The much lower projections in Monday’s fifth five-yearly intergenerational report will mean indefinite budget deficits with no surplus projected for 40 years, only 2.7 Australians of traditional working age for each Australian over 65 (down from four) and average annual economic growth of 2.6%, down from 3%.
“Intergenerational reports always deliver sobering news, that is their role,” Treasurer Josh Frydenberg will say launching the report Monday morning. “The economic impact of COVID-19 is not short lived.”
The report says the pandemic has slowed both Australia’s birth rate and inflow of migrants.
The 2015 intergenerational report projected an Australian population of almost 40 million by 2054-55. The 2021 update projects 38.8 million by 2060-61.
As a result in 2060-61, about 23% of the population is projected to be over 65, up from 16% at present and 13% in 2002.
Although in the future increased superannuation would take pressure off the age pension, superannuation attracts favourable tax treatment which cuts government revenue.
The combined total of age pension spending and superannuation tax concessions was projected to grow from around 4.5% of gross domestic product to 5% by 2061.
Health, aged care spending to soar
Real per person health spending is projected to more than double over the next 40 years, largely due to the costs of new health technologies.
By 2060-61 health is expected to be the largest component of government spending, eclipsing social security and accounting for 26% of all spending.
Aged care spending is projected to nearly double as a share of the economy, largely due to population ageing.
Mr Frydenberg will say that even in the face of these demands the government remains committed to its promise to limit the tax take to 23.9% of GDP. Tax receipts are not expected to reach this level until 2035-36.
“Growing the economy is Australia’s pathway to budget repair, not austerity or higher taxes. This is why we remain committed to our tax to GDP cap, ensuring our COVID support is temporary and persuing productivity-enhancing reforms.”
Net debt is projected to peak at 40.9% of GDP in 2024-25, before falling to 28.2% in 2044-45 and then climbing again to 34.4% by 2060-61.
While Australia’s population will be smaller and older, and debt levels higher as a result of the pandemic, had the government not spent at unprecedented levels to support the economy a generation of Australians might have been condemned to long term unemployment, seriously damaging the budget longer-term.
Other projections have real GDP per person a measure of living standards, growing at an annual average of 1.5%, down from an earlier-projected 1.6%
The result will still be a near-doubling of real GDP per person, from $76,700 in today’s dollars to $140,900 in today’s dollars in 2060-61.
Behind that projection lies an assumed lift in annual labour productivity growth to 1.5%. In the decades before the pandemic, annual productivity growth had been averaging 1.2% and had slumped to 0.4% in the year during the pandemic?
The lift in productivity assisted by government policies that will help individuals and businesses “take advantage of new innovations and technologies” is expected to take ten years.
Not included in the extracts from Monday’s report released by the treasurer late Sunday are the closely-watched projections for net overseas migration and for spending on the national disability insurance scheme.
Presenter Karl Stefanovic noticed Morrison seemed out of sorts, despite the government having delivered the night before a benign budget that was well received and likely to be popular.
“It is a very big budget. Josh Frydenberg had a very big smile on his face this morning. I thought you might be happier this morning, PM. Everything OK?” Stefanovic asked.
Morrison said he was “fine”. He went on: “I’ve got to tell you, Karl, the reason is this.
“I know, look, budgets are big events and that’s all fine, but I just know the fight we’re in – and the fight we’re in, and me as prime minister I’m in, is to be protecting Australians at this incredibly difficult time.
“I am very cognisant of how big those challenges are. It is with me every second of every day.”
First, the government is using the budget to talk up the current threat of the pandemic to an extent it hadn’t been recently.
Morrison, in particular, had previously been anxious to emphasise the return to as much normality as possible. Now it’s more about lurking dangers.
These provide a justification for the government’s mega spending in the budget. (“Did anyone miss out? Perhaps only the beekeepers of Australia,” quipped one cynical Liberal backbencher.)
The language also indicates Morrison wants to do what state and territory leaders have done – use the pandemic to pave the path to electoral victory.
The other point highlighted by the Today exchange is that Morrison was looking somewhat ragged.
This was accentuated by the contrast with Treasurer Josh Frydenberg who, on the face of it, would have been under the greater stress.
Frydenberg’s performances in the week of his third budget were smooth and, whatever nerves he felt, he appeared unfazed.
The week reinforced the impression he is in the box seat eventually to reach the prime ministership (assuming the Coalition lasts in government).
Pre-budget, he and wife Amie were out for the cameras on a Sunday charity run in Canberra. Post-budget, his staff rang around backbenchers to ask if they’d like a picture with the treasurer.
In question time, Morrison found old problems returning to irritate him. He was pressed on the two internal inquiries into who in his office knew or did what in relation to the Brittany Higgins matter, and he had to say neither was concluded (one had been on hold before this week while the police dealt with their investigation of her rape allegation). Whatever the results of these inquiries, Morrison needs to get them cleared away as soon as possible. They are “barnacles”.
Morrison has been travelling a lot recently and may be tired (although those around him say he’s energised by being on the road). Or he may not be used to sharing the limelight. Or the endless round of everything may be just taking its toll.
Then there’s the challenge of explaining this Labor-lite budget to the hardliners in the Liberal base and among the right-wing commentariat.
