Federal Budget 2013: Political correctness gone mad

May 7, 2013, 9:25 amYahoo!7

Deficit has become a dirty word in politics and it shouldn’t be.

When is it the right time to run a budget deficit?

You know it’s budget time when the former Treasurer Peter Costello starts to make a few appearances on television.

He’s been forced to defend his budget record because some of the blame for the state of the current budget stems back to the Howard years.

On the surface his record looks good: he left Labor with zero debt, the budget in surplus and the gigantic Future Fund. But was that enough considering the multi-billion mining sector was throwing money at the government? And given Australia has escaped the worst of the global financial crisis, why are we now in a structural deficit?

The fact is there are certain times when running a budget deficit is financially prudent. There are other times when it’s the responsible course of action to run a surplus budget. Australian policy makers, for now, are simply out of step.

Here’s why.

First up, let’s get just a tiny little bit of history. Stay with me on this.

The 1920s saw a big stock market bubble that burst in October 1929. The Dow Jones Industrial Average fell 13 per cent on October the 28th, then a further 12 per cent the next day. Those who held onto their portfolio or were late to get out lost enormous amounts of wealth. The event had a ripple effect throughout the United States economy.

Now whether it was the 1929 crash or the huge loss of confidence that resulted, the global economy then started to contract for a full decade. It resulted in what we know now as the Great Depression – short circuited by enormous amounts of government spending on the war effort.

In case you missed it, I said the Great Depression was resolved. It was fixed. How? Through economic stimulus and an industrial drive.

An eminent economist at the time, John Maynard Keynes, decided he would write a book about how it worked in practice.

It was called The General Theory of Employment, Interest and Money (1936). In short, Keynes said that in the short run, especially during recessions, economic output or GDP is strongly influenced by aggregate demand (total spending in the economy).

It sounds really simple, doesn’t it? You can boost economic growth by spending more. But what if you need to boost economic growth down the track and you don’t have the money to spend? Welcome to the dilemma faced by the Australian government. It’s found itself in the wrong budget position in the right economic time.

Now while it’s a problem for the current Labor government, both sides of politics are to blame... well at least according to the head of investment strategy at AMP Capital, Shane Oliver.

He argues successive governments over the past decade have spent too much and not taken in enough tax revenue. It’s resulted in a structural deficit. That is, a situation where the government is spending more than it’s taking in tax revenue at a time when the economy is close to full capacity – when it is doing well in other words. In short, the government’s books right now shouldn’t be in the red.

Both sides of politics have questions to answer.

The Coalition in its final few years in government enacted a series of tax cuts that reduced government revenue, and the current government has undertaken a series of spending programs that, in theory, it can’t afford: the Gonski education reforms and the National Disability Insurance Scheme are just a couple of examples.

Peter Costello has been criticised for not putting enough money way during the mining boom. He says that’s ridiculous. He says he paid down all government debt, put the budget into surplus and set up the Future Fund.

Treasurer Swan has been accused of spending too much money, but he says he helped Australia avoided a recession during the global financial crisis when the government injected billions into the economy. The Gillard government is also keen on improving Australia’s education system and making the lives of Australia’s disabled population easier – both great initiatives!

So who’s right? And what do the economics text books say?

Well it’s pretty straight forward. The government’s role, along with the Reserve Bank, is to manage the economy.

They both do - and can - work independently of one another. The government has the responsibility to spend money on infrastructure, education, health and defence and it pays for that with taxpayers’ money. The central bank controls the money supply and the price of money to ensure price stability, currency stability, full employment and just to make sure we’re all happy campers. Sounds terrific!

It stands to reason then in good times Australians will be earning more and spending more. They will also be paying more in tax as incomes rise. Companies will also be paying more tax. The government then should take that money in and NOT spend it.

It helps create a surplus budget – that is, money not spent. When the business cycle turns, and conditions become increasingly tight (you could write a whole thesis on why business conditions turn), the government hands the money back.

It usually ends up needing to spend more money than it has in its kitty, so it borrows money from overseas, or dives in to the national pool of savings. That stimulates the economy and the cycle goes on.

The current government has found itself with a structural deficit but one of the reasons for that was not entirely within its control (it has to do with missing some of the spoils of the mining boom). It was a bad miss.

That reason is also going to make it very difficult for the government to get back on the right budget track.

Much of it is to do with the global economy and it’s again indicative of a much broader thematic being played out.

The government (and Treasury) assumed the mining boom would last longer than it has. They both predicted commodities prices would remain higher, for longer. In the first six months of the MRRT, the government only saw around $126 million. Unfortunately the mining boom is set to taper off further from here too.

So the government’s been caught out. The economy in Australia is doing relatively well and, in theory, Treasurer Swan should be handing down a surplus budget next week.

He won’t be because the government has been denied around $12 billion in tax revenue that thought it was

going to receive. Some of that $12 billion shortfall is a result of the higher Australian dollar and falling commodities – in other words the ripple effects of a slowing global economy.

Australia is now running a structural deficit because the economic problems from around the globe have finally caught up with us. We don’t need to push back into surplus immediately, but we will have to at some point in the medium term – assuming economic conditions domestically don’t deteriorate further.

The bottom line is that if another financial crisis strikes down the track, Australia will need to be well placed to withstand it.

It’s clear from what we know now that the non-mining sectors of the economy have a long way to go before we get to that point. The government therefore will have to work through a very delicate economic plan of increasing taxes or cutting government spending during a time when it’s hoping a good chunk of the economy will somehow start producing solid growth.

I really don’t envy policy makers right now. Even the most politically correct course of action won’t necessarily work, and will no doubt be a hard sell to the electorate.

Deficit has become a dirty word in politics and it shouldn’t be. Now, however, is a time we should be in surplus, but we’re not because of factors – some would say - outside our control.

I would argue though the government should not have relied on the tail end of the mining boom to fix its obsession with achieving a surplus budget. It had more important policies to work on like tweeking the rest of the economy.

It’s simply not politically correct to always be in surplus and avoid deficit at all cost. There is a time for both.

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