We're going up in the financial world, but no one's noticed

Economists like us to think they’re cooly rational in all things. Nah. They’re just as susceptible to fads and fashions as the rest of us. In my working life they’ve gone from being obsessively worried about Australia’s financial dealings with the rest of the world to neither knowing nor caring.

When the “balance of payments” figures – which summarise all our financial dealings with other countries – are published each quarter, they go almost totally unreported and unremarked, meaning most economists have no idea of how our position in the financial world has changed, or why.

But two honourable exceptions are the Reserve Bank’s Penny Smith, who gave an amazing but little-noticed speech about it in 2023, and Deloitte Access Economics’ John O’Mahony, who has written an eye-opening paper about it.

O’Mahony noted that, when you looked at rich countries’ “net international investment position” they could be divided into those that were always owed money by the rest of the world and those that always owed money.

The “creditor nations” included Germany, Switzerland and Japan, whereas the permanent “debtor nations” included Canada, New Zealand and ... Australia. But, O’Mahony said, we may be on the way to becoming a “switcher nation” – moving from global debtor to global creditor.

To Smith, there’d been an “extraordinary decline in Australia’s net foreign liabilities”. She noted that, after reaching a peak of 63 per cent of gross domestic product in 2016, our net foreign liabilities had fallen to 32 per cent, “the lowest level since the mid-1980s”. Since then, they’ve fallen to 24 per cent.

So what’s causing this extraordinary change? Many factors have contributed, but one stands out: the Keating government’s decision in 1992 to introduce compulsory superannuation. But first, when were economists so terribly worried about our international finances, and why?

It was in the late ’80s and early ’90s, after we’d been forced in 1983 to abandon our fixed exchange rate and float the dollar. Economists saw the current account deficit was blowing out, causing huge growth in the net foreign debt. In the 12 years after the float, the current account deficit averaged 4.5 per cent of GDP. Whoa! Not good.

I can remember that whenever the latest balance of payments figures were published, the radio shock jocks would read the government another lecture on the folly of allowing the country to “live beyond its means”.

The consternation continued until the ANU’s Professor John Pitchford told the econocrats to wake up. All the international borrowing and lending was occurring in the private sector between “consenting adults”. They should be free to act as they saw fit – and bear the consequences should any of their decisions prove unwise.

With hindsight, it’s easier to see, as Smith has, that the economy was simply adjusting to the removal of the controls on inflows and outflows of financial capital, which had been part of maintaining a fixed exchange rate. After the float, foreigners could more easily invest in Oz, and Australians could more easily invest overseas.

Plus, back then we had to remember that the balance on the current account of the balance of payments represents the difference between how much the nation’s households, companies and governments choose to invest in new housing, business plant and structures, and public infrastructure, and how much those three sectors choose to save via bank accounts and superannuation etc, company retained earnings, and budget operating surpluses.

To an economist, the current account deficit equals national saving minus national investment. So, invest more than you save during a period – as we almost always do – and your current account is in deficit. You fund that deficit by borrowing the savings of foreigners, or allowing them to own Australian shares, businesses or property.

Which brings us to compulsory super. Keating and his ACTU mate Bill Kelty decided to introduce the “superannuation guarantee” mainly to give ordinary workers something better than the age pension to live on in retirement, but also because the econocrats decided Australians should be saving more.

The other rich countries had introduced national retirement schemes after World War II, but Keating’s scheme was very different. Whereas their schemes had contributions going straight into the budget, and pension payments coming out of that year’s budget, our contributions go to a private sector super fund for investment, with the same fund sending you regular payments once you’re in “pension mode”.

It’s mainly because our scheme has money invested and piling up in super funds, and because roughly half that money is invested on foreign sharemarkets, that our net foreign liabilities have fallen so far relative to GDP – and may one day fall to the point where our foreign liabilities become our foreign assets. Our super savings now total $4.2 trillion, with O’Mahony estimating they could be as high as $38 trillion by 2063.

The national super scheme has been far more successful than expected in increasing Australia’s rate of saving. We’re not only saving more than we used to, we’re saving more than other rich debtor countries.

Largely as a consequence, we’ve been running a surplus on our international trade in goods and services since June 2018. And although we still run a current account deficit, it’s much smaller – about 2 per cent of GDP.

Back in the ’80s and ’90s, our net foreign liabilities were high because as well as our high and growing net foreign debt, we also had much foreign equity investment in Australia, particularly ownership of our mining industry.

But this equity liability to foreign owners of Australian companies and shares has steadily been outweighed by our growing ownership of shares in foreign companies. In June this year, our net foreign equity assets of $760 billion offset our (still-growing) foreign debt of $1420 billion, to reduce our net foreign liabilities to $660 billion, a mere 24 per cent of GDP.

And although it’s had help from an undervalued Aussie dollar and an overvalued world share market, most of the credit for this “extraordinary” fall in our net liabilities to the rest of the world goes to our unusual national super scheme.

Read more >>

When does bipartisanship happen? When there's mutual self-interest

If you think Labor and the Liberals are always at each other’s throats and never agree on anything, you haven’t been watching closely enough. Sometimes – last week, for instance – they do deals with each other they hope we won’t notice.

When they’ve reached an agreement they don’t want seen, it’s because they’ve colluded to do something that advances their interests at the expense of the voters.

It reminds me of economist Adam Smith’s observation that “people of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public”.

What do we want from our politicians? That they get on with fixing our many problems. When we discover the present lot isn’t doing that, we toss ’em out. In practice, however, it’s not that simple. We’ve long had a system of two-party government, which means that when one side’s no good, we turn to the other one. But what happens when it too proves to be no good? We have no alternative but to return to the first side, which we already know isn’t up to snuff.

That’s the position we’re in now. We tossed out Scott Morrison and replaced him with Anthony Albanese, only to discover he’s not game to do what it takes. So, does Peter Dutton strike you as the good leader we’re looking for? You’d have to be a terribly rusted-on Lib to think so. What now?

Actually, our loss of faith in the political duopoly isn’t new. It’s become clear that the two sides have just about fought themselves to a standstill. Neither side is game to do anything much, for fear of the scare campaign the other side would run.

This explains why voters have been groping towards plan B. In the 2022 federal election, almost a third of voters – a record proportion – gave their first-preference vote to candidates other than from the two majors. Many Labor voters have turned to the Greens, while the growing number of independents was boosted by the six teal independents taking over seats in the Liberals’ heartland. What’s the single biggest source of discontent with the duopolists? Their reluctance to get on with fighting climate change.

We’ve already come close to having a minority government, and there’s high chance we’ll get one at this year’s election. This gives the smaller parties and independents the balance of power, allowing them to achieve braver policies in return for keeping the minority government in power. Not such a bad arrangement.

But this is where last week’s passing of the electoral reform bill comes in. After doing a deal with the Coalition, Labor got it through the Senate despite the vehement opposition of the Greens and, particularly, the teal independents.

As Labor claims, the act involves the most comprehensive changes to the electoral system in four decades. And many of the changes are genuine reforms, limiting how much individuals can donate to candidates or parties, and tightening up rules on disclosing the identity of donors and the timeliness of that disclosure.

Labor claims its reforms will take the “big money” out of election campaigns. Don’t you believe it. It’s true it will stop the Clive Palmers from giving millions to a party, but that was never a big worry. Various loopholes will allow Labor to continue getting big bucks from the unions and the Libs getting much moolah from business and the secret funds in which money has been stashed.

In any case, the act makes up for any loss of donations by greatly increasing the money the parties and independent candidates get from the taxpayer. After an election, candidates who get more than 4 per cent of the votes get about $3.50 per vote. That will be increased to $5 – which you can double because we each cast two votes, for the House and the Senate.

And that’s before you get to a new payment to cover “administration costs” of $90,000 per election for members of the lower house, and half that for senators.

