Welcome, my name is Dr. Jan Libich and I'm
really pleased to be joined by Dr. Stephen
Kirchner from the University of Technology
Sydney as well as affiliated with the Centre
for Independent Study in Sydney that kindly
provided these premises.
Today we will be talking about a very hot
topic.
We will be talking about fiscal sustainability
or maybe fiscal un-sustainability.
So Stephen can you please summarise the situation
for us.
What's wrong with fiscal policy across the
globe?
Well I think that one of the problems with
fiscal policy is that it's not good at focusing
on what it's good at.
So when you are looking at tax policy and
expenditure policy really that should be driven
by micro-economic considerations.
So you want policies that create good incentives
for working, saving and investing.
You want policies that stack up on a cost
/ benefit basis.
Unfortunately politicians tend to use fiscal
policy for macro-economic reasons so they
are either using it to stimulate or restrain
economic activity and that's something that
fiscal policy is not very good at and it diverts
politicians away from those micro-economic
considerations.
O.K, so this is a big picture problem.
But it seems there is more to it than that.
It seems that fiscal policy in most countries
is on an un-sustainable path.
Why would that be?
If it's only about macro-economic considerations
about smoothing the cycle then it should cancel
out on average over business cycle and we
shouldn't have that problem.
So what's driving that?
Yes, so there's an issue around fiscal sustainability
in that we know politicians have an incentive
to spend more than they are bringing in in
terms of revenue at any particular time.
And in a sense Keynesian economics provides
an intellectual justification for doing something
that politicians have a temptation to do anyway,
and that is to spend beyond their means.
So what is the incentive, what's driving that?
Well it's an electoral incentive that if politicians
feel that they are spending on things that
are popular this will help them get re-elected
and they can send the bill to future generations
in terms of rising debt.
So ultimately it must mean that voters are
not fully informed or not fully rational to
be buying those sort of promises, and this
sort of sup-optimal behaviour and sub-optimal
policies.
Yes, there's a big question about how forward
thinking voters really are.
So there's the idea of Ricardian equivalence
which says that current voters recognise that
government spending that is unfunded equals
higher taxes and when the government announces
an unfunded fiscal stimulus essentially what
it's doing is announcing a future tax increase.
And if voters anticipate that to some degree
then they're going to respond to that by increasing
their level of saving which of course makes
the fiscal stimulus less effective.
So empirically it's an interesting question
as to how big that effect is...
But empirically it doesn't seem to work and
there are some good reasons why you should
deviate from Ricardian equivalence such as
borrowing constraints, myopic voters and these
sorts of things.
The literature in Australia would suggest
there is a Ricardian offset to government
spending which blunts the effectiveness of
fiscal policy.
The big picture is really the demographic
changes that imply that the future is going
to be more challenging than dealing with the
past fiscal...so can you just outline what
is happening on the demographic front in most
developed countries?
So we have the baby boom generation hitting
retirement age starting around now so this
leads to an increase in the age dependency
ratio that the number of old people relative
to the number of people still in the workforce.
These are massive changes right?
Going from five or six workers per pensioner
to close to two or even one in some countries...
It is a large change but there is of course
a precedent for this which was in the post-war
period where you had a big increase in the
age dependency ratio and part of those aged
between 0-16 so this is when the baby boomers
were children.
And that didn't lead to a significant fiscal
problem because the welfare state was much
better contained in the early post-war period
and government spending was more under control
than it is now.
So a big increase in the age dependency ratio
in itself is not necessarily a problem.
What is a problem is the unsustainable public
expenditure that we have attached to this
ageing population.
So my view would be that you need to tackle
this unsustainable expenditure profile.
So let's just try to put some numbers..
If you think about the United States currently,
the deficit to GDP ratio is about eight or
nine per cent, which doesn't seem like a big
number but it's probably not a fair comparison
because the government doesn't actually own
the GDP.
So if you think about the dollars that they
spend out of three dollars it's spending,
one it's actually borrowing.
Probably an even better comparison is that
if you think of revenue as being out of 100
then the expenditure is actually 160 so the
deficit is the proportion of the government
revenue is actually 60% so these are really
big numbers.
Would that be across the board?
Would other countries also face these sorts
of short-falls?
