Defective analysis and the "Never Never Budget".

• Author: Stone, John
• Position: Company overview
• Pages: 8(17)

On 27-28 March, 2009, the H.R. Nicholls Society (1) held a conference in Melbourne under the general theme, "Fair is foul, and foul is fair". What follows, initially, is the text of my address to the opening dinner on 27 March. (2) In it I analysed the origins of our present economic discontents, and also ventured some opinions about our economic future. In an epilogue I now attempt, given the Government's 2009-10 Budget, to update those latter opinions.

Dinner address, 27 March 2009

The title for the H.R. Nicholls conference is drawn from the witches' cabal in Macbeth--"Fair is foul, and foul is fair". Could this be a reference to a certain "Welsh witch" who rides the Rudd Government's industrial relations whirlwind with an iron broomstick? More mundanely, I construe it as highlighting that the consequences of the so-called Fair Work Act 2009 for the Australian economy will be extremely foul, and that only witches could be so wicked as to describe its foul measures as being "fair".

When Ray Evans wrote asking me to speak, he began by observing that this year will see the 25th anniversary of my Shann Memorial Lecture, which he described as "arguably the seminal document in the campaign for liberalising our labour market". He said he would be glad if I "would pick up the leitmotif from that lecture and bring it up to date, in the knowledge that we are heading into perhaps the most serious recession since the 1930s". In passing, let me delete that word "perhaps". The recession in which we now find ourselves is certainly the most serious since the 1930s, and in some dangerous respects it is unprecedented in the Federation's history.

Ray then referred to some predictions of mine last year about the future of Mr Kevin Rudd, (3) and potentially therefore of his Government, and asked me to suggest some "things which a post-Rudd Government ought to do to ameliorate what will be an unemployment crisis greater than that of 1982".

I shall try to conform to those guidelines under four heads:

* First, I shall say something about the economic situation likely to confront us in 18 months' time.

* Second, I shall speculate briefly on the consequences of that for the Labor leadership in Canberra.

* Third, I note that, however politically propitious the economic circumstances late next year might seem to be for the Coalition parties, they have little hope of winning office under their present leadership.

* Fourth, since I may be wrong in that judgment, or the Coalition parties may meanwhile find themselves another, more electorally acceptable leader, I assume for the sake of argument that they do prevail at the 2010 election--or that even if they don't, by that time the Labor Party will have sufficiently come to its senses to amend its current policy stance. On one or other of those assumptions, I consider how the unemployment crisis then prevailing should be addressed.

The economic situation and prospect

Australia's economic situation grows more serious by the day. When the Rudd Government was elected 19 months ago, we were extraordinarily well-placed. We had no federal debt, a federal budget in strong surplus and a well regulated banking system largely free of the excesses of many of its overseas counterparts. We were enjoying strong economic growth, with record business investment and extremely low unemployment. Whether Labor likes to admit it or not, this was the legacy of the Howard-Costello Government.

Today, federal debt is growing by leaps and bounds. The budget is already heavily in deficit and destined to become much more so. Economic growth has vanished, business investment is beginning to fall, and unemployment is rising sharply. Our banking system is still relatively robust by international standards, but is under strain nevertheless.

Not all of this is the Rudd Government's fault. Many of the depressive forces acting upon our economy have their origins abroad. The real charge against the Government is that, in addressing those depressive forces, its analysis has been defective and its actions have been as reckless as they have been unproductive (or even counterproductive).

To make matters worse, the recent enactment of the Fair Work Act constitutes a disaster in the making. That Act not merely repeals the Howard Government's Work Choices Act but also takes labour market regulation back, in many respects, to pre-Keating days. At a time when the restoration of business confidence is a vital ingredient in any recovery process, Julia Gillard has laid an axe to it.

Moreover, although it is not a topic for this conference, the Government's Carbon Pollution Reduction Scheme, which it stubbornly proposes should come into operation next year, (4) would be another blow to our cost structure and hence, again, to business confidence. Even if you believed in the dodgy "science" purporting to underlie it, it would simply make no sense at this juncture in our economic affairs.

Why do I say that the Government's--and I fear, the Treasury's--analysis of our problems has been defective? It is because, I believe, it has wrongly diagnosed the very nature of those problems.

In a newspaper article last February, I urged the Government to think about how the present situation has arisen: (5)

For years now, many Australians, and many of our corporations, have over-borrowed. While the Howard-Costello Government was paying off the Commonwealth's entire net public debt, the private sector was hell-bent on the path of debt-financed asset inflation. The fact that most of the developed world (the United States in particular) was also doing so enabled this process. That has all changed. Asset inflation ... has been replaced by asset deflation. Share markets have fallen dramatically. Commodity markets, with the significant exception of gold, have fallen even more dramatically. House prices have fallen, and will undoubtedly fall further; so have commercial property values, despite developers' notable reluctance to admit it. ... Unemployment is rising, as are bankruptcies. Confidence, both of individuals and businesses, has been shot to pieces. Last October, when the Prime Minister made his "decisive" decision to blow $10.4 billion of our money, he apparently did so on the basis of Treasury advice to "go early, go hard, go households". That advice was said to be based upon the Keating Government's experience when dealing with--or failing to deal with--the 1991-92 recession. If so, I believe that was a mis-diagnosis. Apart from its likely unemployment consequences, the recession on which, by last October, we were already embarked bears little relationship to that of 1991-92.

The difference was well defined in a paper (6) given to a special meeting of the Mont Pelerin Society in New York which I recently attended. It drew a sharp distinction between "conventional" recessions (like ours of 1991-92)--usually brought on because the monetary authorities have been forced to raise interest rates to check inflation--and the much rarer (and much more difficult to deal with) "balance sheet" recessions. (7) In this latter kind of recession, "corporate, financial or household balance sheets will have been swollen by large quantities of debt. Typically the debt will have been used to buy assets ... and the fall in asset prices will create widespread negative equity for firms and individuals, triggering an economic downturn. The main focus of indebted firms or households in this situation is de-leveraging or debt repayment". (Emphasis added).

The key point is that, once this kind of recession has become established, both households and corporations will wish to give priority not to spending, but to repairing their balance sheets. Even though "banks may have funds to lend, households or firms may not want to borrow, preferring to repair their balance sheets before spending again". (8)

This "deleveraging" process seems to me to describe very accurately the situation today not only in Australia but throughout the developed world. If so, no wonder Mr Rudd's $8.7 billion handout last December appears to have had so little noticeable effect on consumer demand. Most of it, as I suggested in that newspaper article, would have gone to repairing household balance sheets. I expect the same will be true of the $12.7 billion being distributed as part of Mr Rudd's $42 billion February package.

On that basis, these two measures boil down to requiring taxpayers to hand over $21.4 billion to people who have borrowed imprudently, so that they can reduce their debts!

If I am right about likely household behaviour in these circumstances, consumer demand is unlikely to recover for some time. Indeed, if household confidence is further sapped by watching the Government "making it up as it goes along", it will fall further. Falling business investment, including downward inventory adjustment, will exert further recessionary pressures.

Export demand, in turn, seems likely to suffer from the similarly mistaken fiscal policies enacted abroad by President Obama, Mr Gordon Brown, and to a lesser extent, others. To quote again that earlier newspaper article, "today's world leaders and self-interested International Monetary Fund spokesmen all seem hell-bent on committing errors similar to our own, thereby worsening the international environment".

There is much talk these days, both here and abroad, about the need for banks to...