Sustainable Finances – Why Bother?

Mike Baird is the NSW Treasurer and has held this position since the O’Farrell Government was elected in March 2011. He was first was elected to the New South Wales Parliament in 2007. After initially serving time in a range of junior shadow ministries, in 2008 Baird was promoted to the position of Shadow Treasurer and touted as a future Liberal leader. Mike Baird began his professional life with the National Australia Bank under its graduate program. He then worked in investment banking with Deutsche Bank as a senior manager before spending a year in Canada studying for the Anglican ministry. At age 29, Baird unsuccessfully sought preselection for Manly, and returned to the NAB, working in London, before returning to Sydney to work for HSBC Australia. Mike Baird spoke at the Sydney Institute on 22 March 2012.

SUSTAINABLE FINANCES – WHY BOTHER?

MIKE BAIRD

Thank you, Gerard, and thank you for giving me the opportunity to speak this week.

For those who had the opportunity to hear Lord Bragg at The Sydney Institute Annual Dinner this week, it reminded me of an event in London. When you’re in London as an Australian, you have the capacity to go into the draw for tickets to Wimbledon.  My wife called me one day excitedly and said, “We’ve won the draw, we’ve won the draw!” I said, “What day, what day?” She gave me the date and I said, that’s final day, that’s final day, we’ve got a ticket to the Wimbledon final!  She said, yep, final day court one. But, I thought, that’s not centre court. So I enjoyed watching Virginia Wade in the over-35 doubles while Pete Sampras and Pat Rafter were over on centre court.

So I feel much same as I follow Lord Bragg this week. In many respects, I’m not quite centre court. But I do appreciate the opportunity, and that you have all come along to hear me talk about sustainable finances and why we should “bother”. What a title for a state treasurer.

Fiscal sustainability – what is it and what does it mean. I’ll give you two definitions, and one is from the Commonwealth Treasury. The technical definition of fiscal sustainability is that it happens when “all obligations, current and future, can be met without changing current policy settings”.  The IMF’s guide reads: “A set of policies is sustainable if a borrower, in this instance the government, is expected to be able to continue serving its debt without unrealistic large future corrections to the balance of income and future expenditure.”

So, in essence, sustainable finance is about operating within your means, preparing for today with the capacity to meet your future. So, in a NSW government context, it allows the government to meet the community’s expectations of services, health, transport, education, police, together with infrastructure, to build the infrastructure we need today and over the longer term.  It brings a dividend back to the community in that context.

More broadly, however, sustainable finances are an important step in ensuring long-term economic growth and employment. If you are sustainable, there is more certainty around expenses and revenue, allowance for better strategic planning, and provision for governments to look to the long-term with a sure base. I’d also say that it allows a culture of micro-economic reform.

There was a habit, in days gone past, for reform to come only when savings were needed to shore up crisis budgets. Whereas, if you have a stable, sustainable base, you have the ability to have a culture of ongoing reform. It also helps us safeguard that each generation is provided for fairly; it doesn’t place an unfair burden on one generation over the next.

Sustainable finance is best reflected in the credit rating. Maintaining the highest credit rating enables a government to have what I call the “three Cs”; it enables you to maintain confidence in the finances of state; confidence across the economy for businesses as well; and it gives you capital. A loss in rating begins to restrict you in accessing capital, a loss that brings increased cost and the difference in borrowing rates has moved post the recent global financial crisis. I asked treasury recently, to cost the loss of our rating at the moment. The answer is about $3.75 billion over ten years. And that’s money which would go into debt servicing rather than the service or infrastructure we’re talking about.

If a focus on sustainability is lost – in simple terms, if governments spend much more than they earn on an ongoing basis – the consequences can be severe, and they start a slippery slope. A loss of credit rating brings a loss of confidence and money will be diverted to service debt at the expense of services. One proponent who puts it well is Niall Ferguson, for those who might have heard him. I would call him, at the moment, a glass half empty man, rather than half full, about the current state of global finances. But he’s got some very worthy insights. Ferguson says that without financial sustainability the risk is that at some point your fiscal policy will lose credibility in the eyes of investors. Then, very quickly, you’ll find yourself in a debt spiral of rising rates, widening deficits, crumbling credibility and yet more rising rates.

So, where do you end up if you lose your sustainability and you lose that battle? Well, I would say the most extreme example we have before us, a current example, is Greece. There, the consequences are severe. The painful austerity measures are born by the current generation, but possibly for generations to come. The minimum wage cut, we’ve seen there’s been cut by 22 per cent. And, 32 per cent for workers under 25. Pension payments have been cut by 12 per cent and there have been 150,000 public sector jobs cut. That’s more than 20 per cent of total government jobs by 2015. As well, there have been service cuts, and the list goes on and on. There are severe consequences if you lose sustainability in your finances.

