Government investment as the path to growth?

This morning the AFR  (sub. required) had Richard Dennis of the Australia Institute suggesting that the government should continue funding the Clean Energy Finance Corporation (CEFC) as it is allegedly making a profit.

Of course the key issue is would those funds offer a better return elsewhere?  The straightforward answer to this is that the green funds are only invested in energy assets that enjoy a regulated price on their output. This is at least double the output’s real value if only because the assets benefit from the Renewable Energy premium.  In many cases, like solar farms, such outputs require a price four times that of commercial assets in order to cover costs.

It can never be a good business to invest savings or borrowed funds from abroad to finance assets whose viability requires two to four times the price of the output of commercially-built competitive assets.  A nation embarking on such a strategy for all its investment would see its capital productivity halved or quartered!

That apart, Dennis makes a fundamental mistake in his analysis.  Even if the government can raise money at 4 per cent and obtain a return of 8 per cent, this is not a good deal.  The reason is that money is fungible – there is no hermetically sealed pool of it that goes to the government.  All funds are linked through interest rates which largely depend on loan duration and risk assessment.

Every time a government raises funds it has to tap into funds that require a higher interest rate.  The premium increases with the perceived risk of default, a factor in which is the relative size of the borrowed funds.  Hence the premium for Australia with a relatively low level of public debt is quite low yet for highly indebted Greece it is very high – probably without the EU backing it is infinitely high.

Unfortunately for those who would see government expanding its role in the economy as a path to riches or at least to a green nirvana, the higher interest rate does not just apply to the target borrowings but to all borrowings.

Some suggest that each borrowing increment is immaterial to the cost of funds.  But this is just not plausible. One estimate of the magnitude of the costs of additional borrowing has been offered by Kieren Davis of RBS.  Davis estimates the premium on Australian debt of a $10 billion new raising is 0.07 per cent. $10 billion is the sum envisaged to be raised for the CEFC.

Hence, superficially, if the interest rate required for Commonwealth debt is 4 per cent, another $10 billion at 4.07 per cent costs $407 million a year, a premium of $7 million.  But the new premium applies to all debt, say $370 billion, and the cost is therefore $259 million a year.  That means raising the extra $10 billion requires interest payments of not $400 million a year and not even $407 million a year but $666 million a year.  Suddenly the four per cent rate has become 6.7 per cent.  And that is before all the inevitable wastage that occurs with government ownership – for some reason Dennis seems to think that state building of electricity assets in Australia was a masterpiece of efficiency!

Dennis sees a vastly expanded role for government funding. He rhetorically asks if funding is regarded as bad for green matters does this not extend to others including CSIRO and agricultural R&D?  In the case of the former of these, at least, most of the funding is already directed to wasteful climate change related matters so that answer is straightforward.

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17 Responses to Government investment as the path to growth?

  1. Driftforge

    How can a valid return on investment for government financed organisations be claimed when a large portion of that return is the result of government subsidy?

    It’s approaching the perpetual motion machine; a fully government funded entity solely devoted to efficiently securing government funding.

  2. stackja

    It is only tax-payers money so why should Richard Dennis of the Australia Institute be concerned.

    Driftforge
    #1113998, posted on December 17, 2013 at 1:09 pm
    perpetual motion machine

  3. H B Bear

    Silly season is in full swing at the AFR.

    Hurry up and die Fauxfacts.

  4. HK_Brother

    When one finds the money trail…One will find the deviants and scammers to this Climate Change scam.

    Look at the UK…
    => Climate Fat Cats exposed with naked conflicts of interest. Where was The BBC?

    I wouldn’t be surprised if one finds the same in Australia.

  5. Art Vandelay

    No doubt Richard Dennis also doesn’t take into account the fact that the money used to fund the CEFC (or that pays off borrowings) comes from taxes that gives rise to deadweight losses of around 20-50 per cent (not to mention compliance and collection costs).

    Such costs should be taken into account when determining the NPV of government proposals (but in most cases are not).

  6. .

    Art,

    So basically they fudge the figures from the get go?

    Amazing? Bugger all people would know that.

  7. .

    Err,

    It’s amazing that this happens, poor practice that it is, and unfortunately very few people know about this.

  8. Andrew

    The thing should be closed down not because it’s unprofitable but because the stuff it funds is toxic beyond belief. The question, for any of the grubs dropping by to read the Cat, is not “CAN the govt make money funding things that quadruple power prices?” it’s “SHOULD it?”

    Now many of these filthies should argue “yes it should because CO2 that has influenced temps to the extent of 4C/log2 CO2,” but that’s a different question.

