MICHAEL KEATING. Covid-19 and the Economic Outlook

Apr 13, 2020

The Government’s unprecedented cash splash to shore up the economy will save us from what could have been a much worse recession. This makes it doubly strange that the Government is so uncommunicative about the future economic and fiscal outlook and what it hopes to achieve.

At last the Government has provided some information about its planning to limit the number of people to be affected by the Covid-19 virus. Unfortunately, however, we still lack any assessment from the Government about the economic impact of its response to the virus, and the consequences for the Budget.

This reluctance by the Government to provide essential information represents a denial of ordinary democratic accountability. In addition, it undermines the possibilities for an informed public discussion and consensus building that is always vital to the development and implementation of sound policies.

In the absence of government information, private forecasts regarding the economic outlook have proliferated, but they vary remarkably. For example, in a survey of 15 economists published in the Sydney Morning Herald on 4 April, their forecasts for peak unemployment ranged from 8.5% to 20% – more than double – with an average peak unemployment rate of 11.5%. Similarly, these economists’ forecasts for the fall in GDP in the current June quarter ranged from a 15% fall to a modest decline of 2.8%, with the average decline forecast to be 8¼%.

This dispersion in expert economic opinion is hardly reassuring, and further emphasises why we need the Government to come forward and indicate what assumptions and projections its policy responses are actually based on. Given the present uncertainties, the authorities should not be criticised if they are wrong, but they do need to bring the rest of us into their confidence, if they want our continued support for their policy responses.

Of course, the greatest uncertainty in forecasting the economic outlook is how long the virus will last, and therefore how long the restricted trading of numerous businesses will last. In addition, there is inevitably continuing uncertainty about the effectiveness of the measures taken so far – although the signs are hopeful – but we cannot be certain that further restrictions, affecting say the building industry and parts of manufacturing, won’t be necessary.

Nevertheless, in the absence of better information from the Government, I will provide my own assessment of the economic outlook, based on the Government’s currently announced plans: namely that the pandemic will last for six months and by the end of August the present controls will have been eased and the present measures that are supporting business and their employees will then end. In addition, I will assume that the Government will spend the amounts announced – no more and no less – so that it will not prove necessary to extend some measures such as the JobKeeper Payment.

In short, my forecasts are conditional: they depend upon future employment and economic activity being consistent with what I think are the Government’s present expectations and plans.

Employment outlook

The latest ABS data for employment and unemployment refer to February, and the presently available Social Security data on the number of people on Newstart refer to last December. Of course, these data do not reflect any impact from the Covid-19 virus.

But we do know that the rate of increase in hours worked – an early indicator of the labour market demand – has been declining since February last year, and for males the number of hours worked in February 2020 was less than a year earlier. Clearly the labour market was already weakening, even before the Covid-19 virus.

A second known fact is that the queues outside Centrelink offices are enormous. Also Google data show that the number of hits searching for “newstart allowance” grew twenty-fold in the first three weeks of March.

Third, an ABS survey of businesses in the week beginning 30 March reported that two-thirds (66%) had experienced a reduction in turnover or cash flow, and that nearly half (47%) had made changes to their workforce arrangements as a result of Covid-19.

As expected, the industries most affected by the enforced closures and requirements for social distancing are travel, tourism, food and accommodation, arts and recreation services, and discretionary retail. Demand for accommodation and food services has fallen by as much as 90%, more than any other industry, although arts and recreation services, administration services, construction and education and training all reported major declines of more than 70% in the demand for their services.

According to the ABS survey, only 47% of businesses in arts and recreation services were trading in the week beginning 30 March, with information, media and telecommunications, food and accommodation services, and retail trade being the next most affected industries. However, as many as 65%, 69% and 76% of the businesses in these three industries respectively were still trading in the survey week.

Of the businesses that reported changes in their workforce arrangements, around a quarter temporarily reduced staff hours, and about 20% placed staff on paid or unpaid leave. On the other hand, about 7% of these businesses either temporarily increased staff work hours or they hired additional employees.

Furthermore, the ABS survey reported that trading operations in most other industries were largely unaffected by the Covid-19 virus, and in some industries, such as health and supermarkets, their demand for labour has increased.

