The Word That Dare Not Speak Its Name - Growth
Sydney Morning Herald
Saturday November 10, 2007
It's as if there's a dirty economic secret in this election campaign. It isn't a threat that is about to choke off Australia's growth, such as a Chinese financial tsunami, a US economic meltdown, an oil shock or a sudden collapse of the mining boom, that no one wants to talk about. Quite the reverse.
It's that the economy may actually grow faster, for longer, than government forecasts and both sides of politics' rhetoric suggest, and at a time when it is straining the limits of capacity, this will make future economic management more challenging in a different sort of way.It not only makes more interest rate rises more likely; it also means that, whatever side wins on November 24, fiscal policy may have to be handled in a more counter-cyclical way, rather than the "set and forget" approach of a budget surplus locked on 1 per cent of gross domestic product, pursued by the Coalition and effectively endorsed by Labor.This is not to suggest a return to fiscal policy as an instrument for short-term "finetuning" of the economy, but rather to allow the budget's "automatic stabilisers" to operate a bit more freely than they have in the past five years. That more balanced policy approach to macroeconomic management means tax cuts may need to be less generous, with the counterbalance being interest rates being lower than they otherwise might be.More "growth surprises" also make even more urgent the supply-side policies and reforms that are needed to add to the economy's capacity, productivity and efficiency, helping it grow faster without higher inflation. As it has manoeuvred to deal politically with this week's rate rise, a tone of gloom and impending crisis has coloured the Coalition's recent rhetoric on the economy. John Howard and Peter Costello have talked darkly of difficult times ahead and, in their more purple moments, the lurking threat of a "China shock" to the global economy and recession in Australia.Only rarely is the challenge framed, by either side, in terms of the greater likelihood that growth will be overly effervescent, notwithstanding this week's rate rise. As HSBC's chief economist, John Edwards, has pointed out, Treasury's updated forecasts, although stronger than in the May budget, may understate the economy's likely growth trajectory. Its assessment of the risk to its forecasts may, likewise, focus too much on the downside, especially the fallout from global financial market turmoil and the risk of a world economic slowdown depressing demand for Australian exports and commodity prices."Treasury projects an economy in which growth and inflation gently slow while commodity prices tumble, with the risk ... that global growth is not as strong as expected," Edwards says."It's a projection which avoids examining Australia's most likely problem. It is not the chance of global slowdown or a sudden fall in commodity prices; it is that we won't be able to handle the strains of operating for a very long time at the very limit of our capacity."Although Treasury raised its growth forecast for this financial year from 3.75 per cent to 4.25 per cent, it sees it slipping back to 3.5 per cent in 2008-09 and it projects 3 per cent growth in the two years thereafter.In part, this reflects projections of non-rural commodity prices losing almost 50 per cent of their recent gains in 2009-10 and 2010-11 as coal and iron ore prices return to their long-term average. This, Edwards suggests, would require a big increase in supply, or a substantial slowdown in the global economy, particularly in China.Inflation is projected to fall to the middle of the Reserve Bank's 2 to 3 per cent comfort band, despite the assumption that interest rates don't change through the period, while employment and wages growth also scale back.But, as Edwards suggests, it's easy to construct a scenario in which growth and inflationary pressures actually get stronger, not weaker, particularly if rates were not to move again, as Treasury assumes.Consumer demand will continue to be buoyed by rising employment, wages and tax cuts. Continued strong demand, fuelled by immigration, rising rents and house prices, means an eventual upturn in housing construction.Strong business investment looks like continuing. This, and the extra capacity already in the pipeline in sectors like mining, would help to boost exports. The global economy and commodity prices may also hold up better than Treasury forecasts. As ANZ's Mark Rodrigues noted recently: "The outlook for the global economy remains robust, with global growth expected to remain in the range of between 4.5 and 4.75 per cent in 2008 and 2009."This outlook incorporates a marked slowing (though not recession) in the US and a more moderate easing in ... Europe and Japan. However, conditions in the part of the world most relevant to Australia - Asia - are expected to remain robust, with growth in China, in particular, expected to remain in double-digit territory in 2008. As a result, commodity prices will continue to be supported by strong demand. "For Australia, this means that the river of gold will continue to flow."In this light, it's little wonder that further interest rate rises are expected. Importantly, it also means tapping the tax-cut honey pot won't be as easy for the next government.Giving tax cuts while keeping the surplus at a bit more than 1 per cent of GDP has not pushed up rates, per se, but by not allowing the budget's "automatic stabilisers" to operate, fiscal policy has failed to "lean against the wind" of rate pressures being generated by the booming economy and capacity constraints.A continuing "growth surprise" would generate even more revenue but it means a future government would need to be more judicious in handing it back. Rebalancing monetary and fiscal policy, with a bigger surplus as a share of GDP and smaller tax cuts, may have to be the order of the day - including some of the $30 billion-plus in tax cuts goodies already promised, perhaps?
© 2007 Sydney Morning Herald