  9. Andrew of Randwick

    I wrote about the CEFC submission to the Senate Inquiry at the start of the month (4 Dec) – the questions still apply. This submission was quoted extensively by Labor and Green senators in the filibuster debate.
    .
    Perhaps some furphies could be exposed about these dodgy investments (Appendix C). Based on my intermittent listening of the radio on the 4th December, a starting list would be:
    1) The CEFC is making a profit. This is justified because the CEFC project returns are 7% and the 5 year bond rate is 3% – hence a 4% positive difference. Here I would say that the CEFC debt is almost certainly subordinated to private debt and thus a return of 15-20% should be required. And thus the CEFC is making a loss on a risk-adjusted return. (I am assuming here that the CEFC is not a seed equity provider)
    2) The CEFC has multiplied the private lenders to put in $3 for every $1. What are the different terms for the lenders?
    3) Do all CEFC projects rely upon the Renewable Energy target for existence?
    3) What is the EBITDA to Interest coverage of these projects?
    4) Oh and is I was devious I would look at equity. What is the capital structure of the projects? And is the equity true equity or faux equity where a subsidiary is capitalised with a loan from a parent that has covenants that put its debt on a par with other debt holders, i.e. in front of the CEFC.
    5) The CEFC is helping to create thousands of green energy jobs. Where?
    6) The CEFC is helping Australia build internationally competitive industries in green energy. How much green energy has Australia exported? Oh alright, I may be being a bit harsh. How much green energy equipment or knowhow has Australia exported?
    7) The CEFC will help Tasmania become a green energy powerhouse and power Australia. Oh yeah- how?
    8) The CEFC has helped Warrnambool City Council replace street lights. What is the total ownership cost benefit of that scheme when capital is taken into account?
    .
    And so it goes on. The one piece of information missing from all of the speeches is what is the fully loaded c/kWhr of these projects.
    .
    P.S. Why are the explanations of the financials for the case studies in Appendix C so obtuse? No mention of capex, opex – just words like “provided finance”.

  10. Art Vandelay

    Dot, cost-benefit analysis (in the form of Regulation Impact Statements) is required for many government decisions, however most of them are of very poor quality (and rarely seek to quantify costs and benefits) or aren’t done at all. Gillard and Rudd were prime offenders but Coalition governments also have little commitment to the process. Governments aren’t interested in transparency since it might inhibit the bribes they pay with our taxes.

    It’s amazing that this happens, poor practice that it is, and unfortunately very few people know about this.

    Unfortunately people don’t understand (or care) about this sort of thing!

  11. .

    Governments aren’t interested in transparency since it might inhibit the bribes they pay with our taxes.

    This is why I end up on the scrapheap of idealists.

    A conservative or reasonable social democrat Government ought to endeavour to have trasnparent, utilitarian policy.

    A libertarian one would demand that of itself.

  12. Andrew of Randwick

    Art Vandelay at 4:31 pm

    Dot, cost-benefit analysis (in the form of Regulation Impact Statements) is required for many government decisions, however most of them are of very poor quality (and rarely seek to quantify costs and benefits) or aren’t done at all

    And when they do them they follow this rather special approach

    In its advice on measuring costs and benefits in policy analysis, the Department of Finance and Administration (2006, Appendix II) underlines the importance of counting non-market improvements in the quality of life. In 1996, a group of eminent economists, including Nobel laureate, Kenneth Arrow, set down principles for good cost-benefit analysis, noting that: “Not all impacts of a decision can be quantified or expressed in dollar terms. Care should be taken to ensure that quantitative factors do not dominate important qualitative factors in decision making. (Arrow et al. 1996)”

  13. ar

    Articles by Richard Dennis are a good reason not to subscribe to AFR…

  14. JC

    Richard Dennis is the George Costanza of economics.

  15. Yohan

    Did anyone see Michael Pascoe’s article today? He says government defecit expenditure was over 3%, and GDP growth was 2.5%. Therefore, according to Pascoe, if we did not have the government running a deficit, we would have been in a recession.

    For him its a simple as government deficits being equivalent to real economic growth dollar for dollar. Its economics for Morons.

  16. Yohan

    Any economic activity is only as useful as the human want’s that are satisfied in the course of its expenditure.

    But Leftwing and Keynesian economists do not know this simple truth. To them building pyramids and bridges to nowhere with government debts are the equivalent of private sector activity.

    We all know governments are so wasteful some estimate they need to spend $5 to $8 to create the same economic wealth as $1 of private sector activity.

  17. Infidel Tiger

    Did anyone see Michael Pascoe’s article today? He says government defecit expenditure was over 3%, and GDP growth was 2.5%. Therefore, according to Pascoe, if we did not have the government running a deficit, we would have been in a recession.

    Pascoe is the worst of the lot and I’ve read Jessica Irvine.

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