Today’s economic data releases in Australia confirmed what all the previous data is telling us – the economy is slowing and may even be going backwards. The latest estimates of tax revenue are showing that the Federal government will receive much less this financial year than they forecast in the last Budget (May 2010). It is thus no surprise that the estimated deficit has been revised up. A responsible government, entrusted with the duty to ensure public welfare is advanced (via employment growth etc), would see these developments as a sign that they should craft further fiscal stimulus initiatives to arrest the slowdown. What does the Australian government propose? Even harsher spending cuts than previously hinted at. Why? Because they are going to pursue a budget surplus by 2012-13 by hook or by crook. It is an obsession. Is that responsible? No, it is mindless vandalism and an abrogation of prudent fiscal management. Their excuse? We are booming and at full employment. Reality check – back to the data – 12 per cent labour underutilisation, retail sales contracting etc. Their ideological blinkers have led them into denial.
Let’s start with some facts:
Fact 1: When private spending falls, economic growth will falter unless an increase in net public spending fills the gap.
Fact 2: Even if a government chose not to fill the gap, and instead did nothing, its budget deficit would rise as economic activity fell due to the operation of the automatic stabilisers (tax revenue falling, welfare spending rising).
Fact 3: After a period of rising public deficits, if private spending remains flat, cutting the budget deficit will damage economic growth.
Fact 4: When there is an external deficit (net exports negative), if a government runs a surplus, the private domestic sector must be running a deficit and accumulating indebtedness overall. If the private domestic sector resists that dynamic, then growth will falter and unemployment will rise.
Fact 5: The central bank sets the interest rate.
Within this context, with growth slowing, the private sector saving ratio rising, the external sector draining growth and labour underutilisation rates around 12 per cent, the last thing the Federal government should be doing is cutting net spending in next week’s Federal Budget.
But it is the very thing they are proposing to do. They have been captured by the deficit terrorists and cannot see beyond the “surplus is good” mantra. At the moment, the pursuit of austerity will be very destructive.
News Limited journalists have become obsessed with the deficit and continually demand higher surpluses. They also seem to be oblivious to the on-going developments in the economy.
This article, May 3, 2011 – Deficit is driving up the Australian dollar – from The Australian newspaper’s economics editor, Michael Stutchbury is no exception. Stutchbury regularly writes the same column twisting it a bit here and there but the message is always the same – the budget deficit needs to be a budget surplus.
In this article (rant) , he writes:
…. the more fundamental story is that Canberra’s structural budget weakness is helping to drive the Australian currency to its new post-float high of $US1.10.
The deficit blow-out to be revealed a week from tonight will mean that the budget’s bottom line is perhaps two to three percentage points of gross domestic product – or perhaps $40 billion – structurally looser than demanded by the mining boom, our record high export prices and a jobless rate heading below its “natural” 5 per cent level.
Instead of being close to $50bn in the red, the budget already should be building up a solid surplus buffer to stabilise the mining boom economy.
At least this is a twist on the usual argument presented by opponents of deficits that in open economies they lead to a collapse in the currency.
I suppose anything will do when you are obsessed.
I will come back to some of the other components of this quote later but what are the mechanisms that Stutchbury thinks relate the budget deficit to the appreciating $AUD.
He mounts the case that “the floating dollar and the budget bottom line need to fully play their role as the economy’s front-line “automatic stabilisers”” and by which he means that when private spending growth is strong and the economy approaches capacity, public spending growth should moderate. At the same time, if the growth is sourced by an export boom then the exchange rate will also appreciate to ease inflationary pressures and stifle some of that “externally sourced” growth.
I agree with all of that except then you have to examine the facts.
If growth is insufficient to fully employ all available resources … AND …if the external sector is not adding to growth … AND … if private spending is still dragging …. then you do not move the budget position towards surplus much less into surplus.
The facts sheet about the Australian economy does not include a statement that the external sector is a net contributor to economic growth in Australia at present. The most recent National Accounts showed that the external sector was still a drain on economic growth. Please read my blog – Australian National Accounts – I wouldn’t say the economy is great – for more discussion on this point.
