Whether they realise it or not – probably not – the people up in arms about the size of the federal public debt and criticising Scott Morrison and Josh Frydenberg for not doing more to get it down in last week’s budget are saying they should have made the same error the major economies made early in their recovery from the Great Recession.
If you’ve heard Frydenberg saying he won’t “pivot to austerity policies”, you’ve heard him vowing not to make the mistake the Americans, and particularly the Brits and Europeans, made in 2010.
After they’d borrowed heavily in response to the global financial crisis, their recoveries had hardly begun before they looked back at their mountainous debt and panicked, slashing government spending and whacking up taxes.
This policy of “austerity”, as critics dubbed it, proved disastrous. It stunted their recoveries and meant they didn’t reduce their deficits and debts much at all.
This is why, to prevent the budget’s support for the still-recovering private sector falling precipitately over the coming four financial years to June 2025, Morrison and Frydenberg decided to use most, but not all, of an unexpected improvement in forecast budget deficits to increase spending and cut taxes.
Even so, the net debt in June 2024 is now estimated to be $46 billion lower than expected in last October’s budget, as independent economist Saul Eslake has pointed out.
In a speech to the Australian Business Economists this week, Treasury secretary Dr Steven Kennedy defended the government’s two-phase economic strategy.
According to the budget papers, phase one is to promote economic growth through “discretionary fiscal [budgetary] policy and the operation of [the budget’s] automatic stabilisers” so as to “ensure a strong and sustained recovery to drive down the unemployment rate”.
We will remain in the first phase of the strategy “until the recovery is secured” and growth has driven unemployment “down to pre-pandemic levels or lower”.
“Only once the economic recovery is secured will the government transition towards [phase two and] the medium-term objective of stabilising and then reducing debt as a share of gross domestic product,” the budget papers say.
But some economists – the most well-credentialled of whom is former Treasury secretary Dr Ken Henry – are concerned this willingness to live with unusually high levels of deficit and debt for many years, and without mention of any effort to return the budget to surplus – which would reduce the debt in dollar terms, not just relative to GDP - is complacent and risky.
But, with one proviso, Kennedy argues strongly that the presently projected paths of our budget deficit, our debt and the interest bill on the debt aren’t particularly risky.
When I get to that proviso you’ll see that Kennedy and his old boss aren’t so far apart. And remember this: Henry is now free to give the government advice in public, whereas the Westminster system requires Kennedy to give all his frank advice in private, not in speeches to economists.
Starting with the budget deficit, Kennedy says it grew hugely in 2020, partly because the lockdown caused tax collections to collapse and the number of people getting the dole to leap (this being the operation of the budget’s “automatic stabilisers”), but also because of the unprecedented degree of “emergency support” provided to businesses and workers.
The deficit’s expected to peak at $161 billion (equivalent to 7.8 per cent of GDP) in the financial year soon to end, then fall to $57 billion (2.4 per cent of GDP) in 2024-25. This “relatively quick” fall happens mainly because all the emergency support was temporary.
“At this stage, [a hint that policies could change, and probably will] the deficit is expected to persist through the medium term,” Kennedy says, by which he means that, seven years later in 2031-32 (the “medium term”), the projected deficit is still 1.3 per cent.
Budget statement 3 (page 100) shows that’s about the projected size of the“structural” budget deficit – the deficit that’s left after taking account of the cyclical factors affecting the budget – by then.
Kennedy explains this as representing the government’s structural (lasting) increases in spending on what it calls “essential services” – particularly aged care, disability care and the tiny permanent increase in the rate of the dole – in this year’s budget.
Such a structural deficit isn’t huge, but its existence is a tacit admission that, if government spending isn’t going to be cut, taxes should be increased.
Turning to the projected path of the net debt, Kennedy says the budget projections suggest the government is on track to stabilise and begin reducing the debt as a share of GDP in the medium term (the next 10 years), given the present economic outlook “and policy settings” (hint, hint).
The net debt is expected to be 34 per cent of GDP at June 2022, rising to almost 41 per cent at June 2025, before improving to 37 per cent at June 2032. (Eslake reminds us all this is less than half the average for the advanced economies.)
Finally, “debt servicing costs” - fancy talk for the interest payments on the debt. As a proportion of GDP – that is, comparing the interest payments with the size of the nation’s income – net interest payments are projected to “remain low by historical standards at around 1 per cent over the medium term”.
Two eye-opening graphs in Eslake’s first-rate budget analysis show 1 per cent is much lower than we were paying throughout the last quarter of the 20th century (in the late 1980s it was above 2.5 per cent). And, in inflation-adjusted dollars per head of population, it’s much lower than we were paying in both the late ’80s and the late ’90s.
Responding to Henry’s concerns, Kennedy says “there remains fiscal space [room] to respond again with fiscal policy if the need arose”. But here’s the proviso Kennedy adds: “there will come a time where it is prudent to accelerate the rebuilding of our fiscal buffers”.
That’s as frank as Treasury secretaries get in public.
