Costello's 7th budget

So wherein lies the long-term vision?
Fred Argy & Frank Stilwell

The Budget & Australian egalitarianism

Fred Argy

Economic effectiveness of the Budget

Good fiscal governance calls for long term strategic management of the nation's saving and investment needs, combined with short term flexibility to cope with changing economic conditions.

For a time, the Howard government got it wrong on both counts. It rigidly sought medium term debt reduction (an underlying cash balance over the cycle) as an end in itself, without regard for long term strategic needs and irrespective of short term conditions. Fortunately, being a pragmatic government, it seems to have somewhat changed its stance - in practice at least, although not in its rhetoric. In 2001-2, when unemployment threatened to rise, it stimulated the economy by shifting from fiscal surplus to deficit. It was a brilliant piece of economic intervention (especially the home savings grant) which Keynesian sceptics in the Labor Party should duly note.

Moreover Costello is now budgeting for only small cash surpluses over the next few years. Assuming that a significant recession will inevitably hit us over at some stage over this time, and assuming the government will again run a fiscal deficit in such circumstances, this approach appears to be consistent with running small structural deficits over the business cycle. If this is indeed the effect (intended or otherwise), it will make sense. There is no economic or social logic for state or federal governments to strive for fiscal balance over the cycle (zero net government borrowing), and thus aiming for zero public debt in the long term. Government borrowing is needed to fund essential economic infrastructure whenever the private sector cannot as economically manage the risks involved. It is also needed to fund long life social infrastructure spending (see below). To fund such investment out of revenue would be a denial of intergenerational equity.

But wouldn't an increase in public debt over the business cycle mean higher average interest rates and a 'crowding out' of some private borrowing and investment over the period? Some interest rate increase may be necessary to induce the private sector to make room for public investment under conditions of genuine full employment - conditions that have been rare in recent history. A switch from private to public debt may also mean that global markets impose a higher risk premium on Australia, but experience shows that this is unlikely to be large for a country like Australia, given its low debt levels and history of fiscal prudence.

These minor qualifications aside, economic aggregates will be not be greatly affected by a moderate trend increase in government debt. Only the composition of spending will be different; for example, less housing and business investment and more public infrastructure. And who is to say such a shift is not in line with consumer preferences? Of course governments should insist on comprehensive cost benefit evaluations before approving infrastructure projects. These would need to allow for externalities, including the benefits for household productivity (in the form of higher productivity, higher education, better public transport and communications, urban amenities, etc).

So if, despite its silly rhetoric, the Howard government is now having a secret change of heart about Keynesian contra-cyclical management and about reducing public debt over the cycle (subject to some disciplines), that is all to the good. One cannot count on it, but the signs are promising. In the meantime, Labor (at both federal and state levels) continues to show more fiscal rigidity than the government.

Social effectiveness of the Budget

Unfortunately, the Costello Budget will do nothing to heal society's wounds. Indeed it will aggravate them. Something needed to be done to curb the rising cost of disability pensions and pharmaceutical benefits. In both cases, however, there were softer alternatives. On disabilities, the government could have followed the much more moderate recommendations of the McClure report. On pharmaceuticals, the impact on relatively low income working families not entitled to a Health Card should have been tempered, or the scrip proposal replaced with a small increase in the Medicare levy.

What is happening to our egalitarian society?

The Budget is doubly culpable when one takes account of the changing face of our egalitarian society.

Australian-style egalitarianism has always suffered from internal contradictions. In the first seventy years after federation, Australian society took good care of its disadvantaged workers (those with low skills and education and little individual bargaining power in the market place). But it excluded non-whites and indigenous Australians. It discriminated against women. It was torn by sectarian hatreds. It flouted intergenerational equity by neglecting our natural environment. And widespread protection and regulation restricted individual freedom of choice.

Over the subsequent three decades, successive governments set about making our society much more inclusive (by improving gender equality, widening access to superannuation, giving higher priority to the environment and aboriginal concerns, etc). They also maintained social spending at high levels and tightly targeted it at areas of need. And they opened up the economy to competition. As a result, Australia enjoyed an economic renaissance but without experiencing the increases in inequality seen in other liberal, reforming countries.