The point is, these old and new payments go to incumbents, giving them a huge financial head start over new people trying to get in. Even before you think of all the expensive advertising you’d like, setting up an office, staffing it, and paying for printing and stationery ain’t cheap.

But sitting members get an electoral office and a staff of five, plus transport and a generous printing budget they use to get themselves re-elected. So, would-be independents have to raise and spend a lot of money to have any chance against an incumbent member.

Which is where the act’s new limit on spending of $800,000 per candidate puts incumbents way ahead of newcomers. What’s more, political parties are allowed to spend $90 million each on advertising, which they can direct away from their safe seats to their marginals.

Get it? The two major parties have cooked up “reforms” that benefit them by stacking the rules against new independents. The Greens aren’t greatly disadvantaged because they’re a party and have incumbents. The existing independents don’t get the extra benefits going to a party, but do now have the advantage of incumbency.

But future independents – including further teals – will find it a lot harder to win seats than before. Why has Albanese done a deal that mainly benefits the Liberals, his supposed lifelong enemies? Because if independents can do over the Libs, next they can do over Labor.

When the chips are down, the duopolists must stick together and put their mutual interests ahead of the voters’ right to choose. If you want proof that our politicians put their own careers way ahead of their duty to the people who vote for them, this is it. I’ve never felt more disillusioned.

But note this: these changes won’t apply to this year’s election. This will be our last chance to register our disapproval.

Read more >>

Trade deficits don't have to be wicked, unless you believe Trump

By MILLIE MUROI, Economics Writer

While the US president-elect would have you believe a trade deficit is a wicked thing, it’s not a hard and fast rule. In fact, it can actually be good. We’ve become used to the word “deficit” being synonymous with “bad” (think about how many governments highlight when they’ve got a “budget deficit” – not a lot!). But deficits don’t have to be bad.

Since late 2016, Australia has had a run of trade surpluses, meaning the value of all the goods and services we export has been bigger than the value of all those we import. That doesn’t make us any better than countries like the US which have run a trade deficit every year since the 1970s.

Generally, countries are better off when they’re importing things other countries can make more efficiently and cheaply. For Australia, that includes cars, electronics and pharmaceuticals. If we tried to make more of these things ourselves, just to improve our trade balance, we’d be wasting resources we could use to tinker away at other things we’re better at making.

We can always buy, more cheaply, the things we’re worse at making – unless of course we’re trumped by tariffs (which, note to Trump, almost always leaves both countries worse off).

A “current account” deficit is not a bad thing either. Australia had one for more than 40 years, until September 2019. The current account records how much is flowing in and out of Australia when it comes to the value of goods, services and income.

We learnt last week that in the latest September quarter, for instance, the value of our exports ($156 billion) minus the value of our imports ($153 billion) gave us a trade surplus for the quarter of about $3 billion. And the value of interest and dividend payments we were paid by foreigners ($28 billion) minus what we paid them in interest and dividends ($45 billion) gave us a “net income deficit” of about $17 billion.

Combining the net income deficit and the trade surplus leaves us with a deficit on the current account in the September quarter of about $14 billion.

It’s one of the two big parts of what’s called the “balance of payments”: a map of Australia’s economic transactions with the rest of the world.

The balance of payments records the flow of money from everything including exports and imports of goods, services and financial assets (such as shares and bonds) – even transfer payments like foreign aid. Basically: payments to foreigners and payments from foreigners.

Of course, by “Australia’s transactions” we mean those made by Australian residents. Loosely, this means people who live here, businesses operating here, and our governments, which all do deals with the rest of the world.

Now, back to the current account. Why has Australia recorded so many current account deficits?

Historically, we’ve tended to import more than we export, and we’ve paid more in dividends and interest to foreign owners and lenders than they have to us for our foreign shareholdings and loans.

Whenever we import, or pay income (such as dividends) out to people in other countries, it’s recorded as a “debit” in our current account and an equal “credit” in what’s known as the “capital and financial account” – which we’ll come back to. When we export, or receive income from overseas, it’s a “credit” in our current account and an equal “debit” in the other account.

Because of this, the two accounts are, in theory, meant to balance out (because of measurement issues, they usually don’t). When the debits exceed the credits, an account is in deficit. When the credits exceed the debits, it’s in surplus.

The main reason we’ve run so many current account deficits through the years is that we’ve tended to have a heap of investment opportunities (more than we could hope to finance with our own savings).

The inflow of foreign capital meant we were able to grow our economy, paying out dividends and interest to foreign investors for their help. Now, where do we record all this investment?

Enter the capital and financial account. The financial account takes up the lion’s share of the combined bucket. It records any transactions involving assets and liabilities changing hands. This includes things like direct investment (long-term capital investment such as buying machinery or when an investor owns 10 per cent or more of a company through shares), and portfolio investment (smaller purchases of shares in a business, or bonds).

When we sell foreigners shares in an Aussie business, borrow from them or sell them some real estate, that’s a credit in the capital account. When they sell us shares or land or lend us money, that’s recorded as a debit.

The much smaller capital account, meanwhile, captures transactions where nothing tangible is received in return: things such as debt that has been forgiven, foreign aid to build roads, or transactions involving intangible assets (such as trademarks or brand names) or rights to use land.

For some time in the past decade, we briefly went into a current account surplus and a financial and capital account deficit. This was partly thanks to rapid industrialisation in China which turbocharged our exports of minerals, energy, education and tourism (remember: credit in the current account, debit in the financial and capital account), but also our increased tendency to save and cut down our local investment spending on new housing, business equipment and public infrastructure. At the same time, the proportion of our savings going into superannuation, which invests partly into shares of foreign companies, had grown.

Recently, we’ve switched back to running a current account deficit. Is this bad? Not necessarily. It’s partly due to a continued fall in commodity prices such as iron ore and coal, for which demand has weakened, which is bad news for our exporters. But we’re also paying more income to non-residents (remember: this is mostly because they’ve been investing or lending to us, usually to help us grow by helping to finance our investment spending).

But the current account deficit is also thanks to factors such as a rise in service imports. We’ve been travelling more, meaning our spending overseas has increased. A bad sign? Hardly.

So, while we have a current account deficit, that doesn’t automatically mean we’re doing badly. Deficits can help us grow and surpluses don’t always leave us better off. Trump should be careful playing his cards.

Read more >>

THE BUDGET, INFLATION & UNEMPLOYMENT

UBS HSC Economics Day, May 29, 2024

I want to talk to you today about the federal budget two weeks ago and how it relates to the two key issues the managers of the economy need to keep under control: inflation and unemployment. Right now, inflation is still at the top of our worry list, but we shouldn’t forget that we’ve been doing exceptionally well on unemployment, and it’s important we do what we can to avoid fixing inflation at the expense of making unemployment our new problem.

Of course, what most voters see as our big economic problem – thereby making it the government’s biggest political problem - is the cost-of-living crisis. You may think that’s the same thing as what economists think of as the inflation problem, but it’s not that simple. When people complain about the pain they’re feeling from the cost of living, what they want is some immediate relief. By contrast, what economists want is a lasting reduction in high inflation. And this distinction matters because the economists’ standard solution to the pain caused by high inflation is to make it better by first making it worse. It’s actually the pain caused by this solution that people are complaining about most.

Economists know that the only cause of inflation their shorter-term macroeconomic levers can do anything about is inflation caused by the demand for goods and services growing faster than the economy’s ability to produce – supply - more goods and services. When demand exceeds supply, businesses use the opportunity to raise their prices. So, if you want to stop them raising their prices so freely, you have to reduce the demand for whatever it is they are selling. How do you do this? By putting the squeeze on households’ finances, thus making it harder for households to keep up their spending. How do you do this? The main way is for the RBA to raise interest rates, thus greatly increasing monthly mortgage payments. But it adds to the squeeze when bracket creep means the government takes a bigger tax bite out of workers’ pay rises. And it also helps if the government finds other ways to take more money out of the economy with its taxes relative to what it puts back into the economy by its own spending. That is, when you are reducing a budget deficit or increasing a budget surplus.

