Fiscal prudence still important

A VERY substantial and worrying difference is opening up between the state and federal governments' responses to the global economic slowdown.

Colin Barnett's state government has been very cautious, reviewing its capital spending plans (to the frustration of many business people) and cutting recurrent spending to ensure the state retains its triple-A credit rating.

In contrast, caution is the last word that could be applied to Kevin Rudd's federal government, which in six months has initiated spending plans that sit in the tens of billions of dollars.

The scale of Mr Rudd's spending plans may have been obscured by the extraordinary numbers that characterise the global financial crisis.

Earlier this month, the Group of 20 summit agreed to commit an extra $1.4 trillion for international bodies, including the International Monetary Fund.

It has been estimated the G20 nations will have spent $US5 trillion by the end of next year battling the global slowdown.

It's a bit hard to comprehend numbers that large.

A review by the International Monetary Fund has found that Australia is one of the biggest spenders, relative to the size of its economy.

Australia's discretionary fiscal response (ie the increased government spending) equates to 2.1 per cent of 2009 GDP and 1.7 per cent of 2010 GDP.

That is an enormous shift in fiscal policy and is only possible because of the large budget surpluses that prevailed for most of the past decade.

It is also an extraordinarily big response for a country that is performing far better than most others.

Among major industrial countries, it is rivalled only by the US, which is at the epicentre of the global slowdown and is unambiguously in dire economic circumstances.

Federal opposition leader Malcolm Turnbull argues correctly that the government's response is not only very large, but more worryingly it is poorly targeted.

The government's handouts, worth a total of $23 billion, have proved to be a very imprecise way of boosting economic activity.

It appears that many families have kept the handouts to reduce their debt, which is great for family budgets but not much help for current economic activity.

Liberal treasury spokesman Joe Hockey coined a nice turn of phrase to characterise the federal government's fiscal response to the economic slowdown: "Kevin Rudd's solution to a drought was to create a flash flood and it did not work".

The legacy of the increased spending will, of course, be increased debt. If the spending was measured and carefully targeted, it would be hard to criticise, but the sheer scale of the extra spending makes it difficult to ensure quality.

As well as the increased spending, the federal government has become guarantor for the nation's banks and, most recently, the states.

The banks are making proverbial hay while the federal government continues to guarantee their wholesale fund raising. Whether the guarantee was needed for more than a short period at the height of the financial crisis last year, if at all, is questionable.

Australia's banks - particularly the ANZ, Commonwealth, National and Westpac - are in remarkably good health compared to most of their peers around the world.

They continue to report solid profits and are among a small group of international banks with AA or higher credit ratings.

It is ironic that credit ratings are still seen as a measure of financial health, in light of the merciless bagging that ratings agencies like Moody's and Standard & Poor's have copped over the past six months, but they are a fact of life in international finance.

The guarantee on banks' wholesale borrowing has recently forced the federal government to extend its guarantee to the states, which were worried they were being squeezed out of wholesale funding markets.

A deeper concern is the cynical manner in which the Rudd government has milked the financial crisis.

Opinion polls suggest Mr Rudd's 'strong leader in a crisis' tactics are winning him popular support, but the way in which he exploits the crisis does him no credit.

Australia's prosperity over the past two decades was built on market-based economic reforms yet all we hear about is cowboy capitalism.

A measured and nuanced response is needed, not reckless spending and wild generalisations about the underlying causes of the current economic problems.