Deficit doom and gloom but it could be worse

Treasurer Josh Frydenberg. Picture: Elesa Kurtz
Treasurer Josh Frydenberg. Picture: Elesa Kurtz

Treasurer Josh Frydenberg said the figures were "eye watering".

He could have said "jaw-dropping" or "gob-smacking" and nobody would have disputed it.

  • The output of the economy fell by 7 per cent in the three months to June.
  • In March, April and May, 870,000 jobs were lost.
  • This year, tax receipts are expected to be down by $95.6 billion, putting the deficit - the excess of government spending over revenue - at $85.8 billion and $184.5 billion next (get used to billions and even trillions because millions are small change in these calculations).

To underline the seriousness, Mr Frydenberg said we are in the "greatest economic crisis since the Great Recession".

Does the deficit matter?

It is the biggest deficit since the Second World War but it still isn't as cataclysmic as you might think.

A country is not a household. When our family incomes fall, we tighten our belts and spend less.

For a country, it's not the same. Governments (like companies) borrow money over decades and repay over decades. The rate of interest on that borrowing is not far from zero at the moment.

Mr Frydenberg thinks the Australian economy will grow next year (though he can't be sure of that because nobody knows the course of the virus, particularly in the United States).

But if the economy grows, the government can borrow to spend and the spending should prompt further growth.

Professor Ian Harper who is on the board of the Reserve Bank said the government could borrow for 30 years at one per cent and that meant the debt could be serviced.

So the government can just borrow like crazy?

No. There are constraints.

If the deficit spooked the international finance markets so that they thought Australia was being profligate beyond any wisdom, there might be reluctance to lend to Australia.

But we are far from that situation, according to Ian McAuley, a fellow of Centre for Policy Development and formerly a lecturer in economics at the University of Canberra.

He said he was "not at all worried" about the current deficit because it's low in international terms. It's much lower as a proportion of economic output than that of the United States or Japan, for example.

There would be a constraint on government borrowing, too, if it led to a rise in inflation - but the overwhelming consensus among economists at the moment is that inflation is not something to worry about.

Will there be tax cuts?

There might be but that would be a political judgement as much as an economic one.

As unemployment and bankruptcies rise, the government is likely to want to inject spending into the economy.

It could do that with tax cuts (so leaving people with more money in their pockets which they might spend) or by borrowing and spending on public sector projects.

Which it chooses would be a matter of politics as well as economics.

Stimulating the economy might be better done by "modest" public spending, according to Ian McAuley.

He told this paper that the benefit of spending on smaller projects like constructing school buildings, for example, would be that the wages get spent in Australia.

Tax cuts might not turn into extra spending, particularly if they go to the better off.

And the result might not be that beneficial to the wider economy or society, he felt.

"The rich might spend on a luxury car or another extension to a bathroom but what we are not getting there is useful investment."

And the more that any stimulus went to the better off, Mr McAuley argues, the more likely it would be to end up outside Australia.

"The rich would buy a BMW and benefit the German economy", is the way he puts it.

The route ahead

We are coming out of Phase One.

The government put in place emergency measures to stop the economy going off a cliff but those measures - JobKeeper, for example - are being wound down.

The next stage is to get the economy growing again, says Warren Hogan, Industry Professor at the University of Technology, Sydney.

"Phase Two will require genuine fiscal stimulus: not a security blanket of the kind we have had, but a direct injection of money that will spark a new wave of investment and employment."

And Phase Three will mean rethinking the economy. "The final stage will involve structural reforms; alterations to tax settings, regulations and industrial relations."

And that will happen in a world we can barely imagine at the moment. Will immigrants still be available with rare skills at the top end or the willingness to work for low pay at the other? Both benefit the economy.

"The pandemic will have changed the way we work and play," Professor Hogan said.

"It is not yet clear whether people will take advantage of remote working and move out of congested cities. It is not yet clear what it will mean for digital health, digital education and digital shopping."

A warning

"Prediction is very difficult, especially if it's about the future," as the Nobel prize-winner Nils Bohr put it.

Mr Frydenberg put it less wittily when he warned that forecasting was "difficult at the best of times" and even tougher during the current global pandemic.

The government deficit is the difference between two very big numbers (revenue and expenditure) which are very hard to forecast and have big margins of error.

Getting either wrong by a relatively small amount throws the forecast out of the window.

All those impressive decimal points on Mr Frydenberg's power-point presentation are an illusion of exactness.

Fasten your seat belts.

This story Doom and gloom but it could be worse first appeared on The Canberra Times.