It's not just the size of your stimulus package...
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It's not just the size of your stimulus package...

There are a complex range of actions governments can take in poor economic circumstances, though debate around responses to the global financial crisis focussed on two broad approaches: austerity and stimulus. The stimulus approach envisions that government can play a critical role in helping the economy. Austerity involves government reducing its activity, thereby leaving economic recovery to the private sector.

There is growing international evidence that austerity doesn't work – or at least doesn't work as well as its advocates say. The International Monetary Fund's chief economist published a paper this year indicating that government spending cuts do not, as was forecast, reduce economic activity by 50c for every $1 that government did not spend; rather, it may reduce economic activity by $1.50 for every $1 cut. In April, a spreadsheet error in the research for an influential article was discovered and, as a result, the case that high levels of debt are associated with lower growth is now much weaker than it appeared.

Australia was one of only three advanced economies that avoided recession during the GFC. International acclaim has been consistently directed at the Rudd government's stimulus response to the GFC. "One of the best-designed Keynesian stimulus packages of any country," said former World Bank chief economist and Clinton administration adviser Professor Joseph Stiglitz. Stiglitz was not alone in heaping high praise on the Rudd government's fiscal injections. An open letter was circulated in 2010 signed by more than 50 professors and lecturers from Australia's leading universities praising the government's actions in stimulating the economy and preventing a recession and mass unemployment. The IMF also commended the "quick implementation of targeted and temporary fiscal stimulus", which it considered to be "among the most effective in the OECD".

Turning to the calls of waste and inefficiency that have been a hallmark of some media coverage of the stimulus package, Stiglitz again offers a cogent argument for the government's approach and the efficiency with which its agencies delivered the program.

"If you hadn't spent the money, there would have been waste. The waste would have been the fact that the economy would have been weak, there would have been a gap between what the economy could have produced and what it actually produced – that's waste. You would have had high unemployment, you would have had capital assets not fully utilised – that's waste. So your choice was one form of waste verses another form of waste. And so it's a judgment of what is the way to minimise the waste. No perfection here. And what your government did was exactly right."

Treasury's calculations support Stiglitz's analysis. It estimated that growth would have been negative for three consecutive quarters without fiscal stimulus. Originally, the stimulus was forecast to increase GDP growth by 2 percentage points in 2009 and to detract about 1 percentage point from growth in 2010; the estimates have changed only slightly since then. This means the stimulus's effect was to avoid the waste of our economy being $7 billion smaller.

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It's interesting to note that while Australia's stimulus package was one of the world's largest as a percentage of GDP, a number of nations with large packages did not perform very well subsequently. The OECD concluded that the effectiveness of our stimulus was due to both the size of its measures and the speed with which they were introduced. The targeting of households and schools (on which work can be undertaken rapidly) also contributed to the speed of its effect. So it seems the design of the stimulus is critical, and this requires sufficient public service capacity to plan, cost, establish and monitor large projects, perhaps against very tight time frames.

A number of other explanations have been suggested for Australia's performance during the GFC. Some of these alternative explanations also point to the critical role of a high-quality public service. For example:

Banking regulation: None of our major banks failed, and Australian was one of only two Group of 20 nations that did not need to inject public funds into the banking system (though, as in many countries, the government did issue guarantees for bond issuance and deposits). OECD analysis shows our regulations were not stricter, but they were well implemented. Our banking system benefited from years of rigid supervision by "better than world-class financial regulators".

The Reserve Bank: Appropriate actions by the RBA, and supporting government monetary policy, helped to maintain the stability of the financial system during the GFC (though indications are that the full effect of monetary policy is delayed and was muted by the nature of the financial shock).

Other explanations for Australia's success have been offered that imply less of a role for government, such as population growth, structure of the economy, and demand from our major trading partners, especially China. Indeed, China's demand is the most common explanation given as an alternative for why we did so well. However, it's worth noting the example of Canada, which also has large mineral resources but did not fare as we did. Also worth noting is the argument of economist Steve Keen that, if our current economic position was the result of China's strong economy (itself boosted by a substantial stimulus program), export industries would have experienced jobs growth first, followed by the rest of the economy. Instead, the growth was driven by industries benefiting most from the stimulus. The likelihood is that all these factors played complementary roles, with the non-government aspects being fed by, and feeding into, the effectiveness of government actions. And it should be kept in mind that the "non-government" aspects may have involved a significant government role in the long term – for example, immigration policy affecting population growth, and international trading relations facilitated by diplomacy.

While free-market ideologues continue to offer commentary that dismisses the efficacy of the stimulus package during the GFC and talks of the endless waste of big government, the economic reality is that Australia avoided recession, prevented mass unemployment and has an economy today that is the envy of the developed world – partly because of timely government intervention in a slowing global economy.

The stimulus's effect was to avoid the waste of our economy being $7 billion smaller.

Christopher Stone is the public service research director at the Centre for Policy Development. This is an edited extract from his report False economies: doing less with less.