Thirty years ago, Australia was in the depths of its longest recession since the 1930s. The unemployment rate climbed for three years to a peak of 11.2 per cent, then took a further eleven years to descend to its pre-recession level. And the reason it went on for so long? The Hawke–Keating government and the Reserve Bank felt no need to do anything about it.
We were already in recession when Paul Keating brought down the August 1990 budget, but neither the government nor the bank admitted it. Keating blithely forecast no recession, and did nothing to stimulate activity. Earlier in 1990, the Reserve Bank had lowered the cash rate from its ridiculous peak of 18 per cent to 15 per cent, but then sat on its hands for months without cutting it further, as companies collapsed and workers were laid off around it.
Even a year later, when the recession was at its peak, the August 1991 budget did nothing to tackle it, with Treasury persuading the new treasurer, John Kerin, that there was no need. The Reserve Bank’s cash rate was still 10.5 per cent — it had gone up in the lift, but had to come down by the stairs.
The classic summary of Australia’s policy in that recession was a cartoon by the great Bruce Petty in the Age. Kerin, at the wheel of a cobweb-smothered car labelled “Treasury Driving School,” asks his instructor, “Don’t you think I should try to restart the motor?” To which the Treasury guy replies, “What! And risk having it stop again!”
The contrast between economic policy then and now is stunning. The recession of 2020 was over almost before it began. It stood no chance against the deluge of money flowing from the federal government to households and business, and from the banking system (directed by the Reserve Bank) to anyone who wanted to borrow.
In this recession, incomes soared: the Bureau of Statistics estimates that household disposable income in 2020 shot up by $85 billion, or 6.6 per cent. House prices soared: Core Logic reports that at the end of April, prices nationally were already up 10 per cent since September, and rising by roughly 2 per cent a month. In most areas of the economy, the jobs came back quickly. By March, the employment/population ratio was back where it was when Covid struck. The recession was over, the economy booming – and the need for stimulus was gone.
Yet, in the mirror image of what we saw in 1990–91, today’s federal government and the Reserve Bank aren’t changing course. This time they both have their feet jammed on the accelerator pedal.
And just as in 1990–91 — when the commentariat (except for a few of us in Melbourne) either applauded the government for holding firm or suggested it should be even tougher — this time the commentariat is either applauding the government for keeping its foot down, or arguing that it should accelerate harder.
The last criticism is bizarre. We may think the government spends too much in some areas — for example, the $10,000 per person per day it reportedly pays Brisbane company Canstruct to run the offshore prison for asylum seekers on Nauru (per Ben Doherty in the Guardian) or the $50 million it has reportedly spent to drag a Tamil refugee family from Biloela through the courts and imprison them on Christmas Island (per Michael Pascoe in the New Daily) — but the economy is already back in gear, by any sensible definition, and yet this big-spending budget is still pumping on the accelerator.
In the coming financial year the government plans to spend 27.6 per cent of the nation’s GDP, compared with our long-term average of 24.6 per cent. Just on that measure, it will be the third-highest rate of spending in any year since the second world war, beaten only by the current year and last year. In round figures, the government will spend an extra $60 billion on pumping up an economy that is already back to normal.
This year’s deficit, at 7.8 per cent of GDP, is easily the highest on record. On the budget estimates, next year’s will be the second-highest, and 2022–23 will be the third-highest. There is no need to run deficits on that scale.
As for the Reserve Bank, nothing in its previous history remotely compares with the measures it is now taking to flood the economy with money, as spelt out last week in a speech by deputy governor Guy Debelle.
Debelle was very direct in declaring that the bank’s goal was to lower unemployment, and the collateral damage to other goals — notably, housing affordability — wouldn’t stop it. I accept that there are good arguments for this. We will come to them.
But let’s take stock. Unemployment in March was 5.6 per cent, a smidgeon below the average of the pre-Covid unemployment rate since the Coalition took power. If unemployment at that level wasn’t a good reason to stimulate the economy anytime between 2013 and 2020, why now?
