The assumptions behind the current parameters of the budget debate are wrong. Discussion is being dominated by the loon pond that has occupied the business media and has either no idea what it is talking about or has a vested interest in seeing the LNP elected. Take your pick.
The loon pond frame is set nicely by Shadow Finance Minister and austerity champion Andrew Robb at the AFR:
Take Penny Wong’s assertion that the budget crisis is a “new economic reality”. No it’s not; it’s an old Labor reality – namely too much spending. It reminds me of the old Margaret Thatcher quote: “The problem with socialism is that eventually you run out of other people’s money.”
The Gillard government has a spending and forecasting problem, not a revenue problem. It has persistently made overly ambitious revenue growth predictions, spent at those levels and then cried “woe is me” when the forecasts aren’t realised.
The facts are that annual revenues are up $70 billion, but spending is up nearly $100 billion on 2007 levels.
…The commission of audit we have committed to in government becomes more important by the day. Assessing the quality of all Commonwealth spending will be fundamental to restoring the budget’s structural integrity.
Robb’s assertion about poor Labor policy process is spot on. It has a bad habit, inherited from Kevin Rudd, of announcing big projects then negotiating them backwards in the public domain. I’ve written about that many times myself and it is going to cost Labor government.
But what Robb and the broader debate misses is the simple facts of the economic reality that we face.
Labor did embark on an aggressive fiscal consolidation. The problem is we’re headed into a national income and growth hole even faster. And that that hole has no apparent bottom. Australia is in the early stages of an historic adjustment downwards in its income growth as the terms of trade fall. The Prime Minister did a pretty good job of discussing this in her speech on Monday:
What is new is how strong the revenue pressures on the nation’s Budget are.
We must plan for these strengthening pressures – and that is a key part of preparing our Budget for this year.
The persistent high dollar, as well as squeezing exporting jobs, also squeezes the profits of exporting firms: with lower profits for these companies comes lower company tax going to Government.
We can’t assume this will change soon.
The high dollar is also placing competitive pressures on firms here, who face new pressures from cheaper imports – holding down prices across the board, with the high dollar making it hard for these firms to pass on price increases, holding down profits – and in turn holding down company tax.
Consumers do benefit, but many businesses are doing it tough.
All this means the data on our economy now reveals a significant new fact.
This is the striking and continuing divergence between what economists refer to as real GDP growth and nominal GDP growth.
My best shorthand description of those terms is this.
Real GDP growth is growth in the volume of the economy.
The actual activity in the economy, how many jobs there are, the quantity of infrastructure we build, the amount of goods and services we export – how many tonnes of coal, how many international students pay for a course here, how many houses are built.
Nominal GDP growth counts this growth in volume and it also counts growth of the prices of all these things.
Today, real GDP is growing solidly – we’re creating more jobs, exporting more goods and services and buying and selling more from each other, just as we planned.
However prices are growing at a slower rate than is usual for this stage of the economic cycle, a slower rate than was forecast – and so nominal GDP growth for this current year is significantly slower than was forecast and we expect nominal GDP growth for future years to be revised down.
The current data shows nominal GDP growth after the first half of the 2012-13 year was an annual rate of two per cent.
At Budget last year, we had forecast nominal GDP to grow at five per cent.
What’s changed?
While the prices of our exports continue to be lower than their recent peaks because of weak global demand and increasing global supply, the prices of imports are now lower than forecast because of the strength of our dollar.
The prices of goods produced at home are also lower than forecast because competition from imports is so fierce.
This is now putting so much downward pressure on prices that growth in nominal GDP is actually lower than growth in real GDP.
Now, granted, Labor’s budgeting for this was also delusionally optimistic. But at least now it is being said. The ground work is being laid for the big changes to our standards of living that are in the offing.
Anyone not discussing this as the backdrop of the next three years of economic management is either more delusional still or plain lying.
