What’s behind Frydenberg’s debt epiphany?
In the months leading up to this week’s budget, there were hopeful whispers Josh Frydenberg had set himself on the road to Damascus.
It wasn’t only the change in Frydenberg’s public language that prompted these whispers – for the costs of the pandemic made it inevitable the rhetoric about debt and deficit had to be abandoned, along with the dream of a budget surplus.
It was the fact the treasurer had started quietly consulting people other than the usual sources of conservative advice – respected economists who made the case to him that the government needed to aim not just to restore the economy to its pre-pandemic state, but to go further and spend until unemployment was much lower than it had been before the pandemic. To spend until there was some growth in wages and inflation.
The people he called were surprised and probably a little bit flattered that Frydenberg would seek their input, and encouraged him to use the cover of the pandemic recession to spend big on social programs. They counselled him that in a world with interest rates at zero, governments need not fear debt, at least in the medium term.
Leave aside, for a moment, the budget that emerged after these conversations. The fact that Frydenberg was even prepared to consider such views sets this treasurer apart from his conservative predecessors in recent decades. For that alone, independent economist Saul Eslake gives him a fair measure of credit.
Eslake who, after more than four decades of economic prognosticating, both in senior positions within government and in government-adjacent areas in the financial sector, has long insight into how various treasurers went about their budgets.
“I think it’s fair to say that Frydenberg has a genuine intellectual curiosity about the portfolio he’s been handed,” he says.
Peter Costello, Eslake recalls, was never “particularly intellectually curious about the portfolio”. And perhaps he didn’t have to be, given he had an easy job at a time when the mining boom saw revenue flowing in as fast as the Howard government could spend it.
Whatever the reason, Costello had “no interest at all” in hearing the views of market economists, or even listening to the Reserve Bank, which was forced to jack up interest rates to counter the Howard–Costello government’s profligate spending.
Eslake remembers Labor’s Wayne Swan, who had to deal with the global financial crisis (GFC), as far more consultative.
“Swan was a better treasurer than many give him credit for,” Eslake says. “And although he was intensely political, at least he was sufficiently adventurous to ask people what they thought.”
Swan’s Liberal successor, Joe Hockey, did not have non-government economists around for dinner to discuss the budget in advance as Swan did, says Eslake, “but he would at least talk to market economists”. It did tend to be a one-sided conversation, however.
During his tenure as treasurer, Scott Morrison didn’t speak with anyone who might express views at odds with conservative economic thinking.
“Scott Morrison had no interest in engaging with any [independent] economist at all, as far as I know,” Eslake says.
Morrison’s approach to budgeting was marked by an “obsession with secrecy”, with authoritarian inclinations.
With Frydenberg though, Eslake believes something is different. This is in spite of the treasurer’s alignment with the conservative side of the party and his past lip-service paid to Reagan and Thatcherisms.
“He doesn’t strike me as a doctrinaire conservative in the way that so many in the present government are. He’s not afraid to ask questions and to seek advice from outside the official lines of advice, and I personally think that’s very much to his credit,” Eslake says.
The economist sees in the evolution of the treasurer’s approach indications that Frydenberg has come – albeit somewhat belatedly – to understand some substantial changes in the world’s developed economies. The first is that labour markets no longer work as they once did. What was long considered full employment is no longer full.
This is the result of a variety of factors. Globalisation is pushing workers to compete for jobs not only with the unemployed in their own country but also with people elsewhere who are prepared to work for a lot less, as well as with machines, robots and algorithms. There has been a shift from manufacturing to services along with the rise of the gig economy and the increasing feminisation of the workforce – “typically women are less bolshie than men”, Eslake says. As well, changes in the legal framework through which wages are negotiated have shifted power and rewards from employees to employers.
The corollary of this is that rates of unemployment have to be quite low before there is any significant upward pressure on wages.
The other recent shift in developed economies is that monetary policy alone – the raising or lowering of interest rates – is no longer sufficient to fix the problem. There has to be greater emphasis on fiscal policy, in the form of government spending. And record low interest rates mean governments can borrow money very cheaply to finance such spending.
“Frydenberg has, for the second year in a row, made the right choices from an economic perspective about how to put the budget together,” Eslake says.
“Last year, he quite explicitly ditched what had been more than a decade of Coalition rhetoric about the evils of debt and deficits. He said that the government wouldn’t embark on the task of discretionary budget repair – that is trying to get the budget back to surplus – until the unemployment rate was comfortably below six [per cent].
“Yet here we are: as of March 2021, the unemployment rate is 5.6 per cent, which is clearly below 6 per cent [and] Frydenberg has shifted the goalposts and said, we’re not going to start doing that [budget repair] until – and I’m paraphrasing him – the unemployment rate is comfortably below 5 per cent.
“That’s obviously done with a political eye as well. Nonetheless, from an economic perspective, [it’s] the right and proper thing to do.”
This shift does come with an enormous price tag. The budget projections show deficits to 2031-32, which is as far as such projections go. It will probably extend beyond that. Gross public debt is expected to reach $1 trillion by 2023 and $1.5 trillion by 2030.
Numerous media commentators have tagged this big spending budget as “radical”, but in truth it is radical only in comparison with conservatives’ previous relentless attacks on Labor’s “debt and deficit disaster” caused by big spending in response to the GFC.