Of course, these are still early days, and the employment situation may well deteriorate further in the weeks and months ahead. On the other hand, the timing of the ABS survey makes it unlikely that the business responses would have fully factored in any positive impact on their employment and working hours as a consequence of the Government’s JobKeeper payment.

In trying to forecast the longer-term employment outlook, the above evidence suggests that it may be best to focus on the industries and occupations that are likely to be most affected by the impact of the restrictions to limit the Covid-19 virus. It is these industries that will most suffer at least initially from these restrictions, although all industries would be affected by a prolonged and deep recession.

In this regard, an analysis by the Curtin Economics Centre found that about 1.3 million people work in the occupations that are most at risk. That represents about 10% of the present total employment, and it would seem to put an upper limit on the likely increase in unemployment if (as assumed) we succeed in containing the spread of the virus.

Not all of these people would, however, necessarily become unemployed. Instead, as already noted, a café for instance, might retain some staff using the JobKeeper subsidy to serve take-aways. Indeed, the evidence from the ABS survey is that so far employers are much more likely to adjust the number of working hours, or ask staff to take leave, than to stand them down.

Finally, we know that the Government has estimated that the additional cost of the JobSeeker allowance will be $5.2 billion in the current June quarter and $8.8 billion in 2020-21, most of which will be paid in the September quarter. Of course, some of the recipients of this new additional payment will be people who are already unemployed, but I estimate that the amounts provided will be sufficient to cover an additional 1.1 million when unemployment peaks around the end of June.

Of course, it would have been much better if the Government had provided this information, on the number of unemployed people it expects, as it would normally have to do in a Budget. But in the absence of authoritative information, my best guess is that unemployment will peak at about 12½ per cent around the end of June.

Economic outlook

The outlook for economic activity (as measured by GDP) will largely mirror the fall in employment. Obviously this fall in employment reduces economic capacity, but it also mirrors the extent to which demand has declined as people are not able to shop for non-essential goods and services.

In fact, GDP is likely to fall by more than the decline in employment. First, as noted, the evidence so far suggests that the hours worked per employee are even more likely to decline. Furthermore, in future, businesses will be able to use the JobKeeper payment to keep more employees on the payroll than they require. Second, this labour hoarding will also result in some reduction in productivity per worker where the subsidy results in employees being paid for more hours than the business strictly needs.

Taking account of these three factors – employment, hours and productivity – I estimate that real GDP fell by 1% in the just-finished March quarter and will fall by another 8½% in the June quarter. For the current financial year – 2019-20 – as a whole, I forecast that real GDP will fall by 1% compared to the previous year.

It can reasonably be expected that economic activity will start to recover after the spread of the Covid-19 virus is contained, and present restrictions are gradually eased. This recession could therefore be shorter than its predecessors, but it seems unlikely that the economy will bounce back.

Indeed, even before the virus took hold, economic growth was very sluggish, and business investment will not pick up before consumer demand improves. However, consumers are already very highly indebted and many will have even more debt when they get back to work. In addition, wages and productivity growth will continue to stagnate.

It therefore seems unlikely that aggregate demand will bounce back in a sustained way. Although, if the present restrictions are lifted as expected, there will be a bit of a short-term surge in demand and activity, mainly in the December quarter.

On this basis, I forecast that over the course of the next financial year, real GDP will increase by 8% or a tad more, which is a quite sharp rate of economic recovery. However, year-on-year I expect that real GDP in 2020-21 will still be 2% lower than in the current financial year.

In sum, this economic downturn will be the worst since the Great Depression. On the other hand, I expect that it will not be all that much worse than the 1982-83 and 1991-92 recessions, and the country recovered reasonably well from those recessions.

Indeed, this time the Government has been remarkably quick to intervene and adopt Keynesian measures as necessary to support the economy. Furthermore, the size of this support is unprecedented, amounting to as much as 10 per cent of annual GDP. But because of this support, Australia’s productive capability should be largely maintained, and demand can be expected to recover as the restrictions on movement are lifted.

What the fiscal support so far implies for the Budget and the future of fiscal policy will be discussed in a further follow-up article tomorrow.

Michael Keating is a former Head of the Departments of Prime Minister & Cabinet, Finance, and Employment & Industrial Relations. He is presently a Visiting Fellow at the Australian National University.

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