Date created: 28 November 1996

Last modified: 18 November 1997

Maintained by: John Quiggin

John Quiggin

Categories set up hurdle in savings debate .

Australian Financial Review ,

20 March, 1995

With the economy cooling rapidly, the macroeconomic case for a contractionary budget has become much weaker. The central issue now is that of the levels of public and private savings and investment. Unfortunately, the whole debate is being conducted in terms of economic categories that are not merely outdated but a positive obstacle to an understanding of our economic problems. Furthermore, when these categories are challenged, the response is frequently based on propositions that defy economic logic.

Our current national accounts were designed for an economy based on mining, manufacturing and agriculture, along with an infrastructure system based on transport, construction and public utilities. Services like education and health were regarded as a cost burden on the 'real economy' and analysed in a purely ad hoc fashion. This view of the economy was at least a reasonable approximation in the sixties when mining, manufacturing and agriculture employed more than 35 per cent of the workforce and infrastructure a further 18 per cent. It is totally inadequate today when all of these industries together provide jobs for only 30 per cent of the labour force, a proportion which is steadily shrinking. The growth areas are those of personally delivered services, including community, public, recreation and personal services. These sectors are about to overtake the traditional goods economy as a source of employment, and provide the only real hope of generating enough new jobs to make inroads into unemployment.

With the shrinking of the goods economy has gone a shrinking of the physical investment required to support it. This has been reflected in a decline in both the investment and savings shares of GDP as traditionally measured. However, this decline has, at least until recently, been offset by increasing investment in human capital, in the form of improvements in education and health.

One attempt to incorporate human capital measures into estimates of savings and investment was made by Depta, Harding and Ravalli. They found that reclassifying spending on education (and some health spending) as investment rather than consumption eliminated most of the measured decline in national investment and about half of the measured decline in savings. However, they failed to take into account a central element of the human capital model - the earnings foregone by students in order to increase their future earning capacity. Considering tertiary students alone, this probably amounts to 3 per cent of GDP and is enough to wipe out the whole of the measured decline in national savings.

Advocates of cuts to health and education, such as the Institute of Public Affairs, have made a twofold response to arguments of this kind. First, they have embraced various critiques of human capital theory, such as screening models, or have claimed that education is really a form of consumption. This kind of deviation from mainstream orthodoxy would certainly not be adopted if it led to support for government intervention.

Second, they have argued that these sectors of the economy have the special 'magic pudding' quality that general reductions in resource use can be made without affecting either the quantity or quality of output. In particular, it is claimed, on the basis of fairly dubious econometric studies, that class sizes have no impact on the quality of teaching. Interestingly, these views do not seem to be shared by the private school sector. Wealthy private schools have smaller classes than the state sector. More generally, the share of resources allocated to teaching staff is almost identical in the private and public sectors. The analysis of the community services sector is yet another example of the willingness of economic fundamentalists to embrace propositions totally at variance with mainstream economic theory whenever they serve the tactical purpose of supporting attacks on the public sector.

The reclassification of education and health expenditures as investment does not affect the government's fiscal position. The benefits of higher education are received in the form of higher earnings and generate only a partial return to government in the form of higher tax payments. Since the trend increase in productivity associated with higher education levels have already been factored into growth projections, the reclassification not affect projections of the government's future debt position.

Thus, the government must take action to repair the damage done by the unaffordable tax cuts presented in the One Nation and Investing in the Nation. However, it should not do so in a manner that will reduce public and private savings. In the absence of radical cuts to transfer payments of a kind that would undermine the integrity of the entire welfare system, the only real option is an increase in taxation.

John Quiggin is Professor of Economics at James Cook University and author of Great Expectations: Microeconomic reform and Australia, published by Allen & Unwin.

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