February 25, 2015

Debt, deficits and averting disaster

By Russell Marks
Debt, deficits and averting disaster
Are we really stealing from our kids to fund a debt crisis?

The new head of treasury, John Fraser, believes strongly in the virtue of austerity – the slashing of government spending during economic downturns. That’s helpful for Joe Hockey, who appointed Fraser, because it’s what Hockey also believes. Government spending is bad, because it leads to budget deficits and public debt, which are worse. Practically the government’s entire budget strategy is built around this idea.

Take the proposed GP "co-payment", for instance. One way or another, the Australian government led by Tony Abbott is determined to put a “price signal” on visits to GPs. The plan has had various iterations since it was announced with virtually no forewarning as part of last May’s budget measures: first, co-payments of $7 for GP visits and $5 for prescription medicines; then a short-lived cut of more than $20 to the Medicare rebate for some consultations; now a $5 rebate cut for general patients that is scheduled to start in July. All iterations do the same thing: increase the out-of-pocket costs for patients when they visit the doctor or buy medicine doctors prescribe, and consequently reduce the amount the government pays through Medicare.

Why is this government policy? There are two reasons. The first is an application of simple economic logic. “Something that’s free is not valued,” said Commission of Audit chair Tony Shepherd last May. According to departmental figures, more than 80% of GP consultations are bulk-billed. When Shepherd discovered that each Australian visits the GP 11 times every year, he concluded that he just didn’t think we were that crook: a price signal would work, in theory, to correct some of the “distortion” presently in the system.

The second relates to what the government sees as the problem of public debt. The federal government’s share of public debt is presently between $350 and $400 billion. On that debt, the government pays interest – just under $1 billion every month. The opportunity cost of paying all that interest, according to Tony Abbott, is a “brand-new tertiary hospital every single month”. Every year the government records a deficit in its budgetary balance sheet – every year the government spends more than it receives in taxation revenue – it adds to the debt and interest burden. And one of the fastest rising components of government spending is Medicare. The Commission of Audit predicted that as the population ages, the cost of the Pharmaceutical Benefits Scheme will grow by 5.4% every year, the Medicare Benefits Schedule (which pays for some or all of the cost of seeing doctors) by 7.1% every year and hospitals by 10.4% every year. The government says “growth in health spending has become unsustainable”.

Of course, $5 here and $7 there wouldn’t do very much to make the system more sustainable. And given that the co-payment was originally going not into the budget but a new “medical research future fund”, the direct effect of the co-payment on the budget was probably going to be close to nil. But by adding a price signal to Medicare – in other words, by moving from bulk-billing towards a “user pays” model – Abbott and Joe Hockey hope, like Tony Shepherd and Abbott’s former health adviser Terry Barnes, that patients will be discouraged from seeing the doctor when they don’t really need to. The best way to cut the MBS component of the budget is not to claw back $5 from every GP visit, but to pay for fewer visits overall. Fewer GP consultations means lower MBS expenses and hopefully even lower PBS expenses, as surely part of the problem of the overuse of prescription medication is that patients are in doctors’ rooms too often in the first place.

All this requires economic literacy of the most elementary, supply-and-demand kind, and the obstinate refusal of Australia’s public to “get it” is causing Hockey extreme frustration. The only way to turn around Australia’s growing debt (and interest repayments) problem is to get the budget back into surplus. To achieve that, Australians need to accept either that they must pay higher taxes – and Abbott promised before the election that they wouldn’t – or that government must cut the amount it spends on services like health, university education and welfare. If the Senate continues to hold up the government’s austerity program, the debt (and interest repayments) will continue to balloon, and Australia will end up just like Greece.


Aside from the government’s media cheer squad and some well-placed business advisers, nobody is buying the above story. The Australian’s Janet Albrechtsen thinks that’s because the public is “selfish”, but it’s probably more the case that the public smells bullshit.