Before we get to this month’s budget, we need to understand where the economy is now by going back to see where it’s come from.

The recovery from the pandemic and the return to full employment

After the COVID virus arrived in Australia in early 2020, governments sought to slow its spread through the population until a vaccine could be developed. They closed our international borders, limited travel between our states, and locked down the economy, getting people to work from home if possible, closing schools and closing many shops and venues. The idea was for people to stay in their homes as much as possible. The result was a sudden collapse in economic activity – a sort of government-caused recession, with unemployment shooting up.

But governments knew they had to do what was necessary to hold the economy together during this temporary lockdown so that, as soon as it could be ended, the economy would quickly resume normal activity. So the economic managers unleashed huge monetary and fiscal stimulus. The RBA cut the official cash rate almost to zero, and the federal government spent loads of money on JobKeeper grants to employers and many other things. The state governments also spent a lot. From an almost balanced budget in the financial year to June 2019, the federal budget balance blew out to a deficit of $85 billion (equivalent to 4.3 pc of GDP) in the year to June 2020, then a peak deficit of $134 billion (6.4 pc of GDP) in the year to June2022.

But when the lockdowns ended, all the stimulus caused the economy to rebound. People started catching up with their spending, employment grew strongly and unemployment – and underemployment – fell like a stone. The economy boomed. With our borders still closed to immigrants, the rate of unemployment fell to 3.5 pc, it’s lowest in almost 50 years. So we had returned to full employment for the first time in five decades.

This strong growth did wonders for the budget balance. The temporary spending programs ended. When people go from being on JobSeeker to having a job, they start paying income tax – a double benefit to the budget. When people who want to are able to go from working part-time to full-time, they pay more tax. And when workers get bigger pay rises, their average rate of income tax rises, often because they’ve been pushed into a higher tax bracket. People call this “bracket creep”. But economists call it “fiscal drag”. They know it’s the budget’s inbuilt “automatic stabilisers” changing direction and acting to reduce workers’ after-tax income, thereby limiting the rate at which the economy is growing and adding to inflation pressure. (Another factor increasing tax collections was the world prices for iron ore and other commodities we export, which stayed high and cause our mining companies’ payments of company tax collections to be higher than expected.)

You can see this in the change in the budget balance. From a deficit of $134 billion (6.4 pc of GDP) in the year to June 2021, it fell to a deficit of $32 (1.4 pc) in the year June 2022. And then, in the first financial year of the Albanese government, it flipped to a budget surplus of $22billion (0.9 pc). This was all very lovely. But while it was happening, trouble was brewing: inflation was building up.

The return of high inflation

Since the early 1990s, we – and the other advanced economies – had enjoyed a low and stable rate of inflation within the RBA’s 2 to 3 pc target range. Or, in recent years, even a bit lower than the target. But with the economy booming, from early in 2022 the rate of inflation started rising rapidly. In May 2022, just before the election in which government passed from the Morrison Coalition to Albanese’s Labor, the RBA started raising interest rates to slow the growth of demand. By November 2023, it had raised the official “cash” interest rate 13 times, from 0.1 pc to 4.35 pc. Now, 4.35 pc is not high by the standards of earlier decades, but this was the biggest and quickest increase in interest rates we’ve seen, imposing great pain on households with big home loans. For separate reasons, we’ve seen an acute shortage of places to rent, allowing landlords to make big increases in the rent they charge.

So, while the RBA was raising interest rates to slow demand, consumer prices kept rising, with the inflation rate reaching a peak of nearly 8 pc – 7.8 pc to be exact - by December 2022. Last year, 2023, the RBA kept tightening monetary policy, and the inflation rate started falling, reaching 3.6 pc over the year to March, 2024.

It’s important to remember that not all of the rise in prices was caused by strong demand within Australia. A fair bit of it was caused by overseas disruptions to the supply of various goods we import. The disruption was caused by the pandemic and by Russia’s invasion of Ukraine, which pushed up the prices of petrol and gas. The resolution of these disruptions helped get our inflation rate down. And while all this was happening, the squeeze on households’ budgets had pretty much stopped any growth in consumer spending, thus slowing the economy’s growth. This meant a weakening in the demand for labour, causing the rate of unemployment to rise from its low of 3.5 pc to 4.1 pc by April this year. Now, that was where the economy was at when Mr Chalmers announced his budget two weeks’ ago.

The 2024 budget

The part of the Mr Chalmers’ budget that got most attention from the media was the decision to give all households a one-year, $300 rebate on their electricity bills. This had the political benefit to the government of giving voters some relief to cost-of-living pain they have been demanding the government provide. But it was designed also to produce a benefit to the economy: combined with an increase in the rent allowance paid to people on welfare payments, it is expected to reduce the consumer price index by 0.5 percentage points during the coming financial year, 2024-25. This device will come at a cost to government spending of $4.4 billion over two years. Some economists criticised the rebate, arguing that its cost to the budget would actually add to inflationary pressure. They noted that all the new measures announced in the budget would worsen the budget balance by almost $10 billion in the new financial year, and by a total of $24 billion over the coming four years. So they denounced the budget as inflationary at a time when the RBA and the government were still battling to get inflation heading down to the inflation target of 2 to 3 per cent, so that the RBA could start lowering interest rates.

But what the critics have missed is that the measure that will do by far the most to worsen the budget balance from an expected further surplus of $9 billion (equivalent to 0.3 pc of GDP) in the financial year just ending, to a deficit of $28 billion (1 pc of GDP) in the coming year, is the stage 3 tax cuts. These have been government policy since 2018, but were rejigged a few months ago to ensure that more of their benefit went to low and middle-income taxpayers. Their cost in the first year of $23 billion, accounts for more than 60 pc of the total expected turnaround in the budget balance of $37 billion.

The other big announcement in the budget was the government’s Future Made in Australia program. This is a most important change in the government’s micro-economic policy. But the expected cost to the budget of about $23 billion will be spread over 10 years, with little of it spent over the next few years. This means it is not a big issue for the short-term management of the macro economy.

The new macro “policy mix”

So where does the budget leave the authorities use of the two instruments of macro demand management – monetary policy and fiscal policy? It leaves us with the “stance” of monetary policy having got progressively more restrictive over the past two years, with the long lag in policies having their full effect on demand meaning there is more contractionary effect to come.

The huge growth in tax collections caused by the budget’s automatic stabilisers has caused the budget to have two financial years of surpluses, meaning a restrictive stance of fiscal policy has added to the contractionary pressure from monetary policy. But, although Mr Chalmers has denied it, there can be no doubt that, thanks mainly to the stage 3 tax cuts, the budget changes the “stance” of fiscal policy from restrictive to expansionary.

The government’s critics argue that this expansion will jeopardise our efforts to get inflation down to the target range. I disagree. The economy is weak, expected by Treasury to have grown by only 1.75 pc in the financial year just ending, and to grow by only 2 pc in the coming year. If anything, that’s probably on the optimistic side. At 3.6 pc over the year to March, the inflation rate has already fallen close to the 2 to 3 pc range, and it’s easy to believe it will keep falling in the coming year, as Treasury forecasts. After a lag, the tax cut will take some of the pressure off household spending. But, with luck, it will help ensure the economy’s slowdown doesn’t become a recession. Even so, Treasury’s forecast that the economy’s continuing weakness will push the rate of unemployment no higher than 4.5 pc is probably also on the optimistic side.

