Posted by Greg Jericho
Thursday 27 February 2014 theguardian.com
As Joe Hockey prepares a tough budget, many countries are finding ‘cuts only deepen short-term economic woes’
Treasurer Joe Hockey during question time in parliament. Photograph: Alan Porritt/AAP
Every year from now until May we experience a fair bout of pre-budget softening. The messages of doom and tough cuts and choices ahead are standard political fare. No treasurer is foolish enough to promise goodies in a budget and then come the second Tuesday in May find that his words are not greeted with all the joy he had hoped. Far better to be gloomy, then at least any surprises will be positive ones.
Joe Hockey is following the script well. He and other ministers have already put out soundings about tough choices ahead. The prime minister, in reacting to a bad Newspoll this week, has even suggested the tough job ahead of repairing the budget would inevitably lead to bad polling.
But it remains to be seen whether talk of tough austerity will be just that. Deputy prime minister Warren Truss has suggested the budget “repair” will not be completed in this term, and the strategy reported in the Australian Financial Review appears to be to put the ugly costs of cuts to education and health off until after the election.
Such a strategy is not only policy savvy, but economically smart, as there is almost zero need for Australia to embark on a bout of quick, deep austerity.
At the G20 meeting last weekend, the IMF and the OECD suggested a number of measures which fit within the government’s narrative of the need for “reform”, but both organisations are less hyped up about the need for fast budget repair.
The G20 communiqué, which outlined Joe Hockey’s desire for a greater growth target over the next five years, specifically stated of fiscal or government-led budget repair that the G20 nations would do so only in a manner which took “into account near-term economic conditions, so as to support economic growth and job creation, while putting debt as a share of GDP on a sustainable path”.
Such wording underscores the view of the majority of the G20 nations that while perhaps, as Tony Abbott loves to say, no nation ever taxed its way to growth, neither is there much support for the view that cutting expenditure while growth is weak will do anything other than make things worse in the short term.
When it comes to fiscal austerity the key is knowing when to embark on such a path, and then doing it in a manner that acknowledges the economic situation.
The OECD has suggested that among the best areas to target are health and education. This certainly is in keeping with the Abbott/Hockey strategy.
The reason for this was highlighted in a paper last year issued by the OECD on the “Politics of fiscal austerity”. It noted that fiscal consolidation in advanced economies is required because with an ageing population and rising health costs, “unlike previous recessions, the return of strong growth” will not be enough to solve budgetary issues. By the time strong growth returns, the health bill will have continued to grow well beyond what it had previously during past recessions.
But the paper also noted that “as many European countries are finding today, cuts only deepen short-term economic woes”.
Certainly the experience of the Eurozone countries has shown that sharp austerity during an economic downturn appears to exacerbate the downturn.
But the Eurozone is unique and perhaps the experience of those countries only serves to prove that if you are going to embark on a period of deep fiscal austerity, don’t do it with a joint currency.
When looking across the entire OECD, the link with higher austerity and weaker growth remains, but it is less strong.
Certainly those countries with the lower growth tend to have tightened their budgets the most, but even the many nations with strongest growth lie in the middle of the austerity range and have not taken extreme measures. This suggests that if you are going to be austere, it’s best not to go overboard.
And certainly, Australia has adopted this approach over the past three years. Looking at the change in the general structural deficit gives us a good proxy for the impact of government budgets on GDP growth.
On this measure, in the past three years the reduction in the budget deficits of the federal and state governments has reduced GDP growth by just over 0.5% each year. This austerity is not as strong as was seen in the 1990s by the Keating and Howard governments, but is above what the Howard government undertook in the mid 2000s.
The UK by contrast has seen government austerity reduce GDP growth in three of the past four years by more than ever occurred in the 1990s and even by more than the Thatcher austerity years of 1981 and 1982.
America as well, despite what the Republican party would have you think, has also indulged in sharp austerity – according to one estimate – the sharpest such austerity for 50 years.
Australia was also fortunate that we were able to begin our fiscal consolidation when growth was near trend. The OECD has noted that past evidence of large austerity measures shows they work best when “the macroeconomic environment ... had already turned favourable before consolidation started”.
On this measure, the UK rather jumped the gun.
It is well known however that Australia’s debt situation is relatively better than other nations, for our economy has a lot less fat to trim than other nations – and thus has fewer easy cuts to find.
On health, the OECD estimates efficiency reforms here would see only 0.5% of GDP in savings – certainly still a sizeable amount, but the second lowest among OECD nations:
This suggests that the path back to surplus does not involve finding easy efficiencies – these have already been found. And given the government is already pledging to increase the annual defence budget by 0.5% of GDP, it means other cuts will need to be made – or extra revenue raised.
It suggests that unless Hockey is also willing to look at the revenue side of the budget, there will be cuts in areas like pensions, and government sector wages and benefits. In this context, it is no surprise these areas have also been targeted in the pre-budget softening-up period.
We will have to wait and see how deep and how fast the cuts will be, but from his rhetoric, it would appear Hockey does not believe slow and steady cuts win the race to growth.