The budget has made the opposition’s already formidable task of carving out room for itself more difficult, but it is also proving a hard swallow for those rusted on to the Coalition’s old “debt and deficit” preoccupation.
Many of these critics will be reluctant to buy the proposition the big spending must continue because the pandemic is a constant threat, given they’ve thought the threat was exaggerated in the first place.
The government could attempt to deal with these critics by saying it will “snap back” into tackling debt and deficit as quickly as possible.
But facing an election soon, it doesn’t want to do this, for obvious reasons.
In the budget the timing of the next stage, fiscal consolidation, is imprecise.
The budget papers say: “Progress on the economic recovery will be reviewed at each Budget update. This phase of the Strategy will remain in place until the economic recovery is secure and the unemployment rate is back to pre-crisis levels or lower.”
While some commentary is focused on how the Coalition has done a dramatic U-turn from its old debt-and-deficit rhetoric, there’s an opportunity for Labor to run a major scare campaign claiming it’s not a U-turn at all – that the debt truck is just in the parking lot.
Remember, it can say, when Tony Abbott promised no cuts to health, education and even the ABC – and recall what happened. This time, so the argument runs, cuts and savings will be Coalition priorities again as soon as it has secured the votes.
Morrison and Frydenberg this week have been invoking John Howard’s advice, given to Frydenberg in the early days of the pandemic, that “in times of crisis there are no ideological constraints”.
The question is whether the Liberals have softened their ideology, or just put it in storage during the crisis.
While there can be no definite answer, Tim Colebatch, writing in Inside Story. makes a strong case that the Coalition “won’t dump its political tactic of branding itself as the ‘fiscally responsible’ party and Labor as the party standing for deficits. This [budget] is a short-term tack that will be reversed after the election.
“Of course no government promising $503 billion of deficits in five years can be called fiscally responsible, so it will make cuts then to reclaim the brand,” Colebatch says.
Morrison and Frydenberg are both pragmatists rather than ideologues. But opinions in the wider party are also relevant, as Malcolm Turnbull found on the climate issue.
Frydenberg has pledged there will not be “any sharp pivots towards ‘austerity’”.
Nevertheless, there must be a budgetary reset at some point. And whether a pivot is sharp or not, and what amounts to “austerity” depend in part on whether you are one of the losers.
The projected deficit is $161 billion for 2021-22, but rather than tackling this in the next four years, the government’s focus is instead on payments and long-term serviceable debt.
The government is projecting a bump in real GDP growth in the next financial year, before growth settles again over the near future.
Part of the reason the government can afford to keep spending high is the low cost of international debt. This means that while net debt will continue to increase beyond the next four years the budget estimates cover, net interest payments should remain low.
And another major factor in the budget’s performance – despite the big spending – is the impact of a very high iron ore price, in the midst of a global pandemic.
The chart below shows the difference between policy decisions and other factors, generally beyond its control.
With a major focus on business and infrastructure spending to revive the economy, extensions to tax benefits and announced packages for childcare, there are many spending announcements in this year’s budget and very few cuts or savings.
The difference is so great that we have drawn out some of the major spending announcements and included all significant cuts in our headline figures for this year’s budget.
Steven HailThere are many uncertainties about the next federal election, but there is one thing about which you can be almost completely certain. It is the response that both the Prime Minister and the Leader of the Opposition will give when asked this question:
How are we going to pay off our COVID-19 debt?
Scott Morrison and Anthony Albanese disagree on a great many things, but in their answer they will be in perfect harmony.
It will be: “we will need to pay it back in the future by spending less or taxing more — otherwise, we might lack the means to deal with a future crisis”.
They might even talk about “fiscal firepower” — the need to up a budget surplus in order to have something to spend the next time there’s an emergency.
The strange thing is that although this is for them the safest answer to give, and although it is the conventional wisdom, it simply isn’t true.
Consider the following chart. It shows the general government debt as a share of gross domestic product in six countries with similar monetary systems to Australia’s, just prior to the pandemic, and then a year later.
Bank for International Settlements
You cannot help but notice that four of the other five countries had more general government debt than Australia before the COVID crisis, and Japan’s national government had four times as much government debt as Australia.
It made no difference to their ability to spend as needed to support their economies during the pandemic, none whatsoever.
Debt hasn’t hamstrung responses to the crisis
This means it’s wrong to suggest that our government wouldn’t be able to support its economy, even if it didn’t pay back its COVID-related debt.
You might imagine (it’s been said) that more government debt would drive up interest rates, but of late that hasn’t been the case either.
Indeed, the rate of interest on 10-year Japanese government bonds has been close to zero for five years, because it has been held there by the Bank of Japan.
Or perhaps you think that more government debt will lead to higher inflation. In Japan and elsewhere that hasn’t happened either. Japan has had the lowest average inflation rate of these six countries.
And so far it hasn’t stoked inflation
So many myths.
The pivot the Coalition is taking to winding back spending with the end of JobKeeper and the withdrawal of a liveable JobSeeker payment isn’t needed, and is also unwise.
The reluctance of the Labor Party to support a non-poverty unemployment benefit, and its promise to avoid net spending commitments in its election platform, are also unjustified.
Especially in an economy where labour force underutilisation (unemployment plus underemployment) remains over 14%. Nearly two million people are either unemployed or underemployed.
