Sunday, 17 June 2012

Queensland's Budget Crisis?

So apparently the Queensland Government's budget is in crisis, and without drastic action we will all be ruined.  It must be so because Peter Costello says so.

Soon after its election the new Queensland Government appointed Costello, long-serving treasurer in the Howard government, to head a commission of audit into the Queensland budget.  Its interim report suggests that the government needs to save 25 to 30 billion dollars over a five year period to regain its AAA credit rating from Standard and Poors.

Should we believe them?  Well, I'm no economist but I have my doubts.  For a start, why did the government appoint a veteran Liberal politician, and one notorious for his fiscal conservatism and love of surpluses, instead of, say, a distinguished economist?  Why does new Queensland Treasurer Tim Nicholls look so much like Costello's little brother at the press conference to launch the report?

Secondly, the report includes a set of forward estimates from Queensland Treasury which suggests that in the absence of any policy change the state fiscal balance, after peaking at a deficit of $9.5b in 2012-13, will gradually recover until the deficit is less than $1b in 2015-16.  In other words, Treasury believes things are pretty much going to plan.

Costello and his colleagues disagree.  Using their own assumptions, they project that it will take perhaps four or five years longer to get back onto balance.  The difference centres around how realistic assumptions are about public sector wages growth, growth in revenue, and capital expenditure.

Prediction is extraordinarily difficult, especially when it concerns the future.  Nonetheless, both Treasury and the auditors agree that the state is moving back towards balance - they just disagree on how quickly.  So why the alarm?  The issue seems to centre around the recovery of Queensland's AAA credit rating.  This begs the question as to why Standard and Poors should be allowed to set Queensland's econmic policy.  Part of the reason is that the better our credit rating, the less our borrowing cost.  Apparently at our current level of debt our AA+ rating means we pay about $100m a year more in interest than we would with a AAA.

Still it does seem we need to think about some other things.  Government budgets are supposed to act counter-cyclically.  This means that when economic conditions get worse, governments spend more and take less in tax, running a surplus to fill the gap in private sector spending.  When the economy recovers, this situation will right itself - government revenue will bounce back as people start to pay more tax again, and it will be able to cut back on spending as less is needed.

One of the arts of economic policy is the management of deficit reduction.  Reduce it too slowly and you end up fuelling inflation.  Reduce it too quickly and you end up prolonging the recession by removing investment while it is still needed. 

Costello, however, is noted for a blindness on this subject, a belief that budgets should be balanced no matter what.  He got away with this during his time as Australia's Treasurer because he never had to face a recession.  His Labor successors were confronted with one almost as soon as they were elected, and deficits suddenly blossomed around the country.  Costello wants us to get back to balanced budgets as soon as possible.  However, his justification for this is a little alarming.  Our revenues will not recover as fast as Treasury thinks, he says, therefore we should make cuts.  In other words, in the face of continued poor economic conditions we should cut expenditure or raise taxes more rapidly.  The experience of earlier recessions suggests this is most likely to delay the economic recovery and hence become self-fulfilling.

I suspect, however, that this is beside the point.  The audit is not primarily an economic exercise, it is a political one.  It aims to create space for the government to do two things.  The first is to pursue its small government strategy by cutting public service numbers.  Don't be fooled by talk of only cutting "backroom" staff and leaving "front-line" staff untouched. If you have less people, you will get less work done.

But this is not the real punchline of this huge political joke.  Here it is.

"It will require careful utilisation of the balance sheet and utilising the proceeds of asset sales to reduce debt."

Did I just hear you say "asset sales", Mr Costello?  The previous Labor government decided to sell assets to reduce its deficit.  They now have seven members in the State parliament.  The LNP gleefuly got stuck into them and vowed they would not do the same thing.  This was barely ever credible from a conservative party, and it has taken them less than three months to start singing a different tune.  The unionists who turned against Labor in disgust will be feeling profoundly depressed.


Brad McCoy said...

Hi Jon, just a few thoughts...

I don't think it matters that Costello is a full-blooded Liberal (Liberal *party*, that is), any more than Garnaut being a Labor boy should bring his climate reports into disrepute. The report should be judged on its merits (or lack thereof). There is definitely a discrepancy between Treasury forecasts and Costello's forecasts, because Costello essentially extended trends of the past 5 years into the future estimates, which to be fulfilled would require another GFC and more state-wide flooding. Treasury estimates, on the other hand, are probably a little overly optimistic. I guess truthis somewhere in between.

Whether budgets should be countercyclical is greatly contested. But assuming they should be, the govt shouldn't be stimulating the economy because unemployment is shrinking (which is usually the target of govt stimulus). Anyway, as far as I understand, the govt is looking to cut operating expenditure, not so much capital expenditure. Capital expenditure (infrastructure building, etc) is probably more likely to boost employment than operating expenditure anyway. And state fiscal policy probably has little effect anyway - the fed govt is still stimulating economy through cash handouts (targeted at boosting retail sector) and the RBA is doing its bit with monetary policy (low interest rates).

The focus on achieving surplus isn't just from Costello either - it's been on the minds of Treasury for a while. It's a difficult time to raise debt because of what is happening overseas. Add to that the poor credit rating (which S&P can hardly be blamed for - it's based on the facts), and it becomes difficult to continue servicing debts.

Queensland should certainly be doing better with its finances. We've got a strong and growing economy, compared to non-mining states, yet we've got unnecessary deficits and one of the worst credit ratings.

I think the govt needs tobe more efficient. Whether I agree with how the LNP is doing it is another matter.

Jon said...

The audit commission has two major differences with Treasury - the choice of measure, and the optimism of the projections about revenue and spending. Costello et al believe the Treasury projections are too optimistic - in other words that economic conditions will be worse. Their answer is to cut more,which means to contract with the contraction rather than against it. Treasury by contrast is planning on the basis of a recovery. The point of contention is not whether to reduce the deficit, but how fast.

I don't think you should underestimate the significance of the State govt in the economy, and the Commonwealth is also in deficit reduction mode. Nor is the S&P credit rating as objective as you suggest - it is based on a particular view of government debt.

No doubt government can be more efficient. The dept I deal with the most is an absolute nightmare. The LNP's approach is not very encouraging so far though - not renewing contracts for temporary staff is just taking the line of least resistence.