The economic wreckage caused by the coronavirus was abrupt, frightening and savage. Suddenly Australia was on track to lose a tenth of its annual national production. Even with the federal government spending hundreds of billions on employment and income support, even with the central bank taking interest rates to rock bottom and acquiring more than half the bonds the government issued to pay for its extra spending, output in the second quarter of 2020 fell by 6.3 per cent compared with the same quarter in 2019. The average real income of Australians fell by 7.4 per cent, and more than a million Australians were unemployed by July.
Abrupt, frightening, savage — but also short and unexpectedly shallow. It was a deliberate recession, one brought about by government and by people’s fear of infection, and yet important parts of the Australian economy kept working. Mining and farming continued. So did manufacturing and major construction work. Electricity, gas and water utilities kept operating. Public servants were still working, often at home. Tradespeople, cleaners and gardeners were working more often than not. Most health workers remained on the job, busier than ever. Schools and childcare facilities remained open in most places, continuing to employ their staff. Office workers found that new technologies enabled them to work as productively from home. Media staff struggled to keep up with the demand for news and entertainment.
It may have been the case that many service workers who remained in jobs couldn’t produce as much as before. Yet so long as they were paid, they could sustain their usual spending and were counted in Australia’s total output. All up, and notwithstanding that Australia was often reported to be in “lockdown,” most of the Australian workforce kept working, either from their usual place of work or from home.
The economic collapse, such as it was, centred on discretionary retail such as clothing and furniture, local and foreign travel, and sports, entertainment and the arts. When the numbers for the three months ending June 2020 were published, they revealed that the big drop in GDP for that quarter was almost entirely caused by a fall in household consumption spending. There was a correspondingly huge increase in household savings. Government payments meant that income was actually up in the quarter. The fall in consumption — and the corresponding fall in output in industries including food services, medical services, transport, sports and recreation, administrative services and so forth — was not the result of a financial crisis, or a turn in the business cycle, or the failure of an export market, or any of the usual causes of recession. It was due, as the Australian Bureau of Statistics remarked, to “movement restrictions” in response to the pandemic.
Australia’s extraordinary three-decade economic expansion was over. Yet compared with the countries to which it usually likens itself, Australia had a good pandemic. When the rich countries’ international economic agency, the OECD, published its forecasts in June 2020, it expected Australia to experience a milder economic contraction over 2020 than any of the OECD’s thirty-seven members except South Korea. At 5 per cent, the expected shrinkage was less than half that forecast for Britain, a little over half that forecast for the eurozone, and less than those forecast for the United States, Germany and Canada.
When it met via video conference on 2 June 2020, the Reserve Bank board agreed that it was “possible that the downturn would be shallower than earlier expected.” So it would be. When it published a new set of forecasts on 6 November 2020, the expected peak unemployment rate was down to 8 per cent in the fourth quarter, thence falling gradually to 6 per cent two years later. What these figures revealed was that the Reserve Bank believed Australia’s annual GDP at the end of 2021 would be about the same as at the end of 2019. Soon enough, that forecast too proved pessimistic.
Although that was a more cheerful scenario than the earlier forecasts, the great economic cost of the pandemic wasn’t in doubt. Even with good recovery, Australia would have lost perhaps 6 per cent of GDP by the end of 2021 — the amount by which it may well have risen without the pandemic. Measured as real GDP per head, living standards at the end of 2021 would still be below the level reached at the end of 2019. Employment would be considerably higher than it had been at the end of 2020, but probably still a little lower than at the end of 2019. Unemployment at the end of 2021 could still be around 6 per cent of the workforce, or more than 900,000 people. And by then, Australian government debt would be beyond what anyone could have imagined as the bushfires raged through southeastern Australia two years earlier.
The full recovery of the Australian economy would depend partly on the global economy, many parts of which were in dire trouble. After a precipitous decline in the first three months of 2020, production had resumed growing in China, though it was far from the level projected before coronavirus. Japan, South Korea, Taiwan and Singapore had also gone back to work, but with many areas of activity still disrupted and intermittent episodes of reinfection. Jobs and output had dropped vertiginously in Spain, Italy and France and were only slowly recovering. The east and west coasts of the United States, the location of much of its industry, were still grappling with the aftermath of an epidemic far more severe than China’s.
