Why this could be the summer Joe Hockey turns Keynesian.

Next year’s budget offers the Government a horrible array of choices.

The government was badly burned by this year’s budget. Ideas like the GP co-payment saw their popularity plunge in May, and they’ve been in an election-losing position since.

polls
Source: the inestimable Edmund Tadros, AFR.

They burned their fingers badly, and what’s worse, didn’t even grab substantial fiscal gain from it. The Treasurer’s office is staring down the barrel of a budget with another big deficit next year.

If they try to push the budget back to surplus, the public will have their worst fears confirmed – these guys really are mean!

So the Treasurer can’t cut too hard.

The alternative – running a deficit and being proud of it – looks unpalatable. But there are ways to change one’s tastes …

Australia’s growth in the last quarter was poor, falling to 0.3 per cent.

gdp grwoth
Source: ABS National Accounts

There is a big school of thought in economics that says when growth is poor, governments should spend to prop it up. This is broadly known as Keynesianism, named for John Maynard Keynes, who was a major theorist of the great depression. The more contemporary theorists are known as New Keynesians

Spending to support growth is common. That’s what Kevin Rudd and Wayne Swan did in the GFC, giving us school halls, insulation and $900 cheques. The Rudd stimulus left Australia with a medium-sized amount of debt, and arguably prevented Australia from falling into recession alongside the rest of the western world.

The opponents of this policy included one of the national daily papers, The Australian. They hated it in 2009, and they hated it even more by 2013 and 2014.

But by 2015, might their rigidities soften? The political needs of the current government may demand it. The only way to not commit political hara-kiri while setting a framework for the 2015-16 Budget will be to adopt a far more generous way of thinking.

Torn between two forms of cognitive dissonance, “I am setting the national Budget in a wholly political way” and “I am a late convert to the need to support aggregate demand,” I suspect Mr Hockey may be tempted by the latter.

This summer, as he lies on his towel, listening to the Pacific Ocean waves crash on the beach, Joe Hockey may well be turning the pages on a biography of Keynes. Perhaps the same one Mr Rudd read in 2009. It might be the thing that saves him.

Bill Shorten should probably zip it about next year’s budget deficit.

Next May, Tony Abbott and Joe Hockey are going to feel very uncomfortable indeed. They’ll be bringing down a Budget that is completely the opposite of what they hoped for.

The 2014-15 Budget was full of spending cut plans and forecasts of rising tax revenues. The spending cuts are mainly in shreds on the floor of the Senate, and the rising tax revenue projections got vapourised by weak growth and falling iron ore prices. The few measures they did pass, like a temporary tax hike on high income earners, aren’t likely to be enough.

The Abbbott/Hockey game plan was to get their horror budget out of the way early. But the ghost train didn’t stop at the station, and it looks like they’re stuck on the ride as it enters the tunnel once again.

The Budget, when it comes out, is going to include some large negative numbers. They were expecting deficits of $30 billion this year and $17 billion next year.

deficit

But revenue fell hard in the most recent quarter as growth fell to 0.3 per cent.

Budget update

I expect the government will be forced to admit the deficit this year is very much like the last Labor year (around $50 billion), and that the 2015-16 one will be at least twice the size they expected.

What’s worse for them is this – the more they try to correct this scenario, the worse their reputations become.

I wouldn’t want to face the dilemma Hockey faces – try to put the budget on track and cement once and for all the impression of having a heart of stone, or try to salvage a bit of popularity while letting the nation’s finances spiral away. Perhaps he will happily give up his job to Mr Turnbull.

So, from a fiscal perspective, Opposition leader Bill Shorten has been given a free kick in the goal square. This is political gold!

But should he go hard on this topic? Should he try to drive a fiscal stake through this government’s heart?

I see three reasons he should not.

1. Don’t perpetuate Deficit-phobia.

The fear of deficits is extremely corrosive to our national debate. Governments are absolutely petrified of borrowing, for fear of being accused of running a deficit.

Interest rate the government faces on a 10-year loan. Source: Bloomberg
Interest rate the government faces on a 10-year loan. Source: Bloomberg

The cost of borrowing, right now, is exceedingly low, and the benefits of borrowing could be very high. Almost everyone thinks Australia could use a big whack of infrastructure to set it up for the next century. Obsessing about spending only what you earn is for people who can’t get credit, or for people whose expenses are smooth and predictable. A mid-size first world nation can get credit cheaply, and might want to occasionally build a huge project. In those cases a deficit should be celebrated.

If Shorten accusing Abbott of incompetence because of the existence of a deficit, then he further limits the policy options of all governments of all stripes.

2. Focus on something important.

Budget day I argued in April that Labor should have made equality a big budget figure. You could hoard all the relevant data on equality until Budget day, brief the right people that an important measure was coming out that day, and then boom, get some cut through on a topic that wasn’t so meaningless.

If Mr Shorten goes after Mr Abbott on the defict, he adds his imprimatur to the idea that managing a deficit is the most important job a government can have. Assuredly, it’s part of the government’s role. But to place it at the centre of responsibilities is to show a distinct lack of imagination. Find something important and make Budget day about that instead.

3. Tying your own noose.

If Mr Shorten wins government in late 2016 and the deficit is all he’s talked about for the preceding three years, he’ll be forced to fix it, fast. That could prove uncomfortable for him.

Mr Shorten’s approach will depend to some extent on what Mr Hockey has planned. We will know a but more about that once the mid-year economic update (MYEFO) comes out.

It was exactly 51 weeks ago that I wrote about the first MYEFO that Mr Hockey brought down, which was clearly setting the stage for big cuts. I wrote this

“What is the last “cut” that is heralded as a major political reform? Howard strangled the dole payment down below some estimates of the poverty line, but that’s oddly omitted in his hagiography. Even right-wing economist Judith Sloan has argued the dole should now be raised.

When we list the economic reforms that have made Australia great we include microeconomic reform, floating the dollar, an inflation-targeting central bank and the GST.  Not cuts.

If the Abbott government’s first term economic reforms can mainly be labelled “cuts”, what will be its legacy?”

It will be very interesting to see what themes we can read into this year’s MYEFO (perhaps coming out next week, and required by law before the end of January).