But the internal contradictions remain. The disadvantaged workers that we looked after so well in the first seventy years of our nation's history have become the big losers - in terms of employment opportunities, job and income security, relative wages and quality of life. They have lost any control over decisions affecting their wellbeing in the workplace and the amount of time spent with their family. Housing is less affordable and accessible for them, and they and their kids are falling further behind the rest of the community in education and health standards. If they live outside the key urban centers they have poor facilities and even poorer employment opportunities. They benefit from a progressive tax system, but this advantage is steadily eroding. If they become unemployed they are at the mercy of a welfare system which has become conditional, demeaning and moralistic.

Not surprisingly, we are seeing signs that income and wealth inequality - already high by international standards - is on the rise, and there are emerging pockets of real poverty, especially among many of the 385,000 long-term unemployed and single parents but also among workers and their families.

Australians remain basically egalitarian in their personal relationships but our society is at risk of becoming fragmented, with an 'under-class' of battlers who are risk-averse, under-educated and asset-poor and an 'over-class' of confident, knowledge-rich, asset-rich people thriving on risk-taking. These two groups are becoming increasingly isolated from each other in terms of material wellbeing, quality of life and opportunity for self-improvement.

Is the retreat from egalitarianism unavoidable?

Many believe this is sad but unavoidable. First, they say, redistribution has become less economically sustainable. In a globalised economy, taxes, especially on mobile capital, need to come down, not go up. And the personal tax burden is at record levels (twice that of the 60's) and cannot be increased any further. And old forms of social protection like regulation are no longer available.

These arguments have a core of truth, but it is hard to see why economics should prove a major constraint on egalitarian policies. If average levels of household affluence continue to grow at anything like the rate of the last ten years, the revenue base will grow strongly. And if a real effort were made to prune the many poorly targeted tax exemptions and deductions and attack blatant tax minimisation practices, the tax system would be simpler and more efficient, as well as fairer, and the revenue base would be further broadened.

Similarly, good economic as well as social arguments can be made to justify a moderate increase in public debt levels (now at exceptionally low levels) to fund long-life social infrastructure, such as in health, education, training, housing and public transport. It is often forgotten that well-designed programs of this kind are not only effective means of redistribution, but they also encourage labour mobility and skills preservation and development, diminish community resistance to new economic reform, and create a more stable investment environment.

The aging of the population will not have any significant impact on Budget expenditures for another 15 years, and thereafter one could expect a combination of policy and market responses to ease the problem considerably (for example, via effects on labour force participation). It is nonsense to suggest expenditure cuts are needed now to ease the looming problem.

As for globalisation, it constrains the methods of intervention that governments can use - but not their social priorities. So it is basically a matter of priorities - not economics.

Secondly, it is argued that egalitarian policies, especially of the passive kind, are becoming increasingly ineffectual in addressing poverty and reducing inequality. These assertions do not stand up to close research and analysis. That said, governments would be wise in future to make greater use of 'active' social policies that help change behaviour and reduce the long term competitive disadvantages of the poor.

Thirdly, it is said that, like it or not, Australians are revolting against egalitarian values. The evidence for this is inconclusive. In any case, community opinion is fungible and responsive to political leadership. It is governments that will ultimately determine the fate of Australian egalitarianism. This Budget has not supplied any building blocks in the reconstruction process.

So wherein lies the long-term vision?

Frank Stilwell

More than an important statement of government economic policy, the annual federal budget is indicative of a government's social priorities. Of any budget, it is pertinent to ask three questions. How will it affect the overall level of economic activity over the year ahead? How will it affect the distribution of income? What social vision for the nation does it embody? These questions suggest the need for a broader analytical perspective than just asking 'what's in it for me?'

