Not surprisingly, the page one lead of today’s edition of The Australian blared “Hard cuts needed to save the budget”. The piece warned of the need for “painful cuts to growth in public health and education spending” in order “to avoid a European-style debt quagmire”, based on a new report from the Grattan Institute.
The report was released on Sunday but provided to journalists under embargo last week, to maximise its exposure. It asserts that the combined deficit of Australian governments will rise “to an alarming 4% of GDP by 2023”. Assuming that GDP grows by around 2.5% a year (roughly trend) for the next decade, the current $1.5 trillion current estimate of our GDP will grow to around $1.9 trillion. If the 4% estimate is based on that, the combined deficit will be equal to roughly $70 billion. If it is based on current figures it will be around $60 billion.
Financing those deficits will boost debt, which is currently around 10% of GDP (or roughly $150 billion) in net terms. A decade of deficits would see several hundred billion dollars of debt issued — say to around $700 billion, without any corrective moves by government. That’s high (just under 50% of GDP), but a long way from the “European-style debt quagmire”.
To become such a quagmire, the ratio would have to soar sharply to around 80% (currently Germany’s level — and The Australian and no doubt the Grattan Institute would argue it is a well-run economy) or more. Australia would have to issue more than a trillion dollars of debt in the next decade to become a member of the quagmire club. Germany, by the way, still has a AAA stable credit rating at that debt-to-GDP level. It’s forecast to fall to 77.5% next year, if the eurozone doesn’t tank. Germany’s deficit to GDP level much lower than Australia’s — it was around 1% in 2011. But deficit to GDP ratio isn’t a key measure, it’s the level of debt as a percentage of GDP.
This is not to say unchecked increases in debt are a good thing. They are not, spending needs to be contained and the budget’s revenue base needs rebalancing and widening, if possible. Rather than new spending, we should try curtailing it and reshaping current spending patterns to produce immediate savings, rather than simply spending those savings.
But just cutting spending to the exclusion of everything else (including tax rises and broadening) smacks of the lightweight partisanship and Tea Partyish, Laffer curve nonsense that passes for economic policy-making from the conservative wings of the American commentariat.
But the tenor of the coverage this morning of the Grattan paper takes you back to the early days of the Howard government after its election in 1996, or Paul Keating’s banana republic comments a decade earlier.
The panic merchants obviously haven’t taken on board the debunking last week of the Carmen Reinhart-Kenneth Rogoff paper that asserted economic growth could disappear once a country’s debt-to-GDP ratio moved past 90%. Two academics and a 28-year-old graduate student at an American university blew a great hole in the Reinhart-Rogoff paper. Its implied “cut spending to achieve growth” approach and the use made of it by people, especially in Europe (to justify the austerity regimes forced on countries such as Ireland, Portugal and Greece) is now under attack.
For example, Adam Posen, a former member of the Bank of England’s key monetary policy committee wrote at the weekend:
“The claim that there was a clear tipping point for the ratio of government debt to GDP past which an economy’s walls caved in never made any sense. If such a critical level were to hold, there would have to be some equally abrupt causal mechanism by which the dire predictions for growth would have to come to pass — perhaps interest rate rises, a currency crisis or an increase in hoarding and saving resulting from feared future tax rises? Such an event would be clearly visible in the data among those countries that went past the debt event horizon of 90%. But it is not there.”
And Financial Times associate editor Wolfgang Munchau was today tougher, writing:
“Many policy makers have interpreted this rule as a call to reduce debt to below that level for the sake of growth. Profs Reinhart and Rogoff have thus become the intellectual godmother and godfather of austerity… Especially in Europe, pro-austerity policy-makers have tried policies based on their research with catastrophic economic and human consequences. The Harvard economists’ tragedy is not the misuse of a Microsoft Excel spreadsheet but the misuse of Microsoft PowerPoint. They hyped their results. In doing so, they followed the golden rule of tabloid journalism: simplify then exaggerate.”
And we saw some of that with the Grattan paper (which played to the obsessions of the conservative commentariat). It’s a pity the paper wasn’t more complete with some suggested tax changes and other ideas to stabilise the budget and its revenue base.
Would Grattan follow-up papers be greeted with the same unquestioning page one treatment if they suggested a higher and broader GST and getting rid of or reducing dividend imputation? More likely, the national dailies and others would fall upon the Institute and give it a right mauling (in a familiar Tea Party way), which would be a bit 2010 when Reinhart-Rogoff was all the rage.