Ever since the GFC, and even more acutely since the pandemic struck, Eslake notes, organisations such as the OECD and International Monetary Fund, “which used to be caricatured as bastions of fiscal conservatism, have been quite explicit not only in encouraging governments to run the deficits, but also to get serious about climate change and raise progressive taxes and that sort of thing”.
And governments across the developed world have been responding, many of them more strongly than ours, incurring higher levels of public debt and engaging in greater fiscal stimulus. They learnt the lesson of the GFC, that responding to crisis with budget austerity only made the problem worse.
In truth, says Peter Tulip, chief economist of the right-of-centre Centre for Independent Studies, there is nothing radical about this budget.
Given the economic circumstance, he says the “No. 1 priority … is to stabilise unemployment and inflation”.
“And in that context, fiscal stimulus is appropriate. And this is sort of conventional thinking among academics and in the official family, and no one’s changing their mind,” he says.
Tulip notes, though, that coincident with the need to respond to the immediate economic crisis is a change in social values that demands greater spending in areas such as aged care, disability and childcare.
“And so, we are seeing a long-run trend towards big government, in particular in the form of social insurance. At some stage, the taxes to support this big expansion of the safety net will come due. And I am curious as to what happens then,” he says.
He’s not the only one talking about tax rates. The left-of-centre Australia Institute noted this week that Australia is the fifth-lowest taxing country among 35 rich nations in the OECD. The federal tax to GDP ratio in Australia was 23 per cent for 2019-20, and 28.4 per cent for all levels of government. If we were to tax at the OECD average – 33.8 per cent – revenue would be higher by $105 billion, the Australia Institute noted. Certainly, that would help pay down the deficit.
But Tulip sees no urgency to increase the tax take.
“If you look at the [debt] projections, they’re actually relatively comfortable,” he says. “Debt as a percentage of GDP will rise a little bit, but it remains at moderate levels, much below what other countries are showing, and then it starts to decline.”
In the past, when interest rates were high, government debt “really was a significant drain on social resources”, according to Tulip. But not now. Real interest payments – that is rate of interest compared with the rate of economic growth – is “essentially zero” and is likely to be for the medium term.
The government remains adamant that the federal tax take will not exceed 23.9 per cent of GDP. This supports Tulip’s argument that we are not seeing any real change in its ideology or that of the treasurer.
“I mean, there is clearly a change in rhetoric. But that’s a response to changed circumstances,” he says.
That said, Tulip says the focus on employment is “a great advance on their thinking from just a year ago”.
But is it enough to get wages growth going again? The budget’s figures suggest not in the short term, says Danielle Wood, chief executive of the Grattan Institute.
“We do see [the forecast for] unemployment come down to have a four in front of it – hitting four and a half by 2023-24 – but no real wages growth until 2024-25. That’s pretty extraordinary. That brings up a decade of wage stagnation.”
The budget numbers suggest to her that the Treasury economists think the unemployment rate needed to get wages growing at a healthy clip is actually somewhat lower. “We have heard the Reserve Bank governor say that perhaps it’s in the high threes,” she says.
“The trouble is, you don’t know what the NAIRU [the non-accelerating inflation rate of unemployment] is until you actually see wages pick up. We’re all speculating. But I think there’s a balance of evidence that suggests it’s either low fours or high threes.”
Wood marks the budget as a solid B, largely because it represented such a significant departure from the government’s past practice.
“If we compare this to a Coalition budget back in 2019, there’s been a pretty extraordinary turnaround. I think it’s important to recognise that people do make a good step in the right direction,” she says.
But it could have been a much bigger step. Consider the two initiatives the government is most loudly trumpeting.
Comprehensive reform of the shambolic aged-care sector would cost up to $10 billion a year, a royal commission told us. Frydenberg settled on just over a third of that – $3.5 billion. According to calculations by Ross Gittins in the Nine newspapers free childcare would have cost about $2 billion a year. The budget allocated less than $600 million a year.
There was nothing to boost the supply of housing; instead, there were policies that will increase demand. The need to address climate change – the biggest issue confronting this country and the world – was again ignored.
Economists across the spectrum say there was a lot of spending in Frydenberg’s third budget, but not much actual reform. Notably, there was no talk of tax.
Overseas, some key Australian allies are engaging in that hard conversation. The Biden administration in the United States is set on increasing corporate taxes, and those on the wealthy. So is the Johnson government in Britain.
Wood agrees with Eslake and Tulip that in the face of permanently higher spending on areas such as aged care, childcare, the National Disability Insurance Scheme, et cetera, hard consideration of how to pay for it is inevitable.
As things stand, the government’s only tax plan is to cut rates on high and middle incomes, from 2024-25.
“If you want to reduce rates on income taxes, you need to tackle tax reform at the same time and actually look at some of those tax concessions and try and broaden your base,” she says.
“We need to talk about how you raise taxes in a way that is not going to cause substantial damage economically. And I think there’s probably a lot of room to move on that.”
Just don’t expect this government to move in the next year. Josh Frydenberg is looking down the road to the next election, not Damascus.
This article was first published in the print edition of The Saturday Paper on May 15, 2021 as "What’s behind Frydenberg’s debt epiphany?".
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