MICHAEL KEATING. What’s Wrong with The Economy?

The headline economic news this week is that the IMF has revised down its forecast for the Australian economy. That should not have come as a surprise; it has been obvious for a few years that the Australian economy is not growing well. The underlying reason is low wage growth, and the real issue is why and what to do about it.

The IMF now forecasts that in 2019 Australian GDP will only grow by 1.7 per cent – weaker than Greece, as the SMH headline helpfully pointed out.

Franky I am not sure why anyone was surprised. According to the latest national accounts data, the Australian economy only grew by 1.4 per cent over the twelve months to last June. Thus, realisation of the IMF forecast would actually require the economy to accelerate.

Certainly, the IMF’s forecast performed the useful function of putting another nail in the coffin of the Government’s Budget absurd forecast that the economy would grow by 2¼ per cent over the current financial year. That Budget forecast was never believable, as I pointed out at the time (see The Budget: Part 1, Pearls & Irritations, 8 April 2019).

What is more relevant is what should be done to lift Australia’s growth rate. The standard reaction is to call for more economic stimulus. There is however an increasing consensus, including the Reserve Bank, that with the RBA cash rate of interest as low 0.75 per cent, any further easing of monetary policy is unlikely to make much difference.

In addition, as former Treasurer, Peter Costello, has pointed out, the main impact of lower interest rates has been to inflate asset values, and this has not flowed on to increase investment. I agree and intend to explore further in a later article the reasons and implications of this fast rise in asset values which has outstripped the past and prospective increase in incomes.

Right now, however, most of the Government’s critics, again including the Reserve Bank, are pushing for fiscal policy to do more to stimulate the economy. In response, the Government points to its recent tax cuts and the size of its infrastructure program. The Government does not, however, give any indication that it regards the Australian economic outlook as being so poor that it would be prepared to risk its budget surplus; although it might be prepared to reduce the surplus by a couple of $billion, but not more as that would risk the surplus.

However, I think there is also a question about what fiscal policy can achieve in present circumstances.

First, many of the calls for more fiscal stimulus argue that this stimulus should be based on infrastructure spending. Increased expenditure on infrastructure potentially has two advantages:

1. It is relatively easy to turn the government spending tap off as the economy recovers

2. If the investment in infrastructure is economically warranted, it should improve future economic growth

There are, however, two problems in trying to promote an infrastructure-led economic recovery. A major concern is that many of the favoured infrastructure projects have very long lead times and cannot be implemented in the desired time frame. For example, I personally was very involved in the Keating Government’s One Nation response to the 1991 recession, and at that time the Government agreed to fund a list of projects that the States declared were “shovel ready”. Unfortunately, as it turned out, many of these funded projects had barely started two years later when the economy had recovered.

Furthermore, the other problem with increased infrastructure funding is that the sort of projects favoured by the Commonwealth Government are rarely economic. Indeed, the rush to bring these projects forward means that they are even less likely to go through a proper assessment process.

In my view, if increased infrastructure funding is going to play a role in economic recovery, it would be better to focus on increased maintenance expenditures and relatively small projects such as additional school buildings. These are almost always economic and can be started and finished quickly. In addition, given Australia’s present needs for low-cost housing, it would be good if the opportunity were taken to spend more on this. Building more social housing would again involve relatively small costs per unit and could be started and finished quite quickly.

But, in addition, there is another second critical limitation to what can be achieved by a temporary fiscal stimulus. Many of those arguing for this stimulus, seem to assume that Australia’s recent low rate of economic growth is entirely a cyclical phenomenon. For example, the Reserve Bank seems to think that as and when the rate of unemployment is reduced to (now) 4.5 per cent, the economy will revive and grow at its past potential growth rate, or even better during the two or three-year recovery period.

As I have argued in a previous recent post – Economic Update, Pearls & Irritations 7 October 2019 Australia like most other advanced nations, has been experiencing economic stagnation for some years now. There are therefore good reasons to believe that the reasons for this secular stagnation are structural as well as cyclical, and that a return to past rates of economic growth will require structural reforms as well as a cyclical stimulus.

