Wednesday, May 14, 2008

Australia's 2008 budget - written from a slightly US perspective

Photo: Australia's new Treasurer, Wayne Swan

Australia's new Treasurer Wayne Swan has delivered the first budget of the new Rudd Government. While I have only done a very partial analysis of the budget, I thought that I had better make some comments now or I might never get round to it!

The comments that follow are obviously my own opinions. I stand to be corrected on errors of fact and interpretation! I also thought that I might write from a slightly US perspective, adding some explanatory comments to aid interpretation of this down under land.

Let's start with the bottom line that has featured in so much coverage, the budget surplus of $21.7 billion or 1.8% of GDP. For the benefit of my US readers, if my maths is correct this is about equivalent to a US budget surplus of around $US250 billion. Since 1970, the US has achieved budget surpluses in just four years, none equal to this figure.

The Australian figure was about what I expected. Wayne Swan had talked about $17-18 billion, so I knew that the actual number must be higher. I have reservations about our obsession with budget surpluses, but there is no doubt that the surplus is within normally accepted conservative norms.

Now one of the things to consider here is the extent of national debt. The US national debt is around $9.4 trillion dollars. I am not sure that I know the exact way that this figure was derived, so I had better be careful. However, thanks in part to Peter Costello, we can say that Australia has no national net Government debt. It's all been paid back.

While Australia has no national debt, we have (like the US) a dreadfully low savings ratio. We also have rapidly rising levels of household debt. The combination means that we as households are spending more than we earn. This translates directly into imports.

As a nation, we have a deficit on the current account that is greater than the US. In the past, Australia had a surplus on the current account (we sold more overseas than we bought), but a surplus on the capital account (we took money from overseas for investment purposes). Now we access overseas funds to support current consumption.

The budget notes, correctly, that the terms of trade (the price we receive for our exports as compared to the price we pay for our imports) has moved in Australia's favour. The budget also postulates that the terms of trade will continue to improve.

I doubt this.

Import prices are rising. I expect this to continue since the structural factors (technology change, the surplus population in key supplier countries) that have aided us are coming to an end. When I look at the demography of China, for example, I see little but emerging labour shortages.

Export prices depend on world growth. This is slowing. We are at the end of a long structural shift. The mills and factories in countries such as China that have fueled our growth will not be able to afford the price increases that we have been able to demand in the past.

I see the failure of the budget to address trade imbalances as a major flaw. Mr Swan would argue that keeping inflation under control, increasing productivity, will address that flaw. I am not sure.

Let's start with inflation. The budget includes a number of measures that will increase prices. Mr Swan would, I think, argue that this will be offset by reduced fiscal stimulus and greater productivity.

Listening to the various commentators, there appears to be something of a consensus that the budget will lead to a mild contraction in demand. I think that this is right, although my first reaction was the opposite. However, that contraction is too small to really affect prices in a downward sense unless, of course, the economy contracts for other reasons.

This is possible. My view for a little while has been that the slowing in demand is greater than people realise. The reason for this is simple. Most economists and forecasters live in relatively protected worlds and deal with statistics. Move outside this world, and you find people who have been worried and under pressure for a while.

Now turn to increased productivity. Productivity changes are necessarily long term. There is little in the budget that will affect productivity in a two to three year time horizon.

Mr Swan made great play about the focus on working families. This jargon is part of a refocusing from the big to the small end of town. Australians are tired of the way in which most of us struggle while a small group at the upper end seem to get obscene wealth.

This does not mean that Australians are opposed to wealth or the chance to get it. Far from it. Yet Australians also feel that the Government should focus on the majority of the Australian population for whom the glow of wealth is, at best, a future dream and have to survive in the meantime. They also feel that Government should protect the weakest.

So the new Government approach appears to have gone down well here. However, I find it interesting chatting around that the two most commonly mentioned positive measures are the tax cuts plus the increased income level on the medicare levy.

By way of explanation for my international visitors, medicare is one mechanism that subsides national health care. There is no US equivalent that I know of.

A previous Australian Government wanting to reduce demand on the public purse decided than Australian should be encouraged to take out private health insurance. The mechanism adopted was a special tax levy on those earning an income above a certain figure who did not take out private insurance.

The decision to substantially increase the income figure for levy purposes is, I think, enormously popular among those who paid the levy because they did not think that private insurance was worthwhile, as well as those who did take out private insurance but who did not feel that they were getting value for money.

The last topic I want to deal with is the severity of the expenditure cuts, something that Mr Swan has really focused on in his speach and subsequent public comments. Having been through the budget entrails, the cuts were not especially severe. Further, some may have been misdirected. But that's really the subject of a further post.

My bottom line in all this? A workmanlike budget overshadowed by hype.

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