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.