Kevin Rudd's idol FDR did it, so why doesn't he?

For electoral reasons Australian states will seek to balance their budgets by raising taxes rather than shedding staff (or, heaven forbid, cutting salaries). But eventually, radical spending cuts will be required, although in Australia this normally has to await changes in government. Doubtless Queensland Premier Anna Bligh has recognised this and is seeking an early election to avoid having to go to the polls ahead of radical cost cutting surgery.

Cost saving economies by private sector businesses are widely evident in Australia. Jobs are being shed across the private sector. Alcoa workers are among those who have volunteered to accept a wages standstill to assist the company’s competitiveness and nabCAPITAL’s January survey indicates private sector wages are beginning to fall.

Mr Rudd’ defence of bloated public sector paying excessive wages is part of his fiscal stimulus philosophy. This is based on a crude Keynesian formula that equates income with consumption, investment and government spending. The problem is that trying to boost income through government spending brings offsetting reductions in private spending and investment, and in doing so reduces the economy’s productive capacity.

The Rudd policy rests on the alchemy of government fiscal multipliers providing extra bang per buck spent. While cash injections can boost regional economies, a national economy’s multiplier is accompanied by a negative multiplier resulting from governments’ eating into private wealth and incomes. Hence the aggregate national multiplier is unlikely to diverge from zero.

We therefore have a combustible brew. Mr Rudd’s penchant for spending and profound mistrust of individuals making their own such decisions is combined with Treasury’s advice. This is anchored in a poorly understood Keynesian framework and is abetted by business lobbies all seeking a share of government spending spoils. Instead of a gentle economic warming, the measures proposed, which already amount to $80 billion and approach 10 per cent of GDP, will torch the economy.

Though having more scope to engage in imprudent deficit spending, even national governments have to confront reality once their deficit financing threatens lenders’ risk preferences.

What is needed now is a careful husbanding of expenditures and reductions in the regulatory costs. Ironically, such measures were promoted by Small Business Minister Craig Emerson just as Kevin Rudd’s essay calling for fiscal intemperance hit the streets.

Instead of policies that dissipate savings and mortgage the future without providing corresponding assets to furnish the debt, we need to encourage savings. Foreign investment is important to allow economies to benefit from global technologies and for poorer countries can be a useful supplement to domestic savings. But for too long Australia has been reliant on overseas capital inflow which instead of supplementing domestic savings has been used to allow excessive consumption. Removing taxation on savings would be one way of doing this.

We also need to remove regulatory measures that lower the productivity of capital. Among these are many of the environmental regulations - the mother of all being directed at greenhouse gas emissions - that add costs and impair real returns on investment. And we need to abandon the array of interventions like those in favour of green cars, those preventing telecommunications investment and those that impede private investment in ports and railways.