DESPITE the federal fiscal stimuli we had to have, Australia is almost certain to experience the recession it was not supposed to have.
So, with earlier stimulatory measures failing to work as expected, what alternatives would work better?
The answer is: those primarily focused on the production rather than the spending side of the economy.
Federal fiscal packages unveiled since October last year have aimed to boost consumption in the short term, in keeping with Treasury advice at the outset that the best fiscal response to the global financial crisis was to “go early, go hard, go households”. However, an arguably sounder fiscal response would have been the exact opposite: go later, go easy, go firms.
This does not mean federal policymakers should have ignored the downturn or that all aspects of fiscal stimulus packages have been unworthy. On the contrary, many infrastructure projects scheduled for future years have been overdue, there is some business tax relief and business regulation problems are being addressed.
But too much faith has been put in using fiscal policy to boost consumption on the demand side of the economy in the short run via tens of billions of dollars’ worth of bonus payments. A different mix of measures should have recognised that the financial crisis first struck the aggregate supply side of the economy, not the demand side.
For federal fiscal policy to go later would have meant letting monetary policy go further in the first instance to pre-emptively manage the expected downturn in short-run macro-economic activity.
The Reserve Bank of Australia has had much greater scope to do this compared with central banks abroad because official interest rates in Australia had been too high for too long before the global financial crisis hit home.
Inflation also had been wrongly diagnosed as an aggregate demand problem rather than a supply side, or cost-push, problem thanks to high oil and other international commodity prices.
The lowering of official interest rates by four full percentage points since September and the sharp exchange rate depreciation since then will do more to buffer the economy from the worst of the crisis than any fiscal action in train.
It also would have been advisable for federal fiscal policy to go easy in the light of the whack to budget revenue and the budget bottom line as a result of global commodity price falls and diminishing company and capital gains tax receipts.
Moreover, going easy on fiscal policy would have avoided the problem that will soon arise when government borrowing to fund growing state and federal budget deficits puts upward pressure on long-term interest rates, thereby limiting the Reserve Bank’s discretion to lower interest rates across the spectrum.
“Go households” has meant channelling scarce federal fiscal outlays to select segments of the economy’s household sector. But this has ignored the fact firms were the first victims of the crisis.
For many struggling firms, falling sales were initially less of a problem than the unavailability of credit. Paradoxically, the raft of hasty public spending initiatives implemented across the world may hold back recovery if households and markets become increasingly alarmed about higher future taxation, interest rates and inflation.
Unemployment is the scourge of recessions. However, it is the business sector, not households, that ultimately employs most people, creates most of gross domestic product and invests in the economy’s future. Hence, it would have been better to assist firms’ bottom line directly on the cost side through rapid regulation relief and tax relief, such as payroll tax reduction, than assist indirectly on the revenue side through trickle-down sales.
Though the federal fiscal response so far offers some business tax relief, this is dwarfed by the bonus payments aimed at boosting consumption.
Rather than following aggregate demand-oriented approaches adopted by the US, Britain and other countries, federal policymakers should look to New Zealand, which so far has avoided measures aimed directly at inflating consumption spending. Instead, the NZ Government has emphasised supply-side measures that will flatten marginal taxes levied on individuals, improve infrastructure and quickly lower the regulatory burden on business.
This is not the first time NZ has led the world in economic policy innovation. It was a Labour government there that initiated comprehensive economic reform under the direction of treasurer Roger Douglas from the mid-1980s.
This change in policy direction occurred following a currency crisis resulting from fiscal excess and included labour market reform, privatisation, public finance reform and trade liberalisation.
The breadth and depth of NZ’s reforms had no precedent in the Organisation for Economic Co-operation and Development, and the measures were initiated before the Hawke-Keating government commendably followed suit with a similar reform program that delivered the strong productivity gains Australia enjoyed until the turn of the century.
NZ was also the first country to formally legislate for an independent central bank whose sole
objective was to keep inflation low. Years later Australia adopted a weaker version of the NZ monetary policy model, as did Britain. It’s now time to emulate the spirit of NZ’s fiscal response to the crisis.
We all know about NZ’s rugby prowess and how often it beats Australia at the game. If we were to score Australia v New Zealand on fiscal responses to the global financial crisis so far, it would be Australia 0, NZ 1.
That’s not counting penalty tries where one side gets points for being obstructed by the other. Such obstruction will be evident as public sector borrowing resulting from aggregate demand management by the state and federal governments in this country pushes up Australian interest rates at NZ’s expense.
Tony Makin is professor of economics at Griffith University’s Gold Coast campus.