extra costs of disabilities.
• To facilitate movement between paid work and care-based time demands, accept the principles outlined in the Henry report for reducing effective marginal tax rates but inquire further into whether this is best done by changes to the tax or to the means test to reduce current effective marginal tax rates.
• Set up a review of cohabitation and interdependence under the Human Rights Commission.
• Accept the principle in the Henry recommendation that there be a single family tax benefit payment and that the total amount of family assistance should be withdrawn with a single rate to avoid overlapping withdrawal disincentives for working.
• Explore the Henry proposal possibilities of taxing payments rather than income testing them and other ways to reduce the savage effective marginal withdrawal rates.

Retirement and non employment income

• There should be a retirement bonus payment as a top up for those who have zero or very limited superannuation ($10,000) or other forms of saving by themselves or legal partner. This payment would supplement those solely receiving the single age pension who have often had good reason for being unable to save or contribute and balance the public contributions to substantial retirement income via tax concessions.
• A longer term options could be a social investment income support payment to be made available for people who engage in extensive socially valuable tasks in communities. This could encourage community services generally as well as make viable communities where there are no other sources of funding e.g. in isolated areas such as homelands.

Co-habitation reforms

• Questions of joint income testing (transfers) versus individual own income testing should slowly move towards being similar across tax and transfer systems, but in the meantime co-habiting should be assessed on shared income and costs.
• The law should recognise that social relationships do not equate with financial ones where there is no legal obligation or evidence of shared financial resources.
• Pooling of incomes should be assumed only where there is evidence of shared control over a set proportion of incomes or a formal agreement for funds to be pooled for use by both parties.

Conclusions

The above recommendations are a very brief set of policy proposals in response to complex issues. They point to alternative approaches to those adopted by both the major parties during the 2010 election, and seek to counter the scramble to sell the economic credentials of the major parties to voters via bribes and fear of tax increases. The evidence can be read to show that people distrust those who offer bribes and bargains and prefer trustworthy leadership. ¹⁸ In the long run politicians cannot hope to retain voters’ trust while pursuing unfair and ineffective policies based on flawed assumptions about what is important to people and society.

Endnotes

AUTHORS(S): Eva Cox

by Tani Shaw

When it comes to the really important things in life, research shows that people from all walks of life share a lot in common¹. The things that we value most seem to be spending time with those we love, a fulfilling job, a healthy life in a safe and secure environment, access to a good education and health care, time in the sunshine enjoying nature and Australia’s beautiful landscapes, the right to believe and vote² according to our values and a sense that we are part of a community.

The other chapters in this book show different areas in which Australians want progress. 75 per cent of us support stronger human rights protections³ for example, and 72 per cent want action on climate change, even before a global agreement is reached.⁴ Very little has been done in either of these areas. Why? What other forces may be overriding this clear call for change? Part of the problem lies with a single statistic that governments and economists use to track how Australia is performing economically. This simple statistic is often treated as the most important measure of whether or not we are on the right track as a country.  It is “GDP” or Gross Domestic Product. Despite being aware of its limitations, many policy makers, political leaders and commentators treat GDP as the most important measure of the “progress” of our society and our “quality of life”. GDP measures the total amount of goods and services sold in Australia each year. When GDP is seen as the primary measure of success, then the most important economic goal of any “good” government is to make sure that GDP grows every year.

A large part of the debate over whether Australia should introduce an emissions trading scheme before most other countries turned on whether this would make us less economically competitive than the countries that delayed. If so, we were told, this would negatively impact on ‘economic growth’. Other countries were having the same debate, and although the facts pointed in the opposite direction⁵, even the fear of harming GDP growth was enough to stop many politicians in their tracks. The wish to keep GDP growing at any cost has contributed to the current international stand-off on climate change. The costs associated with climate instability are going to be enormous…but let’s not think about that now. There are short term gains to be won.

So does producing more each year actually help us to secure what we value most? Of all of the ‘universally valued’ things listed above, none of them are counted in GDP (although below a certain level of GDP per capita some of these things tend to be far less attainable). So why does this measure have so much influence over the way our country is run?  This chapter aims to unpack that question and to describe a movement that exists in Australia and worldwide to find a better way to measure “progress”.⁶

If we are measuring and aiming for economic growth in GDP then this is what we will achieve. If we are measuring economic strength and stability, environmental sustainability and the well-being of people then we are more likely to achieve it. This brings us to key point #1:

Key Point #1 – National primary statistics and indicators need to reflect the goals of society

Firstly, let’s unpack GDP a bit. GDP was not designed to be the main indicator of progress.  In 1944 each country had different types of systems for national accounts. This caused problems because when one country’s figures changed the other countries didn’t know how to react and this caused unnecessary fluctuations in international markets. So in 1944 at the Bretton Woods conference in the U.S. 144 nations decided to choose a single measure by which to compare economic activity between countries, GDP.  The goal was transparency and greater economic stability.

Economists then began to equate GDP growth with the economic well-being of individuals.  So what does “economic well-being” really mean? In 2009 President Sarkozy of France commissioned some of the best economic minds in the business, Nobel prize winners Professor Joseph Stiglitz and Professor Amartya Sen, together with Professor Jean-Paul Fitoussi to look at GDP, economic performance and social progress.⁷  They identified some pretty significant gaps in the usefulness of GDP as a way to measure economic well-being.

GDP does not include all those types of personal economic well-being that cannot be measured with a price tag, such as support at home from family and friends, volunteer work in the community and many other activities which can make a difference to the affordability of someone’s existence. As well as not measuring a lot of activity, GDP is so unrefined that if there is a major environmental accident, GDP generally goes up because of the cost of the clean up and if there is a war, it goes up because of the boost in weapons production.

GDP also does not include many of the positive and negative things that happen when purchasing something. An inexpensive item like a bus fare to visit a relative may hold much more “value” than an expensive repair to a car. Economists call these hidden values “externalities”. Negative externalities include pollution or toxic waste that a product may leave behind or under-priced access to a natural resource which is depleted or lost in order to produce something.

Sometimes goods and services can cost more than they are actually worth just because they are difficult for people to understand, such as complex financial and investment packages or mobile phone plans. They may be expensive and will be counted in GDP, but may not represent a high level of value to someone’s economic well-being.

Finally, and this is a big one, a country can have high GDP but have a huge gap between rich and poor. GDP is calculated for the whole country then divided by the number of people to get an average figure. So if Australia has a large number of poor people, we will not be able to tell this from looking at GDP.

When it comes to the natural environment, on which we depend, the biggest problem with the GDP growth model is how unsustainable it is in the long term. As GDP grows, so do negative externalities. With GDP growing at four per cent each year, total production doubles every 18 years. If you match this increase with population growth, expected to reach 35 million in Australia by 2056, then our current model of GDP growth would have each person in this larger population producing more each year. If current patterns continue, this would lead to resource shortages, accelerate species extinction and many other environmental impacts. This may come with the benefits of genetically modified food, mass produced consumer goods and hi-tech living in concrete jungles… but is this the type of life we want?

So, if GDP is so inadequate as a measure of national progress then why aren’t more people talking about it? Well there has been an active effort by the Australian Bureau of Statistics (ABS), the Australian Treasury, academics and non-government organisations (NGOs) to put forward a broader approach to measuring progress. Since 2002 the ABS has put out a report called “Measuring Australia’s Progress.”⁸ The Australian Treasury also has a wellbeing framework for strategic planning and decision-making.⁹ Policy think tanks and NGOs including the Centre for Policy Development, The Australia Institute and the Australian Conservation Foundation are actively involved in sustainable economy and well-being initiatives. The ABS also gathers a wide range of data from health and education to the environment, to help inform wider measures of progress.

Broader measures of progress exist, such as the ABS “Measuring Australia’s Progress” report. However the dominance of GDP as the main indicator of progress remains in policy decision making and announcements to the Australian public. This brings us to the second key point:

Key Point #2 – GDP growth dominates and overrides all other measures of progress

If we are to achieve economic strength, environmental sustainability and societal well-being, statistics will help inform this process but will not change it. The change comes from how policy is made by government…when taxes are being decided on such as an emissions trading scheme, or budgets are set to fund initiatives such as free dental care for all Australians, or new laws are created such as container deposit legislation which has been stymied by drink companies and bottle manufacturers for years.

Collecting statistics does not change anything. The change comes from the use of the new measures in government decision making.

This raises key point #3:

Key Point #3 – Indicators alone cannot change the way we measure progress, the real test is how policy is developed and communicated

How do we influence how policy is made? One way is for governments to design policy based on the needs of the citizens of Australia. This has been put forward recently by the head of the Department of Prime Minister and Cabinet, Terry Moran, who in March of 2010 released a paper entitled “Reform of Australian Government Administration: Building the world’s best public service”.¹⁰ Moran proposes in chapter six of the review that the needs of citizens be the starting point for all Australian Public Service Programs. But how can the needs of citizens be determined?

One approach which is gaining popularity, particularly at the local and regional level of governments, is extensive citizen input. Projects are popping up around the country, such as Community Indicators Victoria¹¹ and the commencement of the development of the Australian National Development Index.¹² Such projects seek to determine what Australians consider to be “progress” through extensive consultation. Another example worth mentioning, due to its solid reputation amongst statisticians around the world, is the Canadian Index of Wellbeing¹³, which involved extensive consultation with Canadian citizens.

“Consultation” is a bit of a dirty word in some circles. It smacks of tokenism and lip service and there are plenty of community groups who have been badly burned by giving up their time to contribute ideas only to have decisions made which ignore them. Never-the-less, consultation seems to be moving from tokenism to becoming a vital part of our democratic processes for governance.

There is also some promising news from the “top”. Australia is part of the club of richest nations in the world, known as the OECD (Organisation for Economic Cooperation and Development). It is an invitation only club but non-member countries also participate, sharing knowledge in many areas, including national statistics. For decades statisticians from each member country have been gathering data on all manner of things, from health to education, the economy to the environment. The United Nations also does the same thing, but is more focused on developing countries.

