Scott Morrison – The federal budget’s forecasts have relied on dodgy assumptions for years
The federal government will release its budget this week.
The numbers in the budget will be based on “forecasts” of the economy.
Specifically, they will rely on forecasts for wages growth, inflation, employment, taxes, population, and commodity prices, among other things.
Some of the government’s decisions about where to spend money, and how much to spend, will be based on those forecasts.
But what if the assumptions behind the forecasts turn out to be wrong?
Well, as it turns out, some have been wrong for years. And the consequences haven’t been negligible.
The downward spiral (of wage growth)
Let’s look at a couple of the big ones.
Here’s a graph showing the Australian Bureau of Statistics’s Wage price Index, which is a measure of wage growth.
Notice there has been a marked slowdown in the rate of wage growth in recent decades. It’s currently sitting at a record low 1.4 per cent.
However, when you thumb through past budget papers, you’ll notice Treasury officials have consistently been assuming that annual wages growth will rise to 3.5 per cent “in a few years”.
Year after year, they’ve been forecasting that wages growth will pick up to levels the economy hasn’t seen since 2011/12.
See the table below.
One of the big head-scratching questions at the moment, for economists, is why wages weren’t picking up in recent years (before the recession).
Decades ago, the link between wages growth and the unemployment rate seemed clear: as the unemployment rate declined, wage pressures would build.
But that trusty dynamic doesn’t work as well anymore.
Back in 2017, when the national unemployment rate hit a then four-year low of 5.5 per cent, the Reserve Bank governor, Philip Lowe, said workers should start asking for pay rises because the labour market was tighter than people thought.
But while he was saying that, the trend underemployment rate was sitting at a historical high of 8.8 per cent, having just risen for six consecutive quarters.
Wasn’t that a sign that the labour market wasn’t as tight as the official unemployment rate suggested?
In fact, at the time, wages were growing at 1.9 per cent annually, which was a record low at the time. With the cost of living rising by 2.1 per cent, it meant “real” wages had actually declined over the past year.
The old treasurer
Scott Morrison was the federal treasurer at the time.
His budget that year (2017-18), which you can see in the table above, was predicting wages to grow by 2.5 per cent that year, then 3 per cent the next year, then 3.5 per cent the following year, then 3.75 per cent the next year.
He was banking on a wages break-out to return the budget to surplus by 2020-21.
But strangely, at the same time, his budget was only forecasting a fall in the unemployment rate from 5.75 per cent to 5.25 per cent over the next four years.
How could wages start growing at faster rates annually if the unemployment rate was barely falling?
(For the record, the unemployment rate was 5.6 per cent when the budget was released in May 2017, and it fell to 5 per cent by September 2018, years ahead of Morrison’s schedule. But it never got lower than that. It hovered between 5 per cent and 5.3 per cent for the next 18 months, until the pandemic hit in early 2020).
Needless to say, with no concerted effort by the government to drive the unemployment rate down well below 5 per cent, Morrison never got his forecast wage growth.
Let’s just keep the unemployment rate at 5 per cent, shall we?
Which brings us to the next point.
The 2019-20 budget was the last “traditional” budget before the 2020 pandemic forced the Coalition to embrace deficit spending with gusto.
By then, Josh Frydenberg had become Treasurer and Scott Morrison had become Prime Minister.
These were Mr Frydenberg’s forecasts for the unemployment rate, in his 2019-20 budget:
Notice anything odd?
He was predicting no further improvement in the unemployment rate. He was planning for the unemployment rate to sit at 5 per cent for the next five years.
It’s written there in black and white. He wasn’t prioritising pushing the unemployment rate down further.
Coincidentally, at the time, Treasury officials believed the labour force would be sitting at “full employment” when the unemployment rate was roughly 5 per cent.
According to Treasury’s model, if the unemployment rate fell below that level we ought to start seeing wages and inflation growth pick up.
But listen to this.
Last month, Treasury officials released a mea culpa paper, of sorts, which said they had recently reviewed their model and they now suspect the economy could have handled a lower level of unemployment over the five years to 2020, somewhere between 4.5 per cent and 5 per cent.
So all of those assumptions, in previous budgets, about the likely rate of wages growth in coming years were relying on a view of the economy, and tight labour market conditions, that was misguided.
In fact, it’s worse than that.
The idea that the economy has been anywhere near “full employment” over the last decade or more has been seriously challenged recently.
Officials from the Reserve Bank, Treasury, and even Mr Frydenberg have admitted that the unemployment rate could be much lower than they previously thought.
They’ve said Australia’s economy could now handle an unemployment rate “with a four in front of it”, and that’s probably been the case for years.
Meanwhile, some highly regarded economists have argued that that’s still not sufficient.
They’ve been wondering aloud why we don’t just drive the unemployment down as hard as possible, to find where genuine full employment really is, and to scrap the neoliberal policy of using thousands of unemployed people as a buffer against inflation.
So yes, budget forecasts can tell you a lot about how policymakers view the world — especially when the assumptions behind those forecasts turn out to be wrong.
It’s something to watch out for this week.