What does it say about the government’s fiscal performance?
The headline news is that the Budget deficit for the current fiscal year, 2014-15 has blown out by $10.6 bn from $29.8 bn in the Budget to $40.4 bn in the Mid-Year Economic and Financial Outlook (MYEFO) released on Monday. Over the four years to 2017-18 the deterioration in the Budget balance since last May is projected to accumulate to some $43.7 bn. According to the Government none of this deterioration in the Budget is the Government’s fault; indeed as much as $39.6 bn is explained by changes in the economy and only $4.1 bn represents the net impact of policy decisions taken since the May Budget.
But as a point of comparison try telling this story to Wayne Swan. Swan’s last Budget was for the fiscal year 2013-14, and between May 2013 and the release of the MYEFO for that year, the Budget balance deteriorated by $28.9 bn, and over the four years ending in 2016-17 by $101.2 bn. Clearly on the face of it the deterioration between the Budget projections and the MYEFO for the next four years was worse in Swan’s 2013-14 Budget, but the deterioration was much the same in both Swan and Hockey’s Budgets for the first Budget year, being $28.9 bn in 2013-14 (Swan) and $29.8 bn in 2014-15 (Hockey). Furthermore in terms of fiscal responsibility, only $0.4 bn of that deterioration in the Budget balance in 2013-14 was explained by policy decisions taken by the Labor Government before they lost office, and Labor’s policy decisions in its last few months actually improved the Budget balance for the four years to 2016-17 by as much as a net $8.2 bn.
The difficulty for both former Treasurer Swan and the present Treasurer Hockey is that the economy has not performed to expectations. Swan expected to balance the Budget in 2015-16 and Hockey six months ago expected to almost achieve that balance in 2017-18. Now Hockey is asking us to believe that the Budget will be balanced by 2020-21, another six years away. It will be interesting to see how financial markets react to this ‘forecast’, but many may see the pursuit of this Budget surplus as an ever-receding mirage.
Personally I think the Government is right not to pursue fiscal consolidation at any cost, and to allow the Budget to act as a shock-absorber until the economy is more robust. Also in some respects, the way the economy is evolving at present is quite remarkable. In fact the latest forecasts in the MYEFO predict no change since the Budget for real GDP growth in the current financial year at an annual rate of 2½ per cent. So while the economy is sluggish, economic growth is still being maintained, and unemployment is expected to only slowly drift up a bit further. But what is unusual is that nominal GDP growth for this year is now forecast to be only 1½ per cent compared to double that rate of 3 per cent as forecast back in the May Budget; this change is because producer prices are now expected to fall, mainly as a consequence of declining commodity prices, and even though consumer prices are expected to rise in line with the Reserve Bank’s target rate of around 2½ per cent in this financial year. It is this forecast softness in producer prices and wages that is hitting the forecast of Budget revenue hardest.
In addition, the medium-term economic outlook is for another round of economic restructuring. Mining investment and construction are being wound back, but mining exports are booming, and with the falling exchange rate, imports are likely to be subdued, and there will be something of a shift in favour of service exports and advanced manufacturing. However, given the hit that manufacturing has taken in recent years, this shift back in favour of a more balanced industrial structure is likely to be relatively slow compared to previous such episodes.
Nevertheless, despite the Government’s special pleading, this is not the first time that Australia has experienced a dramatic decline in its export prices. As the Government is at pains to point out, in the last three years to September 2014, which of course covers the last two years of the previous Labor Government, the terms of trade fell by as much as 25 per cent, but on an annual basis this is no faster decline than the Hawke-Keating Government experienced when the terms of trade fell by 17 per cent over the two years to September 1986. It is therefore of some interest to compare how the present Abbott Government is handling this difficult situation compared to Hawke and Keating almost thirty years ago.
The Abbott Government continues to ask us to believe that over the present year and the next three years fiscal consolidation will continue at an average annual rate of 0.6 per cent of GDP per year. By comparison, the Hawke-Keating Government’s starting point was a Budget deficit in 1985-86 equivalent to 2.0 per cent of GDP, or much the same as the Abbott Government inherited for 2013-14 on taking office in September 2013. However, the rate of fiscal consolidation that the Hawke-Keating Government actually delivered was equivalent to an annual rate of more than one per cent of GDP over the following four years, or around twice the rate proposed by the Abbott Government (and yet to actually be delivered). A key factor explaining this difference is that the annual rate of real GDP growth achieved by the Hawke-Keating Government between 1985-86 and 1989-90 averaged 4 per cent, whereas the Abbott Government is only projecting the economy to grow at an annual average rate of 3 per cent between 2013-14 and 2017-18.
As Joe Hockey says a strong budget may be necessary for a strong economy, but perhaps even more so a strong economy helps produce a strong budget. The question is then what to do if the economic outlook is not all that strong, and that is addressed in the following comment on Where to from here.