Something started happening about five years ago within the OECD. Statisticians started turning out in big numbers to discuss the notion of “progress” and how it is to be measured. The OECD found itself home to a social movement for change, coming from statisticians, calling for a broader measurement of “progress” that goes beyond just economic growth. This movement reminds me of the green ban marches that happened in Australia in the 1970s. Builders in Australia were protesting at the demolition of heritage buildings and the construction of inappropriate building. The builders protested to the point of stopping major construction jobs. The construction companies lost millions of dollars and the builders, whose bread and butter came from construction, lost their income. The result however was the introduction of new demolition laws to preserve buildings of special significance.¹⁴

Statisticians may not be going on strike, but in a way they are on the front line as the builders were. Statisticians are the interface between policy makers and the public, and according to the chief statistician of the OECD at the time Enrico Giovannini, they are saying that “we are measuring the wrong thing”. They are diligent, dedicated professionals and to do their job well they have to become good listeners. Good research and statistics is now based increasingly on consultation rather than observation from afar. Statisticians have been joined by academics, NGOs, philanthropic organisations, The World Bank, the United Nations Development Program and others to call for changes to the way we measure progress.¹⁵

The Australian Bureau of Statistics is an early adopter in this movement for change. However, none of this action means anything if, at the end of the day, it fails to influence the way policy is made by government. At the moment the greatest signs of influence are at the local and state level, with projects such as Community Indicators Victoria. The implementation of the Moran Review in the Australian Public Service provides an opportunity to find innovative ways of determining the “needs” of the Australian public. Perhaps this will foster a culture of consult first, plan later, in the public sector. The head of Treasury, Ken Henry, is also a vocal advocate of incorporating environmental sustainability into our national fiscal policy as a matter of urgency. ABS and Treasury are advisors, but are not the decision makers. Ultimately it is the prime minister and elected ministers who can choose whether or not to heed the advice and instruct policy makers to incorporate broader measures of progress at the outset of policy development.

In 2009 the OECD Global Project entitled “Measuring the Progress of Societies” conducted training courses for future policy makers in various countries, including the Australian Bureau of Statistics in Canberra. In the course a framework was presented by which broader measures of progress could be incorporated at the outset of policy development. During the scoping and initial design of a new policy, dimensions of progress are nominated and indicators by which the dimension could be measured. For example, when developing a policy for new release of a region for urban development broader measures of progress could be incorporated into the policy through the design of an indicator table as follows:

Example – Measures of progress for new urban development

The use of dimensions and indicators, as above, can assist policy makers in determining measurable outcomes for the various elements of “progress”. Much will depend however on the brief for policy design, which comes from the relevant minister. This brings us to another key point.

Key Point #4 – Moving beyond the GDP growth paradigm to broader measures of progress requires a choice by elected politicians to change the way policy is developed

The extent to which a policy maker can influence the dimensions and indicators for a particular policy outcome may vary within each organisation. In the meantime individual policy makers – whether they are a policy maker in a government department, an academic, a statistician or a minister – have the opportunity to incorporate broader measures of progress into the planning. A groundswell of interest will create an environment conducive to change.

If things do start to change, the signs will be that policy announcements from politicians will focus less on economic growth as the magic cure for quality of life in Australia. GDP will no longer be regarded as the only guiding light for moving us forward. We will know things have changed when we turn on the radio in the morning and instead of hearing how our problems are solved because we’ve produced a whole lot more stuff than last year, the news will read something like this:

“Australia’s national progress improved overall last quarter, according to our National Development Index. We saw a rise in the sustainability index due to the significant improvements to water flows in the Murray-Darling; our economic strength index dipped slightly due to unexpected delays in the implementation of the much-anticipated Emissions Trading Scheme and our well-being index rose sharply on news that the Federal Government will cease the Intervention in the Northern Territory, in accordance with international human rights law.”

Some commentators have argued that implementing an index of this kind would be a mistake because it is inherently flawed owing to the subjective nature of its basic value judgments. After all, who will decide which components are included in such an index and how much weighting/emphasis should be given to one aspect of progress over another? There is some merit to these concerns. However, a better way to look at this challenge might be to ask:

Would this be more or less valuable and informative than using a single, unrepresentative measure of production as the national indicator of whether or not quality of life in Australia is getting better or worse?

Endnotes

AUTHORS(S): Tani Shaw

Why public service reform needs systems thinking

by Ray Ison

Future public sector reform needs to differentiate between reform that does the wrong thing in the right way and reform that does the right thing.¹ To consider what the right thing is, we need to look at the big picture and ask: does Australia have the forms of governance it needs to be effectively governed? This chapter takes a step back and presents a systemic perspective on:²

• how some situations that need to be governed are, or could be, framed,
• the systemic failings that are built into our current governance arrangements,
• some of the findings and recommendations of the recent Moran Review³, and
• recommendations for improving public sector reform.

Re-framing governance in a climate-change world

What is governance?

Governance encompasses the totality of mechanisms and instruments available for influencing social change in certain directions. While governance is a much broader idea than management or administration, it is not some abstract label but an action that has to be carried out. Governance is the context in which adaptive planning, designing, regulating and then managing sits. Governance that is ‘adaptive’ incorporates learning and change in response to uncertainty.

Governance and systems thinking

There are many good introductions to systems thinking and how it can be used.⁴ Unfortunately too few people know what it is and how to use it. Most rarely make it to first base because they are trapped in a dominant linear, causal mode of thinking typified by projects, prescriptions, objectives, deliverables and blueprints. Better governance requires a more skilled use of systems thinking.

Reframing the situations to be governed

At this moment in Australia, the public service (APS) faces a growing number of seemingly intractable policy problems, and the pressing need is to work out how to make governance work in conditions of uncertainty.

In 2007, the APS Commission (APSC) produced a very thoughtful review of ‘wicked problems’. This review described ‘wicked problems’ as problems that:

‘go beyond the capacity of any one organisation to understand and respond to, and [where] there is often disagreement about the causes of the problems and the best way to tackle them…key ingredients in solving or at least managing complex policy problems include successfully working across both internal and external organisational boundaries and engaging citizens and stakeholders in policy making and implementation.’

Rittel and Webber coined the term ‘wicked problems’ in the 1960s, and contrasted them with ‘tame problems’ where the main stakeholders agree on the nature of the problem and what would constitute a solution. With tame problems, they found that traditional problem solving approaches could be reliably used. In their experience, however, ‘tame problems’ were rarely present and traditional approaches often made wicked problems worse.

Walking becomes painful if the shoes no longer fit, or are wearing out. This is a good description of the failure to deliver systemic and adaptive governance in a world in which an increasing proportion of the problems that governments face are ‘wicked’. Making these ideas real in terms of public sector reform is a great challenge. Unfortunately there are very few examples of using systems thinking and practice (ST&P) to guide public sector reform.

Whether situations are framed as ‘wicked problems’ or not is a choice we can make. In the Moran Review, for example, the word ‘wicked’ does not appear. Instead there are framing phrases like: ‘policy challenges in the era of globalisation are so complex, and the solutions so contested…’ or ‘policy issues are increasingly complex and interrelated…’ “Complex” is one of the new framings of choice, but while the language may change, the situations to which the language refers have not gone away. They are, if anything, multiplying and it will take a shift in thinking, the practices that result from that thinking, and in our governance structures to engage with them effectively.⁶

Alternative structures of governance

The term New Public Management (NPM) has been applied to an approach to public service reform that focuses on performance management, the devolution of managerial controls to individual agencies, the restructuring of public sector industrial relations arrangements and outsourcing of service delivery to third-party service providers.⁹ Kathy MacDermott has looked at the history of New Public Management in Australia and found that the approach has been internalised by the APS in ways that leave it much more vulnerable to the pressure towards politicisation. The Moran Review needs to be considered in this light.

Ian McAuley notes that the Moran Review report uses the words ‘strategy’ and ‘strategic’ 136 times in its 81 pages ‘but not once are they defined…What is meant by the term ‘strategic policy’? Is it long term and system wide? Is it just clever?’¹⁰

The report states that ‘…strategy requires having a vision over a horizon of a decade or more, not a single planning cycle. For the public service, strategic thinking means thinking how the public service will do its job beyond the next electoral cycle.’ But if strategy is just long term planning, then there is nothing to suggest that the Moran Review will achieve anything other than doing more of the wrong thing in the right way. What is missing is an understanding that good strategy depends on how situations are framed (e.g. the ‘wickedness’ of problems) and how the ‘system’ of governance is structured.¹¹

McAuley also draws attention to the report’s use of the term ‘leadership’:

‘…another word used freely — 63 times — … again without explicit definition. For example, senior public servants are expected to “model leadership behaviours including promoting innovation and challenging unnecessary risk aversion …” This all sounds fine’ he says, ‘but note the tautology: leaders model leadership. The implicit leadership model, illustrated in the report with a neatly drawn pyramid, assumes that authority and leadership are closely intermeshed or perhaps even indistinguishable.’

Leadership is better understood as an emergent property of the interactions of individuals and context rather than as the position description or personality trait of an individual. Our current governance arrangements are for the most part designed to maintain hierarchical, command and control decision making. There are other options better suited to our circumstances.

To me, responsible autonomy is the form of governance that most closely aligns with the skill set that is desirable in the 21^st Century public sector. If the aim is to create the space for new solutions to emerge then there are clear advantages to purposefully creating the conditions for devolved self organisation – a key attribute of systemic and adaptive governance.

Unfortunately the essential measure of public sector performance under New Public Management and the Moran review, is that of efficiency. In systemic terms, this is only one of several measures of performance. One could add efficacy – does it work? Effectiveness – does it achieve its purpose? Equity – how are the benefits distributed? Ethicality – is it ethically defensible? Efficiency gains may come at a cost to other measures of performance. ¹⁴

Investing in systems thinking and practice

I have argued for embedding systemic thinking and practice in the APS as a core capability within a broader systemic and adaptive governance regime.¹⁸

I am not the only one. In July 2009, Lynelle Briggs argued for the development of more horizontal accountability mechanisms (a form of horizontal governance) and the need for skills and capabilities for APS staff in:¹⁹

(i)             problem framing and boundary setting

(ii)           generating fresh thinking on intractable problems

(iii)          working across organisational and disciplinary boundaries

(iv)          making effective decisions in situations with high levels of uncertainty

(v)           tolerating rapid change in the way problems are defined, and

(vi)          engaging stakeholders as joint decision-makers (not just providers or recipients of services).

Other research has highlighted the need for systemic capability for effective leadership and sustainability management. In ‘Exceeding Expectation: the principles of outstanding leadership’ research undertaken by The Work Foundation (UK) shows that outstanding leaders ‘think systemically and act long term… Outstanding leaders achieve through a combination of systemic thinking and acting for the long term benefit of their organisation. They recognise the interconnected nature of the organisation…’

Geoff Mulgan, writing in 2001, identified seven factors that increased the relevance of systems thinking to policy making and to the functions of government. These were:

1. the ubiquity of information flows, especially within government itself

2. pressure on social policy to be more holistic

3. the growing importance of the environment, especially climate change

4. the connectedness of systems and the new vulnerabilities this brings

5. globalisation and the resultant integration of previously discrete systems

6. the need to be able to cope with ambiguity and non-linearity

7. the understanding that planning and rational strategy often lead to unintended consequences.

