Wrong time for the Razor Gang

Over the fold, my column in yesterday’s Fin. Not the final version, as I made some last minute changes in response to Lindsay Tanner’s defence of the Razor Gang yesterday.

If there is one thing that has become evident from the grim macroeconomic news of the past couple of months, it is that the global economic crisis will last well beyond 2009. Global trade is collapsing, and the World Bank has recently forecasting negative global growth for the first time since World War II.

On these projections, it is optimistic even to hope that the decline in economic activity will level out in the course of this year. Moreover, weakness in private demand, particularly investment demand, is likely to persist for years into the future.

To suppose that the fiscal and monetary stimulus measures announced so far represent an adequate and complete response to the problem is unrealistic wishful thinking. Yet it is precisely such wishful thinking that seems to be shaping the planning of the Budget to be released in May.

Both in public statements and in private discussions with various interest groups, the government is indicating that expenditure will be tightly constrained as a consequence of declining revenues and the need to finance the stimulus packages announced so far. Lindsay Tanner has proposed a cap of 2 per cent on new spending, and the government is backing away from promises made during the election campaign.

In effect, this amounts to partially withdrawing, in May, the stimulus introduced only three months earlier. That would make sense if the problem were a short-term crisis of confidence, as some commentators suppose during the near-meltdown of late 2008. It makes no sense if, as seems certain, further rounds of stimulus are going to be needed before the crisis is over.

Of course, the crisis will not last forever, and the budget must be balanced in the long run. Given the cost of additional stimulus measures and the decline in revenue projections, the government cannot achieve this goal and deliver on all its electoral commitments.

The critical question is, what changes to the government’s plans are most consistent with the need to provide substantial stimulus for the next year or two, and replace weak private sector demand, while allowing a return to surplus in the medium term and the achievement of long-term budget balance.

The obvious candidate for change is the tax cuts, originally promised by the Howard government, but matched, with marginal changes, by Labor. The idea of promising large tax cuts on the basis of projected revenue growth was criticised strongly at the time, and many economists urged the Rudd government to abandon these commitments in its first budget.

At the time, the government rightly judged that the importance of keeping faith with the voters was paramount, and that nothing had changed since the election to justify repudiating a promise, even an ill-judged one (Promises a core responsibility, Australian Financial Review, 8 May 2008).

But now everything has changed. The surpluses out of which the tax cuts were to be paid have vanished. A substantial part of the tax cut was compensation for anticipated bracket creep, on the basis of anticipated inflation that is no longer likely.

In real terms, the tax cuts are larger, and more unaffordable, than when they were promised, even as the real capacity of the government to finance any tax cut has diminished. To keep this promise, the government will have to break many others, abandoning core commitments like the ‘Education Revolution’.

It is hard to imagine any policy instrument less appropriate to our current circumstances than a permanent tax cut, heavily tilted towards upper-income earners. The proposed tax cuts for July 2009 offer a paltry $3 a week to anyone with an income under $80 000, and nothing at all for those under $34 000. The biggest proportional benefit accrues at individual incomes of $180 000 a year. Such regressive tax cuts will do little good in the short run, either to boost consumption, or to repair the balance sheets of middle and lower-income households.

And in the long run, the implications of the government’s policy are even worse. Tight limits on spending will make it impossible to respond to the long downturn that seems increasingly likely. Delivering the tax cuts will tie the government’s hands for years to come.

When a car swerves sharply to avoid an obstacle, anything unsecured inside it continues travelling in its original direction, with unfortunate consequences. The same thing is happening in the Budget process. It is time for the government to recognise that this is more than a bump in the road, and adjust its priorities accordingly.First Sunday full movie

19 thoughts on “Wrong time for the Razor Gang

  1. The last time an efficiency dividend was brought in, CSIRO closed down science. There are really no more “efficiencies” in many areas aligned with government to be gained. Anyways, I came to the fore and resigned, saving the organisation heaps. Unfortunately I am now contributing to the collapse of the tertiary education sector.

