Transcript of Question & Answer Session Panel participation at the 9th Annual Australian & New Zealand Investment Conference

Well, good morning again, ladies and gentlemen and thank you very much for joining this panel discussion. We have labelled this the three Ps of politics, policy and performance. We hope to have a lively discussion amongst the panellists, and with you the audience, on really the state of Australia at the moment. Can I start by introducing our panellists?

I'll start on my near left, Dr Luci Ellis, who's Assistant Governor, Economic, at the Reserve Bank of Australia, a role that she's held since December last year. Dr Ellis has a distinguished academic and professional career, has been at the RBA for 26 years. She was also, prior to her current role, the Head of Financial Stability Department for eight years and spent two years at the Bank of International Settlements just as financial crisis was emerging. That was probably an interesting and informative experience.

Next to Luci, Valerie Fowler is a career member of the US Senior Foreign Service since September last year. She's been Consul General for the United States here in Sydney. Not many of you may know, but the Consul General post here in Sydney dates back continuously for 180 years, so it is the longest standing US foreign mission in Australia. Valerie has had an extensive career in the Foreign Service for the United States with posts in Europe, Africa, Afghanistan, back at home in the US and maybe most relevantly for us, multiple posts in Asia, including China, Singapore, and Hong Kong.

To my far left, someone who maybe well-known to some of you, Jennifer Westacott has been CEO of the Business Council of Australia since 2011, so Jennifer is well versed in operating at that intersection of business and policy and addressing some of the most fundamental issues in our economy on behalf of her member companies. Jennifer has had an extensive career both in the public and private sector and a special focus on infrastructure and energy, two particularly relevant sectors for us today, as we consider the state of the Australian economy.

The format will be familiar to you, we'll have a discussion with the panel for approximately for 20 minutes and then we're very keen to throw open to Q&A to the floor and we'll take questions first from our investor clients, and time permitting, we can take some media questions and, as always, if people would identify who they are and what organisation they represent.

With that, Valerie, I'm going to start with you. It's now 11:37, I think you landed from San Francisco under two hours ago.

That's right.

So thank you very much for being here. Why were you in the States and what's the current view from the US at the moment?

Well, I was in the States for friends' weddings and then my college reunion, so it was entirely a personal trip. The United States, I think, is optimistic. We, as you are all aware, have some polarising political views, but there's a very positive sense of traction in California, except for the wildfires. I was in Sonoma the days before the wildfires. The amount of natural disasters that have hit the United States in the last couple of weeks or couple of months is really resonating, but at the same time, things like the President's announcements last week on his framework, his desired framework for tax reform from an investor's standpoint are getting positive traction because now there's a framework to begin the discussion, and that was one of his fundamental policy points that he ran on for President. After a lot of statements, when the market goes up, now there's a discussion starting point on that, so I would say that from an investor's standpoint, from a business standpoint, the mood is optimistic.

Is that shared inside the beltway? Is there an optimism the legislation will be passed?

I think there's more optimism on things like tax reform and regulatory reform than there is on the Affordable Care Act. The administration started with one of the tougher elements and is now looking for areas such as tax reform and regulatory reform, where they're more likely to get broad bipartisan support. As more administration officials are named, I think there are more folks who can help him push his agenda, forward.

Very good. Luci, you've just returned from the G20, right?

Yes, a little bit, a few more days ago than Valerie. I got back on the weekend, so I was there for the G20. That's correct.

And you were working, as opposed to …

I was working, yes. The whole time.

Perspectives from the G20?

Yeah, I think where the G20 is at, is very much an organisation that really came into its own in the immediate aftermath of the crisis. That was when the leaders' meetings started happening. I think there was a lot of sense of shared purpose during that peak of the crisis, and there was co-ordinated policy stimulus happened at that time. I think we're now in a continuity rather than a big bang change mode for the G20. You can see as each country hands over presidency to the next, you can see things carrying forward. It's kind of a more regular work flow, so the meeting I attended was the last deputy's meeting chaired by Germany. Argentina is taking over as the presidency of the G20 starting at the beginning of December, so I'm going to be going to Bariloche at the beginning of December.

I think each presidency has its own take on things. I think there's been a change in the conversation from surviving the crisis, regulatory reform, a lot of focus on financial regulation. It's now moving to questions like inclusive growth, and what do we mean by inclusive growth. I think there has been a real opportunity to integrate G20 as part of global governance with some of the broader issues that, for example, the IMF, and other sort of broader constituencies are looking at.