And not just now but thinking about the future.
But if you look at the US it was running budget
surpluses up until the late 1990s.
Under Clinton.
Yes.
And then you had the recession in 2001 which
sent the U.S economy into deficit and the
budget position really didn't recover and
then we went into the Global Financial Crisis
and a very severe economic downturn which
is worse than the fiscal position.
I think if you look around the world the countries
that have the worst fiscal policy outcomes
are the countries that have had the worst
recessions so there is a big cyclical component
to this.
And it's actually hard to separate out the
cyclical and the structural component.
There is an IMF paper out from 2009 that calculates
the cost of the Crisis as a proportion of
GDP and compares it to the impact of the demographic
of the ageing populations.
It finds that in most industrial countries
the crisis is only about 10% to the cost of
the impact of the fiscal position on the ageing
population which is in the order of 400-500%
of GDP.
So the worst is really yet to come.
But thinking about the possible solutions...so
what is there to be done?
And you actually have a proposal with your
colleague Robert Carling about reforming some
of the fiscal legislation.
So what is it all about?
So that proposal is in the Australian context.
If you look around the world there are a number
of countries in the 1990s that introduced
fiscal responsibility as legislation so we
had that in Australia, New Zealand, Canada,
many of the Scandinavian countries adopted
a fiscal responsibility legislation so doing
what was being done with monetary policy at
approximately the same time which is bringing
in a more rules-based approach to the fiscal
policy.
So in Australia we had the Charter of Budget
Honesty which came into legislative force
in 1998 and what that did was to lay out some
principals for the fiscal policy but what
it didn't do was to lay down some hard rules
to what fiscal policy should consist of.
So it said that the government should have
a fiscal strategy but it didn't actually say
what that strategy should be.
So what kind of strategies do you suggest?
What are your rules?
So what we have proposed is a more prescriptive
approach to fiscal policy rules so not just
laying down the principals but laying down
some hard and fast enforceable rules.
And so in the Australian context we firstly
recommended a budget balance rule which says
that the budget balance or the fiscal balance
needs to be kept in a range between plus or
minus 2% of GDP.
And is this cyclically adjusted balance or
just...
No, no we see this as being an annual constraint
and if you look historically at the budget
outcomes for Australia going back to say 1970
you'd be able to accommodate most of the budget
balances that we have seen historically within
those parameters.
So we also proposed a net debt rule which
was to say that net debt to GDP should not
exceed 10%.
Which again is very close to the historical
average for Australia since about 1970, and
then a size of government rule.
A size of government rule says that the revenue
expenditure shares with GPD should be capped
at 25%.
And this is in fact consistent with an existing
government policy which the current government
says it's going to keep.
Taxation share of the GDP at 2007, 2008 levels
which if you add up the non-tax revenue shares
of GDP it adds up to 25% so basically we are
saying you should make up a legislative rule
out of the governments existing policy commitment.
In other words you are trying to 'institutionalise'
this rather than resting with individual government
that might be replaced and the preferences
might change?
Yes, so it's a less discretionary approach
to fiscal policy and part of the reason for
that is that we want to refocus fiscal policy
back on what it's good at.
So focusing on the role of
tax policy and expenditure policy in conditioning
micro-economic incentives and leaving macro-economic
stabilisation to monetary policy which has
that comparative advantage in terms of that
particular objective.
So why these three specific rules.
There seems to be an overlap between them.
If you are running a balance budget you shouldn't
run up your debt,,,
Well they are designed to interact.
So with the budget balance rule you could
actually run deficits for many years in terms
of that rule so you could have for example
a deficit of 1.5% or 1.9% of GDP every year
and still be consistent with that rule.
So the idea of the Net Debt rule is to limit
how long you can do that.
But still giving governments the flexibility
to run deficits for expended periods if that's
necessary.
So the rules are designed to reinforce each
other.
Now there have also been rules in the Euro
area and we know how they turned out ... as
part of the Growth and Stability Pact, there
are the Maastricht Criteria.
So can you maybe outline the similarities
and differences between the European rules
and yours ...
So the Maastricht rules were designed to do
two things.
Firstly, lay out convergence criteria that
countries had to satisfy in order to gain
Euro accession.
