Tony Abbott's Biggest Problem Is Not Leadership Instability

The Abbott government has many problems.

Riven by internal dissent and helmed by one of the most unpopular leaders in Australian history, the government is none-the-less wedded to an ideological agenda that voters appear to have comprehensively rejected. The Coalition is adrift in a sea of troubles: health, education, human rights, submarines – not to mention the fact that two-fifths of Tony Abbott's colleagues don't want him.

But there’s one problem that looms larger than even the leadership question. 

It’s a troubling combination of domestic weakness and international events, over which the government has little control. It’s an issue that clearly worries voters, in a policy area where the responsible minister has proved himself a liability, and where the government seems largely out of its depth.

It’s the economy, stupid.

Australia’s economy is in trouble, and there appears little Abbott and Joe Hockey can do about it.

Growth is weak. Unemployment is rising. The mining investment boom is tailing off rapidly, and Australia’s income is falling. Consumers remain cautious, business confidence is low, and prices are so subdued that some economists worry about incipient deflation.

The Reserve Bank’s recent statement on monetary policy, released this February, makes for glum reading. “The domestic economy continued to grow at a below-trend pace over the second half of 2014,” the Bank wrote. “Growth of private non-mining business investment and public demand remain subdued, while mining investment has fallen further.”

The RBA expects the economy to operate “with a degree of spare capacity for some time yet”. After dropping interest rates a quarter of a per cent this month, many now expect RBA Governor Glenn Stevens to cut rates again soon.

Australia is a long way from recession. But stagnation looms. Real wages are flat, which means pay packets are only just keeping pace with inflation. And with the price of crucial Australian commodities like iron ore falling, our national income is declining too. Despite the temporary boost provided to exporters provided by the falling Australian dollar, and the handy benefit to commuters from lower oil prices, the domestic economy is growing only slowly.

This means that unemployment will keep rising. January’s figure of 6.4 per cent was already the highest in 12 years. Unemployment has now been above 6 per cent for eight consecutive months. As economist Stephen Koukoulas wrote on his blog, “the bottom line is that the pace of economic growth is simply too weak to make meaningful and lasting inroads into the unemployment problem.”

All in all, the gloomy prognosis offered up by Ross Garnaut in 2013 appears to be coming true.

The weak economy is not just a problem for those looking for work. It’s also a huge problem for the Abbott government, which is currently crafting its critical second budget, due to be delivered this May.

The government has been asleep at the wheel on the economy ever since it came to office. It has single-handedly set out to destroy the renewables industry, and has almost succeeded, with renewables investment dropping by 90 per cent since the announcement of RET Review last year. The government has also badly damaged confidence in the health and education sectors with the uncertainty surrounding its budget measures. Meanwhile, the resources sector that it set so much store in has been hammered by declining commodity prices.

Much of this has been driven by ideology. Politically, Hockey is committed to returning the federal budget to surplus. But the weak economy has destroyed any hope of that. Far from returning the budget to the black, the deficit is actually getting worse – much worse. December’s mid-year economic and fiscal outlook (MYEFO) detailed a $43 billion blow-out over the forward estimates. Falling commodity prices were chiefly to blame.

Given the weak economy, orthodoxy would dictate further cuts to interest rates and a boost to government spending to try and get growth moving again.

We’re now likely to get those interest rate cuts. But any government stimulus is off the cards: the Abbott government is ideologically opposed to government spending, and continues to insist it will do something about Australia’s supposedly disastrous deficit.

As a result, fiscal policy is likely to remain neutral or even contractionary. Hockey runs the risk of counter-acting the Reserve Bank’s monetary stimulus, simply because the government is so committed to deficit repair.

There is a word that describes cutting public spending in a time of economic weakness: austerity.

Austerity has comprehensively failed in the European economies that adopted it after 2010. In Britain, for instance, there was even a double-dip recession after the Cameron government embarked on massive cuts to government spending.

The people that advise Joe Hockey in the Treasury know that the economy is weak and the serious budget repair will have to wait for the medium term, when growth will hopefully pick up. That was the reasoning behind the timing of the bulk of Hockey’s sweeping budget cuts announced last May, which were scheduled to kick in after 2017.

But will Hockey take their advice? The pressure is already on for further austerity from the business sector and the deficit hawks in the Murdoch media. Last week, for instance, The Australian’s David Uren and Adam Creighton penned an article warning that another $40 billion could disappear from federal revenue by the time the May budget rolls around. Other commentators have leapt on the remarks of Glenn Stevens last week, warning that if the economy did slide into recession, “the budget deficit would go from 2 per cent of GDP to 5 or 6 in a heartbeat.”

But Stevens also admitted he was constrained in what he could do with monetary policy. With rates already at record lows, further cuts may not necessarily spark a sustained lift in economic growth.

“We have a significant lack of confidence,” Stevens told Parliament’s standing economics committee last week. “I think more in the business community actually than among households, to invest, to hire, to innovate and I do not have, we do not have with our instrument, something directly connected that will change that.

“You know, interest rates maybe help, but we don't suddenly spark animal spirits with lower rates.”

Stevens’ caution was a stark warning to the Abbott government that things are likely to get worse before they get better.

It was the worst news imaginable for a government that has already exhausted its political capital on a budget that didn't even do that much to reduce the deficit. In a chaotic environment where the government's key goal seems chiefly to survive the next few weeks without another spill, fiscal paralysis has set in.

With Australian bond yields at their cheapest ever, the government could be investing for Australia's future prosperity. It's not. That's a bad sign for Australia's economic health.