Outlook for the budget and the public debt

Treasury’s forecasts and projections suggest the budget is likely to remain in small but declining deficits over the decade to 2034-35. The federal government’s gross public debt is expected to be $904 billion (34 pc of GDP) at June, 2024. The gross debt is projected to peak at 35 pc of GDP in June 2027, then decline to 30 pc by June 2035. This proportionate decline would occur because the economy was growing faster than the small deficits were adding to gross debt.

Read more >>

We're investing more overseas than foreigners are investing here

 For pretty much all of Australia’s modern history, our strategy for getting more prosperous was to be a “net importer of [investment] capital” from the rest of the world. But four years ago, that was turned on its head, and we became a net exporter of investment capital.

If you think that doesn’t sound like a good thing, I agree with you – though probably not for the same reason as you. I think it does much to explain why the economy – and the productivity of our labour – have grown so weakly over the past decade. And are likely to continue growing slowly once the Reserve Bank has beaten inflation out of our system.

How come you haven’t heard about this historic turnaround? Because, though economists hate to admit it, economics is subject to fashions, and for many years they haven’t been much interested in talking about what’s happening in the economy’s “external sector”, which accounts for about a quarter of the whole economy.

All of Australia’s households’, businesses’ and governments’ economic dealings with the rest of the world during a period are summarised in a document called the “balance of payments” – payments to foreigners and payments from foreigners.

The balance of payments is divided into two accounts, the “current” account and the “capital and financial” account.

The current account shows the value of our exports of goods and services ($171 billion in the latest, March quarter) less the value of our imports of goods and services ($129 billion), to give us a trade surplus for the quarter of $42 billion.

But then it takes account of our interest and dividend payments to foreigners of $57 billion, less their payments of interest and dividends to us of $24 billion, to give us a “net income deficit” of $33 billion.

Subtracting this deficit from the trade surplus of $42 billion leaves us with a surplus on the current account for the quarter of $9 billion.

So, we ended up making a profit during the quarter, as we have in every quarter for the past four years, whereas for almost every year before that we ran deficits. We’ve made some progress.

Is that what you think? Sorry, as the father of economics, Adam Smith – born 300 years ago this year – spent his life explaining, this “mercantilist” notion that a country gets rich by trying to export more than it imports is wrong.

We benefit from importing the things that other countries do better than we do, and they benefit from us exporting to them the things we do better than they do. Economists call this the “mutual gains from trade”.

In any case, like the accounts of every business, the balance of payments is based on “double-entry bookkeeping”, where every transaction is seen as having two, equal sides, a debit and a credit. So, it’s wrong to think that debits are bad and credits are good.

Similarly, it’s wrong to think that the resulting deficits (debits exceed the credits) are bad, and surpluses (credits exceed the debits) are good.

And remember that the “current” account is only one half of the balance of payments so, since the debits and credits are always equal, if we’re running a surplus on the current account, we must be running a deficit of equal size on the other, capital and financial account.

Until four years ago, we always ran a surplus on the capital account, but now we’re running a deficit. But what does this switch actually mean?

It means that, until recently, our households, businesses and governments always spent more on investment – in new housing, new business equipment and structures, and new public infrastructure – than they could finance from their own savings.

(Households save when they don’t spend all their income on consumption. Businesses save when they don’t pay out all their after-tax profits in dividends. Governments save when they raise more in taxes than they spend on their day-to-day activities.)

How can we, as a nation, spend more on new physical investment than we’re able to finance with our own saving? By getting the extra savings we need from abroad. We can borrow it, or we can allow foreigners to own Australian businesses or real estate.

And that’s exactly what we did until four years ago. We borrowed overseas and let foreigners own “equity” in our economy. This is what it means to say Australia was a “net importer of capital”.

Why did we do that? Because we had more opportunities for economic development than we could finance from our own saving, and figured that allowing foreigners to join us in investing in our economy would leave us better off.

The consequence was that, for more than 200 years, our economy grew faster and our standard of living improved faster than if we’d kept everything to ourselves.

So, what’s changed? Why have we switched to being a net exporter of investment capital? Why have we begun investing more of our savings in other countries than they’ve been investing in Oz?

Partly because the build-up of our compulsory superannuation system means we, as a nation, are saving a lot more of our income than we used to.

Now here’s the killer: but also because, particularly since the end of the mining investment boom a decade ago, we’ve been investing a lot less in improving and expanding our businesses.

You wonder why, until the government and the Reserve Bank mistakenly caused the present brief inflationary surge, the economy’s growth was so weak? Now you know.

You wonder why the productivity of our labour’s been improving so slowly? Because we haven’t had enough business investment in new and better machines. Or in research and development, for that matter.

And the main thing we’ve got to show for this deterioration is a current account surplus. You beaut.

Read more >>

Gilding the budget lily: Labor brings in the creative accountants

This month’s budget is not as profligate as its critics claim, but nor is it the deficit-disappearing, penny-pinching budget it was tricked up to be.

When ministerial staffers use words to gild the fiscal lily, it’s called spin doctoring. When the government’s bureaucrats show the treasurer and, more particularly, the finance minister how to do it with numbers, it’s called creative accounting.

So, never fear, Jim Chalmers and Katy Gallagher didn’t need to pay PwC a motza to explain how to make the budget seem better than it was.

No, not the way the former NSW Coalition government paid KPMG to show it how to make its budget balance look better by moving the state’s trains off-budget. Nor has the same firm been paid by another part of the state government to write a report on why it was a bad idea.

There was something a bit odd about the media’s treatment of Chalmers’ second budget. Because the budget’s purpose is to reveal the government’s plans for taxing and spending in the coming financial year, the media give all their attention to the budget balance for the coming year.

Which, this time, is expected to be a deficit of $14 billion, rising to $35 billion the following year, with the budget projected to stay in deficit through to at least 2033-34.

Usually, the media ignore the estimated budget balance in the present financial year, which will end on June 30. It’s “old”. But not this year. This time, a surplus of $4 billion is expected.

Once the media got wind of a surplus, they lost interest in anything else. A surplus! First surplus in 15 years! What an achievement. And after being in power for only a year. How could you get more convincing proof of Labor’s skill as a manager of government finances?

Now, let’s be clear. The expected surplus is perfectly believable, and not the product of creative accounting. But it is the media displaying their economic ignorance.

For a start, in a budget of $630 billion a year, in an economy of $2600 billion a year, a surplus of a mere $4 billion is nothing to get excited about. It’s really a balanced budget, just as much as a deficit of $4 billion would be near enough to a balanced budget.

More significantly, the notion that any treasurer, no matter how wonderful, could turn an expected deficit of $78 billion into a surplus of $4 billion in the space of a year is fanciful. If any pollie should get the credit for it, it would have to be Chalmers’ Liberal predecessor, Josh Frydenberg.

Only he had enough time to do the things capable of helping produce such a result. With the benefit of hindsight, what Frydenberg did was greatly overstimulate the economy, adding to a surge in inflation as well as causing the unemployment rate to fall to 3.5 per cent so workers and businesses paid a lot more income tax.

Another way to look at it is that, had Treasury been better at forecasting, Frydenberg could have forecast a return to budget balance in his last budget.

But this didn’t stop Chalmers and his spin doctors from claiming the credit for himself. Consider this from the budget papers: “The improved fiscal outlook since October largely reflects government decisions to return tax upgrades to budget.”

Talk about twisting the truth. Chalmers wants to take all the credit because, confronted with an unexpected surge in tax collections of $88 billion, he only spent a bit of it.

But, surely, it was the silly media that made all the fuss about the surplus, not that nice young Mr Chalmers. Well, that’s certainly what his spin doctors want you to think – all the adulation came from the crowd.

But they were subtly pushing an easily distracted media in a favourable direction. Consider this. The usual practice in the construction of budget tables is to highlight the coming “budget year”. Not this time. This time it was the old year that got highlighted. So, the $4 billion surplus was shown in bold type, not the $14 billion deficit.

