Monday, February 14, 2011

Fiscal heaven is pollies worrying about deficits

The most surprising thing in the great debate over how Julia Gillard should finance the cost of "rebuilding Queensland" is the alacrity with which some economists have urged her to just add it to the budget deficit rather than - gulp - temporarily increase taxation.

Admittedly, the best argument for putting it all on the tick is that the sum involved - $5.6 billion over three or four years - is too small to worry about.

And some economists have pointed out that, since most of the cash will be paid out this financial year and next, the cost is highly unlikely to endanger Gillard's election promise to return the budget to surplus in 2012-13, as she has claimed it would. (Though putting it on the tick would add to the stock of public debt, of course.)

But for the sake of argument, let's pretend the amounts involved - including the horrendous impost of the one-year flood levy - are big enough to worry about so we can debate the principles involved. What's amazed me is seeing economists telling the government it's far more worried about the urgency of getting the budget back into surplus than it needs to be; that it's propagating pre-Keynesian nonsense. This year, next year, the year after - what's it matter?

Funny thing is, I don't remember any of these guys offering that advice when the opposition was shouting populist nostrums about the evil of deficits and debt and, in the process, painting into a corner a deeply insecure government.

Seems like it took the threat of having to pay a bit more tax to get these guys to speak out about fiscal silliness. So short are our memories that no one seems to have noticed the remarkable role-reversal we're witnessing: the pollies - on both sides - more worried about budget deficits than the economists are.

We've been playing the must-get-the-deficit-down game on and off since Malcolm Fraser's day. And in case you're too young to remember, the way the game's played is that,

. in the aftermath of a recession, Treasury and a few economist

. supporters bang on endlessly about the need to reduce the deficit, while the pollies pretend to care and the electorate yawns.

Now, believe it or not, the pollies are leading the charge to get the budget back to surplus, with

Treasury trailing in their wake. And the punters have been convinced it really matters.

The point is, economists should think twice before they pour cold water on this fashion, even if the reasons the non-economists think it's so important are dubious and their sense of urgency is greater than needed.

Much of the credit for this remarkable role-reversal goes to my old mate Peter Costello. He started the fashion of using deficits and debt to beat the heads of his Labor opponents, and some good has come of it.

Costello and his charter of budget honesty also get the credit both for asserting the need for adherence to a medium-term fiscal strategy and for the sounder-than-it-looks formulation of that strategy: "to maintain budget balance, on average, over the course of the economic cycle".

Contrary to the impression he and his mates might leave you with, that formulation makes full allowance for the operation of the budget's automatic stabilisers in pushing it into deficit during recessions (and restoring it to surplus during recoveries) and for adding discretionary Keynesian stimulus on the top, provided that stimulus is wound back as the economy recovers.

Whether because of her innate sense of fiscal responsibility or her fear of Costello's successors, Gillard is determined to stick to this strategy and has imposed various strictures on the government - such as limiting the real growth in government spending to 2 per cent a year - to ensure it's achieved.

Sensible economists should think twice before telling her she's trying harder than she needs to. They should also avoid being too picky about exactly when the return to surplus is to be achieved.

Whenever governments seek to "operationalise" a nice economic concept, whenever they turn a "medium-term strategy" into a target to be hit (or missed), they're drawing a line in the sand that smarties can condemn for being quite arbitrary. What's so magical about 2012-13? Why not a year earlier or later?

But such criticism is too smart by half. It fails to understand the simple human difficulty in achieving objectives that are too flexible. The difficulty prime ministers, treasurers and finance ministers have in preventing their colleagues from doing what comes naturally: spending taxpayers' money too freely.

If more economists were familiar with behavioural economics, they'd see Gillard's promise to return the budget to surplus in 2012-13 not as an irrational "political" act but as a "pre-commitment device" - a calculated act of self-control - akin to what the Productivity Commission wants to be available to problem gamblers.

And there's one other point to note: who says there's no urgency to get the budget back to surplus? I bet that's not what the econocrats are telling Gillard.

It seems the expectations of many business economists have been too influenced by the weakness of consumer spending. The September quarter national accounts purported to show the economy slowing to a crawl, and these guys believe it.

Well, let me tell you, the econocrats don't. They see record terms of trade, low unemployment and a wall of mining construction spending about to descend on the economy.

With such an outlook, the faster Gillard returns the budget to surplus the better.