The Politics of Stimulating the Economy – David Uren

David Uren has 35 years of experience in economic journalism, working from the Canberra Press Gallery since 2004. As Economics Correspondent The Australian he covered the global financial crisis of 2008 very closely.  From this he produced the book Shitstorm, with Lenore Taylor. On Tuesday 20 July 2010, David Uren addressed The Sydney Institute evaluating the Rudd Government’s economic stimulus package along with its intended, and unforeseen, consequences.

THE POLITICS OF STIMULATING THE ECONOMY

DAVID UREN

In launching our book Shitstorm on the fourth last day of his government, former Prime Minister Kevin Rudd commented that “perhaps the government has suffered politically because we acted so quickly that many Australians today aren’t even aware of the threat we faced”.

He cited our comment from the book that:

Australia bore the recession very lightly… The reality is that people only factor in what they know. Those whose jobs were saved don’t know who they are and, even if they did, would be hard pressed in most cases to draw the link between retaining their employment and the Government’s actions.

The government is fighting election 2010 at least in part on its economic record; its view that its actions through the global financial crisis which dominated its agenda throughout 2008-9 saved Australia from sharing the fate of the rest of the advanced world.

I would like to look first at the influence which the government’s actions had, and are having, on Australia’s economic performance. I will then outline our thoughts on whether they spent too much, burdening Australia with a crippling debt, as we are being encouraged to believe, and concluding before handing over to Lenore Taylor with my take on what are and are not the lessons.

As Coalition treasury spokesman Joe Hockey has commented, Australia’s good fortune had many fathers. The government’s finances were in a great state to start off with. The Reserve Bank’s actions in cutting rates provided an immediate relief to mortgage-holders and businesses. The precipitate fall in the currency helped domestic manufacturers and exporters.

The commodity boom, which had been running full bore through 2008, meant that Australia entered the downturn with the momentum of record levels of business investment. Australia’s banks were in good shape, with little exposure to the toxic assets that sent so many of the world’s financial institutions into bankruptcy. He acknowledges that government stimulus spending played a part – throw enough money at a problem and some of it will be spent.

Another source of stimulus, which Hockey doesn’t mention, is the record rate of immigration. On a per capita basis, Australia’s economy did suffer a recession. However the population growth helped firms to maintain sales and staff. It is when layoffs start dominating the headlines that economic downturns enter a vicious cycle.

There is no way of apportioning the credit. But there are enough pointers to enable at least some tentative conclusions. The power of fiscal policy to shape economic outcomes had been paramount in Treasury thinking through the 1950s and 1960s, but it steadily lost favour from the 1970s onwards, with the mid-1970s experience of simultaneous inflation and economic stagnation destroyed faith in the power of deficit spending. There were academic theses developed showing fiscal stimulus could not work, but the reservations at Treasury, in the years prior to the crisis were mainly practical: could you get enough money to the point where it mattered, quickly enough, given the lugubrious pace of parliamentary politics.

The cash splashes were controversial – Grateful Dead get a rise from Kev, was the way the Daily Telegraph reported stimulus payments to 17,000 deceased estates. Alan Jones fulminated about rapists and murderers receiving government cheques in prison. Even some retailers were doubtful – Gerry Harvey, from Harvey Norman, suggested that the money had largely been saved. But from a meeting of the Strategic Priorities and Budget Committee on 11/12 October, it took little more than six weeks before cheques were in the mail.

December 2008 was a dark time: share prices were down by more than 40 per cent and house prices were also starting to fall, with some suggesting they would follow United States prices down. World trade had plunged an unthinkable 25 per cent. Early hopes that Asia might be “decoupled” from the traumas were cast aside as it emerged that China’s industrial production was actually falling. The National Australia Bank’s measures of business confidence had recorded a four standard deviation fall: business was expecting depression.

Around the world, shoppers pulled back, with retailers recording their worst season on record, and laying off workers. But not in Australia. When the ABS finished tallying the December retail sales, they had recorded the largest Christmas boost on record. True, many of the goods sold came from China rather than from the disappearing Australian manufacturing industry, but many tens of thousands of retail, wholesale and transport employees kept their jobs over the New Year period.