(By the way, as The Australian Financial Review has reported, had Frydenberg’s $690 million [yes, million] deficit in 2018-19 – the one that presaged all the Libs’ happy election talk about “back in black” – been calculated using the same accounting rules under which Chalmers’ surplus was calculated, it would have been a surplus of $7 billion. But no, this isn’t a fiddle, either. The decision to change the rules was made, in prospect, many years earlier by some finance minister named Penny Wong.)

Now we get to the creative accounting, which the Centre for Independent Studies’ Robert Carling, a former NSW Treasury officer, has pointed out. The budget papers make much of the claim that “the government’s spending restraint has limited real [note the real] payments growth to an average 0.6 per cent over five years from 2022-23 to 2026-27”.

Wow. Now that’s what I call restraint. What an achievement. Elsewhere in the papers we’re told that this compares with real average spending growth of about 4 per cent in the eight years before the global financial crisis, and 2.2 per cent over the eight years before the pandemic.

Wow. What restraint the Albanese government is showing. Except that pollies usually quote budget figures over the four years of the budget year plus three years of “forward estimates”. So, why is the 0.6 per cent an average over five years?

Because the extra year includes in the sum the pre-budget year ending in a month. And, purely by chance, real government spending in 2022-23 is expected to fall by 4.3 per cent.

By contrast, real spending in the coming year will grow by 3.7 per cent. Then comes projected annual real growth of 0.6 per cent, 1.9 per cent and 1 per cent.

Why the huge fall this year? Partly, I suspect, because of the effect of temporary pandemic spending programs coming to an end. But also because the indexation of various spending programs was lagging the huge rise in the consumer price index, which is the inflation measure used to calculate the “real” change.

What’s worth remembering from this little fiddle is: never trust calculations of average spending growth into the future. The first year will be close to the truth, but the projections for subsequent years will always be way too low because they’re based on the assumption of unchanged policies, whereas it’s certain that spending plans will have grown by the time we get there.

The first treasurer to con me with this averaging trick was Chalmers’ former boss, Wayne Swan. But Swan got his comeuppance by making himself a laughing-stock when he treated Treasury’s forecasts of future budget surpluses as in the bag. Turned out they weren’t.

The assumptions that policies won’t change and that targets will always be achieved are the reason the budget papers’ “medium-term” projections of deficits and debt 10 years into an unknowable future shouldn’t be taken seriously.

In both sense of the word, they are calculated to mislead.

Read more >>

THE BUDGET, INFLATION AND MACROECONOMIC MANAGEMENT

UBS HSC Economics Day

There’s never been a better time to be studying macroeconomics than this year. If you want to know why economics is interesting and important – why it deals with real-world problems – turn on the radio or television news, read the paper, look on the internet or just look out the window. What you see is people struggling to cope with the cost of living, as prices rise much faster than wages, as the Reserve Bank keeps increasing mortgage interest rates, rents keep rising and Treasurer Jim Chalmers makes sure his budget isn’t worsening inflation, while giving families a little relief from the rising cost of living.

Macroeconomic management involves national governments and central banks trying to smooth the ups and downs in aggregate demand – spending – as the economy moves through the business cycle of boom and bust. The economic managers try to keep the growth in demand as stable as possible because, when growth’s too weak this increases unemployment, while when growth’s too strong this causes inflation. The two tools or “instruments” the economic managers use to stabilise demand are monetary policy (the manipulation of interest rates) and fiscal policy (use of the budget to manipulate government spending and taxation).

When the Covid pandemic broke out in early 2020, the great fear was that our use of lockdowns – ordering everyone to stay at home and leave the house as little as possible – to slow the spread of the virus until a vaccine could be developed would lead to massive unemployment. To prevent this, the economic managers applied extra stimulus to demand. Interest rates were already very low, but the Reserve Bank cut them further. However, the main stimulus came from the federal government increasing government spending and tax concessions by more than $300 billion over two years.

The return to full employment

The result of all this stimulus was that the economy rebounded quickly from the lockdowns and then grew very strongly. As a result, after shooting up to 7.5 pc, the rate of unemployment quickly fell back and kept on falling until it had dropped to 3.5 pc, its lowest in almost 50 years. The rate of under-employment also fell sharply, with the rate of participation in the labour force rising to a record high. As well, an unusually high proportion of the extra jobs created have been full-time. So the one good thing we have to show for the pandemic is our unexpected return to full employment, after an absence of half a century.

The return of high inflation

For a number of years before the pandemic, economic growth was slow, the unemployment rate got stuck above 5 per cent, there was little growth in real wages, and nothing the Reserve Bank did could get the rate of inflation up into its 2 or 3 pc target range.  But about two years ago inflation began shooting up, reaching a peak of 7.8 pc at the end of last year (2022). It has since begun falling back, and was 7 pc in March this year, but this is still way too far above the target band.

Many factors contributed to this surge in inflation. One was shortages of cars, computer chips and many other things, caused by the pandemic’s disruption of their supply. Another was leaps in the world price of fossil fuels and some foodstuffs, caused by the war in Ukraine. These are cases of imported inflation, caused by shortages of supply, not demand. But it’s also clear that the strong growth in demand in our economy following the stimulus and end of the lockdowns is adding to the prices of locally made goods and services. It’s this local source of inflation pressure that has prompted the RBA to increase the official cash rate 11 times since May last year, increasing the rate by 3.75 percentage points to 3.85 pc.

The “policy mix”

Since the 1980s, Australia has followed the practice of giving monetary policy the primary role in achieving “internal balance” – price stability and full employment, aka low inflation and low unemployment. This leaves fiscal policy (the budget) playing a subsidiary role. It assists monetary policy by allowing the budget’s “automatic stabilisers” to improve the budget balance when the economy is booming and monetary policy is trying to restrain demand. Fiscal policy assists monetary policy when the economy is dropping into recession, by allowing the budget’s automatic stabilisers to worsen the budget balance.

Apart from assisting monetary policy, fiscal policy’s primary role is to achieve “fiscal consolidation” – to cut the budget deficit when the economy is recovering from a downturn, so as to limit the growth in the public debt (and the annual interest bill on it). This is so the budget and fiscal policy will be well-placed to be used to support the economy during the next recession or pandemic.

Note, however, that it is good for fiscal policy to take the main stabilisation role from monetary policy during emergencies such as recessions and pandemics. The stage we’re at now is that the emergency has passed, so the primary stabilisation role has passed back to monetary policy and it’s time to get the budget deficit down and keep it low.

The 2023 budget

The former government’s use of the budget to respond to the pandemic caused the budget deficit to blowout to $85 billion (or 4.3 pc of GDP) in 2019-20 and rise to a peak of $134 billion (6.4 pc) in 2020-21.

But most of the pandemic measures were temporary so, with the end of spending measures and the strong recovery causing the budget’s automatic stabilisers to change direction and start tax receipts growing strongly, the following year (2021-22) saw the deficit fall back to $32 billion (1.4 pc).

Mr Chalmers forecast that the budget balance would improve further in the financial year that ends next month, 2022-23, to a tiny surplus of $4 billion (0.2 pc). This further improvement was caused by the continued strong growth in the economy, with more people in jobs, pay tax and not having to get unemployment benefits. Although wages aren’t rising fast enough to keep up with prices, they are rising faster than they were, meaning more of workers’ wages is being lost to “bracket creep”. In other words, it’s the budget’s automatic stabilisers that are doing most to get the deficit down. As well, mining companies are paying more company tax because world prices for our mineral and energy exports have stayed high. So the only credit Mr Chalmers should get for this is for keeping his new spending limited, so that almost all the surge in tax collections went through to the budget bottom line.

In the coming financial year, 2023-24, the economy is expected to slow, while government spending grows faster than tax collections. This should cause the budget to return to a small deficit of $14 billion (0.5 pc) and go a bit higher to about $36 billion (1.3 per cent of GDP) in the following two financial years.

