Unloosing entitlement

What does a recent comment by Bill Shorten, the global debt crisis and looting in London have in common?

The answer is a lost comprehension of wealth creation. Mr Shorten, Western governments and the mindless looters on the streets of London are all, in their own different ways, cargo-cultists. They all appear to think things can be had as of right.

Shorten in commenting on the proposal to develop a national disability insurance scheme said that it would complement “the four pillars which assure the quality of Australian life for all – the minimum wage, the aged pension, compulsory superannuation and Medicare.” Leaving aside debate about the merits of a minimum wage when it puts people out of work, none of these four pillars provides any assurance worth more than a brass razoo without wealth and prosperity to back them up.

In particular, only if a society is wealthy and prosperous and stays that way does it have capacity to help the disadvantaged. Shorten knows this you might say. Maybe he does and maybe all those governments in Europe knew it too, but it was not part of their narrative. Their narrative unfortunately became policy and then wormed its way into the very fabric of society.

Keynesianism helped enormously. When spending is thought to be equivalent of producing, it is a short step to making promises that can’t be kept, or to giving people free money to spend (entrenching dependency), or spending on make-work projects, or hiring more unproductive public servants who will then be able to spend the money paid to them. It is a Keynesian topsy-turvy world.

Listen to all of the nonsense being spouted now in Australia about the fall in consumer spending lowering economic growth; as though it had anything at all to do with economic growth. If you think it does then insist that all consumers earning above a certain level of income spend at least fifty dollars more a week in retail stores, else it will be confiscated. Gerry Harvey’s face would light up, but watch what happens to economic growth as interest rates rise; not to mention, imports from China. Decisions by businesses to invest and produce generate employment and this fuels sustainable demand. That is the direction it works.

Governments using taxpayers’ money can provide benefits only if the private sector economy can generate sufficient wealth over the long term. And removing benefits is far harder, politically and socially, than not providing them in the first place, as we are finding out. The purely fiscal problem of restoring stability in government debt markets is not that great, if that is all there were to it. Governments don’t go out of business like companies. Take the United States.

The Unites States has a federal government debt to GDP ratio of a little over 100 percent (based on 2011 financial year estimates). It pulls in revenue of around 14 per cent of GDP. Interest payments are only one tenth of this, because the average interest rate on its outstanding debt is so low. All it would have to do to give markets absolute confidence is to put in place measures to gradually bring the budget deficit down from its current plus 10 percent to something close to 2 per cent of GDP, in line with a reasonable economic growth target.

There is a good argument to suggest that a combination of tax increases (at a time when wars have to be paid for and revenue is below its recent historical average) as well as spending cuts is called for. While tax increases are a problem for the Tea Party members of the GOP; cutting into entitlement spending at all this side of, say, 20 years into the future, seems to be poisonous for either political party to contemplate. They only need look to the demonstrations and sit-ins in Wisconsin when the governor there reduced union entitlements to get the picture.

Even moribund Italy, with a debt to GDP ratio of 120 percent, second to Greece in the EU, could still turn its position around, increase market confidence and reduce the interest rates it would pay on new debt, if it could balance its budget over the next few years as intended. At question is whether this will prompt riots in the streets.

It is salutary to understand that the Italian budget deficit against GDP is not much above Australia’s. Australia has the twin advantages of relatively low government debt (only after years of high commodity prices) and good growth prospects. Australia’s growth might remain solid for some years. However, it would be wise not to raise expectations about putting in place expensive new entitlement programs at a time when debt is growing, the budget is in deficit, the world economic outlook uncertain and, to add the mixture, when billions of public dollars are earmarked (off budget) for an unproven national communications network and it is intended to hit Australian industry with a carbon tax.

When governments float the idea of new entitlements people should ask themselves whether they can and are willing to make a substantial contribution. Not whether someone else can – those rich folks across the way – but whether they can. First there are not enough rich folks to go around and, second, those rich folks are the only ones that save very much to provide the financial capital to build physical capital to keep us all growing wealthier.

Prosperity, and very high level of confidence in its sustainability, has to come before locking in substantial increases in public spending; however laudable the purposes of the spending. In an Australia dependant on commodity exports, one measure of that would be the considerable size of a sovereign wealth fund that the government had built. Any such fund would currently stand in the net negative. Entitlement spending unhinged from economic growth produces ruin and then riots in the streets. Australia is not immune.