MICHAEL KEATING. The Budget: Part 1

 

The Budget provides the opportunity for the Government and the Opposition to outline their respective economic strategies and their relative priorities. Interestingly, while there are significant differences between the two major political parties, there are also important similarities; probably reflecting the economic constraints which both parties have had to work within.

When this Coalition Government was originally elected in 2013, it promised that its first priority would be to return the Budget to surplus and to remove the debt. Whether that should have ever been the Government’s first priority is debateable, but it is a salutary reminder of the difficulty in meeting political promises to achieve economic outcomes over which governments do not have complete control.

Now six years later, this 2019-20 Budget once again claims to achieve a budget surplus, combined with lower taxes, while still ‘guaranteeing essential services’. The Government sees this trifecta as the winning formula to distinguish itself from the Labor Party. It is the basis for the Government’s claim that it is the better economic manager – to wit it got the budget back into surplus – and it will always be the low taxing party, which in turn will always deliver higher economic growth.

But what is striking about the fiscal policies of the two parties at the macro-level is how similar they are. Indeed, Bill Shorten has pledged that Labor’s Budget numbers when they are released later in the campaign will show ‘stronger surpluses paying down national debt faster’ than promised by the Coalition. Equally over the next three fiscal years leading up to the 2022-23 election there will be no difference in the amount of tax paid by the vast majority of taxpayers, whoever is the government.

Accordingly, what I want to explore in this article is the economic and fiscal outlook and how that might be impacted by the different economic strategies of the two main political parties. Then a second and following article will explore the differences in the spending and taxing policies of the two contenders, and what that says about their relative priorities.

The economic outlook

The key economic forecasts in this Budget are shown in Table 1 below, with the addition of the forecast for labour productivity and real wages, which can be inferred, but significantly is not considered worthy of mention. The first question is how credible are these forecasts on which the projected budget surplus depends?

Unfortunately, the Government and its advisors in the Treasury and the Reserve Bank now have established a track record for being far too optimistic about wage growth in particular, but they have also tended to over-estimate the growth of economic activity. The Government can properly boast about the rate of job growth, but given the overall weakness of the economy, this job growth has come at a cost to productivity which is increasing much more slowly than past norms.

Table 1 Key Domestic Economic Forecasts

Percentage change on previous year
2017-18
2018-19
2019-20
2020-21
2021-22
2022-23
Real gross domestic product
2.8
3
3
Employment
2.7
2
Unemployment
5.4
5
5
5
5
5
Labour productivity
0
½
1
1
GDP deflator
1.8
½
1
1 ½
1 ½
Consumer price index
2.1
Wage price index
2.1
Real wages
0
1
½
¾
1
1
Nominal gross domestic product
4.7
5
The unemployment rate is the rate for the June quarter. Employment, the wage price index, the consumer price index and real wage growth are through-the-year growth to the June quarter.

In the last two years for which data are available – 2016 to 2018 – labour productivity grew at an annual average rate of only 0.4 per cent, and in the second half of 2018, productivity actually fell. This recent performance compares with an average annual rate of productivity growth of around 1½ per cent which was widely assumed to be the long-run potential growth rate in the past. Similarly, real wages only increased at an annual average rate of 0.2 per cent between 2016 and 2018. Not surprisingly the Government never refers to these facts when it claims to be superior in its economic management.

To its credit the Government has to some extent acknowledged its past forecasting errors in this budget and has marked its forecasts for wages and productivity growth down a little. Nevertheless, the Government is still forecasting in the Budget that productivity growth will accelerate to 1 and then 1½ per cent from here on, and real wage growth will also slowly recover over the next four years to something closer to past rates of increase. Clearly these Budget forecasts are still ambitious compared to the recent experience just cited.

But even if these forecasts for wage and productivity growth were marked down a little further over the next say two years, my judgement is that a return to a budget surplus would probably still be possible in the short-term. The bigger short-term risk to that surplus is the uncertain economic outlook overseas, and I consider that on the basis of what is presently known, that risk has been adequately addressed in the Budget. However, if slow wage and productivity growth persist in the medium to longer term beyond say the next two years, then sustaining a budget surplus after 2020-21 would be much more problematic.

Economic Strategy

Essentially the Government and its official advisers assume that the slow rate of wage growth is a cyclical phenomenon which will correct itself as the labour market tightens and unemployment comes down. But the Government itself forecasts no significant further tightening of the labour market, with unemployment forecast to remain unchanged, so even on their own model, it is hard to see what will kick-start faster wage and productivity growth.

As I have argued in previous posts, however, it is much more likely that the low wage and productivity growth is structural and not just cyclical. Low wages and increasing inequality started some thirty or even more years ago in most of the advanced economies, but their consequences for aggregate demand and economic growth were masked for a long time by increasing household debt, which sustained consumption even as income growth slowed. But that increase in debt was never sustainable. It all came to end with the Global Financial Crisis, and ever since most capitalist economies have experienced economic stagnation.

Labor is correct in its analysis: we do need policies to increase the rate of wage growth. Wages are not just a cost, they are equally an income. Faster wage growth will increase consumer demand, and therefore investment leading to faster productivity growth.

Labor is promising to change the legislation and to support increases in low paid jobs in particular. Employers rightly warn that too big a wage increase too quickly can be disruptive and counter-productive, but modest increases over time to increase the minimum wage should help increase demand without reducing employment. First, the Australian minimum wage has been higher in the past – 52% of the average wage in 1997 and only 44% in 2017 – without any marked impact on employment. Second, the minimum wage in Australia is high relative to most other countries and much higher than in the US, but employment participation by unskilled workers aged 25-64 in 2015 was 58% in Australia and only 55% for comparable people in the US, and it is these unskilled workers who would be most affected by an increase in the minimum wage.

The more critical question is whether changing the system of wage determination will be sufficient to reduce earnings inequality and so support higher rates of consumption and investment demand growth. The reason why earnings inequality has increased over the last few decades is principally the way technology has impacted on the labour market. Consequently, the main policy instrument to substantially reduce inequality over time must be improved education and training so that the workforce is better equipped to adopt and adapt to technological change. Both political parties are promising to do more, but Labor is ahead in this regard.

Conclusion

Future economic growth is most dependent on adequate demand growth and a skilled workforce. Thus, the provision of good government services is not just a burden on the economy, as the Government would have us believe.

Taxation and spending levels are lower in Australia than in almost all other western democracies. Smaller government should not in itself be this country’s main objective, and lower taxes are not some sort of guarantee of economic and employment growth. Instead, the reality is that we need more effective government, and not necessarily smaller government, if we want to achieve a fair society and grow the economy and jobs.

So the real question is not how big the government is, but how effective are the respective policies of the two main contending parties for spending and taxing. And that will be the focus of the following article tomorrow.

 Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.

 

 

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One Response to MICHAEL KEATING. The Budget: Part 1

  1. Evan Hadkins says:

    “The reason why earnings inequality has increased over the last few decades is principally the way technology has impacted on the labour market. Consequently, the main policy instrument to substantially reduce inequality over time must be improved education and training so that the workforce is better equipped to adopt and adapt to technological change.”

    That second sentence doesn’t follow from the first. It presumes that the reason for the rise in inequality is that people don’t know enough to operate the technology. It may be instead who owns the technology, or some other factor.

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