Election campaigns in Australia often seem to crystallise around the dire performance of a single economic indicator.
In the 1996 election, it was the size of Australia’s foreign debt (Peter Costello argued that it was catastrophically high).
In the 2004 election, it was the interest rate (as John Howard put it, “I will guarantee that interest rates are always going to be lower under a Coalition government”).
Presently it is the government budget deficit (as Tony Abbott would have it, we have a “budget emergency”).
Sloganeering of this kind, faithfully reported by an uncritical media, is useful. It helps win elections.
But the focus often shifts after the election. Incoming governments soon realise that foreign debt, interest rates and, in the short run budget deficits, are determined by factors outside their direct control. There is also implicit acknowledgement that, despite their earlier assertions to the contrary, single-number measures are an inadequate measure of economic success or failure; the costs of achieving these single-number targets outweigh the benefits.
Take foreign debt as an example. Net foreign debt measures the net amount Australians – business, government, and private individuals – owe foreigners (overall net foreign liabilities are a larger amount as it also includes equity investments). In March 1996, net foreign debt stood at $192 billion, or 37% of GDP. By September 2007, just before the Howard government lost office, it had risen to $577 billion, or 53% of GDP. It currently stands at 51% of GDP.
Were a government committed to cutting foreign liabilities, a starting point would be to recognise that the increment to foreign liabilities is the balance on the current account of the balance of payments – the difference between current receipts from foreigners for goods, services and income, minus current payments to foreigners.
Absent short-term valuation effects arising from exchange rate changes, a reduction in foreign liabilities requires a positive balance on the current account. In turn, the size of the current account balance depends on the interest payments on the existing debt, and the difference between exports and imports of goods and services.
Not much can be done about flows of interest payments. The stock of debt is the result of past decisions, while interest payments on the debt are determined by the rates required by foreign lenders.
What about the trade balance – the balance between exports and imports?
In an open trading economy like Australia’s, with low tariffs and export assistance, increasing the trade balance means that domestic demand must be restrained while exports grow. This politically unpalatable situation “works” because soft domestic demand generally implies lower imports.
This combination of events has recently been illustrated with the release of the March national accounts. In the March quarter, exports of goods and services increased, while imports fell. It was this turnaround in the trade balance which underpinned real GDP growth.
Although the trade balance recorded a small surplus, it wasn’t large enough to offset the outflow of interest payments on our existing debt; the current account remains in deficit, and the stock of net foreign liabilities continues to rise.
As the accounts show, continued low levels of domestic demand, pursued with sufficient vigour, might be effective in generating a current account surplus, but at a high political cost.
This brings us to the second reason why election slogans sometimes fade away. Maybe the indicator – foreign debt in the present example – wasn’t so problematic after all.
In the early 1990s there was a lively debate in academic circles, led by John Pitchford at the ANU, which supported this view. He started from the perspective that prices at which borrowing and lending decisions are made generally reflect the corresponding social costs and benefits.
To illustrate the argument in a standard mortgage market, if the lender and borrower are both fully aware of their financial circumstances, and the terms of the loan are set accordingly, then it is not clear why an increase in household indebtedness is cause for concern.
Applying this argument to international credit markets, the “consenting adults” view of Australia’s foreign debt was that, providing the terms are correctly priced, reducing foreign debt should not be a target for policy.
Whether Mr Costello relied on this argument for his change of heart is not clear.
What is clear is that the premise on which the consenting adults view is based – that terms are correctly priced – does not always apply.
This is particularly the case with borrowing by Australian banks and the States and Territories. Being regarded as too big to fail, the big four Australian banks enjoy the benefits of an implicit government guarantee which enables them to borrow on better terms than would otherwise be the case. Similarly for the states.
During the global financial crisis, these guarantees became explicit. State and bank borrowing was guaranteed by the federal government. Banks were charged a fee for this service with the larger banks paying a lower fee than smaller, regional banks.
In some respects, this is a curious way to run an insurance scheme. After all, most insurance companies are justifiably reluctant to write household insurance policies as the bushfire comes over the hill.
The “consenting adults” view and Costello’s benign neglect of foreign debt would have greater force if the terms on which the banks and states borrow on international markets more closely reflected social costs. For the banks, the costs would be shared between shareholders and customers, rather than having risks borne by taxpayers.
If the Coalition wins government in September it may well be that, as with Mr Costello’s earlier change of views on foreign debt, Mr Hockey takes a more nuanced approach to the federal budget deficit and government debt.
The costs and benefits of deficit reduction will get more careful analysis, particularly as deficit reduction measures are likely to be more costly in a slowing economy. One can only hope that the debate will move on from whether or not particular forecasts have been met.