He concluded that out of all these factors has come a ‘common understanding that we live in a world of complexity, of non-linear phenomena, chaotic processes, a world not easily captured by common sense, a world in which positive feedback can play a hugely important role as well as the more familiar negative feedback that we learn in the first term of economics.’ He also recognised that ‘so far remarkably little use has been made of systems thinking or of the more recent work on complexity’ and that in part this is ‘to do with the huge sunk investment in other disciplines, particularly economics’.

The trends and imperatives recognised by Mulgan have, if anything, become more pronounced since 2001.²⁰ However,  so far little has been done in Australia to respond to them and it is not clear that key decision-makers would know how to do so. There is a tendency within government to limit the definition of need to skill development,²¹ but research demonstrates that to do this is to miss the point entirely; skills are necessary but not sufficient unless developed within a theory-informed organisational ‘ecology’ that is systemic and adaptive.

Evidence of systemic governance failures

A major study by Stein Ringen looked at what the UK New Labour party achieved in terms of its own social policy objectives over the ten year period 1997-2007.²² Ringen studied the flagship policies of child poverty, education, social justice and health. He found that they had achieved ‘absolutely nothing’. His study provides strong evidence for the systemic failure of UK governance by highlighting the problems that emerge when governments adopt a command and control approach and fail to mobilise citizens or stakeholders in policy development and implementation. His sobering conclusion is that no UK government, of any political persuasion, can currently get done what it is elected to do.

Ringen’s findings illustrate a situation that can be understood as a ‘structure determined system’. It is not only governments that are constrained by the system in which they operate. Take utility companies that deliver social goods – such as water or energy. Most now have as a main measure of performance the profit derived from sales of water or energy and associated services. The system is not structured to recognise that in today’s world the main social benefit from water and energy comes from how little water or energy is used and the efficiency of its use. We create measures of performance which conserve particular structural relations that give rise to particular forms of organisation. Only by inventing new organisations with different structural relations can we break out of the constraints that the old structures impose on our thinking and behaviour.

Challenge #4. Seriously examine Ringen’s prescriptions for the reform of the British ‘constitution’ in the Australian context

Ringen argues for:

•           a return to genuine cabinet government, breaking the power that has moved to the Executive, which has distorted the historical ‘constitution’ on which the Westminster system is built

•           the re-invention of local governance, something very different to local government as we know it (this can be understood as a new form of horizontal governance)

•           public funding of political parties through a citizen-based voucher system and the abolition of all donations to political parties, thus creating a level playing field sensitive to citizen interests and totally transparent.²³

Innovating in systemic and adaptive governance

Our current governance system does not have the variety that is needed to maintain a viable system. Ringen’s analysis looks increasingly relevant to the Australian context. In reinventing local governance (horizontal governance) we need bold institutional arrangements which protect the self-organising and emergent nature of the local and which is coupled more fruitfully with the existing vertical model that underpins our form of representative democracy. There is no blueprint for doing this – we have to invent new ways forward. By framing the challenges in ways that embrace uncertainty and complexity we can relegate command and control strategies and optimisation strategies to where they rightfully belong – subsidiary to systemic and adaptive governance.

What doesn’t work: joined up government, targets and ‘deliverology’

In the UK New Labour’s catch cry of “joined-up government” was built on understandings of the ‘third way’ as articulated by Anthony Giddens. It espoused a desire to increase the extent of joint working between different parts of government and to identify innovative ways of delivering public services which served their Better Government agenda as well as reducing the cost of delivering public services and/or improving the quality and effectiveness of services delivered to the public.

As experience in the UK demonstrates, the notion of ‘joined-up thinking’ and ‘joined- up government’ became, conceptually and practically, an empty cliché. It can be argued, joined-up government failed because of inadequate conceptual and praxis skills and poor institutional settings to enact joined-up government. Targets and ‘deliverology’ in particular undermined New Labour’s espoused intentions.²⁴

The ‘targets culture’ that became endemic in the British New Labour government as well as widespread in other areas of government and corporate life. The development of a targets culture is a good example of privileging systematic approaches over systemic, sometimes at considerable social cost.

As Simon Caulkin, The Observer’s former management editor, rightly observed:

‘The Health Commission’s finding last week that pursuing targets to the detriment of patient care may have caused the deaths of 400 people at Stafford between 2005 and 2008 simply confirms what we already know. Put abstractly, targets distort judgment, disenfranchise professionals and wreck morale. Put concretely, in services where lives are at stake – as in the NHS or child protection – targets kill.’²⁵

Simon goes on to say:

‘Target-driven organisations are institutionally witless because they face the wrong way: towards ministers and target-setters, not customers or citizens. Accusing them of neglecting customers to focus on targets, as a report on Network Rail did just two weeks ago, is like berating cats for eating small birds. That’s what they do. Just as inevitable is the spawning of ballooning bureaucracies to track performance and report it to inspectorates that administer what feels to teachers, doctors and social workers increasingly like a reign of fear.’

John Seddon has been an erudite and consistent critic of New Labour’s commitments to targets and ‘deliverology’, a term coined by Sir Michael Barber, a former Downing St insider.²⁶ Unfortunately ‘deliverology’ seems in danger of breaking out in Australia.  Responding to criticism of failed service delivery, the former Prime Minister Kevin Rudd’s strategy for the future had all the hallmarks of ‘deliverology’ gone mad. He said:

‘We need to lift our game, I need to lift my game, in terms of delivering on these undertakings… The key thing for us is to get on with the business of delivering to the Australian community, in critical areas of need, in health, in education, in real action on climate change as well… This is critical for the future, and we’re taking a pounding because we haven’t been up to the mark so far… I think people are becoming disappointed at the pace of the delivery of the commitment that we have made.’²⁷

One can be sympathetic at the sentiments that appear to lay behind this act of mea culpa, but in its framing and in its prescription, it is a recipe for ongoing systemic failure.

An agenda for future public sector reform

1. Our concept of the reform process needs to be expanded to include the need to reinvent governance
2. Those responsible for managing public sector reform need to reframe the issues. The reform agenda as currently framed – as one of better administration, service delivery, narrowly defined efficiency and enhanced command and control by the executive – is a recipe for poor governance
3. Intractable policy issues require more systemic approaches; governance arrangements are needed that broaden our definitions of problems by opening up the process to a wider range of perspectives
4. Investment in the skills of systems thinking and practice is an urgent priority that needs to run in parallel with the invention of new institutional arrangements that are conducive to engaging with and managing complex, ‘wicked’ situations
5. New experiments in horizontal governance are urgently required. A good starting point would be to reinvent catchment management authorities so that they operate nationally to govern water, rivers and human livelihoods as a coupled social-ecological system. Such authorities would work most effectively with an income stream (e.g. a rateable base) that is independent of government short-termism. A similar model needs to apply to Australia’s cities.²⁸

Endnotes

AUTHORS(S): Ray Ison

by Marian Sawer, Kathy MacDermott and Norm Kelly

‘Everybody to count for one and nobody for more than one.’ – Jeremy Bentham

The principle of political equality has always been central to democracy and to the way democracy was understood by the democratic reformers of mid-19^th Century Australia. The Australasian colonies were regarded as being in the vanguard of democratic innovation and at the end of the 19^th Century such innovations became part of the federal compact. The new Constitution expressly precluded plural voting (provisions for property owners to have extra votes), and the Senate was to be directly elected on a popular franchise, unlike any other upper house of the time.¹ There were to be no privileges based on property, and in the words of the first commentator on the Australian Constitution, University of Melbourne Dean of Law Harrison Moore: ‘The predominant feature of the Australian Constitution is the prevalence of the democratic principle, in its most modern guise’. He believed that this underlying principle meant that rights were protected not through a Bill of Rights, but through ensuring as far as possible that individuals had an equal share in political power.²

During the 20^th Century, progress in this area continued. For example, property qualifications for State upper houses were finally abolished. Later, the malapportionment which made the votes of rural property holders worth more than the votes of urban residents was gradually removed, except for in the Western Australian Legislative Council. However, the last quarter of the 20^th Century saw the influence of property again assume a major role in electoral politics. The dependence of political parties on corporate donations has served to undermine fair electoral competition and hence the principle of political equality.

Australia started introducing public funding for political parties in the 1980s in order to reduce dependence on corporate money and to ensure parties had the means to communicate with the electorate. As in other countries, the amount of public funding was tied to the level of public support for the party, measured by the number of votes gained above a certain threshold, with all votes being of equal value. However, Australian governments “forgot” to tie receipt of public funding to abstention from private donations. Unlike public funding, corporate donations were not tied to a fairness formula, so that parties received very different levels of funding per vote. For example, at the 2001 federal election the amount of private money received by political parties with parliamentary representation varied between $29 and $6 per vote, while public money was set at a standard $1.80 per vote.³

Instead of becoming less dependent on private money, the major parties became ever more dependent on it, especially with the escalating costs of television campaigning. At the same time, the remaining statutory caps on campaign expenditure were removed, except for the Tasmanian Legislative Council, giving an advantage to those with the wealthiest friends and backers. The degree of fairness that public funding was intended to introduce into democratic elections had been swiftly undone.

Political finance reform in international perspective

Australia is not the only democracy confronting the dilemmas posed by the role of money in electoral politics. The combination of the escalating cost of campaigns, shrinking party membership and deepening public mistrust about politicians and money contributes to loss of confidence in democratic institutions. The 2007 Australian Election Study showed that 69 per cent of voters believe that big businesses – the kind of organisations which make the most substantial donations to political parties – have too much power.

But while other democracies, including Canada, New Zealand and the United Kingdom (UK) have taken serious steps in recent years to tighten up their political finance regulation,⁴ Australian governments have been slow to grasp the nettle. Indeed, under the Howard Government things went backwards at the federal level, with the weakening of disclosure requirements, raising the threshold for disclosure to $10,000 (or $90,000 if a donor gives to the State, Territory and Federal divisions of a party). The Rudd Government twice brought forward Bills to bring the disclosure threshold back down to $1,000, but they were defeated in the Senate.

