2006-05-10

Using the Surplus

The Australian Federal Government has collected $22 Billion more money than it needs to pay for its services.

This is good news for Australia. In 1995 the government was running a $10.3 Billion deficit and public debt was around 20% of GDP. Today we have all but paid off that public debt - it is now minus 4.8% of GDP - in other words, the government has completely paid off its debt and is now saving money.

This may sound good... but it is even more remarkable when compared to other nations. Here are some public debt figures courtesy of the CIA factbook:

United States of America: 64.7%
United Kingdom: 42.2%
Italy: 107.3%
Belgium: 93.6%
New Zealand: 21.4%

Note: The CIA has Australia's 2005 public debt at 16.2% which seems at odds with Australian budget figures in 2005 of 0.7%. A different methodology is probably used but even the CIA figures show Australia's debt is exceptionally low.

We need to understand that the Australian government's fiscal state is unique not just in the world at the moment, but also in terms of economic history going back 30-40 years. No other industrialised government (OECD), as far as I know, has managed to completely pay off its debt.

Of course, it is silly to assume that somehow deficits are bad and surpluses are good - this is the error of mercantilism. Economics is all about balance, which means that if Australia keeps running larger and larger surpluses into the future and has greater and greater public savings, it is actually a bad thing.

In the past I argued firmly that surpluses need to be used to pay down government debt. Now that the debt has been paid off, what to do with the extra money?

The first thing to remember is that Keynsianism is not dead: Fiscal policy still has a place in "pump priming" a slow economy and putting the brakes on an overheating one. In practice, this should mean that the government should move into a deficit during a slow period and move into a surplus during a good period, with public debt figures moving around accordingly as well. If Australia can manage to keep public debt/savings within 5% of GDP, things should run well. Anything beyond that should be reined in.

Note: It's important to state again that running large surpluses and having large amounts of public savings is not desirable. Our surplus would be another government's deficit, or a private sector deficit - that's how economics works.

That's why I'm not all that impressed with the tax cuts mentioned in the latest budget. Australia's economy is running (relatively) well which means that tax cuts are superfluous at the moment since they would stimulate an economy that does not need it. Granted, there is some recent economic data to cause concern - but nothing concrete yet that is impacting the economy badly.

The second thing to remember is that the "twin deficits theory" is obviously now dead in the water. This theory, which linked government debt with the current account, has been proved to be false simply by looking at the figures. As I have mentioned, public debt is now minus 4.8% of GDP, but Australia's net foreign debt (that is, the total amount of money that the entire economy - not just the government - owes the world) is running at around 51% of GDP.

So while the fiscal status of the government is great, Australia's foreign debt levels are still pretty bad. Back in "the day", it was thought that the best way to reduce net foreign debt would be to reduce public debt - to balance our debt with the rest of the world we needed to balance the government's budget.

There's no doubt that fixing government debt levels has affected our net debt and our current account - yet all the evidence shows that the "twin deficits theory" was too simplistic a model to work out in reality. One economic problem has been solved (government debt) but another one remains (foreign debt).

It should therefore be a top government priority to fix this level of debt. One way would be to use the surplus to purchase Euro, Yen and US-dollar denominated bonds, thus increasing our international currency reserves. The selling off of Australian currency and the purchasing of foreign currency by the government (via the Reserve Bank) would put downward pressure on the Australian dollar, making it cheaper and thus making Australian goods and services more competitive. This would then increase our exports and decrease our current account deficit. As soon as the current account goes into surplus, our net foreign debt would begin to decrease. Hopefully, as years go by, this current account surplus would reduce our foreign debt levels to zero, much in the same way as federal government budget surpluses have eliminated public debt.

The third and last thing to remember is that reducing public debt has meant that more money can be spent in the future. This is an argument that many left-leaning people need to remember, especially those who argue that government debt is nothing to be worried about.

In 1996, which was the height of Australia's debt crisis (and when Howard and Costello began their work to reduce it), interest payments on this debt was around 1.5% of GDP. In other words, all the money that the Australian government had borrowed meant that interest payments alone were around 1.5% of GDP. Given the fact that tax revenues were around 30% of GDP, it meant that $1.50 in every $30 the government gained was spent in paying interest. With the removal of public debt altogether, so too are interest payments removed. This means that the government can spend more money on health, education and the environment without having to worry about going into deficit.

This is the problem that besets OECD nations like the USA, Italy and Belgium. With public debt levels at high levels, more and more tax revenue is used to pay off that debt, which means that it becomes harder and harder to fund important government spending in health and education. When 50% of your income is spent paying interest on your credit card, you know that something needs to be done before you become bankrupt.

So while I have nothing but disdain for the Coalition's stance on the Iraq war and immigration, I can at least give them the kudos for their fiscal prudence. In this sense, the Australian Coalition government is actually truely more "conservative" than its profligate American cousin, the Republican Party. And it is also good that Coalition politicians like Malcolm Turnball - who seems to believe in "supply side economics", objectivism and other stupid
American ideas - can sit in the background grinding their teeth while the leaders of their party make (reasonably) sensible economic decisions. I'm hoping Turnbull - who is on record as wanting to make massive tax cuts for high income earners - will not unduly influence too many Australian politicians with his voodoo economics.

Erratum:
I need glasses I think. The external link to the budget papers actually shows that public debt is NOT -4.8% of GDP but -$4.8 Billion, which is -0.5% of GDP. Moreover, from the same paper we learn that public debt in 1996 was 18.5% of GDP - which is still very low by international standards today. (11 May 2006)

From the Osostrian School Department

© 2006 Neil McKenzie Cameron, http://one-salient-oversight.blogspot.com/

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1 comment:

CraigS said...

Some good sense there Neil.

Personally, I would have liked to have seen some more taxation restructure, to remove all the "double-handling" of money that is currently a feature of our tax/welfare system.

I am pleased that the gov has started to take care of unfunded superannuation liabilities.

I will be interested to hear the oppositions response tonight.