Document Sample
Risk_Capital_Markets_and_Policy_Longer_version Powered By Docstoc
					Risk, capital markets and the future:
a new generation of policy reform

A speech given at Catalyst 02: an Annual Congress of
the Property Council of Australia

Nicholas Gruen

Lateral Economics

1. Introduction: Australia as a leader in government and economic
It is an Australian cliché going back at least to Donald Horne‟s „Lucky Country‟
that we excel at sports but have failed to extend that excellence to other areas
of national life. Yet the list of things at which Australia excels keeps growing.
Despite the frustrations and compromises of government and politics in
Australia – the inevitable product of democracy – you may be surprised to find
that we are amongst the best in the world at Government.
Of course our politicians and our bureaucrats do all sorts of terrible things.
Really stupid, and really nasty things. But that‟s in the nature of the game.
They also do really good things. And like the add with Ian Thorpe and seals,
its not really fair to compare human beings and seals at swimming. Despite the
heroics of the ad with Ian Thorpe, the seals win every time! So the only
reasonable way to asses our performance at government is in comparison with
Individual policy programs have frequently been world leaders, studied and
emulated around the world.
   Higher Education Contribution charges (HECs)
   The enforcement of family maintenance orders through the tax office
   AIDS policy
Indeed, it would be hard to find any country that had managed to combine a
talent for policy with its passion for sport as successfully as Australia. As the
Commonwealth Games remind us when those things combine, extraordinary
things happen.
These examples are part of a larger picture. Two Australian institutions at the
apex of their respective areas of government, would be recognised by their
peers as amongst the best in the world:
   the Reserve Bank of Australia and
   the High Court.
Then there is a list of major areas of policy in which the successes of the last
two decades make us world leaders. Because they are human institutions they
are the product of constant compromise and complaint by various groups with
different interests and perspectives. But the compromises we‟ve made appear
to have worked better than the compromises made in comparable countries.
Such policy areas would include:

   Micro-economic reform generally, though the federal system has created
    important obstacles. It is hard to find countries that have done better than
        Note that others have done it more unfairly (eg the US with huge tax
         cuts to the rich) whilst others did it too ambitiously, and their political
         institutions turned from driving reform to resisting it (New Zealand).
        The CEO of New Zealand's Business Roundtable, Roger Kerr who I
         think had previously been in Roger Douglas‟ „shock therapy‟ cheer
         squad, recently suggested that Australia's reform program had had a
         “remarkably consistent, coherent and credible strategy of economic
         reform over the last two decades”. The relative fairness of the process
         may have something to do with this – in contrast to the „stop-start‟
         reform that Kerr argues characterised New Zealand's reform during the
         same period.1
   A critical part of the fairness of our own reform has been our uniquely
    targeted and means tested social security system. It has a unique blend of
    low US style cost and wide European coverage and security for
    beneficiaries. As a senior World Bank Official put it in 1998
                The Australian social security system . . . is one of the most cost
                effective in the OECD in terms of net expenditures as part of
                GDP; it has also . . . one of the most comprehensive coverages.
                Cost effective comprehensive coverage is a magic element in
                what we‟re looking for. . . . It also probably benefits the poorer
                parts of the population more than most other systems.2
   For much of the last two decades reforms actually worked actively against
    the increasing inequities being thrown up by the market. In other countries
    like the United States, important policy decisions intensified inequality. By
    contrast, Australian tax and transfer policy meant that between 1982 and
    1997 the real income of the poorest 10% of households grew by over 30% -
    the highest real percentage increase of any group of households.

1Roger Kerr, “Be More Like Australia”, Executive Director New Zealand business roundtable
25 July 2002.
2  Qaiser Khan, Senior World Bank official, ABC Background Briefing, 11/10/1998, at

Figure One: Real dollar and per cent changes in equivalent family income 1982–97

Figure Two: Weekly re-distributions through the tax and transfer systems ($ real, 1982-97)

    We have one of the most fiscally responsible political systems in the world
     – with one of the best fiscal performances.

