RDP 9002: Public Sector Growth and the Current Account in Australia: A Longer Run Perspective 5. Conclusion

We have examined the behaviour of private savings and investment, the primary fiscal deficit and the trade balance since the 1960s. We argue that the general deterioration in the balance of payments between 1975 and 1983 was related to the growth in the size of the public sector.

By distinguishing between the consequences of changes in government spending on goods and services, transfer payments and taxation, we argue that the fiscal adjustment since 1985 has not been as large as would be suggested by only focusing on the change in the public sector borrowing requirement. In addition, a significant part of the fiscal adjustment on the spending side has fallen on capital expenditure, which may have implications for future productivity of the economy if these cuts have been on essential public goods such as infrastructure investment.[21] This needs further study.

Nonetheless, the recent fiscal adjustment has been substantial and so we suggest two explanations why the large cuts to government spending on goods and services have not yet led to an improvement in the balance of payments. The first is that the adjustment has been partly offset by Ricardian-type fall in private saving, and strong investment growth partly induced by the fall in long real interest rates in response to the fiscal adjustment. Any remaining spillover into an improvement in the balance of payments via secondary changes in relative prices has been postponed by the appreciation of the real exchange rate due to strong commodity prices which was followed by tight monetary policy. The second explanation is that the distortions caused by the interaction of the tax system and inflation may have been as important as the effects of changes in government spending.


Evidence in Aschauer (1989) for the United States suggests a strong statistical relationship between declines in U.S. public sector capital expenditure and declines in economy-wide productivity. [21]