But then also to hold the Euro zone together
so that you didn't have a situation where
fiscal policy would blow up monetary policy.
And in a sense fiscal policy rules in Australia
would be designed to do the same thing.
You want a fiscal policy regime that is going
to support the monetary policy regime.
Because if we know a government is running
irresponsible fiscal policy then what can
end up happening is that the government can
effectively force the monetary authority to
accommodate fiscal expansion.
That's the unpleasant monetarist arithmetic...
It's this sort of fiscal theory of the price
level.
So in a way you want the fiscal regime and
the monetary regime to reinforce each other.
So of course Australia is a monetary union
so part of what you are trying to do with
a fiscal regime here is to provide support
for what the Reserve Bank is doing for monetary
policy.
Now as the European example shows it's not
just enough to have the rules.
You need an enforcement regime and an enforcement
mechanism that actually gets used.
And do you propose anything to go with your
rules?
We do.
The Euro zone had an enforcement mechanism
as well it just wasn't used properly.
So we know if 2003 and 2004 both Germany and
France violated the rules and they were not
held accountable under the Maastricht framework
for those violations and that kind of set
a bad precedent which was then followed by
other countries and led to the existing problems.
So I think what this shows is that it's not
just enough to have the rules written down.
You actually need a culture that says these
rules should be enforced.
How do you develop a culture like that in
an institution that is very new?
Well, I think the process of just writing
down the rules is one of the ways you can
develop the culture.
It's a reinforcing process.
But rules by themselves are not going to be
enough.
If politicians are determined to violate the
rules and electorates don't hold politicians
accountable for those violations then no fiscal
policy regime is going to be able to withstand
that.
But I still think the rules are important
because they are part of creating the culture
and the accountability mechanisms that you
hope will restrain politicians.
What kind of enforceability mechanisms do
you suggest?
So in Australia we have proposed an Independent
Fiscal Commission which would conduct research
into fiscal policy and monitor compliance
with the rules.
It would also enforce the rules in terms of
imposing pecuniary penalties on Members of
Parliament for breaching the rules.
So it would essentially be a fine on all Members
of Parliament if the rules were breached.
And it's not because we think that politicians
are necessarily going to be particularly responsive
to that sort of pecuniary incentive we see
it more of a non-pecuniary incentive which
is that if you have an independent body imposing
penalties on politicians this involves a loss
of reputation for politicians.
Politicians do guard their reputations quite
jealously.
Do you think something like that could work
in the European context?
We've seen the recent fiscal compact where
most countries except two have actually committed
to a sort of balance budget rule on a sort
of cyclical basis but obviously there is no
accountability procedure as yet.
Well the Maastricht Treaty did have those
provisions, so there was provision to fine
countries who breached the rules...
You can't keep anyone out of there.
Well this is part of the problem that they
are trying to hold the Euro zone together
and this makes it difficult to impose discipline
upon the members.
So the Maastricht Treaty did have a penalty
and an enforcement regime.
It is just that this regime has not been rigorously
applied and of course this has led to the
problems that we now see.
So on the one hand it shows us that there
are limits to the effectiveness of these rules
but on the other hand it highlights the effectiveness
of adhering to the rules.
Because then you can have a situation where
fiscal policy essentially undermines fiscal
sustainability but as we have seen in the
Euro zone potentially compromising monetary
policy as well.
So how would it work in practice?
So suppose you have an independent fiscal
commission and I suppose you would model it
as an independent central bank type of institution
so what would happen if they came up with
an intergenerational report using Kotlikoff's
Intergenerational accounting and found out
that there is a huge fiscal gap and that something
needs to be done.
How would they actually get back to the politician
and make sure there is a change in the fiscal
stats?
Well, we do have intergenerational reports
at the moment.
Part of the problem with those reports is
that they are prepared by Treasury and whether
justified or not they are not seen to be independent
of government.
And I think this reduces the authority of
those reports and so we would expect that
the Fiscal Commissioners as part of its independent
responsibilities would be compiling these
reports.
Because it's an independent body these reports
would carry a little bit more authority and
part of what the reports would be designed
to do is whether or not fiscal policy is sustainable
or not.
Australia, if you go back to the 2007 Intergenerational
Report, that report said very explicitly that
over a forty year horizon there was a large
fiscal gap and that this would lead to unsustainable
net debt dynamics.