The “stance” of policy adopted in the budget

In deciding whether the budget helps or hinders its efforts to slow the growth in demand (spending) the RBA doesn’t look at particular budget measures. Rather, it looks at the direction and size of the expected change in the budget balance. Mr Chalmers is expecting the budget balance to improve from a deficit of $32 billion in 2021-22 to a surplus of $4 billion in the financial year just ending. This means the gap between how much the budget puts into the economy in spending and how much it takes out in taxes should improve by $36 billion, a tightening equivalent to 1.6 pc of GDP. But in the coming financial year, the budget balance is expected to worsen by $18 billion, a loosening equivalent to 0.7 pc of GDP. Putting the two years together, I think the RBA will conclude the budget in no way hinders its efforts to slow the growth in demand and reduce the upward pressure on prices.

On these forecasts, I judge the “stance” of fiscal policy adopted in the budget to be “mildly contractionary”.

The outlook for the public debt

Because the strength of the economy’s growth means the budget deficit has fallen much faster that was expected this time last year, the outlook for future budget deficits and levels of gross public debt is now not as bad as we’d earlier thought. Whereas a deficit of $78 billion for the financial year just ending had been expected, a surplus of $4 billion is now expected. This means no increase in the debt this year, and no consequent increase in the annual interest bill in this and subsequent years. Over the 12 years to 2033-34, this is estimated to avoid a total of $83 billion in interest payments. It also implies gross debt is now expected to reach a peak of 36.5 pc of GDP in 2025-26, five years earlier and more than 10 percentage points lower than expect in last October’s budget.

The outlook for the economy

With prices rising faster than wages, bracket creep taking a bigger bite out of wage rises and the RBA raising mortgage interest rates, it will be no surprise to see the economy’s growth slow sharply in the coming financial year. The government’s forecasts predict that, after growing by a very strong 3.25 pc in financial year just ending, real GDP will slow to a very weak 1.5 pc.

The main thing driving that slowdown is likely to be slower growth in consumer spending from 5.75 pc to 1.5 pc. This should get the inflation rate down from 6 pc at present to 3.5 pc by next June, then down into the inflation target zone by June 2025.  Wages are expected to grow by 4 pc over the year to next June – but I wouldn’t start spending the money yet. All this is expected to increase the unemployment rate to 4.5 pc, but not until June 2025. 

And if all that sounds a bit too good to be true – it probably is.

The medium-term fiscal strategy

For many years under Liberal and Labor governments, their “medium-term fiscal strategy” was “achieving budget surpluses, on average, over the economic cycle”. This left the government free to run budget deficits during years when the economy was weak, provided these were offset by budget surpluses during years when the economy was growing strongly.

 With the arrival of the pandemic and all the fiscal stimulus it involved, the liberal government changed to a two-part strategy: first, to support demand during the pandemic. But then, second, once the crisis had passed, to “focus on growing the economy in order to stabilise and reduce debt”.

The new Labor government has adopted its own, rather wishy-washy strategy: “to improve the budget position in a measured way, consistent with the overarching goal of reducing gross [public] debt as a share of the economy [nominal GDP] over time”.  The budget “will be improved in a manner consistent with the objective of maintaining full employment. The government will “allow tax receipts to respond in line with changes in the economy, directing the majority of improvements in tax receipts to budget repair”. This means the new government has abandoned the old government’s 23.9 pc cap on the level of tax receipts as a percentage of GDP.

Read more >>

Chalmers and Lowe: good cop, bad cop on the inflation beat

Have you noticed? There’s a contradiction at the heart of Treasurer Jim Chalmers’ budget. Is it helping or harming inflation?

Both Chalmers and Reserve Bank governor Dr Philip Lowe are agreed that our top priority must be to get the rate of inflation down. That’s fine. Everybody hates the way prices have been shooting up. The cost of living has become impossible. Do something!

But while Lowe seems to be just making it all worse, jacking up mortgage interest rates higher and higher, nice Mr Chalmers is using his budget to take a bit of the pressure off, helping with electricity bills, cutting prescription costs and so on.

It’s as though Lowe is the arsonist, sneaking round the bush to start more fires, while Chalmers is the Salvos, turning up at the scene to give the tired firefighters a kind word, a pie and a cup of tea.

Is that how you see it? That’s the way Chalmers wants you to see it, and Lowe knows full well it’s his job to be Mr Nasty at times like this.

But what on earth’s going on? Has the world gone crazy? No, it’s just the usual dance between brutal economics on one hand, and always-here-to-help politics on the other.

Let’s start from scratch. Why do we have an inflation problem? Because, for the past 18 months or so, the prices of the things we buy have been shooting up, rising much faster than our wages, causing the cost of living to become tough for many people.

Why have prices been rising so rapidly? Partly because the COVID-19 pandemic and Russia’s attack on Ukraine caused international shortages of building materials, cars, computer chips and fossil fuels. But also because the massive increase in our governments’ payments during the pandemic left us cashed up and spending big on locally made goods and services.

When the suppliers of the stuff we buy can’t keep up with our demand for it, they raise their prices. The media may call this “price gouging”, but economists believe it’s what happens naturally in a market economy – and should happen because the higher price gives the suppliers an incentive to produce more. When they do, the price will come down.

When inflation takes off like this, what can the managers of the economy do to stop prices rising so fast? They can do nothing to magically increase supply; that takes time. But what they can do is reduce demand – discourage us from spending so much.

How? This is where it gets nasty. By squeezing households’ finances so hard they have to cut their spending. Once demand for the stuff they’re selling falls back, businesses are much less keen to raise their prices.

At present, households are being squeezed from all directions. The main way is that wages aren’t keeping up with the rise in prices. As well, more of the wage rises people are getting is being eaten up by income tax, thanks to “bracket creep”.

And the fall in house prices means home-owning households aren’t feeling as wealthy as they were.

All that’s before you get to Mr Nasty, raising the interest rates paid by people with mortgages, which is particularly tough on young home owners, with more recent, much bigger mortgages.

(You may wonder if this extra pressure on, say, only about 20 per cent of all households is either fair or the most effective way to get total household spending to slow. And you may be right, but you’d be way ahead of the world’s economists, who think the way they’ve always done it is the only way they could do it.)

But what part is the budget – “fiscal policy” – supposed to play in all this? It should be helping put the squeeze on, not reducing it. Now do you see why some are questioning whether Chalmers’ $14.6 billion “cost-of-living relief package” will help or hinder the cause of lower inflation?

The budget balance shows whether government spending is putting more money into the economy, and its households, than it’s taking out in taxes. If so, the budget’s running a deficit. If it’s taking more money out than it’s put back in, the budget’s running a surplus.

The way the Reserve Bank judges whether the budget is increasing the squeeze on households, or easing it, is to look at the size and direction of the expected change in budget balance from one year to the next.

The budget papers show the budget balance is planned to change from an actual deficit of $32 billion last financial year, 2021-22, to an expected surplus of $4 billion in this financial year, ending next month.

That’s an expected tightening of $36 billion, equivalent to 1.6 per cent of the size of the whole economy, gross domestic product.

No doubt such a change is adding a big squeeze to household incomes. But then the budget balance is expected to worsen in the coming financial year, 2023-24, to a deficit of $14 billion. That’s an easing of pressure on households’ finances equivalent to 0.7 per cent of GDP.

Put the two years together, however, and its clear the budget will still be putting a lot of squeeze on households – on top of all the other squeeze coming from elsewhere.

Somewhere in there is most of Chalmers’ $14.6 billion relief package. As a matter of arithmetic, it’s undeniably true that, had the package – which, by the way, is expected to reduce the consumer price index by 0.75 percentage points – not happened, the squeeze would be, say, $10 billion tighter than it’s now expected to be.