Many more are in insecure employment, including hundreds of thousands whose jobs are now at risk because of the failure to replace JobKeeper with something such as with a federal job guarantee.
It isn’t as though the Australian Greens are speaking from a fiscal script which is that different. The Greens obsess over costing their policies and finding extra tax from resource companies and billionaires to “pay for” their commitments to full employment, social security, education, healthcare, and investment in renewables.
They may not talk so much about repaying the debt, but they do not want to be accused of adding to it.
The Greens worry like the others
Like the bigger parties, the Greens are reluctant to challenge the narrative of the federal government as a household, with a budget it must manage in order to avoid insolvency.
But the household metaphor is another myth, and it needs to be challenged.
The federal government’s finances have nothing in common with those of a household, however wealthy that household might be, and nothing in common with any business, big or small, or even state and territory governments.
None of these are currency issuers. They have to generate income or borrow before they can spend, and their borrowing puts them at risk of insolvency.
Our federal government is different, like the national governments of Japan and the United States. It is the monopoly issuer of the Australian-dollar-denominated currency.
The government does not need to increase taxes in order to increase spending, and it doesn’t even need to borrow. Its Reserve Bank issues currency for it all of the time, every day.
Federal government spending is funded when it is authorised, usually by parliament.
Having spent its currency into existence, the government usually offers savers the opportunity to convert that currency into treasury bonds, which usually offer a better rate of interest than transaction accounts with a bank.
Our government chooses to sell treasury bonds – it doesn’t need to.
This means it can’t be held hostage by the bond market. It can’t be forced into insolvency or austerity. The selling of bonds doesn’t constitute borrowing in the normal sense of the term. It is better described as a way of winding back the money supply.
At the end of the life of the bond (when the “loan” comes due) it can pay it off (swapping cash for the bond). Or it can issue a replacement bond if it doesn’t want to inject more money into the economy.
It’s not just me saying that. It is also a senior economist with the US Federal Reserve, David Andolfatto, in December in a paper published by the St Louis Fed.
Together these considerations suggest we might want to look at the national debt from a different perspective. In particular, it seems more accurate to view the national debt less as a form of debt and more as a form of money in circulation.
President Biden is listening to voices like Andolfatto’s. Australian politicians are not. Ours continue to see federal deficits as a burden on future generations, when they are not that at all – they supply financial resources to the present generation.
The national debt is nothing more than the dollars the government has put into the economy and not yet taxed back out. Deficits matter, but not the way Albanese and Morrison seem to imagine. They matter because if they get too big, they might stoke too much inflation.
What if our leaders spoke the truth
In an economy with spare capacity (unemployment and underemployment) and with wage setting institutions that make it difficult to argue that there will be significant persistent inflation in the foreseeable future, there is no reason at the moment to wind back spending, not until unemployment and underemployment are much lower.
For the Greens, there is no need for them to tie themselves in knots, arguing on the one hand that they need to shrink coal mining to address climate change and on the other that they need to raise taxes from the mining industry to pay for government services.
Taxes collected from the mining and other industries (and form individuals) don’t fund federal government spending. It is self-funded. And the limits on spending are not imposed by tax receipts and the ability of the government to borrow. They are imposed by the availability of productive capacity in our economy and our ability to use that capacity without stoking inflation.
When our leaders are next asked, “how are we going to pay off our COVID-19 debt”, they ought to take a deep breath, look the interviewer in the eyes, and say “we don’t need to, because it is not debt in the conventional sense of the term”.
They ought to tell the public the truth. It’s a novel idea, perhaps, but it would lead to a better educated public and a fairer and better-managed economy.
With the government borrowing heavily to fund its pandemic response and recovery, it has been suggested it could simply cancel its debt by printing more money. That sounds like an attractive idea, but it is one that would have seriously adverse consequences.
Derived from “modern monetary theory” (MMT), the suggestion is that expansionary monetary policy (i.e. money creation by the central bank) be used to finance government spending.
According to proponents of MMT, a country that issues its own currency can never run out and can never become insolvent in its own currency. It can make all payments as they come due. Therefore, there is no risk of defaulting on its debt.
This is a flawed idea based on economic misconceptions. It has been opposed by economists, liberal and conservative, including Nobel laureate and New York Times columnist Paul Krugman and Harvard University’s Greg Mankiw.
So, what does happen when the government wants to spend more than it raises in tax revenue? It needs to borrow money (known as deficit financing), and so instructs the Treasury to issue debt.
There are three major types of debt: treasury bills, treasury notes and treasury bonds.. Treasury bills have the shortest maturity (less than a year) while treasury bonds have maturities of ten years or more. They all must be paid back in the future.
The debt is typically held by banks, institutional investors and managed funds (such as Kiwisaver accounts). Because the government is not expected to default on the loans, the debt is considered to be secure. So, these bonds can typically be issued at lower interest rates than bonds from other financial entities.
Increasing the money supply: Reserve Bank of New Zealand governor Adrian Orr announcing a change to the official cash rate in 2019. GettyImages
Where government debt goes
When the Reserve Bank of New Zealand (RBNZ) engages in “quantitative easing” it essentially buys up these government issued bonds. To do this, it prints currency to pay for the bonds and this currency goes into circulation, increasing the money supply.
