QED

Wayne Swan’s Comprehension Deficit

swan zeg smallFormer Treasurer Wayne Swan has recently taken to suggesting the Coalition is the mirror image of the Republican Party in the United States. Trying to equate the cousin parties is quite a strain when you consider matters like gun control, abortion and religious issues, but even when it comes to economic policy Mr Swan is very wide of the mark.

Consider, for example, the differing approaches to supply-side economics. In late September, 2005, on a visit to Washington Treasurer Peter Costello was asked about the Bush Administration’s signature policy of unfunded tax cuts.  “Supply-side economics is an example of what not to do,” Costello said bluntly. “The idea that you can balance the budget by driving it into deep deficit and letting it fix itself has been tried in the United States and it hasn’t worked.” Costello’s criticisms illustrate the deeply contrasting economic management philosophies of the Australian Coalition and the Republican Party in modern times.

The Coalition government, under the twelve-year economic leadership of Treasurer Peter Costello, always made a priority of the government living within its means. Tax cuts were always desirable, but only after ensuring that expenses were accounted for. “If you can balance your budget and fund your expenditures, then you should try and keep taxes as low as possible,” was the Costello mantra, with an emphasis on the sequencing.

It was the consistent application of this conservative philosophy over many years that saw a long series of budget surpluses, the eventual elimination of government debt and the build-up of significant financial assets. While this philosophy was often frustrating to people impatient for tax cuts, such fiscal discipline presented a striking policy example of what psychologists call deferred gratification, or the ability to restrain ones appetites with a view to longer term gains.

The American Right, by contrast, abandoned the long-standing approach of living within your means around thirty years ago in favour of a tax cuts now approach. Republican leaders were greatly influenced by the famous “Two-Santas Theory” proposed in 1976 by a writer at the Wall Street Journal. Jude Wanniski’s argument was that Republicans needed to start promising unfunded tax cuts to compete with unfunded Democrat promises. “The only thing wrong with the U.S. economy,” ran the first line of Wanniski’s seminal essay, “is the failure of the Republican Party to play Santa Claus.” Reflecting the me-generation’s signature characteristic of instant gratification, other new so-called “supply-side” writers urged Republicans to stop being “hypnotised” by budget deficits and start cutting taxes immediately.

Republicans went on to embrace this Santa Claus approach to managing finances with the endorsement of numerous eminent economists who predicted that the deficits would pay for themselves. As it turned out, of course, the deficits didn’t pay for themselves, the long post-war trend to lower government debt reversed dramatically, and record expansions of government debt were to occur under the administrations of Ronald Reagan and then George W. Bush.

The dramatic departure of actual results from academic predictions should have seen alarm bells ringing about the validity of the underlying theory, but such is the appeal of unfunded tax cuts that concerns about budget imbalances continued to be dismissed. “Deficits don’t matter,” Dick Cheney infamously claimed in 2002 when challenged about large unfunded tax cuts, encapsulating in three words the disastrous philosophy that had taken hold of Republican Party policymakers in modern times.

The greatest test between the two philosophies occurred when the global financial crisis hit in 2008. In the United States the deep and deepening indebtedness of the government left it severely weakened when the storm broke, and this vulnerability damaged consumer confidence, hit business investment, exacerbated the slump in economic activity, and contributed to the collapse of financial institutions. A vicious cycle kicked in – high government debt contributed to economic weakness which in turn added to debt – a cycle which continues to bedevil the US economy six years later.

The contrast with the Australian situation when the crisis hit could not have been greater. In 2008 Reserve Bank Governor Glenn Stevens said our capacity in Australia to respond to adverse events was “virtually without peer” thanks to the fiscal consolidation undertaken by Costello.  He was right. The Australian government’s debt-free financial position provided a deep reservoir of strength and stability. Knowledge of the government’s financial strength lent invaluable confidence to consumers and businesses panicked by the global crisis. The government of the day was able to afford stimulus measures (of varying quality) to help avert a short-term collapse in economic activity. Along with elevated commodity prices, the pre-existing financial strength of the government saw economic activity sustained, employment levels remaining solid, and Australia, virtually alone amongst developed countries, avoid a recession.

The differing fortunes of the two countries over recent times provides a compelling contrast between the “deficits don’t matter” philosophy of the US Right and the “deficits of course matter” philosophy of the Centre-Right Down Under. After many years of real-time experience the jury is in, and the verdict is that the Santa Claus supply-side approach failed. The mountain of debt left by Reagan and Bush should serve as the burial mound of “deficits don’t matter” economics.  Former Treasurer “Deficits-every-year” Swan might take note.

David Alexander is a former senior adviser to Treasurer Peter Costello, now Managing Director (Federal) at Barton Deakin government relations in Canberra

Leave a Reply