Figure Three: General government net financial liabilities

                                          Norw ay



                                          Sw eden



                                      New Zealand


                                    United Kingdom



                                      United States





                                         Euro area




    -150%        -100%          -50%             0%          50%   100%        150%

Source: OECD

More generally our political system is one of the best mixtures of separation of
powers and scrutiny of the executive, together with substantial power of review.
   We have a bi-cameral system but one in which (with one spectacular
    exception) the Upper House has generally reviewed and moderated
    legislation rather than obstructed government. (This may change
    depending on the fate of the Democrats.)
   Our system makes use of proportional representation only in the Upper
    House. So long as it retains its status as a house of review, this seems
    manageable – and superior to the legislative gridlock and weak government
    that emerges from the endless coalition building in many European
    Parliaments and the US Congress.
   Yet although single member electorates ensure major party dominance,
    there is a constructive role for minor parties in our system. Our preferential

    voting system avoids the unfairness of first past the post voting and allows
    minor parties to play more than a „spoiling‟ role.
As a result of our many successes, after long and steady decline from the early
20th century, our productivity and output per capita, and so our living standards
have been steadily rising both absolutely and compared with other nations.

Figure Four: Labour productivity in the business sector 1992-2003 (forecast)

      New Zealand
          Euro area
       Total OECD
   United Kingdom
     United States

                        0%   1%      2%      3%       4%      5%

Source: OECD
Of course acknowledging our excellence creates the risk of complacency. On
the other hand it should give us more confidence. But more importantly it
highlights the fact that, if we are to stay ahead we need to throw off two
ingrained national characteristics. Those are our pessimism – our assumption
that we‟re really not much good, that government in Australia is pretty mediocre
and self serving. I recall several taxi ride conversations I've had recently in
which the taxi driver said to me that it was “no wonder Australia was doing so
badly economically”. It was a real conversation stopper when I informed him

that actually Australia had one of the healthiest economies of all the developed
world. The figures must have been cooked.
Something related to this is a derivative kind of cultural conservatism. We don‟t
really have confidence that something home grown might be the best, or often,
even the best for us.
Yet quite obviously, Australian policy cannot stay at „best practice‟ without the
confidence to innovate as we have done in the past.

Diminishing returns to the existing agenda of economic reform

One symptom of where we are is that a lot of the „low hanging fruit‟ in the
reform program we are on has already been picked. Having recommended
zero tariffs two years ago, the Productivity Commission has reversed course
arguing for automotive tariffs to remain at or above 10% for another eight years.
Its arguments are fairly confused. But the fact is, except for absorbing our
energies in fighting over symbols, it doesn't really matter much. As the
Commission rightly points out, the economic gains associated with further tariff
reductions will produce “very small gains” – and that‟s before you count some of
the losses.
The GST too will be a government cash cow for decades into the future, but as
respected economic modellers like Chris Murphy and Peter Dixon pointed out
before its implementation, the actual economic efficiencies from the broader tax
base are painfully slight. Against these gains has to be set the government
administrative and private compliance costs both to establish the regime and
then to run it over time. Its hard to argue that it‟s a more efficient system when
virtually every invoice has to be „double handled‟ even for a few seconds, to
separately account for purchase prices net of GST and the GST. How sad that
we didn‟t expend the political capital on more clearly advantageous tax reform –
like congestion taxes and road pricing for instance.

2. Managing risk: a new field of reform
I think there are many new frontiers where we could be making major gains with
further reform. They will usually require more imagination from reformers,
politicians and business to be seen and then seized as opportunities. We need
to be looking at new ventures, rather than just going over old ground.
I want to concentrate on some areas that are of considerable importance for the
property sector. They relate particularly to the efficiency of capital markets and
to the way we handle risk in our economy.

In a political sense, trade and risk management occupy similar territory. They
are abstract things that go on within an economy unlike manufacturing or
agriculture for instance – and so they are often poorly understood. When we
shine the light of economic analysis on them, we find that there are
arrangements which have built up which seemed to make sense, but which can
be greatly improved with a new approach.