Quantitative easing floods the system with liquidity — the amount of money readily available for investment and spending. In turn, this should put downward pressure on interest rates because money is cheaper to borrow when there is more of it.
The RBNZ can also lower the official cash rate (OCR) to push retail interest rates (on mortgages and savings deposits) down. The aim in both cases is to make borrowing cheaper in the hope that businesses will borrow money to invest, in turn creating more jobs.
If the RBNZ is buying government bonds from the banks and investors who had bought them earlier, it follows that the creditors have been paid off. So why can’t the government simply write off this debt?
Firstly, this takes away the RBNZ’s ability to act as an independent entity, which in itself is problematic. But even so, the debt does not disappear, it just takes the form of that additional amount of money floating around the economy.
At some point this extra money will end up being deposited in commercial banks and be held as reserves which earn interest from the RBNZ.
The currency in circulation is also legal tender backed by the authority of the government. If no one else wants to accept it, holders of this money should be able to sell it back to the RBNZ for something of value in return (US dollars, say).
One way or another, sooner or later the debt will have to be honoured.
Overheated housing markets: when money doesn’t flow to productive investment, speculative bubbles are a risk. GettyImages
The risk of inflation
In the meantime, if lower interest rates do not lead to business expansion and higher production (and there are good reasons to suppose they may not) then the net result is a larger amount of money circulating in the economy with no new production happening.
This will eventually set off inflationary pressures, which make savers worse off and provide a disincentive for saving. But saving by households is fundamental to making funds available for businesses to borrow.
In the absence of increased production this extra money may also make its way to non-productive financial assets such as equity and houses, setting off speculative bubbles in those markets.
Why might businesses not expand, even with lower interest rates? In deep recessions it is not the lack of credit that holds them back, it is that they cannot sell their goods at prevailing prices. This reduces demand for labour, further reducing demand for goods because more customers are unemployed.
It becomes a vicious cycle of insufficient demand, where the key issue is not credit or liquidity but rather a crisis of confidence. Monetary policy loses its teeth at this point, leaving fiscal policy (via deficit financing or tax cuts) as the only option.
It’s all about trust
However, government borrowing is a long-term game. The entire system, whether deficit financing or printing money, is based on trust — that the government will honour its debt.
Simply put, no government could satisfy all its creditors if they wanted their money back at the same time. But as long as the government keeps making the interest payments on the loans, or at least has the capacity to pay back some of those creditors (sometimes by borrowing even more), the economy remains stable. The juggler’s balls stay in the air.
If for some reason trust in a government goes, watch the balls come crashing down. Any hint of default or not honouring debt obligations will lead to long-term damage to a government’s reputation and its future ability to borrow. No one will want to hold the government’s debt in the form of government bonds.
When that happens, we see capital flight — money flows out of the country as people seek a return elsewhere. The value of the currency goes through the floor, with catastrophic effects on the economy, such as occurred during the Asian financial crisis in 1997.
The economic crisis New Zealand is facing is real and deep. Attempting to cancel debt would only reduce trust in the government and risk making the crisis worse.
Ananish Chaudhuri, Professor of Behavioural and Experimental Economics
After two decades equating budget surpluses with good economic management, it might seem convenient that the federal government has changed its fiscal strategy just before the budget to focus on jobs over keeping the deficit in check.
But it’s the right move. The world has changed in ways that make government spending more necessary and government debt more sustainable than ever.
The COVID-19 recession is the biggest economic shock since the Great Depression. GDP fell 6.3% in the year to June, the worst annual result since 1929.
The federal government should use its balance sheet to spread the costs of such a large shock over time. The alternative would be to leave those who lost their jobs or businesses in poverty.
The government’s emergency response saved businesses and jobs from going under in the short term. Now, as we emerge from the crisis into the recovery phase, large-scale stimulus is needed to boost demand and create new jobs.
Debt has never been cheaper
It has never been cheaper for governments to borrow. As the next chart shows, the interest rate on 10-year Australian Government Bonds is less than 1%. If inflation stays above 1%, as the Reserve Bank and Treasury expect, the “real” interest rate the federal government pays on the bond will be negative. That is, it will effectively be paid to borrow.
Author provided
These very low interest costs change the dynamics of managing debt we accrue now. Investments that boost future growth – including spending to reduce unemployment and close the output gap – will pay for themselves.
This is the fiscal “free lunch” spoken about by the former chief economist of the International Monetary Fund, Olivier Blanchard, and the deputy governor of the Reserve Bank of Australia, Guy Debelle.
Extra stimulus won’t spook financial markets
To get the unemployment rate below 5% by the end of 2022, the Grattan Institute estimates a further A$100 billion to A$120 billion of fiscal stimulus is needed on top of what governments have already announced.
This is unlikely to cause financial markets to break a sweat. Even if gross debt was to nudge 50% of GDP in the next few years, it would still be far below that of most other developed nations before the COVID crisis. At the end of 2018-19, the gross public debt in the UK was 85% of GDP, in the US 103%, and in Japan more than 200%. All have borrowed substantially more since then at very low rates.
There’s also no risk that significant government spending will cause wages or inflation to rise dramatically. In fact, Australia has the opposite problem. Wages were stagnant before the crisis and are forecast to remain so for years. Inflation has been persistently below the Reserve Bank’s inflation target and is forecast to remain so for years.