But there’s no way, looking at that – and all the other sources of squeeze – the Reserve will be saying, gosh, Chalmers is adding to inflation pressure, so we’d better raise rates further.

Chalmers has said the “stance” of fiscal policy adopted in the budget is “broadly neutral”. Not quite. So, I’ll say the nasty word Mr Nice Guy doesn’t want to: the stance is “mildly contractionary”.

Read more >>

Debt and deficit fixed in just Labor's second budget. Really?

Small things amuse small minds. Too many people have allowed their excitement over an expected budget surplus of a tiny $4 billion this financial year to distract them from noticing a much bigger deal.

Remember that mountain of government debt we ticked up fighting the pandemic? Now Treasurer Jim Chalmers tells us it’s more like a big hill. Remember the frightening spectre of the “structural” budget deficit? Not to worry, it’ll have disappeared in a decade – if you can believe it.

Assuming it happens, achieving an infinitesimally small, and one-off, surplus of $4 billion may be significant politically, but from an economic perspective, it’s not worth popping the champagne cork. In a budget worth $630 billion a year, in an economy worth $2600 billion a year, it’s no more than a rounding error.

No, what’s genuinely significant is not that magic word “surplus”; it’s that this time last year we were expecting a deficit of $78 billion. It’s the absence of another big deficit that’s the big deal. It represents the passage of a year in which we didn’t add to the existing public debt. And, as a consequence, didn’t add to the size of our annual interest bill every year until we’re all dead.

What’s more, the absence of a deficit this year suggests the expected deficits for the next few years will also be smaller than we thought. So next year will see not just a smaller than expected annual interest bill, but a smaller than expected addition to the debt, and thus an even smaller than expected addition to the following year’s interest bill, and so on and on forever.

Well, in principle, anyway. What this news also shows is how hopeless Treasury (and all economists) are at predicting the future.

Next, note that this year’s expected deficit disappeared not thanks to Chalmer’s superior management, but thanks to Treasury’s failure to realise how strong the economy would be. More people are in jobs and paying tax (and not needing to be paid the dole).

Company profits are up, as is the tax they pay. Export commodity prices have stayed higher than Treasury was expecting, so mining companies’ taxes are well up. And remember this: inflation causes taxes to rise faster than government spending does.

But though nothing Chalmers did caused the big improvement, he’d like a round of applause for not spending much of the extra dosh.

And he’s got some very impressive news he’d love me to tell you about. Treasury hasn’t just produced revised forecasts for the financial year just ending and for the budget year 2023-34, it’s done “projections” for a further three years. It’s also made “medium-term” projections right out to 2033-34.

What they show is truly amazing. Unbelievable, even. The budget papers say the absence of the formerly expected $78 billion deficit this financial year, and consequent improvement in forecasts for the following few years, “will avoid $83 billion in interest payments over the 12 years to 2033-34. It also means [the government’s] gross [public] debt, as a share of gross domestic product, will be 7.1 percentage points lower in 2033-34.”

That bit you can believe. It’s just compound interest – which, of course, works in reverse for a borrower rather than a saver.

Now it gets hairy. The Albanese government’s various decisions to limit the growth in government spending mean real spending growth is now “expected to average 0.6 per cent a year over the five years [to] 2026-27”.

This compares with average real (inflation-adjusted) spending growth of about 4 per cent in the eight years before the global financial crisis of 2008, and 2.2 per cent a year over the eight years to 2018-19, before the pandemic.

Really? That’s a truly Herculean achievement. And with so little blood on the floor.

What used to be a mountain of debt is now just a big hill. Phew. And we thought it was only Scott Morrison who could call forth miracles.

Except, of course, that it hasn’t been achieved. It’s just “projected” to happen. All those other averages are “actuals” whereas, the unbelievable 0.6 per cent is simply a projection.

Projections are based on assumptions, which are then mechanically multiplied out, year after year. One assumption is that the economy, and the budget, will just move in a straight line over the next five years, with nothing unexpected – say, a pandemic or a recession – blowing us off course.

The five-year projection says the gross public debt is now expected to peak at 36.5 per cent of GDP in June 2026. Now, get this: this would be 10.4 percentage points lower, and five years earlier, than projected just seven months ago in Labor’s first budget.

And if you keep cranking the projection handle, the public debt “will” (their word) be down to 32.3 per cent of GDP by June 2034.

Next, remember all the economists wringing their hands over the “structural” budget deficit? This is the part of the budget balance that’s left when you take out the part that’s just the product of where the economy happens to be in the business cycle at the time.

The balance will look good when you’re at the top of the boom (as we are now) and bad when you’re at the bottom of a recession (as we may be in a year or two). The structural deficit or surplus is a calculation of what the balance would be if we were in the dead middle of the cycle, neither up nor down.

In Chalmers’ first budget, last October, Treasury took its projection of the budget balance out 10 years, and estimated the structural component to be steady at a deficit of about 2 per cent of GDP.

That’s $50 billion a year in today’s dollars. A medium-size economy with a big debt can’t live with that. We have to get it down, so we’re well placed to borrow heavily in the next recession or pandemic.

Well, has Chalmers got good news for those economist worrywarts. Seven months later, the projection (budget paper No. 1, page 131) shows the structural deficit steadily withering away until it reaches almost nothing in 2033-34.

So, how did Chalmers magic it away? Assumptions, dear boy, assumptions. For years, the biggest single program driving the growth in government spending has been the explosive growth in the National Disability Insurance Scheme.

But the government has decided to take steps to limit its growth to a mere 8 per cent a year. The projections are based on mechanically projecting “existing policy”, so the 8 per cent target – which may or may not be achieved – is baked in.

Take that monumentally optimistic assumption, add further optimism about restraint in other spending areas, allow them to magnify the believable bit (that a disappeared deficit right at the beginning of the projection significantly reduces our formerly expected interest payments over a decade) and you’ve eliminated the problem.

If only reality was as easy.

Read more >>

Handle with care: Productivity Commission's advice on getting richer

If you accept the Productivity Commission’s assumption that getting richer – “advancing prosperity” – is pretty much the only thing that matters, then the five priority areas it nominates in its five-yearly review of our productivity performance make a lot of sense.

But when you examine the things it says we should do to fix those five areas, you find too much of its same old, same old, preference for neoclassical ideology over empirical evidence.

And you find no acknowledgement that part of our claimed failure to improve the productivity of the “government-funded non-market services sector” has occurred because, over recent decades, governments have acted on the commission’s advice to keep the public sector small and taxes low by outsourcing the provision of human services to profit-motivated businesses.

Which, if anything, has made matters worse rather than better. As witness: the mess we’ve made of aged care and vocational education and training, and the ever-growing cost of the National Disability Insurance Scheme.

The report is quick to explain that improving productivity does not mean getting people to work harder. Perfectly true. It’s supposed to mean making workers more productive by giving them better training and better machines to work with.

Except that when you see the commission recommending a move to “modern, fit-for-purpose labour market regulation” – including, no doubt, getting rid of weekend penalty pay rates – you realise the commission has learnt nothing from the failure of John Howard’s Work Choices, nor from the failure of the reduction in Sunday penalty payments to lead to any increase in weekend employment, as had been confidently predicted.

So, what the commission is really advocating is that the balance of power in wage bargaining be shifted further in favour of employers and away from workers and their unions. Which probably would lead to people working harder for little or no increase in pay.

What the commission should have said, but didn’t, is that workers would be more co-operative with bosses’ efforts to improve the productivity of their firms if they were more confident they’d get their fair share of the benefits.

At present, they have good reason to doubt that they would.

What’s conspicuously absent from all the bemoaning of the slowdown in our rate of productivity improvement, is any acknowledgement that there’s also been a huge fall in the rate of the flow-through to real wages of what improvement we are achieving.