So effectively what they were saying was that
over a forty year period fiscal debt was unsustainable.
The 2010 report never used the word 'un-sustainability'.
They kind of fudged it a little bit.
Despite the fact that the situation was looking
much worse.
Well actually on the numbers the situation
improved a little bit between 2007 and 2010,
but it is an unsustainable situation.
So part of the role of an independent fiscal
commissioner would be to comment on the sustainability
of fiscal policy but also to then enforce
the fiscal policy rules, so to say to governments:
"You are in breach of the rules.
Here is a penalty and here is what you need
to do to get back on track.
This is the magnitude of the fiscal adjustment".
And that would be non-negotiable, the politicians
would have to comply?
Well, yes.
The idea would be that you would want to make
these provisions enforceable.
If you look at the existing Charter of Budget
Honesty in Australia the very first provision
of that legislation says that nothing in the
Charter of Budget Honesty will be subject
to administrative or judicial review.
So effectively the existing legislation says
that there is no enforcement mechanism.
Now you can't take politicians to court to
make them adhere to the rules...
Was that a deliberate...
Of course.
So they are saying: 'we'll have these fiscal
principles but we're not going to lay down
fiscal rules and we're not even going to be
accountable for the fiscal principles.
There are some countries that have gone further
than Australia in their fiscal reforms.
Some of them have implemented a fiscal commission
or a fiscal council.
Similar proposals are floating around Europe.
Can you talk a little about the real world
examples?
Yes.
There are lots of examples.
I think the New Zealand example is a good
one.
It's still the case with the New Zealand legislation
that they don't prescribe so much what the
fiscal strategy should be, but they have very
good transparency and accountability mechanisms
built into the legislation.
There are independent fiscal authorities in
a number of countries, the Netherlands for
example is a very good independent fiscal
authority that looks at and evaluates legislation
in terms of its fiscal impact.
Those sort of cost benefit analysis and so
forth.
So, I think generally speaking the sort of
model that you want defines the parameters
within which fiscal policy needs to be made.
I don't think you can have a situation where
you can have an independent body telling politicians
what expenditure decisions and what taxation
decisions they are going to make because they
are not necessarily political decisions and
governments are not going to surrender their
responsibility for those.
But what you can do is put parameters around
the budget aggregates and the debt position
and so on.
And I think this serves a number of purposes.
The first being that you are kind of taking
the politics out of those parameters.
So the idea that the fiscal policy should
be conducted sustainably should not be something
for political debate.
I mean it should be a settled issue and I
see nothing wrong with making politicians
make decisions that are consistent with long
run fiscal sustainability.
So that's one element of it, the other element
of it is of course is that you want to tie
down the public's expectations in relation
to fiscal policy.
That's anchoring of fiscal expectations that
Eric Leeper has talked about numerously....
Yes.
Because we have recognised that this is important
for monetary policy but we haven't recognised
it's important in terms of fiscal policy.
I think what makes large budget deficits and
unstable debt positions harmful is not so
much the actual numbers.
It's something we know from experience that
countries can actually run very large deficits
and very large net deposition for extended
periods of time.
So it's not the existing fiscal policy that's
the problem.
It's the public's expectation that future
policy is going to lead to serious problems
and that is very destructive to economic confidence.
So, the implication is that a large part of
the European problem may be now that expectations
about the future are unsettled and unanchored
and if we have some longer term reforms that
may take some pressures off the focus, off
the immediate debt numbers?
Which I mean if you look at Spain and Ireland
the debt to GDP of those countries up until
very recently was fairly low, much lower than
France and Germany.
So, the future seems to be playing a fairly
major role in this.
Now, you mentioned the overlap with monetary
policy and we have seen similar types of reforms
to independence and transparency and accountability
in monetary policy and you have done quite
a lot of work with that.
Can you outline what they have been and what
the sort of similarities with fiscal policy
are there that we can learn.
So starting in the early 1990s, or, in the
case of the Reserve Bank of New Zealand (RBNZ)
in 1989.
The RBNZ was really a pioneer in this respect.
There was a move to make Central Banks firstly
more independent to government and this was
in recognition of the fact that the empirical
literature seemed suggest the more independent
a central bank was the better the inflation
outcomes.