We can manage debt without austerity
Frydenberg has signalled that, as employment recovers, the government’s fiscal strategy will shift to stabilising and then reducing debt as a share of GDP. Although his stated threshold of “well under 6% unemployment” is not ambitious enough, the idea makes sense.
The good news is that with interest rates on government borrowing so low, debt as a share of GDP can be reduced without pursuing austerity in the form of deficit reduction.
The interest rate is one of three factors that affect the size of debt relative to GDP. The other two are the budget balance (the incremental contribution to debt) and nominal GDP growth, which depends on economic activity and inflation.
Even if interest rates were a little higher than now (say, 1.5%), the government can reduce debt relative to GDP even while continuing to run large deficits, provided that nominal GDP growth returns to a moderate level (say, 4.5%, as it was before the pandemic).
The next chart shows that under these circumstances the government can run deficits of up to $50 billion and still reduce debt as a share of GDP.
Author provided
Different rates of GDP growth would change this story, as the next chart shows. With an even higher nominal growth rate, debt would shrink even faster relative to GDP. In a scenario of prolonged low growth, debt would increase relative to GDP a little, but remain very modest.
Author provided
The government can do things to boost nominal growth in areas such as tax reform, education and skills, workforce participation, energy and climate policy, and land-use planning. The Reserve Bank should also do more by boosting inflation, which would support nominal growth.
Don’t scrimp on stimulus
There are many urgent and valuable priorities for government spending right now, such as permanently raising JobSeeker, boosting child-care support and building more social housing.
More debt might impose a small cost over a very long time. But the cost of insufficient stimulus and a prolonged recession would be vastly bigger.
The choice is simple. We should not let debt panic distract us from making it.
Overwhelmingly, the 50 leading Australian economists surveyed by the Economic Society of Australia and The Conversation ahead of Thursday’s economic statement want the government to keep spending to support the economy — even if it means a substantial increase in debt.
The economists polled were selected for their preeminence in the fields of microeconomics, macroeconomics, economic modelling and public policy. Among them are former and current government advisers and a former and current member of the Reserve Bank board.
Each was asked whether they agreed, disagreed, or strongly agreed or strongly disagreed with this proposition:
Governments should provide ongoing fiscal support to boost aggregate demand during the economic crisis and recovery, even if it means a substantial increase in public debt
Only three of the 50 economists polled disagreed with the proposition, none of them “strongly”.
It is one of the starkest results in the survey’s five-year history.
Of the 50 economists polled, 44 supported the proposition, 33 of them “strongly”.
Of the remaining six, three were uncertain, and provided well-argued accounts of their reasoning which are published in full along the responses of each of the other participants at the bottom of of this article.
Debt now, concern later
Rachel Ong of Curtin University said the amount of public debt that has accumulated during the COVID-19 crisis was at a historical high and had to be repaid at some point. But she said governments had to be careful about removing support until the economy was clearly on a trajectory of recovery.
Nigel Stapledon of the University of NSW said while some level of on-going support was needed, at some point the cost would be larger than the benefit. Some sectors, including universities, will have to permanently adjust to lower incomes.
The economists who strongly agreed said that if not enough support was provided or if it was withdrawn too early, the resulting recession would itself make the debt that had been run up less sustainable (Fabrizio Carmignani, Griffith Business).
Financial markets are keen to lend
Beth Webster of Swinburne University argued the only real limit to government spending was high and damaging inflation.
If the government was worried about debt, it could finance its spending in other ways, by borrowing from the Reserve Bank (which could itself create money and “monetise” the debt).
Sue Richardson from the University of Adelaide agreed, using a technical term to argue that the was economy was “so far inside its production possibility frontier” (producing so much less than it was capable of) and inflation was so dormant, that there was a case for creating money.
Saul Eslake said that wasn’t necessary. Even with the hundreds of billions committed, financial markets appeared to be comfortable with the debt and keen to lend.
Debt is how we do things
Reserve Bank board member Ian Harper said the Commonwealth could borrow for 30 years at about 1%. “Can we expect the economy to grow faster than 1% per annum in nominal terms over a 30-year horizon?” he asked rhetorically. “I would have thought that’s a shoo-in,” he answered. If so, then the debt would be easily serviced.
Consulting economist Rana Roy pointed out that public debt was “not an anomaly”. It was an enduring and defining feature of the modern economy, providing an enduring and defining asset class, sovereign bonds, which were in high demand.
Of the three economists who opposed the proposition, Tony Makin of Griffith supported “supply side” measures such as JobKeeper that would keep firms in business but opposed “demand side” measures to boost consumer spending, saying they would ultimately prove counterproductive.
Escalating public debt would induce capital inflow, drive up the dollar and make Australian businesses less competitive. Although interest rates are at present low, they would increase when the debt had to be refinanced.
Doubts for differing reasons
Paul Fritjers of the London School of Economics said he would normally support running up government debt for the sake of the economy, but could not support it being run up to support an economy the government itself had run down.
The government should wean the population off of its “irrational fears” and letting “normal economic life return”.
Although strongly argued, these views were more weakly held than those of the majority.
