The great deficit embrace


Chalk up another one for MB. For the past two years we’ve forecast that there will be no return to surplus for the Australian budget ever again. And now the world is waking up in a rush.

Over the weekend Tony Abbott ended the Coalition’s commitment to a public surplus for the its first year in office and probably for all time. From the AFR:

Opposition Leader Tony Abbott has declared “all bets are off” on whether the Coalition will deliver a surplus in what could be its first year in office, prompting warnings from a prominent economist that the budget may not be balanced for years.

The Gillard government seized on the shift to accuse the Coalition of “crab walking” away from a promise to deliver a surplus in its first year in office after pummelling the government for never posting a surplus.

“This is despite the Coalition telling Australians repeatedly that they will deliver a surplus, even after the government had flagged that doing so would risk jobs and growth,” Assistant Treasurer David Bradbury said.

“The hypocrisy from Tony Abbott about the surplus is extraordinary.”

Asked at a public meeting in Melbourne when the Coalition would deliver its surplus, Mr Abbott said he had previously been confident about the timing based on government figures as they stood just before Christmas. He indicated he had changed position because the government wouldn’t reveal the budget’s true state.

“But all bets are off given that the ­government won’t tell us what the deficit will be,” he said.

…Mr Abbott said: “We are confident that we will, at all times, deliver more prudent and responsible financial management than the current government because it’s in our DNA to deliver surpluses and pay back debt. Just look at what the Howard government did.”

Sensible choice from Abbott, economically and politically. Politics 101 at work here. Break your promise, blame the other guys. Not that it matters given Wayne Swan’s impeccably bad timing has led him to declare today:

…that the budget will not return to surplus until tax collections recover from a strong dollar “sledgehammer” that he said pushed revenues $7.5 billion below official forecasts for this financial year.

Mr Swan said the revenue write-down would occur across the four-year budget forecasts, putting at risk the $6.4 billion surplus which the government’s mid-year budget update in October projected for 2015-16.

But he suggested the government would not seek to offset the revenue write-down with spending cuts, instead allowing the so-called “automatic stabilisers” to work and weaker revenue to flow through to the bottom line.

The government would be “taking the responsible course in fiscal policy that when revenue returns then we come back to surplus,” Mr Swan said.

“If you’ve got this hit to revenue we shouldn’t be seeking to make up for it by savage cuts across the budget.”

No, you shouldn’t. Not when you’re headed off an investment cliff. And Swan’s solution is good news. At least we now know that when we fall off the mining investment cliff later this year that fiscal policy won’t be pro-cyclical. But it does not look like it will be very anti-cyclical either, which is what what will actually be needed for any decent growth outcome. So both parties have now committed themselves to an at best outcome of a low growth economy for the foreseeable future.

Meanwhile, the Grattan Institute is now forecasting deficits to eternity, From The Conversation:

Structural changes in the economy are likely to leave Governments across Australia facing budget deficits of around 4% of GDP for at least the next decade, according to research released today.

The Grattan Institute paper, Budget Pressures on Australian Governments, suggests it could be a long time before Australian governments post a collective surplus.

While the budgets of the Commonwealth and the states are forecast to be close to balanced within the next few years, our research shows flagging revenues and continued spending pressures have put them on track to post annual deficits of around 4% of GDP within a decade.

The greatest pressure comes from sustained increases in health spending. Over the past decade, in real terms, governments spent an additional $43 billion on health. At this rate, government spending on health will rise by 2% of GDP over the next decade. Contrary to popular belief, this is not primarily because of the ageing population but is driven by changes to the practice of medicine. Australians of all ages are seeing doctors more often, having more tests and operations, and taking more prescription drugs. They are living longer, better lives, but someone has to pay for it.

Spending on school education also rose substantially in real terms, although to date it has done little to improve student performance. Welfare expenditure grew more slowly, but only because of low unemployment and slow growth in benefits for Newstart, Youth Allowance and parenting payments. The other three large categories of welfare spending – aged and disability pensions and family support – all grew by around 50% in real terms over the last decade.

As with health, demography is not the major driver of increased aged pension spending. Most of the growth above GDP resulted from government policy choices to increase pension benefits.

Real increases in government spending 2003 to 2013 (2013 $ billions)


If these trends continue, they will increase welfare expenditures by another 0.5% of GDP. Welfare spending could also grow if the end of the mining boom brings an increase in inequality and an end to rising real incomes. Overseas these have led to increased pressure for welfare payments.