A number of obvious problems with Hockey’s story have emerged. The first is that Australia’s ratio of public debt to its national income – a more meaningful way of talking about debt than the sheer amount of it – is under 30%, as measured as a percentage of gross domestic product, GDP. That’s not high, either historically or comparatively. For the century until about 1970, Australia’s total public gross debt-to-GDP ratio was always above 30%, and it twice (the early 1930s and the late 1940s) peaked above 150%. Greece has a debt-to-GDP ratio of over 170%, and since it joined the European Commission (later EU) in 1981, its ratio has never been below 50%. Out of 50 countries listed by the website Trading Economics, Australia’s ratio is the ninth lowest. And Australia’s ratio is lower than three quarters of the G20 nations. So the government’s central claim – that Australia faces a “debt and deficit disaster” – is itself highly contentious.

Secondly, in leaving relatively untouched the budget amounts spent on wealthier people, Hockey lost all control of the story of his efforts to cut into pensions, welfare, health and education. Those efforts became about unfairness and inequality instead of debt reduction. On negative gearing (a tax-offsetting scheme that allows property owners to amass a portfolio of properties with government support) and tax concessions or rebates to superannuants, private health insurance consumers and trustees, the Australian government spends nearly $50 billion every year. Why did the 2014 budget target the spending that went to the poor but not that which went to the rich?

That the 2014 budget was “unfair” became quickly axiomatic. Early efforts by government ministers to assert that it wasn’t – such as Hockey’s suggestion that low-income earners would not be affected by the proposed unfreezing of the fuel excise because they “don’t have cars or actually don’t drive very far in many cases” – became further evidence that they were “out of touch” with the prevailing understanding of fairness in Australia. More recently, the government has attempted to recast the national conversation about inequality by claiming – as Hockey’s parliamentary secretary Kelly O’Dwyer did in a major speech to a free-market think tank recently – that its 2014 budget is all about “intergenerational fairness”. The question is not whether today’s poor are disproportionately being required to fix the federal finances. It is whether we are prepared to steal from our children to fund our profligate lifestyles today, now that the mining boom has ended the Howard-era good times. National debt, explained Tony Abbott himself to the National Press Club, is really just “intergenerational theft”.


What is government debt, and how is it raised? Could we really be building a new hospital every week if we didn’t need to pay the interest on the government’s present debt? Are we really stealing from our kids?

Governments raise funds in two ways: through taxation, which is politically difficult for obvious reasons, and by issuing bonds and notes. Such instruments are promises to repay whoever buys them at the full purchase price at maturation, which may be in two, five, ten or fifteen years’ time. Like any other loan arrangement, to make it attractive to the bond-buyer, the government must also compensate the bond-buyer during the time the latter holds the bond: it does this by paying interest at fixed intervals. By definition, the bond rate must be competitive with the prevailing price of money on the open market.

When the bond rate is very low, as it is now – the ten-year bond rate is at an all-time low of 2.55% – the government can borrow money and repay bondholders at that rate of interest for the next decade. By definition, if whatever project or investment the government spends that borrowed money on generates a return of greater than the bond rate, the debt is a very, very good idea. And it’s a much better idea to borrow now to fund an infrastructure project that’s predicted to generate high returns (like a new hospital, or a rail extension, or a justice reinvestment scheme to reduce prison spending) than to avoid borrowing and therefore leave that project to a future government that will probably need to borrow at a higher bond rate.

There are many problems with equating all public indebtedness with “intergenerational theft”. One, as explained above, is that it ignores occasions when borrowing can (like using a mortgage to fund the purchase of a house) help the government improve the national asset stocks and actually generate “returns” that over time reduce its reliance on taxation revenues. Another is that such a discourse highlights the Abbott government’s repeal of the carbon price, which was demonstrably working to slow the greatest intergenerational theft of all time: the burdening of future taxpayers with the problem of climate change, which will only become more and more expensive to reverse.

