Comment

John Hewson
View from the brink of recession

Australia’s growth outlook is more uncertain than ever, with recession drawing closer. The economy expanded just 0.2 per cent in the first three months of this year, and this week New Zealand declared that its economy is officially contracting.

New Zealand is a canary in the global coalmine. Its recession has been attributed to aggressive interest rate increases, and climate-related disaster, in the form of the devastating cyclone Gabrielle that struck the North Island in February.

Both factors are familiar to many countries around the world. The United States also faces mounting concerns about an economic slump, particularly since the recurrence last year of a reliable recession indicator in the bond market – an inverted yield curve. Markets here recorded the same phenomenon last week, though interest rates have risen less sharply in Australia than those in both its nearest neighbour and the world’s largest economy.

Our economy has already entered a retail recession, in which discretionary household spending has dried up as savings have been depleted, the much-lauded “buffer” built from financial support throughout the pandemic lockdowns is all but gone and personal debts have blown out. The country is slipping towards a per capita recession – in terms of GDP per person – which some fear will only get worse with the planned increase in immigration. The technical definition of recession hasn’t been met here yet, but these latest weak growth numbers suggest it wouldn’t take much to tip our economy over the edge. Another setback in the already troubled house building and construction sector, with many building companies hitting the wall and household spending remaining flat, may well be enough to do it.

The RBA governor has spoken repeatedly of a “narrow path” to avoid a recession, and concern is mounting that his foreshadowed further increases in the cash rate could push the economy off that narrow path. There is considerable debate among economists as to just how high the bank will drive the cash rate from the current level of 4.1 per cent – most seem to be expecting about 4.5 to 4.6 per cent. I was disturbed to see recent press reports of internal modelling in the RBA working with a cash rate of about 4.8 per cent. It is difficult to predict where the cash rate will peak, though bond prices suggest the market anticipates roughly two more increases this year.

In August last year I drew on an important Covid-related submission to government by R. Quentin Grafton, Long Chu, Tom Kompas, Mary-Louise McLaws and Dan Suan for a column in this paper, warning the impacts of pandemic mismanagement could contribute to a recession in this country. This concern about the handling of the pandemic relates back to the Morrison government’s premature relaxation of requirements for mask-wearing and for isolation once infected about mid-December 2021, on the fictional argument that he was restoring “our freedoms” in the run-up to the May 2022 election. Recent data suggests we are in another wave of Covid-19 infections, with some 21,000 cases reported last week and about 200 more deaths, and concerns are mounting about the destructive potential of long Covid.

It would be unwise to underestimate the real economy effects of Covid-19 mismanagement, especially the possible labour market impacts and the drag on consumer and business confidence that are also slowing key spending and overall growth.

Grafton, an economics professor at the Australian National University, remarked to me recently that “the adverse public health and economic impacts of Covid and also long Covid on both labour supply and productivity in Australia and other countries in 2022 and 2023 have been significant”.

He added that “the economic impacts of a supply shock due to constrained labour supply and lower-than-otherwise labour productivity have contributed to recent Australian and global inflationary pressures. Much higher cash rates to mitigate inflation are a blunt instrument and will neither increase labour supply nor labour productivity.”

Grafton also pointed out “sensible low-cost strategies, such as mask-wearing on public transport and widespread air filtration inside public buildings, would have substantially reduced the associated economic impacts and public health consequences over the past 18 months”.

Both the prime minister and the treasurer seem unconcerned about the risks posed by another wave of infections. Time will tell whether they are forced to re-embrace the lesser restrictions of mask-wearing and infection control. Now we no longer have the daily Covid reports, meaning the issue is no longer front of mind to most voters, I fear the government is just hoping we somehow will muddle through.

Both the Treasury and the RBA have said our overall growth will slow over the next year or so, but their forecasts for continued expansion of 1.75 per cent and 1.2 per cent, respectively, are among the highest in the range of economists’ views, many of which put the risk of a recession at more than 50 per cent over the next 12 months. Of course, the central bank has been wrong before – we all remember interest rates weren’t expected to start rising before 2024 – and I haven’t seen any evidence that its modelling takes effective account of the continuing effects of the pandemic.

Another potentially serious and overlooked impact on growth is climate change. With the return of the El Niño weather pattern, meteorologists are predicting a very dry, bushfire-prone summer in Australia this year. Again, despite warnings from experienced firefighters, it seems we may well be unprepared for a dangerous bushfire season and the real economy effects could be significant, based on the experiences of recent years. While the devastation in terms of lost lives and livelihoods cannot be counted, the Black Summer of 2019-20 cost the agricultural sector as much as $5 billion.

Unfortunately, the politics of this situation threatens to get very messy. On one hand, the government needs the Reserve Bank to successfully complete its attempt to rein inflation back to rates consistent with its declared target of 2-3 per cent. The opposition seems to have pinned its hopes to some extent on this failing. I have been staggered at the ridiculous extent the shadow treasurer Angus Taylor has gone to in claiming the government as a primary source of inflation, and then exaggerating the extent of the pressure. We know from Taylor’s attack on Clover Moore, concerning the Sydney lord mayor’s alleged travel spending, that he can’t be trusted with data. However, his media mates seem reluctant to pull him up on this irresponsible behaviour.

The government also wants to see improved real wages and to avoid a recession. The RBA governor has been pretty confident we will avoid a wage-price spiral from the increases under way in the system, including the minimum wage increases and the boost in pay for nurses and aged-care workers, as well as from the industrial relations reforms that were passed last year and are presently being implemented.

In a recent speech to a business audience, the prime minister said economic growth had to be shared among all residents. The government is aware recessions tend to hit lower-income groups harder. Having committed to “leave no one behind”, it is already grappling with the differential impacts of the ongoing cost-of-living pressures and interest rate increases. However, Anthony Albanese made no mention of differences in growth rates across the country – an issue that may easily become more important politically, depending how the economy unfolds.

Both New South Wales and Victoria are still in deep deficits while Western Australia and Queensland appear to have the most resilient state budgets. A sharp divergence in growth and unemployment in future would see considerable pressures mount on the federal government, whether about the distribution of GST revenue or their respective electoral prospects. There is also expected to be a redistribution to create a new seat in WA, with both NSW and Victoria losing a seat each.

Though Prime Minister Albanese recently ruled out an early election, unfolding circumstances, including a recession, may force his hand. If revenue tightens, one option would be to seek a mandate for reforms he will need to raise money for priorities such as aged care, in line with the funding issues raised by that royal commission. Among the reforms that would become more pressing in a downturn are those related to housing, taxation and national productivity. Tax reform is a particularly tough proposal in light of Labor’s 2019 defeat – widely regarded as the result of a policy-heavy agenda. Albanese would have to decide whether to take his chances with a strategy like that of former prime minister John Howard, who went to the 1998 election advocating broad reform – including tax reform, reversing his previous commitment to “never ever” introduce a GST. He won, albeit narrowly, with that particularly high-risk approach.

There’s been much discussion about the potential for Labor’s embattled housing bill to present a trigger for a double dissolution election, should it fail again when the issue resurfaces for debate later this year. As things stand today, I doubt Albanese would pull that trigger. It remains to be seen whether a recession would shift the balance of probabilities.

As an economist myself, I am particularly conscious of the perils of forecasting, especially as some economists have predicted something like 29 of the last two recessions. But the fear of an impending recession is global, and whether or not Australia ends up in one soon will depend to a large extent on how government and central bank officials act to protect the health of not only the economy, but of all Australians.

This article was first published in the print edition of The Saturday Paper on June 24, 2023 as "View from the brink of recession".

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