So we wanted to take monetary policy out of
the political arena and separate it from fiscal
policy.
So we want to reduce the scope for monetary
policy to accommodate fiscal policy.
And at the same time there was a move to a
more rules-based approach to fiscal policy.
So rather than just making it up as you go
along and responding to a wide range of macro-economic
variables in ways that were sometimes consistent
there was a much stronger focus on defining
what it was monetary policy was trying to
do.
So that ended up being inflation targeting.
So the idea is that you want to target a low
rate of inflation and this has the advantage
of firstly focusing monetary policy on something
that it's good at.
So one thing we know that monetary policy
in the medium to long run is tie down the
price level.
So you've got monetary policy focused on a
policy objective where there is a reasonable
chance of success.
And this has the added advantage to the extent
that people believe that the central bank
will realise this objective then you are tying
down long run inflation expectations.
And if you can do that it actually makes the
job of setting monetary policy much easier.
Because consumers and other people setting
prices in the economy, if they have an expectation
that monetary policy will do what the central
bank says what it's going to do they are going
to factor that into their price setting, their
wage setting, makes the job with the monetary
authority much easier.
They will be less responsive to the shocks
so the policymaker can more easily stabilise
the situation...
You mentioned New Zealand and in one of our
previous interviews we had Dr. Don Brash,
the pioneer of inflation targeting, the first
Governor of the RBNZ.
We talked about those issues and one the issues
that came up again is that these kind of rules,
if you implement them in monetary policy,
may somehow have an impact on fiscal policy
as well.
So the 1989 RBNZ Act that came up with inflation
targeting and made monetary policy more independent
and transparent appeared in 1989 and only
five years later we've seen the Fiscal Responsibility
Act.
And Don would argue that part of it is because
the central bank became more independent,
more committed, that sort of forced the politicians
to realise they can no longer use fiscal policy
for their idiosyncratic political goals.
Would you believe that is a possible mechanism,
between monetary commitment and maybe fiscal
outcomes?
Yes as we said before, you want the fiscal
regime and the monetary regime to support
each other.
Part of the problem in the United States I
think has been firstly that the Federal Reserve
has a dual mandate.
So it is pursuing not only price stability
but it has a mandate to stabilise activity
as well.
So that has perhaps led to a monetary policy
that has not been as focused on inflation
policy as it should be.
There is a piece of empirical literature that
shows that regardless of whether you have
a dual mandate or a unitary mandate with a
focus on inflation the Central Banks have
pretty much behaved in the same fashion, if
you look at the Reserve Bank in New Zealand
and in Australia and all these others, like
the Swedish Riksbank.
Well it's partly the way that they have interpreted
the mandate.
So if you interpret the mandate to say that
the best way to secure the price stability
is to smooth economic activity or if you look
at economic activity or if you look at economic
activity as essentially predicting what's
going to happen with inflation in the short
run and responding to that then there's a
sense in which you can make that mandate compatible.
I think that's how the Reserve Bank of Australia
which also has a multi-variable mandate, if
you like.
The way the Reserve Bank of Australia would
interpret it would be that all that activity
gives us information about inflation in the
future.
And if that's your interpretation of the mandate
you can reconcile those objectives.
But what I think we have seen in the US and
in Europe recently increasingly you have had
monetary accommodation of fiscal policy, and
in the US this has happened because they don't
have a well-defined monetary or fiscal policy
regime.
And in Europe although you have this reasonably
well defined regime on paper it is not being
respected in practice.
Now if we think about the accountability we
mentioned as an important aspect of fiscal
reforms, how is it solved in terms of monetary
policy.
In some countries, New Zealand for example,
the governor is personally accountable for
achieving the inflation target on average.
Can you think of a parallel in the fiscal
arena?
How would that accountability work?
I think the accountability mechanisms basically
have to be reputational in nature.
You can add a pecuniary element to it as well,
with fines.
But I don't think that fines will necessarily
do the job themselves.
Certainly in British Colombia in Canada there
is a regime where provincial politicians can
have their salaries reduced significantly
if they breach the fiscal rules.
So I think they take a 30% pay cut while the
state's finances are in breach of those rules.