Maybe we'll come back to that inclusive growth later when we talk about upbeat assessment of the economy. The full trifecta, Jennifer, you've been in the US recently?

I have, and working. I guess similar points to Valerie, we felt there was a tremendous sense of optimism, a lot of momentum now behind tax reform, a sense in two perspectives. One, that they've got to get something done and get momentum for the administration. But secondly, a lot more bipartisan agreement that the system as it currently stands is not working. The question, I think, will not be if something gets done but the scope of what gets done, the extent to which it's just tax reductions, or rank reduction versus broader reform, and that will obviously be the contested part as it goes through the congress and the senate, but, we've got a lot of sense of momentum behind tax reform.

The other area that, of course, has not been talked about almost at all here is regulation, where there is big progress being made on simplifying regulation, getting rid of some poor regulations, and business has responded very positively to that. But you look at the data, they're growing faster than Australia, their share market is in very good shape. When the president makes some of these announcements, it gets in better shape. My observation of the presidency is this is the kind of disrupter-in-chief, and he's disrupting a lot of the institutions, and obviously we'll see where it lands, but we do get a very curated sort of narrow view of the administration here, and of course when you're there, on the ground, you can see that the support for him in his base is still huge, I mean it's 98 per cent.

There are some very serious and very competent people in the administration, so there's nothing like being there and I was very buoyed by spending a few weeks there.

Maybe we can bring the conversation, and make the link back to Australia. The BCA, at the moment, is putting a lot of weight behind the Enterprise Tax Plan, and you're making announcements on that this week. Take us through your assessment of how important that is for local competitiveness in Australia, and is it about just that global competitiveness, or is there more to it as you see the benefits of tax reform in Australia?

I think fundamentally, it's going to be about global competitiveness. If you look at our rate compared to Asia at 22 per cent, ours at 30 per cent, the UK going to 17, the Americans talking about 35 to 20, the French, even, are talking about going to 25. That now puts us way behind the pack, and what does it mean?

I think we've always got to remember the context of the Australian economy, which is the point we're trying to make. We cannot afford to have an uncompetitive tax rate because we are a capital importer. We do rely on foreign investment. If we were to try and do that investment here through savings, it's just not doable. What does that mean? Well it means that the jobs and business growth that will come with it, particularly in some of those core sectors that require big investments. They're not going to come if companies have got choices about where they can put their money in a more competitive environment. So fundamentally, it's about competitiveness.

The second thing though, David, is it's about productivity. In all of our research, one of the biggest things driving the sense of community disgruntlement, if there's such a word, is low wages, is low wage growth, and the BCA called this out a couple of years ago and said, look at the wage numbers. That's actually something to start worrying about. Now, there's only two ways to get wage increases. You get a terms of trade hit, which you can't bank on, or you get productivity improvements, and by that I don't mean people working harder for less, but getting those investments to drive, different ways of working, expanding into markets, creating new sources of value.

Now, you don't get that without business investment. You would know this from the data that goes back a long way. The link between productivity, wage growth and business investment is just inextricable, and our business investment is now the lowest it's been as a share of the economy since 1994, off the back of the last recession. So, we have to do something to drive business investment. That's the fundamental argument for us around the Enterprise Tax Plan. The government's put it on the table, it's a slow growth, it's a slow trajectory, and our argument is, if not this, what?

Do you share that view on the importance of the tax policy reform for corporate investment, without commenting maybe on the policy, but really the benefits for the economy.

Well, I'd reiterate the point I made when I was asked a similar question at the parliamentary hearing earlier this year. One of the differences between Australia and many other economies is we have dividend imputation, and from the perspective of the domestic investor, the corporate tax rates are irrelevant. It really just doesn't matter, because you get it back anyway through dividend imputation. It really only matters if you're a foreign investor making the choice to invest in Australia versus another economy. I think the important thing … I certainly can't claim to have great insights into the minds of multi-national corporations, but when businesses make decisions about where to locate their investment, the tax rate, presumably does matter, but what also matters is things like the business environment, the institutional framework, the rule of law, the macroeconomic outlook, and the educational base of the country, and where the resources are.