The debt equity premium

Fundamental to the observations I want to make are some enduring
characteristics of the capital market. One is the so-called debt equity premium.
Equity earns returns around 12% or higher in some sectors like banking where
it is over 15%. By contrast, returns from lending money are much lower –
around 5% lower according to some measures. The gap between the two kinds
of finance reflects its risk. Generally speaking equity is riskier than debt.
When one thinks about risk, diversification is a time honoured and incredibly
powerful tool. One can diversify to protect oneself from most specific risks –
such as risk to a specific project or a specific sector. And if one could diversify
away all risks, one would expect the cost of debt and equity to pretty much line
up with each other. Individual equity investments might be riskier than debt, but
in a portfolio of equity investments star performers can help pay for losers.
However one risk that can only be handled very partially, is the „systematic risk‟
of a recession. In a recession almost all holders of equity are exposed to loss
(though this does also depress lending returns as more borrowers default). All
this underscores the value of economic stability. If our economy becomes
more stable, risks fall and the cost of equity will fall – that is share prices will
rise. And as the cost of equity falls, so hurdle rates fall and investment rises.
Our economy has become more stable and more supple due to the reforms we
have pursued. Our success is also due in no small part to the so far excellent
judgement the Australian Reserve Bank has exercised – crucially superior and
less influenced by the herd for instance than its New Zealand counterpart
during the Asian meltdown a few years ago.
But there are more things we could do to moderate the economic cycle and so
over time drive down the cost of equity.

3. The BCA agenda for macro-economic reform
In 1999 the Business Council released a provocative discussion paper as part
of its „New Directions‟ initiative. The discussion paper explored ways of

broadening the base of policy instruments we have at our disposal to moderate
economic fluctuations.

Increasing the share of pay ‘at risk’

The BCA's discussion paper pointed out that we could build more automatic
stabilisers into our economy by sharing risk just a little more with our workforce.
The wage share of the economy is so much larger than the profit share that one
does not need to share risk very much to have a strongly stabilising effect on
profits and – perhaps more importantly, on employment and on the macro-
economy more generally.
In countries which make relatively little use of bonuses, volatility in economic
output maps fairly directly into volatility in the labour market – firms make
quantity adjustments by hiring and firing workers.

           Figure Five: Annual % change in unemployment rate and rate of GDP growth

Source:   OECD, Main Economic Indicators
           In the Asian economies such as Taiwan and Japan, output volatility translates
           into far less volatility in the labour market. In effect there is a price, rather than a
           volume adjustment.

           Figure Six: Annual % change in unemployment rate and rate of GDP growth

Source: OECD, Main Economic Indicators and Taiwan Statistical Data Book, Council for Economic
Planning and Development, Republic of China.

           Refashioning Fiscal Policy in the image of Monetary Policy

           As I indicated earlier, we‟ve been more successful than most other countries in
           turning away from fiscal laxity. But it has become fairly clear that current
           political arrangements make it virtually impossible to sustain large surpluses
           during booms. The point of building large surpluses during these times of
           course is to increase public savings and to „load the fiscal cannon‟ so that it can
           be fired – so that we can run substantial deficits – to moderate future
           In Australia as in many other countries like the United States and New Zealand,
           politicians who follow a previous government that has run up large surpluses
           are invariably tempted to spend it. In Australia the last politician to run large
           surpluses for a sustained period was Jeff Kennett. He was bundled out of office
           by an Opposition which was then able to spend a large portion of the surplus on
           its own projects at the same time as staying in the black to demonstrate its own
           fiscal respectability.
           The Bush administration in the United States has made a vigorous return to
           fiscal profligacy after the long haul back from the Reagan years. The other
           problem with fiscal policy has been that it usually takes too long to alter in the
           face of changing economic circumstances as budgets are debated and
           negotiated through Parliaments.
           We have largely ironed out these problems in the area of monetary policy as
           the Reserve Bank targets inflation through the cycle, is insulated to a

substantial degree from day to day politics, and at the same time can act swiftly
if necessary.
The Business Council paper suggested a mechanism whereby fiscal policy
could be literally remoulded in the image of monetary policy. A central agency
independent of government could have a role in setting a general parameters
that would affect income taxes by a very small amount. If it was felt that fiscal
policy needed to be tighter for either long or short-term reasons, the parameter
might be moved from 1.00 to 1.01. This would increase income tax rates by
1%. Fiscal policy could be eased by reducing the parameter to .99. The
indicative table below makes an assumption that simplifies for the sake of
illustration that tax rates are 30% above a threshold. Below the threshold tax
rates are zero.

