Deficit of courage

FUNDAMENTAL to the idea of political leadership on the economy is the ability to move public sentiment, shift expectations and educate the community about economic reality.

In the guise of upholding confidence, the Rudd Government has blundered in its stubborn refusal to prepare the ground for an almost certain period of budget deficits. This is the direct consequence of the coming downturn.

This denial is assisting Opposition Leader Malcolm Turnbull. It is hardly a surprise that Turnbull told the National Press Club that a competent government should keep the budget in surplus. This statement has a simple origin: when your opponents offer a free political kick, you normally accept it.

Understand what has happened here: the Rudd Government's refusal to confront this issue is a sign of its weakness, not its strength. If the Government cannot come clean with the public during what it repeatedly declares to be the worst financial event since the Depression, then it merely underlines its lack of influence, persuasion and authority.

The Government looks frightened and timid on the D-word. The longer it postpones this concession, the worse it looks. Treasurer Wayne Swan and Finance Minister Lindsay Tanner seem embarrassed during media interviews as they struggle to answer questions about the deficit. The questions will not go away. The damage is self-inflicted and it invites the insight that Labor is more vulnerable on economic management than generally assumed.

The deficit debate suggests Labor has not recovered from the legacy of its 1996 election defeat and, more important, that it still carries psychological scars from its early 1990s recession legacy under Paul Keating.

The branding John Howard and Peter Costello gave Labor in the years post-1996 has stuck: that the ALP is the party of irresponsible deficit spending. The Howard years enshrined the virtue of the budget surplus. The public associates the budget surplus with sound management. Howard and Costello worked for 11 years to build this nexus and, contrary to the claims of many economics commentators, this was a sensible political and financial tactic.

The Rudd Government now sends hopelessly mixed messages. Kevin Rudd has said the outlook will be "tough, ugly and hard". He has said the nation confronts "the economic equivalent of a rolling national security crisis".

He has said the crisis is "the single greatest threat to economic security in a generation" and the worst upheaval "in the global financial system in our lifetime".

Guess what? None of these epic events leaves open the option of a budget deficit. That's an absurd proposition. Rudd's latest formulation in Lima rejects any concession whatsoever. He says "we do not believe" there is any need for the Government to borrow (a deficit rejection formula).

The dynamics driving the move to deficit were explained by Access Economics principal Chris Richardson on ABC television's The 7.30 Report on Monday: government revenues will collapse because of falling profits. This means "the Government doesn't need to spend another cent and we'll be in deficit anyway". Of course, the Government will spend more as part of its fiscal stimulus, policy commitments and infrastructure agenda. This is a sensible counter-cyclical fiscal policy to minimise damage from the slowdown, the approach being adopted across the world.

The Rudd Government's dilemma is far greater than appreciated. The issue is not just politics but policy.

The Treasury's midyear forecasts are optimistic and in conflict with those of Access Economics. They envisage growth staying at 2 per cent and above over the next few years, Australia avoiding recession and the budget remaining in a narrow surplus. As Swan says: "We are projecting a modest surplus. Access is not. There is simply a difference in the forecasts." In this context the Rudd Government hopes to preserve its medium-term fiscal strategy. As signed off by Swan and Tanner in the midyear review, this aims to achieve "budget surpluses, on average, over the medium term".

In Lima on Monday, Rudd invested this with a philosophical status. He said: "I think the clear philosophical position this Government has had since Opposition and since becoming government is this: that we believe in maintaining a government budget surplus over the economic cycle."

For Rudd, this is a Labor belief. For Swan, it reflects the Treasury forecasts. So despite the worst crisis in a generation, medium-term fiscal policy is unchanged, and it is unchanged because it is a contemporary Labor ideology and philosophy to which the PM is pledged. This means it will not be lightly surrendered.

Yes, Rudd has delivered a fiscal stimulus equal to 1per cent of gross domestic product. But no, Rudd says this doesn't mean a deficit and it doesn't mean any change whatsoever in medium-term fiscal policy. Tanner affirmed this stance on the ABC's Lateline on Monday night, though he looked uncomfortable.

There are two issues at stake here: whether the budget goes into deficit and whether such deficits are so prolonged that they reduce to ruins the Rudd Government's medium-term policy stance. (Of course, a budget deficit may still be consistent with this medium-term strategy.)

In a sense, Rudd's stance is admirable. It suggests the Government's fiscal outlook is alert to objectives of short-term stimulus as well as medium-term responsibility. This is the generous interpretation of Rudd's stance.

The political conclusion is that Rudd wants the best of both worlds: to be champion of the fiscal stimulus but also champion of fiscal conservatism. If the downturn is serious, these two positions may be incompatible.

Reserve Bank governor Glenn Stevens offered some useful advice in a speech on November 19, making clear the real test was not surplus or deficit but the need to ensure public spending was worthwhile and met the good-policy test.

It requires little genius to spin this into a formula that offers more flexibility on the deficit option.

Newspoll this week showed the public expressing concern, by 56per cent to 39per cent, about the budget going into deficit. This shows Rudd's stance is poll-consistent. The risk, however, is that when the budget does enter deficit, it will appear to be a greater failure on the Government's part. This is Turnbull's tactic and he will have a litany of quotes to use against Labor.

The Treasury's optimism may yet be vindicated. The damage to Australia may not be great. Rudd's mission to deliver Australia from the worst of the crisis may be realised. On display, however, may be the defining feature of Rudd's political mind: his inability to address and resolve contradictions and competing ideas.