Nation-building policy now almost reality…

(Oct 16, 2015) After many years of saying that a development bank is impossible for Australia, the Federal government has backed China’s Infrastructure Investment Bank (AIIB) and now Labor’s leader, Bill Shorten, has announced plans to turn Infrastructure Australia into a development bank!

Question: So what should be the Coalition’s policy?

Answer: They should offer an even better development bank proposal.

More information…

This year the Federal government announced its support for China’s Asian Infrastructure Development Bank (AIIB) to fund major investment projects across the Asian region.

Now Bill Shorten has announced a policy to turn Infrastructure Australia into a development bank.

It would be financed with seed funding and direct public funding. It would operate on a commercial basis providing either loan guarantees, loans, or in some cases, take equity stakes in privately led projects (Sydney Morning Herald, October 8, 2015.)

This move in the right directions is likely to gain electoral support for Labor at a time when the Australian economy has stagnated after the commodities boom has subsided, and when the Coalition is languishing in Victoria and South Australia. These states are set to lose up to 50,000 jobs with the impending closure of the car industry.

The International Monetary Funds (IMF) says that part of the solution to a stagnating world economy – for a world where the supply of goods is not matched by demand – involves major public investment in infrastructure, which is lacking, or crumbling, in most advanced economies and emerging markets (with the exception of China). With long-term interest rates close to zero in most advanced economies (and in some cases even negative), the case for infrastructure spending is indeed compelling.

Australian economic commentator, Alan Kohler says: “The only antidote, and I do mean the only one, is public spending on infrastructure to improve human efficiency – mainly through better transport facilities.”

The IMF, Kohler and Summers proposals will increase public debt, if conventional infrastructure funding methods are used.

So, how can Australia boost infrastructure spending without running up huge state government debt?

The Bank of England is the oldest reserve bank in the world. Last year, it devoted two articles in its Quarterly Bulletin (2014, Q1) to explain with great clarity — and to sort out the confusion over — how reserve banks and commercial banks create money.

The Bank of England has declared that it is a myth that banks act simply as intermediaries between savers and borrowers. Neither do they “multiply up” central bank money to create new loans and deposits. Rather, the BoE says money is mainly created in two ways.

First, commercial banks create money by making loans to customers. These loans are expunged when borrowers repay their loans.

While commercial banks can create money as loans at will, central banks manage the overall amount of money in circulation. Reserve banks “manage up” the official interest rate to restrict lending, or “manage down” interest rates to expand commercial bank lending.

Secondly, in times of crisis such as the 2007/08 global financial crisis, reserve banks can undertake “quantitative easing”, i.e., using cash to buy government and corporate securities, thereby injecting spending into the economy.

The Bank of England’s model has important implications for how the Federal government could fund major infrastructure projects.

The government could create an Infrastructure Finance Corporation that could be authorised to create and lend money, just as commercial banks create loans for customers, under Reserve Bank supervision.

This would mean that Australia could fund infrastructure projects and create jobs without having to increase government debt or sell off more government assets.

If the Federal government can support China’s Asian Infrastructure Investment Bank, then it should consider creating a similar investment fund for Australian infrastructure.

Many other nations have set up successful, broad-based government-backed investment banks, such as Germany’s famous Kreditanstalt für Wiederaufbau (KfW), established in 1948 as part of the post-World War II Marshall Plan to rebuild the Federal Republic of Germany. By 2012, the KfW had a balance sheet of €494.8 billion.[i]

Banks like the KfW typically channel investment into major infrastructure projects and into domestic industries with long-term growth prospects that commercial banks would not necessarily fund.

Such banks help governments to separate government capital expenditure from recurrent expenditure, while filling a major gap in the financial markets. In turn, this allows a government to avoid debt and budget deficits, and to maintain a high credit-rating, thus enhancing the government’s borrowing capacity.In which case, the Turnbull government could be facing a backlash from the Australian electorate at the next federal election.