A lot of people believe Tony Abbott and Joe Hockey begin their first
full year in office facing a daunting economic challenge, even a crisis.
But what is the nature of the challenge? How daunting is it, and how
pressing?
Well, let's analyse it - and do so using some of the standard distinctions economists use to get their heads around a problem.
People
see the government as having a problem with the economy and with its
budget. To the casual observer, the economy and the budget seem pretty
much the same thing. But, though the two are obviously interrelated,
economists draw a clear distinction between them.
The government's
budget (its spending and revenue-raising) has an effect on the economy
(the whole nation's production and consumption of goods and services,
income-earning and spending) and, equally important, the much-bigger
economy has an effect on the government's budget.
But we'll get a
clearer picture of what's happening if we deal with the two separately.
Let's focus on the economy and leave the budget for another day. (Don't
worry, you'll hear a lot more about the budget in coming weeks.)
And
in thinking about the economy, let's use the economists' trick of
distinguishing between cyclical and structural factors. Cyclical factors
are those temporary influences that are causing the economy to speed up
or slow down at present and over the coming year or two.
Structural
factors are those that operate underneath the cyclical factors,
affecting the economy less dramatically at any particular moment, but
having a much longer-lasting and hence more important influence in
changing its shape.
Starting with the cyclical outlook, it isn't
too hot. The economy's production of goods and services (real gross
domestic product) grows at an average rate of about 3 per cent a year,
sufficient to keep the rate of unemployment steady and inflation within
the Reserve Bank's 2 per cent to 3 per cent target range.
But
we've been growing more slowly than 3 per cent for the past few years,
and Treasury's expecting growth to slow to just 2.5 per cent this
financial year and next, 2014-15. The recent slow growth explains why
unemployment has been creeping up - to 5.8 per cent on the latest
reading - but inflation hasn't been a worry.
The forecast of
continued weak growth implies unemployment will continue creeping up -
to 6.25 per cent by June next year - but inflation will stay controlled.
The
reasons for the past and coming slow growth are well known: the end of
the resources boom's investment phase and the high dollar the boom
brought with it. Most growth was coming from mining construction, with
the rest of the economy pretty subdued, but now mining construction is
expected to fall off rapidly, with the rest of the economy only slowly
getting back on its feet to take up the slack.
We've already done
what we need to get the economy growing faster: the Reserve Bank has cut
interest rates to historic lows, and the dollar has fallen by about 16
per cent (partly because the Reserve has been talking it down). Now
we're waiting to see how long it will take for the medicine to work.
Remember
that primary responsibility for managing the macro-economy rests with
the Reserve Bank, not the elected government. Hockey's main job is to
make sure the budget doesn't add to the present weakness, but also stand
ready to apply emergency fiscal stimulus should mining construction
spending unexpectedly collapse at some point.
So the economy's
short-term, cyclical position isn't wonderful, but there's isn't a lot
more we can or need to do. Leaving aside the inevitability that one day
our record period of expansion since the last severe recession will have
to end, the economy's longer-term, structural position is vaguely
similar: it's not as dire as some imagine but, as usual, there's plenty
of room for improvement.
While Labor was in power, it suited some
business lobby groups to claim our rate of improvement in productivity
(output per unit of input) had stalled. Surprisingly, the answer was
always for the government to give them the rent-seeking privileges they
wanted.
The truth is less apocalyptic. It's true we had an
uncharacteristically strong burst of productivity improvement in the
second half of the 1990s, but then weak to non-existent improvement
through much of the noughties. Since then, however, productivity has
been improving at a rate that's OK but hardly wonderful. Analysis of our
formerly weak performance suggests much of it was explained by one-off
factors and measurement problems.
But in Treasury's periodic
intergenerational reports, it has consistently projected slowing in our
long-term rate of growth in real GDP. Most recently, in 2010, it
projected that the annual rate of growth in GDP per person would slow
from 1.9 per cent over the previous 40 years to 1.5 per cent over the
coming 40.
This may not sound disastrous - and to me it isn't -
but to our deeply materialist economists and business people it is. So
note that half the decline is explained by a fall in the proportion of
the population participating in the labour force as the baby boomers
retire and the population ages.
This can be predicted reasonably
confidently, but the other half is explained merely by Treasury's
assumption that our 40-year average rate of improvement in the
productivity of labour will fall from 1.8 per cent to 1.6 per cent a
year.
Plenty of economists around the world share Treasury's fear
that productivity improvement will be slower in coming years. And this
probably wouldn't take anything like 40 years to become apparent.
So
for the Abbott government and those who share its professed commitment
to maintaining strongly rising material affluence (and don't worry about
little annoyances such as the survival of the planet), there is a
reason to pursue reforms that improve labour force participation and
labour productivity.