There are remarkably few restrictions in Australia on the size or source of donations to political parties. Australia even allows donations by foreign interests or those with an interest in government contracts or planning decisions. One exception, arising from continuing and well-publicised scandals, is the legislation passed in New South Wales in December 2009 prohibiting donations from property developers.⁵ While the singling out of one class of donations is understandable, it is unlikely to be effective in the long term in allaying integrity concerns or achieving a level playing field.

By contrast, in Canada both Liberal and Conservative governments have taken major steps to remove the influence of corporate money from the electoral process and to ensure a level playing field in elections. Instead of campaigns being mainly funded by large corporations, they are now predominantly funded (at a lower level) out of the public purse.

But what of the so-called hydraulic nature of political finance – the idea that if money can’t go directly to political parties it will flow through other channels, such as third parties? In Canada, third parties have to register with Elections Canada once they have spent more than $500 on election advertising. They then have to disclose their expenditure and donors and comply with an upper limit on third party expenditure ($150,000).

The Canadian model of political finance regulation, in the fully-developed form shown above, has been in place for the last three general elections. It requires close oversight by a highly-respected and independent electoral management body (Elections Canada) and provides a useful model for Australia to build on.

In Australia, it is sometimes suggested that political finance reform would be constitutionally impossible. The argument is based on Australia’s short-lived (1991–92) ban on paid political advertising in the electronic media, which was found by the High Court to infringe the implied Constitutional right of political communication. Similarly in Canada, Constitutional challenges were made on the grounds that restrictions on third-party advertising infringed the freedom of expression guaranteed by the Canadian Charter of Rights and Freedoms. However, the most recent restrictions (rather than bans) have survived such a challenge, with the Supreme Court finding in 2004 that the restrictions were reasonable in the interests of electoral fairness.⁶ It concluded that the restrictions were necessary to provide a level playing field for political discourse. The restriction of some voices was necessary so that others might be heard.

This should also be the argument put forward in Australia. There should be limits on the size of political donations and on campaign expenditure, whether by parties or third parties. Through ensuring that these limits are reasonable and appropriate to achieving electoral fairness, they should not fall foul of the “implied right of political communication” identified by the High Court in the 1992 Australian Capital Television Case.⁷ Such reasonable restrictions already exist in Australian electoral law, including the three-day blackout of electronic political advertising in the final few days of a campaign.⁸

Timeliness

The only real restriction on political donations in Australia has been the requirement for disclosure. However, the usefulness of disclosure has been significantly reduced by its lack of timeliness. For example, it took 16 months after the 2004 federal election before voters found out that Lord Ashcroft, a foreign citizen (of Belize and the UK) had given $1 million to the Liberal Party before the 2004 election. If he had given this amount to the British Conservative Party during an election campaign it would have been disclosed within a week.⁹

Some steps have been taken in Australia to improve timeliness. For example, New South Wales and Queensland now require disclosure every six months.¹⁰ However in the era of electronic transfers, there is no reason why donations should not be reported to the Australian Electoral Commission (AEC) at the same time as they are transferred to the bank, and then published on the AEC website.

Government advertising

One way in which political parties supplement the donations received from private sources is by using government resources for party purposes. Clearly this is most open to incumbent governments, and the most flagrant example is the use of government advertising for political rather than public benefit. Expenditure on government advertising reached a peak in the later years of the Howard Government when the federal government became Australia’s biggest advertiser, ahead of corporations such as McDonalds or Coca-Cola.¹¹

Then Labor leader Kevin Rudd declared the misuse of government advertising to be a “cancer on democracy” and the 2007 Labor Platform made a number of important commitments to remove this “cancer”.

In 2008 the Rudd Government fulfilled its promise to put in place guidelines to ensure taxpayer-funded advertisements were not used by the Federal Government for party political purposes. The guidelines set out procedures for ensuring that advertising campaigns of a certain value complied with five principles – relating to when campaigns could be conducted, how campaign materials should be presented and the legal and procurement responsibilities to be considered. In 2010, those guidelines were amended following a review conducted by former senior public servant Dr Allan Hawke. The main issue arising from the amendments is whether the revised guidelines will make it easier for the government to spend taxpayers’ money on campaigns that serve its political interests rather than the public interest.

The 2008 Guidelines were not legislated (indeed, the commitment to legislation was dropped from the ALP’s 2009 National Platform) and were not always clear with respect to some procedural matters. But they did have a practical impact. For example, expenditure on public advertising fell. Transcripts of government advertisements can now be found on agency websites, as can certification from both the Auditor-General and agency chief executives that campaign material complies with the guidelines and is not party political in content. The factual content of campaign advertisements has arguably increased, although there is little evidence that the “good news” overtones are being muted.

It is important to understand what has been achieved through the Government’s 2008 Guidelines in order to understand the extent to which this achievement has been put at risk by the 2010 revisions.¹² The revised approach incorporates two key changes: the transfer of the responsibility for reviewing proposed campaigns from the Auditor-General to a new Independent Communications Committee appointed by government and composed of eminent former public servants, and the widening of the scope for exemption from the Guidelines.

The transfer of the responsibility for reviewing proposed campaigns from the Auditor-General to a new Independent Communications Committee has occurred because of concerns that the Auditor-General was taking, ‘an overly risk-averse, conservative approach to Government communications activities’.¹³ The Guidelines require the Auditor-General to pronounce on the compliance of a campaign with the Guidelines before that campaign is undertaken, while the ongoing functions of the Auditor’s Office entail undertaking performance audits of the same campaign after it has been completed. As the ACT Auditor-General noted when asked her views on the same model: ‘That created a risk for us, because later on, if we come back and do a performance audit and find a number of government advertisements are totally a waste of money because they did not achieve the intended outcome to change people’s behaviour or to inform people, it looks as if we are in conflict with ourselves because we approved them in the first place’.¹⁴ The possibility of such a perceived conflict, it has been argued, would tend to make the Auditor-General’s decisions unnecessarily conservative. Hence the expectation that the transfer of the review function to an Independent Committee is likely to result in a more relaxed application of the Guidelines.

Moreover, the scope for excluding particular advertising campaigns from compliance with the Guidelines has been widened. Under the old 2008 Guidelines, the Cabinet Secretary could exempt an advertising campaign from compliance on the basis of a national emergency, extreme urgency or other extraordinary reason. In the revised Guidelines “extraordinary” has been revised to “compelling” on the ground that this revision provides more flexibility. There is clearly a question as to whether such additional flexibility is desirable or necessary.

These are the changes that have been criticised as watering down the implementation of the government’s 2007 election commitment and widening the scope for political interference in government advertising campaigns. Such concerns have been exacerbated as the government moved quickly to give itself an exemption from its own Guidelines in order to fast-track a defensive campaign on its proposed mining tax.¹⁵ That campaign was withdrawn following a deal with the mining industry, which ceased its own campaign at virtually the same time. It is to be hoped this exemption did not represent the first of a series that will progressively undermine Labor’s 2007 election commitment to clean up government advertising.

Until they become law, the Guidelines will remain vulnerable to reinterpretation or revision. In the Australian Capital Territory the Liberal Opposition, with support from the Greens, has passed legislation to regulate government advertising. The Government Agencies (Campaign Advertising) Act¹⁶ was passed in December 2009 and came into force July 1st 2010. Among other things, the Act requires campaigns costing over $40,000 to go to an independent Campaign Advertising Reviewer for a compliance review. The appointment of the Reviewer must be supported by at least two thirds of the members of the Legislative Assembly. Ministers may exempt urgent matters from the Act, but the exemption will be disallowable by the Assembly.

The incoming federal government should follow the example of the Australian Capital Territory and legislate to ensure government advertising is not used for party purposes. Any exemption from the procedures and principles applying under the legislation because of a national emergency, extreme urgency or other compelling reason should not exempt the campaign from the application of Principle 3 (Campaign materials should be objective and not directed at promoting party political interests). Where an information or advertising campaign has been exempted from the usual compliance oversight, agency chief executives should be required to certify that the campaign is nevertheless compliant with Principle 3.

The legislation should, at minimum, incorporate a requirement to report annually on the value of each campaign as defined in the 2010 Guidelines.

The electoral roll

While getting private money out of electoral politics and preventing the misuse of public money is part of the recipe for restoring the principle of political equality, another equally important ingredient is ensuring that eligible citizens are able to participate.

Although enrolment is compulsory for eligible Australians, the Australian National Audit Office estimates that 1.1 to 1.4 million otherwise eligible voters are missing from the electoral roll.¹⁷ This is because they have never enrolled, or because they have moved location and have not enrolled at their new address. Apart from the portion of the population who will intentionally avoid being enrolled, there are two significant reasons for this high level of non-enrolment: complicated procedures to enrol, and a lack of sufficient time to enrol after an election is called.

In 2006 the Howard Government introduced more stringent “proof of identity” requirements for people wishing to enrol or to change their enrolment. The new ID rules make it more difficult for the AEC to enrol people, even when the Commission is aware of an enrolled person’s new address. Under current Commonwealth rules, the AEC can send an enrolment form to a person’s new address, but the person has to fill out, sign and return the form to the AEC before becoming enrolled. Often a voter will see that the AEC has their new address, and assume that they are enrolled. In addition, the 2006 changes shortened the opportunity to enrol once an election was called – previously seven days – to the day election writs are issued. Federal elections are not held on a fixed date (as occurs in some States, including New South Wales and Victoria), so this leaves potential voters little time to enrol or update their enrolment.

Best practice in modern international electoral administration provides for “smart” enrolment, also known as “direct” or “automatic” enrolment. Under an automatic enrolment regime, a commission initiates or updates a person’s enrolment when it is notified by government agencies that a person has reached enrolment age or has changed address. The person is then informed that they are enrolled and asked whether they have any objections. This shift of emphasis is important, as it requires the person to take action to un-enrol, rather than to enrol. Automatic enrolments address, in particular, the relatively low enrolment of young people who tend to be highly mobile and either drop off the roll, or never get on it. Other demographic groups, such as transient workers and renters, also benefit. In these days of electronic rolls, automatic enrolment also largely removes any need to “close” the rolls before an election. There is no reason why new enrolments and enrolment updates cannot continue up to election day, as occurs in countries including Canada and New Zealand.

Of course, best practice in achieving a more comprehensive roll can also have partisan affects. Young and itinerant people are considered less likely to vote for conservative parties and more likely to vote for Labor or the Greens. However, the democratic principles of fairness and inclusiveness should override any partisan considerations. While the Coalition may argue that citizens have a duty to comply with the current registration requirements, there is an onus on government to facilitate ease of access to participation, especially under a compulsory enrolment and voting regime.