Interestingly, Peter Costello seems to agree. However, Costello’s preferred structural reforms would focus on more deregulation to revive growth. On the other hand, Stephen Bell and I have argued at some length in our book, Fair Share, why we think that further deregulation is unlikely to make much if any difference to productivity. Essentially the main gains from regulatory reform have already been realised; for example, the removal of tariff protection, financial markets, competition policy and wage bargaining. Indeed, recent experience has suggested that there may be a need for less light-handed regulation of financial, electricity and water markets in future.

Instead as the Reserve Bank Governor, Phillip Lowe, put it two years ago the “crisis really is in real wage growth”. We need to increase wages and household incomes in order to increase consumption, and in response, businesses will then increase their investment when they can see an increasing demand for their products as consumption starts to rise faster. Furthermore, this rise in investment will improve the rate of adaptation to innovation and will thus lift productivity.

So the main issue for structural reform, and for that matter for fiscal policy, is how to lift wages and household incomes. That will require more spending, especially on lifetime education and training, but fiscal policy should also do more to increase assistance to low-income households, starting with increases to Newstart and the rental allowance.

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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12 Responses to MICHAEL KEATING. What’s Wrong with The Economy?

  1. murray william says:

    If not for NDIS economy would be tanking even worse. High money speed but choked by bureaucrats, qualified practitioners. The one LNP resisted. They favour cayman island mates. How about collecting tax from big business mates, Energy Australia etc. RBA stacked🤷‍♂️

  2. Charles Lowe says:

    Quote: “the main issue for structural reform, and for that matter for fiscal policy, is how to lift wages and household incomes. That will require more spending, especially on lifetime education and training, but fiscal policy should also do more to increase assistance to low-income households, starting with increases to Newstart and the rental allowance.”

    Keep advocating, Dr Keating. Keep pushing. Keep posting. People like me will keep advocating to our Social Media bases the truth of your thesis. We will win. When we have a competent and a courageous Opposition. In the meantime – we so need your informed input.

  3. Terry Moran says:

    Mike Keating is right and exactly these issues arose in October 2008 as the Global Financial Crisis broke. Interestingly, Treasury aligned economists again supported large scale infrastructure funding. Mike’s experience of the 1991 downturn was quoted back at Treasury. Inevitable the senior Ministers went for smaller projects which could absorb building workers at the local level and building products contributed by the manufacturing sector. Thus the school building program. It was a considerable success, mobilising capacity across the economy and within State and Territory administrations. An audit after the event disproved the hysterical criticisms from some at the political level.

    Our current predicaments seem unduly tied to a belief akin to a child’s in Santa Claus. An unjustified hope that a collection of many different challenges bearing down on our economy will all resolve in a positive direction is unwise, to say the least. The better path is for the coalition to swallow its pride and do what it strenuously opposed during the Global Financial crisis – coordinated monetary and fiscal stimulus. The sooner the better.

  4. Wayne McMillan says:

    The time has come for a permanent federally funded Universal Job Guarantee provided with adequate training and proper working conditions. Wages could be set at a minimum so as not to compete with the private sector and the jobs could be in a range of industries but mainly in the growing service or new renewable energy/ sustainable environmental industries. When private sector demand for skilled workers picks up there would be a pool of skilled workers to choose from and a smooth transition for workers to move across to the private sector.

    The beauty of this scheme is that it would give workers who are unemployed/underemployed a job, more income and new skills. It would also stimulate aggregate demand and spending immediately across the economy. A Universal Job Guarantee and a Green New Deal are long overdue.

    • Charles Lowe says:

      Wayne – would you please take whatever opportunity you can to explicate the difference between a Universal Basic Income and a “Universal Job Guarantee”?
      (And why you favour the latter rather than the former?)

  5. Peter Small says:

    Much is written about Australia and the Western Worlds malaise. It is really simple.When an employer is confronted with increased demand and a higher work requirement. He has the alternative if increasing the number of employees or investing in technology.
    As much of Australia’s workforce lacks productivity through lack of skills and/or lack of motivation, if possible investment in technology gets the tick!
    The answer.
    1.Increase motivation by reducing social security.
    2, Arrest the decline in education and training from Prep to Phds with massive government investment!
    Otherwise we will soon become the “trash of Asia” The decline in my lifetime is frightening and will soon be irreversible!