In his budget speech tonight Treasurer Josh Frydenberg announced that under a Coalition government we will see a decade of surpluses that will “continue to build toward 1% of GDP within a decade”.
He went on: “we climb the mountain and reach our goal of eliminating Commonwealth net debt by 2030 or sooner.”
But a funny thing happened on the way to paying off the debt.
As the budget papers point out, net debt as a proportion of Gross Domestic Product (GDP) is predicted in the budget to peak at 19.2%.
You might ask, then, how do we get from 19% to 0% debt/GDP in ten years if we’re generating a surplus of 1% per annum?
A small part of the answer is that with the economy forecast to grow at 3% a year, GDP is a fair bit bigger 10 years from now. And a 1% surplus of a bigger GDP number is a bigger dollar surplus. This has a larger impact on net debt.
That’s part of the story, but not much of it. If we make the most generous assumptions in favour of the treasurer and his surpluses (even if you believe them), they’re only paying down about two-thirds of the debt.
The case of the vanishing debt
So how does the treasurer get the rest of the debt to disappear?
The budget documents, voluminous though they are, don’t have the answers. But there are only a handful of logical possibilities.
First, let’s unpack what net debt is. Net debt is basically the gross debt issued by the government (for example, by issuing government bonds) minus the assets the government holds.
The surpluses Frydenberg announced help reduce gross debt. So, the debt-disappearing act has to involve some assets getting bigger.
The leading possibility concerns the Future Fund (Australia’s sovereign wealth fund). Simply put, if the Future Fund earns, say, 8% per annum, then those assets are going to be growing a lot faster than GDP. This reduces debt to GDP quite apart from anything else.
Another way to think about it is that the Australian government is running a big hedge fund with a lucrative profit opportunity. If it can earn 8% per annum while the government is funding this with debt that costs less than 2% (as is the case currently, given yields on 10-year Australian government bonds), then that’s a great deal.
Don’t get me wrong, I’m fine with that. But to the extent that debt reduction is coming from the Future Fund, it has nothing to do with fiscal rectitude.
An even more obscure possibility is that asset values are being hypothetically affected by assumptions about the interest rate the government will pay on its debt. Currently, it is about 1.72%, but the budget documents suggest a return to long-run historical levels of around 5
First, that seems very unlikely to happen in a post-GFC world. Second, it’s unclear that it’s of a sufficient magnitude to explain away the vanishing debt. And third, it’s an accounting artefact, not a matter of economic substance. Again, whatever it is, it’s not fiscal rectitude.
The only other possibilities are even more remote. A massive increase in the value of the essentially defective National Broadband Network? A colossal spike in student loan repayments while future students pay their own way? Nope and nope.
Should we be aiming for zero net debt?
Another question altogether is whether it is wise to reduce government debt to zero in the coming decade.
Fiscal discipline is good and avoiding structural budget deficits is important.
But as I’ve written before, we live in an age of “secular stagnation”, where there is a glut of global savings chasing too few productive investment opportunities and where economic growth is permanently lower than in previous decades.
As former US Treasury Secretary Larry Summers has pointed out, in a secular-stagnation world it will likely take a lot more government spending to sustain full employment and reasonable wages growth without financial bubbles.
Or, to put it another way, if the Australian government can borrow at less than 2%, there are a lot of attractive public investments in physical and social infrastructure that should be made. The idea of “Social Return Accounting”, which the UNSW Grand Challenge on Inequality launched last year and I wrote about here, offers a framework for thinking about this.
The live hand of Peter Costello
The treasurer presumably didn’t mean to be ironic when he said of the down-to-zero debt paydown:
Only one side of politics can do this… John Howard and Peter Costello paid off Labor’s debt.
But it is ironic that Peter Costello’s Future Fund is doing a good deal of the heavy lifting in paying off Josh Frydenberg’s debt.
In distinguishing between “good” and “bad” debt, federal Treasurer Scott Morrison equates good debt with infrastructure investment. However, not all infrastructure investment announced in the budget is necessarily “good”.
We are now in the Anthropocene – a new geological age defined by the global scale of humanity’s impact on the Earth – which places new requirements on our infrastructures. We need to move beyond the AAA ratings mindset, and instead aim for net-positive outcomes in social, economic and ecological terms from the outset.
Infrastructure (such as transport, water, energy, communications) underpins our ability to live in cities and our quality of life. And most infrastructure is very, very long-lived. Therefore, our infrastructure investment decisions matter enormously, especially for tomorrow.
More than half of the world’s people live in cities, and have just one planet’s worth of material resources to share around. This means we must define a new set of expectations and performance criteria for infrastructure.
Rather than settling for doing less bad, such as less environmental destruction or social disruption, we must aim from the outset to do more good. This net-positive approach requires us to restore, regenerate and increase social, cultural, natural and economic capital.
What sort of change is needed?
Examples of this kind of thinking are, as yet, rare or small.
Bishan Park on the Kallang River in Singapore gets close. Formerly a channelled stormwater drain, this collaboration between the national parks and public utility agencies has recreated significant habitat while providing flood protection and an exceptional recreational space. All this has been done in an extremely dense city.
Singapore’s Bishan Park is an example of a new approach to urban infrastructure.
