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An inconvenient obsession

There was a glimmer of hope earlier today that, boxed repeatedly around the head by evidence that the economy isn’t really travelling so well and that slashing Government spending was only compounding the problem, Joe Hockey had a conversion of sorts.
The Treasurer talked in almost Keynesian terms of the need for the Budget to act as a “shock absorber” for the economy.
Was the political obsession with returning the Budget to surplus as soon as a possible and bugger the consequences for the rest of the economy to be consigned to the rubbish heap of history?
Unfortunately, it appears not.
Whatever Joe Hockey’s rhetoric, in its latest update on the economy, the Government remains obsessed about public spending, devoting a major slab of the Mid Year Economic and Fiscal Outlook (MYEFO) to its “Smaller Government” reforms, including cutting the size of the public service to levels last seen in 2007-08, holding down public sector wage growth to 1.5 per cent a year and axing 175 Government bodies.
None of these bode well for support for economic activity.
The fact is, in earlier times, governments could fiddle with the Budget and not worry too much about the effects on the economy.
But, as Reserve Bank of Australia officials pointed out in a research paper earlier this year, governments need to be a lot more careful now:
“The changes to the taxation system overall are likely to have increased the sensitivity of revenues to fluctuations in the terms of trade and economic activity in the current episode.[8] The larger size of government means that the operation of automatic stabilisers has a more significant effect on overall economic activity” – Australia after the Terms of Trade Boom, RMA Bulletin, March 2014.
There is no doubt that the Budget is looking pretty ugly.
Tax receipt estimates have been slashed by $31.6 billion since May, contributing to a $43.7 billion deterioration in the Budget position.
As a result, the deficit this year (2014-15) is expected to reach $40.4 billion (as opposed to $29.8 billion in May), and the books will stay in the red right through the forward estimates – a deficit of $11.5 billion is projected in 2017-18.
There is no return to surplus projected until very late this decade, at the earliest.
This outlook is hardly surprising given what we have been through, not least a global crisis that has left the international financial system badly shaken.
Overlaid on this has been the unsettling surge and ebb of the resources sector.
Booms, whatever their source, rarely end smoothly, and the economy was always likely to hit some rocky times as mining-related investment faded and other sectors were slow to pick up.
One of the features of this period – a rapid decline in the terms of trade – was hardly unanticipated. All along, it was expected that the massive worldwide investment in mining capacity, encouraged by soaring commodity prices, would drive a huge increase in supply that would drive prices down – and this is what has happened.
In the lead-up to releasing today’s Mid Year Economic and Fiscal Outlook, the Government has been enthusiastically briefing the media on what has been described as a “collapse” in the terms of trade (principally as a result of plunging iron ore prices) and what this has meant to Commonwealth revenues.
It has been keen to highlight a 50 per cent plunge in global iron ore prices since the start of the year, including 30 per cent since the May Budget.
“The extent of the fall in the price was widely unexpected,” the Government said in MYEFO – Treasury had estimated a drop from $US120 a tonne to $US92 a tonne by mid-2016, whereas it is currently at $US63 a tonne.
The result of these and other moves, the Government says in MYEFO, “would be the largest fall in the terms of trade in a financial year since the Australian Bureau of Statistic’s Annual National Accounts started in 1959-60”.
But, as one of this column’s correspondents, Property Insights principal Rob Ellis points out, claims of a record fall in the terms of trade are overblown.
True, the terms of trade have fallen sharply (the index has fallen below 160 points surging above 180 around the start of the decade), but they are still very high in historical terms (see chart).
Nonetheless, the Government has trimmed its real non-farm GDP growth forecasts. The economy is now expected to expand by 2.5 per cent this financial year (a 0.25 percentage point reduction from the May forecast) but still grow by 3 per cent in 2015-16.
And it expects household consumption to grow at a similar rate – a questionable assumption when many workers are seeing their pay go backwards in real terms, and rising unemployment and slowing house price growth are only making households even more careful about their spending.
Dumping even more off the public payroll and squeezing the incomes of those left on it is only going to make the task of achieving these growth forecast more difficult.
terms of trade


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Tony Abbott’s world just gets uglier

