The left’s calls for the Coalition to abandon its tax cut agenda and open the government purse strings for more spending are usually rejected by those on the right on the basis that deficit spending will drive up debt, leaving a burden for future generations to pay off.
While this is undoubtedly an important reason to reject Keynesian deficit spending, it is not the only reason — nor even the most important.
First, fiscal stimulus is largely ineffective in an open economy with a floating exchange rate and a central bank doing its job, spending leaks away to boost imports. At a minimum, any effect of fiscal stimulus is overwhelmed or offset by monetary policy.
Even if fiscal policy can effectively control GDP in the short term — which is itself debatable, given various lags and its inevitably poor targeting — fiscal stimulus cannot generate sustainable economic growth. And the real problem is not a short term collapse in growth, but being trapped in a long term trend of slow growth.
Government stimulus, especially at the federal government level, is almost exclusively about boosting spending. Yet economic growth is not about consumption; it’s about production.
Spending follows production; it doesn’t precede it. An increase in spending not matched by an increase in production merely creates inflation, effectively reducing living standards. Yet in a market economy, an increase in production that does not attract spending is redirected into different, more desirable production, increasing efficiency (and ultimately living standards).
To the extent fiscal policy can be effective in generating growth, it is on the supply side — providing adequate infrastructure to enable production, reducing the burden of regulation, and limiting the effect of government on the efficient allocation of the market.
This is why tax cuts are important. They encourage investment, innovation and ultimately productivity. It is not because unfunded tax cuts can have a short term stimulatory effect — the stimulus only increases demand, not supply.
Because discretionary stimulus is by its nature temporary, there is no reason to think it will lead to a sustained increase in either spending or production.
On the contrary, fiscal stimulus relies on ‘fooling’ business that either consumers will make permanent spending decisions based on temporary increases in income or that stimulus can be sustained indefinitely with no fiscal cost (such as tax increases.)
If it works, it is more luck than design. Instead, the government would do well to heed the advice of new Productivity Commissioner’s calls for a ‘fresh agenda’ to economic reform and scrapping of the most inefficient taxes.
Government spending should be assessed on its merits, or lack thereof, not based on spurious claims about macroeconomic benefits.
Simon Cowan is Research Manager at the Centre for Independent Studies.
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