That's not a bad incentive and you want to
make that incentive legally enforceable as
well.
So that is the kind of the model we have in
mind but I think the probably the better accountability
mechanism is just a reputational one where
you have a well-respected independent body
essentially oversighting what politicians
are doing in terms of fiscal policy and when
they are in breach of the fiscal policy rules
you want the independent body basically criticising
them and imposing these penalties as well.
Because then politicians have to go to the
electorate and justify their record with this
hanging over them and they don't want that.
They want to be able to go to the electorate
and say: 'we've done a good job'.
They don't want to go to the electorate with
the independent body saying they've done a
bad job.
So I think that is the mechanism that you
need to enforce fiscal policy rules and that's
kind of the mechanism that's been lacking
in most jurisdictions.
So assuming that we agree on the fiscal rules,
how about the implementation?
If we go back to the demographic changes that
are really driving the fiscal problem, a balance
budget rule means that as our population ages
and the tax revenue shrinks and the pension
and healthcare expenditure is going through
the roof, politicians that do not implement
any systemic long-term reform are going to
be faced with a budgetary shortfall every
year.
They will have to subscribe to some very non-systemic
and short-sighted cuts which is kind of what
we are seeing in Europe now with all these
austerity measures.
It's not really long term reforms that aim
at the ageing population problem but it's
all short-term cuts and these can be counter-productive.
So would you agree that to be able to deliver
these rules we actually do need reforms of
pensions as well as health care and how do
we do that?
But I think having rules and an independent
enforcement mechanism thereby creates the
technology that politicians can use as a commitment
device.
So politicians can say: 'we have these rules,
we have this oversight body enforcing these
rules', and the politician can say: 'well
I'm being forced to make these decisions because
this is what the law requires me to do.
So it kind of strengthens the hand of politicians
who want to pursue responsible policies.
So part of the inter-generational reports
part of the function of those things is to
highlight the fact that fiscal policy in the
long run, in countries including Australia,
is unsustainable.
So you then want policy decisions that are
going to put us back onto a sustainable path.
I think there is an example of this working
in Australia in a sense that in recent years
the federal government has raised introduced
measures which have raise the age at which
people become eligible for the old age pension.
So those rules don't come into force for some
time but they are now legislated and so politicians
have now effectively said: 'we know we are
on an unsustainable path in terms of public
expenditure so these are the measures we are
now putting in place to try to improve that
long term fiscal profile'.
So here you have the inter-generational reports
directly informing current policy decisions
and that's kind of what you want.
Australia has actually implemented a much
bigger reform of the pension system about
two decades ago when it moved from a pay-as-you-go
system, where you pay for the current pensions
with current taxation to a more individual
account type of scheme.
Can you outline what this reform was about
and whether it has been working?
I think we have two advantages in terms of
pension policy in Australia obviously we don't
have a universal pension we have a means tested
pension so not everybody is eligible for the
pension.
That puts Australia in a very strong fiscal
position on that score relative to say a country
say relative to New Zealand where the pension
is a universal entitlement.
So that's an important aspect of it, the other
important aspect was to create a system whereby
individuals would have pension accounts or
superannuation accounts and the government
mandates that a certain percentage of people's
incomes goes into those accounts so you have
a pre-funding of retirement obligations.
Part of the rationale for doing that is to
reduce the demands on the old age pension
in the future because if you have people with
large superannuation account balances you're
essentially going to be dealing them out of
old age pension eligibility down the track.
I think there are still a lot of problems
with that system.
One of the problems being that there's an
incentive for people to take their superannuation
benefits as a lump sum, spend it on a new
home or something like that and then become
eligible for the old age pension.
There is nothing at this stage to prevent
people from doing that.
So I think we need to look at not only what
happens with the accumulation stage but also
at the decumulation stage.
There have been a number of very good proposals
put forward by people like Jeff Kingston,
Hazel Bateman and John Piggott which say that
you want to put in place a regime of mandatory
annuitisation of retirement benefits as well.
So basically having the government mandate
the form in which you take your superannuation
again with the view to minimising aged pension
eligibility.
I think the retirement income system that
we have in Australia is good by international
standards, but the international standards
is a very low one, so I think we still have
work to do in terms of, in an absolute sense,
improving our system.