The ugly position the Abbott Government finds itself in has been underlined by the latest tax revenue and public expenditure figures from the official statistician.
A lot of attention will probably be drawn to the 15 per cent plunge in tax receipts across all levels of government in the September quarter to less than $100 billion.
There is no doubt that tumbling commodity prices and weak wages growth are weighing heavily on the Budget ledger – Deloitte Access Economics reckons the write-downs will push the Budget deficit to $34.7 billion this financial year – $5 billion more than the Government forecast in May.
But the steep 15 per cent fall reported by the Australian Bureau of Statistics today is hardly unexpected – it happens every year at this time. Historically, the three months to September is the weakest quarter for tax collections, for the obvious reason that most corporations settle their annual tax bill in the June quarter.
What is more telling is the ABS’s assessment that Commonwealth spending (ex-defence) grew 2.2 per cent in the September quarter and is up more than a 1 per cent from where it was when the Coalition came to office little more than a year ago.
The Government will probably claim that this is because so many of its Budget savings measures have been stymied by a hostile Senate.
But they should not be let off the hook so easily.
Take the $7 Medicare co-payment proposal, which is languishing on the Government’s books and hasn’t even made it onto Parliament’s agenda yet.
The Government claims it will save $3.5 billion by slicing $5 from Medicare rebates for GP, pathology and diagnostic imaging services. But this money has not been slated to improve the Budget bottom line.
Instead, the revenue was to be directed to the Medical Research Future Fund, to provide a fig leaf for Tony Abbott’s pre-election pledge not to cut spending on health.
Other measures will take years to deliver savings, such as shifting more tertiary tuition costs onto students.
Ripping more than $1.8 billion out of public hospital funding is a significant (if short-sighted) savings measure, but it won’t really have a big impact on the bottom line until 2017-18, while abolishing programs and agencies, such as the Australian National Preventive Health Agency are mostly small beer (scrapping ANPHA will realise just $6.4 million in savings over four years).
Instead, the Government has lumbered itself with a raft of unnecessary costs arising from impulsive and ill-considered decisions affecting the machinery of government.
For instance, the Government reckons that – on paper, at least – abolishing AusAID and absorbing its functions within DFAT will save $397.2 million over four years.
But there are good reasons to question whether the savings will approach anything like that.
First of all, the savings were predicated on staff cuts, and DFAT offered attractive redundancy packages to entice people to leave. As at 30 June, 272 DFAT staff had accepted a voluntary redundancy. Tellingly, a majority (56 per cent) were 50 years or older and 55 per cent were executive level staff – so their payouts would not have been cheap.
Secondly, the entire process was a productivity killer. For months, nothing much was done as management worked out how to takeover would work, and sorted out the structure of the new, larger, organisation.
Third, the process has been a morale killer for many in the Department, further hitting productivity.
You can only wonder whether all these flow-on costs formed part of the calculation when the Budget was being drawn up. I suspect not.
A similar gag-handed decision is to relocate many of the functions of the Department of Agriculture to regional centres dotted across the country.
For an agrarian socialist, it sounds like a neat way of spreading jobs and encouraging economic activity in smaller regional centres.
But reality has a way of mugging such hopes.
There is the cost of breaking the lease on existing premises, locating and securing appropriate accommodation, assisting staff who are willing to relocate and paying out and replacing staff who are not.
Then there’s the increased expense of co-ordinating activities across and geographically dispersed and decentralised organisation – not least higher communication and travel expenses.
Then there is the challenge of luring appropriately skilled and experienced staff to work in these regional offices – not many rural communities will be flush with people experienced in, say, administering a grants program or overseeing research projects.
As the Government struggles to come up with a compelling narrative to pitch its forthcoming Mid-Year Economic and Fiscal Outlook, it will have seen precious few green shoots of hope regarding the Budget books.
As Reserve Bank of Australia Governor Glenn Stevens noted today, it will be “some time yet” before there is a sustained fall in unemployment, so growth in wages (and hence income tax revenue) will be weak for quite a while yet.
And desultory economic growth will not do much for corporate profits or tax receipts either.
If the Government wants to burnish the Budget books and chart a convincing path back to surplus, it will have to contemplate killing more than a few sacred cows, like the massive subsidies currently built into the system for superannuants and hugely expensive corporate tax breaks and handouts.
If Tony Abbott truly thought last May’s Budget was brave, then he and Joe Hockey will have to deliver something of Homeric proportions if they are serious about setting the Budget on a sustainable path.
Otherwise, we’ll just continue to bumble along on familiar our shambolic path of hasty, ill-conceived and partisan Budget decisions and just hope that something – another China, perhaps? – comes along to paper over the glaring inadequacies of the nation’s political class.

