In his essay in The Monthly on the global financial crisis, Kevin Rudd named me as a neo-liberal (which he didn't define, but which roughly translates as liberal meaning bad and neo meaning very) for proposing cuts in public sector wages.
The Prime Minister argues that public servant wage reductions were a policy of one of his nemeses, Andrew Mellon, US treasury secretary in the Harding, Coolidge and Hoover administrations. He is unaware that one of the first acts of his hero and model Franklin D. Roosevelt, on becoming president in 1933, was to cut all government employees' pay by 15 per cent. It was Congress that reversed these cuts over the following year or so.
Such expenditure restraint policies are being followed by a range of governments, including those tied to the failed Keynesian approach that Rudd finds so attractive. President Barack Obama, in his first executive order, introduced a freeze on White House salaries. Singapore has reduced salaries of top public servants by 12 per cent to 20 per cent, with further cuts foreshadowed. The Irish Prime Minister is implementing an average 7 per cent reduction in gross pay for everyone on the public payroll, in the form of a levy to finance their pensions.
Public servants have long pointed to wages in the private sector as beacons by which their remuneration should be measured. But the near guarantee of job security that public servants enjoy is worth a considerable premium compared with workers in the private sector. This has been recognised by London's mayor Boris Johnson, who has pointed out that in England the generosity of public service remuneration packages has become unacceptable in view of economies forced on private sector employees. Cost-saving economies by private sector businesses are widely evident in Australia. Jobs are being shed across the private sector. Alcoa workers are among those who have volunteered to accept a wages standstill to assist the company's competitiveness and nabCapital's January survey indicates private sector wages are beginning to fall.
Similar approaches must be followed by governments in Australia to ensure parity with the private sector. Moreover, state governments must drastically cut back recurrent expenditure on public service salaries if they don't want to face the fate of Queensland. Standard & Poor's downgrade of the Sunshine State's debt will add $200 million to its interest bill.
Other states will face the same deficit pressures as their profligate spending is left high and dry by revenue shortfalls created by lower taxation income from resource exports, house sales and even the GST. Moreover state governments have less scope than federal governments to borrow (and no scope to print money). In the US, several states are already confronting the budget imbalances this creates. Speculation is mounting that California will fail to cut spending and be the first state to declare itself bankrupt.
For electoral reasons driven by the need for state Labor governments to keep sweet with the public sector unions, Australian states will seek to balance their budgets by raising taxes rather than shedding staff (or, heaven forbid, cutting salaries). But eventually, radical spending cuts will be required, though in Australia this normally requires a change in government.
Rudd's defence of paying a bloated public sector excessive wages is part of his fiscal stimulus philosophy based on a crude Keynesian formula that equates income with consumption, investment and government spending. The problem is that trying to boost income through government spending brings offsetting reductions in private spending and investment, and in doing so reduces the economy's productive capacity. The Rudd policy rests on the alchemy of government fiscal multipliers providing extra bang for every buck spent. While cash injections can boost regional economies, a national economy's multiplier is accompanied by a negative multiplier resulting from governments eating into private wealth and incomes. Hence the aggregate national multiplier is unlikely to diverge from zero.
We therefore have a combustible brew. Rudd's penchant for spending and profound mistrust of individuals making their own such decisions is combined with Treasury's advice. This is anchored in a poorly understood Keynesian framework and is abetted by business lobbies seeking a share of government spending spoils. Instead of a gentle economic warming, the measures proposed, which already amount to $80 billion and approach 10 per cent of gross domestic product, will torch the economy. Though having more scope to engage in imprudent deficit spending, even national governments have to confront reality once their deficit financing threatens lenders' risk preferences.
What is needed now is a careful husbanding of expenditures and reductions in the regulatory costs. Ironically, such measures were promoted by Small Business Minister Craig Emerson just as Rudd's essay calling for fiscal intemperance hit the streets.
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