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Dec 21, 2012

Good riddance to a petty promise

The government's promise to return a surplus this year was silly and made little economic sense, writes economist Professor John Quiggin. There are much more important issues to debate.


In a belated victory for good sense, Wayne Swan has finally announced the abandonment of the promise to achieve a budget surplus this financial year. More surprisingly, Joe Hockey (apparently contradicting his leader) has taken the opportunity to back away from the Coalition’s promise to bring in a surplus in its first year, should it win the election.

Swan’s original promise was silly in two ways. First, there are many different measures of the government’s fiscal balance, and all of them have a substantial margin of error. The question of whether some particular measure is a few billion dollars either side of zero, in a budget of more than $350 billion, is of no significance whatsoever.

More importantly, the idea of trying to maintain a balanced annual budget regardless of economic conditions is recognised as nonsense by nearly all economists. Before the GFC, the standard view was that of a medium-term fiscal balance. The idea was that governments should choose tax and expenditure policies consistent with a low and stable long-term ratio of public debt to GDP. Typically, this would imply a small surplus under normal conditions.

However, when the economy went into a slowdown or recession, revenues would fall and expenditure on things like unemployment would rise. Under the medium-term balance approach, governments would not change policy either to stimulate the economy or to restore short term balance.

The Keynesian view, embodied in the stimulus that helped to save Australia (almost alone among developed countries) from going into recession during the GFC, is that fiscal policy should be actively countercyclical. That is, governments should increase spending and cut taxes during recessions, increasing the deficit.

On either view, the government’s projection, in 2010, that the budget should be back in surplus by 2012-13 was a reasonable one. The recovery from the GFC was faster than expected, and the boom in China seemed likely to be sustained until the end of the decade. The problem was that the projection was turned into a promise. So, when conditions became weaker, the government was trapped into cutting spending, and trying to squeeze out extra revenue, at a time when most economists would have suggested doing the opposite. By the time the promise was finally abandoned yesterday, it was virtually impossible to find an economist who still supported it.

What comes next? In the immediate future, we can hope some of the appalling fiddles of the last few months, most notably the recent reallocation of aid funding to domestic funding on refugees, can be reversed.

Over the next year or two, we need to have a sensible discussion about the role of fiscal policy in macroeconomic management. It is now apparent that interest rate policy alone can’t stabilise the economy. Furthermore, the idea that excessively tight fiscal policy is good because it forces the Reserve Bank to lower interest rates needs to be consigned to the graveyard of zombie ideas.

Over the longer term, we need to ask whether the needs of a modern society can be met while holding the tax share of national income to the levels fixed by the Hawke-Keating government in the early 1980s. As the importance of health and education increases, more resources need to be allocated to these sectors, and it will be hard to do this without additional public revenue. Widely-supported programs like the national disability insurance scheme and the Gonski reforms will need funding. University education has been squeezed to the limit for years, and the crisis in the TAFE sector is even worse. And such needs are only going to grow as people live longer and the number of unskilled and semi-skilled jobs decline.

It’s a big challenge, and it is hard to see our current crop of leaders, or their possible replacements, meeting it. But, at least today, good sense has prevailed.


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