Flat White

EXCLUSIVE: The men who really saved Australia from the GFC

8 April 2019

7:03 AM

8 April 2019

7:03 AM

Often in Australian political life, individuals that make profound contributions to public policy go unnoticed while those more conspicuous have no reserve and ensure their contributions are widely acclaimed. It’s not surprising then that the story of how a handful of individuals forestalled a recession in the twelfth largest economy in the world has up until this point remained unknown and its success unattributed.

Unlike a lot of politics, the claim is no mere puffery, having been confirmed by staff at the Reserve Bank of Australia. A great debt is owed to a small number of individuals who served their country admirably in a time of economic crisis. That we as a nation were never apprised of their contribution is an indictment on our civic culture and the deficiencies that characterise business sector advocacy and the conservative movement.

By late 2008, after the failure of Lehman Brothers, confidence in the financial system and the economy had tanked. Measures of financial, business and consumer sentiment were cratering and officials were warning that a recession was underway in the major advanced economies. The Reserve Bank eased monetary policy decisively in response to the shock, slashing rates by 300 basis points between August and December of 2008. Rates would be cut by another 100 basis points by February 2009 as the economic outlook continued to deteriorate.

Towards the end of November, the then chief economist of the Australian Chamber of Commerce, Greg Evans, met with the former deputy secretary of the Commonwealth Treasury, Des Moore, at ACCI’s offices in Canberra. It was a period of significant economic fragility and the pair discussed a variety of policy options to cushion against the full force of the unfolding global financial crisis. The Rudd government had responded quickly to assist the household sector, but they remained concerned business investment would nosedive, dramatically worsening the economic outlook.

Conversation focused on how to avert a severe downturn in capital spending and the possible guidance offered by policy responses in previous downturns. The discussion included the option of a tax incentive such as the investment allowance mechanism the Fraser government had implemented in the late nineteen-seventies.

The Fraser government’s investment allowance was introduced at 40 per cent for new plant and equipment expenditure incurred from the start of 1976 to mid-1978. After that point in time, it was phased down to a rate of 20 per cent until mid-1983. Firms that invested within the initial eighteen-month window would receive an instant additional 40 per cent write-off of their total depreciation on the asset purchased.

Labor opposed Fraser’s investment allowance. In the early days of the measure, opposition to the policy was led by Paul Keating and Peter Walsh. Walsh claimed, without evidence, that investment would be unaffected by the policy, characterizing the measure as “a massive taxpayer-provided subsidy for business investment” and one that was “extremely costly”.

In a sign of how quaint economic conversations of the era could be, Walsh expressed concern the policy could cause machines to replace workers, citing the potential for investment in “very large tractors” (“usually imported” naturally) which would “displace labour from agriculture” and “inevitably accelerate the drift in population from agricultural areas to the city”. So much for capital and labour being complements in production that deliver substantial gains in productivity.

Walsh also flagged demand-side weakness in the economy and the liquidity constraints facing businesses as potential obstacles to the success of the policy. More credibly, he warned that the eighteen-month window for the 40 per cent allowance, followed by an extended phase-down to 20 per cent were both too long and would undermine the incentive effect of the scheme.

Even as Paul Keating stood in the lower house claiming that the “investment allowance has had no effect whatsoever”, capital expenditure in plant and equipment was surging. The national accounts for the December quarter 1976, released shortly after his remarks in late 1976, show growth in new machinery and investment over the year eclipsing 20 per cent. Labor figures at the time would continue to repeat these talking points for years in parliament without an attempt at substantiation.

Evans knew that then prime minister Kevin Rudd would be responsive to proposals devised by business for business and promptly contacted his senior economic advisor, Andrew Charlton, to discuss how to ensure investment did not deteriorate as a consequence of collapsing confidence and tightening credit conditions.

Evans indicated to Charlton that a targeted investment allowance would be extremely useful in arresting a drop off in capital expenditure, assisting both small- and medium-sized firms as well as larger businesses. Charlton quickly recognised the policy rationale and its potential effectiveness and indicated he would pursue it with the PM. ACCI then provided Charlton with a detailed policy proposal with key design features.

The government moved quickly in response and, despite push back from Treasury, Charlton relayed to Evans that Rudd was fully supportive of the policy and the government would proceed with an announcement.

Immediate past president of ACCI, Peter O’Brien, was also enlisted to make the case for the investment allowance and was able to reinforce its importance to the Prime Minister through his relationship with senior bureaucrats within the Department of Prime Minister and Cabinet. The memory of the original investment allowance was fixed in O’Brien’s mind, he had used the measure to build the largest cold store in Melbourne back in the seventies.

On 12 December, Rudd announced the business investment allowance for plant and equipment as part of the government’s first stimulus response to the downturn. The initial 10 per cent investment allowance was lower than requested but additional lobbying by the Chamber and a further deterioration in the economic outlook in early 2009, saw the measure extended to 30 per cent in the second round of stimulus. The investment allowance was extended to 50 per cent for small business in the 2008-09 Budget.

