As a piece of economic management, the Coalition Government’s second MYEFO should come in for significant and serious criticism. It shows a deteriorating budget position and a deteriorating economy, but more worryingly, it shows a Government that is unaware of what good economic management actually means.
Commodity prices have obviously played a role in the economic and budgetary situation, and there is no doubt both have also been made worse by the real economic impacts of endless and unfounded cries of ‘debt and deficit disaster’ from the Government. But neither of these serve as a justification or excuse for the real problems with the Government’s fiscal strategy.
As Stephen Koukoulas has written elsewhere, “Hockey seems to have forgotten or ignored that budgets and fiscal policy are about the government managing the business cycle, not perpetually striving for the smallest budget deficit possible”.
The Kouk, as he is known, is exactly right; the short to medium term purpose of fiscal policy is to smooth business cycles – the Keynesian role so to speak. He is right to conclude that based on this basic criterion, the Government is failing Australians, especially those unemployed or likely to become unemployed. The Government is making a decision that arresting the misery of the unemployed is not as important as being seen as tough on deficits, even if being seen to be tough actually has no impact on the government’s solvency, Bond market’s willingness to hold our sovereign debt, or rating agencies assessment of the same debt.
However, this is just one of at least three criteria by which any fiscal strategy should be judged. The second and third are both longer term policy considerations and have little to do with Keynesianism.
The second concerns how the government spends its money, regardless of where we are in the cycle. It is a question of the role of government in the economy as well as a question of societal values. How much support for health and education should be public? How much basic research or industry development should be publicly funded? What type of welfare system achieves societal goals of equity, security and efficiency. If we believe the academic literature, the answers to these questions are even more important for growth and people’s wellbeing than whether the government engages in counter-cyclical fiscal policy or not.
On this score, there can be little doubt that the Government is steering Australia in the wrong direction, both for reasons of growth and for reasons of equity. Cutting CSIRO and other research funding, making university education and health care more expensive, ignoring all but road infrastructure, eliminating industry policies to promote industry growth, collaboration, development and take-up of new technologies; through all of these policies the Government is degrading its rightful role in the economy and society. In the long term, they degrade our growth, erode opportunity and stifle our potential. In addition and as has been made clear in the months since the May budget, in the public’s view they violate the basic Australian social contract.
The third consideration of fiscal policy is its constraint, namely the need to maintain solvency. Too often, this has been equated with the achievement of a surplus as soon as possible. In reality, solvency is determined by maintaining access to capital markets by preserving the confidence of those markets that debt will be repaid, in full and on time.
The common equation of achievement of a surplus with solvency is perhaps the most misunderstood aspect of fiscal policy.
It originates from the standard microeconomic analysis where past deficits (and therefore accumulated debt) can only be repaid by future surpluses. But this is an overly simplistic analysis that isn’t suited to assessing a government’s fiscal constraint. It excludes two crucial aspects of the real economy; economic growth and inflation.
Once we take a macroeconomic view of government solvency and incorporate economic growth and inflation, it becomes clear that debt can be paid back through inflation as the value of nominal debt diminishes over time and economic growth which boosts future revenues, as well as through future surpluses.
Financial markets and economists are perfectly aware of this fact. That is why ratings agencies are more interested in the profile of the net debt to GDP ratio and the growth outlook than they are in the size of this year’s deficit or when we project a surplus.
Yet these intricacies rarely filter through to the public debate. Attempts by economists to make these points are rare, but on the occasions they are made, as with the public statement from 63 economists in September this year, a list of signatories that included the Kouk, former RBA chief Bernier Fraser and Former Minister Emerson, as well as the author, they are largely ignored by the media and therefore by the public.
Instead what we get is the identification of a surplus as being the government’s equivalent to a business’s profit. This is fundamentally wrong and should be called out as such.
This common misperception has lead to one side of politics successfully misrepresenting a strong fiscal position as a ‘debt and deficit disaster’ because both sides, in an attempt to out-bid each other as the better economic manager, elevated the importance of achieving a budget surplus far above its real economic meaning. This came at a huge political cost to the ALP when the achievement of surplus was rightly delayed for good economic reasons. The consequence has been the Coalition’s ability to use this now successful misrepresentation of the fiscal legacy of Labor as a basis for an attack on the role of Government and the Australian social contract. This was the greatest bait-and-switch play in modern Australian politics and the ALP would be wise to learn its valuable lesson.
A solid fiscal strategy needs to articulate clearly how the government will approach all three aspects of fiscal management. And in doing so, it needs to respect the public and if need be to educate them, not treat them with contempt by pandering to their fears and misunderstandings as this Government continues to do.
MYEFO exposes a Government that doesn’t have a fully developed fiscal strategy. Their only claim to good management is the maintenance of solvency, which was never in danger. On the more pressing issue of managing the current economic situation and building prosperity and a fair and decent society, they are badly lacking, to the detriment of all Australians.