Forecasting is a risky game, but most of Treasury’s forecasts this year feel more realistic and less wishful than in the past. It forecasts the economy to grow by 4.25 per cent in the new financial year, driven by strong consumer spending and the public sector’s foot on the pedal. It predicts unemployment this time next year to be 5 per cent, the lowest for a decade. The Reserve Bank tips it to be even lower, 4.75 per cent, the lowest rate since mid 2008.
Sure, we want it to be lower than that. A sad bit of humbug that Treasury persists with in this budget is its estimate that unemployment can only fall to between 4.5 and 5 per cent without causing inflation to accelerate. As it knows, that estimate has no factual evidence to back it; the last wage-driven inflation we experienced was in the 1980s, under a quite different industrial relations system. Comparable countries like Germany and the United States have driven their unemployment rates down to 3.5 per cent and lower without experiencing rising inflation.
As Ross Garnaut argues in his recent book Reset: Restoring Australia after the Pandemic Recession, it makes more sense to aim to drive unemployment to 3.5 per cent or lower, then put the brakes on only when you see signs of inflation heading higher than you want it to be.
To the extent that the government is being driven by a desire to lower unemployment and increase wage growth, more power to its arm. But is this the best way of getting there? Or should the Morrison government drop its aversion to economic reform, especially tax reform, and find a better way?
The problem with this budget is not that it is spending too much money. It is that it is spending too much money without paying for it — and sending the bill to the kids.
Unless you think the government should make the Reserve Bank fund whatever deficit it wants to run, that is the inescapable impact of budget deficits: you kick the can down the road, but the debt must be paid at some later time. That’s fine if you are using the deficit to build the economy’s capacity to pay it later, but most government spending doesn’t really do that.
The single biggest item in the budget is a substantial unfunded increase in aged care spending, from $19.75 billion in 2019–20 to $31.1 billion five years later. The spending is needed, as the royal commission demonstrated, but that is not something we should be asking future generations to pay for. We should be paying for it ourselves.
The royal commission proposed a Medicare-style levy. I have no doubt that this would have been accepted by the majority of Australians. But it was not acceptable to Scott Morrison and Josh Frydenberg. They are happy to spend the money but lack the political courage to ask us to pay.
Some genuine conservatives would argue for an alternative system that would set higher standards for nursing homes, and improve their ability to access the value of their patients’ real estate to fund the improvement. That alternative would leave the government picking up the tab just for those without the means to pay for care themselves. But that too was unacceptable to the Morrison government. So instead it is spending without paying.
The table that holds the key to the whole budget is on page 79 of Budget Paper No. 1. It reveals that in the five months since the midyear outlook last December, the unexpectedly strong recovery improved the underlying cash balance for the five years to 2025 by $104 billion. But the budget banked just $8 billion of that. Instead, the government has opted to spend an extra $68 billion and cut $28 billion off tax revenue — boosting the cumulative budget deficits by $96 billion.
Most of the tax cuts will defer revenue rather than wipe it, so the net long-term cost is more like $80 billion for those five years, plus the $15 billion a year cost of continuing the unfunded spending. It’s like spending an extra $155 billion over the next ten years, waving to the kids and saying, “Thanks, guys. You can pay for this.”
While spending as a share of GDP is at record highs, taxes as a share of GDP are at near-record lows. In the past forty years, the only years when taxes have been lower as a share of GDP were 1991–94 (the long recession) and 2009–12 (the unaffordable tax cuts Peter Costello unveiled to try to win the 2007 election, which Labor then implemented).
The political reasons for this are obvious. In 1990 Labor had just been re-elected (just!), and so was not concerned by the prospect of rising unemployment. In 2021 the Coalition is preparing to face an election. For it, winning that election takes priority over any economic argument. People want jobs more than they want a balanced budget, so that’s what this budget aims to provide.
