The public sector boom is dragging us down

There is an old joke about economists that plays on the notion that focusing on averages can conceal important information, which seems quite relevant in the current circumstances.

The naive economist puts one hand in freezing water and one hand in boiling water and declares, “On average my hands feel fine!”

This joke comes to mind when we look at the current state of the Australian economy.

The private sector is freezing, and in fact it’s been going backwards for the last two quarters. The government sector, on the other hand, is boiling, with extraordinary growth in spending and hiring.

While the naive interpretation is to look at the average and think “everything’s fine”, the deeper analysis shows an economy with a deep structural problem.

Put simply, an economy with a private sector going backwards cannot sustain a public sector blowing out. That is asking a weakening team of Clydesdales to pull an increasingly overburdened wagon.

The fact that the public sector is blowing out is placing a major strain on the private sector, and this works through a number of key channels.

First, the Reserve Bank has elevated interest rates because of an inflation problem emanating from a public sector boom rather than a private sector in reverse gear, but the private sector is paying a significant price nonetheless in higher interest rates.

Second, state and federal spending blowouts have pushed taxes higher than they would otherwise be, and will inevitably drive further demands for higher tax down the track.

Third, the private sector sees the reweighting of the economy towards the lower-productivity public sector and the associated higher taxes and pulls back on investing in a slower growth future.

Fourth, the government sector recruitment boom is hoovering up the limited supply of skilled workers and leaving the private sector short-staffed.

Finally, the expansion of government will inevitably result in more pettifogging bureaucrats and interfering policymakers tying business up with red tape and regulation.

The focus on increasing public spending has no doubt come from good intentions, but too little attention has been paid to the risks of establishing an unhealthy dynamic whereby public sector blowouts weigh down private sector growth, which prompts calls for more public spending, which weighs the private sector down further, and so on.

It’s unclear whether the government appreciates the dynamic now in play.

In the wake of the latest official figures showing very weak growth there was some government acknowledgement that the private sector will be needed to escape this economic malaise, but it is unclear as yet what this will mean and when.

On the ground the government is continuing to double down on the increased government spending approach, with a number of new announcements in recent weeks lifting spending in new areas. With an election coming the temptation will be to go further, notwithstanding the economic risks.

It’s quite likely that the over-spending problem will continue for some time yet. Having uncorked the spending genie it will be very difficult to put it back in the bottle. Expectations have been raised, appetites whetted.

Of course the only real answer to the overspend problem is to break out of the cycle and put the economy back on a sound footing.

The government needs an agenda focused on unleashing the latent energies of the private sector.

This means building business confidence that the spending problem is being fixed, addressing the regulatory nightmare that’s suffocating business, liberalising the industrial relations system to generate productivity, and reforming the tax system to encourage growth.

The focus should be on, and should always have been on, growing the private sector. Allowing the private sector to flourish is the only sustainable way to bring about genuine economic growth.

David Alexander is chief of policy and advocacy at the Australian Chamber of Commerce and Industry.