I have an opinion piece in The Age on the fiscal stimulus announced yesterday. Warning, tortured driving analogies ahead.
[DDET Read the article]
Rudd changes gear, but is the car moving?
The Age, February 4, 2009
PETER Costello was fond of describing the Australian economy in driving terms. As of today, the Government has floored the accelerator. Monetary policy is at historic slackness and fiscal policy is clearly expansionary. But the Government has done this while on a steep hill and just how quickly it will rise up that hill is unknown. The Treasury forecasts that, with the foot to floor, we will continue upwards, but we just can’t be sure of that — we could be going backwards by midyear.
Before evaluating the stimulus package, let’s pause and consider the problem.
Right now, the recession is everywhere but in the statistics. Unemployment has not blown out or really risen and prices have not fallen. There are warning signs. For the first time in memory, credit is contracting. The global outlook is dim. So the risk is that the drivers of aggregate demand — consumption, investment and net exports — will soon be challenged.
Consider the investment component. With a gloomy forecast for sales into the next few years, it should not surprise us that projects are being delayed. Many of these are construction-related but they will have an impact on capital equipment.
We will only be out of this once those projects that are being deferred come back on board. And that will require restoring confidence.
The fiscal stimulus announced yesterday is all about plugging the forecast investment hole. And, on the face of it, it does so in a sensible manner. What the Government has done is bring forward projects that might have been implemented many years down the track, if at all. One example is the insulation roll-out into 2.2 million homes. This has the feel of an energy-efficiency project that has been on the shelf for some time, whose time has now come.
A quick calculation shows that, for each household, it will cost up to $1600, saving households $200 in energy costs and two tonnes of carbon emissions a year.
That looks like a reasonable rate of social return. So long as the materials can be produced relatively cheaply (which is an issue of capacity and importing), unemployed labour could be easily employed to do the job.
The school renewal program has a similar feel but with higher ambitions. Undertaking sizeable projects in every primary school will tax planning and regulatory resources, and engineering skills.
If there is a slump in consumption, those resources will be there, otherwise this will be a challenge. And it is hard not to get the feeling that a broader set of options might be in order so the dollars are spent where there is the greatest educational need.
Overall, despite appearances, the stimulus is strikingly economically conservative. Ignoring those one-off investments, the Government has not created a structural deficit. Structural deficits are hard to get rid of. In contrast, one-off items can be paid back over time and the pain smoothed accordingly. This insulates us from an adverse private economic response.
The Coalition has proposed an alternative plan based on tax cuts. But the rhetoric of that proposal (which differs from its actuality) is not fiscally conservative. It is to give tax cuts that raise permanent income. To do that, the tax cuts must be permanent and a deficit based on those would be structural and something that we would not necessarily grow our way out of. That said, when giving details of the proposal, Opposition Leader Malcolm Turnbull argued for bringing forward the tax cuts that were going to come in July and beyond. But, let’s be very clear, and in contrast to what he says, doing this does not change permanent income. The extra dollars that people would receive now would be akin to the extra dollars from a direct handout. One would not expect that to translate into greater spending.
The Coalition and Government’s handouts differ in their targeting. For the Coalition, all would receive some money, whereas for the Government, only households earning less than $100,000 get the cash.
Both are fiscally conservative but each is targeting their traditional political base. The problem with fiscal conservatism of this kind, however, is that it is not going to necessarily get private investment going again and that is what we want to plug holes beyond this year.
To do that relies on a policy lever that has been used in a one-sided manner to date: credit policy. It is “one-sided” because the Government has moved to ensure that our lenders have money to lend but they have not moved to ensure that the money actually gets lent.
We need to ensure that this is the case, otherwise, when business confidence returns, if that confidence isn’t shared by our banks, we won’t see private investment come back. And it is that area of policy that needs renewed and urgent attention.
Joshua Gans is professor of economics at Melbourne Business School. He writes on these issues at economics.com.au.