Figure Seven: The Fiscal Parameter

                    Tax Rate on   Tax Rate on                            Change in
   Parameter                                   Company Tax
                   Income below Income above                             Revenue
     Value                                       Rate (%)
                   Threshold (%) Threshold (%)                            (approx)
      0.97               0               29.1              29.1            -$3 bn
      0.98               0               29.4              29.4            -$2 bn
      0.99               0               29.7              29.7            -$1 bn
        1                0                30                30                0
      1.01               0               30.3              30.3            +$1 bn
      1.02               0               30.6              30.6            +$2 bn
      1.03               0               30.9              30.9            +$3 bn

Moving the fiscal parameter would target the fiscal stance – in the way that the
cash rate allows the targeting of monetary conditions. At the same time it
would leave all the political decision-making about who gets taxed and how
much and how the money is spent where it belongs – with the politicians.
The mechanism would operate in close consultation with the government of the
day as does monetary policy today. And it would also operate „in the
background‟ as a kind of prudential architecture and pressure would be brought
to bear on governments only if they were going beyond the bounds of
prudence. This means that the government would have the discretion to
manage a fiscal expansion or fiscal contraction in its own way rather than using
the parameter. But there would be an institution at arm‟s length from
government charged with the task of safeguarding fiscal integrity and flexibility
should it be necessary.

Superannuation and macro-economic management

Superannuation – about which I will have more to say shortly – also offers a
potentially potent weapon for helping to stabilise the economy. Something
similar to what is proposed for fiscal policy could be done by with variations in
compulsory contributions to superannuation. Indeed, this has been done on
occasion in Singapore. For an economy still in need of additional savings,
increases in compulsory contributions would often make sense when we are
trying to restrain demand in a boom.

4. Beyond the BCA macro-economic reform agenda
If one thinks about the BCA agenda, even though it was not necessarily
expressed this way, all of the ideas seek to improve the way the economy as a
system manages risk.
The logic for pursuing them is similar to the logic of tax reform. You will recall
the slogan “broaden the base – lower the rate”. The BCA agenda for macro-
economic reform involved broadening the base over which risks are shared in
the economy. By doing so they would lower the rate of volatility for certain
parts of the system that would otherwise by overloaded. And some risks would
be traded for other more benign ones. Thus workers might face a small
increase in the variability of their income, yet for that they would have
purchased higher real wages over time and less volatility in employment itself.
They‟d be less likely to be laid off. This illustrates one of the critical things
about risk. One usually can‟t avoid it – it‟s usually a question of how it‟s
managed and who bears it. It‟s better to make decisions on risk management
by design, rather than by default.
Once we identify this issue of how the economy as a system manages risk it
opens up plenty of other avenues of inquiry and opportunities for reform. I will
go through just some of those opportunities below.
Some of the easy „deregulatory‟ work is already done. Capital and goods
market liberalisation has hugely improved risk management in the Australian
economy, both in terms of the sophistication of systems in the market, but
probably more importantly in terms of the massive increase in the depth of the
But this reform has left one critical issue largely unconsidered. The
deregulatory phase of reform has seen government retreat to its core functions
steadily pushing risks back onto the private sector. This is generally one of the
advantages of privatisation, as it helps push risks back to that place in the
market that can best mitigate them. Qantas shareholders now bear the