Looking further into the future, in transport, a net-positive motorway might prioritise active transport and make public transport central by design. It might send price signals based on the number of passengers, vehicle type (such as autonomous) and vehicle ownership (shared, for instance).
Net-positive thinking aligns with a groundbreaking speech by Geoff Summerhayes, executive board member of Australia’s Prudential Regulation Authority (APRA), earlier this year. He identified climate change risk as a core fiduciary concern, and therefore central to directors’ duties.
This shift raises significant questions for the financial and operational validity of major infrastructure projects.
For example, in assessing the WestConnex motorway project, Infrastructure Australia queried why a broader set of (potentially less energy-intensive) transport options was not considered. Similar questions arise for the Northern Australia Infrastructure Fund’s support for Adani’s giant Carmichael coal mine and associated water and transport infrastructure.
A core part of the switch to net-positive infrastructure is the realisation that resilience and robustness are different things. Historically, robustness has been central to infrastructure planning. However, robustness relies on assuming that the future is more or less predictable. In the Anthropocene, that assumption no longer holds.
This could include, for example, phasing infrastructure investment and development over time. Current analysis is biased toward building big projects because we assume our projected demand is correct. Therefore, we expect to reduce the overall cost by building the big project now.
However, in a more uncertain future, investing incrementally reduces risk and builds resilience, while spreading the cost and impact over time. This approach allows us to monitor and amend our planning as appropriate. It has been shown to save water utilities in Melbourne as much as A$2 billion.
Maybe the fact that we can be criticised for not having enough capacity ready in time has influenced our decision-making. We should really be challenged over investing too much, too soon, thereby eliminating the opportunity to adapt our thinking.
Or maybe we are so concerned about the need to build certainty into our planning that we are missing the opportunity to build learning through feedback loops into our strategies.
Surely there is a balance to be struck between providing enough certainty for investment without pretending we know with absolute certainty what we need to invest for the next 30 years.
We need long-term plans alongside learning and adaptation to respond to the imminent challenges facing infrastructure everywhere. These include:
major unregulated growth in interdependencies between infrastructures;
lack of systems thinking in planning and design;
radical shifts in the structure of cities and how we live and work;
increasingly fragmented provision;
no central governance of infrastructure as a system; and
much existing infrastructure approaching or past its end of life.
Regulatory reform is part of what’s required to enable public and private investment in better outcomes. Here too we need to learn our way forward.
Sydney’s emerging, world-leading market in recycled water is an example of a successful niche development that delivers more liveable and productive pockets in our cities through innovative integrated infrastructure.
Ultimately, doing infrastructure differently will also require investment in research on infrastructure. The UK is investing £280 million in this through the Collaboratium for Research on Infrastructure and Cities. But in Australia’s recent draft roadmap for major research investment, infrastructure is largely absent. We overlook infrastructure research at our peril.
The government is committing to more than A$70 billion in new infrastructure spending to 2020-21. This includes up to A$5.3 billion for the Western Sydney Airport, and A$8.4 billion towards the Melbourne to Brisbane inland rail link. Another A$500 million will be put towards passenger rail in regional Victoria, A$844 million for upgrades to the Bruce Highway in Queensland, and A$1.6 billion for road and rail in Western Australia.
A A$1.5 billion Skilling Australians Fund will be created to fund apprenticeships and traineeships. The fund will be supported by a levy on businesses with turnover greater than A$10 million that employ foreign workers.
The $20,000 instant asset write-off for small businesses has been extended to June 30, 2018.
The government has also committed to provide $101.5 million over five years to create an Advanced Manufacturing Fund, to promoted high-technology manufacturing.
To alleviate increasing energy costs, a one-off Energy Assistance payment will be will be given to pensioners and disability support recipients over two years. Single recipients will receive A$75 and couples A$125, at a cost of A$286.9 million. The government will also remove the capital gains tax exemption for foreign and temporary tax residents, and allow prospective first home buyers to make voluntary contributions to superannuation that can be withdrawn for a first home deposit.
The budget won’t fix the cost of living
Phil Lewis, Professor of Economics, University of Canberra
The budget contained several measures supposedly intended to “ease the cost of living”. Notably a one-off “energy assistance” payment to pensioners and those on disability support, and measures to address housing supply and affordability. But these will do little, if anything, to ease the cost of living of most Australians. On other aspects of the cost of living, such as health and education, the budget measures will make the cost of living worse for some groups.
A rise in the cost of living is usually represented by an increase in the Consumer Price Index (CPI) over a quarter, year or decade depending on the issue of interest. The CPI is designed to measure changes in the cost of a “basket of goods and services” that a “typical” Australian household might buy.
Almost half of the current basket is made up of housing, transport and food costs. So movements in these prices have a relatively big impact on the cost of living. But the ability of the federal government to control house prices or the other major component of housing costs – electricity and gas – is very limited. And petrol and food prices are determined by national and international market forces.
Changes in CPI basket. ABS
The above figure shows how the prices of components of the CPI changed over the year to March. The greatest price increases have been for alcohol and tobacco, which are largely due to government “sin taxes”. One of the easiest ways to ease cost-of-living pressure on the poorest households would be to reverse these tax rises, but this is not on the agenda.
The government also has great potential to influence costs in areas for which it is a major funder such as in health and education. These are also areas where prices have been rising faster than the CPI.
