In the post-war era, there is the strong relationship between economic and electoral success. Despite having steered the nation through the 2007/8 crisis, Australia’s left of centre Labour Party was defeated at the 7 September election 2013, primarily for other political reasons.
The new conservative Liberal-National Party government faces a country with altered prospects. As the old racing saying goes, a change in jockey does not necessarily change the horse or the race track.
First, Australia’s enviable strong consistent economic growth, low unemployment and increasing living standards was driven by strong growth in emerging nations, especially China and India, and demand for commodities. But China and India is slowing.
Even if growth levels remain above that in developed markets, the changing composition of growth (a rebalancing from investment to consumption) means that resource use intensity will decrease, reducing demand for commodities. Increased capacity, as a result of aggressive recent investment, will also come on-stream progressively, coinciding with lower demand putting pressure on prices and volumes.
Second, the commodity boom, Australia’s role as an investment proxy for China, AAA rated safe haven status and relatively higher interest rates have increased the value of the Australian dollar, reducing the country’s competitiveness in manufacturing, retail, tourism and exports of education and health services which are all major employers.
Third, since 2001, Australia’s trade account has been weak despite the mining boom and record terms of trade. Based on weaker export performance, Australia’s current account deficit of around 3-4% of GDP is likely to widen, increasing reliance on international financing.
Fourth, public finances, both national and state, are deteriorating as strong growth in the commodity sector no longer offsets weak domestic conditions. Government revenues have deteriorated, with significant budget deficits likely.
In a speech entitled “The End of the Age of Entitlement” to the Institute of Economic Affairs London on 17 April 2012, new Treasurer Joe Hockey questioned the economic sustainability of “entitlements bestowed on tens of millions of people by successive governments, fuelled by short-term electoral cycles and the politics of outbidding your opponents”. It was reminiscent of an observation by former Australian Treasurer and Prime Minister Paul Keating that you cannot “get quarts from pint pots”.
Mr. Hockey argued that “government spending on a range of social programs including education, health, housing, subsidised transport, social safety nets and retirement benefits [had] reached extraordinary levels as a percentage of GDP”. This spending, he stated, should be funded from revenue rather than by borrowing.
Puzzlingly, in the course of the election campaign, the Liberal-National Coalition made $19.8 billion worth of spending promises. In fairness, the defeated government also made numerous promises, though the total was a more modest $2.4 billion.
The new government has promised spending on a varied range of programs ranging from paid parental leave (allegedly to reverse the new Prime Minister’s lack of appeal to female voters) to specific support for a Tasmanian chocolate factory. The details of how these programs are to be financed remains vague. Given that key areas of expenditure, such as health and education, are quarantined from reduction and the government is considering a corporate tax cut, it will be interesting to see how the promised budget surplus will be achieved.
Amusingly, the new government, like its predecessors from both sides of the political divide, will seek to improve its finances from efficiency dividends derived from streamlining the public sector. Given that over 20 plus years successive governments have undertaken similar initiatives, it is truly astonishing how ever greater levels of efficiency and cost benefits can be achieved.
Fifth, the Australian banking system, while well capitalised, has a very high level of exposure to the domestic economy and the housing market, which is over-valued by most measures. A fall in prices, increases in unemployment and decreases in income could expose financial system vulnerabilities.
Sixth, Australia’s cost structure is high, exacerbated by the high currency. Australian minimum wages are around A$16 per hour, compared to around A$7-8 per hour in the US and A$1-2 per hour in China. The cost of Australian engineers is around $170 per hour, compared to $132 in the US, $129 in the UK or $77 in Japan. Cash costs in mining sector have increased by over 250% in the last 10 years.
Improvements in productivity have been lack lustre. According to the 2013 Global Competitiveness Report published by World Economic Forum, Australia has fallen to 21st place, dropping out of the top 20 for the first time. Arch rivals New Zealand is now ranked 18th in the world for competitiveness, three places above Australia.
The reality is that major structural reforms that started under the Prime Ministers Bob Hawke and Paul Keating petered out sometime under Prime Minister John Howard.
Seventh, policy attempts to rebalance the economy have had limited success. Australia’s central bank, the Reserve Bank of Australia (“RBA”) has lowered interest rates to 2.50% per annum, seeking to boost housing and consumption activity as well as reducing the value of the A$.
Lower rates to date have had limited impact on housing, credit growth, consumption, non-commodity investment, employment or confidence. Despite recent falls, the ability to devalue the Australian dollar remains limited, with major economies continuing low interest rate and quantitative easing policies.
The lower currency is seen by many as a solution. It may boost exports, but is dependent on external demand which may be affected by a weak global economy. Currency weakness is a disguised attempt by policy makers to reduce domestic income and cost structures within the economy. It seeks to avoid dealing directly with labour costs, productivity and other structural problems. But its efficacy is doubtful.
As Australia is an importer of manufactured products, a lower currency will also increase prices, lowering purchasing power and dampening consumption. Petrol prices have already risen by 10-15%, reflecting in part the weaker currency. Higher prices for imported products and transportation expenses will increase a wide variety of costs offsetting improvements in competitiveness.
Eighth, Australia’s attempt to rebalance toward Asia is flawed. As the commodity and mining boom slows, Australia wants to sell food, education, health care and financial services to Asia as well as attract Asian tourists. But Asia faces its own challenges. Australia’s Asian strategy also suffers from inherent contradictions between its political and defence partnership with the US and its economic dependence on Asia. Deep-seated cultural barriers, such as the White Australia policy which ended only in the 1960s, are ignored.
In a 29 November 2010 speech entitled The Challenge of Prosperity, Australia’s Central Bank Governor sought to illustrate the combined effects of the gains of the appreciating terms of trade position and the A$ strength in the following terms: “In 2005 a shipload of iron ore was worth the same as around 2,200 flat screen televisions In 2010, the same shipload was worth around 22,000 flat screen TVs”.
In a Freudian slip, the RBA Governor identified a fundamental issue with Australia’s economic model. The mining boom helped maintain income and buying power, as Australia extracted large rewards for its mineral resources, covering up the lack of international competitiveness in many sectors, driven by high costs, poor productivity performance, declining educational achievements and narrow industrial base.
But Australia may have substantially wasted the proceeds of its mineral boom, with the proceeds channelled into consumption.
During an interview on 19 December 2012, the Australian Central Bank’s Governor was asked where growth would come from to replace mining investment. Echoing author Donald Horne’s epithet about being Australia the “lucky country”, the Governor responded: “I think we always get this question: ‘where will the growth come from?’ And most of the time it comes.”
In a fragile and challenging international environment, Australia’s new government will need to make difficult choices and more than the usual quotient of luck to maintain the nation’s stellar economic run.
© 2013 Satyajit Das All Rights Reserved
Satyajit Das is a Sydney based former banker and author of Extreme Money and Traders Guns & Money