Why the budget matters

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Economists generally describe our economy as being ‘small’ and ‘open’. This is not intended to imply that it is ‘insignificant’.  Rather, the simple fact is that, as a nation, we produce goods and services that are sold into world markets where Australian producers exert little influence over price.

The upshot is that aggregate economic activity in this country is largely dictated by the status of these world markets and governments can do relatively little to modify this.

When thinking about Federal budgets it is also important to understand that the Australian economy in 2010 is very different from what it was thirty years ago. Monetary policy is largely independent of government, exchange rates are established by markets and wage rates are generally determined by the relative scarcity of labour.

In simple terms, the Federal budget influences economic activity only at the margin – regardless of which political party is in power or how much governments like to tell us that their actions are pivotal to success.

The Federal budget of 2010 is clearly illustrative of these fundamentals. The Treasury is now expecting a faster return to surplus, largely because commodity prices have rebounded strongly in the past year.

Claims have also been made that the economy did not suffer the expected downturn because of rapid intervention and the fiscal stimulus delivered in 2009. Whilst there is some evidence to support this, it would likely be a very different story if world events had not turned in Australia’s favour.

Similarly, the surplus inherited by the present government was really only on hand in the first instance because of buoyant commodity prices in the previous decade - the Opposition can hardly claim to have influenced world markets any more than the incumbent administration.

So why bother about the Federal budget?

Budgets matter because they shape the distribution of income and wealth, and impact on incentives, albeit at the margin. For example, the 2010 budget announced an increased tax take from the resources sector. Most of the firms that operate in this sector probably already factored in this risk, although they will be keen to limit future impacts. In fact the biggest problem with tax changes of this kind is that they add uncertainty to investment decisions. The revenue that is appropriated is probably less important to these firms than the prospect of having future governments move the goals posts without much consultation.

Clearly, the intended ‘winner’ from the budget is the health sector, with the Labor government apparently keen to use health reform as part of its re-election campaign. In a more general sense, this should raise concerns about the efficacy of Federal governments managing activities that have historically been the responsibility of the states, but that’s a bigger story.

Whilst I am no expert on the health sector, there will undoubtedly be pressure to ensure that some of the embarrassing episodes that accompanied recent spending exercises are not repeated.

A colleague at La Trobe often reminds me that taxpayers should be able to expect governments to ‘waste their money wisely’. In the case of the present budget, the verdict on health spending will largely depend on the accompanying legislation required to support reform. If this is up to scratch and manages to make its way through both houses of parliament then the budget will have done a reasonable job.  Until then, it is hard to judge the merits of the budget.


Prof Lin Crase    
E: l.crase@latrobe.edu.au