Most commentators have missed the obvious corollary. After the election, assuming the government is re-elected, pleasing people will not matter so much. Expect to hear Josh Frydenberg wax as righteous next year about the need to reduce the deficit as he is now about the need to reduce unemployment.
I don’t believe this is a long-term change of strategy by the Coalition; it won’t dump its political tactic of branding itself as the “fiscally responsible” party and Labor as the party standing for deficits. This is a short-term tack that will be reversed after the election. Of course no government promising $503 billion of deficits in five years can be called fiscally responsible, so it will make cuts then to reclaim the brand.
Some will say: “Dude, you’re out of date. Our modern thinking is that governments don’t need to run surpluses. They can just send the bill for the deficits to the Reserve Bank, and it can finance them — and tear up the debt.”
The government and the Reserve have already taken a first step in that direction. At the end of March 2019, the bank held just $3 billion of the roughly $620 billion of government securities then on issue. At the end of March 2021, it held $150 billion of them. While it has bought them in the market rather than from government directly, in net terms it has financed about half of the Covid deficits so far.
But there is no suggestion that it is buying worthless assets that will be torn up down the track. To treat Australian government securities like that would run big risks for all the nation’s financing on global markets. The government will eventually have to repay the Reserve Bank the value of that debt. It will have to get the money either by running significant budget surpluses or (more likely) by issuing new debt at whatever the going rates are at the time. They are unlikely to be as benevolent as those we have now.
As for the Reserve’s own monetary policy, it knows that while cutting interest rates helps stimulate business investment — its ostensible aim — it has even more impact on asset prices. It is throwing fuel on the fire of housing prices, putting home ownership even more of out of reach for aspiring homebuyers.
It is time we went back to economic reform, which the Coalition largely abandoned twenty years ago after its near-death experience introducing the GST. We need to get the adults back in the room, to look at how governments can do their business more efficiently. Bad politics has made good economics take a back seat for too long.
We don’t have to spend $10,000 a day locking up refugees who pose no threat to Australia. We don’t have to allow housing investors to run up losses they can use to reduce their tax bills. We don’t have to allow business to deduct interest bills from their taxable income. We don’t have to allow family trusts and offshore tax havens to enjoy special tax status. We don’t have to allow mining companies to be exempted from the fuel taxes others pay.
Similarly, if our goal is to lower unemployment, we need to look harder at why so many Australians have remained unemployed even though we pride ourselves on having been one of the fastest-growing economies in the Western world over the past thirty years. We would look at the importance of skills training, how we could provide support rather than punishment to vulnerable people out of work, and how we could stop skilled employment visas being used to bring in cheap foreign labour to do the entry-level jobs that formerly gave young Australians their start in the labour market.
We could do more to achieve our goals without leaving huge bills for the kids while pricing them out of home ownership. But it takes political courage. And after 2019, that is in short supply.
Two last points. The $68 billion of net new spending didn’t apply to universities, where the budget proposes to cut support — even though, as the ANU’s Andrew Norton has pointed out, the need for government help is intensifying as the number of foreign students falls sharply. It is breathtaking, and it is tragic, to see this government deliberately starving one of Australia’s main growth industries because it sees universities as the home of political opponents. Menzies would be appalled.
Second, it is not true that the government has decided that Australia’s borders will not reopen until mid 2022, as other media have implied. Rather, to estimate the budget numbers Treasury and Finance had to make some assumptions about what will happen with Covid and the borders — and this was one of the assumptions they chose to make. Frankly, anybody who was shocked by it can’t be following the rising rate of global Covid infections very carefully.
For many reasons, it would be in Australia’s interests for the federal and state governments to be moving faster to expand the areas in which we are opening up. But that involves taking an increased risk, and it seems clear that most Australians don’t want their governments to do that.
Having chosen to “eradicate” Covid-19 rather than learn to live with it, as others have done, it follows that Australia will be one of the last countries to open its borders to the world. I for one would be surprised if this happened by mid 2022. •