But if we were to summarise the advantages
of individual saving account schemes, it seems
that the main benefit is that people have
an idea how much they have saved up and they
can make better decisions.
Whether they are going to save a little bit
more on the side or so on whereas with the
universal pay-as-you-go system the current
young are obviously contributing to the system
but they are very sure about how much they
are going to get back, so this transparency
and again this anchoring is this important
to the uncertainty and improve decisions of
economic agents...
So if you look at the US people pay social
security taxes, the government takes that
money and spends it and the social security
liabilities that the United States is accruing
are largely unfunded and this is part of the
problem in terms of their fiscal sustainability
in the US.
Larry Kotlikoff and co-authors estimated the
size of the fiscal gap in the United States,
which is basically the difference between
the net present value of the future expenditures
implied by the existing legislation, minus
the net present value of the taxation, taking
into account all the demographic trends.
And that is in the order of 220trillion US
dollars, which is more than ten times more
than the official debt.
You know this is actually similar for other
countries.
So the size of the fiscal problem is enormous
and again there is no wonder the current generations
are uncertain about what is going to happen
in the future and that is not a good situation
to have.
Yes, I think it's enormously destabilising
because if you put yourself in the shoes of
the US tax payer especially a young tax payer,
I know that my tax burden is going to increase,
but I don't know what the distribution of
that tax burden is going to be and so how
does this affect my decisions to save and
invest.
Well it probably makes me reluctant to save
and invest because I might be setting myself
up for a higher tax burden in the future.
But on the other hand these numbers are so
bad, in a sense it tells you, something is
going to give, either politicians have to
address the problem or a fiscal crisis forces
them to address the problem.
Which can be very costly because once you
get that situation that Greece is facing now
where you have to do all these very unpopular
steps and you don't actually have time to
do a proper long term reform then a lot of
people are going to get hurt and that's probably
not where we want to get in other countries.
Yes, Greece is in a particular situation where
they are in a monetary union, they have a
fixed exchange rate regime effectively and
we know if you add a fiscal contraction in
a fixed exchange rate regime that is going
to be contractionary for economic activity.
So I think the problem for Greece is more
being part of the Euro than the fiscal policy
situation.
Well it's certainly true for Spain and Ireland.
The sort of straightjacket of the Euro was
really the leading cause of the current problems
and again I think that is something that people
don't really realise and Paul Krugman is one
of the people trying to highlight it.
They have been running surpluses before the
crisis.
They were not surpluses on a cyclically adjusted
basis but still they had surpluses and relatively
low debt to GDP ratio, and the problem was
the housing boom that was really fuelled by
excessively low interest rates.
They had them because Germany was in a contraction
in the early 2000s so the interest rates in
the Euro zone as a whole was set lower than
was optimal for countries like Spain and Ireland
and really fuelled that housing bubble and
now we are seeing the consequences.
So I agree with you that the Euro is certainly
a factor that is making the situation worse
in Europe.
Going back to a crisis leading to bad policy.
I'm not convinced that that is necessarily
the case.
I think sometimes you can get better policy
coming out of a crisis just because the situation
demands it.
And we saw that in a number of countries,
New Zealand for example basically had the
IMF knocking at its door in the early 1980s
which led to a series of dramatic reforms
which you would not have seen in the absence
of a crisis.
The same in Sweden in the early 1990s.
Sweden had a very severe financial crisis
but that led Sweden to implement a number
of reforms which have meant that, if you look
at Sweden today, it's outperforming most of
Europe partly of course because it's out of
the Euro but also because it put in place
these reforms many years ago.
So, it's sad to say but sometimes you get
better outcomes out of a crisis rather than
a situation where politicians just muddle
through.
Going back to the individual saving accounts
as part of the pension reforms they have been
considered in some European countries a while
ago, for example in Germany, and then they
were not implemented partly because of a hypothesis
called the 'asset meltdown'.
It argues that if we have a strong baby boomer
generation retiring they need to fund retirement,
they are basically getting rid of their assets.
And these therefore lose value so people may
have saved up a lot in an individual account
but the value of their portfolio is going
to be reduced over time.
There is a lot of research that shows that
while there is some merit to this idea empirically
it's a relatively small factor ...