Jennifer mentioned that we now have a low share of business investment relative to the recent past. Well, the reason is because we had a mining investment boom, and that mining investment boom is almost over. It's about 90 per cent done. There's still a little bit of the LNG to come. That was unusual. So, I'm not sure I buy the idea that we have a great drought of non-mining business investment happening. We had a phase, which was about 10 years of incredibly strong mining investment. Guess what? Multi-national resource companies are not going to put that investment in a country that doesn't have those resources just because it has a lower tax rate. It will invest where the LNG, and the iron ore, and the coal, and as it turns out, the lithium, all actually are.

In that respect, the reason we attract foreign capital, rather than rely on foreign capital, is precisely because we have these resources that are available, and aren't going anywhere. They can't be moved somewhere else. That creates its own challenges, but I think it needs to be borne in mind. I think one of the really pleasing things came out of the June quarter National Accounts is actually, we are starting to see non-mining business investment picking up. That's been a long time coming, and we think there are probably some synergies between the pickup in public infrastructure investment, which is also picking up, and we're now starting to see the spill overs in that onto the non-mining, private sector. For example, a lot of those infrastructure projects are being built by private firms on behalf of the relevant governments, and then you're seeing they're buying more trucks, they're buying more cranes, in order to effect the other investment that's also going on.

I'm not sure that I would buy that there is a dearth of investment happening, although it is true that non-mining business investment has been weak, but one of the reasons has been because mining investment has been so strong, and inevitably, that squeezes out some of the other sectors during that period.

So, in summary, RBA are not concerned about the ability of Australian organisations to attract foreign capital?

If we can't attract foreign capital at the current exchange rate, the exchange rate will fall, and then we will be competitive.

Jennifer, do you share that, or do you see some greater … We know we've got that shock absorber lever, the exchange rate, but do you think it's …

Yeah, but I guess I contest a bit of that, because when Australian companies say to me that the tax rate, irrespective of imputation, does matter, and it's about the marginal investments, and it's about the things that they would not do here that they would do somewhere else, that it does matter. I think the link between productivity, wage growth, investment, particularly if we want to super charge – yes there are some things that are starting to get green shoots, but why would we not take one of the policy levers we've got over a decade to make ourselves competitive? Why would we … The IMF says that if the United States does what it's proposing to do on tax that you will see foreign capital move to the US, money that would otherwise come to Australia.

I guess I don't buy the argument that you can't source some of those resources from somewhere else, because the geographic reality is you can and companies, those global board tables, are going to make decisions about returns on investment, and I think we're kidding ourselves to think that we're the world with LNG, iron ore, with coal and that we're the only stable place to do business. It's just simply not true. I think if you're in a globally competitive environment, and you're on a global board, and you're making an NPV decision, and you're making … then the tax rate matters.

Remember the 30 per cent rate was set to try and keep us in line with the OECD average. Well, now the average is not where we are, and getting to 25, we'll still be below the OECD average. So, you've got policy levers, President Trump's going to pull two huge ones, and we run the risk of a country that is very dependent on foreign capital, that we are not as an attractive place to invest. I guess I dispute some of those things.

Well, I'm not suggesting that we're the only place with those resources, but I think that was what was driving the strength in total business investment during that period, but I think the point I'm simply making is that there's a broader business environment to consider, and those advantages haven't gone away. The tax rate is one of the inputs into an assessment of the broader business environment.

But if I could just add to that, but it's a broader business investment environment when you talk to investors and people in the room will have a better sense of this, that has a lot of problems as well. Tax is one problem, but then you've got very high regulatory costs, you've got high labour costs. We're not proposing that's a problem, but it's a problem if you don't have multi-factor productivity rising with it. We do have some structural challenges in the economy, and tax is one lever. It's not the only lever, and the BCA has never said it's one lever. Energy costs, regulation, education, are all hugely important, the broad business environment.

But I talk to investors all the time, and they say, "It's getting hard to do business in Australia." People do have choices.

Let's come to that, Valerie. You sit on that nexus between the US and Australia. Do you hear from particularly US companies, what Jennifer's talking about, about that marginal unattractiveness of Australia, or are you still seeing the positives?

I'll just take it a little bit broader initially. We're hashing out many of these same issues in the Unites States at the same time. One of the things that the Council of Economic Advisors says is that 71 per cent of income earned by US companies overseas is not repatriated. That's one of the things the administration's looking at with the new tax plan is to try to bring some of that US capital back. It would be coming back from many places around the world.

