THE BASIC PRINCIPLE OF PLATFORM FUNDING - THE ECONOMICS OF JOBS AND GROWTH
Copyright © Nick Veltjens 2017
The measure of economic activity in a country is GDP, Gross Domestic Product, which is the current market value of finished goods and services it produces in a specific period. It is calculated like this:
GDP = C + G + I + NX
Where C represents the sum of all private consumption, i.e. consumer spending in a nation's economy, G is total government spending, I is the sum of all the country's investment including businesses capital expenditures which is sometimes referred to a finished production, and NX is the nation's total net exports calculated as total exports minus total imports (NX = Exports - Imports).
This is referred to as nominal GDP and is based on current values, while real GDP is adjusted for inflation or deflation; in other words it takes changes of market values into consideration.
Australia’s GDP growth trends around 3% p.a. and last year has shown an increase to 3.1%. Real GDP, however, was less than that, because the market value of mining products has dropped considerably. Nominal GDP can be misleading, as it does not show the underlying conditions such as unemployment and underemployment, and therefore does not measure the relationship between GDP and productivity per hour in the workforce.
In real GDP this becomes visible as these underlying trends are considered. For instance, if these conditions are taken into account, it will show an output gap that can be either positive as in the case of real growth, or negative, indicating a tendency towards depression or even recession. At present, Australia’s reducing real GDP of 1.0% should therefore be considered rather than rising nominal GDP of 3.1%, a downward trend of which the Australian Reserve Bank has repeatedly warned.
This means we are slowly going broke. We are spending more than we earn.
The reason for this, as it is throughout the West, is the fact that we have sent our jobs overseas by having production carried out in other countries, and sending more and more of the necessary raw material over there at ever reducing prices. As a result, jobs were lost and wages have stagnated, and the consequent increase in consumer borrowing causes the underlying national cash balance to become more and more negative.
To overcome this economic slide, underemployment and unemployment need to be reversed by encouraging businesses to resume production and to hire. To start with, the government must stimulate the economy and provide:
• a massive capital injection by commissioning major investments such as infrastructure projects;
• financing innovation;
• support start-up companies; and
• increase the amount of circulating cash to satisfy the resulting growth.
This should not necessarily create a serious debt burden to the government and will not generate any more inflation than what is needed to counteract deflation. Construction of residential projects will create employment during the building process, but there will be no more production resulting from these projects after they are completed. Major investment in public works, however, can be targeted towards construction that will provide employment even after their completion.
Railways and ports provide not only jobs for running the facility after completion, but will provide a service to industry for economically transporting products from the place of manufacture to the local and overseas markets. Thus, larger markets will create more production which will, with the benefit of size, improve productivity.
Such investments will close the negative output gap by creating more jobs, better productivity, and bringing back a positive cash balance, but will not substantially increase the government’s debt level.
Why would the government not suffer a significant increase in the debt level? Capital injection in major projects generate an economic multiplier effect, because workers and businesses will spend some of their income in the region, creating income for others, and they will then also spend. The multiplier effect can be calculated; it is related to the population’s Marginal Propensity to Consume (MPC), which is the proportion of income available to be spent within the region. With an average income of $55,000 p.a., the MPC is about 0.7. For most projects the multiplier effect is as follows:
Multiplier = 1 / (1 – MPC) = 1 / (1 - 0.7) = 1 / 0.3 = 3.3
The following analysis is based on a series of 7 infrastructure projects over 39 years:
• Frankston Station precinct: $1,000,000,000
• Rail Electrification to Somerville: $1,800,000,000
• Hastings Port Development: $1,250,000,000
• Hastings-Lyndhurst connectivity: $8,000,000,000
• International Airport: $17,000,000,000
• Monorail Berwick-Frankston: $2,000,000,000
• Monorail Hastings-Tullamarine Airport: $7,000,000,000
• TOTAL $39,000,000,000
Let us assume that the government spends $1 billion a year on such a series of infrastructure projects, the multiplier effect of 3.3 will create economic activity in the local region of 3.3 x $1 billion = $3.3 billion, which, with the usual delay, will filter through about a year later. Half of this activity would result in wages from 30,000 new jobs at say an average of $55,000 p.a. which amounts to $1.65 billion p.a. From this the government will receive income tax at around 20%, which amounts to $330 million p.a. and that is a return of 33% p.a. on the government’s initial capital injection of $1 billion. That is merely on the cost of development and construction, and does not include the future economic benefits generated by the use of the facilities after completion.
