Morrison government fiddles as the economy stagnates

Jan 10, 2022
Scott Morrison
Morrison will say that he leads the party of low taxation, but the counter-response should be that the Liberals are equally the party of poor and inadequate services. (Image: AAP/Joel Carrett)

The government’s economic forecasts are highly questionable and the uncertain budget outlook raises doubts about the future funding of essential services. 

Scotty from marketing has no economic strategy. Instead, the government’s budget update relies on a series of unfounded economic assumptions to produce what the Prime Minister hopes will be a comforting message.

Despite being elected back in 2013 lambasting debt and deficits, the Coalition is now presiding over the biggest budget deficits and increase in government debt since the Second World War.

Nevertheless, most of us agree that the government has been right to prioritise ensuring a “strong and sustainable recovery in order to drive down the unemployment rate and limit the long-term economic impact of the Covid-19 pandemic”. Furthermore, government debt is a much lower proportion of GDP than in almost all other developed countries and is unlikely to prove a problem in the foreseeable future.

But looking ahead, what is worrying are:

  • The planned continuation of budget deficits even after the economy recovers;
  • Questions about the forecasts and the lack of any strategy to improve on the economic stagnation being experienced under this government before the pandemic; and
  • The risks that the government will not meet its commitment to properly fund the essential services on which we all depend.

Continuing deficits projected                                 

Fiscal and monetary policy together make up the two arms of what is sometimes called “stabilisation policy” where the aim is to ensure that aggregate demand in the economy equates with the potential supply capacity of the economy. When that happens there will be full employment.

The budget balance should therefore reflect the size of the gap between private aggregate demand and the total supply potential of the economy. If private demand is rising faster than the economy’s supply potential, then the government should be reducing its contribution to the demands on that supply potential by reducing the budget deficit or even moving to a surplus.

In the latest budget update, private demand is expected to increase exceptionally strongly over the next two years. Household consumption is predicted to rise by 1.75 per cent and 5.5 per cent in 2021-22 and 2022-23 respectively, while business investment is forecast to rise by as much as 7.5 per cent and 8 per cent over those two years. As a consequence, by the June quarter of 2023 the economy is expected to return to full capacity with an unemployment rate of 4.25 per cent, which is the current best guess of full employment.

In the past it was always believed that a return to full employment, with the economy therefore operating at full capacity, would require a budget surplus. But in its latest budget update, the government is projecting continuing budget deficits as high as 3.6 per cent of GDP in 2023-24, and budget deficits are forecast to then continue even though the economy would be operating at full capacity.

Furthermore, the charter of budget honesty, enacted by the Howard government, commits all Australian governments to “achieving budget surpluses, on average, over the economic cycle”. In other words, the Morrison government is asking us to believe that the charter’s rules no longer apply, although the budget update provides not a single word of justification as to why.

Are the forecasts credible?

There are good reasons for insisting on balanced budgets when the economy is operating at full capacity. Unless the budget is then balanced, there is a risk of excessive demand and inflation, which raises questions about these latest forecasts.

But perhaps the truth is that the government itself is not confident that the economy will recover as forecast. As the Reserve Bank has insisted, the problem over the past decade has been the low rate of real wage growth. The reasons behind this low wage growth are, however, less than clear.

In the authorities’ model, if wage growth is less than forecast then by definition the rate of unemployment consistent with full employment must have shifted down. Accordingly, the authorities are now targeting an unemployment rate of about 4.25 per cent instead of a bit over the 5 per cent previously estimated.

The latest data, however, records nominal wages increasing by only 1.7 per cent over the last 12 months, even though unemployment is down to 4.6 per cent – not far from the full-employment target.

In fairness, in this budget update real wage rates are only forecast to increase by 0.5 per cent in 2021-22 and 0.25 per cent in 2022-23. Subsequently nominal wage growth is forecast to “remain moderate, reaching 3.25 per cent through the year to the June quarter of 2025”, which would imply real wage growth of around 0.75 per cent.

Perhaps the authorities are implicitly acknowledging that there are other structural factors behind the slower rate of wage growth, and not just the tightening of demand in the labour market. Certainly, there is considerable academic research showing that there are structural causes of low wage growth as well.

The low rate of wage growth being forecast represents a continuation of the economic stagnation experienced under the Coalition prior to Covid when real wages only increased at an annual average rate of 0.4 per cent between 2012-13 and 2018-19. The forecast continuation of such a long period of slow wage growth inevitably raises doubts about the viability and strength of the forecast economic recovery.

But what is perhaps most questionable is the assumption that the underlying rate of productivity growth will return to 1.5 per cent, which was the average rate over the 30 years prior to Covid. This assumption completely discounts the experience under this Coalition government prior to Covid when the annual rate of productivity growth averaged only 0.9 per cent between 2012-13 and 2018-19.

In any event, the government is apparently happy with its forecast that real wages will continue to lag the increase in productivity over the next decade. This further shift in factor shares and increased inequality, if it happened, would set Australia up for a continuation of the secular stagnation in economic and productivity growth experienced in the last decade. But the more likely outcome is that the forecast growth of productivity at 1.5 per cent over the next decade is significantly too high.

The Morrison government, however, has no strategy to deal with the causes of these problems and reverse that secular stagnation. Tax cuts, even if they could be afforded, and more rhetoric about deregulation and small government are not going to help.

The provision of essential services

This latest budget update could be the last before the election. Commentators have made much of the $16 billion parked in the contingency reserve, as suggesting that the government will be free spending in the election campaign. But if the economic forecasts and the budget outlook are as questionable as discussed here, then that must raise questions about the future funding for essential government services once the election is over.

The Morrison government always says that it “guarantees our essential services”, but it has an established track record of underfunding them, as supported by the findings of various royal commissions.

Although the government has agreed to provide some extra funding for aged and disability care, it is not as much as recommended. The government was also “lucky”’ in that all the additional expenditure reported in the latest budget update was funded by upward revisions to the revenue forecasts.

But similar revisions to revenue cannot be counted on for the future. Many other areas of unmet need remain, such as childcare, universities (both teaching and research), health, and foreign diplomacy and aid (see my article in P&I, September 22, 2021).

The fear must be that if this government is returned, essential services will continue to be underfunded. Savings could be found in the various “rorts” that the Morrison government has sponsored, but any such savings are unlikely to be sufficient to properly fund all essential services.

And the situation will be exacerbated if further tax cuts are promised in the election. Instead, a good start would be to reverse the final third stage of the government’s planned tax cuts. This is to take effect from 2024-25 and will only benefit the small minority of taxpayers with an income of more than $120,000 at an annual cost of $17 billion.

However, even this $17 billion saving is unlikely to be sufficient to ensure adequate funding of all essential services. Instead, coming out of this election, tax reform should be a priority with the objectives of:

  • Recasting the tax scales to restore their progressivity, and
  • Raising the necessary additional revenue to adequately fund essential government services.

Morrison will say that he leads the party of low taxation, but the counter-response should be that the Liberals are equally the party of poor and inadequate services, and this is costing our nation dearly.

What matters is how well our taxes are spent, and by any standard Morrison is spending them very badly with so many rorts and lack of evaluation.

 

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