So, what have we inherited here in New South Wales? When we came to government  in March 2011, it was clear that we had not inherited a sustainable financial position. The audit that we’ve just released stated there had been a marked deterioration in the state’s financial position, broadly since 2005-06, which has produced an unsustainable financial trend. In simple terms, expense growth had been exceeding revenue growth. Indeed, over the previous five years, expenditure growth had been 6.2 per cent, and revenue growth had been 5.6 per cent. The gap equates, in rough terms, to about $300 million a year. If you compound that over five years, it’s $1.8 billion. That’s an additional $1.8 billion that we could have in our budget today if those were just aligned. The structural deficit beyond that is also significant. Without federal stimulus in New South Wales and accounting adjustments, the budget would have been in deficit quite deeply over the past three years. And the projections were getting deeper and deeper.

Obviously, we’ve taken action to start to address the budget difficulties. But there is a huge infrastructure backlog left behind as well. Which doubles the problem. There are many examples you could use but one graphically gives the picture. If you look at the state’s hospitals and health facilities, and more than 50 per cent of them are more than 50 years old, you start to understand the magnitude of the challenge that was left behind. That is a reality that we are dealing with. NSW’s AAA credit rating was under threat with the brief said that the rating, on the path we inherited, would have been lost by 2013-2014.

Sustainable finance is also important because without it, a government’s flexibility is reduced – that is the state’s capacity to absorb shocks; it reduces contingencies, and, ultimately, it reduces our ability to choose. This choice is something I want to dwell on tonight. A lack of flexibility in a state’s finances can be most felt at a time of greatest need. In my electorate, there is a family with a disabled daughter. She’s 16 years old. The family lives, day in, day out, with the concern that when her parents are elderly, where will she live? Who is going to look after her? And, the mother told me about a particular government project she had heard about where millions and millions of dollars were being wasted. She told me how she had cried on hearing that. because she was aware how badly those funds were needed, and not just for her and her family, but by so many other families across the state with similar needs.

So, this question of flexibility for the government and the merit of proposals is something that is critically important in pursuing sustainable finances. And I want to give you just two examples. The first is the National Disability Insurance Scheme. I don’t think anyone would argue against the merits of such a scheme. The Productivity Commission’s inquiry report released by the federal government last August recommended the scheme. It would mean that people with significant disabilities would be insured so that they could access long-term care and support tailored to their specific needs. And the long-term is important, that surety, that peace of mind. That family in my electorate would no longer have to worry; they would have a sense that their daughter was going to be supported for the duration of her life.

Now, the cost of the National Disabilities Scheme is immense. Today alone it is estimated to be $6.5 billion, and that’s on top of the $7 billion that’s already being spent by the states and commonwealth. But any government is going to want to participate in that scheme. And you need the flexibility in your state finances to be able to participate in it.

I had the opportunity, in my MP role, to visit a place called Weemala in North Ryde. For over 100 years, this hospice has looked after the incurables. It is home for the severest forms of MS, those with terrible brain injuries, and generally patients who need long-term care. But it was the physical building that struck me. As I stood in that building, I was struck, not with the people who had a joyous spirit despite their circumstances, but with the sterile nature of the facility. I went into the bathroom block, where they’d need wheelchairs and other facilities to get them into the showers. I was struck by how cold it was, it was freezing. As I stood there with the nurse, and looked up, I could see bar heaters around the top. I asked why the heaters weren’t on? The nurse replied that they hadn’t been on in ten years for cost reasons. That, again, was a reminder of the needs. There is so much need.

My argument for Weemala, and for the National Disability Insurance Scheme, is that if the state government, or any government, has fiscal flexibility, it can address some of those needs.

A particular area is our community sector workers. Again, an example of a group where we’d all agree the decision on their wage claim was well deserved. Certainly the New South Wales government supports equal remuneration, and supports their case. We have said we’ll pay our fair share. We’re working through that now – the details of the timing with the Commonwealth. But, we are already anticipating our ability to respond to that. And this is the point I want to make. Whether it be our community sector workers, whether it be Weemala, whether it be those families with disabilities across the state, if you have flexibility you can respond.

My second point goes beyond the terms of sustainable finances and deals with preparing for fiscal shocks. We need to be prepared for what may come. As we look at our position today, I would say that the examples of the Asia crisis, the tech-wreck, the global financial crisis and the current European financial crisis, should make us aware that they’re not infrequent. Regional and global upheavals do occur regularly. To ignore this as you operate your finances is denial. You need to be prepared. Good governments, I would argue, must be prepared.

