Fast crisis, slow recovery

The Australian and world economies – what comes next?

6 July 2020: We assume (1) Australia succeeds in keeping virus numbers mostly suppressed, allowing restrictions to continue to be lifted, (2) a vaccine or good anti-virals are available from mid-2021, and (3) international borders re-open gradually, starting with New Zealand in late 2020, and broadening to cover essentially the world by end-2021.

1.6 billion people in the informal economy affected.  300 million jobs lost.  Millions of small businesses lost.  In a rotten year for global growth, the Asia-Pacific will shrink the least, with the Americas and Europe being hardest hit.  Where death rates are highest, fears are high too, and scared families and businesses don’t spend.  That’s why opening up if virus numbers aren’t under control is risky.  And, in a volatile environment, it is also why the best leading indicator of how an economy will perform is how that nation is going in its fight against the virus.

Australia’s relative success in our virus fight gives us more room to open up.  Our policies have successfully protected many jobs and businesses that would otherwise have been lost.  Many key trading partners have also fought the virus well.  And it looks like being a corker of a year for farmers too.  So the recession may well have already past its worst.  Even so, families are struggling with the toxic trio of high debt, high unemployment, and low confidence, and 2020 is a shocker of a year.  The ranks of the unemployed will be badly swollen for a while.

Australia and the world are ‘printing money’ hand over fist.  But the very last thing you need to worry about is any lift in inflation.  Demand is dead as a doornail, and wage gains – already weak – are set to fade further. 

Globally and locally, interest rates will be nailed to the floor for years.  That’s because (1) this is a big recession, (2) inflation is as dead as a door nail, (3) governments will bow out of their support, leaving it up to central banks to repair economies, (4) economies are more accident prone than ever before, so central banks will be super cautious and, finally, because (5) interest rates are more powerful than ever.

That last point is important to understand.  The global debt-to-income ratio was at a record when the global financial crisis hit in 2008, and it was higher still when this crisis hit in 2020.  And given that governments are currently piling on the pounds of even more debt, that says interest rates are a hugely more powerful lever than they’ve ever been before.  Even if they go up just a bit, they’d take an enormous amount out of economies.  That’s why they’ll stay super low.

The initial phase of fear sent shockwaves through currency markets, and most exchange rates – including the Australian dollar – fell sharply as money surged to the perceived safe haven of the US.  But the $A has recovered since.  Partly that’s because markets have noted that the US is a less effective safe haven than it used to be.  But mostly it is a recognition that Australia has been successful – to date – against the virus (giving us greater growth potential), and that commodity prices (especially iron ore) have held up better than earlier feared.

No migrants, no momentum.  Because we take more migrants than most, Australia’s overall population growth has been high.  And our population hasn’t aged as fast as others either, as our migrants are relatively young.  But that flow of migrants is now all but turned off.  That hurts tourism and education immediately, and it also weighs on the recovery, affecting everything from housing construction to the utilities.

And these effects will linger:  we assume Australia opens most international borders through 2021, but that leaves total population about a quarter of a million smaller than we had forecast it to be ahead of COVID.  That shortfall is probably here to stay.

Meantime JobKeeper has been great at … keeping jobs.  It has bought vital time for businesses in the hope that the links between employers and employees can be maintained.  But it also means that published job losses and increases in unemployment understate the size of the ongoing challenge.  The current shortfall in hours worked – down a little over 10% since the virus rolled in – is a better indicator of how hard it will be to bring unemployment back down across coming years.  Worse still, the local areas which already had the highest unemployment have now lost the most jobs in the coronavirus crisis – a blow that’s a double challenge.


Industries – what next?

The sectoral damage of this recession continues to change fast.  It began – and remains – with international border shutdowns that have taken migrants, tourists and foreign students out of the economy.  That has ongoing effects across a range of sectors, including not just the airports and airlines themselves, but also in recreation (the missing tourists), in education (the missing students), and in construction (the missing migrants).

