Economist Joseph Schumpeter observed in 1942, “economic progress, in a capitalist society, means turmoil.” That observation shows he had a good handle on the future as it is currently panning out. Chaos seems to be the order of the day, globally, as well as in this country.
The federal budget presented on May 12 was based on the principle of generational equity. Clearly, the tax pendulum has swung too far against Australians under 45 or so, in favour of their parents, and requires adjustment.
The incentivising of investment in real estate was enacted in the changes to the tax treatment of Capital gains in the 1999/2000 budget. Mixed with negative gearing which had been a feature of the tax system since 1936, it created a tax driven distortion in the allocation of capital, resulting in a shelter for investment in real estate.
Taxing capital gains has a potted history.
Prior to 1985 capital gains were untaxed, while wages and salaries were taxed at a 60% top marginal rate. Why should capital profits go untaxed while wages were fully taxed? This inequity created distortions in the deployment of capital. The Hawke government introduced a capital gains tax that matched the top marginal rate, excluding primary domestic residences in 1985, and reduced the top marginal tax rate to under 50%. The taxing of capital gains brought a fierce backlash. In 1987 there was a discount system put in place that recognised the impact of inflation on prices and removed the inflationary impact from any sale price for tax purposes. The changes in 1999 were aimed at simplifying the calculations to arrive at a taxable income that included capital gains, by introducing a flat 50% discount.
The backlash is evident again, as interest groups very effectively use the tools of AI combined with social platforms to rail against the proposed changes. While there are some areas where the detail in the budget was absent, and there are reasonable arguments against the blunt instrument approach in the budget, the principle was clear. Make the difficult changes now. Accept the impact on political capital for the benefit of the economy in the long term.
The pendulum swings again!
There was a lot of other stuff in the budget, but mostly it was business as usual and window dressing. This was not good enough in my view, when there are significant pressures coming from the changing environmental and geopolitical context that need attention.
A few of those are noted in the following sceptical notes.
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- Climate change and the industrial challenges created in manufacturing largely generated by the pivot to electricity sourced from renewables rather than from fossil fuels and the accompanying/enabling technology is a huge change. We need to invest heavily in the technology and infrastructure of global electrification to catch the wave, or be left behind. We must ignore the anti-scientific and financial nonsense coming from some parts of the political spectrum demanding we remain wedded to fossil fuel. Kicking that can down the road, again, is just plain stupid.
- Digital has morphed into AI, and the hounds are, rightly, concerned about job losses, as the shape of organisations and daily work pivots to ‘done for you’ by a machine. The disruption will be substantial, and upon us very quickly, so we need to be prepared. We are not even doing the basic things that will prepare for the changes, such as thinking creatively about how to educate our kids for a world very different to the one we grew up in.
- The steady reversal of the economy from one relying on physical assets to services has made the measurement of just about everything that we see as the foundation of economic modelling redundant. Modelling the outcomes of policy and economic activity is now about as certain as the mumbling from the coloured tent in the corner of the fairground. We desperately need an agreed methodology to realistically measure progress on those parameters. GDP as a realistic measure of activity in the economy is nonsense when it cannot capture most of the activity in services. The cliché ‘if you cannot measure it, you cannot manage it’ is as true in the case of an economy as it is in the management of an SME.
- Geopolitics is in turmoil. This is not just from the depredations of the current idiot in the White House, who has turbocharged it, and the grab by Russia to rebuild the USSR, but from the rise of China. 30 years ago China was an agricultural economy. Now it is the worlds manufacturing and industrial technology powerhouse. While domestic growth has slackened off, it has not stopped, but the rest of the world now relies on China for critical inputs to their supply chains for everything from advanced technology to manufacturing simple appliances, and Christmas ‘stocking-stuffers’. Where to next for China? I think it will attack the sclerotic economies of the west by buying in and disrupting the comfortable order that prevails. For example, European and US car manufacturing is being killed by Chinese imports of EV’s. So, they respond with various barriers that protect their own industries. The natural response from China will be to buy into the market either by start-ups or buying established brands, and building manufacturing capability behind any barriers. Chinese firms already own Volvo, MG and Lotus. Who is next? Volkswagen? The Chinese strategy is clear, and driven by long term thinking, not the next election cycle.
- Australia is not immune. International investment in Australia is essential for our economy. To date it has largely been US and European investors, we have a somewhat xenophobic attitude to Chinese investment, noting we cannot easily invest in China, and if we do, the conditions are onerous. However, we need them more than they need us, so the outcome is obvious. Australia and the western world generally has prospered under the umbrella of international trade fostered by the US since the Marshall Plan set about rebuilding Europe and Japan after the war. Now that plan is in tatters, torn up by its parent. We however, remain wedded to it as the US is so deeply integrated into our economy, while no longer being our biggest trading partner. That guernsey goes to China, the recipient of the openness of world trade, and now in a position to shape it through its domination of the key commodities and technologies of the early 21st century. That reality is yet to work its way into the Australian narrative in any way beyond observations of the importance of China as the major buyer of coal and iron ore. We were taught a painful lesson about the power of China to dictate terms under the previous government. The position we hold as a critical supplier of commodities will diminish over the next 25 years as Chinese integration into mineral wealthy Africa comes of age. What will we do then? Nothing in the budget even gives a hint of preparation, indeed, we continue to spend heavily on straw men like AUKUS.
- Australian R&D, both public and private is low by standards seen in competitive economies. It is also fragmented by our governance system that feeds turf wars at every level of activity. If we set about designing a governance system with a clean sheet of paper, there is no way we would end up with what we currently face. Therefore, it should be a priority of the government, every government, to remove the duplication, waste and opportunity cost such a system encourages. The budget did allocate a small increase in funding for CSIRO, but also directed that the current headcount reduction continue. Other changes to the R&D tax incentive and allocations to specific projects were also announced, but none to address the central challenge of doing the science, then turning it into a commercial outcome.
- The US S&P is driven by tech companies. Of the top 10 in market value, only Berkshire Hathaway is what might be termed ‘Old industry.’ In Australia it is the exact reverse. Of the top 10 only CSL could be termed ‘new industry’. Notably, several unicorns born in Australia have migrated, Atlassian and Canva being the poster children of this migration, but by far, not the only ones. We must find ways to create and nurture innovation. Progressively taking the axe to public expenditure on science, as noted above, is not a good start.
- November 2022 saw the public release of ChatGPT, which kicked off the AI ball. Subsequently, AI-related stocks have registered 76% of the S&P 500’s return, 87% of earnings growth, and 90% of Capex growth. The returns in the US, upon which much of our super returns rely is reliant on the ‘magnificent 7’, and most specifically Nvidia, continuing their growth driven by AI. Shakey ground indeed for the future prospect of returns when we are increasingly reliant on a superannuation system heavily invested in the S&P to fund retirement.
- We have an ossified political system. It is however, starting to break down, exemplified by the capturing of seats by ‘Teal’ candidates who removed the heart of the Liberal party over the last 2 elections, and the rise of the policy free bluster-ball that is One Nation. We need imagination and vision in the national parliament, and the courage to follow through. The outdated structures need to be at least renovated if not removed. We should start by limiting or even removing corporate donations to political parties. The alternative is a publicly funded system, open to citizens, and capable of receiving donations from citizens with a limit. The limit is to prevent rich individuals and businesses donating more than a concerned citizen on a median wage can afford. That might begin to earn the title of ‘Democracy’, and put a brake on the ability to influence policy choices by vested interests.
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This is not a complete list, but it touches most of what concerns me about the direction we are taking.
Header: My thanks to Hugh McLeod for once again, capturing a complex idea in a simple graphic.
