Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
On May 10, 2011, the Australian Treasurer delivered his Budget Speech 2011-12. At the time I wrote these blogs – Australian Federal Budget – more is not less and Time to end the deficits are bad/surpluses are good narrative. Some 6 months later the Australian government received news (November 07, 2011) – Swan warned on surplus timeline – that indicated the economy was slowing and tax revenue was going to be much lower than estimated. It is becoming obvious to most people now (what was clear months ago) that the Government’s obsession with achieving a budget surplus is undermining the growth prospects of the economy. They should never had withdrawn the fiscal support in the first place but now they should definitely abandon this surplus obsession. The Australian Treasurer was like a wind-up doll yesterday when told the economy was faltering. All he could say was “We will cut harder”. Moronic.
The report from a private forecasting firm suggested that the Government had to abandon its “plan for a budget surplus in the next financial year” and that “further cuts to spending as the Government tries to honour its pledge to get back into the black by the end of 2012-13 … could harm the economy”.
I would say will definitely harm the economy.
The report merely repeats what some of have been saying for months – when the Treasurer first made the pledge – that the economy is not strong enough (that is, external activity and private spending is not strong enough) to justify a surplus or allow a surplus to be achieved (without massive damage to real GDP growth.
The Treasurer said in response that:
We’ll take commonsense decisions … We’re always on the lookout for savings. We’ve been up for a very big savings task over four years. We will be making further savings with this process but we’ll do it in a way that’s consistent not only with the economic outlook but with our fiscal rules.
He later elaborated:
We are certainly determined to bring our budget back to surplus in 2012/13 … That means tough decisions will have to be made in terms of the budget … In past budgets we have found over $100 billion worth of savings. So we go through that process.
He also accused the Opposition of preaching a “bit more voodoo economics” when the latter changed a policy which left their own budget surplus estimates some $A70 billion short.
To understand why this obsessive pursuit of fiscal rules is damaging the following logic applies.
The budget estimates were based on assumptions that at the time were too optimistic and in the passing of time have been revealed to be so. The constant narrative that our “once-in-a-hundred-years” mining boom was going to bring bounty to all of us has fallen well short of realisation. Employment growth has been virtually zero for some months and other indicators of growth are faltering.
The ABS published the latest International Trade in Goods and Services, Australia for September 2011 today which showed the trade surplus (before invisibles) narrowing with exports falling on the back of declining terms of trade (so prices rather than volumes falling).
The The RBA Commodity Price Index is showing that commodity prices have fallen by around 4 per cent in the past three months.
The talk among those who analyse the data is that the export boom is slowing and increasing current account deficits (with trade deficits) are likely.
The private sector in Australia has not filled the spending gap left by the government fiscal withdrawal. There was no sound reason to assume it would given how much debt it is carrying as a result of the credit binge leading into the crisis.
The external sector continues to act as a brake on growth.
So tax revenue is falling below estimates because real GDP growth is not as robust as the Treasury claimed. Further, the world economy is imploding which will further undermine our export revenue.
The Treasurer at that point should admit this and demonstrate leadership by introducing new fiscal stimulus measures to ensure our growth trajectory lifts and we avoid getting dragged back into the mire that many advanced economies are now headed for (or in).
Let’s go back to May 2011 when the Treasurer delivered his Budget Speech. In that Speech he said (among other things) that:
1. “the purpose of this Labor Government, and this Labor Budget, is to put the opportunities that flow from a strong economy within reach of more Australians. To get more people into work, and to train them for more rewarding jobs. So that national prosperity reaches more lives, in more corners, of our patchwork economy”.
2. “And to succeed in the good times as we did in the bad – by choice, not by chance – by applying the best combination of hard work, responsible budgeting, and well-considered policies to the difficult challenges ahead”.
3. “And just as deficits are the right thing to fight a global recession, or to rebuild from natural disasters, so too are surpluses right for an economy set to grow strongly again. We have imposed the strictest spending limits … ensuring our country lives within its means. We are on track for surplus in 2012-13, on time, as promised”.