demand risk when Qantas buys new planes – not government. Qantas is also
able to make sophisticated arrangements with other market players to manage
those risks.
But we should not forget that though it is often not the right bearer of
commercial risk, government – with its immense size, credibility in capital
markets and its taxing power – is an excellent, least cost bearer of some kinds
of risk.
As we have privatised state owned enterprises and property, government has
been simply buying back its debt, rather than rebalancing them as a private
wealth manager would do based on an appreciation of its risk preferences.
Yet the issue of asset allocation is surely a separate issue from the one of
whether government should run enterprises. So if it makes sense to sell the
Commonwealth Bank and Qantas as I believe it did, if it makes sense to sell off
Commonwealth office blocks (which I‟m not sure it does) it does not necessarily
follow that the funds released from that transaction should simply retire debt.
Apart from anything else this represents a sale of high yielding assets to fund
the purchase of lower yielding assets.
If a well run private firm were to sell some of its businesses it would consider its
appetite for risk (or rather the appetite of its owners – and prospective owners –
in the market) and then seek an asset allocation that maximised its risk-
adjusted return. If that meant retiring debt – well and good. But it is more likely
to mean a more complex rebalancing of asset holdings. Currently government
asset allocation is largely by default. Government spends the revenue it raises
and borrows – or lends – the rest.
Government is too large, too important, and has too unique a role in the
economy for it to handle its asset allocation by default. The Government has
the health of the entire economy to consider, rather than simple returns to itself.
But it should have an active asset allocation strategy that considers its role in
handling the many risks that must be managed by the economic system.
If all this sounds fanciful or perhaps overly theoretical, these issues are actually
pressing on government‟s attention right now. The funds due on further sale of
Telstra raises the spectre of the Commonwealth moving from being a net
debtor to being a net creditor in the not so distant future. And the existence of
a market in Australian government debt has clear utility in generating
information and liquidity for Australian money markets.
In my view, providing it is properly balanced, and specific investment decisions
occur at arm‟s length from Government (probably in the private funds
management market), we can all benefit from governments investing in

equities. This will make its own contribution to raising equity prices closer to
their true value, reducing the debt equity premium.
Further it would make sense for government to manage the investment in a
broadly „contrarian‟ way – holding more equities when they are relatively cheap,
with less exposure when equity prices are higher. This would generate several
benefits. Firstly broad contrarianism is a reliable way to make good returns
over time. Secondly contrarian investment would be stabilising investment – at
the same time as making money over time, government contrarianism would
help reduce their volatility. This would improve their efficiency and also operate
counter-cyclically – moderating the economic cycle.
A possible institutional framework for such an approach would be a body – such
as the Reserve Bank taking responsibility for macro-economic stability and
maximising economically sustainable growth. It would play the lead role in
managing interest rates, fiscal policy and asset allocation, with private
managers competing for funds management contracts and managing stock
Again, you may think all this is fanciful, but there are already precedents. This
is pretty much what we do now in the foreign exchange market with the
Reserve Bank intervening with the objective of reducing both short and longer
term volatility and as a result adopting a broadly contrarian strategy. It has
bought low and sold high. The result has been out of Milton Friedman‟s
textbook for beneficial speculation – reducing market volatility at the same time
as making money. This is the diagram RBA researchers used to illustrate the
ideal behind the strategy.

Figure Eight: Stabilising, contrarian investment

Source: “Reserve Bank Operations in The Foreign Exchange Market: Effectiveness and
Profitability”, Andrew, R and Broadbent, J, Research Discussion Paper 9406, November 1994,
Reserve Bank of Australia, p. 5
Of course the government agency will not always be a winner. We know the
Treasury has not been successful recently, though any such speculation should
occur at further distance from government than a government department. I
expect the sustained fall in the Australian dollar has also tested the Reserve
Bank‟s contrarian prowess. But over time I expect it will continue to beat the
market. And even if a government holding of higher yield assets did not beat
the market it would enjoy a higher return at an acceptable level of risk.
Instead of managing our asset allocation by default we should manage it
according to the following principles. We should:
   increase government net worth through the cycle and beyond; and
   manage government assets so as to improve economic efficiency and
    growth and contribute to an optimal management of risk by the economic