The government’s spending on construction, through the school-building and public housing programs, has also served to support employment, as intended. Construction is typically the first industry to suffer in a downturn, because development finance dries up immediately. In the 1991 recession, employment in the industry dropped by 10 per cent a result which, if replicated in 2009, would have generated 100,000 jobless. Non-residential commercial construction has, indeed collapsed, with activity falling by 25 per cent, but employment has held steady because of government stimulus spending.

It is not possible to do the counter-factual with any exactness. Canada shared many of Australia’s strengths, having gained from the resources boom, and with a sound banking system. True, it has a 3000 kilometre border with the United States, whereas our neighbouring region is Asia.  But a strength it had was its current account surplus which meant that unlike

Australia, it was not dependent upon international capital markets. Canada’s fiscal stimulus was less than half the size of Australia’s. Its economy contracted 2.6 per cent in 2009 (a sharper fall than in the United States), compared with Australia’s 1.3 per cent growth. It unemployment averaged 8.3 per cent.

In launching our book in Melbourne, Alan Kohler gave an interesting cut on the difference between 2008-9 and 1991-2. He says business saw that government was investing to keep the economy going and was prepared to keep staff on, even if hours were reduced, in the hope that the worst would soon be over. In 1991, former Treasurer Paul Keating had declared “this is the recession we had to have,” leaving business with the impression it was completely on its own. When, in 1992, the One Nation stimulus package was launched it came far too late, with the economy growing strongly by the time measures were implemented.

When advising the government on the stimulus, Treasury assumed that a dollar spent would lift output by 60 cents, for cash hand-outs and 85 cents for investment spending on schools and so forth. Treasury now believes the multiplier was greater partly due to the intangible, and completely unmodellable, effect on confidence. Once people understood their jobs were safe, they started to spend.

But the economy has not looked like one that over the last nine months appears to need a great deal of stimulating. Unemployment is now down to levels approximating full employment.  Business conditions are at healthy levels, according to the National Australia Bank’s business survey. Business investment is going gangbusters, thanks to the reborn mining boom. The Reserve Bank is clearly getting close to shifting its stance from returning rates to normal to one of tightening monetary policy to slow the horse down.

It is, prima facie, evidence that the government spent more than was needed to steady the economy. It was a risk that the government knew it was taking. Wayne Swan rarely impresses with his use of language, but I liked his line to us:

We were not hesitant. We were not meagre. We acted promptly, decisively and in a big enough way to make a difference. The lesson of history is that governments have typically acted too timidly and too late in response to a downturn. We were determined not to repeat those mistakes.

So what lessons would be drawn for the next crisis, which may come sooner than we would want?  It is notable that, around the world, the pendulum is swinging against fiscal stimulus. In so many countries, the legacy of the downturn has been public debt burdens that that shackle their futures. This, one must stress, is not the case in Australia, despite the political rhetoric to the contrary.

Our debt, peaking at around $90 billion, is little more than six per cent of GDP. The OECD average will peak at close to 100 per cent. The government’s borrowing on bond markets has zero influence on the short-term interest rate and no measurable impact on the long-term rates either, which are overwhelmingly determined by global capital markets.

However, the trend is away from stimulus spending globally. It is far from clear that capital markets would look so kindly on stimulus spending of a similar scale were the global markets again in turmoil. The last war always provides misleading cues for the next battle.

I think that one of the reasons fiscal stimulus was successful in Australia is because the crisis was relatively short-lived.  It was enough to tide business over the worst period. It is less clear that it would work as effectively in a more sustained downturn. This is the problem faced at present in both the United States and Europe: stimulus programs are starting to wind down, subtracting from growth, but private sector demand remains weak.

I have no doubt that, were the current government returned, it would return to the fiscal well that worked so successfully for it in 2008-9. But the legacy, next time, could well be a more challenging debt, potentially with a budget in a structural deficit.