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special issue: federations and the economic crisis
Australia counting on co-operation and luck to weather crisis
REUTERS/Tim Wimborne
A tipper truck climbs out of an iron ore mine north of Perth, Australia. Chinese steel mills have a voracious appetite for rich Australian ore.
By Mike Steketee
Australians like to imagine themselves as the lucky country even though, when Donald Horne wrote a well-known book by that title in 1964, it was meant as an ironic criticism of complacency.
Still, economic good fortune has often smiled on this nation, not least with the sale in recent years of unprecedented quantities of coal and iron ore to China and India at unheard of prices. Even with the gathering international economic storm last year, some argued that economic development in Asia had so much momentum it would decouple the region from the rest of the world and, with it, Australia.
That proved to be wishful thinking. Commodity prices slumped, hitting hardest Western Australia and Queensland – the two states that benefited most from the resources boom. National unemployment rose to 5.8 per cent in June 2009.
Even so, Australia’s luck may not have run out completely: while the country undoubtedly is in recession, current forecasts indicate it will be less severe than in most other developed nations. The federal government’s estimate that unemployment would reach a peak of 8.5 per cent is still below the estimates for other countries, and if China’s emerging recovery is sustained, it should help support the demand for minerals.
Deficit looming
Australia’s budgetary position is among the healthiest in the developed world. Thanks in large part to the resources boom, Australia entered the recession with no net federal government debt and with part of the proceeds of budget surpluses salted away in reserves. But a slump in revenue and two economic stimulus packages have moved the federal budget from a forecast surplus of US$ 18.5 billion for 2008-2009 to an estimated deficit of US $49 billion for the new financial year. As in other developed countries, budget deficits are expanding and, although net government debt is expected to peak at a comparatively modest 13.8 per cent of GDP in 2013-2014, Australia’s total net foreign debt, including the private and public sectors, already is 61 per cent of GDP and rising, creating a potential constraint on future growth.
Australia’s banking system is relatively well regulated and capitalized, with only minor exposure to sub-prime loans. Nevertheless, with confidence in all banks shaken, the federal government guaranteed all deposits in banks and other financial institutions as well as their wholesale borrowings. When state governments complained that this threatened their loan-raising efforts, the federal government guaranteed their borrowings as well. Although a temporary measure in theory, it is the latest example of the states’ dependence on a financially dominant federal government.
The recession has brought a reassessment of the role of Australia’s six state governments in economic policy. The traditional approach has been for the states to give priority to balancing their books, leaving to Canberra the task of managing the national economy. The states ceded income-tax powers to the federal government during World War II; their own revenue base is narrow and in some areas, such as stamp duties on home purchases and land and property transfers, volatile.
States rely on sale tax
While the states and territories have had a reliable source of revenue since 2000 from the proceeds of the Goods and Services Tax (GST), Australia’s 10 per cent sales tax, they have not benefited from the surge in company and income taxes that swelled federal coffers during the resources boom. Because GST is collected by the federal government and replaced some state taxes, it has increased the states’ financial reliance on Canberra even more – this in a nation in which the mismatch between where revenue is raised and where it is spent was already the greatest among the 30 countries of the Organization for Economic Co-operation and Development. The recession has seen GST revenue fall, putting added pressure on state budgets.
Facing falling revenues, the Labor government of New South Wales (NSW), Australia’s largest state, introduced a traditional mini-budget in November 2008 that increased taxes and cut spending. However, the federal government was moving towards the first of its stimulus packages, including cash grants to lower- and middle-income earners and other spending designed to underpin economic activity in the short term.
Such a conflict on economic policy has not arisen for many years. Since the 1970s, federal governments have avoided active intervention through the budget, leaving the Reserve Bank’s setting of interest rates as the main short-term instrument of economic policy. But with Keynesianism back in fashion, with its emphasis on priming the economy with government spending during a recession, the issue has come to the fore.
