Budget 2021: Plan mostly politics with little economics

Treasurer Josh Frydenberg delivers the budget in the House of Representatives.

Budgets are always a mix of economics and politics. Tuesday’s budget was no exception.

My first impression was that it was one part economics, four parts politics. Having waded through Budget Paper No 1 — the key document — I ended up coming to the conclusion that this year’s budget is nearly all politics, with a potentially serious misreading of the economic outlook and the scope for government spending and interference to cause more harm than good.

In particular, the continuation of the fiscal pump-priming in the context of an accelerating pace of economic growth means that everything could quite quickly end in tears, although after the next election (which may be as early as the end of this year).

Just take a look at the figures. The expected deficit for the coming financial year is $107bn or 5 per cent of GDP. With that level of fiscal stimulus, you might expect unemployment to be 8, 9 or 10 per cent. But according to the latest figures, unemployment is around 5.6 per cent.

What’s more, the Reserve Bank is forecasting that GDP will grow by a rate of 9 ¼ per cent in the year ending this June quarter and unemployment will average 5 ¼ per cent in the quarter.

Treasury expects unemployment to be 4 ¾ per cent — under the magical 5 per cent — by mid-2023, but the pump-priming continues through all four years of the forward estimates.

Even in 2024-25, a deficit of $57bn or 2.4 per cent of GDP is anticipated. At that point, government net debt will be close to $1 trillion or 41 per cent of GDP. This is a far cry from the negative net debt of 2.2 per cent of GDP recorded in 2007-08 — thank you, Peter Costello.

The medium-term outlook also points to ongoing budget deficits for the rest of this decade — a dispiriting prospect, if there ever was. It’s extraordinary to think that the Treasurer boasted of the budget being back in black only two years ago

This budget is being handed down at a time of close to record terms of trade and a record iron ore price, over $US200 per tonne. Effectively, the government has chosen to spend this windfall rather than putting it away for a rainy day. The weird assumption is the iron ore price will be only $US55 per tonne by the end of the March quarter next year. We will see.

As far as this budget is concerned, a lot depends on the output gap — the difference between current output and the maximum output that can be sustained without creating inflationary pressures in the coming years. The Treasury thinks the gap is still substantial and can be filled by more public spending. Unsurprisingly, the Treasurer is happy to go along for the ride as he showers all sorts of worthy (and politically sensitive) causes.

The fact that this gap could be better filled by private sector activity, spurred by private investment (which has performed so woefully for many years), should appeal to a Coalition government. But clearly that is so yesterday, with the execution of what is effectively Modern Monetary Theory so much more politically palatable these days

And we are talking big licks of government spending. There is an additional $17.7 billion for aged care and an extra $13.2 billion to cover the (unrationed) costs of the NDIS. The main problem with both these expenditure items is that, in the absence of any real structural reforms, the costs will simply continue to blow out and we will be in the same pickle in four years’ time.

While giving emphasis to home-based care for elderly folk is a good idea, the extraordinarily low rate of co-contributions from the recipients of the services is a cause of real concern. People with both adequate income and assets should be asked to make much larger financial payments to cover the costs of their care. The same goes for the costs of nursing homes.

When it comes to the labour market and wage growth, the Treasury has now swung from one extreme to another. For years, future growth in wages was significantly underestimated, with forecasts of annual increases in the wage price index often in excess of 3 per cent but never achieved. (These figures are important in their own right but also as underpinning income tax revenue, the largest single source of government revenue.)

In 2019-20, the WPI grew by only 1. 8 per cent. In 2021-22, it is forecast to grow by 1 ½ per cent, rising to 2 ¾ per cent by 2024-25.

But here’s the thing: it is expected that there will only be a gradual return of permanent and temporary migrants from mid-2022. Indeed, population is expected to grow by only 0.2 per cent next financial year and by 0.8 per cent in 2022-23. (The most recent pre-Covid annual increases were close to 1.3 to 1.5 per cent.)

It is already evident that there are significant shortages of all sorts of workers, in both cities and regional areas. The ramping up of home building, which is being driven by a range of government programs, is leading to widespread shortages of skilled tradies as well as a lack of some supplies. Farmers are having trouble getting the help they need.

There is also talk of too few vets (to look after all those Covid puppies) as well as chefs.

Wage pressures are all on the upside as employers seek to lure workers away from other employers or from out of the workforce. If wage growth is much higher than forecast in the budget, it is also possible that inflationary pressures may likewise grow.

Any indication of incipient inflationary pressures would be of real concern because of the sensitivity of our hugely indebted household and government sectors to any increases in interest rates notwithstanding RBA Governor Phil Lowe’s assurance that the cash rate will not rise before 2024.

In any case, the actions of the Fed could well force his hand before then. That’s the tears scenario.