Australia – the good and bad of the Economic Policy Statement

Last week, the Australian government issued an – Economic Statement – which provided updated estimates from Treasury (since the May 2013 Budget) of the state of the economy and the budget position. The good news is that the Government is allowing the deficit to rise after a year of contraction as part of its obsessive and impossible pursuit of a budget surplus this year. The bad news is that the Government is not allowing the deficit to rise enough and as a result unemployment is forecast to rise significantly above its already high levels. The reason? It is still trapped in its obsessive budget surplus mania even though the reality is forcing them to postpone when they claim they will deliver that outcome. The conclusion? The Treasury clearly is reeling from its massive forecasting errors (revenue is $Axx billion down of what they forecast in the May 2012 Budget and $AxX billion down on what they forecast in the May 2013 Budget). It is also realising that they cannot fight against a significant private sector spending slowdown.

On Page 25 of the Economic Statement you see a classic case of “everything’s fine but …” analysis that pervades the whole document:

The labour market is expected to remain resilient with slower wage growth, an important mechanism for supporting employment growth in the rest of the economy as the relatively employment-intensive resources construction phase passes its peak. Nevertheless, the unemployment rate is now expected to reach 61⁄4 per cent by mid-2014, owing to lower forecast real GDP growth and the current rate of unemployment being a little higher than expected. The unemployment rate is expected to stabilise at that level in 2014-15 but remain one of the lowest in the developed world, with many countries still feeling the effects of the global financial crisis

They know the truth is that the economy is starting to tank and that their past obsession with budget surpluses has, in part, caused the slowdown. But they still have to preface the admission that unemployment is going to rise from 4.9 per cent in April 2011 (after the fiscal stimulus and then mining investment combined to offset the worst of the global financial crisis in Australia) to 6.25 by June 2014.

We should note also that in February 2008, at the peak of the last economic cycle, the unemployment rate was 4 per cent and underemployment was 6 per cent. Underemployment is now at 7.3 per cent and rising with the unemployment rate.

The Government’s justification these days is that we are doing best than most nations, most of which are mired in recession or close to it, with dysfunctional policy settings and many do not even have control of their own currency.

To use these nations as our benchmark given we issue our own currency and do not peg it and have just been through a period of record terms-of-trade for our exports is ludicrous in the extreme and undermines any notion that the Government is on top of economic policy.

On Page 27, the detailed sectoral forecasts are presented, which allow us to assess how much contraction came from public final demand last year and the change in discretionary policy in the current fiscal year.

Private final demand was forecast in the May 2012 Budget to be 4 per cent and that is now being revised down to 3.5 per cent. We will know about the actual result in the common month when the June-quarter National Accounts is released.

For the current fiscal year (2013-14), private final demand was forecast in the May 2013 Budget to be 3.5 per cent and this has been revised down to a low 2.25 per cent with only a small improvement in the 2014-15 year now expected (2.5 per cent).

But the really interesting admission in the document is that public final demand contracted over fiscal year 2012-13, by 3 times more than they had forecast in the May 2012 Budget. In that document, they pursued a contraction in public final demand of -0.5 per cent but they now admit it will be -1.5 per cent, at a time that private final demand is also growing more slowly than predicted.

In other words, they have admitted that fiscal policy has been sharply pro-cyclical – that is, working with the cycle, which in this case means it has been causing the economy to slow faster than it otherwise was slowing due to a contraction in the pace of growth in private demand.

That is why the unemployment rate, which they forecast in the May 2012 Budget to be 5.5 per cent is already well above that and rising. It is also why their May 2013 Budget estimate for the unemployment to be 5.75 per cent in 2013-14 has been revised upwards to 6.25 per cent, a level that they claim will persist at least through to the end of June 2015.

On current labour force estimates, that is an additional 64.3 thousand workers who will be forced into joblessness because the Government refuses to provide sufficient spending stimulus to the economy via the Budget.

It has come some way towards realising that.

In the May 2013 Budget, it predicted that growth in public final demand would be zero in the current financial year. They have revised that in the August Economic Statement to a growth rate of 0.75 per cent and 1 per cent in 2014-15 (up from the previously estimated 0.5 per cent).

But do not get the impression that this amounts to any growth in spending. The Budget revisions are a reflection of the massive decline in forecast revenue that the slowing economy has delivered to the Federal government.

For 2013-14, the May 2013 Budget forecast an $A18,043 million deficit. That is now revised upwards to a $A30,142 million deficit. A substantial, but welcome variation, given it will provide greater support to aggregate demand that the initial fiscal position outlined in the Budget Statements.

What accounts for that variation?

1. Policy decisions increase the estimated deficit by $A373 million only (increased taxes of $A1,067 mostly offsetting increased spending of $A1,440).

2. Cyclical variations etc increase the estimated deficit by $A11,727 million (a decline in revenue of $A7,805 and a rise in spending of $A3,922).

Over the period the Government calls the “forward estimates” – 2013-14 to 2016-17 – total expected revenue has fallen by a staggering $A33.3 billion. While the number is of no particular importance, the reality is that the Australian Treasury grossly underestimated the speed at which the slowdown that the Government’s fiscal policy contraction was causing.