Labor elected despite tax hike
The NSW mini-budget made an already unpopular government even less popular. This was the dilemma that confronted Queensland Premier Anna Bligh, who had to call an election by the end of the year after 11 years of Labor rule. Faced with a deteriorating economy, Bligh decided to go to the people in March with the campaign theme that an experienced government was best able to manage the downturn.
Just before she announced the election, the government released revisions to the budget estimates showing a sharp deterioration in revenue and growing budget deficits. Despite Queensland’s reputation for conservative fiscal management under successive governments, Bligh made a virtue of a large increase in spending on infrastructure to save jobs. Queensland promptly lost its AAA rating but, although the Opposition highlighted this issue together with rising government debt, Labor won the election with a healthy, albeit reduced, majority. The focus on jobs, including representing the Opposition’s promise to cut government waste as an attack on public service employment, appears to have been an important factor in Labor’s success.
The debate about the wisdom of the states trying to cushion a downturn through their budgets remains unresolved. In early May, the Labor government of Victoria, which is generally seen as the best managed state, became the first government in Australia to bring down a budget since the onset of the recession. It forecast a continued, though much smaller, surplus of US$ 139 million for 2009-10, whereas most other states are heading for substantial deficits.
State sets modest budget
At the same time, the government of Victoria announced a large increase in infrastructure spending, financed partly from the budget but mainly from a big expansion in borrowing, in a conscious effort to stimulate economic activity. Victoria appears to be aiming for the best of both worlds politically: demonstrating that it is not sitting idly by while the recession takes hold and at the same time pushing its credentials for responsible economic management.
In Western Australia, the country’s only conservative government adopted a different approach, giving businesses a full or partial rebate on their payroll tax for 2009-10, depending on the size of their operation. The Labor Opposition there is arguing that states should retain their traditional approach instead of increasing spending to try to stimulate the economy.
Western Australian Opposition treasury spokesman Ben Wyatt wrote recently: “Counter-cyclical spending at the state level largely results in an increase to net debt that takes a long time to repay as the increased revenue flow largely ends up with the federal government.” Wyatt’s argument is that state governments should focus on balancing their budgets and not increasing debt levels, another way of saying that the states’ revenue base is too narrow to rely on for growing their way out of a deficit since they don’t have a large enough resource base from which to repay debts.
But federal government help can be useful. Co-ordination between governments is an important element in the renewed emphasis on co-operative federalism by the government of Labor Prime Minister Kevin Rudd.
Australia has seen a drift to centralism under successive governments, none more so than the previous conservative administration of John Howard. This was despite his leading a Liberal Party with a historic attachment to states’ rights and the dispersal of power.
Hospital takeover
Howard simply lost patience with the lack of progress on federal-state reforms, particularly since he governed for most of his period with Labor in power in all the states and territories. He went so far as to set up federal technical colleges in competition with the states and even took over a hospital in Tasmania that the state government planned to close down (and which happened to be in a marginal federal electorate).
Much of the reform program initiated by Rudd since he came to power at the end of 2007 relies on agreements between the two levels of government through the Council of Australian Governments (COAG). The federal government has boosted funding to the states and territories, particularly for hospitals and schools, and offered further encouragement through a range of incentive and performance payments.
The Victoria state government has conceded that, with falling revenues including from the GST, it owes its budget surplus to the additional US $2.5 billion it received in federal funding. To share the costs of addressing the crisis, a COAG meeting at the end of April 2009 agreed on a youth compact to be implemented jointly by federal, state and territory governments, aimed at ensuring all Australians under 25 are at school, working or in a training program.
The financial crisis has confirmed the federal government’s dominant role in economic management. Canberra responded quickly with bank guarantees to underwrite confidence in the financial sector and with two economic stimulus packages, in part funded through the states. With some variations, the states have headed in the same direction in their own stimulus packages, but with an emphasis on longer-term investment in infrastructure. Australia may need more than co-operative federalism and its legendary luck to weather this crisis. 
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