Scomo's economic reform options - three effective economic weapons

The 2019 federal election was about many things, but at a Politics 101 level, it was about how big a role government should play.

At issue was whether the role and size of government should expand, with more spending for instance on health and education, as proposed by the ALP, or remain much the same, as proposed by the LNP. Aware that significantly higher taxes would have to be paid to achieve the ALP's bigger government objective, the electorate narrowly favoured the LNP's position.

As a share of GDP, spending by all levels of government in Australia is 37 per cent. Had the electorate voted for Whitlamesque higher taxes and spending, it may well have ratcheted up to forty per cent or more within a few years.

This would have steered Australia further down the European economic road, where sclerotic economies like France, Greece and Italy have public spending shares over 45 per cent of GDP.

In contrast, in more dynamic Asia where Australia mostly trades, government size measured as a proportion of GDP is considerably smaller. For instance, in the advanced economies in our region, government spending in Singapore (more competitive and richer on a per capita basis than Australia), South Korea and Hong Kong is only around twenty per cent of GDP.

The sharpest ever rise in government spending in Australia occurred after the election of the Whitlam government in the early 1970s. It peaked in 1987 under the Hawke government, though this spike was, some years later, reversed by ALP Finance Minister Walsh. That fiscal consolidation was notably stronger than has occurred under any LNP government in the post war years.

In the wake of the Rudd-Swan government's inevitably counterproductive response to the GFC, the government spending share spiked again and remains close to that peak, despite attempted fiscal repair by the Abbott, Turnbull and Morrison governments. This contrasts with other advanced countries where the government spending shares of GDP have generally come down from their GFC peaks.

There was little, if any, mention during the election of Australia's competitiveness and its place in the world, except as a coal exporter. It was as though Australia is an economic island unto itself, and that whatever happens fiscally has no macroeconomic consequence. But it is not, and it has.

Higher taxes on capital and labour to fund higher levels of spending ultimately reduce the incentive to invest and work, slowing economic growth. Extra public spending also means labour and other resources are drawn away from industries that compete internationally, and toward the government sector, which is shielded from international competition. This adversely affects both competitiveness and productivity, further stymying long term economic performance.

Australia's economic history shows that whenever the size of government increases, it will not be significantly wound back, the notable exception being during the Hawke-Keating years. Yet, contrary to Keynesian dogma prevalent in Australian media and university circles, empirical evidence from the academic literature suggests when public spending is wound back, the economy is buoyed up.

Economic research on the optimal size of government in advanced economies, for instance, suggests a one per cent increase in the size of government reduces long-term economic growth by ten basis points.

This implies a five per cent cut in government spending across all levels of government would deliver a half a per cent of extra growth per annum over a five-year period. That would cumulatively generate tens of billions of dollars' worth of extra national income for Australia.