This level of forecasting inaccuracy (amounting to around 2 per cent of GDP over the period 2013-14 to 2015-16) is a sign that the modelling framework used by Treasury is defective and should be reconsidered. It means that the macroeconomic understanding held in Treasury is defective and they should seek advice. It means that fiscal policy has been excessively damaging to growth and employment and any claims to the contrary are wrong.

It also means that with a federal election now announced for September 7, 2013 the economic statements coming from the Federal Opposition are also decidedly nonsensical. They are claiming variously that the rise in unemployment forecast is a travesty (yes) and they would do something to reduce it (good). But then in the next breath, they deride the upwardly revised deficit forecasts as being “approaching the end of the world” territory (no) and that they would cut it dramatically (bad).

The statements are, of-course internally inconsistent even without my little quality assessments in brackets.

The fact that the Government is not proposing to cut spending even more in order to chase the declining tax revenue is a sign that it, at least, understands that it would cause even higher unemployment than it already has.

In other words, the rising deficit is mainly the work of the so-called automatic stabilisers. At least the government is allowing them to work (mostly).

But the fact that it won’t reverse the overall discretionary fiscal direction tells us that it is still locked into its mindless fiscal rules and has failed to understand that the real goals of government are not to “achieve budget surpluses, on average, over the medium term” (Page 43 of the Economic Statement) but to achieve full employment and price stability.

In terms of the real goal, this Government is a total failure. It is interesting to emphasise that in terms of its goal – it is also a total failure. And the two failings are linked.

Had the Government pursued the real goal and allowed the deficit to rise to support growth while private spending growth was lower than necessary, then the loss in tax revenue would have been much lower and it is not within the realms of possibility that the budget net position would have been to the Government’s liking.

However, none of that should be taken to mean that I care one iota about the headline budget figure. For a currency issuing nation such as Australia it is a figure that demands no attention. We should always concentrate on what it reflects – the real economy.

The Government’s version of it deliberate assault on employment growth over the last fiscal year is represented in the Economic Statement as “Responsible savings” which provides a “a strong focus on the medium-term sustainability of the budget”.

The reality is that cutting public final demand in a pro-cyclical manner and thus exacerbating the slowdown in private spending is fiscally irresponsible and amounts to vandalism. It is a signal of policy failure.

That policy failure is embedded it the fiscal rules that the Government refers to as its “medium-term fiscal strategy”:

• achieve budget surpluses, on average, over the medium term;
• keep taxation as a share of GDP, on average, below the level for 2007-08 (23.7 per cent); and
• improve the Government’s net financial worth over the medium term.

Do you see any reference to the external sector balance? Do you see any reference to the private domestic sector balance? Which means that these rules are without context to the wider economy, including the labour market.

It also means that the strategy is locking in the private domestic sector to run deficits, on average, over the medium term, given that the current account is likely to remain in substantial deficit for the foreseeable years. The Government is forecasting an external deficit of around 3.75 per cent of GDP over the forward estimates.

One of the reasons that private domestic sector spending is constrained at present is because the household sector, in particular, is carrying massive levels of debt after the last credit binge.

Relying on the private domestic sector to carry even higher levels of (increasing) debt as part of the fiscal strategy is madness and doomed to failure.

That failure is revealing itself now as successive estimates are not being realised and abandoned.

The only fiscal rule that makes sense is outlined in this blog – The full employment budget deficit condition.

It is interesting that last week, the CEO of one of the big four banks came out and chided the Government for its obsession with budget surpluses.

In the Fairfax press article (August 1, 2013) – More debt needed for investments: NAB chief – we read that Australia should “issue more debt to fund desperately needed infrastructure”.

He was quoted as saying:

If we continue to have the debate that suggests that all debt is bad, and not a debate on the productive use of debt, we will simply not be able to fund the degree of infrastructure this economy needs to thrive into the future.

Unfortunately, the reasoning deployed by the CEO – that we had this “unique window” arose because current government debt was low is erroneous.

Such a window always exists as long as there is spare capacity in the economy (or at times of full employment, that the government is willing to tax away resource access to the private sector to make spending space for public resource use).

The unique capacity is related to the currency issuing status and the current level of debt or fiscal position is largely irrelevant.

I would go further and say that the government should stop issuing debt and still engage in large-scale national infrastructure development.

Of-course, the banks want more public debt issued so they can more easily accomplish the new requirements for Basel 3.

Conclusion

So, it is good that the Government isn’t attempting to further cut spending to chase after the falling revenue, which earlier public spending cuts have, in part, caused.

It is bad that they are not seeing that their fiscal rules are ill conceived and that they are prepared to oversee a totally unnecessary rise in unemployment.

Kakadu National Park, NT, Australia

I spent a couple of days over the weekend just gone in the Kakadu National Park, which is about 3 hours drive east of Darwin. It is very remote and has some great places to visit although there is a lot of driving through dry scrubland involved. It is the dry season at present. In the wet seeason, a lot of the places we went to (and ran and hiked through) are inaccessible.

But it was a great experience and better than thinking about Government fiscal policy failures for a few days.

I took the first photo at the – Anbangbang Billabong – looking back to the Nourlangie Rock, which on the border of Kakadu and Arnhem Land. I just used the panorama function in my iPhone camera. It seems to work well. I normally am challenged by the need to keep the object in the centre of the frame!

The second photo is the view looking west from – Ubirr Rock – over the East Alligator River flood plain just before sunset.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.