Here is Andrew Leigh promising doom and gloom after the election:
ANDREW LEIGH: Certainly the two parties will be presenting very different visions to Australia on seventh September. The Coalition are clearly planning savage austerity. We know from estimates that John Quiggin* has done that for every $10 billion they take out of the economy, the unemployment rate is going to rise half a per cent and we know the impact that that sort of a slump would have on the jobs and the life prospects of Australians leaving school.
First things first – the ALP itself is predicting an increase in unemployment.
Second – it isn’t clear what the current government have done for “the jobs and the life prospects of Australians leaving school” – to demonstrate this point I have plotted the unemployment rate for 15 – 24 year olds (seasonally adjusted).
Bottom line the obscene spending that we’ve observed over the past six years has not improved prospects for school leavers. That is even before we take into account how the government has been rorting the unemployment figures.
Finally there is the allegation that spending cuts will cause an increase in unemployment. We have heard this argument before. When Mrs Thatcher came to office there was the famous letter from 364 economists predicting doom and gloom.
In 1996 there was a similar letter organised in Australia. Unfortunately no public copy of the letter exists, but I’m reproducing Alan Wood’s column from The Australian (25 June 1996) where he discusses the letter below the fold.
The case for reform of our public finances is a compelling one despite what some academics might think
A DRAFT letter is circulating around Australian economics faculties seeking signatures for an attack on the Howard Government’s fiscal policy.
Its originators are four academic economists John Nevile of the University of NSW, John Quiggin of James Cook University, Frank Stilwell of Sydney University and Phil O’Hara of Curtin University. All share a belief in big government as a solution to our economic problems, contrary to the current view of mainstream economics.
The letter invites recipients to sign it “and/or circulate it to potentially sympathetic colleagues” – presumably other economists who have failed to draw any useful lessons from the collapse of eastern Europe, Euro-sclerosis in the West or the rise of Asia.
The letter consists of three paragraphs, which are worth considering in turn.
The first paragraph reads: The Federal Government’s commitment to reduce expenditure by $8 billion is economically irresponsible. Expenditure cuts of that magnitude will inevitably cause job losses – directly in the public sector and indirectly in the private sector as a result of the downward multiplier effects. There is a strong possibility of precipitating a substantial economic recession.
The last sentence immediately brings to mind a famous letter from a group of academic economists of similar views, which was written to The Times of London in 1981.
The economy in the United Kingdom was in recession, but prime minister Margaret Thatcher was determined to bring down a tough Budget to get government spending under control.
The 364 academic economists who signed the letter warned against such a course of action, predicting disaster for the British economy. In the event, 1981 was the last year of negative growth and the economy picked up strongly from then on.
Both the International Monetary Fund, in its recent World Economic Outlook, and the Organisation for Economic Co-operation and Development, in its OECD Economic Outlook, look in detail at the issue of fiscal consolidation (deficit cutting) and economic growth.
Both conclude that, to quote from the IMF, “a policy of tight fiscal consolidation does not necessarily lead to recession”. There are a significant number of cases, including Australia in the latter part of the 1980s, where tough Budget policy has been followed by faster economic growth.
The relationship is not a simple one and depends on a wide range of variables, including what is happening in the rest of the world at the time fiscal consolidation takes place and the stance of domestic monetary policy.
Since 1997 is expected to be a year of accelerating world growth, it looks a good time for Australia to be cutting its budget deficit. Whether interest rates should also be cut is less clear.
While the OECD favours rate cuts for the European economies with a lot of economic slack, it does not favour them for the United States, and Australia is closer to the US than Europe in its growth profile.
While many economists would agree that if the deficit cuts are delivered they will slow economic growth, few see the prospect of “substantial recession”. The second paragraph of the letter reads: The goal of a balanced budget indicates pre-Keynesian economic thinking. It ignores the creative role which fiscal policy can play in economic management, especially in tackling unemployment. Moreover, the expenditure cuts would likely fail to produce a balanced budget anyway because the consequent reduction in jobs and incomes would result in lower tax revenues being generated in the next fiscal year.
This is just plain wrong. Even a committed Keynesian would accept the proposition that it makes sense to build up budget surpluses during the growth phase of the economic cycle, so that there is a buffer for the downturn. The balanced budget goal is simply a (inadequate) step in this direction.
A major macro-economic policy problem in recent years in many countries is that because of high budget deficits, fiscal policy has not been available to stimulate economic growth and an excessive burden has fallen on monetary policy, with various adverse consequences.
As for the effect of budget cuts on the economy, current thinking has moved beyond the simple Keynesian multiplier model to recognise other influences such as wealth and expectations effects which, to quote the IMF, may “outweigh the negative Keynesian effect relatively quickly”. Paragraph three of the letter reads: More attention needs to be given to the role of government expenditure on repairing the nation’s rundown infrastructure, creating jobs and fostering industry and regional development. If necessary, increased taxation and other revenue options should be under consideration. Savage expenditure cuts are economically irresponsible and socially damaging.
This is the usual attempt by the big government lobby to have it all ways. If there is a shortage of public infrastructure spending, it is because more and more of available revenue is being spent on social entitlement programs and handouts to business.
A choice has to be made between spending on infrastructure, including social infrastructure such as education, on the one hand and industry subsidies, middle-class welfare and regional rorts on the other.
YET attempts to cut in such obvious areas as export development grants, the Development Import Finance Facility, health or childcare bring forth howls of protest from the same groups complaining about the lack of infrastructure spending.
As for the argument about whether the deficit should be cut by spending cuts or tax increases, the IMF and OECD have a bit to say about that as well.
Their conclusion is that spending cuts are preferable to tax rises and that the available evidence favours “in particular, cuts in the government wage bill, in other government consumption and in social security payments”, to quote the IMF.
The usual response when confronted with these mainstream international views in favour of what Australia is doing with fiscal policy is to say they don’t apply here.
Australia has a relatively low budget deficit by international standards and a modest public sector debt, so why worry?
Because Australia also manages to run one of the lowest household savings ratios and highest current account deficits in the OECD and has one of the highest levels of net external liabilities.
In other words, our economic behaviour tells us that the incentives to work, earn income and save in Australia are disturbingly weak – we behave as if we had one of the worst deficit and public debt position in the OECD.
That means the case for reform of our public finances is a powerful one, if we want to enjoy higher growth and be able to provide on a sustainable basis for the genuinely needy.
If we compare ourselves with Asia – a far more valid comparison than Europe, whose finances and economies have been ravaged by decades of welfare statism – the case becomes irresistible.
* as always this is not an invitation for gratuitous insults directed at John Quiggin.