The Federal Government’s Economic Reform Roundtable has three key themes: resilience, productivity, and budget sustainability and tax reform. Little has been said about the link between budget sustainability and economic resilience, but there is a strong connection.
One angle to think about is the resilience or vulnerability of Australia’s aggregate fiscal position. When combining the Commonwealth and the States into a single, consolidated general government sector, the underlying cash deficit is more than 3 per cent of GDP. This is middling by OECD standards, but high by historical standards for Australia – and especially so given an economy at full employment and with a high terms of trade.
More than half of this deficit comes from the States. While Australia’s level of debt is low by world standards and, of itself, unproblematic, the direction of travel is less benign. Consolidated general government net debt has gone from zero to over 35 per cent of GDP since 2007-08. Since 2017, most of the increase is due to the States.
How resilient is Australia’s aggregate fiscal position?
Prior e61 analysis by Lachlan Vass and Aaron Wong shows the Federal Budget position would worsen significantly over the next decade if assumptions about productivity growth, defence spending and bracket creep do not turn out as projected.
Another, more acute, risk would be another significant external shock like the Global Financial Crisis (GFC) or COVID-19 pandemic.
When the GFC struck, the Commonwealth’s budget position went from a surplus of 1.7 per cent of GDP to a deficit of 4.2 per cent two years later. Immediately prior to the pandemic, the budget had just returned to balance but fell into a deficit of 6.4 per cent of GDP two years later.
In both cases, the budget deteriorated by an amount equivalent to about 6 per cent of GDP between the onset of the shock and the fiscal low point.
And consistent with the 1990s recession, real spending growth remained high in the recovery phase. There are understandable political and macroeconomic reasons why it is hard to tighten fiscal policy just as the economy is recovering. But it resulted in a step change in debt. This tendency needs to be factored into the thinking of policymakers about the potential fiscal cost of future external shocks.
But the link between budget sustainability and economic resilience runs deeper than the fiscal aggregates.
In many ways, fiscal policy is all about resilience. In addition to providing core public goods like roads and police, much government activity is about pooling risk across the community. It’s unclear who said it first, but several prominent economists have described government as an insurance company with an army.
Government programs support individuals and households when downside risks come about: like job loss, accident or illness. This is particularly true for those risks which the market cannot fully insure. Taxes act as a form of compulsory premium.
Fiscal programs are sometimes designed explicitly as insurance, such as workers compensation. But often the insurance premise is more implicit. This is the basic premise of Assistant Treasurer Daniel Mulino’s book, Safety Net: The Future of Welfare in Australia.
This is not to justify all government spending on insurance grounds. The incentives and design details of programs matter, as does the efficiency with which money is raised to pay for them. The safety net can aid resilience or undermine it. Previous work at e61 has demonstrated the value of a higher rate of Jobseeker to recipients’ wellbeing, but also the potential reduction in work incentives.
Fiscal policy also insures across time. When economy-wide shocks emerge, government ‘pools’ this risk by borrowing from the future.
Today’s debt is the price paid for the fiscal response to two large external events – the GFC and COVID-19.
There can be difficult trade-offs between pooling risk across the community and pooling risk over time. Spending more on social programs today, if it weakens the Budget, can leave Australia less able to respond to the next big shock.
So where does the balance of risks lie?
Forthcoming e61 research shows that there is some evidence that income volatility is lower today than in past decades. It also illustrates that wage scarring due to job loss is less pronounced in the growing services sector than was true in manufacturing or agriculture.
On the other hand, Australians are perhaps exposed to risks that their global counterparts are not. Australians have defined contribution superannuation accounts, which bring a degree of investment risk. The family home is a key form of ‘self-insurance’ buffer, partly due to variable rate mortgages with offset and redraw accounts, which are more prevalent in Australia than elsewhere.
Australia faces some collective risks too, like a more challenging strategic environment, for which higher defence capability acts as an insurance premium of sorts. As a resource exporter, Australia faces macro-economic volatility from global price movements, in addition to the fluctuations in real growth that most developed economies contend with.
Australia cannot fully insure against all individual and collective shocks. Resilience is ultimately about adaptability rather than protection. But fiscal policy is an important way that policymakers soften the blow.
The challenge is to get the trade-offs right. Unfortunately, we are better at identifying harms in the here and now, than provisioning against the unknown. And there are natural political temptations to borrow from the future. It’s not clear we have the balance right.
Government spending has expanded. e61 has pointed out that some of this expansion is not particularly weighted towards low-income households. Some of it has an insurance motive, but much does not.
Our weakened fiscal position – Federal and State – works against resilience, as it limits Australia’s ability to pool risk across the community and through time.