Finally, one agenda in micro-economic reform which has largely stalled is the
issue of general regulatory reform. We have made great strides in de-
regulation – the sweeping away of regulation that should not exist. Much of this
regulation was in the finance sector.
But with most regulation simply sweeping it away is not sensible, and is not a
political option in a democracy, even if were desirable. We‟ve known what
regulation should ideally look like since at least the 1960s when the Robins
report in the United Kingdom pointed out that regulations requiring a
mechanical guard on a machine saw actively prevented better ways of ensuring
the safety of workers – such as a light beam circuit.
We need what are called „output based‟ regulation. Yet its amazing how much
financial regulation is not „output based‟. Classic examples of relevance to the
property industry are the widespread use of prohibition on various financial
transactions – rather than the use of „health warnings‟ for consumers. Thus
foreign loans are all but prohibited, where it would surely meet the regulatory
objective to ensure that anyone taking one our was clearly advised of the scope
for risk and adverse outcomes.
If the prohibition on retail lending in foreign currencies sounds fairly small beer,
ask a pensioner how easy it is to get a home loan to unwind the equity in their
house to spend in their declining years. The Uniform Credit Code makes it
heavy weather indeed. Major lenders have given it up as too much trouble.
These restrictions may sound fairly modest, and fairly reasonable. But their
significance adds up. Take the arbitrary prudential rules for safeguarding the
funds – soon to exceed Australia's GDP – in superannuation. In general,
superannuation funds are not permitted to borrow or to invest in derivatives.
Of course they should not be permitted to do either of these things imprudently,
but derivatives are a risk management tool. It is ridiculous that we impose huge
restrictions on using them – as they were by BT before the 1987 crash – to
reduce portfolio risk. And as I expect all the delegates here know only too well,
well managed debt exposure is central to building wealth efficiently and
prudently. Indeed, it will often enable a competent fund manager to achieve a
lower risk for high yielding portfolios, because it can be used to increase the
asset diversification from equities into property thus increasing asset
diversification without sacrificing yield.
And – especially at a time when compulsory contributions to superannuation
are still inadequate to fund retirement – it is also silly to prevent superannuation
funds making prudent use of debt. Take the example of a 20 year old who

expects to have at least 25 years of contributions before retirement. Are we
really serious that preventing her super fund from accessing some gearing in
her super especially early in her working life is in her interest – or the
community interest more generally.
To provide you with an example we abstracted from tax and took a 20 year old
professional contributing $5,000 per year to her superannuation for 25 years
with returns at 10% with interest at 6%. The base case generated a fund of
$489,000 when she reached 55. If she were to have geared her commencing
portfolio at 60% in the first five years, 50% in the next five years falling by 10%
each five year period, she would end up with a fund of $703,000. If interest
rates were 1% higher, the geared fund would still be $150,000 more.

Figure Nine: Superannuation with and without gearing
   $23,419      Y   50%      $17,349   $17,349   -$1,128        $4,973      $2,689    $25,011         $1,592
   $30,968      Y   50%      $25,011   $25,011   -$1,626        $4,973      $3,877    $33,860         $2,892
   $39,347      Y   40%      $33,860   $22,573   -$1,467        $4,973      $4,740    $43,573         $4,226
   $30,548      Y   40%      $43,573   $29,049   -$1,888        $4,973    -$27,306    $21,240        -$9,308
   $38,881      Y   40%      $21,240   $14,160     -$920        $4,973      $2,974    $29,186        -$9,695
   $48,130      Y   40%      $29,186   $19,457   -$1,265        $4,973      $4,086    $38,244        -$9,886
   $58,397      Y   40%      $38,244   $25,496   -$1,657        $4,973      $5,354    $48,571        -$9,826
   $69,793      N   30%      $48,571   $20,816   -$1,353        $4,973      $6,280    $59,823        -$9,970
   $82,443      N   30%      $59,823   $25,638   -$1,666        $4,973      $7,734    $72,530        -$9,913
   $96,484      N   30%      $72,530   $31,084   -$2,020        $4,973      $9,377    $86,879        -$9,605
  $112,070      N   30%      $86,879   $37,234   -$2,420        $4,973     $11,232   $103,084        -$8,985
  $129,370      N   30%     $103,084   $44,179   -$2,872        $4,973     $13,327   $121,384        -$7,986
  $148,573      N   20%     $121,384   $30,346   -$1,972        $4,973     $14,718   $141,074        -$7,499
  $169,888      N   20%     $141,074   $35,269   -$2,292        $4,973     $17,105   $163,152        -$6,736
  $193,549      N   20%     $163,152   $40,788   -$2,651        $4,973     $19,782   $187,907        -$5,642
  $219,811      N   20%     $187,907   $46,977   -$3,053        $4,973     $22,784   $215,663        -$4,149
  $248,963      N   20%     $215,663   $53,916   -$3,505        $4,973     $26,149   $246,784        -$2,179
  $281,322      N   10%     $246,784   $27,420   -$1,782        $4,973     $28,380   $280,137        -$1,185
  $317,240      N   10%     $280,137   $31,126   -$2,023        $4,973     $32,216   $317,325            $86
  $357,108      N   10%     $317,325   $35,258   -$2,292        $4,973     $36,492   $358,790         $1,682
  $401,363      N   10%     $358,790   $39,866   -$2,591        $4,973     $41,261   $405,024         $3,661
  $450,485      N   10%     $405,024   $45,003   -$2,925        $4,973     $46,578   $456,574         $6,089

