A government budget going into deficit as an economy heads towards a recession should evoke no more than a yawn. The alarm bells should ring, if a budget remains stubbornly in deficit after growth resumes. Now that he has finally admitted that a deficit might occur, the test for Kevin Rudd is whether he takes steps to see that the economy — and the budget — rebounds as soon as possible.
Having spent the last few months pretending that his government would always maintain a budget surplus, the prime minister suddenly acknowledged last week that a “temporary” deficit might occur. His earlier behaviour simply gave the Opposition leader Malcolm Turnbull the opening to claim that a budget deficit would be an admission of failure.
But Turnbull will earn few marks from business if he keeps arguing that the budget must stay in surplus. Most firms struggling with falling sales would not welcome a surplus that continues to withdraw money from the economy. If Rudd stumbles, however, Turnbull could gain from his claim that Labor governments can’t be trusted to ensure that deficits remain “temporary” once a crisis has passed.
The prospects for growth in other countries look bleak, particularly in the US. Against this backdrop, Australia’s economy looks like sliding into recession and the budget into deficit.
It is impossible to know for sure what will happen — which is one of little noticed lessons from the global credit crunch. Arrogance, not greed, was the crucial sin committed by US financial executives. Crazy risk taking was justified by the extraordinary conceit that it is possible to know how a radically uncertain future will unfold. By now it should be clear that it’s not — forecasting errors will not always cancel each other out in a risk assessment model, leaving a high degree of probability of obtaining the correct answer.
As Turnbull is no doubt anticipated, this won’t stop journalists from asking Rudd and the Treasurer Wayne Swan to guarantee that the budget won’t stay in deficit for more than a year. It is impossible to give such a guarantee. The duration of the deficit will depend on the depth and duration of the recession — assuming one occurs.
But Rudd and Swan should undertake to improve the structure of the budget so it will be easier to move back into surplus, once the impact of the recession recedes. The Reserve Bank governor Glenn Stevens said in a recent speech there is nothing wrong with using additional government spending to stimulate economic growth during a slow down. But he stressed it had to be for “worthwhile” purposes.
Not all of Rudd’s initial $10.4 billon stimulus package meets this definition. There is no excuse for the $1,400 hand out to pensioners to go, as it will in next couple of weeks, to people with a tax free superannuation pension of well over $100,000 a year. Nor does it make sense to double the first home owners grant to $14,000 to help people buy second hand houses — that does nothing for a flagging building sector. But most of the spending will probably go on buying goods and services from firms that might otherwise sack staff or go bankrupt.
Rudd should focus the bulk of his new spending on investment in areas such as physical infrastructure and education and training to boost the productive base of the economy. To reduce the medium term cost of tackling global warming, he should get cracking on developing low emissions technologies.
The government has about $26 billion in special infrastructure funds it can spend without borrowing. It is in a strong position to borrow more for productive investment. It has no net debt — unlike most developed countries where government debt is over 50 percent of national output.
To emerge in better shape from a recession, the government should make room for extra spending in areas such as education and infrastructure by cutting fat left by the last government. John Howard splurged on welfare spending, much of it on people who can afford to fend for themselves. He gave almost all retirees prescription drugs at the $5 concessional rate once confined to pensioners. There is no charge once spending on prescriptions hits $290 a year. Yet ordinary members of the workforce pay $31.30 until they spend $1,141. Then they pay $5, not zero.
Rudd has done almost nothing to impose restrain. Soon, some people will qualify for a part age pension, although their income is higher than most members of the full time workforce. When Howard came to power in 1996, spending on the aged was less than $17 billion. It is estimated to hit $56 billion in 2011-12. The costs of special tax concessions, often for the well off, is estimated to reach $65 billion in 2011-12.
These two areas total $121 billion. Savings of $20 billon a year should not be hard to find. That’s enough to fund serious improvements in education, training, transport and so on, as well as cut the high effective marginal tax rates facing some middle income earners.
If these measures don’t keep any recession short and shallow, then a deficit might have to last a little longer. That’s OK.