4. “our commitment to tightening our belt has not diminished one bit. We’ll be back in the black by 2012-13, on time, as promised. The alternative – meandering back to surplus – would compound the pressures in our economy and push up the cost of living for pensioners and working people”.
5. “We will reach surplus despite company taxes not recovering like our economy”.
6. “Our economy transitions from sluggish growth to stretching at the seams; our Budget from deficits in tough times to surpluses in better times”.
And so on … you get the message.
This is the same nonsense that has driven the UK economy backwards since the new government took office in May 2010. Claiming that consumers and firms were just waiting for a commitment by government to lower the budget deficit before they would unleash a renewed spending burst (the Ricardian equivalance argument), the British government embarked on a harsh austerity drive – with the worst is yet to come.
The British economy started to slow almost immediately they were elected and promising drastic cuts and has been going backwards ever since. Yesterday’s release of the BRC-KPMG Retail Sales Monitor – which has a good track record in predicting movements in spending showed how bleak things have become in Britain.
The Monitor reports that:
UK retail sales values were 0.6% lower on a like-for-like basis from October 2010, when sales had risen 0.8% … Food sales growth slowed and non-food sales also weakened, with big-ticket items suffering most.
The official commentary went like this – “Which part of the wave we’re riding varies from month to month but the water is consistently chilly … This is evidence of the basic weakness of consumer confidence and demand and worrying this close to Christmas”.
There has been almost “no growth in non-food sales”.
The British government is single-handedly undermining private sector confidence and destroying jobs and private wealth. History will not judget their obstinate pursuit of free market ideology very well.
So while the Australian economy is not in as bad a shape as Britain the same vandalism by elected governments is out in force.
In Budget Paper No 1 you find the Table 1: Domestic economy forecasts, which provide the forward estimates of the key economic indicators that condition the budget estimates.
Budget Paper No. 1 says:
The current account deficit is expected to narrow sharply in 2010-11, reflecting the expected increase in the terms of trade, and then widen in 2011-12 and 2012-13, reflecting strong growth in import volumes and the expected gradual fall in the terms of trade. The trade balance moved into surplus in 2010-11 and is expected to remain in surplus over the next two years. The net income deficit is expected to widen over 2011-12 and 2012-13, as rising export earnings generate increased equity income outflows.
I agree that is likely to occur – an ongoing deficit – or drain to domestic demand (spending). This is one of the areas of macroeconomics that people find it hard to get their head around. Australia is enjoying record terms of trade (the prices of exports relative to imports) and export volumes are strong.
And with all the crazy commentary in the media (which is tapering off lately) about our “once-in-a-hundred-year” mining boom creating conditions of wealth never before seen, it is little wonder that people are looking for the golden lining.
But the reality is that the external sector remains a contractionary force because more of the income we earn from our booming exports are going into imports. So the rest of the world is actually enjoying our mining boom in terms of growth impetus. We end up with lots of imported gadgets etc but a drain on growth. I realise this is hard to for people to understand.
The following Table is constructed from the actual Budget estimates presented in May 2011. The Budget balance and Current account balance are taken directly from Budget Overview (budget balance) and Budget Paper No 1 (external balance).
The Private Domestic Balance is then computed according the National Accounting rule that the sum of the balances has to equal zero.
- The budget balances (T-G) – is positive if in surplus and negative if in deficit. T is total taxation and G is total government spending.
- The external balance (X-M) – is positive if in surplus.
- The private domestic balance (I-S) – is positive if in deficit (spending more than income) and vice versa. I is total investment and S is total private saving.
Please see this blog – Saturday Quiz – November 5, 2011 – answers and discussion (Question 2) – for a more detailed discussion of the way the sectoral balances are derived and interpreted.
The point is that the forward estimates are based on the range of assumptions that the Treasury make about government spending and tax policy settings, private spending growth, overall real GDP growth, inflation, interest rates, the labour market etc. Based on these assumptions, the national income trajectory would deliver these outcomes.