If these projects are funded by loans (bonds) negotiated each year for an annual expenditure of $1 billion, and all of the return of 33% p.a. is used to repay the loans each year for that capital, then each of the loaned amounts will be paid off in three years, and the total remaining net debt will never be more than a platform of $2 billion at any time after three years; that is why I call it “platform funding”.
This means, for instance, if a series of projects totalling $39 billion is funded by annually borrowed loans of $1 billion over 39 years, and all the 33% return from income tax is used to repay each loan over three years (after one year’s initial delay), then the project will never have created a debt of more than $2 billion at any one time from year three on.
This is flexible. Should the government wish to retain part of its 33% return, then the retained amount can be spent on social services, education or health, but the platform will be higher. For instance, if retaining:
• nil % p.a. (33% return p.a. remains to repay loans) the platform will be $2 billion after 3 years;
• 8.3% p.a. (25% return p.a. remains to repay loans) the platform will be 2.5 billion after 4 years;
• 13.3% p.a. (20% return p.a. remains to repay loans) the platform will be $3 billion after 5 years, and
• 23.3% p.a. (10% return p.a. remains to repay loans) the platform will be $5.5 billion after 10 years.
This opens the opportunity of negotiating a Public Private Partnership (PPP) arrangement with an investor such a consortium that wishes to buy a 99 year lease of the infrastructure for the right to operate it. Instead of retaining some of the return as above, the same amounts, i.e. either 8.3%, 13.3% or 23.3% (see above), of the overall 33% return would be repaid to the government by the consortium each year. This then means that for each of these ratios the government receives from its partner the relevant annual amount of $83.3, $133.3 or $233.3 million respectively each year to spend on social services etc. The investor’s ultimate purchase prices accumulating over 39 years would then be $3.25, $5.2, or $9.1 billion respectively.
That means that the government can use all of the 33% return from income tax to repay its annual loans. The debt would then again never exceed $2 billion after three years, and yet the government can spend the money received cumulatively each year from its PPP partner on social services, education and health. It’s like having the cake and eat it too.
Coincidentally, GST will do something similar to the economy of the states. With the annual investment of $1 billion in one of the states and a multiplier effect of 3.3 the regional economic activity rises to $3.3 billion. If this were to raise 10% of GST, i.e. $330 million p.a., then that state also gets a nominal return of 33% on that investment, whether it was spent out of their own coffers or someone else’s; nominal only because it has to share this with other states and that depends on the rules of distribution.
There is, however, a risk attached to this. As with all business investments, one should assess it by a SWOT analysis; Strengths, Weaknesses, Opportunities, Threats.
The Strengths of Platform Funding lie in the considerable reduction in interest charges. Its flexibility compared with overall long-term cumulative funding allows for each year’s loan to be adapted both to the social and economic environment at the time, and to the rate of repayment in accordance with the national needs as perceived at the time.
The stimulus will ultimately reduce both the regional negative output gap and underlying negative cash balance, as will the ongoing benefits after completion.
The Weaknesses are the need for negotiating each loan and the associated costs and a small increase in the national debt level, although this is much less than with cumulative funding.
Opportunities relate to the capacity of such schemes to act quickly and decisively each year as the shifting underlying economic conditions change. Plus, there are opportunities for attracting private investment to free capital for social budget expenditure and for supporting innovation and productivity increases, while paying off the loans to maintain the $2 billion platform.
Threats can be recognized in the inherent mixture of components of the GDP measure itself. While increased government funding “G” in the above formula will increase consumption “C” resulting from the increase in the number of jobs, if this consumption is not satisfied by the
“finished production” resulting from business investment “I”, then it will increase imports in the formula’s NX. That would then limit GDP growth. This means that to increase business investment to enable successful competition with imports, products have to be at least equally if not more attractive than imported products, and that means innovation, improved productivity, and aggressive marketing.
As these calculations do not include company tax from the benefitting contractors, that additional income could be used by the government to pay interest and other costs.
This essay may be an over-simplification, but it is offered as food (cake?) for thought.