Hockey should score reform goals
Consider the case of the budget. On the face of it, Treasurer Joe Hockey's problem is that the closer he got to inheriting the budget and its deficit, the more he realised that - contrary to everything he and his boss had been saying for three years - returning it to surplus would be no easier for the Coalition than it had been for Labor.
That's why, in the campaign proper, he took care to make no meaningful promise about when he would get back to surplus - even leaving open the possibility it wouldn't be within the government's first term - and why, as soon as the election was won, all talk of a "budget emergency" instantly self-destructed.
Had a Labor government changed its tune so abruptly we would never hear the end of it. But Hockey is right in confidently assuming a Liberal treasurer can get away with things no Labor treasurer could. Tony Abbott keeps saying the Libs have good economic management in their DNA and, as decades of polling make crystal clear, most punters know in their heart it's true.
In other words, Hockey's budgetary performance need be no better than Labor's for his government to be judged "better than the last lot".
But the challenge he faces isn't quite that simple. As we were reminded last week by two economics professors from Melbourne University, John Freebairn and Max Corden, some time over the next year or two investment spending by the mining industry is expected to drop from 8per cent of gross domestic product to 2per cent.
That's a massive fall in economic activity. And it's not at all certain the most expansionary stance of monetary policy (low interest rates) will be sufficient to ensure consumption and investment spending in the rest of the economy are strong enough to offset that massive fall.
Saul Eslake, of Bank of America Merrill Lynch, says there's a 25 per cent chance the economy could contract in 2015. The econocrats think that sounds pretty right.
Even if the economy didn't actually go backwards, it could easily slow to a point where unemployment started climbing rapidly. With monetary policy already fully extended, what should a responsible treasurer do? Stick with all the anti-Keynesian rhetoric about unnecessary, even wasteful fiscal stimulus the Liberals subjected Labor to, and do precisely nothing?
The treasurer - Liberal or Labor - who could resist the temptation to use the budget to apply stimulus at a time when the economy was slumping has yet to be born (the ill-fated John Kerin excepted). Hockey would be no exception.
As the two professors have argued, the obvious answer to the rapid retreat of mining investment spending is to fill the vacuum by ramping up federal infrastructure spending. They propose being ready to roll out a "capital investment stabilisation fund".
This would limit the rise in unemployment, invest at a time when construction prices were low and, if the projects were well chosen, help raise the productivity of the wider economy.
Even so, it would involve consciously adding to the budget deficit at a time when all your debt-and-deficit-anxious supporters were expecting you to do the reverse. This could present credibility problems even for the most arrogant treasurer.
What to do? Follow the example of the state governments and redefine the deficit to include recurrent spending but exclude capital spending. This would bury the Libs' hypocrisy under genuine fiscal reform.
The one glaring conceptual weakness in the bipartisan medium-term fiscal strategy to "maintain budget balance, on average, over the course of the economic cycle" is its failure to distinguish between recurrent and capital spending.
Shifting the focus to the budget's "operating" balance (as opposed to its overall borrowing requirement) would retain the discipline of public opinion over recurrent spending, though it would risk taking the discipline off capital works spending, which is undoubtedly susceptible to political temptation.
This why the reform should be completed by taking up the professors' proposal that all capital projects be rigorously evaluated by a body with independence, similar to the Productivity Commission's, which would publish benefit-cost assessments for all major projects.
If Abbott and Hockey could summon the courage to make such a reform, they would immediately put themselves up with Bob Hawke and Paul Keating, John Howard and Peter Costello.
Frequently Asked Questions about this Article…
The article explains Joe Hockey discovered that returning the budget to surplus would be no easier for the Coalition than it had been for Labor. He avoided promising a quick return to surplus during the campaign and dropped talk of a "budget emergency" after the election, recognising the structural difficulty of fixing the deficit.
Melbourne University professors John Freebairn and Max Corden warned mining investment could fall from about 8% of GDP to 2%, a massive drop in economic activity. The article says this could slow growth, push unemployment higher and even raise the risk of an economic contraction—saints such as Saul Eslake put the chance of contraction around 25%—which can hurt company earnings, share prices and investor returns.
The article notes monetary policy was already highly expansionary (very low interest rates), and that even this stance might not be enough to ensure consumption and non-mining investment rise enough to offset a large fall in mining spending. In other words, rates alone may not stimulate enough activity to replace the lost mining investment.
The professors propose a capital investment stabilisation fund that would let the federal government ramp up infrastructure spending when mining investment falls. According to the article, this could limit unemployment, take advantage of lower construction prices and, if projects are well chosen, boost productivity—outcomes that support stronger economic conditions for businesses and investors.
The article argues it could. Consciously adding to the budget deficit to apply stimulus when supporters expect fiscal tightening might create credibility problems. That tension is why the authors say any stimulus plan risks political pushback unless accompanied by clear fiscal reform and safeguards.
They suggest redefining the deficit to include recurrent (operating) spending but exclude capital spending. Shifting the focus to the budget's operating balance would keep discipline over recurrent spending while allowing capital works to be treated differently—making it easier to use infrastructure spending counter-cyclically.
The article endorses the professors' idea that all major capital projects be rigorously evaluated by an independent body—similar to the Productivity Commission—that would publish benefit–cost assessments. This transparency would help ensure projects are well chosen and reduce the risk of politically driven, low-value spending.
If Abbott and Hockey had the courage to redefine budget measures and set up independent benefit–cost assessments for capital projects, the article suggests they would elevate their reform credentials—bringing them into the same league as notable reforming leaders like Bob Hawke, Paul Keating, John Howard and Peter Costello.
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