In 2009, the New South Wales Labor Government passed legislation for automatic enrolment, and is set to implement it ahead of the March 2011 State election. In order to avoid confusion, New South Wales is waiting until after the Federal election to implement the new arrangements. In June 2010, the Victorian Labor Government introduced legislation into Parliament for automatic enrolment. With a general election due to be held in Victoria on November 27th 2010, it is unclear whether the Brumby Government will seek to pass the legislation prior to then. As the States and Territories operate “joint-roll” arrangements with the AEC, there is huge potential for confusion if voters become automatically enrolled at the State level, but remain unenrolled for Federal elections. The different systems will create confusion for voters unless the Commonwealth also adopts automatic enrolment. Given that the two largest States (which contain 58 per cent of all Australian voters) are moving to modern enrolment systems, it is imperative that the Commonwealth and other States and Territories also adopt a process that is seamless for voters.

Since coming to power in 2007, the Labor Government has introduced legislation to reform the current enrolment requirements. The proposed changes include restoring the seven-day enrolment period after an election is called, removing some of the ID requirements introduced by the Howard Government, and to allow voters to update their enrolment electronically (as you would, for instance, for your bank accounts). Previous reform attempts have been stymied by the Senate, so it may not be until the new Senators take their seats from July 2011 that the current Bills can be passed. Under the agreements between the newly-elected Gillard Government and the Greens and Independents a national inquiry into broader electoral reform will also report by October 1st 2011, enabling further legislation in 2012.

It is time for reforms that place political equality ahead of perceived partisan interests. Political equality and democratic integrity cannot be taken for granted. These values require sound legislation and strong oversight bodies that remove temptation from the government of the day. We have attempted to show the urgent need for this in the areas of political finance, government advertising and electoral enrolment.

Photo Credit: Kat Mere, http://www.flickr.com/photos/katmere/101812716/

Endnotes

AUTHORS(S): Marian Sawer, Kath Macdermott and Norm Kelly

by Ben Spies-Butcher and Adam Stebbing

Introduction

Each election year both sides of politics make their claims for economic responsibility. In 2010 the Coalition focused on government debt, while Labor placed a self-imposed limit on new public spending. Many people may not realise that Australia’s debt is already very low by international standards, and our taxes are below those in most rich countries.

Despite this, there is still plenty of room to improve the federal government’s financial position. But we heard little this election about the most wasteful and inequitable government spending. We could be saving billions each year, while providing greater support to those on low incomes and reducing the cost of living – but to do so will require considerable political courage.

In this chapter we examine three of the most important areas of social spending – retirement incomes, housing and childcare. We also put forward some general rules for getting better value for public money: increasing the accountability of public spending; making funding direct to service providers; and simplifying consumer choice.

The story so far

Getting value for our tax dollars is important to all citizens. But public debate on this issue is often based on ideology and double-speak. While governments from both sides of politics talk of cutting spending, they have consistently increased backdoor tax rebates and loopholes that give most to rich. In housing, superannuation and elsewhere our governments now spend as much through complex and unfair tax schemes as they do in direct support through more targeted spending initiatives.

While the Howard Government claimed fiscal responsibility, it consistently increased spending in some of the least efficient, but most electorally beneficial ways. Free market think tanks called this ‘big government conservatism’, as spending on the baby bonus, private schools, private health insurance and families all increased in ways that maximised the cash paid to the (often well off) individual, but minimised the level of services delivered per government dollar.

Labor has slowly begun to wind back some of the worst excesses. But in many areas it has continued to build on dodgy foundations. It has added to the inefficient childcare rebate, rather than taking the opportunity for genuine reform. It promises to extend superannuation in a way that guarantees even more public support for those on the highest incomes, rather than reforming the system to genuinely support low and middle income workers. And it has left in place tens of billions in tax concessions that actively undermine broader economic objectives in housing policy. By making public spending simpler, more direct and more accountable there is significant scope for savings.

Areas needing reform

1. Pensions and retirement incomes

The retirement incomes system has particularly wide ramifications for the value we get from our public money because the government offers considerable financial support to both its major arms – the aged pension and superannuation. While Australia is well positioned to deal with the effects of an ageing population, it does increase the urgency of ensuring that our policy settings are both equitable and efficient. The government has made some progress on retirement incomes policy, but much more remains to be done.

Current government policy

Age pension

The age pension is the major retirement income policy, providing at least some assistance to 78 per cent of the population aged 65 years and over in 2008¹. Funded out of tax revenue, the pension cost around $27 billion in 2008-09². Long overdue, the government increased the weekly full rate of the age pension by $32.49 for singles and $10.14 for couples³. It also simplified pension allowances, by incorporating the GST pension supplement, as well as the pharmaceutical, utilities and telephone allowances into a sole pension supplement ⁴.

The government has placed additional pressures on workers, particularly those who undertake manual work, by increasing the qualifying age for the pension to 67 years by 2020⁵, a measure that is difficult to justify on financial or equity grounds.

Superannuation

Superannuation provides a secondary source of retirement income to more than 90 per cent of employees⁶. It is supported by the government through the Superannuation Guarantee (SG) that directs nine per cent of wages into super and by generous but extremely unfair tax concessions that reduced tax revenue by $24 billion in 2008-09⁷– costing almost as much as the age pension.

These concessions reduce the fiscal sustainability of the Budget. They cost the Budget two per cent of GDP each year, but are expected to reduce spending on the pension by only 0.2 percent of GDP in 2050 – meaning we spend $1 of public money on super for every 10c we expect to save on the pension.

The government has taken small, but important, steps to reduce the inequities of the super tax concessions: it reduced the annual contribution limits that the tax concession applies to $25,000 for those younger than 50 years and $50,000 for those who are older⁸; and it has improved their overall equity with its proposed 15 per cent rebate (up to a ceiling of $500) for those with annual incomes under $37,000⁹. And, improving fairness and simplicity, the government also banned commissions for financial advisors and required funds to provide a low-cost default super option to consumers¹⁰.

However, the government also reduced the benefits that low-income earners receive from the co-contribution super scheme, lowering the matching rate from 150 per cent to 100 per cent from 2009 to 2012¹¹. And, the proposal to increase the Superannuation Guarantee to 12 per cent creates greater inequity because it will amplify the problems already present in concessional tax arrangements. Thus, it will effectively increase support to high-income earners.

Proposed reforms

Make Super Fair

Target assistance

The super tax concessions’ fairness could be enhanced by heeding advice that the Rudd-Gillard Government received from a range of sources, including the proposals of the Henry Review and our paper for the Centre for Policy Development¹² found in Table 2. While the Henry Review recommended a flat rate 20 per cent tax discount for super contributions up to annual limits, our Centre for Policy Development report proposed a 20 per cent rebate for those earning up to $80,000, with a taper that reduced the rate of the rebate by one per cent for each additional $1,000 of income. Both of these proposals, particularly that of the CPD report, would improve the equity of the super tax concessions.

Table 2. Proposals for Reforming the Tax Concession for Super Contributions

Improving accountability

Support for super avoids many budgetary oversights and long-term projections, such as the Intergenerational Reports, making it harder to assess the value the public is getting for its money. Concessions given to superannuation should come under the same scrutiny as public spending on the pension.

Using savings for nation building

One aim of super is to enhance national savings. If that is the goal and tens of billions of public dollars are spent on the effort, it is reasonable that a more direct link be made by requiring super funds to make a small investment in government bonds to make funds more available for public infrastructure and nation building.

Making super simple

A key problem with super for workers is its complexity. Creating a default public super fund would help people manage choice, particularly for young and casual workers who move between jobs and industries.

2. Housing

Housing policy has one of the largest impacts on the federal budget of any social service. However, its impact is often overlooked because the bulk of support comes through concessional tax arrangements, similar to those supporting superannuation. In the past support for both public housing and home ownership have broadly met the needs of the community. But gradually spending on public and affordable housing has decreased while support for purchase by owners and investors has increased. The result is rising house prices, leaving many behind.

There are now 105,000 homeless in Australia. Another 445,000 low-income families are in housing stress in the private rental market. High house prices and rising interest rates mean hundreds of thousands of low-income owner-occupiers are also in housing stress¹³.

Ironically, it now appears that government spending on programs meant to improve affordability (like the First Home Owners Grant) is actually exacerbating the problem. Rather than increasing the supply of housing as population increases, these types of policies tend to increase the price of existing housing. The limitations of current housing policy are increasingly accepted across the economic community, but there are significant political obstacles to reform. The first-term Labor Government took some steps in the right direction.

Current government policy

Supporting renters

A long-term lack of funding for social housing has meant increasing need to subsidise private renters. These subsidies now cost $2.6 billion per year¹⁴. There is no direct means test – renters who qualify for other government payments can also get rent allowance – but this means that some low-income earners fall through the cracks. The level of assistance also does not account for higher rents in cities like Sydney and Melbourne.

The stimulus package began to address this by investing $6.6 billion to building 20,000 new units of social and defence housing¹⁵. This is a significant commitment, but still only a small step towards reducing the 230,000 waiting list for public housing¹⁶. The National Rental Affordability Scheme also offers greater rental stock by encouraging institutional investors like super funds to build affordable housing.

Helping first home buyers

Both the past Coalition and the Rudd-Gillard Government introduced new schemes to support first home buyers. Initially these were poorly targeted, giving most assistance to the wealthiest. Labor has made some modest improvements. It amended its own First Home Savers Scheme, and the First Home Owners Grant, to better target these payments. Even so, these programs do relatively little to benefit low-income earners.

The extra support provided by the government to home buyers has been far from efficient. While incentives for new housing can stimulate building, the grant also goes to those buying existing housing, which tends to simply inflate prices. Indeed this appears to have been the intended effect of the stimulus measures, encouraging first home buyers into the market to stabilise falling house prices. However, it has left many with large mortgages as interest rates now increase, prices rise and investors return to crowd out new entrants.

Billions in tax concessions

The budget provides $40 billion a year to existing home owners in concessional tax treatment, primarily through the exemption on capital gains ¹⁷. This encourages home owners to spend more on renovation than they otherwise might and to retain larger houses than they need – pushing up house prices for everyone. The government then spends an additional $5 billion on negative gearing¹⁸, and billions more in the concessional treatment of capital gains (although this is not properly reported), for investors. Negative gearing has been shown to push up house prices for all¹⁹.

