Opinion & Commentary
Plan delivers little bang for very big bucks
When it comes to activist fiscal policy, it seems that nothing succeeds like failure.
The apparent failure of previous stimulus packages to achieve the desired boost to economic growth is always seen as arguing for yet more stimulus measures.
Governments never draw the more obvious conclusion that activist fiscal policy is ineffective.
The government has now implemented no less than four stimulus packages: the $10.4 billion Economic Security Strategy; the December Nation Building Package; the Council of Australian Governments funding package and now the $42 billion Nation Building and Jobs Plan.
What’s more, the government says it ‘stands ready to take further action.’ With an election due next year, it is unlikely this latest fiscal stimulus package will be the last.
In the analysis of fiscal policy, it is important to distinguish between discretionary and non-discretionary changes in government expenditure and revenue and their implications for the budget balance.
As a small and open economy, Australian cannot avoid the consequences of a severe global economic downturn. On the Treasury’s own numbers, real economic growth is now set to slow to less than one percent in 2009-10.
Without the government taking a single policy action, the budget balance could be expected to swing into deficit as a result of the operation of the so-called ‘automatic stabilisers’, those components of government spending and revenue most closely tied to the level of economic activity.
It would make no sense for the government to take offsetting policy action to keep the budget in surplus in the context of an economic downturn. The automatic stabilisers have the very desirable effect of cushioning the economy from the downturn.
This cyclical deterioration in the budget balance is ultimately self-correcting. When the economy recovers, the cyclical component of the budget balance can be expected to improve, without the government having to take explicit policy decisions other than to allow the automatic stabilisers to do their work.
The government’s four fiscal stimulus packages, however, represent discretionary policy actions that add to this cyclical deterioration in the budget balance.
The government has rationalised its stimulus packages as measures to support economic growth and employment. On the Treasury’s numbers, GDP is expected to be around 0.5% higher in 2008-09 and 0.75% higher in 2009-10 as a result of the latest stimulus package.
The government also claims the package will ‘support’ 90,000 jobs. Note that the government is careful not to claim that the package will ‘create’ 90,000 jobs. The Treasury still expects the unemployment rate to rise to 7% by the middle of next year.
Even on the Treasury’s numbers, this represents little bang for the stimulus buck. But this should come as no surprise. Historical experience with fiscal stimulus packages both in Australia and abroad is far from encouraging. Japan, for example, rolled-out one stimulus package after another for the better part of a decade during the 1990s, to little effect.
Why is activist fiscal policy generally ineffective in stimulating economic growth? The failure of discretionary stimulus measures reflects a basic reality that no government can escape. Governments cannot create economic activity, they can only redistribute the income and wealth created by the private sector.
This redistribution can occur both between different sectors of the economy, but also across time. Discretionary fiscal stimulus attempts to bring forward demand through unfunded spending measures or tax cuts. In other words, the public sector saves less and spends more. This can take the form of running down an existing budget surplus, as well as going into deficit.
The problem for all governments is that these unfunded fiscal stimulus measures ultimately have to be paid for out of future taxes. An unfunded fiscal stimulus package of $42 billion is thus equivalent to announcing a $42 billion future tax increase.
To the extent that households and businesses anticipate a higher future tax burden, they will respond by reducing spending today. The idea that activist fiscal policy can stimulate growth and employment relies on the notion that the private sector suffers from a form of fiscal illusion.
This is not to say that governments should do nothing in response to an economic downturn. There is much that the government can do to improve the structural performance of the economy, supporting long-run economic, employment and productivity growth.
But the criteria for good government policy do not change with the business cycle.
It is very easy for governments to come up with long lists of seemingly worthwhile projects. The hard part is choosing which projects should be funded given limited resources and competing uses for those resources.
The danger with activist fiscal policy is that governments relax the criteria for good policy for the sake of pushing money out the door. By throwing out the constraint that new policy measures should be fully funded, they abandon the fiscal discipline that would otherwise force the government to choose carefully between competing alternatives.
Fiscal stimulus packages often result in a misallocation of resources, as the government hands out money to the endless list of seemingly worthy projects, while the rest of the economy is left to pick-up the bill in the long-run.
The correct focus for fiscal policy is the structural and supply-side measures that will deliver sustainable gains in future prosperity.
Unfortunately, the political imperative is for governments to be seen to be doing something, regardless of long-run consequences. The latest stimulus package satisfies that imperative, but at the cost of future prosperity.
Dr Stephen Kirchner is a Research Fellow at The Centre for Independent Studies, he spoke at the CIS Crisis Commentary in Sydney on the 3rd of February.