Increases in costs are not the only pressures on government budgets. Underlying revenues are weaker than they seem. Company and mining taxes, and carbon price revenues are likely to be 1% of GDP – or $15 billion a year – less than current forecasts. Current revenues are also inflated by the mining boom and Australia’s high terms of trade. If, as many predict, minerals prices fall, revenues will fall by another 1% of GDP.

Finally, the federal government and opposition have both raised expectations of substantial new expenditures on the National Disability Insurance Scheme, schools, additional paid parental leave, and carbon Direct Action, among other policies. Even a subset of these could well cost 0.5% of GDP.

Over the economic cycle of boom and bust, balanced budgets are much better than the alternative. Persistent government deficits incur interest payments, limit future borrowings and, as many European countries are learning, drastically reduce the capacity to fund services and programs. Deficits can make it hard for governments to spend to overcome an economic crisis, and can load a debt burden onto future generations. Given all the problems persistent deficits cause, why do they exist? Very often, the answer is politics.

Governments invariably find it hard to run a surplus, even in good times. The temptation to please voters and spend money is just too great. In Australia, voters have come to expect policies that leave no losers.

With these pressures, responsible leaders will need to find 4% of GDP in savings and tax increases to balance their books by 2023, That will require governments to make savings and increase taxes to the tune of $60 billion a year in today’s terms. How can they do this and is it likely?

The signs aren’t good. At a forum organised by the Australian Financial Review late last week, shadow treasurer Joe Hockey — who pledged in January that a Coalition government would deliver a first-term surplus — acknowledged that such an outcome would be unlikely. Instead Hockey emphasised the importance of being prudent. “We’re not going to go down the path of austerity simply to bring the budget back to surplus because it would end up being a temporary surplus depending on how big the deficit is that we inherit,“ he said.

Potential deficit of Australian governments (percent of GDP)


Smaller government is not necessarily the answer. Australian government spending as a proportion of GDP – 34% – is low by OECD standards. Globally, there are big governments that run surpluses and small ones that are persistently in deficit. While increasing productivity and participation are good ideas, they are also unlikely to solve the problem.

We will have to leave more options on the table. Health, education, welfare, defence and transport account for more than two thirds of government revenue.

Commonwealth, state and territory governments expenditure by policy area, 2012-13


To retrieve a budget deficit equivalent to 12% of government spending, cuts to some (or all) of these areas are inevitable. We cannot afford – as the Gonski reforms are suggesting – to guarantee continued growth in education spending without searching for efficiencies. Similarly, we will need to look harder at how health services can be delivered at lower cost.

History suggests that the only way to improve budgets is through tough policy choices. That does not mean politicians have to slash and burn. But they do have to change political culture.

Over the last decade, governments have tended to “buy” reform, accompanying any budget pain with a budget gain. The GST, the carbon pricing reforms, and school funding all came with promises that all but the wealthiest would be “no worse off”. In a decade of rising government revenue, exceptional economic growth, and rising prices for Australian minerals, governments could afford this approach.

The future will be more difficult. Clawing back a budget deficit of 4% of GDP requires that everyone bears some budget pain. Governments will have to sell this message. This will be politically difficult, but the alternative is unsustainable: budget deficits that will be even more painful to reverse in the future.

Australia’s strong economy gives our governments more options than many of their overseas counterparts. But they need to explain to the public why balanced budgets matter, for our current prosperity and that of future generations. Everyone will need to give up something. Which brave leaders will step forward?

“Australia’s strong economy” is a cliche undermined by the article itself. The economy’s strength was based upon a cyclical chimera of temporary income born high commodity prices. That we saw it as anything else was a big mistake.

On Friday Moody’s also said:

Global ratings agency Moody’s Investors Service said on Friday its ­outlook for Australia’s AAA credit rating was stable and the risk of a downgrade was “relatively low” despite the budget remaining in deficit for longer than targeted.

Moody’s senior vice-president Steven Hess told Weekend AFR the high dollar threatened the budget.

“If the exchange rate does not adjust, the end of the investment boom in mining and lower commodity prices – if they materialise – could mean that growth will be below its recent pace in the coming few years,” he said.

“This is only a risk at this point, and not a forecast. Nonetheless, such a scenario would mean the government’s achieving a budget surplus would be more difficult.”

I am prepared to bet that the dollar will adjust but growth will still be poor and the incoming Coalition government will lose the AAA rating in its first two years of office. Prepare accordingly, banks.

