Fred Argy & Frank Stilwell
The Budget & Australian egalitarianism
Economic effectiveness of the Budget
Good fiscal governance calls for long term strategic management of the nation's saving and investment needs, combined with short term flexibility to cope with changing economic conditions.
For a time, the Howard government got it wrong on both counts. It rigidly sought medium term debt reduction (an underlying cash balance over the cycle) as an end in itself, without regard for long term strategic needs and irrespective of short term conditions. Fortunately, being a pragmatic government, it seems to have somewhat changed its stance - in practice at least, although not in its rhetoric. In 2001-2, when unemployment threatened to rise, it stimulated the economy by shifting from fiscal surplus to deficit. It was a brilliant piece of economic intervention (especially the home savings grant) which Keynesian sceptics in the Labor Party should duly note.
Moreover Costello is now budgeting for only small cash surpluses over the next few years. Assuming that a significant recession will inevitably hit us over at some stage over this time, and assuming the government will again run a fiscal deficit in such circumstances, this approach appears to be consistent with running small structural deficits over the business cycle. If this is indeed the effect (intended or otherwise), it will make sense. There is no economic or social logic for state or federal governments to strive for fiscal balance over the cycle (zero net government borrowing), and thus aiming for zero public debt in the long term. Government borrowing is needed to fund essential economic infrastructure whenever the private sector cannot as economically manage the risks involved. It is also needed to fund long life social infrastructure spending (see below). To fund such investment out of revenue would be a denial of intergenerational equity.
But wouldn't an increase in public debt over the business cycle mean higher average interest rates and a 'crowding out' of some private borrowing and investment over the period? Some interest rate increase may be necessary to induce the private sector to make room for public investment under conditions of genuine full employment - conditions that have been rare in recent history. A switch from private to public debt may also mean that global markets impose a higher risk premium on Australia, but experience shows that this is unlikely to be large for a country like Australia, given its low debt levels and history of fiscal prudence.
These minor qualifications aside, economic aggregates will be not be greatly affected by a moderate trend increase in government debt. Only the composition of spending will be different; for example, less housing and business investment and more public infrastructure. And who is to say such a shift is not in line with consumer preferences? Of course governments should insist on comprehensive cost benefit evaluations before approving infrastructure projects. These would need to allow for externalities, including the benefits for household productivity (in the form of higher productivity, higher education, better public transport and communications, urban amenities, etc).