    I would rather Lindsay spent his time on considering how the government will approach the upside of this depression – whether we see the same old legacies of environmentally damaging infrastructure, or actually get a plan that will invest in decoupling carbon intensity from growth.

    And kids, the globe is going to need a zillion engineers, not to mention other occupations in the hard and soft sciences. I’m happy to take a hit in the top bracket to see that happen.

  2. Roger, my sympathies. Even McFarlane (when he retired as Governor) expressed concern and alarm at the now dearth of appropriate skills at senior Commonwealth levels due to just such efficiency drives.
    I suggest we just watch them crash the car of a once good system and then sit and scratch their heads until a light goes on.

  3. Alice, ta for the sympathy, but I don’t need it. My productivity has gone up heaps! (There are efficiencies to be gained, but it involves juicing mandarins!)

  4. Pr Q says:

    the global economic crisis will last well beyond 2009. Global trade is collapsing, and the World Bank has recently forecasting negative global growth for the first time since World War II.

    On these projections, it is optimistic even to hope that the decline in economic activity will level out in the course of this year. Moreover, weakness in private demand, particularly investment demand, is likely to persist for years into the future.

    I agree that a lengthy recession time horizon is about right. About three years of little or no growth from woe to go.

    But I believe that, so long as interest rates remain well below double figures, AUS will not have a deep recession. So it will probably be long and shallow.

    That implies six-seven percent loss of real growth, below secular trend required to soak up additions to the labour force, from FY2007-08 through FY2009-10.

    I think that, due to high casualisation, there will be a fairly elastic response of unemployment to falls in demand. So that Okun’s Law co-efficient (“c”) is getting smaller ie smaller falls in growth needed to account for a given rise in unemployment.

    Assuming Okun’s “c” = 2 it follows that seven per cent lost growth implies a three percent rise in unemployment. That is, unemployment will rise from 4.5% in FY2007-08 through to 7.5% in FY2009-10.

    The PRC, contrary to Conventional Wisdom, will ride out this recession without too many nasty shocks either economic or political. Its internal stimulus (Hinterland strategy) is already starting to kick in. It will restore some demand for our mineral sector in about over the next couple of years.

    The most important thing for Rudd to look out for is housing prices/interest rates. It is crucial that the former dont slump and the latter dont spike.

    Rudd will be planning to pump-prime the economy big time in the FY2009-10 budget. The recovery will be underway for most of 2010 in the lead up to the election. Which he will win comfortably.

    I suspect that a big chunk of the recent massive wave of immigrants will not be able to get jobs and perhaps dont qualify for welfare benefits.

    But that probably wont change headline economic statistics. They will probably be useful fodder for slum-lords and sweat-shops. Expect an unptick in gang crime and sex-slavery. Dont say I havent been warning you!

  5. In an earlier blog, I suggested that the government needed to abandon its (so-called) efficiency dividend cuts which it is still applying to the public service. It’s another John Howard policy continued under Rudd. “Efficiency dividend” is code for “arbitrary cut”. It’s hardly the time to apply arbitrary cuts to undermine the stimulus as JQ mentions along with his reference to misguided policy momentum remaining from the Howard era.

    “When a car swerves sharply to avoid an obstacle, anything unsecured inside it continues travelling in its original direction, with unfortunate consequences. The same thing is happening in the Budget process.”

    The clear sources of this phenomenon in this case (IMNSHO), are the neocon or “economic rationalist” mandarins still the main chairs in Treasury, Finance and the Reserve Bank (as per Michael Pusey’s analysis in “Economic Rationalism In Canberra).

    Rudd needs to clean them out in order to steer a new direction. These fellows still subscribe to the mistaken doctrines which got us into all this trouble. They are not the right ones to advise a path out. That is where the axe ought to fall.

  6. #3 Roger – Mandarins ? Really?? Now would that be for restaurants? “Duck a la mandarine?

  7. I agree that the tax cuts require a major rethink, for the reasons John has specified.

    Politically, a more sensitive approach than simply abandoning one or more of the tranches may be to restructure the whole lot, to achieve (slightly) bigger cuts for the lower paid, and (significantly) lesser cuts for the higher paid, at a net gain to revenue.

