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Trade-offs, what trade-offs?

More Budget blues

16 April 2022

9:00 AM

16 April 2022

9:00 AM

One of the advantages – could also be a disadvantage – of being locked up in a room with the Budget Papers for several hours is the tendency to take in the detail, including footnotes to charts. Any sane, unshackled person would skim the key points of the Budget and leave it at that.

Don’t get me wrong – I’m not a complete idiot. I always take in a novel but I make myself plough through the Budget Papers for at least three hours before giving into temptation.

Statement 2 of Budget Paper No. 1, Economic Outlook, is particularly important among the many hundreds of pages that make up the Budget Papers. Traditionally, it was this statement that was reserved for the Treasury only to prepare, unfettered by the government’s economic ministers.

The absence of political interference is not so clear-cut these days, but one should still be able to assume that this statement represents Treasury’s best guess of the economic outlook.

So let me take you to Table 2.1, footnote (f). (That’s right, I can be a serious sad sack – get over it.) Here we are told that ‘key commodity prices are assumed to decline from current elevated levels by the end of the September quarter 2022.’

Evidently in six months’ time, ‘the iron ore spot price is assumed to decline from $US134/tonne to $US55/tonne; the metallurgical coal spot prices is assumed to decline from $US512/tonne to $US130/tonne; and the thermal coal spot price is assumed to decline from $US320/tonne to $US60/tonne.’

Now I’m not sure you need to have completed an economics degree, or be an observer of commodity markets, to conclude that these assumptions are completely daft. We are expected to believe that, in this short space of time, there will be a rapid decline in the price of iron ore and catastrophic falls in the price of metallurgical and thermal coal.

There are no reasons given and the discussion in Statement 2 doesn’t point to any forthcoming economic calamity affecting our trading partners that might explain such dramatic commodity price falls.

But here’s the thing: these assumptions are highly significant to the Budget bottom line. Last year, a slightly less ridiculous (but still ridiculous) set of assumptions about commodity prices – iron ore was going to fall to $US55/tonne by the March quarter of this year – it was over $US100 at that stage – meant that close to $30 billion in revenue was missed. Instead of the Budget deficit coming in at $107 billion, the estimated figure is now $80 billion.

You may ask why this matters; after all, commodity prices will be what they will be. But the effect of this seemingly deliberate under-estimating of the price of iron ore and the two types of coal – something that has been a feature of the Budget process for some years – is to give the misleading impression that the Budget position has improved in the next year (and subsequent years) even though it is just the result of Treasury’s mistake.

The real danger from these shambolic, ongoing errors is that the government opts to spend the (illusionary) improvement to the Budget bottom line while claiming a modicum of fiscal responsibility.

Is it too far-fetched to also conclude that the Treasury is fundamentally opposed to the resources industry and the bounty of tax revenue it provides? In all likelihood, there have been structural changes affecting (real) commodity prices that mean the long-run averages are now meaningless – something that Treasury won’t acknowledge.

For very many years, for instance, the real price of iron hardly moved; from around 2005, this all changed. As for coal, my guess is that Treasury regards it as a potential stranded asset, along with all committed greenies. That’s why it keeps bunging in massive falls in its price.

But let me give an example of another ridiculous assumption Treasury uses to devise the medium-term fiscal outlook (over the next decade).

This was an ‘innovation’ commenced under Treasurer Wayne Swan who took the line that if the forwards (four years out) don’t look too crash-hot, check out the situation in a decade’s time.

The medium-term outlook in this year’s Budget indicates that there won’t be one cash surplus between now and 2032-33. But in Treasury’s book, this is OK because as long as the growth in nominal GDP is greater than the interest rate, then gross debt as a percentage of GDP falls notwithstanding those Budget deficits.

Now that might be fine in theory, but the Treasury then simply assumes that the economic growth will be higher than the interest rate and that government debt will be financed at 2.2 per cent. (Leave aside here the distinct possibility that economic growth could be lower or negative at some stages in the future.)

As economist Warren Hogan has pointed out, just last week ‘the Australian government 10-year bond yield flirted with a 3 per cent yield to maturity. The three-year yield rose above 2.5 percent. And the Reserve Bank of Australia hasn’t even started raising the cash rate.’

In other words, the key assumption that Treasury has been using about the sustainability of rising government debt has already been invalidated a fortnight after the Budget Papers hit the streets.

Hogan also makes the point that Treasury has become confused by the decades of low interest rates as representing a new norm whereas the more likely outcome is that interest rates will rise, particularly in the context of rising inflationary pressures.

Of course, it’s politically easy to sell the idea of money growing on trees – effectively what Treasury has been pushing – but when you see the fiscal challenges ahead, it’s more a case of professional negligence. To imply to the public that there are no trade-offs has been both damaging and untrue.

There is talk that the annual cost of the NDIS will soar to around $90 billion by the end of the decade – it started at $12 billion – and that very large sums will need to be devoted to aged care and child care (particularly if Labor wins). Defence will also require much more government spending.

My hunch is that most members of the public understand that we can’t have it all and that choices need to be made.

We are about to bear the consequences of governments, egged on by Treasury, peddling the opposite line.

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