Pearls and Irritations

The government and its advisers expect this recession to be relatively short-lived, but the recovery may well be less complete than they anticipate and are planning for.

Last week the National Cabinet agreed the conditions that would need to be met to allow a staged removal of the present lockdown restrictions, and states and territories have started on this process. Assuming all goes according to plan, and the virus does not flare up again, then most of the restrictions (but not all) seem likely to have been removed by July.

So what does this mean for the economy going forward?

The official economic forecasts

In the last week both the Reserve Bank and the Treasury have released updated forecasts for the economy, which assume this time profile agreed by National Cabinet for getting back to normal movements.

The Treasury and the Reserve Bank’s most likely scenario shows unemployment peaking at 10 per cent in the current June quarter, a rise of 5 percentage points. Treasury then expects that with the restrictions lifted under three separate stages, 850,000 people will be back at work – roughly equivalent to the number of jobs lost. Nevertheless, the Reserve Bank expects the unemployment rate will still be as high as 8½ per cent in June 2021 and 6½ per cent a year later in June 2022. This is consistent with the view that in a recession, unemployment rises quickly, but only comes down slowly in the subsequent recovery.

Similarly, the Reserve Bank is projecting a sharp fall in economic activity of 8 per cent in the current financial year, 2019-20, and as all of this fall is expected to occur in the second half of the year, the Treasury expects that GDP will fall very steeply by as much as 10 per cent or even more in the current June quarter. On the other hand, both the authorities project that almost all of that fall will have been recovered over the twelve months of the following year, 2020-21, and the Bank is forecasting a further increase of as much as 5 per cent for GDP in 2021-22.

One reason why the economy might be expected to recover relatively quickly this time is that, unlike previous recessions, this recession has supply as well as demand causes. As the present restrictions on supply are not expected to continue for long, business capability may not have been damaged too much, and the affected industries could come back relatively quickly once the restrictions on their operations are eased.

Furthermore, JobKeeper program is a novel response to this recession. Its purpose is to maintain the continuity of the employer-employee relationship, so this recession should not have damaged economic capability nearly as much as occurred during previous downturns of similar magnitude.

While on the demand side, once we are permitted to go to the cinema or to a restaurant, those of us who can afford to, may avail ourselves of the opportunity at least as much as in the past. Indeed, there may be quite a bit of pent-up demand for goods and services that are effectively unavailable for the time being.

Another peculiar feature of this recession is that the restrictions on supply have disproportionately impacted just a few industries – namely hospitality and arts and recreation services. The ABS survey shows that the number of employee jobs in hospitality fell by 33.4% between the week ending 14 March and the week ending 18 April, and in arts and recreation services the comparable fall in the number of employee jobs was 27%. Whereas, the number of employee jobs fell by around 10% in agriculture, rental, hiring and real estate, administrative and support services, and other services, but in all other industries the fall in employee jobs over this period was around 5% or less.

According to this ABS survey, the total fall in the number of employee jobs for Australia between mid-March and mid-April was 7.5%, but interestingly, the fall of 8.2% in wages was slightly more, implying that of those who kept their jobs, some got paid for less time, but not much less on a net basis.

JobKeeper was announced on 24 March, so hopefully the rate of job loss has slowed since this survey period. Furthermore, according to the Reserve Bank, “More of the labour market adjustment is likely to occur through hours worked than job losses in economies with comprehensive wage subsidy programs”, like JobKeeper.

Overall, the Bank projects that total hours worked in the current June quarter will decline by around 20 per cent. However, employment is only projected to fall by 8 per cent, and because quite a few of the people who lose their jobs are expected to quit the workforce, unemployment is forecast to rise by only 5 per cent.

In addition, it seems that compared to previous recessions, the impact of the restrictions on employment has been much more concentrated on the hospitality and arts and entertainment industries. Thus, it is young people and women who are bearing a disproportionate share of the burden of this recession, while the typical male breadwinner has been left relatively well-off compared to previous recessions.

One piece of silver lining, however, is that these industries that have been most affected are used to a high rate of labour turnover, so the process of recruiting and rebuilding skills may take less time than in other industries. Indeed, of the 850,000 extra jobs that Treasury is predicting after the lifting of restrictions, more than half of the workers will come from hospitality (338,000), arts and recreation (76,000) and transport, postal and warehousing (71,000).

Comment

While I accept, for the reasons elaborated above, that the recovery from this recession will most likely be faster than usual, I think the official forecasts tend to err on the side of being too optimistic.

First, in my opinion the recession is probably a bit deeper than the authorities are estimating. In a previous post (13 April), I projected that the unemployment rate would peak at 12½% in June; a 7½ percentage point increase over the pre-Covid unemployment rate compared to only a 5% percentage point increase estimated by the Bank and the Treasury.

My unemployment forecast has subsequently been matched by the Grattan Institute which is also projecting a peak unemployment rate between 10 and 15%. And this difference in unemployment alone means that it is likely to take longer to fully recover from the recession than the government is presently planning for.

Second, over the last few years, the main driver of Australian economic growth has been the increase in population. More than half of this population growth is accounted for by net migration, but the closure of Australia’s borders means that the rate of population growth is likely to halve this year. Furthermore, migration levels are unlikely to recover fully, and analysis by Abul Rizvi (27 April) concluded that “net migration in the decade of the 1920s will be well below that of the past 20 years”.

In particular, this slower growth in population is likely to impact the construction industry. Treasury already expects dwelling investment to fall by 18 per cent because of the coronavirus, and it is not surprising that this industry is already calling on government for more support. As Labor has pointed out, there is an opportunity to expand social housing, which is in much shorter supply than other housing.

In addition, two other industries that are likely to be impacted for a very long time – perhaps permanently – by the closure of Australia’s borders, are international tourism and education, especially higher education. Furthermore, higher education is essential to driving Australia’s future supply of skills and innovation, but it will not recover without substantial government assistance, which so far does not seem to be forthcoming.

Third, Australia, like many other countries has been experiencing secular stagnation for some years because of inadequate demand, which in turn has been due to low wage growth. The experience of this recession will have made this problem worse, and it is unlikely that it will be reversed with a continuation of present policies.

The Reserve Bank’s forecasts for consumption project that the 15 per cent fall in household consumption expected in the current half year or so, can be recovered over the next couple of years. But a substantial number of households and businesses will have drawn down on their savings and/or accumulated increased debt, in which case they will be looking to make continuing economies in their discretionary expenditure, and thus spending less. While more generally, given the recent history of income growth and the outlook for the future, a 15 per cent rate of recovery in consumption, as projected by the Bank, appears extraordinarily ambitious to me.

Conclusion

While we can expect demand and output to pick up in Australia as the restrictions on movement are eased, I think full recovery will probably take longer than is projected by the official authorities. Furthermore, even a more modest rate of recovery would be jeopardised if the Government moved to tighten up its support too soon and resumed its quest for budget surpluses.

The longer-term outlook for the Australian economy is that the secular stagnation that we have been experiencing, may well get worse. Australia really needs to take this opportunity to change course, but will it? The track record of this government does not inspire confidence.

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