Turnbull: Labor plan takes growth for granted

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Not for the first time, MB wishes that there were a fifth law of thermodynamics that triggered the spontaneous implosion of those guilty of cosmic levels of hypocrisy. From Mad King Malcolm:

“Our opponents take a … very complacent view. They seem to assume that economic growth is a given, and that no matter how much you tax, how much you spend, the good times will keep on rolling,” he said.

“The 2020 vision of Kevin Rudd crumbled in the chaos of the Labor-Greens minority’s government debacle.

“Much like Kevin Rudd, now Bill Shorten wants to take us on a flight of fantasy to 2026. The same old Labor; Australians will not be taken for fools.

“It has often been observed that a vision without resources is an hallucination.”

Let’s make no bones about it, Labor has been bloody stupid handing the Government the free kick of running higher deficits in the short term. But, Australians have already very much been taken for fools by the Mad King and his resourceless Budget, which takes “growth for granted” on a grand scale. As Treasury itself basically confessed:

The medium-term economic and fiscal projections are sensitive to the assumptions that underpin Treasury’s estimate of potential GDP — that is, assumptions about population, productivity and participation. They are also sensitive to the assumed pace of the economy’s return to potential — that is, the assumption that the adjustment period lasts five years.

Analysis reported in the 2016-17 Budget shows that a faster (two year) adjustment to potential requires comparatively faster growth in real GDP and employment as the output gap closes and spare labour is put to use. This leads to lower unemployment and faster growth in wages and domestic prices, increasing nominal GDP and improving the projected underlying cash balance over the medium term even as long-run real GDP is unchanged from the Budget projections. A more gradual adjustment period (eight years) is estimated to have broadly opposite effects on the projections.

Analysis in the 2016-17 Budget also shows that lower trend productivity growth than assumed in the Budget projections would directly reduce potential growth — leading to permanently lower real GDP and wages with only a small impact on prices. In this scenario, lower nominal GDP leads to lower projected tax receipts which weakens the projected underlying cash balance over the medium term. By contrast, assuming faster trend productivity growth than assumed in the Budget projections results in higher nominal GDP and tax receipts, strengthening the underlying cash balance.

…The medium-term projections show that, without considerable effort to reduce spending growth, it will not be possible to run underlying cash surpluses, say in the order of one per cent of GDP, without tax receipts rising above 23.9 per cent of GDP. Even if payments were reduced from the levels projected at the 2016-17 Budget to the long-term average of 24.9 per cent of GDP by the end of the medium term, tax receipts would still need to rise to around 24.2 per cent of GDP by 2026-27, well above the average of the past 30 years, to achieve a surplus of one per cent of GDP. Reducing spending growth has proved difficult in practice.

…Australia has a relatively strong fiscal position by international standards. However, Commonwealth Government debt levels are projected to reach recent historical highs, both on a gross and net basis. These debt levels are not an immediate concern given historically low interest rates and a growing economy. But should Australia experience a significant negative economic shock or increased interest rates or debt levels rise above current projections over the medium term, the debt burden will impose an increasingly significant cost on the fiscal and economic outlook. It is crucial for Australia to maintain its top credit rating to ensure the Commonwealth’s borrowing costs, and those across the economy more generally, are kept as low as possible.

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The RBA agreed:

Plans to balance Australia’s federal budget by around 2021 are implausible, says Reserve Bank policymaker and economist John Edwards, adding that the nation risks losing its prized AAA credit-rating status.

Mr Edwards said the plan outlined by Treasurer Scott Morrison in the government’s 2016-17 budget to bring the budget back into balance by 2021 was too slow as it relies on rising income tax collections to be achieved.

“I don’t think we can disregard the possibility that the ratings agencies will lose patience with a fiscal trajectory which is simply not plausible, relying as it does on increased personal tax collections,” Mr Edwards, a Reserve Bank of Australia board member, said in an interview with The Wall Street Journal.

If Australia lost its AAA rating, it would be a “big deal,” he added.

“Given that we have higher foreign liabilities than similar rated countries, and given that debt as a share of GDP is rising more rapidly than many other highly rated countries, there is always a risk we are going to be kicked out of the (AAA) club,” he said.

Mr Edwards said a return to budget balance over the next two years would be a smarter idea, saying the government has favored tax cuts for corporations over the mounting task of lowering the budget deficit, which would protect the economy against shocks.

Moody’s did too:

“The projected increase in revenues as a share of GDP is based on a return to robust nominal GDP growth which generally comes with a higher revenue-intensity of growth. Our forecast for nominal GDP growth is somewhat more muted than the government’s. We estimate that the adjustment to an environment of lower commodity prices is still underway and will continue to weigh on corporate profitability and wage growth. As a result, improvements in the government’s revenues may be somewhat more muted than currently budgeted.

PM Turnbull’s Budget outlook is a pure hallucination yet it forms the underpinning for both party’s election costings in the Pre-Election Fiscal Outlook (PEFO). The problem begins with the iron ore price:

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The 2016/17 Budget of Lies is behind by roughly -$20 per tonne, a full 40% drop on the Mad King’s fantasy outlook. Taking the most reliable futures market in Singapore, on iron ore alone the Budget is currently mis-pricing nominal GDP by some $25 billion and tax receipts by $8 billion per annum.

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But that is only the beginning. Other assumptions are just as bad:

  • dwelling investment to grow 2% when we already know it has peaked in ABS data;
  • business investment is expected to fall -5% when hard ABS data is already measuring it at -14%;
  • wages and demand growth based on 1.6% productivity gains and 2.5% wages growth when the current trend is sharp falls and 1.6% wages growth in the last quarter (and still falling);
  • nominal growth is supposed to be 4.25% but when you add the right outlook it falls to 2.5%, the same as this year, at best.

So, the deficit reduction outlook is also a lie. Here’s what the chart looks like when you apply realistic assumptions:

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And the net debt outlook as well with realistic assumptions:

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Budget of lies = PEFO of lies = election of lies = PM of lies.

Not only should Labor have matched the Coalition deficit outcomes, they should have gone further and based their costings on realistic economic modelling assumptions to expose the Government.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.