In the case of Peter Costello's seventh budget, it has to be said that the economic outlook is uncertain. The Treasurer is forecasting fairly rapid economic growth at 3.75 per cent, low inflation at 2.75 per cent and unemployment falling a little further to 6.25 per cent. Sounds good, relative to the recent economic performance of many other nations. Whether it materialises in practice is another matter. There is nothing in the budget itself to stimulate the level of economic activity. Running a projected budget surplus of a little over $2 billion is a modest dampener, according to the principles of Keynesian economics. According to those same principles, the unintended budget deficit for the current financial year - caused partly by the surge in military spending and partly by the lower than expected tax revenues - has helped to ensure a reasonably buoyant economy. This was a good achievement in conditions where recession has been a feature of many of our major trading partners. Although Treasurers these days, rejecting Keynesian principles, seem to think that budget surpluses are inherently good, the unintended deficit this time has probably been an appropriate economic stabiliser.

Impacts of the budget on the distribution of income are also difficult to predict. Recent years have seen growing economic inequality in Australian society. There is nothing in the budget to reverse this underlying trend. It is conspicuous for its lack of policy changes on the revenue side: the structure of taxes remains largely unchanged. On the expenditure side, there are winners and losers. The military and security sector gets the biggest boost. The consumers of medicines will pay more - $6.20 per prescription (up to $28.60) and $1 more for holders of concession cards (up to $4.60 per perscription). People on disability pensions will have to face stricter eligibility tests, having to demonstrate inability to work for 15 hours a week rather than the 30 hours a week previously. Social welfare analysts agree that encouraging engagement in useful employment is normal and desirable, but say that this approach has punitive connotations. It seems that the government has been sufficiently encouraged by the electoral popularity of its 'work for the dole' scheme to extend 'mutual obligation' principles to the disabled, presumably expecting that this will also be seen as shaking out undeserving claimants.

So wherein lies the long-term vision? The Treasurer has made much of his 'intergenerational review', projecting the effects of an ageing population over a forty year period. It is unusual and commendable to initiate long-term planning. In this case, however, it is fraught with difficulties. The demographic projections are themselves contentious, as a recent report by the Australia Institute emphasises. If immigration is to be increased, as the government has just announced, that would presumably offset the ageing tendency. And successive Australian governments since the 1980's have effectively pursued a policy of privatising the pension for the bulk of the population: compulsory occupational superannuation is now the norm. A long-term vision should presumably raise questions about how we might more sensibly control those superannuation funds - now effectively handling the lion's share of our national savings - and steer them to more effective economic and social purposes.

This budget will be remembered as the one that redirected public money significantly into defence, border protection and security measures. In that sense it consolidates what have already become the well-established political priorities of the incumbent government: aligning itself with the United States in the so-called 'war on terrorism', and with the enforcement of a tough stance on 'boat people'. Allocating over $455 million over 4 years for the construction of a detention centre on Christmas Island is perhaps the most striking symbol of this priority. Meanwhile, the seemingly permanent funding crisis in the health and education systems, particularly in Universities and the TAFE sector, continues. Economics textbooks describe the choice between 'guns and butter', symbolising different types of expenditure priorities. This budget is mainly about 'guns' - building 'a safer Australia' or 'fortress Australia', according to your point of view.


Fred Argy, AM, OBE, is a Visiting Fellow at the Australian National University and an Adjunct Professor at Queensland University. He is the author of Australia at the crossroads: radical free market or a progressive liberalism? (Allen & Unwin: Sydney, 1998) and a forthcoming book on The changing face of Australian egalitarianism (Allen & Unwin). Fred also assisted the group that was chaired by the former Governor of the Reserve Bank of Australia, Bernie Fraser, which produced the Foundation's report A fair and adequate tax system (Evatt Foundation: Sydney, 1999), and is a contributor to the Foundation's collection on Globalisation, the Asian crisis and the future of Australian jobs (Evatt Foundation: Sydney, 1998). This article is an updated version of a column that first appeared in The Australian on 14 May 2002, the eve of the Budget.

Frank Stilwell is Professor of Political Economy at the University of Sydney, the editor of the Journal of Australian Political Economy, and a member of the Evatt Foundation's Executive Committee. Frank is also an Emeritus Professor of Economics at Flinders University, and an Adjunct Professor at the Northern Territory University and Curtin University. His most recent book is Changing track: a new political direction for Australia (Pluto Press: Sydney, 2000). Image courtesy Murdoch International.


Suggested citation
Stilwell, Fred Argy & Frank, 'Costello's 7th budget', Evatt Journal, Vol. 2, No. 4, June 2002.<>