Saturday, November 08, 2008

Surely not a surplus regardless

That's what the Australian's economics editor Michael Stutchbury asks for in his piece: Tanner needs to sharpen his razor gang to stay in surplus.

At Club Troppo, Fred Argy responds this way:

After reading today’s column by Michael Stutchbury (“Tanner needs to sharpen his razor gang to stay in surplus”), where he urges that the “Government should not fatten the budget’s structural bottom line”, I remain as bemused as ever.

The Government’s fiscal strategy is clearly defined as
- achieving budget surpluses, on average, over the medium term; and
- improving the Government’s net financial worth over the medium term.

This requires the Government to run a deficit in times of extreme market failure – of which there is no better example than the present. All western g

Unfortunately, the Government (notably Mr. Swan) is itself indecisive – stressing at times the risk of running a deficit and at other times the risk of not doing so.

Mr. Stutchbury jumps on the Swan bandwagon and puts forward three arguments against discretionary spending.

The first argument is political. “Voters remain skeptical of deficit budgeting”. Yes, they are skeptical (thanks to the rubbish that Costello was feeding the public for many years). But wouldn’t voters treat the prospect of higher unemployment as a much more serious type of threat? Even Malcolm Turnbull is urging the Government to do more to “save jobs, jobs and jobs”. How else can you do it without active political intervention – including infrastructure spending?

The second reason is economic. It is “one thing to allow the budget surplus to shrink naturally as the automatic stabilisers from a weaker economy”, as they boost spending on unemployment and reduce tax revenue. It’s another thing again “to deliberately blow the surplus”. Where does the fiscal strategy make any distinction between “automatic stabilizers” and “discretionary spending” – especially of the infrastructure kind?

The third reason is political economy. “Once the possibility of a deficit world is entertained, there is no obvious limit to what could be spent”. This is ideology triumphing over sound economics.

Stutchbury's piece is below the fold:

Tanner needs to sharpen his razor gang to stay in surplus

WAYNE Swan did more than tear up Labor's first budget in 13 years this week. He formally buried the financial foundations of the Rudd Government's first term, with the loss of $40 billion from its four-year budget bottom line.

Now the Treasurer must follow through on his warning that the Government is "going to have to cut our cloth to suit the circumstances". Cut is the word, for the alarming deterioration in the budget's bottom line signals that Finance Minister Lindsay Tanner needs to sharpen up his razor gang. And, although he appeared bumbling this week, Swan was right to refuse to concede that the budget might slip into deficit.

The idea that we should now spend the surplus built up in good times to use in today's bad times, so we can soon return to the good times, ignores one critical point.

This is not a normal economic cycle. In structural terms, the budget is probably already in deficit, which will become apparent as commodity export prices fall to more sustainable levels. This year's forecast budget surplus has collapsed from $21.7billion to $5.4 billion even though the terms of trade will still rise a final 10 per cent thanks to BHP and Rio iron ore and coal contracts.

Kevin Rudd was elected a year ago on the assumption that these rivers of gold from the China boom, itself supported by the era of cheap credit, would finance his spending programs. Instead, the China boom has come to an abrupt halt and next year's iron ore and coal contract prices will be negotiated down. The budget suggests that this will drag down the terms of trade by 8.5 per cent next year, further shrinking the surplus to virtually nothing.

Rudd's problem is that the spending programs John Howard and Peter Costello embedded in the budget during the boom are now unsustainable. China will ramp up again, but the commodity price bounty is unlikely to be as blue-sky as before.

"I hate the fact that we have wasted so much money," Access Economics director Chris Richardson says of the profligacy of the late Howard-Costello era. "This was a big cycle and it was great on the way up. But we are now losing a lot of money very fast and that process has not finished yet."

That means Rudd, Swan and Tanner need to cut into this structural budget fat before they pile on any more of their own programs. Swan calls the Government's spending plans "ambitious". Think pensioner rises, tax reform, maternity pay, handouts to the states for health, education and infrastructure for starters.

Swan stonewalled something awful during his Wednesday press conference, refusing to acknowledge that Labor's promise to maintain a surplus over the course of the economic cycle meant the budget could slip into deficit, if it were needed to cushion the economic slump.

It was a fair line of questioning. But the Treasurer refused for three good reasons, despite the "yes we can go into deficit" chorus from the big-government cheer squad.

The first reason is political. The Keynesians may be smarter, but voters remain sceptical of deficit budgeting. Malcolm Turnbull and Opposition treasury spokeswoman Julie Bishop know that completely blowing a $22 billion budget surplus in 12 months or so would be a political black mark against the Government's economic competence.

The second reason is economic. It is one thing to allow the budget surplus to shrink naturally as the "automatic stabilisers" from a weaker economy boost spending on unemployment benefits and reduce tax revenue. It's another thing again to deliberately blow the surplus.

The case against using fiscal policy to try to actively smooth out the economic cycle remains that it is all too easy for politicians to hand out budget goodies to people and all too difficult to then take them back. Think of the political furore over the Rudd Government's minor means-testing of Howard's overly generous subsidies for household solar heating. Over time, this political imbalance ratchets up the size of government for no productive end.

It may well be part of the story, highlighted by Reserve Bank governor Glenn Stevens, of Australia's productivity growth slowdown. Tanner tells the story that Liberal and Nationals ministers spent $451 million on 6141 discretionary grants in 2002. By the 2007 election year, this had exploded to $4.5 billion on 49,060 grants.

At various times, the budget papers have tried to measure the size of the budget's structural bottom line in order to make sense of rules such as maintaining a balance or surplus over the course of the economic cycle. This has gone out of fashion in Australia, in part because it suited politicians to treat the terms-of-trade revenue boost as structural and permanent rather than cyclical and temporary.

Treasury insists that any further attempts at budget pump-priming be timely, temporary and targeted. But this three-T rule already is being breached. Rudd and Swan have made it clear that the $4.8 billion pre-Christmas handout to pensioners contained in the $10.4 billion short-term fiscal stimulus package is not temporary at all, but a downpayment on a permanent pensioner pay rise.

And so the third reason is one of political economy. The budget's relatively optimistic forecast of 2 per cent economic growth this year preserves at least the appearance of preserving a budget surplus. This draws a line that must not be crossed. Once the possibility of a deficit world is entertained, there is no obvious limit to what could be spent on what to boost the economy. (By example, my counterpart at The Age urges fighting the recession threat by spending more taxpayers' money on Melbourne train lines, public housing and unemployment benefits.) This does not mean the Rudd Government should tighten fiscal policy as the economy turns down. But it means the Government should not further fatten the budget's structural bottom line. Otherwise, the budget will remain stubbornly in deficit when the economy picks up -- leaving a "black hole" for someone else to deal with.