Scott Morrison has been ruminating about the distinction between good debt and bad debt for months, and his latest missive was contained in a speech to Australian Business Economists and related media release yesterday. It seems he is building up to something new in the May 9 federal budget, and the ‘something’ is likely to be a big increase in capital expenditure (aka ‘infrastructure’) — accompanied by changes to budget reporting to make the impact on the budget deficit and debt appear less alarming.
Morrison’s basic proposition is that deficits on everyday spending and revenue give rise to ‘bad’ debt, whereas public investments funded by borrowing give rise to ‘good’ debt because they contribute to future sustainable economic growth based on productivity growth. It is a proposition with a little bit of merit but a lot of holes in it.
For a start, not all of what is classified as public investment is productive. To borrow Morrison’s terminology, there is ‘good’ public investment and ‘bad’ public investment. The selection of projects is as much political as it is economic. It is not hard to think of ‘white elephant’ projects. Furthermore, public investment includes a normal base level to replace old buildings and equipment, and it is not clear why this expenditure should justify borrowing.
There is also a distinction between social infrastructure (school buildings and the like) and economic infrastructure, though this is more relevant to the states than the Commonwealth.
The starting point also matters. If Morrison were starting with a balanced budget, zero debt and a clear justification for a big piece of economic infrastructure based on rigorous cost/benefit analysis, then there could be a case for borrowing to finance the project. But that is not the starting point.
There is already a sizeable deficit just on recurrent transactions alone, and a mountain of debt accumulated as a result of past recurrent deficits — a mountain of ‘bad’ debt. It is one thing to incur new ‘good’ debt when you have no debt to start with, but another to add to a mountain of ‘bad’ debt that already exists.
According to Morrison, the budget will retain the underlying cash deficit as its key target, but will also highlight an alternative measure of the deficit called the ‘net operating balance’. At the risk of oversimplification, this is like the recurrent deficit. Depreciation of capital assets is included on the expense side.
New capital expenditure isn’t included as an expense, but is deducted to arrive at the overall deficit. As new capital expenditure always exceeds depreciation, the net operating deficit is always smaller than the overall deficit.
State governments emphasise the net operating balance as their key metric. It has been buried in the Commonwealth budget papers for many years, but has attracted no attention. Apparently that is about to change, because the Commonwealth wants to indulge in a large increase in capital expenditure.
This will inflate the overall deficit, but not the net operating deficit (at least, not until depreciation expense starts to increase, and even then the impact will be drawn out).
Expect, therefore, to hear a lot more from Morrison about the net operating deficit. In last year’s budget it was $3.4 billion smaller than the underlying cash deficit.
This year the gap may be much larger. Morrison will say the cash deficit doesn’t matter so much provided the net operating result is moving from deficit to surplus.
One credit rating agency was quick to deliver its verdict on all this: a dollar of debt is a dollar of debt, and Morrison’s rearrangement of the budget numbers will make no difference to the way it assesses the Commonwealth’s credit rating. It’s hard to argue with that.
Robert Carling is a Senior Fellow at the Centre for Independent Studies.
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