Tuesday, December 02, 2008

Planning to go into deficit misguided

The commentators who just months ago were calling for the budget tax cuts to be cancelled are now calling for a budget deficit.  Their argument is quite specific -- not just that the budget could go into deficit, but that the government should deliberately move it into deficit.  Kevin Rudd and Wayne Swan, previously reluctant to buyinto that argument, have now caved in to pressure.

In the first instance, we should recognise the Australian economy is not yet in recession.  Nor is one being forecast by Treasury, the Reserve Bank ofAustralia or the Organisation for Economic Cooperation and Development.  To be sure, forecasting is an inexact science and these organisations have a poor track record.  Nonetheless, the official view is Australia will avoid recession.

The Rudd government has already panicked twice in its handling of the crisis.  The blanket bank deposit guarantee and the expenditure of $10.4 billion were hastily devised policy, squandering a fair proportion of the budget surplus.  Much has been made of RBA governor Glenn Stevens's recent address, in which he argued good investments financed by prudent borrowing might be appropriate in the present climate.  This has been widely interpreted as a green light for deficit financing.  Yet this is a pure motherhood statement.  It raises the questions, what are good investments and what is prudent borrowing?

Indeed, Stevens was asked one of those very questions on the night.  His diplomatic reply was that good investments 12 months ago remain good investments, while bad investments have not become good ones simply because there is a crisis.  That is exactly correct.

Treasury secretary Ken Henry, in a leaked speech, set out the criteria for good public investment before the 2007 election.  He emphasised the three Ps of population, productivity and participation.  This was interpreted as being critical of the Howard government's spending agenda, yet the Rudd government has proved no better.  The pre-Christmas spending spree will not advance any of the three Ps.

It is heartening that 56 per cent of the electorate are wary of deficit financing.  It is here a wide gap appears between the common understanding of government finances and elite economic opinion.  Nobel Prize winning economist James M. Buchanan argues the common view is correct and elite opinion is wrong.

Public debt is repaid out of future tax revenue.  Those future taxes are associated with future deadweight losses that cannot be forecast now.  Consequently, public debt is a burden to future generations.  To the extent public debt is used to finance consumption now, we are simply living beyond our means.  The public knows exactly what that means.

The budget may well go into deficit, yet the government should never plan for it to do so.


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