It has since been appreciated, if not widely known, that the investment allowance was a highly effective stimulus measure. Only more recently, following a comprehensive empirical study of the policy, has the crucial nature of the investment allowance been fully revealed. In June of 2018, the Reserve Bank of Australia released a research paper examining the effectiveness of the investment allowance and its impact at the macroeconomic level. The conclusions of that study were clear. The investment allowance had saved the economy from recession.

The Reserve Bank research paper concluded that the investment allowance had a strong effect on plant and equipment investment and that given the “estimates of the size of the tax break’s effects on aggregate investment and GDP, it should be considered an important part of Australia’s macroeconomic history”.

The researchers estimated that without the investment tax break, real private equipment investment in 2009 would have been 29 per cent lower and that real GDP would have declined in the March and June quarters of 2009. Instead of a short, sharp downturn that led GDP to contract in the December quarter 2008, Australia would have suffered a protracted economic downturn. The finding that the economy would have experienced a recession but for the impact of the investment, allowance highlights its vital importance as a response to the global financial crisis.

The Reserve Bank economists found that investment was highly responsive to the tax break. A 10 percentage point increase in the investment allowance was estimated to raise investment by around 33 per cent. There was no evidence that activity was simply brought forward from future periods either, with investment in future periods unchanged as a result of the measure.

Before the Reserve Bank paper, there had been no serious empirical examination of the impact of the investment allowance. Ultimately it delivered $15 billion in additional deductions for business, in addition to staving off recession. The stimulus partially owed its success to leaving the choice to business where to make an investment, which led to more rational decision making.

Shortly after the release of the paper, shadow Treasurer Chris Bowen was quick off the mark to claim full credit for the investment allowance on behalf of the Labor Party. Significant plaudits are certainly due to Rudd and Charlton for having the good judgment to implement the investment allowance. However, the original proposal had its genesis with ACCI, and Evans and Moore in particular.

In part this speaks to the capacity of the left to generously push its own barrow politically but also the utter state of neglect when it comes to safeguarding the legacy of one of the Chamber’s major policy accomplishments during the era. A wholesale exodus of staff commenced with Evans leaving in 2013, followed by the departure of widely respected chief executive Peter Anderson in 2014. This left the organisation hollowed out in terms of policy expertise. Those staff took with them the knowledge of the role ACCI had played during the peak of the crisis.

Prime Minister Rudd in early 2009 publicly acknowledged the role of the Chamber. After announcing the increase in the tax break to 30 per cent, Rudd highlighted the part played by ACCI in formulating the initiative in Parliament in order to secure the support of the business community for the government’s stimulus package. Rudd openly declared that the investment allowance was “a measure originally conceived in close consultation with the Australian Chamber of Commerce and Industry”.

Later feedback from Rudd indicated that the government had implemented the tax incentive in the teeth of opposition from the Treasury Department. It’s not clear on what basis Treasury would have sought to oppose the investment allowance, there’s no indication that they have ever seriously examined the impacts of similar stimulus measures. In all likelihood, absent any direct evidence, Treasury just assumed that the measure would be ineffective and simply subsidise investment that was going to take place in any case. Greater clarity will come with the release of government documents under the Archive Act.

There’s a morbid irony that a key policy advising body like the Treasury was actively opposing a stimulus measure that would end up warding off recession, while at the same time as acting as a shield for a broader fiscal policy program that would prove wasteful and ill-timed. The modern incarnation of the Treasury increasingly presents as lazy and arrogant. This is just another instalment in a series of episodes that bring into question the capability of a key policy-making organ of government.

To the extent that trust is still placed in Treasury, or at least, to the extent its policy pronouncements are not second-guessed by experts, the department is a liability to good public policy. It is now widely acknowledged within the economics profession that it is necessary for political staffers to apply an acid test to Treasury advice in order to ensure that they are not led astray by poor quality in-house opinions. Nowhere has this been more glaringly the case than with respect to the investment allowance that ended up saving the economy from recession over Treasury opposition.

The Chamber’s advocacy during the height of the global financial crisis represents the epitome of business leadership. The investment allowance was a highly effective stimulus measure that is now recognised as having been instrumental in preventing the Australian economy from suffering a protracted recession. No less an authority than the Reserve Bank of Australia has provided the detailed analysis that brings to light the tax break’s historic importance. A debt of gratitude is owed by many to a handful of individuals who deftly and in a short space of time changed the course of the nation’s economic fortunes.

The silent policy triumph of Evans, Moore and O’Brien is both exemplary and salutary. The factor that matters most in the public life of a nation is leadership. The lesson is that if business leaders would refocus their advocacy intelligently, they could quite easily lead us out of more than a decade of policy drift.

Moral courage, a platform and a small amount of resources are all it took to shepherd the economy nimbly through the global financial crisis. That all three are now in such short supply for good public policy in the private sector points to much darker days ahead.

Burchell Wilson is a consulting economist with Freshwater Economics.

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