Stutchbury can go on about how strong the economy is but a boom in one sector that doesn’t feed through to the rest of the economy is not a signal that the budget deficit should be cut.
Further, unless the external sector boom overall (that is, its contribution to growth) is sufficient to fully accommodate any desire to net save by the private domestic sector then the public balance has to stay in deficit for growth to continue. Australia’s external performance is not anywhere near that level at present.
Stutchbury also continues to run the line that the Government:
… splurged too much again during the financial crisis with its excess budget stimulus.
Well that should have resulted in strong growth being maintained and no rise in unemployment and underemployment. The reality is the opposite. Growth slumped and remains subdued and labour underutilisation rates rose by nearly 50 per cent (combined unemployment and underemployment). The reality is that the fiscal stimulus was inadequate and has been withdrawn too early.
He also mounts a very curious “insurance-type” proposal which is contrary to sound fiscal management.
Apparently, he thinks the budget position now should constrain growth so that the exchange rate will not rise as far. He claims that this would make the demand shock arising from the “unravelling of the global commodity price bubble” less “messy” – because we would already be stifling growth as a result of the fiscal drag.
But a government’s role is not to undermine economic growth “just in case” the growth becomes too strong and pushes the economy up against the inflation barrier. At present core inflation is low and the Reserve Bank maintained its target rate (yesterday) for the 6th month in a row.
With idle labour and signs that the economy is contracting – now is not the time for the Government to be stifling growth even further.
Is there evidence for my position?
We received two pieces of economic data that also confirms my position that economic growth is faltering.
First, the Australian Bureau of Statistics released the Retail Sales data for March 2011 today and the results apparently “surprised” economists – all except this one!
The main highlights of the March 2011 data were:
- Seasonally adjusted retail sales fell 0.5 per cent in March 2011.
- In volume terms (that is, adjusting for inflation), the trend estimate for retail turnover fell 0.1 per cent in the March quarter 2011.
The Sydney Morning Herald report on the data release today (May 5, 2011) carried the headline – Surprise drop in retail sales – and said that:
Retail sales unexpectedly fell in March, the first drop in five months, offering further evidence of a cautious consumer that argues against the need for a near-term hike in interest rates … the Bureau of Statistics reported sales fell 0.5 per cent in March, confounding forecasts of a 0.5 per cent increase. Real sales for the whole quarter were disappointingly flat as well, adding to the risk that the economy contracted in the quarter.
The forecasts were confounded because they are guesses from (mostly) bank economists who are caught up in the “once-in-a-hundred-year” mining boom narrative that the Government and journalists have been running for some time now as part of the cover they need to hack into net public spending as they mindlessly pursue their budget surplus ambitions.
The following growth shows the seasonally adjusted and volume measures (in nominal terms). The two bumps relate to the two fiscal stimulus packages (December 2008 and February 2009) which the Federal government introduced as the financial crisis unfolded.
The reality is that household spending is more subdued now after a decade or more of credit-fuelled binging. As the Sydney Morning Herald article notes:
Australians have turned more frugal since the global financial crisis shocked them into saving more. The household savings ratio has climbed back to nearly 10 per cent having been negative as recently as 2005.
The credit binge was the major reason the Federal government was able to run surpluses between 1996 and 2007 (with one year of deficit). That was clearly an unsustainable growth strategy and now that households are saving again and running down debt, growth has to be supported by a return to on-going deficits. The period of surpluses was abnormal in our economic history.
Stutchbury makes out that governments normally balanced the budget over the cycle but that is historically inaccurate. The federal budget was typically in deficit.
The other major data release today from the ABS was – Dwelling Approvals – which gives a guide to how construction is faring.
The take-home result is that Total dwelling units approved fell by 18.1 per cent over the last 12 months (although there was some improvement in March 2011). The trend was down 14.5 per cent over the year to March 2011 and falling.
The ABS News coverage noted that the March 2011 result “was skewed upwards by a surge in the volatile apartments sector”. The “more stable and widely-watched private house approval figures eased 0.8 per cent”.