So the government is now backing every buyer at an auction, funnelling money to new home buyers, existing owner-occupiers and investors, spending tens of billions each year and yet the effect of all this is basically the opposite of the stated goal of improving housing affordability. All of these measures have a fatal weakness: they compete against other government schemes and give even more to the very buyers that new entrants are competing against.

There is increasing recognition that this situation is unsustainable. A 2004 Productivity Commission report identified the interaction of negative gearing and the capital gains tax concessions as potentially promoting a the boom-bust cycle in the property market²⁰. A number of economists have identified the unsustainable nature of household debt, almost all of which is housing debt generated from rising property prices²¹. And the Henry Review recommended wide-ranging reforms to reduce the preferential treatment of housing in the tax system to allow investment to flow more evenly through the economy²².

Proposed reform

Addressing supply

Addressing housing affordability requires an increase in supply. A series of reports have shown that the most cost-effective way to do this is through direct government investment in social housing (see Industry Commission 1993). The stimulus has been a good first step, but more needs to be done. Likewise, any assistance given to owners or investors needs to be targeted to those building or buying new stock to reduce the inflationary effects of government assistance.

Targeting assistance

In the short term support for the private rental market must remain. But this assistance should be better targeted to those most in need. This requires changing the means test for rental assistance, and restricting tax concessions to landlords who provide affordable housing to low-income tenants.

3. Childcare

The main challenge to childcare in Australia comes from individual public subsidies for the purchase of private services delivered by the for-profit and non-government sectors. In pitching its message at ‘working families’ during the 2007 federal election campaign, Labor identified unaffordable childcare as one of several pressures undermining family ‘work-life balance’ that the Howard government had failed to address and that it could handle better. So, have the government’s childcare policies improved affordability for working families?

Again, the answer is mixed. In contrast to its predecessor, the Labor government has promoted universal access to childcare and envisages it as part of a longer-term strategy that includes increasing labour force participation and productivity, social inclusion and the ‘education revolution’²⁴. Whilst the government has taken steps in the right direction, other policy decisions have undermined both equity and efficiency.

Current government policy

Subsidising Child Care

The government supports private childcare services through two subsidies for consumers, which largely leaves them to co-ordinate activity themselves through market mechanisms in the private sector.

The Child Care Benefit (CCB) is a means tested cash benefit available to those who consume up to 50 hours of services from private providers; each week, it provides up to $30.10 for registered care or $180 for approved care per child. The Child Care Rebate (CCR) provides a 50 per cent flat rate rebate to consumers for their out-of-pocket expenses on approved childcare services up to $7,778 per child each year.

The CCB provides most assistance to those on lower incomes, whilst the CCR benefits almost all consumers of childcare, particularly higher income earners who have greater purchasing power and thus larger out-of-pocket expenses.

Building new centres

An immediate challenge for parents is a lack of quality, affordable childcare. The government has committed to building an additional 38 childcare centres but this is a far cry from the 260 it promised at the 2007 election²⁵. When ABC Learning collapsed – the major private provider that accounted for 25 per cent of childcare places nationwide – the government injected $58 million to support the continuation of childcare services until all but 55 centres (of over 1,000) were transferred to new operators²⁶. But despite the collapse of ABC Learning, the government has yet to impose accreditation or other regulatory controls on the sector²⁷.

Problems with current policy

Failure to regulate

The collapse of ABC Learning has, as Cox²⁸ notes, provided the government with an opening to review the whole system and impose further regulations on the childcare sector. The government has also ‘avoided at all costs’ an active involvement in childcare provision, which would have provided a direct means to increase competition in the sector and expand access.

Runaway prices

Current policy gives parents more money to spend on childcare without sufficiently increasing the supply of childcare places. This tends to push up the price of childcare and reduce value for money.

By raising the CCR to 50 per cent (from 30 per cent) up to a ceiling of $15,000 in 2008, the government has further raised the purchasing power of childcare consumers without adequately addressing supply. Logically enough, this feeds the inflation in childcare fees that reduce the affordability of care²⁹, although the impact may be unwound to some extent by the decision to wind back the ceiling of the CCR to $7 778 per child each year in this year’s Budget.

Moreover, by favouring the CCR over the CCB, the government has expanded the benefits received by higher income-earners at the expense of lower income-earners. In short, the Labor government’s policies have done little to alter the market environment of childcare or extend universal access.

Proposed reforms

Direct funding

Funding needs to be direct. If supply is the issue, than building centres and funding them is the solution; using mechanisms like rebates and subsidies is less direct and less efficient.

Regulation of the sector

Regulation which makes it easy for parents to choose quality care, rather than maximising inefficient and confusing choice in an artificial market.

Table 3. Redistributive Implications of CCB and CCR

* Calculations assume one child in Long Day Care (50 hours) costing $200 per week. CCB rates as of 2005.³⁰

An agenda for reform

There are a few simple principles that can help to make public spending more efficient and equitable. These principles underpin the reforms proposed in the three areas we have discussed, but also apply more broadly.

1. Accountability

The first step to ensure that public programs are sustainable and offer value for money is to find out exactly what things cost. That might sound straightforward, but there are two accounting tricks that make it much more difficult. First, governments can reduce the cost to the Budget by restructuring a policy as a tax concession rather than a spending measure. The effect on the economy and the budget bottom line is the same, but it doesn’t show up on the official statistics. Second, governments can cut spending on services, passing increased costs on to individuals. Instead of paying through our taxes, we pay (often even more) in higher charges, but it looks like the government is being ‘responsible’.

Recognising the need for greater accountability, the Henry Tax Review³¹ proposed that the government release a ‘Tax and Transfer Analysis Statement’ each five years to report on the cost, efficiency and distributive effects of the tax and transfer system, including tax expenditures. This recommendation should be implemented. It would shine light on neglected public programs and hopefully inspire further research and public debate.

2. Make funding direct

The next step is for governments to more clearly match their funding models to what they actually want to achieve. Too often funding is designed to have the maximum short-term electoral effect, rather than the maximum effect on welfare and service provision. Research suggests that reducing the distance between the government as funder and the organisation delivering the service contains costs.

The most obvious example here is the private health insurance rebate. The policy aims to encourage people to use private hospitals. The goal is controversial, but even on its own terms the policy fails. Rather than funding private hospitals the government provides a subsidy to individuals, to purchase insurance, which then covers hospital stays. That is a complex and convoluted way to subsidise private hospitals, and the result is that only half of the money ever ends up supporting private hospital beds³². Indeed, if the government decided to simply provide a subsidy directly to the hospital for each service it delivered, the same effect could be achieved while saving more than $2 billion a year.

By funding insurance rather than hospitals the current scheme also subsidises gym memberships, dental work and administration costs that are not the main focus of the policy. By funding individuals, these subsidies tend to increase inflationary pressure and reduce the ability of governments to ensure good value for money. Often direct provision (as with public hospitals) is the most efficient alternative. But there are many ways of supporting greater choice while also reducing costs by funding services, not individuals.

3. Let people choose not to choose

People do not always want more choice. Recent developments in economics have shown that people’s ability and desire to choose is not infinite.³³ Often having complex choices means that people simply fail to act, or make decisions they later regret. Competition and choice can be powerful forces to improve efficiency – but increased choice often just leads to confusion and to industries taking advantage of governments and consumers. The solution is to give people manageable choices, and to introduce public default options to allow people to opt-out.

Photo Credit: Alex E. Proimos, http://www.flickr.com/photos/proimos/4046053052/

Endnotes

AUTHORS(S): Adam Stebbing and Ben Spies-Butcher

Has Australia been lucky again?

by John Quiggin

Writing in the 1960s, Donald Horne described Australia as ‘a lucky country run by second-rate people who share its luck’. Judging by the experience of the global financial crisis, Australia’s run of good luck has continued. There is a credible argument to be made that good economic management contributed to Australia’s escape (so far at least) from the serious impacts of the crisis experienced in most other countries. It is clear, however, that good luck played its part.

The crisis has bankrupted large numbers of financial institutions, corporations and some governments. It has also demonstrated the bankruptcy of the regulatory systems that were supposed to manage the global financial system, and the ideology of market liberalism on which those systems are based. A re-examination of both institutions and ideology is urgently needed.

The Global Financial Crisis

As long ago as the early 2000s, a handful of economists pointed to the unsustainability of the imbalances in the US and global economy that developed from the late 1990s onwards. The most obvious imbalances were the massive trade deficits that emerged in a number of, mainly English-speaking, developed economies (matched by surpluses for Asian exporters) and the huge growth of the financial sector relative to the economy as a whole. These imbalances were closely intertwined. It was only the growth of the financial sector that permitted the maintenance of consistent large deficits on the trade balance and current account, at levels that would, in earlier periods, have resulted in an economic crisis.

By contrast, the dominant market liberal ideology encouraged the view that these developments were benign. The massive growth in the volume of international financial transactions was seen as reflecting the (presumptively rational) voluntary choices of borrowers and lenders, and as a way of diversifying risk internationally. A localised failure in any one economy could not cause significant loss to investors with highly diversified portfolios. And central banks extended ‘too big to fail’ protection to any institution large enough to be critical to the sustainability of the system as a whole. The only way a system of this kind could fail was through a total global collapse.

And that, more or less, is what happened.

In scale and scope, the crisis was larger than any financial failure since the Great Depression. The estimated losses from financial failures amount to $4 trillion or about ten per cent of the world’s annual income. Losses in output from the global recession have also amounted to trillions, and recovery has barely begun.

Unlike the Great Depression, this crisis was entirely the product of financial markets. Financial markets and major banks were lightly regulated by governments under systems that relied, in large measure, on risk assessments undertaken by the banks themselves, which were based, in large measure, on the ratings issued by agencies such as Standard & Poors and Moody’s.

All of the checks and balances in the system failed comprehensively. The ratings agencies offered AAA ratings to assets that turned out to be worthless, on the basis of models that assumed that asset prices could never fall. The entire ratings agency model, in which issuers pay for ratings, proved to be fundamentally unsound. But, these very ratings were embedded in official systems of regulation. Crucial public policy decisions were, in effect, outsourced to for-profit firms that had a strong incentive to get the answers wrong.

To these systemic failures was added the exposure of long-running fraud on a massive scale. While Bernie Madoff put others in the shade, the collapse of the bubble brought to light a string of frauds involving tens or hundreds of millions of dollars.

