Call it the “Frydenberg pivot”. The government has shifted away from the mantra of debt and deficit toward a willingness to use fiscal policy when warranted.
No longer will the Liberal Party be — as one Liberal MP proudly told me last year — “the party of thrift”. No turns toward austerity. Rather, Frydenberg’s Liberal Party wants to be the party of economic growth.
And, with some nudging from Treasury and others, the Liberals have come to understand that economic growth is not only the best way to make all Australians better off, it’s the best way to deal with the debt incurred during the pandemic.
Since this is a fiscal strategy grounded in sound economics, rather than fearmongering and sloganeering, it is a welcome development.
Get Crikey FREE to your inbox every weekday morning with the Crikey Worm.
But we should also hold the government accountable for delivering on the strategy.
The economics of the pivot
At a macroeconomic level there are really two key variables for the government: the interest cost of servicing government debt (r) and the growth rate of national income (g). As Chris Edmond, Bruce Preston and I wrote in an article last year, these two variables are the key to understanding debt sustainability.
If r>g, then holding the debt-to-income ratio constant requires higher taxes either now or in the future. If r=g, no changes in taxes are required in order to hold the debt-to-income ratio constant.
But if r<g, then even with holding the level of taxes fixed, the debt-to-income ratio will decline over time. In this sense, r<g means the implicit cost of servicing the stock of outstanding debt is relatively low. This means the government could cut taxes or increase spending and still keep the debt-to-income ratio constant.
With the cost of debt at historic lows, a decent rate of economic growth means that the federal government’s debt can shrink away over time.
In fact, with the government able to borrow long term — say 30 years — at around 1.5%, even a decent rate of national income growth will lead to debt shrinking relatively fast. This opens the door to the kind of spending initiatives seen in this budget, and the tax cuts that have already been legislated.
How will we know if the new Liberal strategy is working?
Under the old focus on debt and deficit, success was easy enough to measure and announce. If there was a sniff of a budget surplus — however questionable the assumptions underpinning it might be — the government could start handing out black coffee mugs, do cheesy video grabs, and generally declare victory.
But under the more economically sensible and nuanced Liberal budget strategy, measuring success is, well, more nuanced.
We can, of course, just look at growth in national income and the cost of debt and judge the government by the gap between the two. But that is a rather backward-facing approach, and it only focuses on the narrow question of whether government debt is sustainable.
The real question is whether it is delivering on increasing living standards for Australians. For that we need to focus on a basket of key economic statistics: GDP per capita, unemployment, and wages growth.
GDP per capita tells us a broad measure of economic growth. Before COVID it had almost ground to a halt. GDP itself was being propped-up by population growth due to immigration. We won’t see that level of immigration again for a while.
And we shouldn’t accept the government attempting to mislead us by pointing to the overall size of the economy rather than at what each Australian’s average share of it is. The latter is what drives living standards.
The unemployment rate is not only a crucial factor in determining wellbeing, it is also reflective of how business thinks the economy will perform in the near future. Hiring more people is a sign of optimism.
A lower unemployment rate than we had before COVID will be required to drive wages up. We don’t know exactly how low it needs to be to get wages growing robustly, but we do know two things: real wages in Australia have barely moved since 2013, and in the US and UK it took unemployment rates below 4% to do so.
The government’s budget forecast of 4.5% unemployment in 2023-24 is probably not low enough to really boost wages above inflation. Budget forecasts for the wage price and consumer price indices also reflect this.
Frydenberg has made a significant shift in the fiscal strategy and political branding of the Liberal Party. It is good economics, and should make for good politics — if the government can hold its nerve.
Richard Holden is professor of economics at UNSW Business School, and President-elect of the Academy of the Social Sciences in Australia.