To touch on your point, there are a lot of factors that bring US companies here. We've got more than 1500 US companies here in New South Wales, CBD for example. In the Sydney CBD, they employ 135,000 plus Australians with an average wage of $115,000 Australian. Why are they here? Well, tax rate is certainly one part of it. So is the highly skilled workers with the education, so is geography. It's nice to be in Asia, and as you mentioned, we've got rule of law, intellectual property protection, assuredness of, generally speaking, of stable policies, that sort of thing, that you can find in Australia, which puts us into the Asia, Indo-Asia Pacific, which is very important to us, but it is absolutely true that some companies will adjust where their positioning is based on a wide number of factors.

Housing costs gets into the liveability quotient, so does school systems, all of these sorts of things factor in together to drive the decisions, but the fact that US companies have been here for more than 100 years, and some of our most prominent examples really show that it's weathered different tax regimes, it's weathered different political personalities, and all that. This is a great place for the US to do business. We have $860 billion of investment here. That's approximately 10 times the size of China's investment in Australia. We are by far and away the largest economic strategic investor here, and in exchange, if you will, it's a two-way street.

Australia has seven times more direct investment in the United States than it does in China. This is a good news story on the economic strategic partnership that we've got going, and we are still the number two trade partner for Australia. The bright shining object of Chinese trade, we understand certainly why Australia wants to go in that direction for resources and, you know, send beef cattle and all of that, but if you're looking for what keeps the Australian markets liquid, what helps mortgage rates for any Australian, what products they buy, that relationship is with the United States.

That was a long-winded answer to say we're hashing out a lot of the same things, but there are a lot of really strong reasons for US companies to be here. Corporate tax rates are one of those levers and so is regulatory reform.

Well maybe on that last point, regulatory reform, and just dealing with what I think we could describe as both fractured and fractious, political and policy backdrop. We all know the lack of an executable reform agenda in Australia, and Jennifer, you sit in the middle of that wafer-thin government majority fractured senate. Is anything getting done? Is there good work that's happening that's not obvious as you look at the headlines in the AFR each day?

Yeah, I think good work is getting done. Things have gotten done, and difficult things have been done, and I think there is a sense of a bit of naysay. Let's see what the energy policy is today, but my plea to people is that they look at the detail, they work through the detail, and they don't jump to their normal, "We'll never agree to "X"," or "We'll never agree to "Y"," or "This isn't one of these, therefore it's not workable."

My kind of plea on the energy front is does it meet affordability, does it allow us to reduce our carbon emissions in line with the target, does it improve reliability. They are the three benchmarks. I think the other thing, David, is that we've got to maybe break reform down into chucks, and we would have loved, for example, to see big tax reform, but it's not doable. The political culture is not going to have a tax switch, which you've seen in New Zealand and other countries. So, you've got to say well without reopening the company tax stuff. What's the worst taxes? Well, all of the economists, apart from stamp duty, say company tax is the most damaging to the economy. So, you've got to pick your way through things.

Of course, for the politicians, it's the hard grind of getting those cross-party, cross-bench votes, but that's always been the case in the senate. There's only been one time in recent memory where the government has held the majority in both houses by an easy kind of margin. It's always been thus, that getting stuff through the senate has always been the job of good negotiation and good cross-party work.

But yeah, we got the ABCC legislation through, the media reforms recently went through. The government can get things done, Julia Gillard got things gone. It's just there's a lot of noise around getting things done, which gives people, I think, the sense that things aren't getting done.

You start breaking it down bit by bit, a lot gets done.

You're able to assume that things get done and you can ignore the current what looks like fractious policy as you set your forecast?

I don't really want to comment on the specifics of government policy. I think what my experience has been is that there is benefit to having broad consensus over certain technical areas being given mandates to do their job, and being allowed to do their job, and I think, for example, there's been a lot of reform over financial regulation, and some of that has been coming from the international sphere, for example Basel III, but there's also been a lot of Australian specific twist on that.