A third problem with the government’s “intergenerational theft” analogy is that it fundamentally misrepresents the nature of public debt and government budget deficits, and their relation to private debt. For some time now in Australia, governments of both colours have sought to persuade voters that budget deficits are bad (because they lead to debt and interest payments and now intergenerational theft) and budget surpluses are good. But mostly what a surplus means is that the government is taxing more than it is spending on infrastructure and services. In other words, surpluses take money out of the economy, which is sometimes a good idea – as in during times of inflationary risk like economic booms – but is sometimes a bad idea – like during recessions and economic downturns. If a budget surplus is desirable it’s because it reflects, rather than generates, good times. Pursuing a surplus at all times is like expecting the full cart to somehow push the horse uphill rather than drag it down to the bottom. The only inevitability is, in fact, a gigantic crash.

The Abbott government’s preferred method of generating a surplus – expenditure cuts – can be described as a program of mild austerity. But as Europeans have (not?) learnt since the 2008 global financial crisis, austerity programs don’t often work as intended. As John Maynard Keynes recognised in his General Theory (1936), if consumption is the final goal of economic activity in market economies, then reducing the spending power especially of people at the lower end of income scales during downturns or recessions when their jobs are less secure will tend to exacerbate the downturn across the whole economy. As Mark Blyth argues in his more recent history of Austerity (2013), the recession-augmenting effects of austerity policies have actually been demonstrated on practically every occasion for the last two centuries. It’s no surprise that those European countries that have followed the austerity prescriptions of Brussels have been the slowest to recover, if they’ve recovered at all. It’s also no surprise that Australia, whose government flipped its fiscal policy in line with Keynesian theory and borrowed and spent heavily, was one of the few OECD countries to avoid a technical GFC recession.

Implementing a price signal in Medicare-funded transactions is an austerity measure that aims to dissuade patients from seeing the doctor or purchasing prescription medicine except when they really need it. Putting aside for the moment the odd idea that the number of hypochondriacs who have nothing better to do than to see their GP for no good reason is significant enough to respond with public policy, public health experts have warned the government that cracking down on primary health expenses will very likely push some patients – especially those on lower incomes, who are also statistically the least healthy – into the tertiary health system (that is, hospitals), which is much more expensive. Even if there is evidence of the overuse of GP appointments – and this is highly contentious at best – that probably reflects a working allocation of resources, given that the alternative is even more expensive. Shouldn't we be encouraging people to see the doctor, if just for checkups, so that problems are identified early? And isn't it preferable to remove the question of the patient's capacity to pay from each primary health transaction, and deposit it – as we do already with the Medicare levy, which the government forgets about when it says middle class people should pay to go to the GP – in the taxation system?

The sad experience of unintended consequences pervades the history of austerity, as governments focus too much on nominal fiscal amounts and not enough on what costs those investments are preventing down the track. Likewise, the Abbott government’s desire to claw back a chunk of what it “spends” on university education may well, according to at least one analyst, have the unintended consequence of further blowing out the debt, by increasing the number of bad student debts and triggering higher inflation.

Why is the Australian government pursuing policies of mild austerity, aimed at low-income earners, during a time of rising unemployment, stagnant wages and slow inflation? For that matter, why do some of the world’s most important economic organisations – the International Monetary Fund, the European Union and the Organisation for Economic Co-operation and Development – so often prescribe austerity for countries experiencing poor economic conditions? Mark Blyth traces a long march through the institutions of economists trained in the theories of the Austrian school (like Friedrich Hayek), which found renewed favour among Western policymakers during the 1970s. In other words, the belief in the benefits of austerity is more ideological than empirical.

Blyth also records a long-held suspicion of public debt among Western liberal thinkers. For liberals going back to Adam Smith, David Hume and John Locke, the modern state is a necessary evil – necessary to police the inequalities generated by markets and protect private property from the more numerate have-nots who would inevitably steal or destroy it; evil because any institution powerful enough to do so is also powerful enough to turn against them. (That’s not a Marxist view. It was Adam Smith who wrote, in The Wealth of Nations, that “civil government, so far as it is instituted for the security of property, is in reality instituted for the defence of the rich against the poor, or of those who have some property against those who have none at all.”) When the state needs money, it either taxes (for classical and neoclassical liberals, a bad thing) or raises debt. And despite the largely happy, productive story of public debt over the past two centuries, liberals have always worried that it imposes “unfair” burdens on current and future generations. Hume famously campaigned for most of his 18th-century life against the “degeneracy” wrought by Britain’s public debt, which continued to grow and grow and grow throughout the century of its unchallenged global economic dominance after its war with Napoleonic France ended in 1815.

