Inside Story

A fragile economy heading for an election

This election campaign will take place amid enormous economic uncertainty, writes Tim Colebatch. How are the major parties dealing with this inconvenient truth?

Tim Colebatch 23 April 2016 2184 words

Risky business: Australia’s dependence on China’s economic performance remains high. Photo of Malcolm Turnbull in Shanghai last week by Jiang Ren/AP

The global economy is at risk. That was the warning from the International Monetary Fund last week, and it means that Australia, heading into an election, is also at risk.

Economic debate at this time tends to focus on the budget. But important as the budget is, the economy is more important in terms of jobs, incomes and financial security. It’s just a lot harder to control than the budget.

Yet what lies ahead is unclear. In some ways, our next government will inherit an economy on an upswing. In others, it faces risks that are mounting and all too obvious. How these conflicting forces balance out will depend on many things we can’t foresee now, and most of them will be beyond the control of who is in government.

China, for one. Between 2000 and 2013, our exports of goods to China shot up from $6 billion a year to $94 billion, before collapsing prices cut them to $81 billion in 2015. That skyscraper growth, primarily in exports of iron ore, had a huge impact on our economy. If the Chinese economy in the next three years suffers the hard landing many fear, that too will have a huge impact here.

As the IMF points out, there are many risks to the world economy. Nervous financial markets could tip us into another 2008-style financial crisis. The European Union could fail as a unifying force, and European countries slide back into division and stagnation. The United States could elect Donald Trump as president (okay, the IMF didn’t say that directly, but it hinted at the dire economic consequences of having a president who wants to wall America in).

Two of the biggest developing countries, Brazil and Russia, are in deep recession. Prime minister Shinzo Abe’s efforts to recharge the Japanese economy have failed, and while the IMF is relying heavily on China and India to pull the global economy along, helped by Indonesia and other middle powers, all of them have vulnerabilities that could bring them down.

But the world always faces risks. In recent years, financial markets often seem to have teetered on the brink and then scrambled to safety. The world has kept muddling along, in low gear. Average worldwide growth has slowed from 5.1 per cent before the GFC to 3.3 per cent in the five years to 2016, but crisis has been averted.

There’s a reasonable chance that we will stagger on – and that the government we elect on 2 July will face a similar international environment to that of the past three years. But bear in mind: there is also a reasonable chance that China’s new mountains of non-performing debt will end up sending down an avalanche that could smother its economy.

Australia, too, has kept muddling through. Since 2007, our growth has averaged 2.5 per cent a year, which has looked good compared to other Western countries. But most of that has been driven by the highest population growth we have seen since the 1960s. Real growth per head has averaged just 0.8 per cent a year – less than half our long-term average – and many Australians feel that little of it has trickled through to them.

Indeed, at the annual Economic and Social Outlook conference last November, eminent ANU economist Bob Gregory delivered an astonishing finding that has been virtually ignored since: in net terms, all the new full-time jobs created in Australia in the past decade have been taken by migrants – with no growth at all in full-time work for the Australian-born.

“Our extraordinary economic success since the GFC owes a great deal to the increased level of national income produced by the unforeseen population expansions generated by our new immigration policy,” Gregory told the conference, hosted by the Australian and the Melbourne Institute. The Howard government’s policy of allowing unlimited entry of temporary workers, he explained, has now become our main source of permanent migrants, and lifted forecasts of future migration by a million people a decade.

The high migration intake enjoys bipartisan support, and it will continue to lift the bedrock level of Australia’s economic performance as long as the economy generates full-time jobs for migrants to fill. The IMF forecasts that Australia’s GDP will grow by 2.8 per cent each year, on average, over the three years to 2018, but per capita GDP by only 1.1 per cent.

The latter is the more important figure, if your test of economic success is whether people are becoming better off. But it is amazing how often economic officials and commentators cite only GDP growth, as if the real test of success is to produce more – no matter how many people it takes to do so.

In 2014 and 2015, a depreciating currency joined immigration as a rocket boosting Australia’s growth. In fourteen months from mid 2014 to September 2015, the dollar slid from 94.58 US cents to 69.24, and fell 18 per cent on the Reserve Bank’s trade-weighted index, as the fall in commodity prices led currency traders to price the Aussie down dramatically.

It came as blessed relief to industries whose competition is global: agriculture, manufacturing, education, tourism – and, of course, mining. In the three years to 2015, rural and tourism exports each increased 30 per cent in current dollars, “education exports” (horrible phrase! Let’s call it educating foreign students) earned us an extra 32 per cent, and even our battered manufacturing sector hauled in 14 per cent more.

But that was then – and there is no certainty that a lower dollar will be around to help us out in the next three years.

Since September last year, the dollar has risen, fallen (briefly) and risen again. On Thursday night it was back to 78.12 US cents, and on the Reserve’s index, up 10 per cent since September against the average of our trading partners. If you’re heading abroad, that’s terrific. If your job depends on attracting foreign students, tourists or consumers, it’s bad news.