So this is what the Australian Government thought would happen back in May 2011 and reflected their fiscal strategy over the next several years. You will appreciate the following points:
1. The Australian household sector is carrying record levels of debt as a result of the credit binge prior to the crisis. It is now trying to increase its saving ratio back to the norms that pervaded before the financial sector unleashed the array of tantalising credit products.
2. The Australian property market is overvalued by a considerable margin as a result of the boom and prices are now dropping. I don’t expect there will be a collapse in the housing market along the lines we have witnessed in the US and in Europe but there will be an increasing number of Australians with negative equity over the next several years.
At the time I noted that the Government’s growth strategy hinged on the private sector going further into debt as the public sector withdrew spending support for the emerging growth process. Even at the time of the budget in May it was clear that private spending was weak and the intention was to save.
The other point is that the growth strategy replicated the circumstances that led the world into this crisis – a reliance on the private sector borrowing increasing amounts (spending more than it earns) – to drive spending and hence output growth.
At a time when the private domestic sector should have been deleveraging significantly (and for several years into the future) the Government was deliberately putting into place a strategy that relied on exactly the opposite occurring.
You will not read any analysis like this in the official Budget Papers. It certainly wasn’t in the Government’s political interests to admit that it could only achieve the planned surpluses by 2012-13 if it created conditions that forced the private sector into further indebtedness overall.
The reality is that the Government despite their “tough talk” were never going to succeed in achieving their fiscal ambitions. The reason – growth will not be strong enough. Why? Because the external sector is not adding to growth despite the boom and the private sector is now resuming more normal patterns of spending and saving. I say more normal to mean the behaviour that was evident for decades before the neo-liberal free market credit binge occurred.
In these “normal times” the Australian government ran budget deficits to support growth. The recent period of budget surpluses (1996-2007) was abnormal. On the rare occasions that the Australian government has run surpluses, a major slump has followed. That pattern is common in most nations – especially if they run external deficits.
Even the Canberra Times Editorial today (November 8, 2011) was calling for the Treasurer to abandon his surplus obsession.
Wayne Swan’s commitment to returning the federal budget to surplus by 2012-13, first made in the depths of the global financial crisis in 2009, has wavered little in the 2 years since. Nothing – not continuing economic uncertainty, declining tax revenues, draconian public sector ”savings” nor the misgivings of some economists about the necessity of a surplus in such circumstances – has been allowed to influence the Government’s thinking. However, a sharp deterioration in the Commonwealth’s financial position since the May budget makes it highly unlikely the goal of a $3.5 billion surplus by 2012-13 will be achieved.
They note that the Treasurer’s “determination that the deficit should be wiped by the appointed date is understandable from a political standpoint” given the Labor government has chosen to set the political terrain over fiscal responsibility in straitjacketed mainstream terms – the bigger the surplus the better – no matter what.
They are desperate to be seen by the electorate as “efficient economic managers” and so the surplus becomes an imperative.
It tells you how misguided the public debate over economic policy and budget outcomes has become. The electorate are so indoctrinated into believing that surpluses are good and deficits are bad that the actual reality is lost.
The Canberra Times adds to this nonsense by saying that:
Though a laudable aim of governments, budget surpluses are not always to be regarded as the fiscal equivalent of the holy grail.
Why are surpluses a laudable aim of governments?
Why is it laudable for government to deliberately:
1. Aim to increase the overall spending gap (fiscal drag) especially when the external sector is always in deficit (dragging on growth) and there is at least 12.5 per cent of willing workers idle according to the ABS (either unemployed or underemployed).
2. Force the private sector to have less purchasing power than otherwise.
3. Ensure there is less private employment.
4. Ensure there is less public employment.
5. Ensure there is less public infrastructure investment.
6. Ensure less education and training is provided.
7. Ensure there are less public services provided.
8. Ensure there is less scope for income support.
It is a different matter if a nation is running a strong external surplus (such as Norway) so that the first-class public services can be provided and full employment sustained at the same time as the private sector can save to their desired levels.
