Economic dark clouds gather but the budget is sunny

By David Donaldson

May 9, 2019

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Things were rather gloomy at Wednesday’s meeting of the Melbourne Economic Forum, and it wasn’t due to the wintery weather.

The Australian economy is not in a good place, argued the experts, and is not likely to be for a while.

Falling terms of trade will drag on income growth for the next couple of years at least, eating away at any GDP gains, argued Janine Dixon, senior researcher at Victoria University’s Centre of Policy Studies.

The cost of imports is growing quickly, she said — perhaps because they are finally catching up to the big drop in the Australia dollar in 2014-15 — so governments shouldn’t bank on an uptick in incomes in the near future.

A decision by the Reserve Bank to lower the interest rate, likely to happen soon, would add to the rising cost of imports as the exchange rate follows the interest rate down.

The burden of the slowing economy hasn’t been distributed evenly. Times have been particularly tough for young Australians since the global financial crisis, noted University of Melbourne Professor Jeff Borland.

While young people always suffer more during economic rough patches — they are more likely to be looking for work when companies stop hiring — Borland’s modelling showed the youth unemployment rate had been even worse over the past decade than would normally have been expected in a slowdown.

Young people are working part-time hours much more often than in previous times, even when accounting for the higher amount of time spent in education — and the data suggests it’s not just because new jobs are disproportionately part-time.

When the economy eventually picks up again, perhaps young people will be the first to take the new jobs, Borland said. But until then, it appears they will continue to lose out in the labour market.

Yet the gloom is not reflected in the government’s own predictions.

University of Melbourne Professor Ross Garnaut was critical of the “discredited” approach of Treasury forecasts assuming everything returns to the long-term average in 3-4 years, a practice that has seen predictions miss the mark many times in recent years.

Projections that productivity growth would return to the 30-year average in the government’s pre-election economic and fiscal outlook are especially problematic, given that that average includes the 1990s, when Australian productivity growth topped the OECD.

Danielle Wood of the Grattan Institute believes that while they were originally included in the budget papers to help plan ahead, the government’s medium-term projections have lately been more effective at “obscuring” than illuminating where the economy is heading.

The Coalition’s tax cuts have been justified based on some rather optimistic modelling. Stage three of the cuts, to kick in around 2024 — in two governments’ time — will see the Commonwealth losing out on around $30 billion of foregone revenue.

According to the government’s numbers, this rather significant cost will be balanced by incredibly low growth in payments made by the government — things like pharmaceutical benefits and pensions.

The current administration has already overseen the lowest payments growth in the last 50 years, but hitting the target will require halving that growth again — and maintaining those very low levels. They’ve “baked in” no new spending for 10 years, even taking into account big increases in funding for the NDIS, defence and ageing, a sceptical Wood says.

A fair chunk of the heavy lifting will have to be done by public servants, too. An ongoing efficiency dividend would see 0.3% of GDP shaven off spending on administration in the next decade.

Projections affecting revenue also remain optimistic, so while the government will maintain a historically anomalous level of spending growth, the money is assumed to keep flowing in. This creates a “built-in optimism generator”, she thinks.

Wood is concerned these numbers — for a period too far into the future to accurately predict — are warping policy choices.

A government using this kind of optimistic thinking about distant budget figures to justify expensive reform should lead to a rethink about Australia’s how fiscal institutions operate, thinks Wood — and indeed whether medium-term budget projections are a good idea at all.

Handing over projections to the Parliamentary Budget Office might help, she said, but to date, most of the numbers they have produced looked more like Treasury’s projections than the economists in the room might have hoped.

Considering the widespread view that the economy is not going so well, Garnaut touched on what the winner of the election should do if circumstances fail to pick up. He is sceptical quantitative easing would be very useful and instead urges ramping up government spending on things like high-quality infrastructure.

He also sees oligopolies as a significant drag on productivity growth in Australia, arguing competition reform could help. While internationally competitive industries have made gains in recent years, organisations in heavily regulated industries and natural oligopolies or monopolies have failed to see much productivity growth, and in some cases have seen declines.

Garnaut noted how often through Australian history new governments had arrived in office to find the economic picture was different from what they had anticipated and were forced to change course.

Given the combination of gathering economic storm clouds and optimistic budget forecasts, Garnaut’s question for Bill Shorten and Scott Morrison ahead of next week’s election would be: what will you do if you get into office and the economy is doing worse than expected?

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