Houses and Holes
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  1. ‘I am prepared to bet that the dollar will adjust’

    when roughly are you tipping, and are you tipping a slow gradual adjustment or a patella-prostate adjustment?

    For mine I reckon maybe they can keep the macro facade in place until an election in which case there probably wont be much adjustment. But at some time a see a short sharp something

    • Who knows? But the 2014 convergence of a violent mining cliff, falling ToT on iron ore oversupply and a stimulus-shy new Tory government looks like a very strong candidate.

      • In those circumstances how do you fund a stimulus? A stimulus results in increased CAD’s. When capital is leaving how do you fund it?

        If you just allow the dollar to crash what do you do about the resulting inflation? Raise interest rates? Ineffective I know but necessary in the circumstances.

  2. Now that it appears clear that all are convinced that we need government to do the spending that people are not willing to do (nasty tightwads) the question arises how these endless spendathons will be funded.

    Sell bonds to foreign govts and thereby put upward pressure on the dollar and find ourselves dancing to the tune of our international creditors?

    Sell Aussie bonds to locals?

    Perhaps a bit of MMT and not borrow the funds from anyone.

    How about a radical alternative and get to work on some of the micro economic chaos that undermines confidence, drives up cost ( land) and distorts the economic messaging that allows people to invest in skills and business and the future of the country.

    Bit more of that and we may need a lot less ‘demand pot hole filling’ by our pork barrel specialists.

    • *sell Aussie bonds to locals

      Heap of assets sitting in super that are unlikely to get a better risk-adjusted/currency adjusted return than govt bonds in the next decade or so…

      We should have been doing this a decade ago – fostering a larger uptake of govt bonds in super, branching out into infrastructure (both local and national), even my Research Bond idea, instead of having this funded by asset sales or foreign bond owners.

      It may be too late? As much as the Coalition has now embraced deficits, the paranoia around govt debt remains.

      • Are we going to confiscate the Super Funds or pay them appropriate positive RAT returns?

        If the latter what effect will the increased interest rates have on the economy?

        How do we fund the on-going CAD’s if all we are doing is maintaining our spending levels?

        • Good point flawse.

          If govts are going to raise funds from aussie bonds they must bid for the money and pay the rates required.

          Needless to say – the currency will sag as foreigners are unable to buy these Aussie bonds. A softening currency should start the process of addressing the CAD concerns.

          Less reliance on overseas capital will be a challenge but we should (as a wealthy 1st world economy)be a capital exporting country not a bunch of credit card scroungers.

      • Agree, a mix of lots of 4 (micro reform) and some 2 ( aussie bonds) is the best mix.

        Limiting bond sales to locals will be an excellent discipline as the rates required to attract funds from locals are likely to better reflect our national tendency towards over consumption and under investment in productive assets.

        Of course if the money is spent on pork and marketing distorting incentives that encourage malinvestment throughout the economy we may not get very far.

        • Actually if the dollar does drop , maybe Pork might be competitive. A family of farmers I used to know got out pig farming in 2007 cause they could see the dollar rising.I am not sure but I dont think we are exporting pork.

          • Indeed, the real pork market has been greatly damaged by a flood of domestic metaphoric pork.

      • Theres a lot to be said for a more constructive use of bonds.

        But ultimately I reckon someone has to take a stand on transfer payments to vested interests.

        …..and while commercial media is victimising single mothers and disabled, the private school set and real estate lobby will will presumably keep their place on a public teat.

      • I think trust in government (and its competence) generally – irrespective of brand – will continue to deteriorate. Ergo, those hoping for the general public to embrace “investing” in government using their retirement nest egg may be in for a rude shock.

        They will just steal it (super) … under a smokescreen of comforting platitudes.

  3. Take no hard decisions (specifically on Abbott’s favourite thing middle class welfare) and blame it all on the other guy.

    What’s the easiest way to switch a substantial amount of money to another currency? I don’t think my pokerstars account cuts it.

  4. A good deal of the health and education spending is wasted on federal/state duplication and excessive bureaucracy at both levels. Plenty of easy runs on the board there.

    Then we have corporate welfare. A lot of which ends up going overseas to prop up what are effectively sheltered workshops.

    Then we have the tax system, which overtaxes income and undertaxes consumption.

    And land use restrictions driving up costs for everyone.

    Well, that’s just the start of my personal list. Aorta do something about it.