The good news today is that the global economy is looking slightly better, there is almost a pulse. Certainly, in the USA that is the case, and China looks okay. In Europe,  there still remains a question, but the major event, or scare, we were expecting over the summer period appears to have been averted for now. Still, the IMF and the OECD expect growth below trend. They assume Europe is going to muddle through, but it’s not 100 per cent certain.

There is a risk of another credit crunch. We are not out of the woods yet. If a financial upset does happen, it could be far deeper and longer than what we saw in the global financial crisis. In that context, Australia, and New South Wales should be ready. So, what should be the response if we face that? Obviously, we’ve got monetary stimulus. So significant interest rate cuts would flow, and that’s a strategic strength of the Australian economy. The capacity we have at the moment, with relatively high interest rates globally, provides a strategic strength. But, it also would involve discretionary fiscal stimulus. That is something we would have to go through. I’d argue that it needs to be done carefully. It can’t be money just thrown without thought, without rhyme and reason, without considered process. It must not be wasted. I noticed Judith Sloane in The Australian today said that governments need to be smarter. I totally agree with her on this about stimulus spending.

Three things come to mind; it’s got to be temporary, it’s got to be targeted and it needs to be timely. Temporary speaks for itself and ensures that there’s no long-term structural deterioration in the budget. It’s almost a one-off event. It needs to be targeted, I would say towards the highest multiplier effect which results in government spending that brings the highest multiplier effect. If you look at the work from the IMF and the OECD, and their modelling, each knows direct government spending, especially in infrastructure, has a higher multiplier than cash transfers or tax cuts.

The OECD’s  interim economic outlook in 2009 estimates the multiplier for an infrastructure/capex spend is about 0.9 in the first year and about 1.2 in the second year. That compares with about 0.4 for cash transfers and about 0.3 for tax cuts in the first year. I’m not saying you wouldn’t use a mix of those, but what we can be prepared for is focusing in on the higher multipliers, which is in infrastructure spending.

In terms of delivering it, it also has to be timely; it needs to be delivered and there has to be capacity to move quickly. The list of projects to ensure state priorities are met by the stimulus as part of a national agenda must be maintained. It must be infrastructure and capital expenditure that leads the way.

The New South Wales government is preparing for a whole of state government action plan. We will be ready to trigger that plan within three to six months of being asked to execute it. We must be shovel-ready, and we will be. If you go across the portfolio areas that we are looking at, we have the opportunities in the long-term projects; transport infrastructure; the acceleration of the North-West rail link (a project that’s underway); the Pacific Highway (a project that’s underway).

In the short and medium-term, we have other opportunities. The road-maintenance back-log currently sits at about $400 million before you start to take into account the impacts of recent floods. We expect that to be upwards of $500 million so there’s almost a billion dollars of road maintenance that can be undertaken in a very short time frame. Within rail maintenance, there’s a long-term project to replace wooden sleepers with concrete or steel. We can bring that forward in a very short time-frame. We could start to replace mechanical and electrical components within existing facilities and accelerate a program, some of which is estimated at $300–320 million. In schools, the cost of backlog and repairs has been estimated at about $395 million, but the government is undertaking condition-based assessment of those results, which are due shortly, and we expect that figure to rise substantially. All these are projects ready to go.

At that point, the question becomes who should pay? My proposition would be the federal government remains in the best position. It has the greater tax funds, the greater discretionary income, the greater balance sheet strength, the capacity to undertake stimulus activity early. But, I want the state to participate in that national debate. I want to shape where those funds should go and, most importantly, in the argument that I’ve made tonight, I would say that states with the fiscal flexibility can choose to respond in support of their community and their economy at their greatest time of need. If you have that flexibility, if we have the plan ready to go, the Commonwealth can lead but the states have the capacity to respond and give support at that greatest time of need.

With infrastructure to a standard that will survive seismic and other shocks, it’s time governments realised they need to structure their finances to withstand financial shocks.

Sustainable finances are crucial for all of the reasons outlined. They deliver services and infrastructure the community expects. They ensure economic growth and jobs over the long term. They avoid one generation being burdened. But, it’s beyond that. It’s also having the capacity to choose, the capacity to respond to those with most need. The capacity to respond to shocks as they reach our shores. It is for that reason, I would argue, sustainable finances are not an option, they are a necessity.

That’s why we bother. That’s what drives us – the interests of the people of New South Wales. Sustainable finances are why the government is working so hard to get our budgets back onto a sustainable path. It’s a battle that will be ongoing, and one that we will pursue with vigour.

So next time you hear someone say “sustainable finances”, don’t fall asleep. Listen closely, as there’s a dividend in it for all of us.