$800,000                    $734,189
$700,000                  568920.171
$500,000                                                   $456,000
$200,000                                                     $450,000















                                  Ungeared Fund                       Geared Fund

If things went wrong and her fund crashed by 25% in the very first year without
any „bounceback‟ or increase in return for the next 24 years, she would take
just five years to overtake the non-geared fund from her disastrous start. She

would end up with a fund of $634,000 compared with $473,000 in the non-
geared case – around $150,000 ahead.
Simple rules like „no debt or derivatives‟ might make sense for self managed
funds for instance, but for funds managing billions of funds with elaborate
trustee and audit safeguards, such a simple rule is hugely wasteful and
inefficient. The appropriate regulation should be like some of the more
advanced occupational health and safety regimes where virtually everything is
allowed where it is done within the context of a well documented measurable
and auditable safety plan. Anyone who can demonstrate that kind of system
should be allowed to access a more sophisticated kind of regulation.

‘Minimum Effective Regulation’

Over fifteen years ago the Commonwealth Government committed itself to
„minimum effective regulation‟. Apart from the various mostly sensible ways in
which we‟ve deregulated, we have not gone far down the track of embracing
output based regulation. This is another area in which large gains could be
made and the property and financial markets could become more prosperous
and more competitive, leading to greater economic prosperity and security for
all Australians.
Unfortunately although Oppositions from time to time promise to „cut red tape‟
our political system – like everyone else‟s political system – does not hand out
rewards for the kind of high quality processes which are necessary to effective
regulation. The various regulation review mechanisms impose apparent
scrutiny but are not taken seriously within government – or it has to be said – by
Business should have a right to require regulators to declare the objectives of
their regulation, and a further right to meet those objectives in ways other than
those contemplated in the regulation – provided their compliance with the
objective is measurable and auditable. The gains from doing something like
this would be huge – as the example of superannuation I have given you

5. Conclusion
Finally what would the world I have pictured look like. Some of the burden of
aging would be lifted from Government as it would be earning higher returns as
a result of sharing more risk in the economy. Over time it this would make a
substantial difference.
Equity prices would be higher and so hurdle rates for projects would fall. In the
long run, a fall in the price of equity driven partly by an increase in

indebtedness, could be expected to increase interest rates and returns to debt.
In fact it might not end up that way. With rising stock prices, increasing
investment and lower levels of volatility we would very likely become a more
attractive place to invest.%%
Of course nothing in what is here proposed is a panacea. It won‟t end the
cycle, or prevent all recessions. It won‟t abolish risk for anyone, though it will
improve the way it is managed and shared within our economic system. It
won‟t change the fact that hard work and prudent financial management is the
foundation of prosperity as it always has been. But it would ensure that as well
as working hard, we worked a little smarter, and got a little richer, and a little
further out in front as we continued to set the benchmark in worlds best policy