The pain then spread amid a shift to a much wider range of lockdowns.  These spelled deep trouble for cafes and restaurants, pubs and clubs, and hotels and motels, as well as for gyms, sporting fields, entertainment centres, conference centres, movie theatres and play houses.  Yet those weren’t the only businesses suffering.  Lockdown impacts went deeper.  For a while many miners couldn’t fly into some sites, because state borders closed too.  Farmers were left scrabbling for workers because backpackers and seasonal workers from our Pacific neighbours weren’t here.  Real estate struggled amid bans to in-person viewings and auctions.  Elective surgery was put on hold.  And empty shopping centres saw many retailers shut down:  some hibernating, some closing doors forever.

The bulk of that pain occurred because it had to.  In many cases sellers couldn’t sell as buyers couldn’t easily buy.  But other pain soon became evident too, as purses and wallets snapped shut amid hits to income, to wealth, and to confidence.  That especially showed up in sectors linked to discretionary spending – so car sales plummeted. 

The good news is that many of the hardest hit (including accommodation and food services and arts and recreation) are increasingly opening up.  But international borders remain closed.  And the usual sectoral victims in a recession will be weakening further even as other sectors begin a path to recovery.  That will be true of:

• growth-dependent sectors such as construction and parts of manufacturing,

• pipeline-dependent sectors such as construction and professional services, and

• discretionary sectors such as entertainment and parts of retail.

Finally, and at the other end of the scale, some sectors are largely recession-proof, including the public sector, large parts of education, health and the utilities, as well as food and grocery retailing and wholesaling.


States and territories – what next?

The virus has taken a sledgehammer to Australia’s economy, with no state or territory left unscathed.  But they’re not all being equally hit:

• The largest downturn is likely to be felt in Victoria given its current spike in cases, as well as that state’s dependence on migration and on foreign students in an age of lockdowns and closed borders.

• On the other hand the lift in LNG-related exports from the Ichthys project will protect the Northern Territory, while its strong public sector base is a very welcome anchor in the storm for the ACT.

The Great Lockdown hit service sectors – people businesses – the most.  And NSW is the king of service sectors.  Worse still, its economy relies a lot on migrants, on tourists and on foreign students.  So closed international borders come at a big cost.  And housing construction is hard hit.  But NSW has done a great job in beating back the virus so far, opening up is proceeding fast, and infrastructure is sprinting.  So there’s lots to hope for in 2021. 

Victoria is likely to take the unwanted title of worst performing state through the COVID crisis.  Population, once a key growth engine, has well and truly stalled.  And Victoria’s case numbers were spiking as we went to press.  The need for tighter restrictions has sent job losses soaring and consumers hanging on to their cash rather than spending it.  Infrastructure is the bright spot in this dark near-term outlook until the economy can open back up.

Queensland has managed the crisis well, but it’s come at a cost.  The world is still buying Queensland’s gas, but prices are lower.  And low infection rates enabled the economy to open back up to locals already, with the rest of the nation (except Victorians) welcome from 10 July.  But closed international borders spell deep ongoing pain for particular parts of the state, which has left it with some of the highest regional JobSeeker numbers in the nation. 

Western Australia was looking to make an comeback in 2020 after a period of poor growth.  Then came COVID.  Yet global demand for iron ore holding up relatively well despite the global downturn – supporting both economic growth and State finances.  And success in keeping the virus at bay has led to relatively rapid opening up. 

Tasmania and South Australia both saw a swift response by government that enabled a similarly swift opening of their economies.  But lockdown came at a greater cost to Tassie’s near term momentum.  And while there’s some shelter from the current crisis, these two states are less well-positioned for their longer term growth.

The ACT and Northern Territory will fare the best out of a bad lot.  While unable to escape some pain – Canberra’s lockdown was relatively tight – their high share of public sector jobs has softened the blow.  And so too has the record of the two territories in seeing the greatest success in the nation in beating back the virus.  So successful has the ACT been that it will lead the nation in welcoming foreign students back to Australia’s shores.

