Nothing to fear from debt and deficit

The 2020-21 Budget forecasts gross government debt to hit $1 trillion in the next year. In the coming months, we will undoubtedly see numerous stories about the need to get government debt back under control. A large proportion of Australians were already worried about the level of government debt before the COVID recession. This fear is mostly misplaced. Instead, Australians should fear business failures, high unemployment, and the broader societal issues this will cause.

The government is not a household

Public debt is not like household debt. Consider the differences between the government borrowing and households borrowing for a mortgage. First, governments borrow against an asset, which is the productive capacity of Australia. In contrast, households borrow against the value of a home.

Secondly, people retire – governments don’t. Households are limited by the amount of income they can earn over a lifespan. In contrast, the productive capacity of the country has no finite lifespan. Therefore, the government can roll over its debt indefinitely, provided the nation’s economic activity continues. As the nation’s economy grows, the debt’s size in proportion to national wealth, measured as Gross Domestic Product (GDP), falls.

The Australian Government rarely makes more than it spends. As shown in the charts below, Australia has run budget deficits in 87 out of the 120 years since federation. Few banks would ever lend to a household with similar spending and income arrangements as the Australian Government. Yet, institutions are still willing to lend to the government. There remains strong demand for Australian Government debt, with borrowing costs the lowest since the federation. The Australian Government has never defaulted on its debt and can shrink the debt relative to the economy’s size if Australia’s productive capacity grows.

How to pay down the debt

There will be a time in the coming years when Australia will need to address the build-up of public debt, but the best way to do this is through economic growth. If nominal economic growth (nominal GDP) exceeds the running yield on public debt, the debt to GDP ratio will decline over time. Nominal GDP growth has averaged 8.5% p.a. since 1960 and 4.7% p.a. over the last decade. This has occurred before. Australia rapidly paid down its war debts relative to the size of the economy. The post-war boom saw rapid economic expansion, which in turn, reduced public debt relative to the economy’s size, despite the government running deficits during most of this period.

Ideally, government debt should be in the country’s own currency, so that debts don’t blow out if faith is lost in the currency. This has occurred multiple times in Argentina, where government debt is largely issued in foreign currency. Government debt should also mainly be fixed-rate, so the level of interest payments are predictable. Australia ticks both these boxes, with government debt issued in Australian dollars and at a fixed-rate. The Australian government can currently borrow for 10 years at a fixed rate of 0.9%. Despite the amount of Australian gross government debt more than doubling from 2018-19 to 2023-24, the total interest paid by the Australian government in 2023-24 (18.1 billion) will be lower than the interest paid in 2018-19 ($18.9 billion). It is for these reasons that a survey of 50 leading Australian economists – including academics, RBA board members, and Ai Group’s Julie Toth – found that 94% agreed that “Governments should provide ongoing fiscal support to boost aggregate demand during the economic crisis and recovery, even if it means a substantial increase in public debt.”

The costs of higher unemployment are much higher than the cost of government debt

There are countless studies on the economic and social costs of unemployment. In a recent speech, RBA Governor Philip Lowe described some of the long-term economic scars that can occur from recessions, including:

  • young people unable to get onto the jobs ladder, or slipping off it, with long-term effects on their careers and their lives;
  • people of all ages losing training opportunities with long-term consequences for their careers;
  • lower levels of investment in capital and research by the public and private sectors; and
  • damage to individuals’ lives, their families, and “to the fabric of our society” due to long periods of unemployment.

Dr. Lowe holds that “the government can play an important role here by using its balance sheet to smooth things out and reduce the severity of the downturn. In doing so, it helps not only in the present but in the future as well.” All levels of government must focus on stimulating demand in the economy. An economy operating below its potential due to low demand can create a reinforcing downward spiral. Firms with excess capacity have little reason to invest in expansion, leading to low job creation and increased unemployment, while workers’ skills erode. Workers bring home less disposable income to spend on goods and services. The spiral goes full circle as firms invest less because there is less demand for their goods and services. When the economy falls below its potential, its future growth can be compromised: an unexpected shock can cause a lasting depression, as was the case in the 1930s.

The Great Depression

The Great Depression was a policy failure with catastrophic consequences. A recession in 1930 turned into the Great Depression because of a continued collapse in demand over the subsequent two years. In part, this was due to “the Melbourne Agreement,” which was signed by the federal and all state governments in 1930. It involved austerity measures such as decreasing welfare payments and abandoning public works projects to rein in government spending. Both state and federal governments also agreed to increase taxation to raise revenue. Australia ran a surplus in 1933 despite unemployment remaining at 19% and had no centralised federal unemployment assistance program at the time, which meant the unemployed had to rely on charities for necessities. Similar policies were enacted worldwide, with many historians suggesting they played a factor in the social discord that led to World War 2.

Without JobKeeper and the increase in JobSeeker, Australia’s unemployment rate would be approaching the all-time highs hit during the Great Depression. The Commonwealth Treasury’s effective unemployment rate peaked at 15.4% in April but has now fallen to 9.5%. This measure includes those on JobKeeper who are not working, plus those who have become unemployed since March but are not looking for work. It remains significantly higher than the ‘official’ unemployment rate, which peaked at 7.5% in July and fell to 6.8% in August. The JobKeeper scheme is playing a crucial role in saving thousands of businesses and millions of jobs. Without these stimulus measures, Australia would find itself worse off with higher unemployment and larger deficits, due to reduced tax receipts (from receiving less company and income tax) and higher spending (from paying out more unemployment benefit payments).

Ai Group’s comment on the Budget

Ai Group welcomed the 2020-21 Budget announced by the Treasurer on Tuesday 6 October 2020. While it is a big-spending budget, it is spending up big on the areas required to turn around the economy and set it on the right path for the future. Higher productivity, greater employment opportunities, and renewed business and consumer confidence are prerequisites for a return to widespread income growth in Australia. This will re-establish the tax base on which our future fiscal strength can be regained.

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Andy joined Ai Group as an Economist in 2017. He is responsible for analysis and commentary on Australian and international economic developments. Prior to joining Ai Group he worked for the Commonwealth Department of Industry, Innovation and Science and for a private economic consulting firm in Brisbane. He holds a Bachelor of Economics and Finance from the University of Queensland.

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