Until that’s fixed – until the capitalist system goes back to keeping its promise that the workers will get their fair share of the benefits of capitalism – Australia’s households have no rational reason to give a stuff about what’s happening to productivity.

Back to the point. Productivity improves when you produce the same things with fewer inputs of labour or capital, or produce more – either more quantity or better quality – with the same inputs.

And the report is exactly right to say that steadily improving our productivity is the key to improving the nation’s material standard of living. The rich world has more than two centuries of proof of that truth.

The first of the report’s five priority areas is achieving a “highly skilled and adaptable workforce”. Dead right. This is economics 101. Economists have known for yonks that investing in “human capital” is the obvious way to increase productivity.

(And it’s the better-educated and trained workers who can most easily adapt to the changing demand for labour that the digital revolution and other technological advance will bring.)

But the commission long ago stopped pointing this out, while state and federal governments put their efforts into quite different objectives. The Howard government, for instance, spent hugely on expanding parents’ choice of private school.

“I’m a Callithumpian, and I’d like to send my kid to a Callithumpian school, where they won’t have to mix with sinners.” Next, we had the limited success of the Gonski-inspired push to fund schools based on student need rather than entrenched privilege and religion.

And then we wonder why school results have got worse and so many kids leave school with inadequate numeracy and literacy. How they’ll be advancing our prosperity in an ever-changing world I hate to think.

Which raises a recent “learning” by economists, that doesn’t seem to have reached the commission: if you ignore what your “reforms” are doing to the distribution of income between the top and the bottom, don’t be surprised if your productivity goes off.

For some inexplicable reason, growth in the number of the downtrodden makes the average look worse.

Meanwhile, with universities, the highest priority of successive federal governments – Labor and Liberal – over the past 30 years has just been to get them off the budget.

The feds have made them hugely dependent on attracting overseas students and charging them full freight. One way they’ve coped is by making university teaching by the younger staff part of the gig economy.

Apart from putting the public unis (but not the few private unis) on a starvation diet during the lockdowns, the Morrison government’s last effort to punish what it saw as a hotbed of socialism was a hare-brained scheme to encourage students to choose courses that made them “job-ready” by, among other things, doubling the tuition fees for a BA.

Fortunately, this failed to discourage the students, but did make the humanities a far more profitable product for the unis to push.

To be fair, another recent “learning” does seem to have got through to the commission. It’s third priority for attention is “creating a more dynamic and competitive economy”.

Research by Treasury has found strong empirical evidence that our economy has become less dynamic – less able to change and improve over time. Fewer new firms are being created, and fewer workers are being induced to change their jobs pursuing higher pay.

Our industries have become more oligopolised – allowed by our permissive takeover laws - and, not surprisingly, their profit margins (“markups,” in econospeak) have been creeping up.

No official will admit it, but it seems pretty clear that the reason the Reserve Bank has been raising interest rates so far and so fast – despite falling real wages – is the part that oligopolistic pricing power is playing in our high inflation rate.

And now further Treasury research has confirmed that our high degree of industry concentration (markets dominated by a few huge firms) has given employers greater power to limit the rise in wages.

All this makes it unsurprising that our rate of productivity improvement has weakened. It also helps explain why, over the past decade, virtually none of what improvement in the productivity of labour we have achieved has been passed on to real wages.

Read more >>

Labor will struggle with deficit and debt until it raises taxes

There’s something strange about last week’s federal budget. It reveals remarkably quick progress in getting the budget deficit down to nearly nothing. But then it sees the deficit going back up again. Which shows that, as my former fellow economics editor Tim Colebatch has put it, Rome wasn’t built in one budget.

Let’s look at the figures before explaining how they came about. The previous, Coalition government finally got the budget back to balance in the last full financial year before the arrival of the pandemic, 2018-19.

The government’s big spending and tax breaks in response to COVID’s arrival in the second half of the following year, 2019-20, saw the budget back in deficit to the tune of $85 billion. Next year’s deficit was even higher at $134 billion.

But in the year that ended soon after the change of government in May, 2021-22, the deficit fell to just $32 billion. And in last week’s second go at the budget for this year, 2022-23, the deficit is expected to be little changed at $37 billion – which would be $41 billion less than what Scott Morrison was expecting at the time of the election six months ago.

But the changes in these dollar figures don’t tell us much as comparing the size of the deficit with the size of the economy (nominal gross domestic product) in the same year. Judging it this way allows for the effect of inflation and for growth in the population.

So, relative to GDP, the budget deficit has gone from zero in 2018-19, to 4.3 per cent, then a peak of 6.5 per cent in 2020-21, then crashed down to just 1.4 per cent last financial year. This year’s deficit is now expected to be little changed at 1.5 per cent.

We all know why the deficit blew out the way it did, but why did it come back down so quickly?

Three main reasons. The biggest is that it happened by design. All the pandemic-related measures were temporary. As soon as possible, they were ended.

But also: the rise in world fossil fuel prices caused by the war in Europe produced a huge surge tax collections from our mining companies. Last week’s budget announced the new government’s decision to use almost all of this windfall to reduce the deficit.

And last week we learnt the government had also decided to keep a very tight rein on government spending. It introduced all the new spending programs it promised at the election, but cut back the previous government’s programs to largely cover the cost of the new ones.

Its frugality had one objective: to help the Reserve Bank reduce inflation by first using higher interest rates to reduce people’s demand for goods and services.

Keeping the deficit low for another year has, Treasurer Jim Chalmers said this week, changed the “stance” of fiscal (budgetary) policy to “broadly neutral” - neither expansionary nor contractionary. Which, he’s sure to be hoping, will mean the Reserve has to raise interest rates by less than would have.

Another benefit of his decision not to spend the tax windfall, Chalmers said this week, is that by June next year, the government’s gross debt will be $50 billion lower than it would have been. And, according to Treasury’s calculations, this reduction means a saving of $47 billion on interest payments over the decade to 2033.

Great. Wonderful. Except for the strange bit: two years after this financial year, the budget deficit is expected to have gone back up to $51 billion, or 2 per cent of GDP.

What’s more, the budget’s “medium-term projections” foresee the deficit stuck at about 2 per cent each year – or $50 billion in today’s dollars – for the following eight years to 2032-33.

In the first budget for this year, just before the election, the deficit was projected to have fallen slowly to 0.7 per cent of GDP by 2033. Now, no progress is expected. Which means, of course, that the amount of public debt we end up with will be higher than expected during the election campaign.

The gross public debt is now not expected to reach a plateau, of about 47 per cent of GDP, until the first few years of the 2030s.

So, if the budget deficits last year and this are so much better than we were expecting just seven months ago, why on earth are the last eight years of the medium term now expected to be significantly worse?

Three main reasons. First, because a new actuarial assessment of the future cost of the National Disability Insurance Scheme (NDIS) shows the cost growing much faster than previously thought.

Second, because, with world interest rates having risen so much this year, the interest bill on the public debt is now projected to be much bigger over the coming decade.

Third, because the previous government based its projections on the assumption that the productivity of labour would improve at the quite unrealistic average rate of 1.5 per cent a year, but Chalmers has cut this to a more realistic 1.2 per cent. This change reduces government revenue by more than it reduces government spending.

What this exercise reveals is that the “persistent structural deficit” earlier projections told us to expect, will actually be worse than we were told. The deficit won’t go away but, on present policies, will stay too high every year for as far as the eye can see.

Fortunately, Chalmers freely admits that present policies will have to be changed. “While this budget has begun the critical task of budget repair, further work will be required in future budgets to rebuild fiscal buffers [ready for the next recession] and manage growing cost pressures”.

He repeated this week his view that, as a country, we need to “have a conversation about what we can afford and what we can’t” - his way of breaking it gently that, if the structural deficit is to be removed, taxes will have to rise.

Read more >>