Stimulus package needs more focus on demand-side initiatives

By John Nevile and Peter Kriesler  Monday, 23 February 2009  Opinion Pieces

Until recently, most western government economic policy has been dominated by what is called neoclassical economics. Underlying this is a vision that markets work well at delivering economic outcomes, including employment and growth.

However, in the 1930s Keynes showed that markets were unable, by themselves, to deliver full employment. The problem was not wages, but rather insufficient demand, which required some external stimulus, either from aboard or from governments to fill the shortfall. From the end of the second world war to the 1970s, governments were influenced by Keynes in their economic policies, and the result was, what is often called, the Golden Age of growth, with the longest period of sustained capitalism growth in output and employment.

From the 1970s neoclassical economics reasserted its view of the superiority of markets, and has dominated economic policy since, with an emphasis on smaller government and lower taxes. The current global financial crisis is a result of that policy, and has resulted in a significant fall in demand both globally and domestically.

This fall in demand has and will continue to lead to falls in employment levels, as both retail staff and production staff are no longer required by business. The domestic fall in demand has come from both consumers and producers, the latter in the form of reduced investment expenditure.

So, any solution to the current crisis needs to be in the form of policies which increase domestic demand. The two main policies open to governments are monetary policy, whereby the Reserve Bank sets interest rates, and fiscal policy, involving changes to government expenditures and receipts. Fiscal policy to stimulate economic activity operates either by giving money to individuals and corporations or by public expenditure on goods and services.

In the current recession, reduced interest rates may have some impact on consumer expenditure, as it will increase post interest payment income (particularly for mortgagees) but is unlikely to have any significant impact on investment, as the reduced demand will lead to unemployed resources (including labour), build up of inventories and unused capacity.

The government can increase domestic demand via tax cuts, one off payments or via its own expenditure. Tax cuts and one off payments, although increasing take home income, may not have the desired effect on domestic employment, either because the extra income is saved or because it is spent on imported items (such as plasma televisions) which do not generate many jobs in Australia. In addition, today's tax cuts reduce the government's ability to raise revenue in future years.
Also, the nature of the proposed tax cuts is heavily skewed towards cuts for high income earners, rather than those who really need them at the bottom end of the income distribution.

The package announced on 3 February by the Federal Government has a number of different aspects. A large part involves payments to low income earners, especially families with dependant children. This is significant as these are more likely to spend the extra income than higher income earners without dependants, and are also more likely to spend on necessities which have a lower import component, and so will have a larger impact on domestic employment.

Importantly, a substantial part of the package is aimed at infrastructure and government investment in both physical and human (education, health) capital. The importance of expenditure on capital cannot by stressed sufficiently;. Not only does it directly create jobs by employing people to work on infrastructure programs, or increase employment in education and/or health, but it also has important long term benefits for the economy in the form of increased productivity. The present package fulfils this requirement extremely well, and so provides both immediate relief for the present crisis, but also provides long term benefits to the Australian economy.

John ​​Nevile is a Emertius Professor of Economics and Peter Kriesler is an Associate Professor of Economics at the Australian School of Business.