The stimulus and the costs of unemployment

The Australian fiscal stimulus package has been controversial, with some Australian economists and visiting UK historian Niall Ferguson arguing that it was unnecessarily large or wasteful, and other Australian economists and visiting US economist Joseph Stiglitz arguing that it was well designed and a model for other countries.  The Reserve Bank, however, seems to agree that the stimulus was important in sustaining economic activity.

OECD figures show that the total Australian fiscal stimulus package was the third highest in the developed world over the period 2008 to 2010, with only the United States and Korea spending more on discretionary stimulus. The OECD figures also show that the spending component (compared to tax cuts) of the fiscal stimulus was higher in Australia than any other OECD country.

However, OECD statistics also show that when you add in the effects of the GFC on tax revenues and public spending, the total impact on the Australian budget is forecast to be the 11^th lowest in the OECD between 2007 and 2010, as shown below.

Difference in general government financial balance, % of GDP, 2007-2010 (projected)

This figure is calculated from the latest OECD Economic Outlook, and a couple of explanations are in order.  The figures shows the difference between 2007 and 2010, not the size of the deficit in 2010.  Australia had a general government financial surplus of 1.7% of GDP in 2007, and the forecast for 2010 is a deficit of 3.2% of GDP, hence a difference of 4.9% of GDP.

A lot of the countries where the budget balance has deteriorated less than Australia started off with larger deficits than Australia, so in Greece the 2010 deficit is forecast to be 8.1% of GDP –  much higher than in Australia but less of a deterioration, since in 2007 their financial deficit was 5.4% of GDP. In passing, this calculation also ignores the fact that their 2009 deficit of 13.5% of GDP was much worse than their projected 2010 figure – and it also assumes that they achieve their projections, and ignores the costs of achieving these projections, as Spiegel Online has recently illustrated. It is also notable that Iceland and Ireland have had the largest declines in their government financial balances despite their harsh austerity measures.

Combined with the very strong budget position inherited from the Howard government, this has meant that Australia’s net debt remains amongst the lowest in the OECD. The starting point of low government debt is very important, but so is the fact that the overall impact of the GFC on the deficit in Australia has been lower than most other countries.

So how is it that we can spend more on stimulus than just about any other country, but still add less to the deficit than most other countries?

The main reason is that high unemployment is very costly – to the individuals affected, to society as a whole, and also to Government budgets.

Each person who loses an average private sector job and claims Newstart costs the government about $15,000 in Newstart and Rent Assistance and pays about $17,000 less in income taxes and GST, so the total cost per unemployed person can be more than $30,000 a year.  This is conservative because if a single earner family loses their wage earner then the cost of benefits can be up to $22,000 a year, and every child whose parent loses their job can add up to another $2,800 a year to the Government budget in higher family payments.

On the benefit side, these costs are actually comparatively low because as Bruce Bradbury pointed out last year unemployment benefit replacement rates in Australia are lower than short-term unemployment insurance benefits in most other countries. (Benefits for the long-term unemployed are a different story.)  So part of the reason for the lower budget cost of unemployment in Australia is that we pay people lower benefits in the early stages of recession.  To some extent, this is offset on the tax side because Australia has more progressive direct taxes than most other OECD countries and our family payments are more expensive and income-tested. Nicholas Gruen has also pointed out that over a quarter of the debt from the fiscal stimulus will be repaid from the taxes of those who would otherwise have been unemployed

But most importantly, Australia has had one of the lowest increases in unemployment of any OECD country, as shown below.

Change in unemployment rate, percentage points, 2008 to June 2010

Given the current labour force, if we had New Zealand’s unemployment rate of 6.8% rather than our current 5.2% it would cost the budget an extra $5.5 billion.  If we had the UK’s unemployment rate of 7.8% then the total additional budgetary cost would be around $9 billion, and if we had Canada’s 8% unemployment then the cost would be around $10 billion, and the USA unemployment rate of 9.5% would cost us close to $16 billion.  We probably don’t want to contemplate the cost of Ireland’s unemployment rate of 12.6%.

Of course the cost to the Budget is only a small compared to the human costs of unemployment.  The unemployed experience a sharp drop in income, more so in Australia because our unemployment benefits are flat-rate and modest, and not related to past earnings as they are in most other OECD countries. So an increase in unemployment can lead to an increase in financial poverty, hardship and social exclusion.

It has been known since the 1930s that unemployment leads to an erosion of confidence and self-esteem, leading to the loss of work skills and ill health (and impacts on the health budget).  Recent research suggests that unemployment can lead to family breakdown and growing lone parenthood and also homelessness. For many people, unemployment is relatively short-term, but when it becomes long-term it can lead to older people dropping out of the labour force and some becoming reliant on Disability Support Pension.

A sharp rise in unemployment can have long term economic effects.  A common argument is that higher long-term unemployment leads to deterioration in skill levels and possible morale problems which reduce job search intensity. The loss of human capital and reduction in search effectiveness associated with long periods of unemployment can lead to higher wage pressures at a given rate of unemployment. Thus, the equilibrium rate of unemployment can increase.  The experience in Australia between the 1970s and the 1990s was that unemployment “ratcheted-up” after recessions, and did not return to its pre-recession levels.

Joblessness is one of the major causes of poverty and inequality in Australia today, and is a major contributor to the transmission of disadvantage across generations.  The reduction in family joblessness in Australia that was achieved between 1998 and 2008 was a major contributor to improving fairness in society.  But it took 10 years of exceptional employment growth to get family joblessness back to the level it was in 1980, before the previous two recessions.

Whichever view one takes of the effectiveness of the stimulus package, we should be extremely thankful for the fact that unemployment did not go up to 7% or 8%, and that while it rose to 6% it has since fallen back to close to 5%. Nevertheless, increases in joblessness have been higher among young people and lone parents than for the population generally. Developing more effective policies to reduce long-term unemployment and family joblessness should be a priority of whichever government is elected this weekend.