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Joe Hockey’s G20 secret: believe

Treasurer Joe Hockey appeared to be channelling the eponymous self-help bible The Secret as he talked up the significance of the G20 summit on Sky News last Friday.

“Australians and people around the world have to believe that tomorrow is going to be better and more prosperous than today,” he told interviewer Kieran Gilbert. “Therefore, if they do believe that – if it is going to happen – then they are prepared to invest and create jobs for others in the community.”

When the G20 finance ministers and central bank governors, prodded by Hockey, declared their commitment to raise their collective GDP by more than 2 per cent the existing five-year trajectory, they appeared to be adopting the sort of “believe it, and it will happen” logic that is the The Secret’s mantra.

Their declared intention to “significantly raise global growth”, accompanied only by vague commitments to cut unemployment and increase investment, sounded suspiciously like the The Secret’s advice to “see yourself living in abundance and you will attract it. It works every time, with every person.”

There’s nothing inherently wrong with setting ambitious targets. Just ask Wayne Swan and his commitment to a return to Budget surplus in 2012-13.

But the essentially naive and ignorable nature of the commitment presided over by Hockey was neatly encapsulated in a put-down by German officials, who dismissed Australia’s initiative as a “slightly antiquated form of economic planning”.


The great thing about a collective commitment to something like a growth target is that everyone – and no-one – has responsibility to make it happen.

Let’s look at the wording of the relevant part of the G20 communique:

“We commit to developing new measures, in the context of maintaining fiscal sustainability and financial sector stability, to significantly raise global growth. We will develop ambitious but realistic policies with the aim to lift our collective GDP by more than 2 per cent above the trajectory implied by current policies over the coming five years.”

Plenty of wriggle room for governments there if growth doesn’t turn out as hoped – just say the financial system was too fragile to push things harder, or budget pressures were too great.

Then there is the question of how this jump in growth might be realised.

To achieve this 2 per cent acceleration, the ministers and governors said they would take steps to increase investment, lift employment and participation, enhance trade and promote competition.

All worthy goals, but tell me the government who says they won’t take steps to boost investment, employment, trade and competition. Ask most governments, and they will say that is what they are doing every day (even if they are not really).

So where did Joe get this idea for an additional 2 per cent growth target?

Have a look at the briefing prepared for the G20 meeting by International Monetary Fund staff, go right past the Executive Summary and the first 10 pages, and read the 11-page Annex at the back, which is full of worthy suggestions for stronger growth and how to achieve it.

Specifically, IMF staff have modelled the effects of what they see are necessary reforms in six key areas where policy gaps have been identified: fiscal, rebalancing (of sources of growth), labour supply, other labour market reforms, product market reforms, and infrastructure investment.

According to IMF estimates, the “policies assumed in the [plausible reform] scenario raise world real GDP by about 2.25 per cent ($US2.25 trillion) in 2018, relative to the October 2013 World Economic Outlook baseline”.

The biggest gains, the IMF believes, will come from reforms to boost competition and improve the business environment, followed by investment in public infrastructure, getting more people into the labour force, other labour market reforms and rebalancing sources of growth.

As the Lowy Institute’s Mike Callahan points out, we have been here before.

At their Toronto summit in 2010, G20 leaders committed to work together on a set of policies which the IMF estimated would boost global output by $US4 trillion and create 52 million jobs.

What happened? As we now know, the requisite policies weren’t adopted and growth fell well short of the stated mark.

As Callahan says, having a growth target and a plan to get there is only meaningful if the plan is implemented.

He points out that the necessary reforms identified by the IMF and OECD are politically challenging.

In Australia’s case, they include improving the efficiency of the tax system by lowering corporate taxes and relying more on the GST; improving the regulation of infrastructure by expanding user charges and congestion charges; improving childcare support; and reducing the stringency of the scrutiny of foreign investment. As Callahan observes, this is “tough stuff”.