The response

At the beginning of 2009, the world faced the prospect of a recession more serious than any since the Great Depression. That prospect was staved off by bank bailouts and policies of fiscal and monetary stimulus were successful in containing the damage. Monetary policy was used to an unprecedented degree. Not only were interest rates cut to zero, but central banks undertook extensive ‘quantitative easing’, that is, purchasing financial assets such as corporate bonds, from financial institutions.

Despite all these measures, the global recession has been the most severe in the post war period. At the time of writing unemployment rates approached ten per cent in the US and EU. With the costs of bailouts threatening a new round of crises, a second round of recession seems likely.

Australia’s great escape

According to the popular criterion of two successive quarters of negative growth, the Australian economy escaped recession altogether. How did we do it? The main candidates for explaining this remarkable outcome are:

1. Good macroeconomic management
2. Good economic fundamentals, arising from the reforms to the economy undertaken since the 1980s,  and
3. The good luck on which Australia has always relied.

Good management

Australia has benefited from good economic management. Advance warnings from the collapse of Bear Stearns in March 2008 gave the government and monetary authorities time to prepare a response to the meltdown that took place the following September. The reserve bank relaxed monetary policy, and the Australian government responded more rapidly and vigorously than many others with fiscal stimulus – an immediate cash handout in December 2008 and a much larger stimulus package in early 2009, softened the recession to the point where it has been one of the milder downturns of the period since the 1970s. This was accompanied by a decision to guarantee banks retail deposits and (temporarily) their wholesale borrowings. Broadly speaking this response was effective in insulating the Australian financial sector from the global collapse.

Unlike the relaxation of monetary policy, which received broad support, the fiscal policy response to the crisis was controversial, with the stimulus package being rejected by the main Opposition parties. The success of the stimulus now seems clear. In the context of the forthcoming election, it is important to remember that on the biggest economic policy issue in decades, the Rudd-Gillard Government got the choices essentially right, and the Coalition Opposition got them completely wrong.

Good management can’t provide a full explanation of Australia’s escape from the crisis. Our starting point was much better than that of many other countries, in that only a handful of small financial institutions (mainly mortgage securitisers such as RAMS) got into difficulties, and none failed outright. Macroeconomic policy had to manage the flow-on from the global crisis, but not a domestic financial meltdown like those affecting most developed countries.

Was this the result of sound fundamentals, as has been widely claimed, or, as Donald Horne would doubtless suggest, good luck?

Good fundamentals

Claims about good fundamentals rest on both:

• the microeconomic reforms undertaken in the 1990s, and
• the suggestion that our financial sector is more soundly structured, better regulated and more conservative in its practices than those in other developed countries.

The first of these claims can be dismissed fairly easily. There is no link between microeconomic flexibility and macroeconomic stability. In fact, just as in the Asian crisis of the 1990s, the countries hardest hit by the initial round of the global financial crisis (Iceland, Ireland, the Baltic States) have been precisely those that have undertaken the most comprehensive reforms along market liberal lines.

The view that our financial system is more soundly structured than others has some validity. Australia’s system of prudential regulation helped to avoid the emergence of large-scale lending to borrowers with little or no capacity to pay, along the lines of the ‘sub-prime’ market in the US. Reserve requirements ensure that financial institutions would remain stable in the face of a moderate decline in house prices. The four pillars policy against bank mergers, long derided by supporters of financial deregulation, prevented the banks from adopting risky strategies in the pursuit of competitive advantage.

The paradox behind our good fundamentals is, as former Reserve Bank Governor Ian MacFarlane has observed, that the current structure of our financial system is a result of the rejection of market liberal policy reforms.

Good luck

Much of Australia’s resilience in the face of the global crisis can only be attributed to good luck.

Despite there being plenty of Australian bankers who experienced the ‘cowboy’ era that followed financial deregulation in the 1980s, and the near-failure of major banks in the 1990s recession, that experience wasn’t enough to keep the major banks from close involvement in the financing of new speculative ventures. Examples include the Commonwealth Bank’s promotion of Storm Financial and ANZ’s financing of Opes Prime, both of which ended in disaster. Given a few more years, such activity might have expanded to the point where it threatened systemic viability.

Even aspects of our policies and economic fundamentals that seemed likely to increase our vulnerability turned out to work for the best. Our status as a net international borrower meant that our banks showed less interest in toxic US assets. As MacFarlane said “I have no doubt that if Australian banks had a surplus of domestic funds, they also would have acquired a lot of dubious assets, just as many of our counterparts did.” The current account deficit may have saved our banks from themselves, but it remains a major vulnerability if the global crisis worsens.

And the prosperity of our financial system depends, in large measure, on the fact that governments have managed to prop up housing prices, in sharp contrast to the rest of the world. Although house prices have fallen sharply in many countries, they declined only marginally in Australia, and have already recovered much of the lost ground. This strategy was probably necessary, but it remains high-risk.

The next test: will we be so lucky with the sovereign debt crisis?

By early 2010, the cost of the bailout and the likelihood of further banking failures had begun to threaten the solvency of national governments. Some peripheral countries such as Iceland and the Baltic States had already experienced sovereign debt crises. Governments in these countries lacked the resources to rescue their failed banking sectors, and were forced to adopt austerity policies that exacerbated the recession. The economic impact of the crisis in these countries was comparable to that of the Great Depression.

Such systemic problems emerged first in Greece. During the 1990s, Greek governments had nominally complied with the euro convergence targets, requiring them to reduce budget deficits to less than three per cent of GDP, and public debt to less than 60 per cent. In reality however, they had engaged in a range of expedients to hide debt, using financial instruments designed by the same financial sector institutions (most notably Goldman Sachs) that had produced the subprime crisis in the US.

The EU has acted, with a vigour and determination surprising in that normally unwieldy body, to establish a fund of around $500 billion euros to prevent defaults on government debt. It seems clear, however, that bondholders will have to bear significant losses, whether these are brought about through rescheduling, renegotiation or simply through inflation.

Further rounds of crisis, possibly involving the UK and US, seem very likely. The stability of the global financial system is being tested once again, this time with much less capacity for a public bailout. Australia needs to be prepared for such an eventuality.

A prescription for financial restructuring

In view of the spectacular failure of financial regulation around the world, which was broadly similar to regulation in Australia, it might be expected that the need for a fundamental review of our regulatory systems would be generally accepted, if only to identify “what went right” in Australia compared with the problems overseas. In fact, there is no such agreement.

The Commonwealth has rejected calls for a broad-ranging inquiry into the financial system; though there were some hints that the situation might be reviewed when financial regulation was no longer in crisis mode. More pointedly, Terry McCrann suggested that reform of the financial system is unnecessary because the global financial crisis hasn’t affected us. In his words, ‘Not many dead or even injured in Australia. From any systemic fault, that’s to say.’

It’s true that Australia has come through the crisis without major financial disasters. But it is absurd to suggest that this fortunate outcome implies that our existing system has worked as planned. Decisions such as giving an unlimited guarantee of bank deposits and the government’s establishment of the Ozcar scheme, in response to the anticipated withdrawal from the Australian market of the major providers of car loans, were taken on an emergency basis, justified only by the belief that the alternative would be disastrous.

The most fundamental criticism of the status quo has come from Ian Harper, the former Reserve Bank Economist who played the dominant intellectual role on the Wallis Committee. Harper is a strong supporter of free markets, and an economist of unquestioned intellectual integrity, not prone to blow with the wind of fashion. Harper has observed that the entire intellectual framework of the 1997 inquiry had been rendered redundant by the financial crisis.

‘Our framework was essentially the efficient markets theory,” he said. “We thought we had found the ultimate fixed point in the universe, namely the market price, and so we built on top of that the regulatory framework. But then there was no market price. The evolution we expected has stopped, reversed and gone the other way.’

The reversal of financial globalisation

One of the most striking developments of the late 20th Century was the explosion in the volume, speed and complexity of international financial transactions, and the resulting breakdown of effective regulatory control over the global financial system. The speed with which this process has gone into reverse since the onset of the financial crisis has been equally striking.

Transactions in the global foreign exchange market, once confined to financing trade flows, peaked at around $4 trillion per day in mid-2008. At that pace, two days of foreign exchange trading would be sufficient to finance an entire year’s trade flows. The growth of private credit reached an annualised rate of $10 trillion at the same time.

The market collapsed in the crisis of late 2008. According to the International Monetary Fund (2009), private sector credit growth fell by 90 per cent, and ‘Emerging bond markets virtually shut down for a period of time in the fourth quarter’.

Although rescue measures by governments have restored some credit flows, the long term tendency is towards a reversal of financial globalisation. Banks that have been bailed out or nationalised are being encouraged, and sometimes forced, to sell off overseas assets and focus on their home market. Public policy is simply reinforcing the pressures of the market.

In one of many similar examples, the Rudd-Gillard Government was forced to intervene in the market for motor vehicle finance and, on a larger scale, in the commercial property finance market, in response to the withdrawal of foreign lenders from the market.

The European crisis, driven primarily by excessive lending by French and German banks will entail a further retrenchment, and the strengthening of financial controls applied at the level of the eurozone as a whole.

By the time financial markets have been stabilised, the global financial system that prevailed before the GFC will have contracted rapidly, with many markets and institutions disappearing altogether. The challenge facing governments and regulators will be to construct a new financial system and a regulatory architecture strong enough to prevent a recurrence of the bubble and meltdown that has largely destroyed the existing unregulated system.

An important element of any reform should be a tax on financial transactions, low enough that it does not interfere with ordinary borrowing and lending, but high enough to ensure that the massive short-term speculation that still dominates financial markets is ended once and for all. Even at very low rates of taxation (say 0.1 per cent), it would be impossible to maintain financial markets with turnover in the hundreds of trillions, as at present. And even with a drastically reduced volume of financial transactions, the effective tax on financial sector operations would be large enough to offset the cost to the public of the guarantees required by the system.

The five pillars of financial stability

The essential features of a system of financial regulation to support market stability and prevent another meltdown are:

• Linking and integrating national financial systems to produce a sustainable international financial architecture
• Decoupling exchange rates from the vicissitudes of financial markets – the Tobin Tax
• Guaranteeing and regulating the banks
• Regulating innovation
• An effective ratings system

A new financial architecture

The idea of a ‘global financial architecture’ is both misleading and unattainable. The keystone for any financial architecture is the institution that acts as lender of last resort for others. This function is, and is likely to remain, one undertaken by national governments and their central banks.¹ It follows that there can be no global financial architecture. Rather national systems of financial regulation must be linked and integrated to produce a sustainable international financial architecture.

