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It’s official: debt isn’t the problem

The 2021 Intergenerational Report marks a decisive shift in Australia’s economic debate

John Edwards The Economy 30 June 2021 997 words

Spreading the load: treasurer Josh Frydenberg at the release of the 2021 Intergenerational Report on Monday. William West/AFP via Getty Images


The first thing that should be said about Monday’s Intergenerational Report is that, despite the largely critical reception, it is pretty good. Actually, very good. It is not a big-bang reform plan, but it was never intended to be. It is a strong piece of Treasury work, clearly presented and well supported. It helps us think about the evolution of the Australian economy over the next few decades, and the evolution of government spending and taxes. It therefore also guides us to what the political contest between the major parties will be about, or at least should be.

The striking conclusion is that we can get by, and quite well. This is despite net Australian government debt doubling since the pandemic, and despite deficits projected to add to net debt for the entire forty-year projection period to 2060–61. On the assumptions used in the report, Australian living standards measured as real income per head will be twice as high in forty years as they are today. We will be able to pay for sharply increasing health and aged care costs, for the projected cost of other current spending programs, for aged pensions and superannuation tax concessions and for increased defence spending, and yet end up with a net Australian government debt-to-GDP ratio markedly lower in forty years than it will be over the next few years.

We will be able to do all that with a ratio of taxes to GDP that doesn’t rise above a ceiling of 23.9 per cent — significantly lower than the average of the years when Peter Costello was treasurer. We can do it despite an ageing population, despite slowing population growth, despite a fall in the worker-to-population ratio and the workforce participation rate, despite an assumption that net migration is brought back up to pre-pandemic levels but is then capped, and despite a marked increase in the interest rate on government borrowing.

And while we face deficits for decades, the IGR numbers also show that if government spending is cut by 1 per cent of GDP from the share it will otherwise reach by 2061, while the revenue ceiling is raised to a tax share of 24.9 per cent from 23.9 per cent, the deficit disappears. Changes of that magnitude have been frequent in Australia’s fiscal history over the last four decades. It is a choice, but not one with significant economic consequence.

The remarkable significance of this report is that it officially frees Australia of the politics of debt obsession. It clearly isolates Australia’s long-term economic challenge not as government debt, not as rising healthcare or aged care costs, not as a growing tax burden, and not as an ageing population and slower population growth. We can cope with these. The outstandingly crucial issue, it shows, is the growth of productivity, or output per hour worked. In this report Treasury has shifted the fundamental economic debate from spending and taxation to productivity.

It has shifted the debate — and not just to productivity itself. The IGR also contributes to a wider discussion of the causes of the slowdown in productivity evident over the past few decades, not only in Australia but also in most other advanced economies.

Most of the productivity discussion in Australia in recent years has been about industrial relations and changes in the tax mix, a stale argument that is really more about shares of the pie than its size. More recently it has been argued that the productivity slowdown reflects insufficient investment. The IGR knocks that argument on the head. The slowdown in output per worker, it argues, is not because of insufficient investment but because of a decline in the growth of the efficiency with which labour and capital are used, or “multifactor productivity.”

The causes, the report speculates, may well include the increasing share of the workforce in services, the increasing share of output accounted for by sectors in which three or four big producers can make it difficult for new players to enter, and a slow take-up of new digital technologies. The report argues there is evidence of “declining dynamism” in industries, impeding the flow of resources from less productive to more productive firms. There’s evidence, too, that “Australian firms appear to be slower to adopt world-leading technologies,” with the result that “non-mining businesses in Australian have fallen further behind the global frontier firms and appear to be catching up more slowly.”

To the extent this is true, many of the members of the Business Council of Australia now posing as the hampered victims of governments cowed by “reform fatigue” are themselves the source of the productivity slowdown of which they complain. Once productivity as opposed to spending and revenue is isolated as the major economic issue, it becomes a widely shared responsibility.

It is quite true that the IGR’s ruling assumption of average productivity growth (and thus growth in living standards) of 1.5 per cent a year for forty years is right at the top of plausible outcomes. The GDP forecast of 2.6 per cent is accordingly also at the top of the range. The productivity assumption is rationalised as a projection of the average outcome over the last thirty years. But it can also be thought of as a target. If it can be achieved — and the IGR is candid enough not to assure us it will be, or to confidently tell us how it could be — Australia has a bright economic future.

If productivity growth remains markedly less than 1.5 per cent a year on average, though, the expected outcomes begin to deteriorate. If productivity growth averaged 1.2 per cent, the IGR shows, the deficit in forty years would be twice as high as a share of GDP than it would be with 1.5 per cent productivity growth, debt would be significantly higher, and real GDP nearly 10 per cent less. If this IGR succeeds in shifting the political debate to how to achieve productivity growth of 1.5 per cent, year after year, it will have done great service. •

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