Scomo's economic reform options - three effective economic weapons

The 2019 federal election was about many things, but at a Politics 101 level, it was about how big a role government should play.

At issue was whether the role and size of government should expand, with more spending for instance on health and education, as proposed by the ALP, or remain much the same, as proposed by the LNP. Aware that significantly higher taxes would have to be paid to achieve the ALP's bigger government objective, the electorate narrowly favoured the LNP's position.

As a share of GDP, spending by all levels of government in Australia is 37 per cent. Had the electorate voted for Whitlamesque higher taxes and spending, it may well have ratcheted up to forty per cent or more within a few years.

This would have steered Australia further down the European economic road, where sclerotic economies like France, Greece and Italy have public spending shares over 45 per cent of GDP.

In contrast, in more dynamic Asia where Australia mostly trades, government size measured as a proportion of GDP is considerably smaller. For instance, in the advanced economies in our region, government spending in Singapore (more competitive and richer on a per capita basis than Australia), South Korea and Hong Kong is only around twenty per cent of GDP.

The sharpest ever rise in government spending in Australia occurred after the election of the Whitlam government in the early 1970s. It peaked in 1987 under the Hawke government, though this spike was, some years later, reversed by ALP Finance Minister Walsh. That fiscal consolidation was notably stronger than has occurred under any LNP government in the post war years.

In the wake of the Rudd-Swan government's inevitably counterproductive response to the GFC, the government spending share spiked again and remains close to that peak, despite attempted fiscal repair by the Abbott, Turnbull and Morrison governments. This contrasts with other advanced countries where the government spending shares of GDP have generally come down from their GFC peaks.

There was little, if any, mention during the election of Australia's competitiveness and its place in the world, except as a coal exporter. It was as though Australia is an economic island unto itself, and that whatever happens fiscally has no macroeconomic consequence. But it is not, and it has.

Higher taxes on capital and labour to fund higher levels of spending ultimately reduce the incentive to invest and work, slowing economic growth. Extra public spending also means labour and other resources are drawn away from industries that compete internationally, and toward the government sector, which is shielded from international competition. This adversely affects both competitiveness and productivity, further stymying long term economic performance.

Australia's economic history shows that whenever the size of government increases, it will not be significantly wound back, the notable exception being during the Hawke-Keating years. Yet, contrary to Keynesian dogma prevalent in Australian media and university circles, empirical evidence from the academic literature suggests when public spending is wound back, the economy is buoyed up.

Economic research on the optimal size of government in advanced economies, for instance, suggests a one per cent increase in the size of government reduces long-term economic growth by ten basis points.

This implies a five per cent cut in government spending across all levels of government would deliver a half a per cent of extra growth per annum over a five-year period. That would cumulatively generate tens of billions of dollars' worth of extra national income for Australia.

Cutting public spending, particularly on industry assistance and the overlap in spending at federal state levels, should therefore form part of the new government's reform program to boost Australia's anaemic post GFC economic performance, along with tax reform, including internationally competitive company tax rates and greater reliance on revenue from the GST, as well as industrial relations reform.

The election result was also proof, contrary to another widespread view in Australian media and university circles, that free market oriented neo-liberalism, wrongly blamed for the GFC itself and its aftermath, still breathes.

Economic neo-liberalism inspired the widespread reforms implemented during the Hawke- Keating and Howard-Costello governments that opened up the Australian economy to the world and transformed it for the better. Yet little meaningful economic reform has happened since.

Advanced economies have performed poorly post GFC, with significantly lower economic growth than experienced before the crisis. Real wage growth has also generally been sluggish, a key reason being that private investment, which acts as a conduit for productivity growth by embodying the latest technology, has been anaemic.

In turn, private investment has been adversely affected by the greater uncertainty related to the huge public debt overhang, unprecedented in peacetime, that resulted from ill-considered fiscal stimulus measures implemented in response to the GFC.

Japan holds the record for excessive public debt, with net public debt over 150 per cent of its GDP. Without serious fiscal repair, other advanced economies run the risk of turning Japanese.

Commentary on Australia's economy continues to focus on how it can be managed from the demand side, more recently zeroing in on the expected cuts in official interest rates by the Reserve Bank. However, while of some use, there is little scope for significant adjustment there.

While the prospective income tax cuts have also been interpreted as a demand measure, by improving work incentives they are likely to be more effective on the supply side of the economy, which should garner much greater attention.

In Japan Prime Minister Shinzo Abe has yielded mixed results with his so-called 'three arrows' economic reform programme – known as Abenomics – aimed at increasing Japan's persistently weak growth rate. Abenomics has fallen short however because the government has not addressed Japan's staggering public debt and structural problems that persist on the supply side.

On the other hand, the reforms proposals for Australia outlined above - reduced government spending, tax reform and industrial relations reform - would constitute a more potent 'three spears' package for bolstering the Australian economy. A Scomonomics programme perhaps?