The Abbott Government has already made clear that it has no appetite for taking on the sort of economic reforms that the country is screaming out for, particularly an overhaul of the tax system.

The Commonwealth is over-reliant on income taxation for revenue, and the country needs a broader tax base, of which a higher consumption tax is a key part.

Former Treasury secretary Ken Henry developed a credible and valuable blueprint for tax reform that should be the starting point for the Government.

But, just like the G20 growth commitment, it is hard to see it happening.

Even invoking The Secret won’t make it so.



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Boxall in the box seat?

Just as Martin Parkinson has been forced to contemplate life after Treasury, Treasurer Joe Hockey has to contemplate life after Martin.
The question is, who will he pick? Or, perhaps more likely, who has he already picked?
Most speculation so far seems to centre around two former senior Costello staffers – Mike Callahan and Phil Gaetjens.
Both have the experience that would seem to make them obvious candidates for the position – solid background in developing and providing economic advice, a record of service to the Coalition, a familiarity with the workings of the public service, and political judgement.
Callahan knows Treasury well. He joined the department in 1974 and has spent much of his career there. Following his stint in Costello’s office (from 1999 to 2000, during the introduction of the GST) he rose through the ranks to become head of the Revenue Group between 2005 and 2007, before moving on to be Executive Director, International, from 2008 until he left Treasury in 2012 to join the Lowy Institute, where he is Program Director of the G20 Studies Centre.
Gaetjens, who has been a career public servant at both the Federal and State level, honed his political skills and judgement as Costello’s chief of staff for a decade, before moving on to become Secretary at NSW Treasury following the defeat of the Howard Government.
But there is a third former senior Costello staffer who, oddly, has so far largely been overlooked in connection with the Treasury job, but who would seem to be better qualified than both – former Department of Employment and Workplace Relations Secretary Peter Boxall.
Few top Federal public servants have borne as many scars for the Coalition as has Boxall.
He served as an economic adviser to Andrew Peacock in the late 1980s, where he helped develop the-the Opposition’s 1990 economic action plan.
Later, in Costello’s office he helped frame the Howard Government infamous first Budget, with its swingeing cuts to the public service and Commonwealth spending.
He subsequently returned to the public service where, as Secretary of the Finance Department, he was responsible for the introduction of the system of accruals, outcomes and outputs that is now in place across the bureaucracy.
But it was perhaps as Department of Employment and Workplace Relations Secretary that Boxall really earned his stripes as far as the Coalition was concerned.
The highly-educated economist, who worked at the International Monetary Fund for many years, led the Department through the introduction of Work Choices, and although the policy was eventually repudiated politically (and is still seen to have the whiff of political death about it), the quality of its implementation has never been seriously challenged.
His reputation as a fiscal conservative won’t harm his chances, either.
In an interview he gave to the Canberra Times in March 2006, Boxall detailed his outlook on the job of the public service, and its stewardship of public monies.
“It’s really our job to look at what is efficient, which is more measurable, and effective and ethical,” he said. “And that’s why in the FMA Act [Financial Management and Accountability Act under which Commonwealth departments operate] they have this section … which says that one of the duties of CEOs such as myself is the three Es: efficient, effective and ethical use of taxpayers money. Fairness is an issue for the politicians.”
It is an outlook in synchronicity with that of the Abbott Government.
As the Canberra Times put it: “He considers himself a classic liberal and thinks there is scope to continue to look at government expenditure in a lot of areas to see whether programs are really necessary. This applies even when there is a significant surplus because then there can be lower taxes.”
Little wonder, then, that when the National Commission of Audit was being formed, Boxall was an early inclusion.
Treasury Secretary is one of the top jobs in the Federal public service, requiring a combination of economic smarts, political nous, a strategic outlook, high order administrative skills and well-earned authority.
It is not a position that would treat an outsider parachuted in kindly.
It is a not a job for heroic ‘Captain’s picks’ (ala Fred Hilmer and Fairfax, or Sol Trujillo and Telstra).
Both Ken Henry and Martin Parkinson had the qualities needed to make a success of the position in generous helpings.
Whoever gets the post, it is not going to be an easy ride.