So retail sales and construction are heading south!
At least some private sector economists – who are typically gung-ho about the need for budget surpluses (except when specific assistance to their industry etc is threatened) – are starting to note the disconnect between the “surplus at all costs now” narrative and the reality.
In this article (May 5, 2011) – Budget surplus a bridge too far – a leading bank economist notes that:
THE federal government has painted itself into a corner by committing to promising a budget surplus by 2012-13. That’s a major task. I don’t think we need to cut the deficit so quickly. Indeed, doing so could cost us dearly.
It’s not just about fiscal responsibility. The logic is that growth driven by mining expenditure will soon lead to capacity and labour constraints. The government doesn’t want to crowd out the private sector and is making room for the minerals boom.
Minerals prices are booming and the dollar keeps rising, but minerals projects are not coming through as quickly or as strongly as expected. Meanwhile, the rest of the economy isn’t all that strong. Outside the resources sector, weak profits are affecting tax revenues and business investment remains subdued. Housing is weak and households remain cautious. Growth is around 2.5 per cent — solid but not spectacular.
The danger is that private expenditure won’t come through quickly enough to offset the stimulus from government spending. I think the government should keep spending on infrastructure until private investment comes through, but its focus appears to be on fiscal responsibility.
I imagine if I sat down with this person and discussed macroeconomics we would not agree much. But I agree with all of this.
The data today categorically shows that the economy is not booming – and is – possibly even contracting overall despite the “boom” (which is rather tepid at the moment) in the mining sector.
The article then strays – apparently there has been a dramatic “blowout in the budget deficit because of fiscal stimulus after the global financial crisis”. What is a blowout? What do you assess the budget position against?
There is no meaning in the descriptor “blowout” for a budget outcome. The budget is what it is. As noted above, the fact that unemployment and underemployment have risen by around 50 per cent since the crisis began tells me that the budget deficit didn’t rise enough to combat the slowdown in private spending.
But it gets back on track when it notes that government should not cut infrastructure spending. The article says:
The last time the budget went into significant deficit, in the early 1990s recession, the result was 15 years of underinvestment in infrastructure. That’s why we ran into infrastructure bottlenecks in the middle of the last decade … Already, the GFC-induced fall in business investment means we’ll run into capacity constraints in some sectors in two to three years. Surely we can learn from the past and not compound that with underinvestment in government-funded infrastructure.
The article argues strongly against trying to push for a budget surplus by 2012-13. The writer notes that the Government would “need to be really tough on expenditure” to define a trajectory towards surplus.
The problem then is that they will undermine short-term growth and continue to starve public infrastructure spending which helps underwrite growth over the next few decades.
In parting, we read:
Just remind me why, apart from politics and ideology, we have to reduce the deficit so quickly.
The disagreement I would have with this economist is that he still maintains that fiscal responsibility requires the deficit be cut. His quibble, legitimate though it is, is limited to the speed of adjustment and the motivation at present for the government’s blind pursuit of surplus.
The more general point that gets lost in all this debate is that deficits are not good nor are they evil. They primarily are not a suitable target for policy because they rise and fall on private spending fluctuations.
It is far better to target employment maximisation and let the budget balance be whatever is required.
But the Government is not thinking like this because it has got itself into a political straitjacket (of its own making) which “requires” it to push for a surplus. As each week’s economic data gets worse and the estimates of tax revenue fall even further, the Government just talks tougher about the need for even greater spending cuts.
To say it is moronic is to understate how badly the neo-liberal ideology has infested the policy debate.
The fact that growth is slowing should tell the Government all there is to know about the direction of fiscal policy in Australia at present.
Next Tuesday, the Federal Treasurer will bring down the Budget for 2011-12. The talk will be tough and the policies will further damage the economy. I think it will be another nail in the coffin of this government because they will not be able to claim they have overseen a strong economy with balanced growth (across sectors and regions).
Unfortunately, for us, the Opposition is worse. We now differentiate our major political parties by shades of neo-liberalism.
That is enough for today.