In education, the additional A$18.6 billion over the next decade for schools funding, which is needs-based, should reduce cost of living for more disadvantaged households, although some middle-income households might be worse off.
But the cost of living will rise for university students, as fees rise by 1.82% per year over the next four years. Those with HELP debt on lower incomes will also come under pressure, as the threshold to pay off their loans is reduced to A$42,000 per year.
In health, the re-indexation of the Medicare rebates from this July for regular GP visits, the further reduction in the price of prescription drugs, and scrapping of the 2014 proposal to raise prescription charges by A$5 will all help with the cost of living for those on lower incomes.
Although really a tax increase, the increase in the Medicare levy, by 0.5% from 2019, will nevertheless reduce the standard of living of households on middle to high income.
Big dollars for infrastructure, little transparency
Phillip O’Neill, Director, Centre for Western Sydney, Western Sydney University
Decision-making about infrastructure in Australia reached a new level of incompetence on budget night. Much public money has been committed, and the list of projects is long. Yet the planning and evaluation process for identifying what assets should be built and how their roll-out should be staged remains dreadfully inadequate.
Infrastructure is expensive and imposing. Governments need to select projects well, because when we select a project to build we also decide not to build a competing project. Construction then needs to proceed efficiently and with minimal impact.
Good infrastructure delivers benefits over many decades. Some infrastructure assets – like those for the delivery of water, energy and telecommunications – deliver direct benefits to consumers so they can be funded by user charging, which in turn means some degree of commercialisation of the asset is possible.
Infrastructure also makes our cities more productive and better, safer places to live. These positive externalities are not easily commercialised; but when a project is a good one because there is widespread benefit we are happy for governments to borrow and our taxes to be used to pay down the debt. The presence of good public infrastructure, like good public health and education, marks us as a civilised people.
Getting the right balance of commercial benefits and positive externalities isn’t easy. Infrastructure roll-out needs informed choice and, therefore, engaged public debate. But infrastructure decision-making in Australia lacks both information and debate. The secrecy in Australia surrounding infrastructure – be it for new construction or the sale of brownfields assets – is appalling. Business cases are rarely made public. The claimed benefit-cost ratios are not able to be scrutinised. Project financing and construction schedules are never revealed. Construction contracts are deemed “commercial-in-confidence”, as are the complex sale contracts of existing public assets.
Sadly, the budget gives little hope that any of this will change.
Marion Terrill, Transport Program Director, Grattan Institute
There’s more than a touch of back to the future about this budget: we’ve got so-called nation-building projects and the usual cries of “What about me?” from various state premiers. But in the current world of “good debt” and “bad debt”, the infrastructure choices of Budget 2017 look more defensible than usual.
For a start, there’s plenty to like about the $5.3 billion commitment to Western Sydney airport: the project has bipartisan support; it’s been assessed as having benefits of $1.90 for every dollar it costs; Infrastructure Australia thinks it’s a high priority; and, after 30 years on the drawing board, nobody could say it’s a thought bubble.
Inland Rail may squeak over the line. Despite an equity investment of $8.4 billion, the project has a marginal business case at best, with benefits of just $1.10 for every dollar spent and all the risks on the downside. Indeed, plenty of experts are dubious about the merits of this project.
Don’t listen too much to the political theatre about which states have been dudded in the carve-up of infrastructure dollars. In the end, more than half of what the Commonwealth grants for transport infrastructure is effectively neutralised when the winning states end up with a lower GST share. WA has been singled out for a particularly large $1.6 billion package in this budget, but that will only matter if the Grants Commission is asked to quarantine it from affecting WA’s GST share. New South Wales and Queensland – as usual – get a bigger share of the infrastructure pie than the commission says they need, but their lower GST share in subsequent years unravels more than half of their ostensible advantage.
So, on infrastructure spending, Scott “Good Debt” Morrison’s 2017 budget probably rates a pass.
The lost innovation agenda for industry
Beth Webster, Director, Centre for Transformative Innovation, Swinburne University of Technology
Wealth has to be created before it can be distributed. Unfortunately, this message has not been heeded but the current government.
The budget is high on rhetoric about deficits and the importance of runways, roads and rail but still low on supporting the innovation ecosystem that is needed to transform Australian industry. The government should be playing a role to stimulate the transition to new technologies. It should provide industry with the confidence to launch new products and technologies.
Overall, there has been a reduction in spending on programs dubbed in the budget “Growing Business Investment and Improving Business Capability” by A$93 million. The government has missed the most important form of investment – the networks of people and institutions that drive innovation.
There is funding for Industry Growth Centres (from A$37 million to A$61 million) and the Entrepreneurs’ Programme (A$79 million to A$106 million) but these measures have been matched by cuts. Two measures stand out in these cuts. First is assistance to pivot businesses out of car and clothing to other manufacturing sectors (down by A$84 million) into other sectors. And once again, the budget for Australia’s premier research and development organisation, CSIRO, is down by 4%.
On the plus side, spending on business research, development and commercialisation has increased by 4%. Not large, but it is a win. However all this has come at the expense of programs to inspire Australians to study science and engineering.
Overall, it’s fair to say industry programs have been savaged with programs to support business investment and improving business capability falling by 15%.
Random Thoughts 
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