Vision and reform needed to deliver debt reduction

As he prepared his big-spending, deficit-driven budgets in response to the pandemic, Josh Frydenberg consistently raised the advice he got from John Howard. That is, in times of national crisis there are no ideological constraints. Given Mr Howard’s track record of big spending on middle-class welfare to encourage voters, it can be said that this advice applies to election times as well. In what could well be a pre-election budget for the Morrison government, the Treasurer has followed Mr Howard’s advice and example. The difference is that where Mr Howard and his treasurer, Peter Costello, were debt-free and awash with cash at the height of an economic boom, Australia is sailing on an ocean of debt as it emerges from the pandemic. The question is whether this debt has come from good-quality spending that will grow the economy and jobs. Will Australia emerge stronger in structural terms than before? Is there a credible plan to deal with the hundreds of billions of dollars of debt used to protect jobs during the height of COVID, and now directed to the welfare priorities of aged care and the National Disability Insurance Scheme in the latest budget? Achieving a smaller than expected deficit is not the same thing as attaining a surplus that easily could be spent on something else or saved. Nonetheless, Mr Frydenberg has accepted plaudits from business for his latest effort, which is pitched as a jobs-first, confidence- building budget to solidify the nation’s road out of the pandemic.

As a key player in the Morrison government, Mr Frydenberg has managed the financial fallout from the pandemic well. Australia’s economic position is the envy of the world. And until now spending has been tightly focused on shielding businesses and employees from factors beyond their control while stimulating growth, predominantly through housing. Despite the budget’s big-spending focus on welfare and sectional interests, Mr Frydenberg insists it remains faithful to the Menzies tradition of promoting home ownership and reward for effort. “At the heart of this budget is the concept of backing the private sector,” he says. At the National Press Club on Wednesday, he trumpeted the support his budget had received from business. The Business Council of Australia said it propelled Australia out of the pandemic and laid the foundations for a jobs-led recovery. Economist Chris Richardson said it was “absolutely the right budget” for the times. The fight against COVID has become the fight against unemployment.

Mr Frydenberg says the incentives for business to invest that have been extended are having an impact. There has been a jump in investment in machinery and equipment of more than 8 per cent, the highest in seven years. Businesses capital expenditure expectations are the highest in many years. Business confidence is also high, which adds up to a positive outlook for jobs. It is wise to continue with accelerated asset write-offs and innovations such as the “patent box” to give favourable tax treatment for the commercialisation of successful research.

The $15.2bn for infrastructure is also welcome. Although easy to justify on compassionate grounds, there is still a big question mark over how productive much of the spending in the budget will be. This includes $17.7bn for aged care; an extra $13.2bn for the NDIS; $2.3bn for mental health; $1.1bn for women’s safety; and $1.78bn for childcare. The government has yet to explain how such recurrent spending can be sustained across the long term.

To justify the high level of borrowings and continued deficits, the government has relied on the contention that growth in gross domestic product will continue to be higher than interest paid on borrowings. As a result, debt as a portion of GDP will fall across time, without the need for surplus budgets. This scenario is vulnerable to the rate of GDP growth and changes in inflation and interest rates. Rates are at historic lows globally but already there are mixed signals about the re-emergence of inflation in the US. These have been enough to unsettle financial markets, lift bond yields and put pressure on stock prices. What happens in the US inevitably will have an impact here.

The budget papers show real GDP is forecast to grow by 1.25 per cent in 2020-21, by 4.25 per cent in 2021-22 and 2.5 per cent in 2022-23. Net debt is expected to be 34.2 per cent of GDP at June 30 next year and peak at 40.9 per cent of GDP in 2024-25. That is below the 43.8 per cent peak projected in the previous budget. Net debt is then forecast to fall across the medium term to 37 per cent of GDP at June 30, 2032. It is a far cry from the net-zero government debt at the end of the Howard-Costello era. Our criticisms of Mr Howard 15 years ago were centred on his lack of appetite for reform and fondness for middle-class welfare. At the end of his last term we said it was easy to look like a sound economic manager when government coffers were full due to a housing boom and resource exports. Tax cuts and middle-class welfare win votes in the short term but fail the test when it comes to shock-proofing prosperity into the future. The Morrison government has the benefit of another iron ore boom and an exuberant housing market. But rather than a $19.8bn surplus as Mr Howard had accumulated by his last year in office — with no borrowings — Mr Frydenberg is facing a decade of deficits and a mountain of debt. The social largesse being doled out, however worthy, is on borrowed funds. The pandemic accounts for a lot, but the need for productivity-boosting reform has never been greater.