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Dire MYEFO numbers just political theatre

The manner by which the Mid-Year Economic and Fiscal Outlook is being released – a speech by Treasurer Joe Hockey to the National Press Club – tells you all you need to know about what this document is really all about.
For many years now it has been apparent that the main significance of the major Government economic statements, the annual Budget and MYEFO, has been as set pieces of political theatre rather than anything much to do with running the economy.
The days of markets surging or tumbling on Budget forecasts for growth and spending are long gone.
In the hands of Treasurers who were able political operators (think Paul Keating and Peter Costello), Budgets were more about imagery than numbers.
Keating had his emblematic turns of phrase, like “this is the one [Budget] that brings home the bacon”. During the 2000s, Costello delivered a string of Budgets with “surprise” revenue upgrades (to the extent that Treasury’s forecasting abilities became the butt of jokes).
This is how Hockey’s performance today needs to be viewed.
When he bemoans the parlous state of Government finances bequeathed to him by Labor, take it as a piece of political theatre, rather than an unsentimental appraisal of the fiscal position.
As has been extensively telegraphed by the Government through a series of leaks, MYEFO is likely to show the Budget deficit has ballooned out to close to $50 billion – a massive deterioration from the $30.1 billion estimated in the Pre-Election Economic and Fiscal Outlook released in mid-August.
Has the world really become so much darker in the past four months? The short answer is no.
While all the publicity surrounding the departure of Holden and other high profile business problems may have you thinking otherwise, the evidence in fact suggests that things are improving.
Internationally, the US recovery appears to be strengthening, China shows no signs of falling into the hole that many feared, and the euro zone appears to be negotiating the (very) early stages of a recovery.
Domestically, low interest rates are boosting housing activity and the dollar is easing lower. Treasury is basing its gloomier outlook on several developments since PEFO. It says the pick-up in non-mining activity and housing activity is slower than it was expecting, while mining investment has fallen more sharply than anticipated. “As a consequence,” MYEFO says, “employment growth is expected to remain subdued, and wage growth is forecast to remain well below trend.” This in turn will mean households hold back on their spending, restraining growth. All quite plausible.

But as Treasury itself admits, “nominal GDP growth forecasts carry with them additional uncertainty. The 70 per cent confidence interval for average annual nominal GDP growth over the forecast period ranges from 2 per cent to 5 per cent”. That is a not-insignificant range.

The economy’s transition away from mining investment-led growth to other supports for activity remains hesitant, and the speed with which other sources of growth develop is uncertain. But there is evidence that consumers and businesses hare shedding the funk that has held back spending and investment (excepting resources) ever since the GFC.
But the political story line Hockey wants to outline begins with Australia under Labor being driven into the ground. Queue forbidding music, dark skies and storm-lashed seas.
Over coming years, the narrative will go, the storm clouds will gradually dissipate, and at some yet-to-be-determined point in the future (though possibly in the months before the next Federal election) the first rays of economic sunshine will pierce the gloom, and the Coalition will be able to assure voters is has the country on track.
It is all a piece of political alchemy.
The fact is, in recent weeks, Treasury will have presented Hockey with a range of forecasts for nominal GDP (and hence, revenue) that range from the optimistic to the pessimistic, depending on various scenarios regarding developments in international economic conditions, the exchange rate, commodity prices, the rate of slowdown in mining investment and the speed of improvement in activity in other parts of the economy.
For his political purposes, Hockey has plumped for the worst-case scenario of soft growth and weak revenue flows.
This is not to say that Treasury has ‘invented’ the numbers to suit the Government’s political agenda – the forecasts are plausible and justifiable.
But they are just part of a range of possible outcomes, as Treasury itself explains in Attachments A and B in Part 3 of MYEFO.

On page 57, Treasury publishes a chart (Chart 3.9) indicating that “there is notable uncertainty around receipt forecasts and that this uncertainty increases over the estimates period”. For 2013-14, the 70 per cent confidence interval is a range of $20 billion and, at 90 per cent confidence interval, it is $30 billion.

Treasury is similarly cautious about its forecasts for the underlying cash balance (Chart 3.11, p58). The 70 per cent confidence interval for its 2013-14 forecast is $25 billion, and at 90 per cent it is $40 billion.

