Kevin Rudd did not save the economy in 2008
Tony Makin
Oct 15, 2018 – 11.45pm
Ten years ago this month the Rudd government, having already taken necessary steps to protect Australia's banking system from the financial firestorm flaring from Wall Street, announced its first $10.4 billion fiscal stimulus package.
Days after on these pages I argued that, as an exercise in Keynesianism 101, it was bound to fail as Australia was not a closed economy. If fiscal measures were to be taken, they should be directed to the supply side of the economy via tax measures, not the demand side via increased government spending.
To this day, the architects and apologists for the first and second $42 billion fiscal stimulus package, again mainly focused on increased government spending, insist that this federal fiscal stimulus – huge by international standards – in 2008-10 saved Australia from recession. The old adage that "there are none so blind as those who will not see" fits to a tee those who believe this.
Kevin Rudd with treasury secretary Ken Henry in October 2008. 2008
There is no relevant theory that supports it, and it is at odds with the facts.
First, the facts. According to national accounts data Australia did go into recession during the GFC by the most appropriate measure of recession – two consecutive quarters of negative GDP per capita, as well as by other measures such as the income, production and terms-of-trade-adjusted GDP measures.
Second, claiming the stimulus worked efficaciously is at odds with textbook theory of how an open economy like Australia's with a floating exchange rate and high international capital mobility functions. Yet this orthodox theory perfectly explained the impact of spending oriented fiscal stimulus and its subsequent harmful effects on the rest of the economy.
What textbook theory simply says is that budget deficits put upward pressure on interest rates and induce foreign take-up of government bonds issued to fund the deficit. That pushes up the exchange rate, which worsens competitiveness, negatively affecting the economy's trade performance. Export values fall and imports flood in to displace relatively more expensive locally produced goods and services. Fiscal stimulus therefore crowds out net exports.
Unfortunately, this theory is usually only taught at intermediate undergraduate level in economics majors, which helps explain why anyone without formal economics training is unaware of it. But ignorance of mainstream macroeconomic theory does not mean you can make up your own, or fall back on the original unrealistic closed-economy Keynesian model that assumes the economy has no international trade, capital flows or exchange rate, and that public debt does not matter.
Two major mistakes
The national accounts show that due to implementation lags, the extra government spending supposed to stimulate aggregate demand appeared several quarters after the worst of the crisis had passed. As the stimulus was rolled out, the Australian dollar kept climbing, to reach decade-long highs between 2011 and 2014, with peaks of over $1.10 against the United States dollar in 2011.
As the stimulus was directed to sectors largely immune from international competition it also put upward pressure on non-tradable goods and services relative to tradable goods and services, which further worsened international competitiveness by another route.
It was during 2011-14 that serious fiscal consolidation, focused on reversing the stimulus spending hike, should have begun. That would have taken off the strong upward pressure off the dollar, and stopped the escalation of public debt that had by then begun in earnest, due to the historically large budget deficits.
It is a disturbing fact that the interest paid to holders of Australian government bonds now exceeds, year after year, the original cash splash of the first stimulus package. As two thirds of federal government bondholders are foreigners, the interest paid abroad to these lenders subtracts directly from national income and is about three times the federal government's foreign aid outlays.
So two major fiscal policy mistakes were made. There was the excessive stimulus itself focused on counterproductive government spending rather than tax reform and relief, which would have delivered long-term productivity improvement. And then there was a failure to quickly reverse the spending blowout as occurred under former treasurers Keating and Costello in similar circumstances.
The exchange rate appreciation stemming from large stimulus-induced budget deficits severely worsened Australia's competitiveness and would have cost tens of thousands in jobs, especially in manufacturing, offsetting the dubious 200,00 jobs saved.
If the number of jobs saved, including those of workers installing pink batts who then had to find work elsewhere when the scheme ended, happened to be right, it was at a cost of $250,000 each to taxpayers.
The subsequent employment loss due to the stimulus-induced exchange rate appreciation, which apologists never mention, has yet to be rigorously quantified. It remains a worthy research topic for academic or Treasury economists. Explaining how much fiscal stimulus contributed to the slow economic recovery and to weak private investment, lacklustre economic growth and subsequent stagnant wages is also a worthy topic for research.
One thing is certain. It cannot be done properly while wearing Keynesian blinkers.
Tony Makin is professor of economics at Griffith University and author of The Limits of Fiscal Policy, Palgrave Macmillan
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