A sustainable budget surplus is beyond the government’s control, as Joe Hockey has come to realise

Originally published at The Guardian.

‘It’s Hockey’s promised constant federal budget surpluses that are unsustainable, not budget deficits. Photograph: Mike Bowers/Mike Bowers

Joe Hockey, the treasurer, now concedes he may not be able to deliver his promised budget surplus any time in the foreseeable future. This news is good for private savings because, when the government runs a surplus, the non-government sector must run a deficit.

This is a simple reality of macro-economic accounting. There are only so many Australian dollars. If the government taxes more than it spends (a surplus), it is taking more dollars out of the private sector than it is putting in. Assuming exports equal imports those dollars can come from only one place – private domestic savings. Everyone’s surplus is somebody else’s deficit.

Why almost nobody understands this or reports on it is something of a mystery. It’s an economic and accounting reality that has been talked about for many years by monetary economists such as Professor Bill Mitchell and his colleagues at the University of Newcastle.

The arithmetic is very simple. Total net financial assets in Australian dollars is the sum of government assets, plus net private domestic assets (individuals and businesses), plus net foreign assets. If the federal government runs a surplus then the money has to come from one of the other two. Given the government has virtually no control over the foreign component, a surplus will usually be accompanied by a reduction in savings in the domestic private sector (households and businesses) as they pay more in tax than the government is spending into the private economy.

When the federal government runs a surplus, private debt almost always increases. In other words, the banks create the money to fill the hole left by the government surplus. The much heralded surpluses of the Howard/Costello government were precisely matched by non-government deficits. These budget surpluses were partly supported by trade surpluses (foreign sector deficits) but even so, private debt increased dramatically.

Because there is a finite net number of Australian dollars in the private sector at any one time, total surpluses and deficits across all sectors of the economy must, by definition, sum to zero. The data, of course, support this conclusion. Data from Australian Bureau of Statistics via the University of Adelaide’s Steven Hail.

Hockey has stated that he wants to reach budget surplus and then remain there. The only way that this is sustainable is if we match the budget surplus with a trade surplus – if we export more than we import. Trade balances are largely beyond the government’s control, certainly in the short term. This means that the sustainability and stability of a budget surplus is also beyond the government’s control – as Hockey is belatedly coming to realise.

In the absence of a strong trade surplus, a government surplus can only be achieved by reducing private sector savings – either directly reducing actual savings or being funded by new debt. This is simply an accounting identity, it’s true by definition. There is nowhere else for the money to come from. Similarly, in order for the private sector to increase savings relative to the trade balance, the government must run a deficit. Again, there is nowhere else for that money to come from.

The implications of this simple accounting reality are profound indeed. Our entire national conversation about government finances is based on false premises. When Hockey says he wants a budget surplus, what he’s also saying is he wants to reduce private sector savings. Is that a good thing or a bad thing? At a time when private sector debt is heading up towards 200% of GDP, I’d be inclined to think decreasing private savings is a bad thing. Private sector debt is a much, much bigger potential problem in this country than public sector debt.

It’s Hockey’s promised constant federal budget surpluses that are unsustainable, not budget deficits. You cannot continually pull more money out of the private sector than you’re putting in without destroying the economy.

When the truth is the opposite of what we’re being told, it’s a good idea to examine who benefits. Privatising the deficit means big gains for lenders. Lending money to the public is far more profitable than owning government bonds. The financial sector are both the greatest beneficiaries of such policies and among the greatest donors to both the Coalition and Labor. Coincidence? Maybe.

This entry was posted in Australian politics, Economic theory and tagged , , , . Bookmark the permalink.

2 Responses to A sustainable budget surplus is beyond the government’s control, as Joe Hockey has come to realise

  1. Poppy Hansy says:

    Good article Warwick Smith I have to admit I was totally ignorant on how the federal budget worked, you piece is very handy to know when one is criticising various treasurers through other modern media. Nice one, thanks

    • Thanks Poppy,
      You’re not alone. It’s a crazy situation where so many of the “facts” used in the public and political discussion of government finances are the exact opposite of the reality.

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