Carbon tax not the great economic reform that Wayne Swan claims

Amongst the many claims from Treasurer Wayne Swan, one we hear regularly is that imposing a carbon tax qualifies as an economic reform.  He wants us to see it as part of the great line of economic reforms of the last thirty years, in the tradition of floating the dollar, opening up the banking sector to competition, giving the Reserve Bank autonomy to set interest rates, and introducing the GST.

Swan was at it again in question time today. He arranged to be asked a Dorothy Dixer: “Will the Treasurer outline to the House the importance of delivering on reforms to support jobs and growth?” In his response, Swan had this to say: “We understand the importance of reform. We understand the importance of putting a price on carbon to our future prosperity.”

For at least three reasons, I do not think it is valid to claim that imposing a carbon tax is an economic reform in the great tradition of the last thirty years of reform in Australia. 

First, the great economic reforms we have seen in the past have been introduced for an explicitly economic rationale.  They were intended to make our economic more productive or efficient – and in turn to make Australia more prosperous than it would be in the absence of such reform. 

Floating the dollar, for example, was intended amongst other things to allow the exchange rate to serve as a ‘shock absorber’ in difficult economic times.  The exchange rate would fall, and this would make Australia’s exports cheaper on the world stage; at the same time it would make imports more expensive in Australian dollars.  The result would be a jump in export earnings – and a reduction in consumption of imports.  In turn, this helped Australia to adjust to – and recover from – a financial and economic crisis more quickly than in the old days of a fixed exchange rate.  Australia’s response to the 1998 Asian financial crisis is one good example of how effectively this mechanism has worked. 

By contrast, the carbon tax is not intended to achieve an economic rationale.  It is an economic tool being used to achieve an environmental policy rationale.  There is nothing new in this.  For example, to preserve fish species, governments set quotas as to the quantity of fish that may be legally caught. Similarly economic tools can be used for other objectives, such as public health: consider the imposition of taxes on alcohol and cigarettes.

Imposing a carbon tax is not designed to make our economy more productive, or efficient, or prosperous.  On the contrary, it is designed to force a change that will be costly – a change that will for example mean that vital economic inputs such as cement or aluminium or electricity will cost more than they otherwise would. There is an environmental rationale for doing so – but it is quite misleading to say there is a pure economic rationale for doing so.

The second reason this claim is not valid is that the great economic reforms of the past thirty years are ones that made sense in and of themselves.  They were not conditional upon the actions of other countries.  For example, reducing tariff barriers made sense for Australia – even if no other country in the world reduced its tariff barriers.  The reason is that it lowered costs to Australian consumers (because the price of clothing, or cars, was no longer kept artificially high by tariff barriers); exposed Australian industry to international competition, thus making it more efficient; and allowed the Australian economy to concentrate on its areas of ‘comparative advantage’ such as resources, while allowing us to import at lower cost goods that we could not efficiently manufacture ourselves. 

The carbon tax, however, is a completely pointless exercise unless the rest of the world introduces similar measures.  If the major emitters of the world do not do so (for example, China and the USA together represent over 35 per cent of total world emissions), then Australian industry will be at a competitive disadvantage but the tax will achieve none of its intended environmental benefit.  That is because industrial activity which emits carbon will simply move offshore: Australian aluminium producers, for example, will become uncompetitive against producers who do not have to pay a carbon tax, and hence the global market share of Australian producers will fall while that of non Australian producers will rise.  The net result: there will still be just as much carbon emission from the worldwide aluminium industry (so no environmental benefit will have been achieved) but the Australian aluminium industry’s revenues will shrink, and Australian prosperity will be harmed.

There is a third, equally important, reason why it is quite wrong to include the carbon tax in the tradition of Australia’s great economic reforms of the past thirty years. Those reforms had a unifying theme: to remove the tentacles of government from many sectors of the economy.  It made no sense for government (read politicians) to directly control interest rates; for government to own major companies in many sectors of the economy (transport, communications, banking); for government to control exchange rates. 

In these and many other areas, government does not know best: it should set the basic ground rules and then get out of the way to let the market operate.  The application of that principle has enormously increased the prosperity of Australians in the last thirty years.  Unfortunately the carbon tax and the associated regulatory apparatus will bring a significant increase in government involvement in many sectors of our economy: the inevitable result will be greater cost, lower efficiency and the sacrifice of economic growth and prosperity we could otherwise expect.