The Northern Territory’s vulnerable population in regional areas means that a focus on limiting the spread of the virus will remain important.  But if this can continue to be done, there’s upside potential from local tourism as Australians swap their sunny international holidays for trips to the Top End.


Policies – what do we need next?

Both the feds and the states are spending a lot.  But that’s not the key to higher government debts and deficits.  The bulk of the lift in public debt over the next few years isn’t due to emergency measures pushing spending higher, it is because the weak economy leads to losses in revenue.

And that’s a reminder of a key point:  the best way to fix the budget is to fix the economy.

Meantime our economy is held together by lots of sticky-tape.  And that’s truly great news.  JobKeeper and JobSeeker are the standouts, but a whole range of policies have swung into action to cushion our living standards.  Australia’s ability to do that was made easier, both economically and politically, by our relatively strong position:  the federal budget was balanced and debt was low when the crisis hit.  That’s been marvellous.  Even better still:

• We got the money into people’s pockets faster than we did during the global financial crisis.

• Our success against the virus has cut the cost of our emergency measures – a virtuous cycle.

• The fall in interest rates is so big there’s little change in expected federal interest costs – yes, debt is up, but the drop in interest rates is even more dramatic, and it will gradually apply to old debts as well as new ones.

Yet there are phantom menaces.  One is the belief we have to pay off all this new debt.  But that would flatten the economy.  And it’s not the smart play for war-time debt anyway.  The smart play is that we get the economy growing so that debt gradually shrinks relative to our economy.

Another phantom menace is the belief that, even if we don’t pay off the debt, we have to raise taxes and cut spending to fix the budget.  That’s completely wrong, and it unnecessarily scares the punters.  The emergency measures are temporary.  So, as Treasury notes, if we can repair the economy, then we’ll repair the budget.  Or as the PM puts it, “the best way to raise revenue is to get people back into jobs and the economy moving again”.

Last, there’s the view that government budgets – federal and state – have already done their job.  They haven’t.  As the Reserve Bank notes, the economy will “require considerable policy support for quite some time to come”. 

Every taxpayer dollar is precious.  But every taxpayer dollar is also helping Australians more effectively than it has ever done.  Our fight against the virus cost 835,000 people their jobs and many thousands of small business people a lifetime of work.  That risks leaving generational damage.  We owe it to them to get livelihoods back as fast as we can:

• The best and fastest way to repair the economy is to keep the virus at bay so that we can rapidly open up.

• Yet borders will remain closed for a time, so ‘opening up’ can only get us so far. And the Reserve Bank is already tapped out, so the task of repairing Australia falls more on governments than it’s ever done before.

• That says more dollars are needed. How much more depends on our success against the virus and in opening up.  But the recession is changing shape fast, so the nature, timing and dollars of support needs to change fast.

• Some new types of spending will be needed, building on the recent infrastructure and HomeBuilder packages.

• We also need to smooth transition timing and dollars: too much support ends at the same time.  In some cases that may mean an earlier end, but in most cases it’ll be later.  And we should phase support out where we can.

• Some type of ongoing wage subsidy – a JobTweaker – will be needed too, limited to a rather smaller range of businesses (such as those tied to international borders). And the dollars per person may need to be lower

• But wage subsidies gradually become less helpful the longer they’re used as emergency support. There are rising costs in simply keeping zombie jobs alive.  That doesn’t say pull back overall spending support, but it does say this particular type of support should gradually fade in importance in our defence against the virus.

• The complexity of exiting from this emergency is high. And things keep changing fast.  So, over and above existing reasons to have higher unemployment benefits anyway, keeping JobSeeker stronger for longer will be vital in filling the cracks as emergency safety nets morph or disappear.  We’re all in this together.