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Will the real fiscal conservatives please stand up?

By Rowen Cross - posted Friday, 15 May 2009


The Howard-Costello years represent the boom years of the second half of the last economic cycle and of the first half of this current economic cycle. Over this period the Coalition government ran a budget surplus in every year other than 2002, during which it ran a small deficit, and was able to generate a total surplus of about $112.5 billion.

If the Rudd Government was serious about keeping the budget in surplus over the current economic cycle, it would have limited its spending in the downturn to the $112.5 billion in the kitty from the boom years. The Rudd Government plans to spend nearly double this amount.

It seems that Rudd was never very serious about delivering a surplus over the cycle, and fiscal conservatism was the first promise out the door once Rudd and Swan saw the financial trouble that was brewing. The Government tacitly acknowledged this when it lifted the Commonwealth debt limit from $75 billion to $200 billion in February this year.

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The Government's plan for returning to surplus within six years looks hopelessly optimistic.

According to Treasury modeling, to return to surplus within this timeframe the recession would need to be a short one and the Australian economy must quickly achieve and sustain above trend economic growth - in the vicinity of 4.5 per cent year on year. Treasury is also counting on inflation remaining under control, even though growth will be running hot and despite having spent the last three years or so pumping cash into the economy hand over fist. An ambitious result coming off the back of the "worst economic crisis since the Great Depression".

More sober economists believe government debt will ultimately end up around $300 billion, and many wonder whether Treasurer Wayne Swan will ever deliver another surplus budget again.

But is Labor to blame?

In the face of such a massive economic crisis, is it simply not possible to keep the budget in surplus over the current economic cycle?

Perhaps this is true, but it does not excuse the Government's wasteful spending like the cash splash. The two rounds of cash handouts were only ever going to cause a temporary upturn in GDP figures.

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Call me a cynic, but I believe the two sets of cash handouts, occurring six months apart, were designed to deliver positive GDP growth numbers in two non-consecutive quarters so as to prevent the economy from falling into technical recession - defined as negative growth in two consecutive quarters - thereby allowing Labor to avoid the stigma of presiding over the first recession since Labor was last in power. Alas, the downturn was too great and the cash splash did not work.

The Government argues that the spending was justified at the time because something had to be done immediately. Treasury's advice was to "go hard, go early, go households". Instead of the Government going into debt, it would have been better to use monetary policy to fuel short term demand. Interest rates were extremely high at the time so there was (and still is) plenty of room to move, and a steep drop in interest rates could have stimulated the economy and freed up household income. The Aussie dollar would have experienced a marked depreciation as a result, which would have stimulated the export and tourism sectors and have improved our current account position. All at no expense to the taxpayer.

The cash handouts were a dumb idea, but it is only part of the story - most of the Government spending is focused on infrastructure. This is the right approach, but there is good and bad infrastructure spending. Spending that increases the capacity of our ports and rail systems will deliver growth for Australia over the long term, and is a sound investment. On the other hand, it is difficult to see how installing pink batts in school classrooms will deliver a solid return on taxpayer dollars. On infrastructure spending, the Rudd Government's report card is mixed.

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About the Author

Rowen Cross is a lawyer practising in the private equity, hedge funds and banking industries.

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Creative Commons LicenseThis work is licensed under a Creative Commons License.

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