Cabinet papers show Paul Keating had a ‘budget emergency’ of his own
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Version 0 of 1. In April 1986 Crocodile Dundee was released in Australia and looking through the cabinet papers of 1986 and 1987, one could well imagine Paul Keating saying to Joe Hockey: “That’s not a budget emergency, this is a budget emergency!” The big story in economics in 1986 was Australia’s current account deficit. We were importing much more than we were exporting and, most worrying, our terms of trade fell 10% in the year to March 1986. Coupled with this, the value of our dollar fell in the early part of 1986 to US71c as Australia’s inflation rose well in excess of the rest of the advanced world. In 1986 our inflation, at 9%, was 6 percentage points above most advanced economies – the biggest gap in the past 40 years. We were spending like a prosperous first world economy but the rest of the world was beginning to view us as living above our means. It came to a head on 13 May with the release of the current account figures showing our trade deficit had increased 41% in April alone and our current account deficit was nearly 6% of GDP. The deputy secretary of the Treasury at the time, David Morgan, related in the Labor in Power documentary that when he saw the April figures his reaction was “that we’re stuffed”. The Australian dollar dropped US3c in one day and if the public was not aware of the importance of the obscure trade data, on 14 May the treasurer, Paul Keating, made it crystal clear when he remarked in an interview to John Laws that Australia was in danger of becoming a banana republic. While giving the interview from a phone in a restaurant kitchen, Keating told Laws: “If this government cannot get the adjustment, get manufacturing going again and keep moderate wage outcomes and a sensible economic policy, then Australia is basically done for. We will just end up being a third-rate economy, a banana republic.” The cabinet papers of 1986 begin with the current account deficit high on the list of concerns but with a belief that it could be contained. In March, Keating reported to cabinet that he could not “stress enough” the need for “a budget outcome which will help take pressure off the current account deficit, interest rates and the exchange rate”. He noted that “turning the current account around and setting the conditions for ongoing growth beyond 1986-87 requires a period of consolidation”. That same month he advised cabinet on the budget strategy, stating that it needed to recognise that dealing with the current account issue “is going to be both difficult and protracted”. He suggested the issue needed “to be rectified” if the government was “to go on generating employment growth and reducing unemployment”. If ministers were still unsure of the gravity of the situation after Keating’s banana republic interview, the 28 May cabinet meeting would have left them in no doubt. He informed cabinet that the outlook was “extremely precarious” and that “the combination of a large current account deficit with only modest prospects of improvement and a poor relative inflation performance may well generate pressures for a further fall in the exchange rate”. Keating noted that such a fall of the exchange could happen “quite swiftly if it is judged that we, as a government, are not making an adequate policy adjustment to the fall in the terms of trade”. At that point the dollar was worth US72c, by the end of July, just prior to the 19 August budget, it fell 6% in a week to a then post-float record low of US57.1c. Drastic action was required and in two extraordinary expenditure review committee meetings on 26 and 31 July the government, without consulting cabinet submissions from departments, agreed to a series of tax changes and spending adjustments to slash an extra $1.5bn off the deficit. Among the changes was the deferral of personal income tax cuts for three months, increasing the bank accounts debit tax and the sales tax on luxury motor vehicles from 20% to 30%, increasing the Medicare levy by 0.25% and increasing the sales tax on alcoholic wine and cider from 10% to 20%. They also deferred pension adjustments by two months and introduced income tested family allowances for 17 and 18-year-olds, substantially reduced foreign aid and most contentiously of all for the Labor Party, removed the ban on uranium exports to France. When Keating rose on 19 August to deliver the budget he predicted a deficit of $3.5bn. It ended up being a deficit of only $2.4bn as government spending fell by 1.1% in real terms – still the third biggest cut in government spending since the second world war. By the end of the year the dollar had risen to US67c and in February Keating informed cabinet that the budget strategy “is now producing results”. He did note, however, that more work was required because public debt remained too high and that it was “apparent that the rest of the world will not go on lending to us at such a rate – unless they get a cheaper $A and/or higher interest rates”. Cabinet agreed to offset all new policy proposals with savings and to have a May mini-budget, which included further savings measures such as replacing unemployment benefits for 16 and 17 year olds with a job search allowance that was half the previous junior unemployment benefit rate. By the August 1987 budget Keating was able to announce a balanced budget – which would actually end up being $1bn in surplus. But the economic challenges were not over. Within the submissions on the 1986 budget emergency lay the future. In May 1986 Keating told cabinet that monetary policy had worked to slow down demand in the economy but that using only high interest rates to reduce the current account deficit would only be done “by shutting the economy down”. He noted that “a return to very high interest rates must be seen as a last act of desperation”. Within two years of announcing the 1987 budget, as the current account returned to the levels seen in 1986 and inflation remained above 7%, interest rates would be forced up to 17%. As predicted, the economy shut down to cause one of the deepest recessions since the 1930s. It seemed that in the end to tackle the problem of the banana republic, desperate measures were finally required. Our editors' picks for the day's top news and commentary delivered to your inbox each morning. |