Thursday, December 2, 2010

Funding the Future Commodity Bust

During the debates earlier in the year about the proposal to introduce a resource rent tax in Australia what was sorely missing was a discussion about how to effectively manage the proceeds.

This week Australia's Reserve Bank Governor, Glenn Stevens, has called for improved savings of resource revenues and alluded to the benefits of commodity stabilisation funds. Stevens’ speech echoed a similar call by the OECD last month.

Since 2003 commodity prices, particularly coal and iron ore, have bucked the long term trend of declining terms of trade and delivered strong growth in corporate tax receipts for the Commonwealth Government as well as (more muted) growth in the royalties paid to State governments as higher commodity prices encouraged production expansion.

The Howard Government used these proceeds to fund increased spending on programs, income tax cuts, and more generous family assistance payments while State governments played catch up on large scale infrastructure projects. Both largely allocated all of those extra dollars and placed their budgets in a vulnerable position should the economic and commodity cycles trend in the opposite direction.

That time came in late 2008 and overnight company receipts dried up and commodity prices dipped. The Rudd government also turned to stimulus spending to soften the blow and avoid the hangover that shedding large numbers of workers would inflict.

Denied of the opportunity to draw on the savings that should have been made during the good times the Rudd government instead took on debt. These events demonstrate that for much of the post 2003 period Australian government budgets were probably in structural deficit if we are to factor in the bust as well as the boom.

Sovereign wealth funds, or stabilisation funds, are well placed to smooth out commodity and economic cycles. Chile, Norway, UAE, Alaska and Wyoming all employ such funds to ease currency and inflationary pressures and provide for stable economic growth through countercyclical spending. Australia does have a Future Fund to save for anticipated public service superannuation liabilities but it is not commodity based.

The Gillard government has so far resisted calls to link their proposed Mineral Resource Rent Tax with a stabilisation fund. However they would be well advised to consider that now is the time to begin funding the future commodity bust.