Friday, June 15, 2007

Saturday Forum: Costello puts his foot to the floor

Hold in your head while you still can the image of Australia's Peter Costello as a sober, responsible, besuited economic manager. It vanished on Thursday last week, replaced by a new image of the Treasurer as a leather-jacketed daredevil Grand Prix speedster.

What caused the Treasurer’s brain to snap was economic news that was literally extraordinary.

After an amazing run of employment growth, the jobs market had gone into overdrive. The Statistician reported that an extra 66,800 full-time jobs were created between April and May, roughly half at the expense of part-time jobs and roughly half completely new.

The implications sank in. More than 2,000 new full-time jobs had been created each and every day of the month, including weekends.

During working hours Australians had been signed on to new full-time jobs at the rate of 400 per hour – roughly one every 10 seconds...

The Treasurer threw away the suit and grabbed the metaphorical jacket.

“This is like a highly engineered racing car - one missed cue, you take one corner a foot too wide and it will crash. You need a good experienced driver in control of this highly calibrated economy, I wouldn’t be putting an ‘L’ plate driver in the cockpit at the moment”.

He liked the line so much he refined it and used it again and again when parliament sat this week.

On Tuesday Australia had become “a supercharged economy, like a Formula One racing car. If a driver in this highly calibrated Formula 1 racing car takes a bend at six inches or six centimetres too wide, he is going to have a crash."

By Wednesday if the trade union movement got itself “back in the driving seat of this Formula 1 car, it will be heading to a crash as sure as night follows day”.

The metaphor is a good one. The Australian economy is speeding and accelerating. Where it the metaphor breaks down is the notion that the Treasurer or the Treasury is in control.

In the budget papers the Treasury’s best guess was that unemployment would average 4.75 per cent during the current financial year. This is the kind of forecast that the Treasury should have been able to get right. It already had 10 months of economic data. But so fast has the spurt of jobs creation been that in order to meet that forecast Australia’s unemployment rate would need to climb from 4.2 per cent to more than 8 per cent right now as the Bureau of Statistics conducts its final survey for the financial year this weekend.

Asked this week whether he thought Australia’s present rate of economic growth was sustainable the Governor of the Reserve Bank Glenn Stevens said flatly “Not forever, no. The economy’s trend capacity to produce output is probably 3 point something. I would consider it to be unlikely that year-in, year-out 4.5 per cent domestic growth is going to be feasible”.

We are indeed in overdrive. The new governor is about the only official advisor able to speak freely. The 49-year old has just been put on a 7-year contract that will see him outlast every member of the Cabinet that appointed him.

On Thursday at a seminar in Brisbane he as good as pleaded with Australian businesspeople and policymakers to remember that the bigger the boom the more likely it is to bust.

“The business cycle isn’t dead. It can never be abolished and sooner or later there will be a downturn. I can’t tell you when, but there will be. And structures and strategies that pay no regard to those possibilities will turn out to be damaging to the people who have got them. The longer the prosperity goes the more risk we run of that kind of behaviour occurring,” Governor Stevens said.

His Prime Minister isn’t helping. When I asked Mr Howard in April how Australia would cope in the event of a downturn he replied that there was “no reason why with careful economic management by experienced people we should contemplate a downturn. I don’t believe in recessions you have to have, I believe in continued economic prosperity you are entitled to have”.

And the daredevil Formula 1 racing driver isn’t helping much either. Rather than taking his foot off the accelerator as the economy goes into overdrive Peter Costello is pushing it down harder.

Right now $2.1 billion is being shoveled out of the Treasury and into the economy in one-off bonuses and rewards in a furious rush to meet the end of financial year accounting deadline.

Each veteran is receiving a letter from the Minister advising them that a cheques is on the way and saying that it “only fitting that the dividends of a strong economy are returned to you’.

And after we switch to a new financial year at the end of this month the Treasurer will be throwing in tax cuts worth an extra $5.3 billion, likely to push spending (and employment) to an even higher plane.

Ask the only public servant game enough to express his doubts what he thinks could go wrong and Glenn Stevens will tell you that “the danger is that people become so confident that nothing can go wrong that they put in place financial structures, in particular higher leverage, and they make all sorts of other decisions which turn out to be very costly on the day when something does go wrong. And something will, sooner or later.”

We are spending as if nothing could go wrong. National spending is up 8 per cent, borrowing up 15 per cent.

On Thursday in Brisbane Governor Stevens was at pains to correct the belief that all of this extra spending was good.

“Anything that stimulates demand is thought to be ‘good for the economy’, he explained. But in an economy more fully employed than it has been in decades “unless additional supply is somehow forthcoming, expanding demand just produces overheating and inflation.”

When he thought he was speaking privately earlier this year the head of the Treasury Ken Henry put the point with even greater force. In a leaked internal address to his staff at the Canberra Hyatt Dr Henry warned them to prepare for a flood of spending proposals that were “frankly, bad”.

He warned of a “temptation to think that all problems can be solved by government spending. Such spending adds to aggregate demand, but in a full employment economy it will almost always be the case that government activity that doesn’t expand the economy’s aggregate supply potential will indeed reallocate resources from higher to lower productive areas”.

Dr Henry advised his officers that “the next time any of you get an opportunity to write a coordination comment on a Cabinet submission that proposes a taxpayer-funded handout for some stunning new investment proposition – and I predict that some of you won’t have to wait very long for such an opportunity – I suggest you draw attention to the submission’s failure to identify the businesses that will lose labour, and be forced to reduce output, if the proposal is agreed to”.

The stream of “stunning investment propositions” may be just beginning.

Yesterday the government announced a $15 million land, engineering and environmental study to determine the best route for an inland Melbourne to Brisbane railway. It is not the first time it has announced such a study. It announced a similar one ahead of the 1998 election.

It is not known what the Treasury thought about the proposal then or now. It is known what the Treasury thought about the Prime Minister’s $10 billion Australia Day water plan.

In the words of Dr Henry when he thought he was speaking privately, “water has got away from us a bit in recent times, but it will come back for some quality Treasury input at some stage – it will have to.”

At the time the Treasurer’s co-pilot, the Finance Minister Senator Nick Minchin confirmed that his department had barely been given a chance to look at the spending, but appealed for understanding saying it was only “one billion a year, which is less than half a per cent of Commonwealth government expenditure, let’s keep it in perspective”.

The government is shoveling out money as if it doesn’t really believe that the economy is finely calibrated or that it might crash.

It is hard to work out what its strategy is. An truly awful possibility would be that it doesn’t care whether or not there will be a crash after the election. It will deal with that if it has to.

Another possibility might be that it really does think it is expert at fine-tuning an accelerating economy, although the rate at which its budget forecasts are becoming obsolete should give it reason for doubt.

And a more machiavellian possibility would be that it is putting its foot on the accelerator in order to make the ride scary so that we become frightened of changing drivers.

The Reserve Bank Governor made it clear on Thursday that he wishes things would slow down. He probably wishes that there wasn’t an election this year. He knows he might have to pick up the pieces when it is over.