In shaping this year's budget - their most important macro-economic task
for the year - Tony Abbott and Joe Hockey face a dilemma: the timing
for a particularly tough budget may be right politically, but it's
anything but right economically.
It's clear they intend to follow the
example of John Howard and Paul Keating by using the first budget after
their election to have an almighty cleanout and strike a lasting blow
for fiscal sustainability.
A lot of this simply involves replacing
policies favouring your predecessors' heartland supporters with those
favouring your own supporters - that is, making room for your election
promises - but it has to go further and achieve a significant net
improvement in the "structural" budget balance (the balance we would
have if this were a normal year in the business cycle).
The first
budget after a government's election is the one where it can take
unpopular measures with greatest political impunity. You blame it all on
the incompetence of your predecessors, and you give voters the maximum
time to forgive and forget before the next election.
Fine. But the
economy is so fragile at present, and its transition from mining-led to
non-mining-led growth so tentative and uncertain, that Hockey would be
crazy to produce a budget that cut the deficit significantly in the
coming financial year or even the one after.
You can't be
forecasting growth as weak as 2.5 per cent, with slowly worsening
unemployment this year and next - implying below-trend growth for three
years in a row - and also be tightening fiscal policy. After all, the
Labor government's eminently worthy "deficit exit strategy" (which it
only pretended to stick to) kicked in only "once the economy returns to
above-trend growth".
The sad truth is the economy's prospects are
so uncertain - and the fall-off in mining construction spending so
unpredictable - that Hockey must not only avoid doing anything that adds
to the weakness, but also stand ready to inject emergency fiscal
stimulus the moment it becomes clear a collapse in mining investment
threatens to push us into overall contraction.
The point is that,
while it's undeniable we need to return the budget to cyclical surplus
(and structural balance), this shouldn't happen - and, thanks to our
still low level of public debt, doesn't need to happen - with any
urgency.
So, how should Hockey resolve this contradiction between
smart politics and responsible macro-management and avoid the charge
that he's descended to a counter-productive policy of "austerity"?
One
solution would be to announce all the tough measures in May, and get
them through Parliament, but time them to start only slowly, then build
up rapidly in the "out years" - by which time, we presume, the economy
will have returned to healthy growth.
An alternative, but riskier
approach would be to press on with the deficit-reducing measures, but
offset their contractionary effect by embarking on a big new program of
spending on infrastructure. This makes the point federal governments
have hitherto ignored in their rhetoric: it's only the recurrent (or
operating) budget that needs to be balanced over the cycle.
It's
perfectly responsible for capital works spending to be financed partly
by borrowing - thereby requiring future generations to contribute to the
cost of the long-lasting infrastructure they benefit from - provided
the projects aren't wasteful but yield a high social return.
Another
worry is Hockey's statement before Christmas that his budget-repair
measures would be limited to cuts in government spending, which was
reinforced by Abbott's homily at Davos praising smaller government and
lower taxes.
As John Daley of the Grattan Institute has noted,
there's no precedent for successful fiscal consolidation here or
elsewhere that didn't involve both spending cuts and tax increases.
The
plain fact is that, though there's much scope for spending cuts -
reduced business welfare, including subsidies to chemists, inefficient
arrangements with fee-for-service doctors, home-made submarines,
excessively generous grants to well-off private schools and so on - no
remotely plausible list of spending cuts would be sufficient to achieve
fiscal sustainability.
This is mainly because the greatest single
contributor to Treasury's projections of unending budget deficits is the
inexorable real growth in spending on healthcare. Any pollie who
imagines they could do any more than temporarily slow that growth, or
cover its cost by never-ending cuts in other areas of spending, is an
ideologically crazed fool.
The other problem is that for many
years much "spending" by governments has taken the form of tax
exemptions, rebates and other concessions. Unless Hockey and Abbott's
definition of spending cuts includes cuts in "tax expenditures" I can
tell you now their efforts will fall far short.
