I suppose it’s long overdue that the ALP starts thinking about wage earners, but better late than never. Julia Gillard had a very confusing analogy in her speech today – I suspect there was a slip between the economists and the speech writer.
Imagine a wage earner, John, employed in the same job throughout the last 20 years.
For a period in 2003 to 2007 every year his employer gave him a sizeable bonus.
He was grateful but in his bones knew it wouldn’t last.
The bonuses did stop and John was told that his income would rise by around five per cent each year over the years to come.
That’s the basis for his financial plans.
Now, very late, John has been told he won’t get those promised increases for the next few years – but his income will get back up after that to where he was promised it would be.
What is John’s rational reaction?
To respond to this temporary loss of income by selling his home and car, dropping his private health insurance, replacing every second evening meal with two-minute noodles.
Of course not.
A rational response would be to make some responsible savings, to engage in some moderate borrowing, to get through to the time of higher income with his family and lifestyle intact and then to use the higher income to pay off the extra borrowing undertaken in the lean years.
Running a nation is always more complex than running a family budget and analogies only work so far.
I thought I would first point out that Adam Smith famously said:
What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.
So the bonuses from 2003 – 2007 were replaced by a five per cent indexation after that? So John was lead to believe that temporary income (bonuses) were replaced by permanent income? (But then why did he believe in his bones it wouldn’t go on?) Okay – but then he gets told he will experience a temporary stay on the 5 per cent indexation but then will be fully compensated afterwards? Under those circumstances it does pay him to use debt to smooth out his temporary loss of income. But with perfect certainty there are a lot things people would do differently to how we do things in a world of uncertainty.
But back to Gillard’s story. What she means to say is that John was promised a 5 per cent bonus each year, but then told the bonus wouldn’t eventuate. He made his plans accordingly and now faces a deficit of revenue over spending. What would an economist day to that? Tough – that was temporary income that you planned for as if it was permanent income. Cut your spending and live within your means. Less caviar and more two-minute noodles.
So how does Gillard try to wriggle out of this problem? Well, she argues that the bonuses will return in future – with interest. In fact, the future will compensate for the current loss of revenue. That is a huge call and she cannot know that to be true. That’s short-hand for believing the mining boom will last forever. I don’t know anybody who seriously makes that claim.
If John’s bonuses constitute permanent income then Gillard’s story might make sense as a balckboard economics example. But not otherwise. This is a very confused message from the PM.
Then there was this:
To return to John, you would not expect him to stop funding his son’s top quality schooling or his daughter’s university studies.
Looks like John is sending his son to a private school – maybe he has no faith in the Education Revolution or Gonski. As for the daughter’s uni studies – following the recent Gillard government education announcement it doesn’t pay him to pay for his daughter’s education – better to let the taxpayer take the risks (of her not paying back the HECS) and put any money into some or other investment and then just give her the cash.
So what can we take away from this very confused narrative? The government will continue to spend as if the revenue bonuses (of 2003-2007) were permanent i.e. they intend to ignore any structural deficit that may now exist and simply borrow to smooth over any (what they perceive to be) temporary declines in income.
It seems to be me that the only limit on how much they think they can spend is their imagination.