    It would require a higher maximum marginal tax rate, possibly with higher rates again cutting in at higher income ranges, as doing more for lower income ranges is very expensive. But it would be consistent with the politics of responding to crisis and targeting the benefits of stiumulus at the less well off and putting the greater burden of adjustemnt onto those with the highest capacity to pay.

  8. Yes, I wish someone would put the economic mandarins in a blender.

    I will also say it was I and no other who propped up the entire world economy when I was in work. The GFC happened immediately after my resignation, a clear case of cause and effect! 😉

  9. From whom is the government getting its advice? The Treasury? Lobbyists and commentators? Worse still are Rudd, Tanner and Swan trying to work it out themselves?

    I conjecture that the atrophy of expertise in the Treasury concerning short-term fiscal policy reflects how the best graduates for years have gone to the RBA.

    And academics bear a great part of the blame for longer training students properly in short-term fiscal policy. Indeed, most would be taught that it is ineffective (esp. under flexible exchange rates with mobility of financial capital), so it does not matter much whether spending is raised or cut!

  10. David Peetz’#7 comment is interesting because there is no way the sacred cow can be dealt with without a god-almighty Murdoch-led squawk that would echo down the ages in the annals of victimhood/entitlement.
    They are too eco rationalist and too timid.
    Howard as normal continues. And as Strocchi says, the worst of it will be quarantined to the disenfranchised “othered”, so who cares any way?

  11. No problem with an efficient public service SeanG #13 – just that efficiency dividends don’t achieve it.

    The so called efficiencies have had three main effects. One has been to reduce those at the bottom of the public servant heap as those who make the decisions about who is to go are at the top. That means that there are fewer people to do the actual work.

    It also means that those who are making the decisions have little practical experience of how those decisions play out in a practical sense, especially as there is a second consequence which is the increasing centralisation of decision making processes as those at the top are based in Canberra.

    Centralisation would be less harmful if those at the central level weren’t so divorced from the decisions they are making – ie how they play out in the real world. This is even more so as there is great mobility in Canberra because extra positions are created there to manage the Ministers ie middle management is muddling management due to lack of background/skills/experience in specific areas.

    The third aspect is that there is a reduction in the public service due to the “outsourcing of tasks”. This in turn limits the data available to government for evidence based decision making. The outsourced agencies know that they need to produce data consistent with their contracts and it is not in the interests of the organisation to produce data outside that. Thus the efficiency dividends increase costs as money is shifted from wages into government initiatives delivered privately.

    So whilst there are efficiency dividends there are also efficiency costs which are rarely examined. Roger has pointed out one example of this phenomenon where those with skills and expertise have been the “efficiency dividend”. If we looked closer the mandarins at the top are probably earning a far higher wage and there are probably more of them not making decisions but shuffling paper until someone prepared to make a decision can be found. Those at the top have the focus on accountability (for everyone else) which has crippled action (eg environmental issues) because of the red tape which goes with it and that all decisions are being taken at a higher level for even trivial matters. This process was developed under the Howard government and the failure of the government to address it will mean that it will be increasingly exposed.

  12. If you can do the work with less people it means that for years too much money has delivered too little services.

    I think arbitrary efficiency cuts will do little over the long term – fundamental reform is needed of public services to decentralise decision-making and running of services.

  13. “No problem with an efficient public service”.

    That is not a sufficient criterion; should it be applied to the “Pacific Solution”, say? As someone once remarked, “the worst form of waste is doing efficiently that which should not be done at all”. The Gulag Archipelago made efficient use of resources that would otherwise not have been used.

  14. PM@16. Taking less than a sentence in order to sneer is not a good practice. You have totally taken an introductory comment out of context. However if the government of the day decides on a Pacific Solution isn’t it better that it be efficient rather than inefficient and drag out the stay of residents until it makes them mad? Your comment however has nothing to do with the razor gang as the Pacific Solution has been resolved and those staff have either left or found other positions.

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