AFR - Debt Has Served Us Well

Australian Financial Review, 14 September 2010

Much fun was had during the election campaign when the Chaser lads pointed out to Tony Abbott that while the ratio of Australian government debt to national income will peak at 0.06, his personal debt-to-income ratio is nearly fifty times higher (Abbott's reported $700,000 mortgage is almost three times his annual income).

Yet few people would blink at Abbott's decision to take on personal debt for a new home. My own calculations - using data from the Household, Income and Labour Dynamics in Australia survey - suggest that 60 percent of Australian adults live in a household that has some debt, with an average of over $100,000 of property debt. Mortgage debt peaks at around age 40, with debt loads at that age being around $150,000 per household. On average, debt levels rise with household net worth: for each additional $10 of wealth, households typically take on another $1 of debt.

Thanks to home loans, Australian families are able to buy a home at a much younger age. If we abolished mortgages, the back of my envelope suggests that many of us would move into a home only in the latter part of our working lives. Other sources of credit also make us better off. Business loans help productive firms grow more rapidly. Car loans allow young people to take a job that requires four wheels. And although too many of us carry unpaid balances on our credit cards, they do represent a handy source of finance to carry us through a tight spot.

Yet while it seems obvious that a zero-debt strategy would make households much worse off, there are clearly some in the Australian public debate who take the view that governments should never borrow. Jettisoning economic credibility for a chance at power, the Coalition ran a steady drip campaign against borrowing. Between debt trucks and hyperbole (my favourite was Malcolm Turnbull's claim that debt would burden 'taxpayers yet unborn'), they repeated a simple message: debt is bad.

In effect, the no-debt view implies one of two things about how to fight future economic downturns. One possibility is that the Coalition have taken a permanently anti-stimulus approach. This would put them on the far fringes of economic policymaking, out of step with the mainstream view in the Australian Treasury, the Reserve Bank, and major international bodies such as the IMF and the OECD. (Indeed, because a substantial share of Australia's debt is due to lower revenues rather than higher spending, a no-debt view probably implies that we would need to respond to downturns by raising tax rates or cutting spending.)

The other possibility is that when the Coalition advocate a zero-debt approach, they are implicitly proposing that we permanently raise taxes in order to create a fighting-fund for major economic downturns. If it is aimed at avoiding slumps as large as the global financial crisis, such a fund would need to be substantial - perhaps hundreds of billions of dollars. Curiously, costings for such a fund did not appear in the Coalition's election promises.

Of course, neither of these approaches would make any economic sense. Just as modest amounts of debt constitute prudent economic management for households, so too governments behave sensibly when they borrow to manage a major downturn. In the Australian context, our stimulus package is estimated to have saved around 200,000 jobs and countless businesses. In doing so, we avoided the waste of other nations' recessions, which will see thousands of factories and workers sit idle until their economies recover. In the wash-up, our unemployment rate is just 5 percent, and our debt levels are less than one-tenth the average of the G7 major advanced economies. From the perspective of most developed nations, our current economic performance is their best-case scenario in five years' time.

Economically, counter-cyclical fiscal policy has been well worth the cost. But the anti-debt campaign has clearly served to raise the political cost of sensible fiscal policy. It would be tragic if the next government that faced a major economic slump decided that it could not bear the electoral damage of another debt scare campaign. Let's hope the Coalition can scrap their overheated rhetoric in favour of much-needed bipartisan consensus around good fiscal policy.