  6. Kien Choong says:

    I bow to Mr Keating’s economic expertise, but I feel there is an undue pessimism about the effectiveness of monetary policy. As long as interest rates are still above zero, it’s possible for the RBA to do something. And I would argue that when interest rates are low, small changes have relatively greater effects than when interest rates are high.

    Further, suppose the RBA were to commit to a policy of keeping interest rates low (e.g., by saying that for the next 5 years, it may reduce interest rates but will not raise them), and suppose this commitment is credible, it would reduce long-term funding costs and foster greater public and private investment. Admittedly making a credible long-term commitment is difficult. But at least try!

  7. Colin Cook says:

    When are established commentators going to spell it out, ‘The Liberals are bad economic managers’. The evidence is there for all to see but the myth about their talents remains.
    The Libs are ideologically hidebound and incompetent. They dare not think about home insulation/retro-fitting existing buildings to give better thermal performance let alone schools halls; both these Labor projects have gone down in history – falsely – as disasters when , in fact, they were timely and very effective.
    They dare not abandon their much vaunted surplus for ‘loss of face’!
    What a way to run a country!

    • murray william says:

      Here here but the sensible liberals are a captive of Gina’s IPA. Privatisation, de regulation has reaped havoc in most sectors, dodgy building since building inspection privatised. Crumbling as we speak.The working visa system is bring rorted for captive, cheap labour. 1 vacancy for 9 on Newstart but still we punish. How about TAFE subsidies like Dan in Victoria 🤷‍♂️

  8. John Richardson says:

    One of these days the geniuses mismanaging this country will realise that if you don’t actually make things & genuinely add value, then you will be inevitably doomed to trying to make a living at everyone-else’s expense.
    Digging stuff up isn’t particularly helpful, in particular when its being done by multi-nationals who pay little in the way of tax or royalties & take the profits off-shore, while leaving the cost of cleaning-up the mess to the taxpayers.
    The so-called “service economy” creates no real added value. It just adds a margin for providing services that mostly add little or no value & that we can’t really afford anyway.
    While everyone talks about “growth” like it is some fabled “elixir of life”, the truth is that more & more people are trying to dine-out an ever shrinking pie. Once upon a time, when the music occasionally stopped, maybe one in a thousand chairs at the table disappeared. These days we’re lucky to keep half of them. And let’s not forget that none of the chairs that disappear is ever put back.

    • murray william says:

      After considerable effort 😂 the LNP has created one of the worlds least diversified economies, worse than many third world. Surely not tied to donor base.

  9. John NOBEL says:

    Too much focus on agriculture and ‘Dutch Disease’ resources if no longer non-value added manufacturing/ assembly, rather than design/ make/ maintain services, knowledge and experiences.

    Time to move to a more sustainable rather than a growth model, be it opportunity, cost of living, education, environment, healthcare, human rights, infrastructure and (for real, onshore, as in where people live/ go/ work/ school) public safety and security …
    One way to sort the budget would be to reduce Versailles on Lake Blwxyz Griffin, home to Washminster-style repressive rather than social or direct democracy (#) to about five ministries (DPC/ COAG, dollars, trade, defence, justice), let the states handle the rest (sea or tree changes for acreage or quarter acre blocks rather than ever higher population density), enabled by a lowering of income tax, payroll tax, stamp duty, etc, and broadening and raising of the GST.
    Next rotate a state premier and state governor through the PM and GG slots annually.
    Half parliament and pay the remaining ones double, so we get quality rather than quantity.
    Make aspiring pollyTICs sit a civil service/ advance Australia fair exam.
    Use COAG’s online conferencing instead of the FIFO to Canberra ACT, so we get MPs that go home to their communities and families at night.
    Why not signal the change, by removing the colonial Union Jack from the flag!

    (#, campaign finance reform, a federal ICAC, useful FOI, mandatory and binding referendums for anything over x dollars/ y people/ z levels of gov if not part of a published election program, as well as ADF adventures more than 1000 kilometers from Australia’s economic zone or territorial waters …)

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