But that is a rare situation and one that Australia has never found itself in in recent decades. In our context, budget surpluses are very damaging to the economy.
The Canberra Times Editorial continues in this vein:
Indeed, in times of economic uncertainty they are undesirable (and probably unachievable). What is of greater importance is that governments run more surpluses than deficits over the economic cycle.
Again more confusion. Running “more surpluses than deficits over the economic cycle” is another ridiculous rule to aim for. Even so-called progressive economists fall prey to this seemingly reasonable ambition.
The logic goes like this. When the economy falters, it is okay to run a deficit. But overall the government should run surpluses.
Why is that reasonable? It just means that over the cycle the private sector would be running deficits that we equal (on average) to the average external deficit over the cycle. In other words, the private sector would be – on average – be continually spending more than they earned. The crisis was caused by that sort of growth strategy.
Any pre-imposed fiscal rule about budget balances make no sense at all. The only approach that makes any sense is to start by defining why we bother with government in the first place. We want government to advance the well-being of the populace. We might call this the public purpose role of government.
The state should maximise the potential of its population. The sustainable goal should be the zero waste of people! I consider this at least requires the state to maximise employment. Once the private sector has made its spending based on its expectations of the future, the government has to render those private decisions consistent with the objective of full employment.
Non-government spending gaps over the course of the cycle can only be filled by the government. The national government always has a choice:
- (a) Maintain full employment by ensuring there is no spending gap – that is run budget deficits commensurate with non-government surpluses; OR
- (b) Maintain some slack in the economy (persistent unemployment and underemployment) which means that the government deficit will be somewhat smaller and perhaps even, for a time, a budget surplus will be possible.
The irony and this relates to the Canberra Times bracketed assessment that the budget surplus is “probably unachievable” anyway, given what is happening in the economy, is that taking Option (b) in the hope that the fiscal austerity will deliver the surplus will probably result in a deficit anyway.
I call those sort of deficits – bad – because the economy doesn’t get anything good to show for it. The deficit is driven by rising unemployment which means tax revenue declines and welfare payments rise – a state of general malaise.
The automatic stabilisers ultimately close spending gaps because falling national income ensures that that the leakages equal the injections – so sectoral balances hold. But the resulting deficits will be driven by a declining economy and rising unemployment.
Alternatively, taking Option (a) produces good deficits because the public support for aggregate demand keeps output and employment growth strong and consistent with the aspirations of the workforce (for work) and incomes high.
Option (a) also generates virtuous movements in the automatic stabilisers (rising tax revenue and declining welfare spending because activity is high) which has the effect of reducing the deficit anyway.
Fiscal sustainability is about running good deficits to achieve full employment if the circumstances require that. You cannot define fiscal sustainability independently of the real economy and what the other sectors are doing.
Once we focus on financial ratios, we are effectively admitting that we do not want government to take responsibility of full employment (and the equity advantages that accompany that end).
That is why fiscal rules as stand-alone goals are meaningless or ideological. Please read my blogs – Fiscal rules going mad … and Fiscal sustainability and ratio fever – for more discussion on this point.
The Canberra Times Editorial does make some sense though and seems to realise that now is definitely not the time to be trying to run federal surpluses:
The GFC was a clear-cut case of an economic crisis that warranted a large dose of Keynesian pump-priming. As a result of the size and speed of Labor’s stimulus measures, Australia was one of only a handful of developed economies to avoid a recession. Nevertheless, and despite this achievement, Labor apparently remains obsessed by the notion that the one true indicator of good economic stewardship is a budget surplus, and that this can and must be achieved, even if it requires further cutbacks government outlays. However, a further round of austerity cuts at this time – when the global outlook remains uncertain and signs of weakness have reappeared in the Australian economy – is questionable, and probably unwise. As hard as it as to walk away from this particular promise, Mr Swan should accept that circumstances have changed and adjust his goals accordingly.