The dollar has the Reserve Bank worried. A sustained rebound in the dollar would knock away one of the key supports that has been sustaining growth as the massive mining investment boom winds down. If the Reserve does cut interest rates again in this cycle, the move could well be designed to keep the dollar down and allow the transition from the mining boom to continue.

Whether the Reserve will need to act will depend on what happens to commodity prices. If they come back down from their recent rally, as analysts forecast, the dollar will fall with them, and the Reserve will breathe a sigh of relief.

Our low interest rates have been a third factor keeping Australia’s economy above water, but that stimulus too is coming to an end. While the Reserve was hoping that low rates would generate investment in the services sector to offset falling mining investment, so far they have mainly generated another investor-driven boom in housing prices in Sydney and Melbourne, and a new wave of apartment building in the same two big cities.

Both those booms now appear to have peaked. Housing construction is tipped to recede rather than grow in the next three years, removing another key support from the economy. And high housing prices fuel bank profits but leave home buyers with less money to spend on High Street and everywhere else in the economy.

Household debt has grown to massive levels as a ratio of household income: from 35 per cent in the mid 70s when data was first collected, to 94 per cent by 1995, and 186 per cent now. The vast bulk of it is housing debt – and most of the growth since the GFC has been in debts owed by housing investors. The burden on households is not too heavy when interest rates are so low, but it has slowed the economy already, and will slow it even more in future as interest rates inevitably rise. 

If Labor wins the election, its proposed reforms to negative gearing and capital gains would be the most significant tax reforms in Australia since the GST. In the long term, they would improve housing affordability, increase home ownership, and reduce government debt and deficits. In the short term, there is a small risk that investors might engage in a disruptive sell-off, driving house prices down steeply; but Labor’s policy provides that group with enough buffers to make that unlikely.

(One of the less-noticed virtues of Labor’s policy is that it would also remove a constraint on the Reserve’s freedom to lower interest rates again. Inflation of house prices is not one of the bank’s performance indicators; it is no secret that the fear of fuelling a further resurgence in house price inflation has been one reason why it has held off cutting rates in the past year.)

The fourth driver of Australia’s growth has been the fruit of the mining investment boom: the vast expansion in our potential to export minerals. That looks set to support growth ahead, as long as there are foreign buyers wanting our coal, iron ore, natural gas and the rest. And that brings us back to the future of the global economy…

What should the next government be doing? The IMF last week urged Western nations to speed up reforms to open up their economies so they can grow faster, and to recast fiscal policy so that it provides short-term stimulus and medium-term savings. In two reports last year, it provided specific suggestions for the Turnbull government on how to do it.

For Australia, it argued, the chief priority should be tax reform, with the aim of generating more revenue – both to get the budget back in the black, and to build more infrastructure – and cutting company tax while making industries pay for the damage they do by dumping their waste gases into the atmosphere and adding to global warming.

It put forward a broad wishlist that covers virtually every proposal raised during Malcolm Turnbull’s former “let a hundred flowers boom” phase: raise the GST rate to 15 per cent and widen it to cover all consumer spending (with lower-income households compensated); sharply reduce superannuation tax breaks for higher income earners; abolish negative gearing for all investments; abolish or reduce the tax break for capital gains; replace stamp duties on conveyancing with higher land tax; restore a carbon price; reduce the company tax rate to 25 per cent.

But of that list, next month’s budget will tackle only the superannuation tax breaks, rejecting everything else as politically too hard. Whichever side wins the election will have to finally grasp the nettle of tax reform. The budget will not balance without it.

Many other potential growth-raising reforms appear to be off the table politically, whoever wins. The Coalition’s reluctance to take on the issue of penalty rates suggests that industrial relations rules are unlikely to change. Its new innovation incentives will not bear fruit in the short term, if at all, and there appears to be a similar lack of will to overcome the problem of Australia’s large number of alienated, underperforming students in under-resourced schools.

On the fiscal front, the IMF’s other advice to governments is to borrow and build, to invest in productivity-raising infrastructure projects. Australia has many to choose from, but they are rarely the ones that get chosen – and, as I noted last week, Australian governments have collectively slashed investment in new transport infrastructure from $18 billion in 2012 to just $13.65 billion in 2015. At the very time when financial markets have made it most attractive for governments to borrow and build, ours have shrivelled up and hidden, for fear of being labelled as reckless.

The Andrews government in Victoria appears to be breaking out of this cocoon at last, and maybe others will follow. It is the ideal “no regrets” policy for a government to follow at a time like this, when the economy is at risk of being knocked off balance and could use another engine to ensure that it keeps growing – without the fear that it will later regret having spent the money in that way.

The usually well-informed Peter Martin wrote recently in the Age that the Turnbull government will propose big infrastructure investments, provided the states do more to try to fund projects through “value capture”: that is, by appropriating part of the increases in land value as a result of transport projects (for example, by building offices or housing towers over new metro stations). You hope he’s right, but the under-resourced, oversold $1.5 billion package the PM offered to Victoria recently was not a good omen. Governments that negotiate via media conference are not serious.

We’ve heard a lot about tax lately, but little about infrastructure. Yet it could be the key to seeing Australia get through the next three years. •