To achieve this, there must be no ‘offshore’ financial system, outside the agreements that govern the international financial architecture, but nevertheless allowed to transact with institutions inside the system. This issue has already arisen in relation to international tax avoidance and evasion, and will arise in an even more acute form in relation to the Tobin tax, discussed below. Fortunately, the OECD has already developed a strategy to address tax avoidance that will serve as a model for financial regulation.

The OECD prepared an internationally agreed tax standard allowing countries to choose their own tax rates, but requiring exchange of information to prevent avoidance and evasion. Jurisdictions which implemented the standard were placed on a white list, while those that refused were placed on a black list. Countries that promised to implement the standard but had not yet done so were placed on a grey list. Blacklisted jurisdictions were threatened with sanctions, largely unspecified, but sufficiently effective that, by October 2009, no jurisdictions surveyed by the OECD global forum remained on the blacklist.

The tax standard is inadequate in many respects, and open to the evasive tactics for which tax havens are famous. But it seems clear that the standard will be tightened progressively, and that no jurisdiction will be willing to risk the consequences of refusal to implement them.

The Financial Stability Board, established as part of the response to the global financial crisis has already indicated that the tax haven model will be applied to ‘regulatory havens’ offering lax financial regulation. As with taxation, the process will undoubtedly be slow, but the mechanisms are in place to ensure that evasion of financial regulation through the use of offshore transactions can be prevented.

The Tobin tax

The long-advocated and long-resisted idea of a small tax on financial transactions, commonly called a Tobin tax,² is the most promising option for ensuring that exchange rate movements reflect the economic fundamentals of trade and long-term capital flows, rather than the vicissitudes of financial markets.

A tax at a rate of 0.1 per cent would be insignificant in relation to the transaction costs associated with international trade or long-term investments. On the other hand, daily transactions of $3 trillion would yield revenue of $30 billion per day, or nearly $1 trillion per year. Since this amount exceeds the total profits of the financial sector (profits that are likely to be much smaller in future) an effective Tobin tax would imply a drastic reduction in the volume of short-term financial flows. It follows that the revenue from a Tobin tax, while significant, would not be sufficient to replace the main existing sources of taxation, such as income tax.

The large literature on Tobin taxes has identified two significant problems with the simple proposal for a tax on international financial transactions.

First, it is possible to replicate spot transactions on foreign exchange markets with combinations of forward, futures and swap transactions. To make a Tobin tax effective, it would have to be applied to all financial transactions, including domestic transactions. During the bubble era, when the few remaining taxes on domestic financial transactions were being scrapped to facilitate the growth of the financial sector, this was seen as a fatal objection. It has become apparent, however, that the destabilising effects of explosive growth in the volume of financial transactions are much the same, whether the transactions are domestic or international.

The fact that a Tobin tax on international financial transactions would be integrated with taxes on domestic transactions suggests that, in all probability, revenue would be collected and retained by national governments. However, the suggestion that at least some of the revenue should be used to fund global projects, such as the international development goals of UNCTAD, remains worthy of consideration.

The second problem is that the tax would require global co-operation, since otherwise financial market activity would migrate to jurisdictions that did not apply the tax. Although this will remain a problem in the post-crisis world, it is likely to be much less severe than indicated by earlier discussions, because of the much smaller number of separate jurisdictions that would need to agree, following the emergence of the euro. It seems inevitable that most remaining European currencies, with the possible exception of the British pound, will disappear in the wake of the crisis, and that a Europe-wide regulatory system will emerge.

To address the problem of ‘offshore’ financial centres, such as Caribbean island states, a Tobin tax on transactions among complying jurisdictions may have to be supplemented by a punitive tax, at a rate of, say 10 per cent, on transactions with non-compliant jurisdictions. This would effectively ensure that non-compliant jurisdictions were excluded from global financial markets, though the penalty would be modest as regards trade and long-term investment flows.

Regulating the banks – Guarantees, regulation or narrow banking

The core of financial regulation is the existence of a (partial or total) guarantee that bank depositors who exercise ordinary prudence will not lose their money. Until October 2008, the guarantee system in Australia was carefully ambiguous. Governments and the Reserve Bank implicitly assured both the general public and wholesale lenders that our major banks are completely safe, while simultaneously denying that their liabilities were guaranteed. As was both predictable and predicted, ³ the contradictions in this stance were exposed the first time the system faced a serious crisis. The result was the unlimited guarantee we have now.

We must now consider whether to maintain, modify or withdraw the guarantee. Whatever we do, the crucial issue that has not been faced so far is that publicly-guaranteed institutions require much closer regulation than is consistent with policies of financial deregulation.

So, there are three policy options available:

1. The first is the maintenance of the existing guarantee, and a comprehensive re-regulation of the system. This would not mean a return to the system that prevailed before the 1970s (no such return is ever possible), but it would require direct control over the allowable range of products, the setting of interest rates, fees and charges and the allocation of lending between sectors of the economy.
2. Current government rhetoric suggests the desire to return to something like the old system, with deposit guarantees being withdrawn once the crisis is over. But clearly, we cannot go back to the old ambiguity. If the guarantee is withdrawn, this will be a clear statement to depositors that they must make their own judgements about the safety of their money. It was in this context that the idea of a publicly-owned and publicly guaranteed savings bank was suggested.
3. The third option, in some ways a compromise, is that of narrow banking, in which publicly guaranteed banks stick to a tightly regulated range of well understood activities. This allows for a completely separate set of financial institutions, of which stock markets are the exemplar, where government guarantees are ruled out in advance. These would offer higher returns but no possibility of transferring risk to the public. This is my preferred option.

Narrow banking

Post-crisis financial regulation should begin with a clearly defined set of institutions (such as banks and insurance companies) offering a set of well-tested financial instruments with explicit public guarantees for clients, and a public guarantee of solvency, with nationalisation as a last-resort option. Financial innovations must be treated with caution, and allowed only on the basis of a clear understanding of their effects on systemic risk.

In this context, it is crucial to maintain sharp boundaries between publicly guaranteed institutions and unprotected financial institutions such as hedge funds, finance companies, stockbroking firms and mutual funds. Institutions in the latter category must not be allowed to present a threat of systemic failure that might precipitate a public sector rescue, whether direct (as in the recent crisis) or indirect (as in the 1998 bailout of Long Term Capital Management). A number of measures are required to ensure this:

• Ownership links between protected and unprotected financial institutions must be absolutely prohibited, to avoid the risk that failure of an unregulated subsidiary will necessitate a rescue of the parent, or that an unregulated parent could seek to expose a bank subsidiary to excessive risk. Long before the current crisis, these dangers were illustrated by Australian experience with bank-owned finance companies, most notably the rescue, by the Reserve Bank, of the Bank of Adelaide in the 1970s.
• Banks should not market unregulated financial products such as share investments and hedge funds.
• The provision of bank credit to unregulated financial enterprises should be limited to levels that ensure that even large-scale failure in this sector cannot threaten the solvency of the regulated system.

In the resulting system of ‘narrow banking’, the financial sector would become, in effect, an infrastructure service, like electricity or telecommunications. While the provision of financial services might be undertaken by either public or private enterprises, governments would accept a clear responsibility for the stability of the financial infrastructure.

Financial innovation

The prevailing rule has been to allow, and indeed encourage, financial innovations unless they can be shown to represent a threat to financial stability. With an unlimited public guarantee for the liabilities of large financial institutions, this rule is a guaranteed, and proven, recipe for disaster, offering huge rewards to any innovation that increases both risks (ultimately borne by the public) and returns (captured by the innovators). There must be a reversal of the burden of proof in relation to financial innovation.

The process of financial innovation, involving either the creation of new financial instruments or the design of new financial strategies for firms (often termed ‘financial engineering’) was a central feature of the era of market liberalism. The growth of finance has been almost unstoppable. Seemingly major financial crises like the stock market crash of 1987 or the NASDAQ crash of 2000 stimulated the development of yet more innovative responses. Even the exposure of spectacular fraud at the Enron Corporation, which had been nominated by Fortune magazine as ‘America’s most innovative’ for six years in succession, did little to dent faith in the desirability of innovation.

It is now clear that unrestricted financial innovation played a major role in the advent of financial crisis, by facilitating the growth of unsound lending and by undermining systems of regulation. There is an inherent inconsistency between unrestricted financial innovation and a regulatory system aimed at preventing the failure of financial systems or at insuring market participants against such failures. Guarantees create ‘moral hazard’ by allowing financial institutions to capture the benefits of risky investments, while shifting some or all of the losses to government-backed insurance pools.

Moral hazard can only be offset by the design of regulatory mechanisms that discourage excessive risk-taking. But, as the literature on mechanism design has shown, the effectiveness of such mechanisms depends on the existence of stable relationships between the observable variables that are the subject of regulation and the risk allocation that generates them. Financial innovation changes the relationship. In the presence of moral hazard, therefore, there is an incentive to introduce innovations that increase the underlying level of risk while leaving regulatory measures of risk unchanged.

It follows that the only sustainable approach to financial innovation is one in which proposed innovations are introduced only after the implementation of necessary changes to regulatory requirements and risk measures. If reliable risk measures cannot be computed, the associated innovations should not be permitted.

A public ratings system: capital adequacy, transparency and risk assessment

Another important regulatory adjustment will be the end of the system by which prudential regulation has been, in effect, outsourced to ratings agencies such as Standard & Poor’s and Moody’s. Agency ratings have been enshrined in regulation, for example through official investment guidelines that require regulated entities to invest in assets with a high rating (AAA in some cases, investment grade in others) or provide those responsible for making bad investment decisions with a ‘safe harbour’ against claims of negligence if the assets in question carried a high rating. For these purposes at least, an international, publicly-backed non-profit system of assessing and rating investments is required.

Conclusion

Australia suffered only modest and indirect effects from the first round of the Global Financial Crisis. In part, this favorable outcome reflects good management, but good luck has been at least as important. Trusting to luck that we will be similarly favoured in the future would be highly unwise.

The temptation to put off until calmer times questions about our financial vulnerability has proved irresistible so far. Looking at the current global scene, however, it seems unlikely that economic calm will return any time soon. A careful examination of the vulnerabilities in our financial system will be an urgent task for the newly-elected Gillard minority Government.

Photo Credit: Gordon Banks, http://www.flickr.com/photos/wwworks/2959833537/

Endnotes

AUTHORS(S): John Quiggin