So, I think one of the things that has been quite pleasing over recent years is the strong political consensus that we want a safe financial system, and that we're willing to potentially be a little bit more conservative, or a little bit super equivalent to the international rules, such as Basel, and that has been something that people have been comfortable with, and that there hasn't been this, ‘our banks won't be competitive or our insurance companies won't be competitive’. I think people have understood that there are broad policy directions that you need to follow, and there's been a consensus around avoiding financial instability and having good macroeconomic management. So yes, things get done because there are people behind the scenes who've been given a job to do and that continues.

Do investors have a role to play in this? Jennifer? People in this room?

I think they do. You've got a lot of active investors now, without buying a big argument about it, you have to question whether some of their requirements of companies are actually going to add to shareholder value. Fundamentally, what is the job of an investor on the behalf of people is to create value, and you look at some of the activist shareholder demands on companies and you say, "To what extent is that going to create or destroy value?"

I mean I look at the stock market, which is often, I think, an underestimated indication of the health of the economy, and of course in the US it's a much bigger kind of indicator, but ours has been pretty flat, and if we had performed at the same rate as the Dow Jones, leaving aside whether the Dow Jones is over-valued or not, there'd be $320 billion more value in the Australian share market.

Now, that's money that would otherwise fall to ordinary investors, and I think that's the story. That if the investment community doesn't take any interest in the policy debate, and it surrenders all of the activist stuff to these quite fringe activist arrangements, of course people should be requiring companies to be ethical, and I'm not arguing against that, but if that's the only voice from investors and we don't have the voice for good economic policy, then there's 5 million ordinary mums and dads whose voice is not being heard. Then, there's your superannuation, my superannuation, that really depends on the success of Australian companies, and if the policy environment isn't working for them, then to me, there's a direct link for the investor community there.

Okay. Well, maybe the call to arms can be taken up.

A little bit, yeah.

Let's shift gears before we open up to questions, just come back to fundamental economic assessment and outlook, and I think Luci, you gave a speech last month where you highlighted two things, not just increasing global outlook, but greater predictability of economic growth outlook. Do you want to comment a little bit on that, and also just in that context, we know we're going to have to taper from QE, medium long-term interest rates need to go up, are the policy levers ready, are markets ready to absorb that shock after the sort of science laboratory test we've had for the last 10 years?

Thanks David. Look, growth has picked up a bit from where it was 18 months ago. That's absolutely the message of that speech. Has it become more predictable? I'm not so sure of that. I think there's been some sort of big tail risks have come out, but others remain. They're the tail risks. I think the near-term risk is probably the, "Well maybe things are just a little bit better than we expect," and then the medium-term risks are more balanced, and you can construct more scenarios in the medium term than in the short term that turn out more negatively.

But that's always the case actually. I'm not sure I'd regard the short-term outlook as being more predictable than usual. It's always more uncertainty than usual is always the mantra. I've never known anyone to say that there is less uncertainty than usual, and I think some of the other issues that we've discussed today do speak to some of the uncertainties, and not having a good handle on how some of these things might connect together, how in the medium-term things like technology adoption might drive some of these issues around wages and productivity.

This is a huge conversation in the economics profession at the moment about what's happening, the fact that the companies at the global and national productivity frontiers are so much further ahead than the median company than they used to be. There's some very interesting OECD research, which doesn't have Australian data in it, I should add. Across a range of countries, there seems to be a tendency to have more and more superstar firms that are extremely productive, and then they're getting more and more of the sales and the market share and the profits, and then there is this raft of other companies that aren't doing that, and they're lagging further and further behind. They're all facing the same regulatory environment. They're all facing the same tax environment. So, why are we having this greater spread out? There seems to be something going on with productivity, as Jennifer mentioned, that's not well understood, and I think that's an open question, but it's one for medium term.

But certainly, I think we have been through a period, 10 years of recovery from the global financial crisis in the countries that it affected the most. We're now at a point where, in a number of major economies, the output gap has closed and we're at what we thought was full employment, my suspicion is that the closer you get to full employment, the more you find there are yet more workers who are out there and people get very creative about improving productivity when the economy's tight. When there's plenty of spare capacity and plenty of spare workers, that's when you don't have to think about improving productivity. Productivity is cyclical and I think that's something that we'll need to bear in mind over the next couple of years. But it will be incumbent on businesses to say, "Well, things are tight, I'm finding it hard to find good workers, I'm finding it hard to keep up with the demand that is now happening, because maybe I need to invest, maybe I need to change how we do things."

That's actually something that a high-pressure economy creates. It's all endogenous.