Economic watershed

AUSTRALIA has entered a new world. The economics of the Howard era are terminated. Australia has crossed a threshold to become a budget deficit and government debt nation for many years. This will dictate the new course of politics.

The Rudd Government confronts an awesome task during the next two years, with Treasury forecasting a sharp lift in unemployment to 8.5 per cent during the 2010-11 election year. Beneath their resolution, Kevin Rudd and Wayne Swan are realists about the survival battle they confront once the public's sense of recession unreality evaporates.

In his National Press Club speech, the Treasurer revealed the grim mood last October when ministers recalled the doomed Scullin government of the 1930s, engulfed "by events it could neither understand nor control", and resolved with a collective determination "that history will not repeat itself".

Budget details often obscure the bigger picture, but Australia is heading into a serious downturn followed by a grim recovery.

Swan's budget shows a $77 billion turnaround for next year leading to a $58 billion deficit and projects government debt to peak at $188 billion by 2012-13 compared with the $96 billion debt that John Howard inherited in 1996 and took a decade to eliminate.

This debt burden spells a horror second term if Rudd is re-elected with his Government pledged to keep annual spending growth below 2 per cent in real terms for many years, an improbable task that, if delivered, will smash welfare entitlements, impose a scramble for scarce resources and eliminate tax cuts for years in a setting where interest rates will be increasing.

"The Government welcomes a debate about debt and deficits," Rudd declared in parliament the day after the budget was handed down. He has no choice. But this is the Liberal Party's political territory. It owns these issues courtesy of Howard and Peter Costello.

In his budget reply Malcolm Turnbull sounded effective when he put the brand of "higher debt, higher unemployment and higher deficits" on Labor, and asked: "How many years, how many decades will it take us to pay off hundreds of billions of dollars of Rudd Labor debt?"

The Liberal Party has got its election cause.

This budget draws the battle lines for the next election with the economy as the dominant issue. Rudd will campaign as the leader whose decisive actions saved Australia from the worst brutality of the global recession and Turnbull will campaign to liberate Australia from another long night of Labor deficits.

The Government's ambivalence this week in the teeth of the global downturn was stunning. Rudd and Swan boast about their deficit yet they condemn their deficit. Their deficit is bad yet their deficit is good.

The deficit, when dressed up as the stimulus ameliorating the effect of the downturn, is predicted to boost gross domestic product in 2009-10 by a hefty 2.75per cent, keeping alive jobs and businesses that would otherwise fail.

Yet Rudd and Swan insist with manic determination their deficit is only temporary until the virtue of the surplus and the wonder of fiscal conservatism is regained. This duality is essential to their strategy of stimulus now and sustainability later. Deficits and debt are necessary evils to be purged after their worthwhile purpose is served. When, pray, is that point reached? This is Labor's problem. Have no doubt, it is a difficult position to market and it provides the political opening that Turnbull desperately needs.

This was a transforming week that saw Swan's second budget, Turnbull's first budget reply as Opposition Leader and Greg Combet's introduction into the house of the historic bills giving effect to Labor's carbon pollution reduction scheme to combat global warming. In the first sentence of his second reading speech, Combet called these measures "one of the most significant environmental and economic reforms in the history of our nation". The Coalition hates these bills.

The new politics of recession are shifting the ground rules in ways that challenge both Rudd and Turnbull.

The first message is that Rudd and Swan are big winners in what is best called their "recession-cushioning" strategy to avoid the plight of the Scullin and Whitlam governments. Australian households have never been so well-prepared for recession. They are cash-rich, showered with tax cuts, the biggest pension increase in history, tax breaks for business and home buyers, a parental leave scheme, school infrastructure, investment in clean energy, roads, rail, port, a national broadband scheme, renewed commitments to defence in the new white paper, funds for innovation, universities, the car industry, with the Reserve Bank of Australia cutting interest rates by a whopping four percentage points since the crisis began.

Field Marshal Rudd and General Swan have built anti-recession fortifications on a scale not seen since Federation. You name it and Rudd has probably done it. This prompted his old enemy and social analyst Mark Latham to declare this week in The Australian Financial Review that "so far most Australians are having a happy recession".

These fiscal and monetary expansions offer many households armour-plated protection from the worst of the downturn and affirm the image of a decisive government that, in Swan's words, "refused to be overwhelmed by the brute force of this global recession". Swan and Rudd seek the mantle as leaders who kept the ship steady amid the world cyclone.

