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The confidence trick

By Andrew Leigh - posted Wednesday, 28 May 2014

Since the industrial revolution, modern economies have been in a perpetual state of transition. Indeed, economist Paul Collier once likened economic growth to ‘running across ice floes’.

But sometimes the transitions are particularly fragile. Right now, risks to global growth include potential disruption to European gas supplies, fragility in the Chinese shadow banking sector, and the possibility that structural reform in Japan will falter. Domestically, there is significant uncertainty about how much mining capital expenditure will drop.

So what should a responsible government do in uncertain times? Earlier this month, the OECD’s Economic Outlook recommended that ‘heavy front loading of fiscal consolidation should be avoided’.


In macroeconomic terms, you could argue that the government has not been entirely deaf to the OECD. Since coming to office, it has increased the deficit this year, next year, and over the forward estimates. The Pre-Election Fiscal and Economic Outlook (produced under the Charter of Budget Honesty) had the budget back in surplus in 2016-17. Joe Hockey has now pushed that back to 2017-18.

But macroeconomics tends to ignore the detail of government programs, and that’s when you start to see a different picture. Ben Phillips of NATSEM estimates that families with children in the top quintile will see only an 0.3 percent drop in their disposable income as a result of the budget, while those in the bottom quintile will see a 5 percent drop.

This matters for growth because low-income families tend to spend everything, while high-income families save a quarter of their income. Move $10 billion from the most affluent to the least affluent, and you take $2.5 billion out of the economy. By moving money from the have-nots to the haves, the budget is also redistributing from spenders to savers.

Let’s take a simple example. For the first time in six years, the budget raises the non-concessional superannuation cap, pushing it up from $150,000 to $180,000. At the same time, the budget cuts the School Kids’ bonus, a means-tested payment timed to coincide with the start of the school semester. The net effect will be a drop in consumer demand.

The effect on consumer demand is already showing up in the data. The Australian Institute of Company Directors’ biannual survey fell by 7 points in the first half of this year. Fewer than one in three company directors now believe that the federal government is having a positive impact on their business decisions and consumer confidence. The ANZ-Roy Morgan Consumer Confidence measure is now falling faster than at any time since the GFC. Similarly, the Westpac-Melbourne Institute consumer confidence survey just dropped to 92.9, nearly a three-year low. Confidence has particularly fallen among Labor voters, where the index is a lousy 74.9.  It’s hard to find a time under the Gillard and Rudd governments when Coalition consumers were as pessimistic about the economy as Labor supporters are now.

Robert Menzies liked to say that about half the people didn’t vote for him at each election, and they couldn’t all be wrong. It’s a good way to sum up the value of bipartisanship, but it’s even more important for economic policymakers. If Labor voters close their purses, the economy goes into a tailspin. And yet as political scientist Judith Brett wrote recently, the government is behaving like ‘a bunch of winners taking it out on the losers… It all feels a bit like student politics in its short-term point-scoring, its payback and its intense personal antagonisms’.


To restore consumer confidence, Treasurer Joe Hockey needs to do two things. First, he must recognise that redistributing from poor to rich isn’t just unfair, it will also hurt growth. The Treasurer may not like the piccolo popoli, but he needs to recognise that taking a fistful of dollars out of their wallets will reduce economic activity.

Second, Mr Hockey needs to stop trash-talking the Australian economy. Chest-beating about a ‘budget emergency’ might bolster his support in the Liberal party room, but it is profoundly damaging for economic confidence. Australia is one of the few developed nations to have avoided recession when the GFC hit – and surely the only one with a Treasurer who never mentions that great success. Being upfront about the reform challenges facing Australia does not mean preaching doom and gloom at every opportunity.

As our two decades of uninterrupted growth demonstrates, Australia has a great track record of running across ice floes. Here’s hoping our current economic leaders remember that their role is to jump the gap, not fall in the cold water.


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This article was originally published in the Australian Financial Review.

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About the Author

Andrew Leigh is the member for Fraser (ACT). Prior to his election in 2010, he was a professor in the Research School of Economics at the Australian National University, and has previously worked as associate to Justice Michael Kirby of the High Court of Australia, a lawyer for Clifford Chance (London), and a researcher for the Progressive Policy Institute (Washington DC). He holds a PhD from Harvard University and has published three books and over 50 journal articles. His books include Disconnected (2010), Battlers and Billionaires (2013) and The Economics of Just About Everything (2014).

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