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The 2011-12 Budget: making insufficient room for the expected boom?

By Geoff Carmody - posted Friday, 13 May 2011


The 2011-12 Commonwealth Budget can be evaluated from at least three different perspectives.

Perspective #1:  ‘What’s in it for me?’

Most assessments are from this perspective and I won’t add to them.  Individuals, interest groups and the media have done this type of assessment to death already, and no doubt more are coming.

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Perspective #2:  The Budget as a vehicle for longer-term structural reform

The second perspective asks whether the Budget has introduced reforms that improve productivity, labour force participation, and generally improve supply-side flexibility and capacity.  The more the Budget enhances sustainable supply-side capacity, the better off Australians can be over time.

From this perspective, there are a number of measures included in the 2011-12 Budget that are useful moves in the right direction, including:

  1. The measures to increase (skilled) labour supply, including increased immigration, increased spending on training, increased incentives and penalties encouraging more people to move from welfare to work. These are all moves in the right direction.
  2. Tighter targeting of government benefit payments to reduce ‘middle class welfare,’ is also sensible.
  3. A (partial) move to reduce FBT concessions that at present encourage wasteful use of vehicles simply to meet driving distance thresholds, is good for the economy and for the environment.
  4. Mental health initiatives are also potentially worthwhile attempts to deal with long-standing problems in this area.

Some might take comfort from the fact that these sorts of initiatives have been introduced while keeping the estimated increase in Budget spending to less than 1% in 2011-12 and across the next few years.

This looks good relative to an annual real spending growth limit of 2% per annum set by the Government as it responded to the global financial crisis with its ‘cash splash’ and other spending initiatives.  (Of course, part of this apparent discipline simply reflects cessation of ‘cash splash’ and similar initiatives that boosted spending in the previous years.)

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But the official forecasts have the Australian economy booming next year and beyond.  Why should an annual spending cap of 2% real growth (i.e., more like 5-6% growth in current dollars) be appropriate with the economy stretched to the limit, and forecast to become even more stretched?  Surely there’s a need for the Budget to play a counter-cyclical role, ‘making room’ for a burgeoning private sector?

This brings me to the third perspective from which the 2011-12 Budget should be assessed.

Perspective #3:  The Budget as a shorter-term macroeconomic policy manager

In an economy forecast to recover this year, and then grow quite strongly in later years, with the unemployment rate falling to a forecast 4.5%, the shorter-term stabilisation policy role of the Budget becomes crucial.  In my opinion, this is the most important ‘big picture’ role for annual budgets.

Given the official forecasts on which it rests, the primary task for the 2011-12 Budget should be to ensure that growth in aggregate demand for Australian goods and services, does not run ahead of growth in supply. 

Official forecasts are for a labour market so tight, overall, as to trigger much-increased risks of an inflation breakout, fuelled by wage demands in excess of (currently very poor) productivity growth.

This process has already begun as industrial disputes in support of large wage increases spread across key sectors, including stevedoring and transport.

At present, balancing Australian demand and supply, must take short-term priority over supply side-enhancing initiatives, where these objectives are in conflict.  A much better option is to implement productivity-enhancing supply side initiatives, but within an overall Budget setting that keeps a lid on overall demand growth in an economy expected to be growing very solidly overall.

Macroeconomic policy management at present requires Budget policy decisions reducing aggregate demand, by more quickly moving back into surplus than the Budget would do without such decisions.

What has been the ‘bottom line’ impact of new policy decisions announced as part of the 2011-12 Budget?  In summary:

  • Savings estimated at $21.7 billion (over the five years to 2014-15!) have been announced.
  • New spending totalling $19 billion (over the same period) has also been announced.
  • Between 2010-11 and 2012-13, the net swing towards surplus of new Budget decisions (excluding natural disaster spending) has been about $4 billion.  Actually, tightening does not begin until 2012-13.  In the two previous financial years, net new policy decisions add to the Budget deficit and aggregate demand.
  • The trumpeted ‘back in black’ return to Budget surplus relates to ‘headline’/’underlying cash’ Budget balance measures.  It does not relate to the ‘structural’ Budget balance that removes cyclical effects on the Budget.  Based on various estimates by different groups, that remains firmly in deficit (maybe to the tune of around 2% of GDP in 2012-13).  This hardly seems sensible given the boom conditions assumed in the Budget.

On the official estimates for the Budget bottom line, we will see a $52.9 billion swing from a deficit of about $49.4 billion in 2010-11 to a surplus of $3.5 billion in 2012-13. 

Of that swing, about $4 billion, or less than 8%, is due to net ‘tough’ Budget policy decisions.  The rest is due to other forces, notably assumed economic strength both overseas and in Australia, boosting Budget revenues and easing pressures for more spending (e.g., on unemployment benefits).

The 2011-12 Budget is hardly ‘tough,’ pre-Budget spin to that effect notwithstanding.  Net Budget decisions make a very small contribution to returning the Budget to surplus.  They amount to ‘fine tuning’ of the most delicate kind, at a time when a more robust approach to keeping a lid on demand seems needed.

It is from this third perspective that, in my opinion, the 2011-12 Budget is likely to prove most deficient.

Fiscal Policy Overview:  The 2011-12 Budget in a nutshell

As the global financial crisis loomed a few years ago, Ken Henry, the recently retired Treasury Secretary, is reported to have given the Government some pithy budget policy advice:

Go hard, go early, go households.

What counterpart advice would justify the 2011-12 Budget as tabled, including its very heavy reliance on assumed overseas economic boom conditions to get the Budget ‘back in black’ in 2012-13? 

With apologies to Ken Henry, the 2011-12 Budget could only be justified by the following injunction:

Go soft, go late, go automatic stabilisers.

Unfortunately, accepting that advice increases the risk of two, maybe three, nasty consequences:

Go inflation, go interest rates, and, maybe, go the $A.

I hope I’m wrong.  But early action by the Reserve Bank to raise interest rates might suggest otherwise.

Alternative economic scenarios

One final thought.  The Budget papers highlight significant ‘downside risks’ to forecast economic conditions (e.g., including concern about European debt).  This implies that the official forecasts might have been pitched towards the upper end of a plausible range of possibilities. If so, it might mean that there’s a better-than-even chance economic conditions will be weaker than officially forecast.

On balance, that would not be a good thing.  The fragile ‘back in black’ surplus would suffer a bad case of the Budget deficit blues.  The $A might turn down as the terms of trade weakened more than forecast.

This combination of events could even return Australia, and much of the Western world, to the nasty conjuncture experienced in the 1970s.  That is the combination of lower growth, weakening employment and high inflation, or, in the ugly jargon of the time:  stagflation.

I really hope I’m wrong on that destructive scenario.

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About the Author

Geoff Carmody is Director, Geoff Carmody & Associates, a former co-founder of Access Economics, and before that was a senior officer in the Commonwealth Treasury. He favours a national consumption-based climate policy, preferably using a carbon tax to put a price on carbon. He has prepared papers entitled Effective climate change policy: the seven Cs. Paper #1: Some design principles for evaluating greenhouse gas abatement policies. Paper #2: Implementing design principles for effective climate change policy. Paper #3: ETS or carbon tax?

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