Governments lifted their spending without much argument or political dispute. In advanced economies, the increase in government discretionary expenditure by October 2020 was just short of a tenth of GDP. The various forms of liquidity support — emergency loans, bank funding facilities and so forth — totalled another tenth of GDP. In January 2019, US current government spending was a third of GDP; less than eighteen months later it had risen to over half. The US federal government deficit was a little under US$1 trillion in 2019; the Congressional Budget Office expected it to be three times higher, at more than US$3 trillion in 2020.
Like the health impact, the economic impact of the pandemic didn’t spread as expected. The greatest damage was not in China, where it had begun, or in the poor countries of Africa. It hit hard in wealthy countries, and particularly in America, Britain and Western Europe, where the health damage was also greatest.
But the most unexpected economic aspect of the pandemic was that its impact was not as great or as enduring as first feared. In many wealthy countries, output collapsed in the second quarter of 2020 but was recovering by the third quarter. Income support sustained sales to households, often by package delivery. In the United States, retail sales from June 2020 were way above pre-pandemic levels despite new Covid-19 cases running at three times the level reached in April, when economic activity had plunged.
Even as Donald Trump fell behind Joe Biden in vote counting in the crucial state of Pennsylvania, the Bureau of Labor Statistics reported that the United States had added 638,000 jobs in October 2020, the sixth straight monthly increase. Of the twenty-two million jobs lost in March and April, half had been regained. Even so, US output in the fourth quarter of 2020 was expected to be markedly lower than in the fourth quarter of 2019. At 10.7 million, the number of workers without jobs in the United States in November 2020 was nearly double the total in February.
In China, output plummeted by nearly 7 per cent in the first quarter of 2020 compared with the first quarter of 2019. But output was growing again by the second quarter, and that continued in the following quarters. Both exports and imports swiftly increased. China’s economy, the International Monetary Fund predicted in October 2020, would be among the few to achieve growth over 2020 as a whole. Its recovery was strong enough, warned the Financial Times in late November, to put at risk China’s carbon reduction targets.
By the end of 2020 it was evident that, with a few exceptions, East Asia had handled the pandemic better than most other regions, and the economic growth gap between East Asia and the rest had widened. For Australia, which exports predominantly to East Asia, that mattered. Despite the impact of travel bans on foreign students and tourists, Australian exports were less affected than earlier feared. By November 2020, goods exports were down just 4 per cent on a year earlier.
By October, the IMF assessed that the global economic impact had been very bad indeed, but not as bad as earlier expected. The forecasts, while still bleak, had also improved. The United States and Europe had been stronger than expected and global trade was recovering faster than expected, especially China’s trade.
Even so, on IMF projections, the difference between the increase in global output in 2019 and the fall in 2020 would be equivalent to a global loss of output of around US$6 trillion, or more than three times the total annual output of an economy the size of Australia’s. Global trade was expected to fall 10 per cent in 2020. Comparing the second quarter of 2020 with the fourth quarter of 2019, the International Labour Organization calculated that the world economy had lost the equivalent of 400 million full-time jobs, disproportionately among women, low-wage earners and young people.
The cost to government budgets was also huge. In the fiscal year ending 30 September 2020, the US budget deficit tripled to US$3.1 trillion — more than 16 per cent of GDP. Spending increased 47 per cent over the previous year. US federal government debt to GDP ratio rose to over 100 per cent, and kept going up. The IMF expects 2020–21 budget deficits of one-fifth of GDP in Canada and the United States, a twelfth in China, and a tenth in Australia.
Australia’s post-pandemic circumstances are in some respects typical of all countries recovering from the pandemic, and in some respects atypical.
The economy was growing again. After output fell by 7 per cent in the second quarter of 2020, it rose 3 per cent in the third quarter. Output was then only 4 per cent lower than before the pandemic, in the December quarter of 2019. With a strong fourth quarter in 2020 and again in the first quarter of 2021, Australia might find that by mid 2021 output has returned to the pre-pandemic level — six months ahead of the Reserve Bank’s estimate last November.
