Published by Australian Financial Review, Monday 27 February
The huge five-year fall in mining investment in Australia may be drawing to a close, but non-mining business investment remains close to 50 year-lows, as a share of GDP. Why is non-mining investment low, does it mean Australia risks falling into the stagnation that afflicts much of the rich world, and what should our governments and policymakers do about it?
First, let’s keep some perspective about the figures. Non-mining business investment is indeed lower than many expected. But some of this is actually a good thing: a shift to a services economy, and a decline in the prices of capital goods, means that Australian businesses can still thrive with lower levels of investment.
Nonetheless, investment is too low, and the reason is worrying: it’s because the demand isn’t there. Non-mining output growth has been slow, so firms have less reason to invest.
There are bright spots: NSW and Victoria are doing well, and investment has started to pick up. But Western Australia and Queensland are still very weak. Regional diversity makes the Reserve Bank of Australia’s job tough: a lower interest rate would provide useful stimulus to the mining states, but it would encourage risky lending elsewhere. The RBA will be able to keep interest rates lower if APRA (the prudential regulator) further tightens the lid on higher-risk lending.
So what can policymakers do to encourage investment and growth?
As Ken Henry said in his excoriating speech at CEDA last week, reforms now need to strengthen, not weaken the budget.
Malcolm Turnbull’s big policy idea – the “$50 billion” cut to company tax – fails this basic test. (In reality, it would cost more like $7 billion a year if implemented in full today, and that cost would fall a bit as investment rose.)
Company tax does deter investment, and cutting it as the Prime Minister proposes will add about half a percentage point to investment as a share of GDP over the long run. But a tax cut would probably cut national income for several years, because the cuts largely go to foreign investors, and it takes time for them to invest more.
What about other tax breaks for investment? Both the Turnbull government and the Shorten opposition are advocating tax breaks for small business. They are wrong. It is disappointing that our major political parties appear not to understand that there is little economic rationale for different tax rates for different-sized businesses.
An investment allowance – essentially a subsidy for investment – could be cheaper, though firms may try to game them, re-badging operating costs as capital expenditure. Alternative company tax models such as accelerated depreciation or a cash flow tax can make investment more attractive, but they would cost the budget even more in the early years.
Pro-growth policies needed
Committing to a company tax cut – or other tax changes to stimulate investment – before the budget is on a clear path to recovery is unwise. The government should craft a more comprehensive tax package rather than hoping income tax will rise to fill the gap.
And in the meantime, policy makers should look at a range of other pro-growth policies that would encourage firms to invest. No single policy is a silver bullet, but together they can make a difference.
For example, removing barriers to labour participation, and encouraging competition would boost output and private investment. A stable climate-change policy would remove a big barrier to energy investment.
The states must play their part, too. Shifting the state tax base from stamp duties to land taxes, state governments should build more infrastructure, but only if they can shake their habit of building the wrong projects. In any event, headline-grabbing major projects are the wrong tool to fine-tune demand, because they take years to hit the ground. Instead, governments could spend more on neglected and decidedly unsexy maintenance of infrastructure.
The Grattan Institute’s new report, “Stagnation Nation?“, concludes that investment in Australia is unlikely to return to the boom years of the 2000s. Lower growth may well be the “new normal”, and investment is likely to remain below previous peaks. But that is no reason for policy complacency: sensible policy can help support investment and the national prosperity it underpins.