This week’s mid-year budget update has changed the fiscal outlook markedly. It’s now a lot clearer that neither in this financial year nor those following is a budget surplus assured.
Whether he knows it or not, by staking so much of his political and economic credibility on getting back to surpluses, Scott Morrison has taken an enormous gamble. When the reality of this “courageous decision, minister” finally gets through to him, I won’t be surprised to see him perform a backflip to go down in history.
Since the election of the Coalition in 2013, there’s been a great debate about the causes of our economy’s continuing sub-par performance. While some economists have argued its roots lie mainly in changes to the structure of the economy (and thus lasting), the econocrats have insisted the causes are cyclical and thus temporary.
So Treasury and the Reserve Bank have gone on, budget update after budget after budget update, predicting that, although the latest indicators show the economy remaining sub-par, it will soon return to the trend growth we were used to before the global financial crisis.
Until now. The mid-year update represents the first stage in the econocrats’ quiet shift from cyclical to structural as the predominant cause of the economy’s weakness. And the first hint it was on its way came in late November, when Reserve Bank deputy governor Dr Guy Debelle pronounced that annual wage rises of between 2 and 3 per cent were “the new normal”.
By far the most significant revisions to the budget forecasts were made to annual growth in the wage price index. With the actual for last financial year coming in at 2.3 per cent rather than 2.5 per cent, the prediction for this year was cut by 0.25 percentage points to 2.5 per cent. The following three years were cut by 0.75 points to 2.5 per cent, by 0.75 points to 2.75, and by 0.5 points to 3 per cent.
This would be the main factor explaining why, after consumer spending grew by just 1.2 per cent over the year to September, the forecasts for consumer spending were cut by 1 percentage point to 1.75 per cent for this financial year, and by 0.5 points to 2.5 per cent for next year.
Despite offsetting changes to other components of gross domestic product, these major downward revisions to wages and consumer spending do most to explain why the forecast for real GDP growth for this financial year was cut by 0.5 percentage points to 2.25 per cent – but nothing to explain why growth the following year was kept unchanged at 2.75 per cent (but see below).
The major cuts to wages and consumer spending forecasts do most to explain why, after just eight months, the government’s been obliged to slash the budget’s estimate of tax collections and other revenue over the budget year and the three “forward estimates” years by a total of – amazingly — $33 billion.
Partly offsetting this, however, are its net cuts in estimated government spending over the four years of $11.5 billion. How is this possible when, in the time since the budget, the government has announced additional spending of $8.2 billion over the period on drought support, aged care and accelerated spending on infrastructure?
It’s possible because the lower predicted growth in wages and inflation will save the budget money on indexed welfare payments and, more particularly, because the fall in long-term interest rates will save it big money on interest payments on the net public debt. An expected gross saving on the spending side of $19.7 billion.
See what a difference less optimistic forecasts for the economy make to the budget?
Slashing revenue estimates by $33 billion, less the net saving on spending of $11.5 billion, means the expected budget surpluses over the four years have been slashed by $21.5 billion, from $45 billion to $23.5 billion. The expected budget surpluses have almost halved in the space of eight months.
This means the expected surplus for this financial year has been cut to $5 billion, or just 0.3 per cent of annual nominal GDP. Do you see how, in a budget worth $500 billion, such a small sum could disappear with just the smallest overestimate of revenue or underestimate of spending?
It’s the same for the revised predictions for surpluses in the following years: $6 billion (0.3 per cent of GDP), $8 billion (0.4 per cent) and $4 billion (0.2 per cent).
As former top econocrat Dr Mike Keating has argued, with no fall in unemployment expected until a modest improvement in 2021-22, the revised forecasts offer no convincing reason why annual wage growth will recover from its present rate of 2.2 per cent to a projected 2.75 per cent in 2021-22 and 3 per cent the year after.
Amazingly, the budget update papers imply this will happen because the budget’s projection methodology requires it to. Same with the return to (pre-crisis) trend GDP growth of 2.75 per cent next financial year. (This is a sign the econocrats have some way to go in fully accepting that structural changes will stop us ever returning to the “old normal”.)
But just as hard to believe as the out-year growth projections is the budget’s assumption that, having so far succeeded in limiting average real growth in government spending to 1.8 per cent a year, the government will now limit it to 1.3 per cent a year over the next four years.
As Keating has noted (and peak welfare group ACOSS’s Dr Peter Davidson before him), this implies real government spending per person will actually be falling.
Unsurprisingly, the Parliamentary Budget Office has warned it’s hard to believe such a degree of restraint could be maintained over such a long time.
Even Morrison’s secret weapon, aka hollow log – the budget’s highly conservative assumption on future world iron ore prices – rests on a gamble that iron ore prices will remain abnormally high. It would be so much less risky just to have some fiscal stimulus.