Second, in this climate there is no justification for an early election. That violates the need for business and investment certainty and job maintenance. This week Swan dismissed election talk. Rudd said his view was like Howard's: to run the full term. If Rudd goes early he will spark a ferocious backlash as a leader who puts his own job before Australia's economic interest.

But there is one qualification: if the Opposition is fool enough to deny Rudd's carbon emission scheme and create the basis for a double-dissolution election. This would provoke and legitimise an early poll. It would allow Rudd to go to the polls before the worst of the jobless deterioration, invoke the need to restore investment certainty and depict the Coalition as a bunch of climate change sceptics, a guaranteed winner.

Swan's budget presents the Liberal Party with a "return to sanity" strategy. The Liberals need to retreat from their madness in threatening to block the carbon emission scheme bills, a manifest act of political suicide. This will become the decisive test of Turnbull's leadership; he must carry the party on this path towards responsibility based on a recognition that the true interests of the Liberal Party are a full-term parliament with an election on the economy at the end.

To this goal, the Liberals should sanction, if necessary, the Nationals voting against the carbon scheme bills with the Liberals voting for the bills. Turnbull has already lost his optimum position on this issue: that was Rudd's Mark One version, with the scheme starting next year before the election. By their tactical ineptitude the Liberals drove Rudd to rethink and put the start date into his next term. They cannot afford a second, more disastrous, blunder. The Liberal Party needs to remember that you can win elections by "giving prime ministers their dreams".

Turnbull's reply to the budget invites only one interpretation: the only savings measure the Coalition will oppose is the reduction of the private health insurance rebate. This tokenism towards the Liberal voting faithful is probably the price of a "return to sanity" by the Liberal Party on budget measures. With the Liberals promising lower deficits, they have no credibility whatsoever knocking off Rudd government-saving decisions.

Turnbull must discipline those kamikaze MPs, strong on muscle and weak on brains, who want more budget savings measures blocked in the Senate.

Turnbull's campaign against "deficits and debt" will expose him to the full force of Labor's demand that he nominate his savings. This is a sensible Labor polemic but worthless as an argument; no Opposition is going to identify its full savings agenda mid-term.

Swan's budget, to his credit, lays out a deficit exit strategy. From the start of the budget process, Finance Minister Lindsay Tanner also insisted on this. But it opens the window to the third big message of new recession politics: a grim and painful recovery for which the Australian people are unprepared.

Treasury forecasts three years of low growth in the recessionary phase. In the recovery it predicts a return to surplus in 2015-16 and a reduction in net debt to 3.7per cent of GDP by 2019-20 after it peaks five years earlier. Both projections are heroic.

The budget papers, however, assert that the Government's deficit exit plan is clear and achievable. Consider the assumption that annual spending is limited to 2 per cent in real terms once growth returns, a feat no previous government has delivered on a sustained basis. How credible is it to think the Rudd Government will become in its second term the most disciplined spending outfit in Australia's history after its first-term performance of record spending? Yet this is the foundational assumption.

This budget contains worthwhile surgical reforms and the essential step (given the pension increase) of foreshadowing the lift in the pension age from 65 to 67.

But in his budget commentary, HSBC chief economist John Edwards said: "As expected, this is very far from the tough budget mooted by the Government. The emphasis on this budget is very much on providing some modest additional stimulus while refraining from the severe measures on spending and revenue, which sooner or later will be required to get the fiscal affairs of the commonwealth back in order."

This budget suggests that Rudd has no scope for expansive election promises in the 2010 budget and further suggests that the first budget of the second term must begin the arduous task of greater spending disciplines. It dictates a grim recovery unless Labor decides to delay its return to surplus and its debt reduction schedule. This is Turnbull's point; he asserts the budget is far too optimistic and warns that Australia will be mired in deficits and debt far longer than these budget papers show.

Rudd and Swan have been desperately unlucky in facing the worst post-war global recession during their first year in office. It seems to be Labor's historical curse. Their response has been decisive and may become heroic, yet it offers an insight into their character.

Recessions are about hard choices. The story of the Rudd Government, so far, is that it wants to fight the recession, implement most of its pre-recession agenda, deliver on new promises such as the pension increase and preside over an optimistic return-to-surplus timetable. It sounds too good to be true.

It looks like the work of a prime minister who refuses to cut his expectations to meet the new world being imposed on Australia.