Joe Hockey has a problem. A big problem. And there’s not a whole lot he can do about it.
Australia’s economy is in trouble. We’re not in a recession, but in some sectors and in some states, it sure feels like it.
What’s happened? The mining boom is ending.
Australia’s economy has had an extraordinary run: 23 years of consecutive growth, a record the envy of the developed world. But in recent years, that growth has become very imbalanced.
While much of our domestic economy puttered along in second gear, the insatiable demand for resources in Asia fuelled a massive investment boom in a series of mega-projects in Queensland and Western Australia. This has super-charged those regional economies. Moranbah, Gladstone and Port Headland have expanded at breakneck speed, bringing Perth and Brisbane with them.
All that mining investment helped the broader economy too, creating jobs and helping Australia’s national income, in the form of higher profits for companies and wages for workers. Consumers got a good deal, too: the sky high Australian dollar made overseas travel very rewarding, and imported consumer goods were cheap as chips.
But the mining boom had its dark side. The high Aussie dollar smashed Australian exporters, who had to ask overseas customers to pay more for their goods and services. It also hurt manufacturers competing against overseas imports, like car-makers and white goods manufacturers. Australia’s manufacturing sector has hollowed out in recent years, hurting regional economies like Adelaide and Geelong. The result was falling productivity and the dreaded “Dutch disease.”
Now the high tide of mining investment has turned, as economic data announced yesterday shows. The Australian Bureau of Statistics’ measure of non-dwelling construction, which tracks resource projects like new mines and LNG plants, fell 6.7 per cent in the last quarter. The wonderfully named “gross fixed capital formation,” which tracks investment, fell 0.6 per cent in trend terms for the quarter and 2.2 per cent for the year. The ABS says this wiped half a percent off GDP growth.
To top it all off, Australia’s terms of trade are falling. The prices we get for exports are falling in comparison with the prices we pay for imports, and that’s hurting the whole economy. The fall has been due to the dramatic collapse in global iron ore and oil prices that is hurting Australian commodity exporters – especially gas exporters, whose product is linked to the global price for oil.
As a result, we are in an “income recession”, in which the national economy’s profits and wages have fallen for two consecutive quarters. The overall effect is sometimes likened by economists to a national pay cut, in which we simply don’t get paid as much for the same level of production.
The fall in national income is starting to flow through to the broader economy. Growth is anaemic at just 0.3 per cent for the quarter, in seasonally adjusted terms. Unemployment is rising. Business confidence is falling. Consumer confidence has been in negative territory for nine months now – the longest period since the global financial crisis.
What could provide the growth tonic Australia now needs? For a long time, economists hoped it would be housing construction. Australia’s record run of low interest rates has stimulated home building, but not nearly as much as hoped. Worse, the low rates have added extra fuel to Australia’s housing bubble, pushing housing affordability further out of reach for the lower middle class.
To say this is bad news for Treasurer Joe Hockey and the Abbott government is understating matters. It’s catastrophic news.
As we’ve known for some time (just ask Wayne Swan), the federal budget is highly leveraged to the resources sector. Falling iron prices in particular are knocking billions off the Commonwealth’s tax revenues, even while the government fails to secure spending cuts in the Senate.
The forthcoming mid-year economic and fiscal outlook, or MYEFO, will detail the budgetary bad news. The deficit looks certain to blow out by billions below the May forecasts – perhaps all the way out to $50 billion for the 2013-14 year.
The politics of a ballooning budget deficit are awful for Hockey and the government. In opposition, they made the deficit the number one topic of economic debate, effectively convincing voters that Labor’s ongoing budgetary woes proved it couldn’t manage the economy. Just in case anyone has forgotten, Tony Abbott even declared a “budget emergency”.
The economic tough talk will come back to haunt Joe Hockey – as I warned last year. For a long time, the Abbott government seemed to think that just by taking the reins of power, a magical confidence boost would fix all economic woes. That didn’t happen, of course. But there is no economic plan B to take its place.
Both Hockey and the Australian economy more broadly are now in a difficult position. With the external factors likely to get worse before they get better, the economy clearly needs stimulus. That could be provided by lower interest rates, by government spending or by a pick up in local business conditions. Only one of these three looks likely.
Government spending won’t ride to the rescue. The Abbott government’s infrastructure plans are essentially all recycled spends from the Labor years, and don’t represent significant new investment. Moreover, the Coalition doesn’t really believe in fiscal stimulus anyway. The government wants to trim the deficit, not increase it.
Nor does endogenous growth look likely to pick up any time soon. Australia is a mature post-industrial economy that faces significant productivity challenges. These can be addressed in the long term by measures like greater investment in research and universities, more business innovation, and a better educated workforce. But all of these are long-term settings that won’t bear fruit for many years. Indeed, the Abbott government has made savage cuts to all these areas, for instance to the CSIRO.
About all that Hockey can hope for is for the Reserve Bank to lower rates further. Many economists are now speculating it will do just that at its first meeting in 2015. But with rates at record lows and justifiable concerns about the inflated state of the housing market, the RBA is constrained in how low it can go.
If there is a sliver lining, it is the falling Australian dollar, which should help exporters. That could eventually make a real difference. But exports are only about a fifth of the economy, and higher import prices will of course hurt some industries.
All in all, it’s starting to look like the chilling predictions made by Ross Garnaut last year are coming true. Garnaut, remember, thinks the Aussie dollar needs to drop all to way to 63 cents to the US dollar if Australia is to effectively compete.
The doomsday scenario for the Abbott government is a fully-fledged recession. No-one’s using the R-word just yet, but if they start to, things could get very uncomfortable indeed. It was Victoria’s weak economy that ultimately doomed the first term government of Denis Napthine.
Tough times demand tough measures, but this government has shown itself utterly incapable of crafting fiscal measures that can protect ordinary Australians from the pain of savage budget cuts and widening economic inequality.
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