Yet almost a million people were still out of work, and many of them will remain unemployed for a long time. With employment growing more slowly than output, it could be towards the end of 2021 before the number of jobs was back to where it was in December 2019 —leaving 700,000 people, or 5 per cent of the workforce, searching for jobs. Meanwhile, many new jobseekers will have joined the search.
In the first sustained fall in living standards most Australians have ever experienced, average real income per person (as opposed to the national total) will probably not regain the level of 2019 until 2022. After increasing rapidly since 1991, household wealth slipped in the first half of 2020 — though those losses have since been mostly recouped with resilient home prices and rebounding share prices.
If all goes well, the additional debt can be managed over the decades to come. Because ultra-low interest rates are expected to continue well into the future, the October 2020 budget projected the net cost of Commonwealth debt as a share of GDP to decline slightly, even though the amount of debt was increasing. Nor will the interest cost be large: just 0.9 per cent of GDP even for 2020–21, and 0.8 per cent of GDP by 2023–24.
But those figures are perhaps a little misleading. Before the pandemic, the interest the Australian government paid to its debtors was around 4 per cent. During the pandemic, the ten-year rate fell dramatically, allowing the government to refinance its debt at much lower interest rates while locking in a decade of low rates for the bulge in new debt between 2019–20 and 2023–24. Largely as a result, the government’s net interest payments, both as a dollar amount and as a share of GDP, were higher in 2018–19 (when debt was much smaller) than they are expected to be in any of the four years from 2020–21 to 2023–24.
The government bond rate will almost certainly increase over this decade, but borrowing costs will only rise sometime later. Treasury projects net interest payments to decline as a share of GDP in 2030–31 compared to 2020–21, despite net debt rising by nearly 8 per cent of GDP — and despite its projection that the bond rate will rise to 5 per cent in the next decade. Because it ends in 2030–31, Treasury’s projection doesn’t take account of the impact of gradually refinancing much higher debt during the next decade at an interest rate five times higher than the rate in this decade. The most constraining impact of the 2020 pandemic may not hit the Australian government for another ten years.
Timing the reduction of deficits and the control of debt will require good judgement. Although treasurer Josh Frydenberg says the federal government won’t try to stabilise the growth of debt until unemployment is comfortably under 6 per cent, the scenario offered in his October 2020 budget was quite different. On Reserve Bank forecasts, unemployment won’t drop to 6 per cent until the end of 2022, yet Treasury forecasts the budget deficit falling to 4 per cent in 2022–23. Well before unemployment falls to 6 per cent, in other words, the budget will have turned contractionary. And it will continue to be contractionary, with the deficit projected to fall to 3 per cent of GDP in 2023–24. That, at least, is the plan.
Treasury projects a relatively small increase in tax revenue over the four years from 2020–21 to 2023–24, the result of bringing forward personal income tax cuts and business investment write-offs. To reach the deficit target of 3 per cent of GDP in 2023–24, spending will have to fall by 8 per cent of GDP — a cut of a magnitude not evident in half a century of data. Treasury assumes that the private economy will come back strongly and quickly enough to replace the government stimulus.
It is true that the net debt-to-GDP ratio continues to increase over this period (peaking in 2023–24), but that is because the starting-point deficit is so big, not because it is being reduced slowly. The treasurer and Treasury have suggested the government’s policy may need to be adjusted, depending on the strength of the recovery. The projected settings underline just how much skilled judgement will be involved in fiscal policy over this decade.
Managing debt will preoccupy Australian governments for years to come, though it’s important to remember that the Commonwealth’s net debt, at 38.3 per cent of GDP in 2030–31, will still be far lower compared with the size of the economy than that of Japan, the United States, most of Western Europe and Britain.
The initial political battleground will be unemployment — and especially the speed with which Australia can be expected to reach the Reserve Bank’s new informal target of 4.5 per cent unemployment — and how to pay for reducing the deficit. Growth, and the automatic rise in tax revenue that results, will help. The Reserve Bank will help by keeping the government bond rate lower than it would otherwise be and by continuing to buy a share of additional government bonds. But there will also be pressure to raise tax revenue where it will have the least impact on current demand. As the IMF now argues, that might well include higher taxes on high incomes, capital gains and wealth. •
This is an edited extract from an new Lowy Institute paper, Reconstruction: Australia After COVID, published this month by Penguin.