Don't take the bait on debt

I've had to cut short my leave because of the election campaign, but those who follow the political debate faithfully might be better off taking an overseas holiday for the next three weeks. It's clear they'd miss little but aggravation.

The paradoxical truth is that modern election campaigns are aimed at those who aren't much interested in the topic. Swinging voters are assumed to be completely self-interested and short-sighted, driven by emotion rather than intellect, ill-informed and easily conned by slogans and television ads.

Hence all the nonsense we're hearing from both sides. For those of us who do take an intelligent interest, the best response is to conduct our own debate, ignoring the silliness as much as we can.

This election is the battle of the scare campaigns. Pollies are trying to frighten us about big new taxes, the return of Work Choices, the threat from boat people, and deficits and debt. I've written a lot in recent times about why we don't need to be too worried by budget deficits and public debt. But observing all the trouble the major developed countries are having has caused me to see the matter in a different light.

Many of the European economies and, to a lesser extent the United States, are worried about the huge levels of public debt they have racked up and the risk that the financial markets will begin to doubt their ability to repay those debts.

As a result, the British, German and other governments have embarked on austerity campaigns, cutting government spending and increasing taxes at a time when their economies are very weak. To slash budget deficits at such a time is likely to make their economies even weaker, meaning the actual progress they make in reducing their deficits is likely to be small, notwithstanding the pain the austerity measures are inflicting.

How did they get themselves into such a predicament? Well, the global financial crisis left them with no alternative but to borrow heavily to rescue their mismanaged banks, and then borrow again to try to reflate their economies. Had they failed to prop up their banks - as happened in the Great Depression of the 1930s - things would have been much worse. Fortunately, the worst was averted. But it would be wrong to conclude all the borrowing of recent times is what has got the main economies into trouble.

No, the real problem is they went into the crisis with such high budget deficits and levels of public debt. Throughout the long boom that preceded the crisis, most governments were running annual deficits rather than surpluses, thereby adding to accumulated debt rather than paying it off. They had failed to get their houses in order during the good times and so were badly placed when the bad times struck.

Why were they caught out? Because their politicians had been indulging voters who want ever-increasing government services but are most resistant to higher taxes. Rather than forcing their voters to face financial reality, they just went on year after year putting the shortfall on tick.

When you consider the genuine worries of the big countries, you realise how silly it is for us to worry about our tiny budgetary problem. They have levels of public debt up about 80 or 90 per cent of their annual national incomes (gross domestic product). Our present budget deficits and consequent borrowing are expected to leave us with a net public debt that peaks at $94 billion in 2013.

Does that sound a lot? If it does it's because you don't realise how big our government and the Australian economy really are. It will represent just 6 per cent of our annual national income.

Let me ask you a personal question: how big is your mortgage relative to your annual income? If it amounted to just 6 per cent of your annual income, how worried would you be? It's common for people to take out home loans that are three or four times their annual income.

Unlike the rest of the developed economies, we went into the global financial crisis with no net debt. Peter Costello and the Howard government get the credit for this.

They introduced and stuck to a "medium-term fiscal strategy" of keeping the budget in balance on average over the economic cycle. That is, it's OK for the budget to go into deficit during recessions, provided it goes back into surplus during the recovery, thereby eventually paying off the debt incurred during the period when the economy was weak and the budget was propping it up. The Rudd/Gillard government is following this same strategy. Indeed, so successful has the opposition been in putting the frighteners on the public over deficits and debt that Labor is on its best behaviour, promising to find spending cuts to offset all new spending promises. The usual vote-buying auction has turned into a Dutch auction. Amazing.

As I've argued all along, the Liberals' relatively recent obsession with deficits and debt (it was the creation of Costello, never being part of John Howard's rhetoric when he was treasurer or in opposition) is way overdone. But when you look at the problem the Europeans' and Americans' budgetary laxity has got them into, you realise our antipodean obsession with avoiding public debt has its advantages.

We've been more frugal than we've needed to be, but it has certainly kept us out of trouble.

In economics, however, there are no free lunches. Everything comes at an (opportunity) cost. So successful has Costello been at demonising all government debt - state and federal - that we've failed to invest in enough economic and social infrastructure. Our debt level is minor, but we're living in the worst house in the street.