Productivity key to repaying the COVID-19 debt
Australia is in the middle of – hopefully – a once-in-a-generation health crisis that is causing a similarly unprecedented economic challenge. The Government has responded well on both. The ‘save the furniture’ fiscal policy response will come with a gigantic bill, but the cost of inaction would surely have been significantly larger.
Many are now querying the affordability of the policy response, which may yet need to be further expanded. With interest rates so low the interest bill is not a huge problem at the moment, but the much bigger question is how to repay the additional government debt racking up in ‘building the bridge’ to the other side.
Australia managed the GFC and is handling the COVID-19 crisis well because it started with a strong fiscal position and a sound banking system. We will need to restore this position so that we are best prepared for any future shock.
There is no magic pudding for achieving this. Paying the debt off can occur in one several ways (or combinations thereof). Firstly, inflation can be used to reduce the real value of the debt so normal tax settings allow the debt to be repaid over time. Secondly, the government can run surpluses by increasing taxes and/or reducing spending. Thirdly, higher productivity growth flowing through to higher economic growth increases income and tax receipts (the rising tide effect).
Productivity will be the key to restoring Australia’s prosperity. Let us be clear – without this we are accepting as a nation a permanently lower standard of living as the economic legacy of the coronavirus.
Productivity growth – the fairy dust that helps 1+1=3 – cannot be driven solely by the implementation of government policy. In Australia’s economic system productivity occurs fundamentally as a consequence of businesses seeking a competitive advantage. Government can play a key enabling role by ensuring that our public infrastructure is up to the task and that the regulatory burden on businesses is not stifling.
Attempting to inflate your way out of debt is problematic because it can have significant distributional consequences (real asset holders benefit, others lose out) and undermine the credibility of the reserve bank – these problems may be compounded if many other countries are taking similar actions at the same time.
On tax reform, KPMG was inside the tent with the Commonwealth Treasury during both the Henry Tax Review and the more recent Tax White Paper, and those experiences tell us reform is very hard. Similarly, cutting government spending “razor gang” style is also very difficult.
There will come a time where we need to sharpen our focus on our tax mix and how it can be better designed to rise to the fiscal challenge. That time is not now. Similarly, we will need to confront difficult decisions about how to raise the revenue and reduce costs to bring the budget and debt levels back to sustainable levels. Again, the time for this is not now.
What we can focus on right now is the positive message that the faster we can grow the economy the less we will need to consider difficult decisions relating to increases in taxes and reductions in government spending.
The changes we have seen in the economy over the last six weeks are profound and it is likely that more will happen in the near future. Some of these changes are negative, but hopefully temporary in nature. Many changes are positive in the sense of businesses, workers and governments working together to find innovative ways of keeping the economy going.
All of us need to recognise the economy has fundamentally changed and the chances of a reversion to the previous “normal” are minimal. The lessons learnt during the current crisis and the innovations businesses and individuals have developed and adopted will simply not disappear.
Businesses that have discovered better ways of doing things will lock those gains in, while employees who have experienced working from home, and negotiating more flexible work conditions will push for change in the future to better suit their circumstances.
Importantly we have seen all participants in the labour market accept the need for flexibility and change on the basis that to not do so, and quickly, will ultimately mean a lose-lose outcome for everyone. This has created the basis for a new normal in Industrial Relations for this country where the risk and upside is shared in a better way between employers and employees in a more flexible system.
The challenge now is to encourage institutions, private businesses and workers to continue working together to leverage the learnings of this crisis to boost productivity and their incomes to levels higher then would have occurred without COVID-19 in a business-as-usual environment.
A crisis has come along that has made everyone think about innovative solutions and how to do things better. This should be the lasting legacy of the COVID-19 crisis – not the fiscal mountain that we need to climb.