Hey, big spender, everything’s not so hunky-dory

The Federal Government has failed to adapt to the improved economic environment and must implement more structural changes.

When in 1980-81 I headed the Treasury division advising on the budget, our principal concern was to persuade the government that the major policy priority should be to reduce inflation (then about 10 per cent per annum) by constraining demand through reductions in the budget deficit and monetary growth.

Then Treasurer John Howard announced an estimated deficit of 1.5 per cent of GDP (well down on the 5 per cent deficit emanating from the last disastrous year of 1975-76 under the Whitlam Government) and emphasised “unless we persist in our fight against inflation our full economic potential will not be realised”. The budget papers clearly indicated, however, that Treasury was unhappy that most of the large increase in estimated revenue was being spent, leading to an increase in outlays as a proportion of GDP, and that more had not been done to reduce the budget call on both real and financial resources.

Fast forward 25 years, and we find that John Howard as prime minister faces different - and vastly improved - budget and economic policy situations to those he experienced as treasurer. With the help of much improved monetary and external policy institutional arrangements, the serious problems posed by inflation have been brought under control and the Coalition Government has adopted a medium-term budget strategy to maintain, on average, balance over the economic cycle. In fact, with sustained economic growth and no downward turn in the economic cycle, it has been running budget surpluses that, with the proceeds of privatisations, have almost eliminated debt and even raised the question - what to do with the surplus cash?

This medium-term, budget-balance approach is also reflected in the recognition that economic analysis is not sufficiently robust to warrant making either budget or monetary policy changes designed to fine tune the rate of economic growth. Indeed, Treasury Secretary Ken Henry even pointed out in a recent address, “It is well nigh impossible to forecast the macroeconomy for years beyond the budget year” - and if you can’t make such forecasts, it is difficult to justify policy changes that have lagged effects, but are directed at increasing or reducing growth in the period not far ahead.

Associated with this recognition is the increased acceptance among economists that, providing institutional budget and monetary arrangements are in good shape, there is now a much greater likelihood the private sector will itself adjust to structural changes in Australia or overseas, without experiencing the up or down fluctuations in the economy that involve recessions or unsustainable booms.

Again, Ken Henry pointed out recent strong growth in export prices (principally resulting from the strong growth in Chinese demand) has led to appreciation in the exchange rate that has dampened the growth in export incomes and by encouraging imports, has reduced the pressure on domestic resources and on inflation.

In short, changes to Australia’s external institutional arrangements have provided an “automatic” adjusting mechanism to externally driven structural change and in combination with budgetary and monetary institutional arrangements, has reduced what might in earlier times have prompted changes in budgetary and or monetary policies. Accordingly, while sticking to the budget surplus approach, this has allowed the government to announce additional tax cuts and increased spending in the 2005-06 Budget without running a serious risk inflationary pressures would emerge. Indeed, as (post-budget) it now appears that Australia is experiencing a slowing in economic growth that was not forecast, any addition to demand from tax cuts may well be welcome.

So, is everything in the budgetary scene hunky dory? Well, not quite. The Budget included what Henry described as a strengthening of recent efforts by the government to “re-engage with the workforce those on disability support pension and the parenting payment programs [and] over time raise the labour force participation of many individuals on these programs, lifting aggregate participation outcomes”. But Henry was being rather kind to what was a very poor start by the government to tackling the need to reduce the proportion of the population receiving social benefits and lift the proportion working. As the Treasury’s Intergenerational Report of 2002-03 pointed out, without policy changes, the ageing of the population will mean lower growth in employment and hence, in living standards.

In these circumstances, and with the strong growth in per capita incomes over recent years, it is absurd to have 2.7 million or 20 per cent of the working age population receiving income support compared with only 15 per cent at the end of the 1980s and 4 per cent in 1969. Social assistance benefits alone now contribute 14.3 per cent of gross household disposable income, compared with just 8 per cent under the Whitlam Government.

Indeed, with increased standards of health and education, individuals are more able to take care of themselves and the proportion of the population needing Commonwealth welfare and health assistance should have been falling - and should be continuing to do so. A progressive reduction in the proportion receiving government assistance would make a major contribution to dealing with the longer-term problem identified in the Intergenerational Report.

But the need for corrective action is not simply related to the ageing problem. The OECD’s 2004 Economic Survey of Australia brought that home when it said:

Challenges lie ahead, but policy actions are required now. The main challenges lie in the medium and longer term, but to address them, further policy actions should not be delayed. Ageing will exacerbate the underlying rise in public health costs and to a lesser extent in public pensions, putting pressure on public finances. More fundamentally, although Australia has moved up the “league table” in terms of per capita incomes during the past decade, it has returned only to the relative position it already held in the early 1970s and remains well below the leading countries in terms of labour participation and labour productivity.

Against this background of ageing and required early policy changes, the Budget falls short. Despite the additional welfare-to-work programs designed to encourage welfare recipients to move into the workforce, and costing $3.6 billion over four years, the Budget forecasts suggest no increase in the workforce participation rate over the next four years and the spending estimates show no reduction in the relative (to GDP) size of welfare spending. Indeed, as the estimates of assistance to the unemployed provide for an increase of nearly 30 per cent between 2005-06 and 2008-09, it appears many of those no longer eligible for the disability pension and parenting payments will go on to the dole, with little or no net change in the total number on welfare. The weak explanation being provided by ministers is that it will probably take about eight years for the programs to have a major impact.

Regrettably, this slow adjustment to changed circumstances is par for the course. Under the Howard Government no substantive progress has been made in reducing the size of government spending, either in practice or philosophically. Indeed it has gone backwards. My report to the Australian Chamber of Commerce and Industry shows that since 1995-96 Commonwealth spending, excluding interest, has actually increased as a per cent of GDP - and remains higher than in Whitlam’s final year. Moreover, with the now extensive so-called “tax expenditures” - basically tax concessions - Commonwealth spending is really about a sixth higher than the published figures.

In short, the 2005-06 Budget indicates that the government has failed to adapt to the new improved economic environment in which budgetary policy now operates - but in which structural changes should be implemented to a much greater extent.