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Keeping an eye on the long-term prize

Jeremy Lawson
— 1 minute read

This month’s Australian federal budget took place against the most difficult economic backdrop in more than a generation. 

Australia experienced a smaller output contraction than most other countries at the height of the global pandemic between February and April. But more timely indicators suggest that this outperformance faded through the winter and early spring. And critically, the peak in unemployment probably still lies ahead, particularly now that the generosity of the JobKeeper programme is being progressively reduced.

The silver lining in the current economic cloud is that Australia entered the current crisis in a comparatively strong fiscal position. Net government debt as ratio to GDP was less than half that of most eurozone economies, with the gap to the US and Japan larger again. Australia is also in a better long-term fiscal position than many of its peers because of its more favourable demographic profile and better designed health and retirement income systems. This helped facilitate one of the more aggressive initial fiscal responses to the crisis, while also setting the scene for the additional stimulus announced this week.

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Yet, upon scrutiny it is hard to avoid the conclusion that the government missed a trick. Yes there was more money set aside for an array of “shovel ready” infrastructure projects, including more money for roads, rail and the support of state and local initiatives. But there was also the traditional heavy reliance on regressive tax cuts – largely pulled forward from the future – as well as temporary asset write-offs for businesses to encourage greater investment. Moreover, the government is still planning on significant fiscal consolidation in the 2020/21 fiscal year at a time when private sector demand is still likely to be fragile.

One of our major concerns about the budget is that the fiscal multipliers may well prove to be lower than the government expects. Large personal tax cuts and asset write-off opportunities presuppose a healthy willingness to spend, not to mention plentiful private investment opportunities. But against a backdrop of subdued external demand, tight border restrictions, very high household debt, reduced JobKeeper payments, and insufficiently large public investment plans, the danger is that too much of the additional fiscal support will be absorbed into savings. And with monetary policy close to the end of its rope, there is not a lot of scope for the RBA to pick up the slack.

More generally, it isn’t clear that the government has fully come to grips with the scale of Australia’s long-term growth and social challenges, many of which have been made worse by the pandemic. In the years before the COVID crisis, the economy had become unduly reliant on population growth to sustain aggregate demand. As a result, when viewed through the lens of per capita growth and thus the rate of increase in living standards, Australia had fallen into the bottom half of the OECD pack. Though the government is still signalling that net immigration rates will be allowed to rise again in a few years’ time, we think this will be hard to achieve as the politics of immigration becomes more vexed in an economy with considerable spare capacity and low-wage growth. Besides, even if the era of high immigration were to return, it would do little to solve Australia’s productivity challenges.

Another challenge the government is finding hard to navigate is the breakdown of the US-China relationship. As we all know, Australia’s economy has been transformed by China’s rapid economic development over the past two decades. As recently as 2003, Australian exports to the US were greater than its exports to China, but China’s insatiable demand for bulk commodities like iron ore and coal led to its trade share with China hitting 35 per cent of GDP by 2013 while its trade share with the US halved over that same decade. Even the end of the commodity price boom did not arrest the upward trend as volume growth remained solid and demand rotated to services and in particular education and tourism.

More strategically, Australia was very well positioned to benefit from the era when US foreign policy was both pro-globalisation and aimed at facilitating China’s integration into the global economy. Australia signed a Free Trade Agreement with the US in 2004, and was a leading force in both the TPP and RCEP regional trade negotiations that successive governments hoped would further lift trade integration within the Asia-Pacific region and eventually bind the US and China more closely together. Indeed, that could be seen as the overarching objective of foreign policy because it synthesised the dominant economic relationship with China and its dependence on the US security umbrella, not to mention its much closer cultural ties with the US as well.

However, now that the US-China relationship has deteriorated to the point that it is best characterised by strategic rivalry and conflict, Australia finds itself in a much more complex position. The worst-case scenario would be that it is forced to prioritise one relationship over the other, in which case the government would probably have to choose security and cultural ties over the near-term interests of the economy. The best-case scenario is that the US and China mend their relationship, rendering Australia’s previous foreign and trade policy viable once more. The most likely scenario is that Australian governments are forced to play a more deft diplomatic hand, trying to keep both parties onside even as their relationship with each other deteriorates.

To that end, the Morrison government’s decision to become a high-profile critic of China’s early handling of the COVID pandemic was a high-risk strategy, inviting both the ire and retaliation of the Chinese government in the form of import restrictions on Australian exports of commodities like beef and barley. Nevertheless, it would be much more dangerous for China to begin curbing iron ore, coal or natural gas exports from Australia given their greater importance to the Chinese industrial complex and smaller number of potential trade partners. As such, while a much more damaging disruption to Australia-China trade cannot be ruled out, it is not currently our baseline.

Just as importantly, there was little in the budget to suggest that tackling climate change is a major priority. Setting aside a brief window of accelerated action early in the previous decade, Australia has long been a climate policy laggard and is not on track to meet its Paris commitments, which themselves remain inadequate in the context of the scale of the crisis. With the EU accelerating its own action, China announcing a net-zero emissions objective for 2060, albeit with credibility questions, and the potential for a Biden administration to accelerate US decarbonisation, there is danger of Australia becoming internationally isolated. Even more importantly, it risks missing a major opportunity to drive a stronger recovery while boosting long-term growth by accelerating its own low-carbon energy transition.

Finally, this budget failed to address the myriad inequalities that have been made worse by the COVID recession. Women and ethnic minorities have lost their jobs in much greater numbers than men. The burden of jointly managing homeworking and childcare has fallen much more heavily on women. Low-skill and low-pay workers have suffered more than high-skill and high-pay workers, and are also more exposed to COVID-related health risks at work. Yet the stimulus announced is likely to disproportionately benefit the disposable incomes of men and high-income households while doing little to address the barriers that limit women and  ethnic minorities’ full participation in the labour market. Critically, these are not just distributional issues – they matter for aggregate outcomes as well because they undermine the efficiency of the economy.

It was unrealistic to expect the government to comprehensively address all of these economic and strategic challenges within a single budget. And Australia continues to benefit from strong, stable political institutions and a moderate political culture. But it is high time that Australia seizes on its natural advantages to make the economy more sustainable, equitable and future fit.

Jeremy Lawson, chief economist, Aberdeen Standard Investments

 

Keeping an eye on the long-term prize
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