Three fine spears of economic reform

Australian Conservatives Release

It’s time to seize the initiative now that Labor’s big government push has failed. The federal election was about many things, but at a Politics 101 level it was about how big a role government should play.

The Conservative Party has always stood for smaller government and so it welcomed the win by Scott Morrison’s Coalition.

Economics Professor Tony Makin writes in The Australian, at issue was whether the role and size of government should expand , with more spending for instance on health and education, as proposed by Labor, or remain much the same, as proposed by the Coalition. Aware that significantly higher taxes would have to be paid to achieve Labor’s bigger government objective, the electorate favoured the Coalition.

As a share of gross domestic product, spending by all levels of government in Australia is 37 per cent. Had the electorate voted for Whitlamesque higher taxes and spending it may well have ratcheted up to 40 per cent or more within a few years. This would have steered Australia further down the European economic road, where sclerotic economies such as France, Greece and Italy have public spending shares of more than 45 per cent of GDP.

In contrast, in more dynamic Asia where Australia mostly trades, government size measured as a proportion of GDP is considerably smaller. In the advanced economies in our region, government spending in Singapore (more competitive and richer on a per capita basis than Australia), South Korea and Hong Kong is only around 20 per cent of GDP.

The sharpest rise in government spending in Australia occurred after the election of the Whitlam government in the early 1970s. It peaked in 1987 under the Hawke government, though this spike was reversed, some years later, by Labor finance minister Peter Walsh. That fiscal consolidation was notably stronger than has occurred under any Coalition government in the postwar years.

In the wake of the Rudd-Swan government’s grossly overblown response to the global financial crisis, the government spending share spiked again and remains close to that peak, despite attempted fiscal repair by the Abbott, Turnbull and Morrison governments . This contrasts with other advanced countries, where the government spending shares of GDP have generally come down from their GFC peaks.

There was little, if any, mention during the election of Australia’s competitiveness and its place in the world, except as a coal exporter . It was as though Australia was an economic island unto itself, and that whatever happened here fiscally was of no macro-economic consequence. But it is not, and it does. Higher taxes on capital and labour to fund higher levels of spending ultimately reduce the incentive to invest and work, slowing economic growth.

Australia’s economic history shows that whenever the size of government increases, it is not significantly wound back – the notable exception being during the Hawke-Keating years.

Yet, contrary to Keynesian dogma prevalent in Australian media and university circles, when public spending is wound back, empirical evidence from the academic literature suggests this buoys the economy.

Economic research on the optimal size of government in advanced economies, for instance, suggests a 1 per cent increase in the size of government reduces longterm economic growth by 10 basis points.

This implies a 5 per cent cut in government spending across all levels of government would deliver 0.5 per cent of extra growth a year across a five-year period. That would cumulatively generate tens of billions of dollars’ worth of extra national income.

Cutting public spending, particularly on industry assistance and the overlap in spending at the federal-states level, should therefore form part of the new government’s reform program to boost Australia’s anaemic post-GFC economic performance, along with tax reform, including internationally competitive company tax rates and greater reliance on revenue from the GST, as well as industrial relations reform.

The election result also was proof that free-market oriented neoliberalism, wrongly blamed for the GFC itself and its aftermath, still breathes. Economic neoliberalism inspired the widespread reforms implemented during the Hawke-Keating and Howard-Costello governments that opened up the economy to the world and transformed it for the better.

Yet little meaningful economic reform has happened since. Advanced economies have performed poorly post GFC, with significantly lower economic growth than before the crisis.

Real wage growth also has been sluggish, a key reason being private investment, which acts as a conduit for productivity growth by embodying the latest technology, has been anaemic. In turn, private investment has been adversely affected by greater uncertainty related to the huge public debt, unprecedented in peacetime, that resulted from ill-considered fiscal stimulus measures implemented in response to the GFC.

Commentary on our economy continues to focus on how it can be managed from the demand side, more recently zeroing in on the expected cuts in official interest rates. However, while of some use, there is little scope for significant adjustment there.

Although the prospective income tax cuts also have been interpreted as a demand measure, by improving work incentives, they are likely to be more effective on the supply side, which should garner much greater attention.

In Japan, Prime Minister Shinzo Abe has had mixed success with his “three arrows” economic reform program – known as Abenomics – aimed at increasing Japan’s weak growth rate. Abenomics failed because the government has not addressed Japan’s staggering public debt and the structural problems that persist on the supply side.

The reforms proposals I have outlined for Australia – reduced government spending, tax reform and industrial relations reform – would constitute a more potent “three spears” package for bolstering the economy. A Scomonomics program perhaps?

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