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What do these tumultuous times mean for the economy?

Analysis

In the wake of Brexit and the Australian federal election, Richard Blandy examines the economic outlook for the world, Australia and South Australia.

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Brexit will require major adjustments to the British and EU economies over a number of years, while the main result of the Australian election appears to be that economic populism works (politically).

It doesn’t work economically, unfortunately. Australian and state deficits will grow faster for longer, with no political solution likely for many elections. We will lose our AAA credit rating, for sure. Foreign borrowing (on which Australia relies heavily) will be more expensive and more difficult.

So the economic outlook is more adverse than it would have been – particularly for Australia, which is concerning, because the underlying structural trends were already adverse.

World economic growth needs to exceed 4 per cent per annum to be at its trend rate, where incomes and jobs increase steadily, unemployment does not rise, inflation is stable, and international balances of payments are acceptable to foreign lenders. Australia’s rate of economic growth needs to be 3.2 per cent to be at its trend rate.

World and Australian economic growth this year, and up to 2018, is expected to be much less than these trend rates, according to the International Monetary Fund (IMF), the World Bank, the Organisation for Economic Cooperation and Development (OECD) and the Economist Intelligence Unit (owned by The Economist magazine).

The IMF forecasts world economic growth to be 3.2 per cent in 2016, rising to 3.5 per cent in 2017 – a reduction of 0.2 per cent from its January 2016 forecasts. Australia’s GDP is forecast to increase by 2.7 per cent in 2016 and 2.9 per cent in 2017, also a reduction from the January forecasts.

The World Bank forecasts world economic growth of 2.9 per cent in 2016, 3.1 per cent in 2017 and 3.1 per cent in 2018 (a reduction from its June 2015 forecasts). Australia’s GDP is forecast to increase by 2.5 per cent in 2016, 2.8 per cent in 2017 and 3.0 per cent in 2018.

The OECD forecasts world economic growth of 3.0 per cent in 2016 and 3.3 per cent in 2017 (a reduction of 0.3 per cent from its November 2015 forecasts). Australia’s GDP is forecast to increase by 2.6 per cent in 2016 and 3.0 per cent in 2017.

The Economist Intelligence Unit forecasts world economic growth of 2.3 per cent in 2016 and 2.6 per cent in 2017, with Australia’s GDP forecast to increase by 2.6 per cent in 2016 and 2.8 per cent in 2017.

The immediate outlook, according to these economic forecasters, is for world economic growth to be significantly below trend for the next few years and for Australian economic growth also to be below trend, but not as significantly as world economic growth. Brexit and the Australian election outcome have worsened these expected outcomes.

Productivity growth has fallen significantly in many countries, including the United States and Australia. Investment is weak in many places, including Australia (and South Australia).

Monetary policy globally has been more stimulatory than ever before in world history, but has failed to stimulate a return to trend growth rates.

International trade has fallen as a share of world GDP. Globalisation is in retreat – economically as well as politically. Politicians as diverse as Trump and Xenophon have protectionism in common, if nothing else.

As Yeats said in The Second Coming:

Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,

The best lack all conviction, while the worst
Are full of passionate intensity.

The IMF believes that the increasing risks to the economic outlook include:

The IMF says that structural reforms (labour and product market reforms) in advanced economies like Australia’s can give a strong boost to growth prospects over the medium to long term. Product market reforms should aim to boost competition among firms and make it easier to start a business or attract investment because such reforms “boost output even under weak macroeconomic conditions and without weighing on public finances”.

Readers of my column in InDaily will know that I have been recommending that those sorts of reforms should be undertaken by the South Australian Government to raise the rate of growth of the state’s underperforming economy, in particular to boost jobs growth.

South Australia’s economic outcomes will continue to be bleak until a new economic strategy, which emphasises private-sector renewal, comes into being

The most recent National Accounts figures from the Australian Bureau of Statistics, released on June 1, showed Australia’s GDP growing by 3.2 per cent over the year ended March 2016. This rate of growth is Australia’s trend rate of economic growth, so why are the forecasters predicting below-trend growth for Australia? Even the Liberal Government did not make a great deal of this strong growth rate during the election campaign. Why?

The reason is that this growth in GDP was almost entirely driven by exports, especially minerals exports built on the huge increase in capacity from the recent mining boom. Growth in Domestic Final Demand was only 1 per cent over the year ended March 2016, Private Final Demand did not grow at all, and Private investment fell by 7 per cent.

The growth rate of 3.2 per cent in Australia’s GDP will fall in the near future, as the growth rate of minerals exports falls, reflecting the rising base volume of minerals exports that is being continuously achieved.

Over the past 12 months, South Australian Final Demand grew by only 1 per cent, due entirely to household consumption expenditure growing by 3 per cent and Government spending increasing by 4 per cent. Private investment fell by 8 per cent, dwelling construction fell by 3 per cent and non-dwelling construction fell by 14 per cent.

It is easier to kick goals with the wind than against. The world context is not favourable for strong economic growth in Australia or South Australia in the immediate future. I now expect Australian economic growth to be about 2.6 per cent in 2016 and 2017, with annual employment growth of about 1.3 per cent and the unemployment rate increasing slightly to about 6 per cent.

Similarly, I expect South Australia’s economic growth rate to continue to be about half Australia’s rate – about 1.3 per cent per annum in 2016 and 2017, with annual employment growth in South Australia of about 0.4 per cent a year and the unemployment rate rising above 7.5 per cent from the middle of 2017.

These forecasts may be optimistic. There is a balance of downside risks associated with Whyalla, the closure of Holden, the RAH and other health issues, high electricity and water prices, South Australian Government debt and deficits, credit rating downgrades, and so on, which could see a worse outcome. Upside prospects are longer term, and require changes in South Australian Government economic strategy.

The world will continue to experience well-below-trend economic growth, Asian growth will slow, Australia’s growth will be sub-trend, and South Australia’s economic outcomes will continue to be bleak until a new economic strategy, which emphasises private-sector renewal, comes into being.

Richard Blandy is an Adjunct Professor of Economics in the Business School at the University of South Australia and a weekly contributor to InDaily.

 

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