They should have gone further. A “further round of austerity cuts at this time” would not “probably” be “unwise” they would be completely irresponsible and demonstrate just how little the Government knew about sound fiscal management.
I don’t deny the politics are pushing the Government in this way.
The Opposition has been claiming that they would cut spending further to achieve a surplus – clearly thinking that the dollars the Government spends go no-where!
In reply to yesterday’s report, the Opposition Treasury spokesperson said:
This just confirms what we’ve been saying for an extended period of time … Labor can’t deliver surpluses, it’s not in their DNA. They haven’t delivered one since 1989-90, and I suspect they’re not ever going to deliver a surplus.
The facts are that since 1989-90, the Australian Labor Party’s tenure (to 1996 and then from late 2007) in government has coincided with two massive recessions – early 1990s – the worst downturn for Australia since the Great Depression and now the current crisis.
There is no way the government could have delivered a budget surplus in those year even if it had wanted to (which they did!).
Last night, as it became clear that the economy was shrinking and tax revenue was going to fall well short of the estimates, the Opposition leader said:
I think it’s important that the Government gets us back to surplus. I doubt very much that this government has the ticker to do so … Obviously if the Government does deliver the fiscal responsibility that Australia needs, we’ll applaud it … There are so many examples of waste under this government, the classic example is the $50 billion-plus national broadband network …
Meaning he would cut the only innovative infrastructure (fibre national network) project that this Government has introduced which will deliver massive benefits to future generations once in operation. It is akin to the development of railways and highway systems in the C19 and C20 century.
I do not support wasteful public spending – but I realise that it is a vexed area trying to determine what is wasteful or not. But what is important to realise is that whether the spending is wasteful or efficient doesn’t figure when we consider the impact on aggregate demand.
A dollar wasted has the same impact on overall activity as a dollar well spent.
So while I applaud attempts to cut waste – and I would start by cutting consultancy budgets and the sort of salaries that management get in public institutions like government departments, universities and statutory authorities – cutting spending to eliminate waste introduces the imperative to replace it with “good” spending to ensure that aggregate demand doesn’t falter.
When the conservatives rail about cutting public waste they don’t understand this point at all.
But the point is that by compromising sound economic management by political considerations just means the Government is failing on both grounds. They are failing to provide political leadership which would necessitate they disabuse the public of these notions that surpluses are good and deficits bad.
And by bowing to the rabid conservative hatred of deficits they are undermining the health of the economy.
What the whole debate misses is that Any financial target for budget deficits or the public debt to GDP ratio can never be a sensible. The budget outcome is largely endogenous!
It is highly unlikely that a government could actually hit some previously determined target if it wasn’t consistent with the public purpose aims to create full capacity utilisation.
Further, the government cannot impose incompatible goals on the economy. So with external deficits, it is impossible for the private domestic sector and the public secotr to run surpluses.
There is a need for a new macroeconomics narrative as a demonstration of political leadership. A revised macroeconomic narrative can help us understand: (a) The operational features of the monetary system; (b) The opportunities each monetary system presents to the national government.
A sovereign government always has the capacity to maintain continuous full employment. To achieve that goal – and bring the political and economic dialogues into accord – we have to abandon the focus on financial matters and reorient the debate toward the real side of the economy.
A new macroeconomic narrative is essential if the public is to be disabused of the myths that have been used to erode the collective will. Governments that abandon full employment and then punish the victims of this policy failure including low wage workers should not be supported. A fiscally responsible government aims to maximise the potential of all of its citizens. Public policy should always reflect that goal.
In response to the news that the surplus goal was unlikely to be possible, the Australian Treasurer just said he would cut spending further. The same nonsense that is killing Europe, the UK, and other places that have imposed fiscal austerity as a matter of ideology rather than good management.
The other point is that if they actually understood what was going on they would have realised the the surplus obsession was bad politics anyway. They were never going to achieve that goal given the other parameters and so they have just set themselves up to fail – yet the electorate will not equate failure in this case with a good outcome (which it is). That is how tragic the whole situation is.
That is enough for today!