Pearls and Irritations

In two weeks the Government will bring down its delayed 2020 Budget. This article discusses the economic outlook and concludes that further stimulus measures will be necessary in the forthcoming Budget. The desirable size of that additional fiscal stimulus and the possible new measures to accelerate economic recovery will then be discussed in a subsequent article tomorrow.

Government policy so far

Fortunately the Government has cast aside its past opposition to government debt and deficits, and has responded quickly and substantially to minimise the loss of jobs which could have resulted from the lockdowns required to suppress the pandemic.

Treasury estimated in July that the cost of this government support through JobKeeper and other programs, plus the downturn in tax revenues, will create a budget deficit of $85.8 billion in 2019/20 and $184.5 billion in 2020/21, equivalent to more than 9 per cent of GDP in that year alone. Wage subsidies alone account for half of the spending support, with the rest going to investment incentives, other household income support, residential construction subsidies, cash flow support to businesses, arts subsidies, and so forth.

The JobKeeper assistance has helped more than 900,000 businesses to maintain the employment relationship with their employees, even when they could not be fully employed, or in some cases not gainfully employed at all. Equally important, the government assistance has largely sustained household incomes, which still rose 2.2 per cent in the latest June quarter, despite the economic downturn and a fall in wage incomes.

Altogether the Grattan Institute estimates that the various forms of Australian government assistance pumped an extra $128 bn into the economy, more than 10 per cent of GDP, in the six months from April. State government interventions added another 1 to 2 per cent, and early withdrawals of superannuation another 1.5 per cent.

But on present policies this level of government assistance to households is due to be wound back in another week or so. The Grattan Institute estimates that emergency income support from the Australian government will fall from $16 bn a month in the September quarter to $6 bn a month in the December quarter.

How this withdrawal of assistance will affect the rate of economic recovery is a critical issue for the forthcoming Budget, which will be now considered, starting with the official forecasts.

The official forecasts

Two months ago, in its July economic update, the Treasury forecast that real GDP would fall by 7 per cent in the June quarter, and by 3¾ per cent for 2020 as a whole. Furthermore, Treasury forecast that GDP would only recover by 2½ per cent in 2021. Thus after two years, GDP would still be lower than it was pre-Covid.

In addition, in July Treasury also expected unemployment to peak around 9¼ per cent in the December quarter this year, and to still be as high as 8¾ per cent in the June quarter next year. Furthermore, after allowing for the many workers who quit the labour force or who are working zero hours on JobKeeper, Treasury estimated that the “effective” unemployment rate was as high as 15 per cent in April and close to 11 per cent in June.

Subsequently, the Reserve Bank (RBA) in its 7 August update on monetary policy, endorsed a broadly similar economic outlook, and this was after allowing for the Covid-19 setback in Melbourne. According to the RBA, GDP can be expected to decline by 6 per cent in the December quarter of 2020 compared to output in the December quarter of 2019. Although the RBA expects output to then expand by 5 per cent in the year to the December quarter of 2021, this would still leave GDP lower than it was two years earlier before the Covid pandemic.

In the RBA’s view the economic downturn is not as severe as earlier expected and a recovery is now under way in most of Australia. Nevertheless, recovery is expected to be slow, with the RBA forecasting that the unemployment rate will peak at 10 per cent of the workforce by the end of 2020 and will still be above 8 per cent at the end of 2021.

Support for the RBA view that the economy has started to recover was provided by the latest unemployment figures released by the ABS last week. These showed a fall from 7.5 per cent in July to 6.6 per cent in August – consistent with the view that the economy is now starting to improve. However, this fall in unemployment seems to be solely accounted for by an increase in sole traders, probably working in the gig economy.

Instead, a better measure of the state of the labour market is the number of hours worked, and the hours worked hardly changed in August compared with July. This represents a set-back compared with the rise in hours worked recorded in the previous three months. However, this August slowdown in the recovery of hours worked is entirely due to the fall in hours worked in Victoria.

Another hopeful sign, that is probably influencing official Australian thinking, is that Australian exports have been running ahead of imports, with the June quarter registering the 10th consecutive surplus in the balance of goods and services. Travel restrictions have obviously impacted tourism in particular, and also education exports, which are especially important in Australia. But on balance Australian tourists travelling overseas spend more than foreign tourists spend in Australia. In addition, looking ahead, Australia’s main export markets are in East Asia, and the economies of these countries seem likely to recover more quickly than elsewhere, which will help Australia.

Probably the most critical factor for the pace of economic recovery is the outlook for household consumption, remembering that business investment is also mostly driven by the rate of increase in consumer demand. It is households who will be most affected by the withdrawal of government assistance, but on the other hand they have accumulated considerable savings in the last few months.

Notwithstanding the 2 per cent increase in disposable household incomes – thanks to government assistance – household spending fell by a record 12.1 per cent in the June quarter, with the consumption of services falling by the greatest amount (17.6 per cent). The counterpart of this rise in household incomes and fall in spending was that the ratio of household saving to incomes rose to 19.8 per cent – its highest level since June 1974.

One possibility is that the rise in the household savings ratio mainly reflects the lack of opportunity to spend because of the lockdown. In that case, it is plausible that consumption will kick back quickly as the lockdown restrictions on trading are removed, and that the economy will therefore recover fairly quickly. Furthermore, the index of consumer confidence (produced by the Melbourne Institute and Westpac Bank) surged by 18 per cent month-over-month in September, returning to its pre-Covid level, and reversing the 9.5 per cent fall in August, as Victoria managed to curb a resurgence in Covid-19 cases.

On the other hand, however, it may be that the increase in savings mainly reflects the nervousness by households about their future in these very uncertain times. In that case households (and business) are likely to continue to be cautious about future spending. In addition, as much as $236 bn of mortgage repayments and business loans have been suspended during the pandemic. Thus, many households and small businesses may need to draw down on these savings to repay the debts that they have accumulated, and their consumption and investment will remain constrained by low income growth.

Finally, a word of warning is provided by the independent experts at the OECD who expect a somewhat slower rate of economic recovery in Australia than the official authorities here. In its latest forecasts, released last week, the OECD showed Australian GDP falling by 4.1 per cent in 2020 – in line with the Treasury forecast. But according to the OECD, GDP is only expected to rise by 2.5 per cent in 2021; furthermore this OECD forecast for 2021 represents a substantial downward revision, equivalent to 1.6 percentage points less than the OECD forecast in June. So the OECD is significantly more pessimistic about the rate of Australia’s economic recovery from this recession than it was three months ago, and it is also more pessimistic than the Australian authorities.

Conclusion

In sum, much obviously depends upon containment of the virus, but the Australian authorities seem to think that Australia is on the path back to economic recovery. However, the presently available official forecasts and data do not suggest that the Australian economy will bounce back in the next year or more, even if and after the Covid-19 virus is fully suppressed. And the OECD forecasts suggest a significantly slower rate of economic recovery.

Even on the Government’s forecasts, the rate of recovery from unemployment would be slow – slower than the recovery from the 1982-83 recession and no faster than the recovery from the 1991-92 recession, which was slow. But as the Government has itself recognised, too slow a rate of economic recovery risks people, and especially young people, being scarred by the effects of long-term unemployment, thus damaging their future employment and income prospects, and consequently the economy’s long-term economic potential as well.

Accordingly, it is concluded that further stimulus would be desirable in the forthcoming budget. In particular, the proposed rate for withdrawing the main forms of present government assistance will likely need to be revised. In addition, other new initiatives to further bolster the economy will probably be needed, especially in those areas which have so far been relatively neglected.

The scale and nature of these new initiatives will be considered in a further follow-up article tomorrow.

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