Peter Smith

Here we go again


Treasury secretary Martin Parkinson informed the Senate’s economics committee last week that Treasury had been planning what to do if another global economic crisis occurred. Be afraid.


Last time, under Ken Henry’s charge, we spent quickly and spent big. Now, as I understand the official narrative, this apparently worked to keep Australia out of recession. You might wonder that economic delegations have not flocked to Australia to determine why our fiscal stimulus worked so well. After all, most countries spent with more or less the same abandon without warding off recession.

The reason is clear enough. All the stimulus spending worked no matter where it was applied. The key is to understand that whatever the economic outcome after stimulus spending it would have been much worse without it. Once that impregnable tautological fortress is in place further inquiry is futile.

We have, however, been told that the policy response will be more “measured” next time. That’s a relief until you drill down a little and find that a three-pronged macroeconomic approach is envisaged consisting of relaxing monetary policy; allowing the budget deficit to automatically rise as unemployment benefits rise and tax receipts fall; and, finally, depending on the magnitude of the crisis, to the potential of using discretionary fiscal policy. Exactly what is different about this approach? There is nothing of substance. Here we go again; more school halls.

There appears to be an unshakeable belief within Treasury that government spending on anything will forestall recession and aid recovery. This is despite the experiences of Europe and the United States. And despite the clear evidence that Australia’s easy ride through the GFC had nothing to do with reckless and mindless spending on government handouts, school halls and pink batts but everything to do with China and the sound position of our banks.

One of the problems in exposing the con of fiscal stimulus spending is that its effects come out of a black box. An increase in government expenditure is put into a macroeconomic model and out pops the answer of more growth and more employment. That result is impervious to actual experience. The model is built that way.

With monetary policy there is a fairly clear transmission mechanism at play. Lower interest rates encourage businesses to borrow invest, produce, and employ. The important characteristic of this process is that businesses makes the decisions about what to produce in the knowledge that if they get it right they will benefit, as will the economy, and if they get it wrong they will go broke. Going broke provides an enormous incentive to get it right. And, for the most part, businesses get it right enough – hence our prosperity.

The basis of the success and sustainability of this transmission mechanism is that more well-based production creates more income which underpins more spending. The process does not begin with capricious spending.

Exactly what is the transmission mechanism underlying stimulus spending? How does building an unnecessary school hall help the economy? It doesn’t. It hinders the economy while, of course, giving photo opportunities for politicians and the appearance of the government doing something.

It is one-off so that businesses will not gear up. It helps to keep building costs up which is precisely the opposite of what is required when the economy is struggling to adjust in distressed times. Government borrowing to fund the spending keeps interest rates up. The expected future impost on taxpayers to repay the borrowing adds another level of uncertainty to the business climate. And, on top of everything else, something is built of less value than the materials and labour used in its construction; which, to add insult to injury, then has to be maintained. Only an economist could come up with something so counterintuitive and make it appear scientific.

But you have to admit its appeal. Oh joy! Loosed from the need to earn before spending. With debt swamping them, the French turned to big spending François Hollande. It is looking likely that the Greeks will turn to his fellow traveller Alexis Tsipras.

It is time for a rebellion among people of common sense. No economics is required. If spending money willy-nilly we haven’t got is unsustainable and bad for us individually, then it is surely unsustainable and bad for us collectively.

Governments should prepare for bad economic times by putting money away in good times; by running a disciplined monetary policy; by having a flexible labour market; and by reducing regulatory impediments to business development. Do that and market forces will ensure that the ride is not too bumpy most of the time.

But however bumpy it sometimes gets, there is surely no point in making things worse by doing something that is intrinsically flawed for the sake of being seen to do something. Unfortunately, with Parkinson and his Treasury cohorts at the helm, we are in Keynesian hands and that ain’t good if the economy turns sour.

Visit Peter Smith’s website badeconomics.com.au

Peter Smith’s book Bad Economics has just been published by Connor Court. You can purchase (post free) here…


Subscribe to Quadrant magazine here…


Leave a Reply