    • Plus:

      Shut down the whole CC and Carbon Tax apparatus- hundreds of millions perhaps Billions saved.

      Massive cuts to foreign aid- we send $3-400 mill a year to PNG alone and per capita they are a very wealthy nation. Overal several Billion in savings.

      Audit Indiginous welfare. The waste in this space is obsene and chronic with virtually no positive changes observed.

      Our welfare system is a huge rort. Over 800k people in Disability ? Despite high levels of health and wellbeing scores, we are the most disable afflicted country in the OECD. All able bodied recipients must work for their strictly defined benefit – that would thin the unemployed ranks.

      Time to respect the taxpayer dollar. Freeloaders need to be cleaned out of the trough.

      • Ronin8317MEMBER

        It would be stupid to cut foreign aid. PNG have huge potentials for economic development if you can get the security problem under control, there are huge security implication for Australia if China becomes their sponsor and open a naval base there.

        The biggest recipient of Australian foreign aid is Indonesia, and the money is vital to prevent the country from becoming a Salafist state. You do not want their madrasa funded by Saudi money, is as they are the number one source of radical Islam in the world today.

        Solomon islands, on the other hand.. I have no idea why we’re spending almost 300mil there.

        • As usual, the MSM have only read the press release. The paper itself is a little more nuanced, especially when you read the text as well as the summary. Quote: “The area-weighted average of the best estimate of past temperature from all seven regions indicates that 1971–2000 was warmer than
          any other time in nearly 1,400 years (Fig. 4b), keeping in mind that this analysis does not consider the uncertainty associated with the temperature estimates, and that the reconstructions are of different
          lengths. Area-weighted averages of the three alternative reconstructions generally support this result (Supplementary Fig.  S5). Large uncertainties remain, especially during the first millennium, when only some regions are represented.”

          If you want to read the whole thing, see here

      • Foreign aid review – check; Indigenous Welfare – double check, make that tipple check; Dability review – check. Maybe get Labour to reverse the what the Libs did to massage the long term unemployment numbers by moving them to disability incomes. Nah, that’ll never happen, even Tony wont deal with that one.

  5. Here’s an idea, we let the bubble deflate and allow the economy to readjust on its own. I know that might sound radical to the wise economists who believe government spending is the panacea (just like it was a few years ago and yet here we are again).

    We have to allow the economy to restructure without government spending disrupting the process. Productivity is the goal, not jobs. Why is it that productivity increase during recessions? It’s the economy becoming more efficient as resources (land, labour, capital) are liquidated from non-productive sectors and reallocated to more productive sectors.

    Hate to break it to you but stimulus spending does not work. All it does is borrow from the future to create temporary economic activity. Once government spending is reduced and the debt is paid back, the temporary jobs disappear. This is what’s happening.

  6. It is laughable that the Grattan Institute can conclude that “Smaller government is not necessarily the answer” and cite our ranking next to a bunch of basket case OECD countries.

    Smaller government is the ONLY sustainable answer. Our failure to recognise this is going to destroy us. Increasing taxes at the expense of our competitiveness is NOT a solution. We are uncompetitive enough as it stands – raising taxes because our elected officials blanch at the hard choices necessary is going to destroy us. People have to start getting used to the fact that Government is not supposed to hold their hand through every facet of their lives. Time for people to start taking some responsibility for their own lives, and stop expecting other taxpayers to underwrite their failure to live responsibly and within their means. This is a basic tenet of human existence, and yet completely beyond the ability of the ALP to comprehend.

        • Which is exactly why we need strong, decisive leadership. The wave of easy money of the past 3 decades has masked the risk of people not taking proper responsibility for their lives and living within their means. But that is OVER. People have to adjust, or be made to adjust VERY QUICKLY if they are too stupid to realise it, to the new reality that taxpayers are not going to subsidise other people’s lives ANYMORE. That time is OVER. Time to actually start competing, living leaner, and taking personal responsibility. This will be the watchword for the rest of this Century. We need a strong leadership NOW to take us there.

  7. Chris has an Idea

    “We should have been doing this a decade ago – fostering a larger uptake of govt bonds in super, branching out into infrastructure (both local and national), even my Research Bond idea, instead of having this funded by asset sales or foreign bond owners. ”

    Too many people with little imagination are talking about reducing expenditure to balance the budget rather than increasing the income required for our increasing standard of living.

    More ideas from Chris and thinkers of his calibre please!