Tuesday, August 07, 2007

"The Commonwealth has contributed as much or more to demand pressures as the states" - Fred Argy

From today's Canberra Times:

THE CURRENT upward pressures on interest rates stem mainly from excessive growth in aggregate spending relative to domestic productive capacity and the threat they pose for inflation. Prime Minister John Howard blames these pressures on the states because, he says, Treasurer Peter Costello is running a budget cash surplus whereas state budgets are in cash deficit.

This is a very weak argument that should not be left unchallenged...

First, the combined state and local
general government fiscal deficit is
very small – under 1 per cent of GDP
– and projected to remain at these
low levels in the years ahead.

Secondly, the impact of a budget
on net aggregate demand (and hence
on interest rate pressures) is
determined by the change in fiscal
position relative to the previous year
– not whether it is currently in
surplus or deficit. On this criterion,
the Commonwealth and states have
delivered roughly the same stimulus
to aggregate demand over the last
two years. The 2007 Budget Paper
No. 1 tells us that the
Commonwealth Budget surplus was
1.5 per cent of GDP in the 2005-6
Budget and it is projected to be 0.9
per cent in 2007-8 – thus delivering a
stimulus to the economy of 0.6 per
cent of GDP over the two years. The
states had a surplus of 0.4 per cent of
GDP in 2005-6 and are projecting a
deficit (net borrowing) of 0.4 per cent
in 2007-8 – delivering a stimulus to
the economy of 0.8 per cent of GDP.
The figures on general government
spending tell a similar story. In
2005-6 Commonwealth spending
was 21.3 per cent of GDP and is
projected to be 21.5 per cent of GDP
in 2007-8 – a net stimulus of 0.2 per
cent. At the state/local level,
spending levels were 15.7 per cent of
GDP in 2005-6 and are projected to
be 15.3 per cent in 2007-8 – a net
deflationary effect of 0.4 per cent. In
addition, the Howard Government’s
generous tax cuts are adding to the
surge in private sector spending.

Thus, the Commonwealth has
contributed as much or more to
demand pressures as the states. This
boost to demand is partly why the
labour market is so strong. Does
Howard want to share the credit for
Australia’s low unemployment with
the states?

Thirdly, one needs to look at the
composition of the spending to
assess the longer term inflationary
implications. Howard’s increased
spending has been mostly in the
form of transfer payments, including
a good deal of middle class welfare.
In his 11 years, his government has
done very little to relieve the growing
skills shortage and infrastructure
bottlenecks in Australia.
Furthermore, he has been spending
at record levels on government
advertising, much of it for party
political purposes.

The states have not always been
judicious with their spending but at
present their increased spending is
mainly on productive infrastructure,
which will in turn reduce future
inflationary pressures.

Incidentally, it is ludicrous for
Howard and Costello to say private
financing of new infrastructure is OK
but public sector financing is not.
They both have exactly the same
impact on interest rates.

Finally, how can Howard blame
the states for over-spending when he
is at the same time obstructing their
efforts to rationalise their public
services? Howard recently decided to
invest over half a billion dollars in
new technical colleges instead of
upgrading existing state technical
schools, causing considerable
economic waste and duplication.
And now, with his Mersey hospital
intervention, Howard is thwarting
Tasmania’s attempts to rationalise
its hospital system and improve its

If interest rates do rise, it will be
largely a result of the resources boom
and strong world economy. To the
extent that any of our governments
are to blame, Howard needs to
accept more than his share of the
blame. Responsibility for overall
demand management rests with the
Commonwealth – not the states.

■ Fred Argy is a former high level
Commonwealth public servant and the
author of several books, discussion papers
and journal articles. He is not a member of
any political party.