Australia’s new treasury boss, John Fraser, is at one with Hume in his suspicion of public debt and government budget deficits. He’s more ideologically suitable to the Abbott government than his predecessor, Martin Parkinson, who resigned when he was told he didn’t have Abbott’s confidence. On 25 February this year, Fraser told a Senate estimates hearing that he believes strongly in US President Ronald Reagan’s tax cuts in the 1980s and their claimed (but unproven) “trickle-down” effects. He doesn’t like public debt because it “leaves you liable to the vicissitudes of the market”: when interest rates go up, too much of national budgets are taken up with interest repayments.

Not that that's a problem for the foreseeable future, however. If Australia faces a debt crisis right now, it’s a crisis of private debt. Never have Australians owed more to banks and other lenders as a percentage of GDP – not even during the recession of the early 1890s. And reducing public debt almost always means private debt will fill in the gaps. Right now, public debt pales into relative insignificance against the level of private debt (more than $2.3 trillion), which makes calls on individuals rather than on risk-pooling states. During the mid 1990s, private debt was less than double government debt ($395 billion to $217 billion in 1995). Private debt then rose exponentially during the period of the Howard government, and at one point in 2008 it was over one thousand times greater than the level of government debt. Not surprisingly, private debt only began to level off – and then only mildly – when the Rudd government switched the fiscal policy direction in response to the GFC. But individuals are now so loaded with household and credit card debt that they can no longer respond as intended – by borrowing and consuming more – when the Reserve Bank lowers the cash rate. What the policies of Abbott and Hockey would achieve, even if they were successful at lowering public debt, would be to send private debt careering even higher.

John Fraser was chairman and CEO of UBS Global Asset Management in London for over a decade from 2001. He was in that role when UBS, which was implicated in the US subprime mortgage crisis and later settled two lawsuits for over $1 billion brought by a US government agency and private investors, suffered among the greatest losses of any European bank out of the financial crisis in 2008-09. UBS received huge bailout injections from the Singaporean and Swiss governments, but Fraser remains “suspicious” of government spending. Mark Blyth argues that the European response to the financial crisis, encapsulated in a banks initiative agreed in Vienna in January 2009, was in the end all about saving the banks’ bond holdings — and it was the pensioners and other welfare recipients who had to shoulder the burden. This is the experience Fraser brings with him into the Australian treasury.

If the government wants to get more bang for its buck, there are countless things it could do. It could stop the billions that flow to already-wealthy Australians through tax offsets. It could legislate to require food companies to stop externalising the cost of obesity, which now means a significant portion of what the government spends on health goes directly to tackling obesity. It could require tobacco, alcohol, energy and indeed other private companies from externalising the costs of their own industries too. It could direct the states to pursue justice reinvestment programs that prevent criminal behaviour instead of locking up prisoners at a daily cost of between $300 and $600 per prisoner despite no rehabilitation benefits. But this government doesn’t want to do those things. It wants instead to pursue debt-reduction programs that have demonstrably failed elsewhere and which will only reduce the stability of young people’s employment and burden future generations with our deferred infrastructure and our climate change problem. If that's not intergenerational theft, it’s difficult to imagine what is.

*An earlier version of this article was published on 25 February 2015, prior to John Fraser’s appearance at the Senate estimates hearing on that date. The article has since been updated to reflect that appearance.

Russell Marks

Russell Marks is a lawyer and an adjunct research fellow at La Trobe University. He is the author of Crime and Punishment: Offenders and Victims in a Broken Justice System (Black Inc., 2015). 

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