The Budget: The Assessment

Chief Economist's View

Download the PDF version including our economic update by region here: The Budget: The Assessment

As promised, Treasurer Frydenberg has delivered an historically large budget deficit in the government fight against the ravages of COVID-19. A 2020/21 budget deficit of $213.6 billion (11% of GDP), with deficits larger than during the GFC projected over the four years of the forward estimates. The series of record deficits will push the government’s net debt towards $1 trillion (43.8% of GDP) by 2023/24 as the government charts a course for economic recovery following a record 7% contraction in the June quarter. But no amount of monetary and fiscal policy can force the economy back to its previous level while COVID-19 is still clouding the outlook and forcing parts of the economy to remain closed.

The aim of the Budget is not to remedy the economy of COVID-19, but rather to build a bridge to when a vaccine is developed and distributed, making the economy largely COVID-free. Will this Budget do the job? The bulk of the 2020/21 deficit is contained in stimulus measures designed to support the incomes of households and businesses. Over a third of the 2020/21 deficit (around $80 billion) is contained in JobKeeper and JobSeeker payments that are designed to roll off within the current financial year.

These stimulus measures aim to lift spending by businesses and households, but as we have seen, a significant share of the handouts is saved, thereby limiting the immediate impact on the economy. In addition, their impact on demand is limited mostly to the period over which they are received. As a strategy to get us over the hump during which COVID-19 is disrupting the economy, these measures are quick to administer and, if large enough, provide a significant source of demand to support an economy that is reopening. In that regard, they are probably enough to ensure an ongoing recovery in the economy over the remainder of this financial year and Treasury expects the level of economic activity to return to its March quarter 2020 pre-COVID level by the June quarter of next year.

By the second half of next year, the government is banking on a vaccine to begin lifting the spectre of COVID-19 from the domestic and global economy. Consequently, the government feels that it can dramatically reduce the deficit by a half, from $213.7 billion to $112 billion, by allowing the JobKeeper and JobSeeker supplement payments to expire. But what if the government is wrong and we remain in a COVID-19 world without vaccine? In that case, the stimulus contained in the Budget will not be enough.

Even if the government hopes are realised and Budget deficits are sufficient to carry the economy through to a point where the recovery can be self-sustaining, we are destined to leave a significant legacy of debt to future generations. Of course, many, including the Reserve Bank of Australia, correctly argue that it is not the size of the debt that is important, but its sustainability. According to Treasury, with interest rates at all-time lows, over the four years of the forward estimates, the net interest bill on the debt will be a very modest and easily manageable 0.7% of GDP. To put this in context, the interest bill on the current deficit will be same as it was in 2018/19 when our level net debt was under 20% of GDP.

That’s fine if interest rates remain low. But if the fiscal strategy is successful, surely that means we can’t stay at zero forever? Rates will eventually have to rise. And in any case, with such high levels of debt, aren’t we saddling our future generations with this debt problem, so that the current population can benefit from handouts – particularly the bulk of the population that are within a decade of retirement? But what could else could the government have done?

In our view, the government risks missing an historic opportunity to use its budget to, not only, rescue the economy in the short term from the ravages of COVID-19, but to seed spending on assets that could drive a nation building program. In particular, the lack of spending on infrastructure contained in this Budget is a missed opportunity. Differently from income support packages, infrastructure increases the capacity (or supply) of the economy and allows for growth in the economy with less inflationary pressure, and hence, less pressure down the track on interest rates. Infrastructure spending is longer dated, it provides the demand stimulus up front during the construction phase of the project, then continues to deliver ongoing economic growth during their operation.

The productivity-enhancing features of infrastructure leave a positive legacy for the future. Of course, spending on infrastructure projects has to be shovel worthy as well as shovel ready; not bridges to nowhere as happened in Japan and Greece. They need to be projects such as the Cross River Rail in Queensland that opens up access from Brisbane to the Gold Coast and adds to the development of the economy.

Finally, infrastructure spending leaves the government with a tangible asset. This is important as assets can be sold to pay down the debt. While it’s true that as the asset’s ownership passes from the government to the private sector, peoples’ use of the asset is no longer free. But those future costs are borne by the user who derives the benefit from the asset; i.e., future generations. Compare that with income-support handouts, whose benefits are captured entirely by the lucky few who receive them, but are ultimately paid for by future generations.

Table 1: Financial market movements: 1 - 8 October 2020

Source: Bloomberg