The Wrong Plan for Australia

Source Wall Street Journal
By STEPHEN KIRCHNER

Australian Prime Minister Kevin Rudd has just unveiled a fiscal stimulus plan worth 10.4 billion Australian dollars ($7.4 billion). At around 1% of GDP, it's bold. Will it work? Probably not as intended.

The plan consists of a set of handouts for politically appealing groups, such as old-age pensioners and families with children. There's also a big boost to infrastructure spending. It's a dramatic change for a government that as recently as May was hewing to the tightest fiscal policy since 1970-71, with a budget surplus of 2.1% of GDP. That budget was designed to put downward pressure on inflation. Taken together with the Reserve Bank of Australia's one-percentage-point easing at the beginning of the month, the new stimulus package points to a major reassessment of economic risks on the part of Australian policymakers. Growth has replaced inflation as the top concern.

Mr. Rudd's plan might look like a solution in search of a problem. Economic growth is set to slow, but Australia's real economy has yet to show significant stress from the global financial crisis. Financial institutions remain sound, and confidence has been boosted by the weekend's coordinated move by Australia and New Zealand to insure deposits. Monetary policy has already responded aggressively and a sharp fall in the Australian dollar exchange rate relative to the U.S. dollar is performing its traditional function of insulating Australia from external economic shocks.

There's certainly room for stimulus measures. But there are risks to stimulus, too. Timing fiscal stimulus measures so they take effect when they are most needed is difficult. Get the timing wrong and these measures could end-up being pro- rather than counter-cyclical.

A case in point is the government's proposal to accelerate its infrastructure spending agenda. Even with an accelerated timetable, work on these projects will not commence until well into 2009, with much of the spending not seen until even later, when Australia may already be through the feared economic downturn. Infrastructure spending decisions made in a crisis atmosphere might not be evaluated to the highest standards. Australia could be saddled with some wasteful rather than productivity-enhancing infrastructure projects.

Other aspects of Mr. Rudd's plan are at odds with what government should be doing in the current environment. The plan provides $1.5 billion in grants to first-time home buyers. It would double the grant amount to buyers of existing homes, while tripling the grant to buyers of newly built homes. The latter measure will be useful in addressing the chronic housing shortage that has driven housing affordability in Australia to record lows and seen rising rents makes a significant contribution to inflation.

The grant to buyers of existing homes, however, will serve only to bid up the prices of existing properties, the opposite of what is needed to improve housing affordability. This will benefit existing home owners rather than new home buyers, and has little value as a stimulus measure because it merely transfers wealth from buyers to current owners rather than encouraging new housing supply.

In other respects, the plan moves away from, not toward, broader structural reforms important to the long-term health of the economy. Consider the lump-sum payment to old-age and other pensioners, scheduled for December. Single pensioners will receive a one-time payment of A$1,400, while couples will receive A$2,100. The government calls this a "down payment on long-term pension reform," but it leaves the long-term future of pension reform an open issue. The focus for future reform needs to be on reducing dependence on the government pension. This means making the pension less rather than more attractive, so as to encourage people to save for their retirement.

Similarly, the government will make a one-off A$1,000 payment for each child in eligible families. While this may have some value as a short-term economic stimulus measure, it does not address some of the long-term issues clouding the family payments system, including the disincentives to labor-force participation.

The biggest problem with the stimulus plan, however, is something that's not in it -- tax relief. That too has been left to a future review by the Treasury Secretary, Ken Henry. There had been speculation the government might introduce a one-off tax rebate. Since the government says it is making "down payments" on future reform, a tax rebate would have provided a welcome signal of the government's commitment to this vital policy area. A tax rebate would diffuse more broadly than one-off welfare payments and reward labor-force participation rather than welfare dependence.

Short-term stimulus measures need not conflict with the imperatives of long-term structural reform. The government should have used the global financial crisis to gain increased traction for a long-term structural reform agenda that will provide lasting economic security, and not just a short-term boost to spending. The biggest flaw of Mr. Rudd's plan is all the opportunities it missed.