What the Coalition is doing with the Treasury numbers is nothing new. In the same way, for several years in a row, Labor Budgets contained projections for growth and revenue (particularly earnings from the mining tax) that were much more optimistic than many thought probable, because they supported the-then Government’s political goal of achieving a surplus in a set period.
Don’t get me wrong – Government spending is a problem. But the Coalition so far is taking the same Magic Pudding approach to public finances as Labor.
The current game of deficit/surplus one-upmanship between the major political parties is tiresome and empty.
It will only mean something when there is recognition of the much more important issue (as Rob Burgess highlights in Business Spectator today) of the structural position of the Budget.
The Parliamentary Budget Office forecasts the Budget to be in structural deficit until at least 2016-17, and thought bubbles like the Coalition’s ‘Direct Action’ climate change policy and its over-the-top paid parental leave scheme suggest the Government has no more appetite to tackle the problem than Labor ever did.

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Foreign investment set to be early test of an Abbott Government

Two contradictory faces of the Coalition  when it comes to economic issues were on display this morning.

While on a visit to China, WA Premier Colin Barnett called for an end to “discrimination” in Australia’s treatment of investment by Chinese state owned enterprises (SOE).

Simultaneously, the Nationals are pushing for Government to block a $3.4 billion bid for GrainCorp – which handles most grain grown on the eastern seaboard – by US grains giant Archer Daniels Midland. According to the Nationals, the acquisition would not be in the national interest because of the market power ADM would be able to exert. As part of their attack, the Nationals took aim at the Foreign Investment Review Board, accusing it of rubber stamping foreign investment and not protecting “the national interest”.

So, the conservative government in WA says Australia should be more welcoming of foreign investment, while the Nationals at the federal level want tighter controls.

Let’s take these one by one.

First, Colin Barnett’s concern.

The WA Premier is correct that  state owned enterprises seeking to invest in Australia face different rules to other investors. Specifically,  any proposed acquisition by an SOE of an interest in a mining business – regardless of size or country of origin – must be scrutinised by FIRB. This is different to the rules for other categories of investors, who only face FIRB scrutiny if they seek to acquire a stake greater than 15 per cent in a mining business (a threshold currently around $244 million).

But the reason for differential treatment is obvious: a SOE is not your standard investor. Thanks to their state backing, they are not on the same playing field as purely commercial operators, and can have agendas that are not purely commercial, either. So the idea that they face a different form of scrutiny to other investors appears justifiable.

What about the GrainCorp takeover bid?

Interviewed about it by Fran Kelly on ABC’s Radio National this morning, National Senator Fiona Nash said the Nats didn’t trust the ACCC to protect the interests of farmers if, for example, ADM used its virtual monopoly position to exclude some farmers from its network and/or set rapacious fees.  But, if that is the case, aren’t farmers already vulnerable to such abuses from GrainCorp, given its dominance of the eastern seaboard grain handling network? And what is the evidence that the ACCC would be unable to act to ensure a strong market position was not being abused.

Senator Nash, like Nationals leader Warren Truss, has  also attacked FIRB, accusing it of practically rubber stamping foreign acquisitions in the agriculture sector. She said FIRB should include someone with agricultural industry expertise.

The presumption is that someone from an agricultural background would be more likely to reject at least some foreign investment proposals, the implication being that they would have a better understanding of what constitutes the ‘national interest’ than those currently serving on the FIRB.

Following Senator Nash’s logic further, it would mean that each foreign investment proposal should be scrutinised by a group that includes a member with expertise in whatever particular industry is involved. So who would these experts be? How would they be selected? What specifically would they add to the appraisal process? It would seem to be a pretty slippery path the Nationals want the country to go down.

The concerning thing is that, from 14 September, they will have much more clout to try and get their way. Senator Nash has already flagged that they would ask Joe Hockey, if he became Treasurer, to block the ADM bid. This would put him in a very tricky position. On the one hand, he would be under pressure to satisfy the wishes of a key political ally. On the other, what sort of signal would it send to foreign investors about how welcoming the new government was to offshore capital?

Which way he jumps will be an important early test of his judgement, and of the economic and political abilities of an Abbott Government.

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