I'm not convinced by that idea.
People say this in Australia once the baby
boomers start running down their savings and
selling their shares that share prices are
going to collapse but what are share prices,
it's people's expectations of the future earnings
of the company.
It's not determined by who the buyers and
sellers might happen to be.
And so if people who are drawing down their
savings are selling, well on the other side
of that transaction you have a buyer, and
that buyer is looking at the future earnings
prospect...
The idea is that there will be a lot fewer
buyers because the next generation is going
to be smaller...
But it's not the number of buyers and sellers
it's what they are prepared to pay right and
the prices at which they are prepared to sell.
So are you arguing that because there will
be fewer middle aged and young people the
real wage is going to go up because they'll
be in higher demand to provide the services
for the elderly so they might have more income.
There are all sorts of issues to consider.
If you look at the evidence it seems that
the 'asset meltdown' hypothesis is not really
having much of a support empirically.
Yeah, I'm not convinced by that...
Obviously pensions is one story, healthcare
is really the big issue.
Unlike pensions where we've seen some good
reforms of at least where we should be heading,
there is really no good examples of how to
reform healthcare and again the ageing populations,
this is where the main problem is coming from,
because a main part of health spending accrues
in the last year or last few years of life
so they have a lot of people in that older
age bracket that is going to put pressure
on our health system so there is no really
good examples of how we should reform healthcare
to offset the ageing population problem.
It's certainly true that if you look at the
inter-generational reports for Australia that
a large part of the prospective fiscal gap
is attributable to health care costs so this
is one thing that we've be so far not very
successful in containing.
Part of the reason is that in Australia of
course while we means test the pension we
do not means test access to publicly funded
healthcare...
So even if you are a millionaire you can rock
up to a public hospital and get free...
Yes, so if I was a millionaire I can't qualify
for the pension but I can qualify for government
funded healthcare...
But if you were a millionaire you would probably
have private health insurance.
You'd expect so but there are people in incomes
below that who could afford private health
insurance but none the less do not take out
private health insurance.
And the government has put in place various
incentives that are designed to nudge people
in that direction.
The Medicare levy...
But fundamentally we still have this problem
that we effectively have a universal model
for healthcare coverage.
So that's one area that you could tackle to
reduce healthcare costs, putting a means test
to access to Medicare.
There are problems by doing that of course
because you can create very high marginal
tax rates by putting means test on government
benefits so you need to a bit careful so to
how you do that, you don't want to create
disincentives for labour force participation,
and that's just a trade-off that has to be
made.
And I think the American example shows that
going more toward the private health insurance
may not be all that optimal.
I mean the US spending pretty much doubled
the amount of GDP that other countries on
healthcare.
There are a few people that would argue the
health outcomes in the US are superior to
countries like Finland and so...
Well there is evidence to suggest that US
healthcare outcomes are in fact good relative
to other countries.
But of course they're paying for this, right?
And part of the question we face is: "What
are these health benefits actually worth?".
How much are you prepared to pay for example
to extend a terminal patients life by say
three months or six months, so part of the
problem in the US is that the incentives are
such that you spend that much money, whereas
a system that was structured a little bit
differently might lead to different decision
making in that regard.
Of course voluntarily I can pay for whatever
treatment that will extend my life by three
month to six months but does the tax payer
have to make that payment or do private insurers
have to be compelled to make that payment...
I think you really need a wide debate in the
media and in the public about these issues
because the first reaction when you start
taking about reducing life, or not extending
life as much as you can potentially then people
start talking about euthanasia and all sorts
of things but...
Well the issue is more who pays for it right
so if I want to one million dollars prolonging
my life by three months well that's fine.
If I'm proposing to spend somebody else's
one million dollars to extend my life by three
months that's a different proposition and
it's not just the financial cost if you are
imposing a broader economic cost on society
that's, you know there is a correlation between
GDP per capita and wellbeing and health so
in a way indirectly you are imposing costs
on others.
So I think that that's something that needs
to be looked at especially in the US.
I'm afraid we are out of time but I would
like to thank you very much for your insights
and hopefully we will see some improvements
on this front and we will see countries moving
toward fiscal sustainability.
Dr Stephen Kirchner, thank you very much.
Thanks Jan.
