Are the fundamentals really sound?

Bewildering is the word that best describes the Reserve Bank’s optimism about the economic outlook for Australia. Its quarterly statement on monetary policy released on Friday assures us that GDP growth is likely to have troughed already and is expected to return to trend by the end of next year, while the unemployment rate is expected to remain around its current level for some time before declining. Reserve Bank Governor Philip Lowe told a parliamentary committee the economy might have reached a turning point. So it’s onwards, upwards from here.

While the treasurer’s job includes being the economic cheerleader for Australia, ensuring the government doesn’t inadvertently dampen consumer or investor optimism, the economic agencies can afford to tell it like it is. Yet at a meeting with the treasurer on 11 July, Governor Lowe agreed that the economy’s fundamentals “are strong.”

After more than 40 years as an economist I’m still trying to work out what the fundamentals being strong actually means. If it means Australia does not share a place with Greece, Sudan, Venezuela and Eritrea in the list of the 10 most indebted countries, then yes, our fundamentals are strong. If it means we don’t have the unemployment rates of Syria, Senegal, Djibouti and Namibia, then our fundamentals are strong.

But an economy in which investment, consumption, wages growth and productivity growth are all flat is not fundamentally strong. If it weren’t for strong population growth, Australia would have been in recession for each of the last three quarters.

It might sound like I’m a natural pessimist. Not guilty! In January this year, Peter Martin at The Conversation asked 18 economists to forecast where the Reserve Bank’s cash rate – then at 1.5 per cent – would be by the end of 2019. Fifteen economists said it would be unchanged or higher. Only three of us said it would be lower. My forecast was for a cash rate of 1 per cent by December. That’s where it is now. Since it will likely be even lower by December, I am, in truth, a realist. And the reality is the US-China trade and technology war is escalating, China’s economy is slowing, the rules-based global trading system is facing its greatest existential threat since its post-war creation, global trade flows are flat and global businesses are unwilling to invest for fear of their products being hit by a new wave of tariffs, and the world is drowning in debt. 

In our fundamentally sound economy, the Reserve Bank is fast running out of interest-rate ammunition, beginning to contemplate negative interest rates through non-conventional monetary expansion. That would have the perverse effect of terrifying consumers, who would close their wallets and purses even tighter.  And it would drive even more savers away from banks that would be charging them a fee for the privilege of holding their deposits and into ever-riskier stock markets.

By the time the authorities recognise the economy is in trouble it will be too late. The Morrison Government made a solemn political promise that the budget would be in surplus this financial year. Deadly rivers of mud from a collapsed dam in Brazil have perversely produced rivers of gold flowing from China to our iron ore miners and into the Treasury coffers. 

The Government’s 1 July tax cuts will help a bit, but further measures will be needed to avert an economic slump. 

These could include an increase in Newstart, almost all of which would be spent, an extension of the instant asset write-off scheme to more businesses and to higher-valued assets, accelerated depreciation for large businesses and, as recommended by Philip Lowe, a pay rise for public servants that would help remove the brake on private-sector wages. Add the construction of public housing and accelerating infrastructure repair and maintenance programs and the government would have a suite of policies from which to choose.

Nothing is more fundamental to an economy than productivity growth. But the Productivity Commission has warned that instead of ongoing capital deepening through productivity-raising foreign investment, the Australian economy has entered a period of capital shallowing as old investment isn’t being replaced by new investment embodying the latest technologies. KPMG’s Grant Wardell-Johnson [AFR to insert link] has urged the government to consider accelerated depreciation for large businesses. 

Depending on how deeply the rivers of gold are flowing from China, the various policy options open to the government might put the political promise of a budget surplus at risk. But pursuing a surplus at the cost of jobs and wages would have its own political consequences and is likely to be economically irresponsible. Unless, of course, I am wrong and the fundamentals are indeed sound.