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.