Opinion article

Budget 2015: Why I worry about public debt

In the lead up to the 2015 Federal Budget, Dr Rodney Maddock discusses public debt and the need to reduce to deficit to insure Australia against economic crises.

The Government is the biggest single player in the national economy. Its decision to spend a little more or a little less, has a much bigger impact than your decision or mine. By itself the Federal Government accounts for about 25 per cent of the total expenditure in the economy. This makes it a very important and strategic player in the economy. It alone has the potential to fix serious economic problems.

During the Global Financial Crisis for example, the Government could change direction quickly and add three per cent to net expenditure in each of the two crucial years. Nobody else could have done that. I think we should think of the Government as insurer-of-last-resort to the economy rather than a honey-pot.

As with anyone who spends more than their income, the Government has to find a way to pay for the excess spending. It could just print money but that is not a good idea since it leads to inflation, devaluation and a range of difficult problems. So the normal approach is for governments to borrow to finance their excess spending. This is what Australia and many other countries did during the crisis.

Obviously the money has to be paid back at some stage. The rhetoric about pushing debt onto future generations is correct in this regard. Government is really only justified in running a deficit, spending more than it takes in, in two circumstances:

  1. Where the spending is going to produce enough extra income to pay back the debt in the future, or
  2. In a national emergency or crisis when the economy is temporarily depressed. In both cases the money has to be paid back, so we still need to run surpluses at some stage.

The short run pressure on government is always to spend more, to run deficits - countries like France have not run a surplus since the 1970s. It is politically easy to give voters more welfare, more tax cuts or more infrastructure. It is much harder to raise the taxes or to cut benefits or other expenditure to repay the debt. There can also be shocks which cut government revenues more than expected, as with the fall in the Australian iron ore price at the moment. While this government and the last have expressed good intentions about getting back to surplus, the weakness on revenues from taxes, and the ever-present demand for spending, means that Australia is likely to have public deficits into the foreseeable future.

The accumulation of debt weakens the ability of government to act as an insurer to the rest of the economy. There are many economies in the world where governments can no longer play the insurer role. Greece is the stand-out example, but Italy, Ireland, Spain, France, Portugal and Britain all face similar constraints.

Ireland provides a salutary example. Before the crisis its public debt was 19.5 per cent of gross domestic product (GDP). It is now over 100 per cent of GDP. Spain entered the financial crisis with a debt level of 36 per cent of GDP, and it is now closer to 90 per cent of GDP. Fortunately we started in a better position and are still in a much better position. Australia’s public debt rose from under 10 per cent of GDP before the crisis, to closer to 30 per cent today.

The crucial points for us to think about in the Budget context however are that:

  • Public debt rises sharply in a crisis.
  • High levels of public debt constrain government’s ability to offset shocks.
  • Australia is about the same level of public debt that Ireland and Spain had pre-crisis
  • There is no immediate crisis but we are getting close to the stage where governments’ ability to act in a subsequent crisis is very limited.
  • In effect we have used up our insurance. Let’s hope we do not need it in the future.

Australia has been through this before. Public debt peaked at over 200 per cent of GDP in the 1940s. This was the result of excessive public spending on railways and a series of negative shocks which reduced public revenues (the 1980s depression, the Federation drought, World War I, the collapse of the gold standard, the Great Depression and World War II). It then took 50 years to eliminate most of the debt: this placed a significant burden on the post-war generations.

Governments need to address the deficit now to ensure it does not become a long term issue and to insure Australia against future economic crises. 

About the authors

Rodney Maddock

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Dr Rodney Maddock is a member of the CEDA Council on Economic Policy, which comprises some of Australia's best and brightest policy minds, and guides CEDA's research agenda. Dr Rodney Maddock is Adjunct Professor of Economics, Monash University; and Vice Chancellor's Fellow, Victoria University.
Dr Maddock was previously a senior executive at the Commonwealth Bank after earlier stints as Chief Economist for the Business Council of Australia, Head of Economic Policy in the Victorian Cabinet Office, and a Professor of Economics at La Trobe University. He has written extensively on different aspects of the Australian economy, and comments regularly of the Australian Financial Review and The Conversation

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