The LNP has implicitly acknowledged this truth already in sensibly giving up on its pledges to return to surplus immediately upon election. To do so would be bonkers. As the income falls accelerate and the mining investment boom goes into reverse, to add steep cuts to government spending would be economic suicide. Andrew Robb appears committed to that path still with his mention of “restoring the budget’s structural integrity”. But there is no such hope. The recession that would follow would hit fiscal receipts all the more and have the government outlays leap on automatic stabilisers like the dole.
The AFR’s Alan Mitchell has a more measured take on what might be done to restore the budget:
The problem is not just that the 2012-13 budget is in the red. It is that, on the government’s present strategy, there is no prospect of a return to reasonable budget surpluses in the foreseeable future. As the Grattan Institute has shown, producing surpluses is likely to get harder over the next decade.
The question is how to return to the medium-term fiscal strategy of at least balancing the budget over the economic cycle.
The economy is already labouring under the drag of fiscal consolidation, an overvalued dollar and weakening commodity prices. Spending cuts and tax increases designed to wrench the budget back into surplus in the short term would slow growth and add to unemployment.
But fortunately that kind of stringency is not necessary, because we don’t have a serious debt problem. What we need are reforms to government spending and taxation that will have little impact now, but start making a serious difference to the budget in a few years time. These are what Paul Keating might call quality cuts.
He goes on to describe reasonable steps in health care and other areas that make plenty of sense. But even this will prove very difficult. The adjustment downwards in Australian income growth has a corollary. It was captured late yesterday by Michael Pascoe:
The ABS breakdown of taxation revenue for all levels of government in the 2011-12 year contains multiple lessons about the shortcomings of our tax system.
The impact of reduced growth in corporate tax is only the most topical. Overlay the message about more subdued behaviour inherent in the RBA’s financial aggregates and the bottom line is reduced expectations all round.
It’s not just business and investors who have to adapt to the restructuring economy the RBA has been warning about – our governments do as well.And the reduction in corporate tax growth from 17 per cent last year to seven-point-something per cent this year is before the mining construction boom begins to taper and the economy goes through a delicate period of waiting/hoping for consumers and housing to pick up the slack.
While there are a few tender green shoots around in retail sales and building approvals numbers, the aggregates and APRA banking figures show the consumer is continuing to be a more responsible individual, paying down debt and generally trying to live within his or her means.
Growth in housing credit has been steadily declining for three years and has been stuck at 4.4 per cent for the year to the end of each of the past three months. For owner occupiers, it has been downhill since October 2009 and the score for the past three months is just 3.9 per cent.
The problem Pascoe is identifying is that by definition in a current account deficit country when the public sector runs a surplus (or smaller deficit) then the private sector must run a larger deficit to offset it or growth will fall. That is, the private sector will have to borrow more (or sell more assets).
That might be OK, a return to the Howard/Costello growth model as it were, but our situation is actually worse than Pascoe is arguing. Credit growth is not at such low levels entirely by choice. It is kept low because APRA insists that all new loans are funded by deposits. This limits credit distribution (not price) by driving up credit standards. This in turn is the result of Australian banks no longer being able to borrow money endlessly offshore or they will have their credit ratings stripped. We are, in fact, in a slowly tightening current account squeeze.
This is the vice that I have described for the Australian economy for the past five years. Private credit cannot grow too fast lest it threaten the banks’ credit ratings. Public credit cannot rise too fast because it will threaten the national credit rating which still guarantees the bank ratings. Yet you can’t cut back too fast on either lest growth plunges. We’ve been supported through it so far by massive growth in the external sector (the mining boom) but that is ending.
This election should be about this: which party offers the best path forward out of the trap. The right solution will look something like this:
- a huge productivity drive
- modest public deficits aimed very much at productivity boosting soft and hard infrastructure
- private sector disleveraging and probable deleveraging
- above all, measures to lower the dollar and boost tradables growth without firing up greater credit growth
I don’t see this in either party, though Labor at least has opened the discussion.
