Analysis : Should Labour heed the wisdom of Oz?
Sunday 14 May 1995
First, the background. Remember that the Australian government is run by the Labor Party, and that the Prime Minister, Paul Keating, is the former finance minister. There is a finance minister, called Ralph Willis, but the budget revealed on Tuesday was entirely discussed as Mr Keating's work. There was a particular reason why this should be so: it was an election budget in that it will be the last budget before the next Australian general election, which may come as early as August.
The Australian economy is running about a year ahead of the UK economy in its economic cycle, for it has had three years of strong growth since the recession. Gross domestic product last year was up by more than 4 per cent and is forecast to rise by nearly 5 per cent this year.
Unsurprisingly, the economy is starting to show signs of strain. Consumer inflation, which has been very low at under 2 per cent for the past two years, is now nudging up to 3 per cent and is expected to reach 4 per cent, though underlying inflation is a little lower, around 3 per cent. More worrying, imports are surging with the result that the current account deficit is enormous: it was A$17bn (£8bn) last year, and is estimated to reach A$27bn this year. That is equivalent to 6 per cent of GDP. Most worrying of all, unemployment remains high at nearly 9 per cent.
The problem in a nutshell is that the country has tried to borrow its way out of recession. It did what the new Labour Party in Britain has pledged not to do. It has succeeded in that growth has been strong. But this has been achieved at the cost of a sizeable fiscal deficit, and a large current account deficit.
In one sense, it is not only the government that is guilty of overborrowing. The deficit at its greatest level (1992/3) was still under 4 per cent of GDP. That is a lot less than our own deficit at its peak. The underlying trouble is Australians do not save enough to finance it. Household savings have fallen from 10 per cent of GDP a decade ago to only 3 per cent. This is one of the lowest levels of personal savings of any developed country.
As a result of these pressures, the markets sought to compensate by pushing interest rates up, which is deeply unpopular for obvious reasons, and pushing the Australian dollar down. Somehow the government had to tighten fiscal policy. But it was facing an election and tax increases are not wildly popular. So what did it do?
It managed to produce a budget which, on paper at least, produces a small surplus in the coming year and larger ones in the future. Whether these surpluses will actually be achieved is not at all clear, but the fact that they should be sought at all by Mr Keating is interesting for a start. Here is an astute politician coming from the "tax and spend" fraternity. In the past, he has been very happy to run up large deficits, but he now judges that the political advantage lies in a balanced budget. Why?
I think there are two motives. One is that the government desperately wants to hold interest rates down. Real interest rates are sharply positive at the moment and a highly-borrowed nation (mostly on floating rates) cannot stand high real interest rates for long. This meant a fiscally- responsible budget, for that was what the financial markets wanted if they were not to drive rates still higher. Much of the post-budget analysis in the Australian press and on TV was in terms of whether or not the government had done enough to satisfy the markets. The other motive for seeking to produce a surplus was more political: a judgement that this is what voters wanted. My own conversations with business people in three of Australia's six state capitals during the past few days certainly suggest that the business community desperately wants sound finance. But there are signs that there is a much wider concern about the failure of the country as a whole to save enough.
The best evidence for this comes in the budget itself. The government made a radical shift of policy on pensions. The budget included plans that will increase enormously the funded pensions run by the state. The idea is that the present limited superannuation scheme, paid for by a compulsory levy on employers, will be expanded tenfold, with the introduction of employee contributions and a state payment for lower-paid workers. By 2020, there will be a net increase in national savings equivalent to 4 per cent of GDP.
The government did not have to do this, for it is a separate exercise from its own budget. And it meant going back on a promise of tax cuts, for the government contribution to the scheme is being made in lieu of some cuts. And few governments would regard a scheme that will only come into full effect in the early years of the next century as a short-term vote-winner. But clearly Mr Keating felt that not only would such a scheme be acceptable but that looking forward in this way was something that voters wanted him to do. How did the government manage to produce the fiscal surplus? Three ways: it made small cuts in spending; it raised taxes (mainly on businesses); and it stepped up its privatisation programme.
The spending cuts were a mere $700m, mostly on administrative costs, job support programmes and health. The tax increases were directed away from ordinary voters, with company tax going up from 33 to 36 per cent, new bank licence fees, a higher Medicare levy on companies and faster collection of PAYE from small businesses. Heating fuel duty also went up, but almost the only tax increase that would be felt directly by voters was a rise in car sales tax.
This is an obvious short-termist strategy. Put up company taxation and the effect will eventually come out in lower investment, lower employment, and higher prices; but this is not immediately evident, so carries little short-term costs with most voters.
None of this, however, would have produced the surplus. That was reached by asset sales, in particular the sale of the government's half-share in one of Australia's large commercial banks, the Commonwealth Bank. Total asset sales will be $5bn which, proportionate to the size of the economies, is far larger than the privatisation proceeds in any year of the Thatcher governments. And this is from a government of the left.
Voters all over the world want government services, but they do not want to pay the taxes to fund them. The response of Mr Keating is to maintain spending on services, but squeeze as much money out of the tax net as possible in ways that do not immediately affect the voter - and to sell assets to make the numbers look better. But this rather obvious short- termist response is tempered with a long-term commitment to boosting savings for retirement.
This has its obvious electoral attractions, though we will have to wait until the next general election to see whether it has worked. The more immediate test is whether it is attractive to the financial markets. It is early days, but the signs are unpropitious: after their momentary delight at the sight of a surplus, the markets quickly appreciated that one based on asset sales was pretty meaningless. Since Tuesday, the stock market has sunk slowly, largely in response to the rise in profits tax, while interest rates have failed to come down.
All this might suggest that Mr Keating has failed in his objective of satisfying the markets. It is simply too early to judge whether that is the case. It is not too early though to be aware that the constraints Down Under are similar to those any future British Labour government is likely to experience. It will be extraordinarily difficult to reconcile voters' aspirations with the cold hard arithmetic of public finance. The punishment for laxity is high real interest rates, which may be just as unpopular as higher taxation or real spending cuts. There is nowhere to hide.
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