Tuesday, September 01, 2015

Slow ahead. Expect 'the equivalent of a recession' every ten years

If we were sleepwalking into a mess, would we know it? Our leaders wouldn't.

Tony Abbott opened last week's national reform summit with a self-congratulatory video in which he talked about cutting red tape, the China-Australia free trade agreement, and the need to protect mining from "vigilantism in the courts". Things were heading in the right direction.

Joe Hockey gave a speech that said even less, talking about the rise of the consumer and observing that his dad once told him, "ideas are free, but good ideas are gold nuggets".

Bill Shorten was better. The deficit had doubled. Wages growth was at record lows. Economic growth was nearly a full percentage point below trend. Australia's transition from the mining boom had been patchy.

Then the politicians left the room.

The summit was told that the economy was set to grow at a mere fraction of the officially projected pace, so slowly that the living standard expected in 2055 wouldn't be reached until 2075, when most of us would no longer be alive...

The intergenerational report had assumed average growth in real incomes of 1.4 per cent per year for each of the next 40 years. It would mean that by 2055 real income per person would be an impressive 75 per cent higher than it is today. We would easily be able to afford any extra tax we needed to fund higher pensions and health costs, and our incomes would be climbing so fast, we wouldn't much mind if the tax system was changed.

Even >in March, when the report was released, Treasury officials regarded the assumption as a stretch. Since then views about the future have changed. The Reserve Bank believes Australia's sustainable rate of economic growth may be lower than in the past, so low as to make the projections in the intergenerational report unachievable.

On Wednesday at the reform summit, economic modeller Janine Dixon from Victoria University put numbers on a rate of income growth she said was more realistic. Instead of growing by an average of 1.4 per cent per year, real income per person would grow by a bit less than 1 per cent, enough to leave us only 44 per cent better off by 2055. We would need to wait another 20 years to be as well off in 2075 as the intergenerational report said we would be in 2055.

Her thinking is that productivity (output per hour worked) will grow far more slowly than it has. To prepare the intergenerational report, the Treasury simply projected the growth rate of the past 40 years to the next 40. She said the past 40 years included "an exceptional period in Australia's economic history – a period which included the major economic reforms of the 1980s combined with unprecedented growth in computing and communications technology and the benefits of the stability brought about by a 23-year run of positive economic growth".

Assuming that we are unlikely to computerise once again, and knowing we can't cut high tariffs to near zero again, and that we are most unlikely to survive yet another generation without a recession, she has come up with a much lower estimate of normal productivity growth by excluding the exceptional years between 1994 and 2004.

Professor Ross Garnaut seized on the implications. On present settings, Australia had no chance of achieving the promised 2020 surplus, and instead faced "ever increasing budget deficits".

Dixon outlined other implications. If incomes don't rise as rapidly, we will need to save more in order to fund the things we could have once relied on income growth and future generations to fund. "Decisions about who should forgo consumption to fund investments become contentious," she said. Baby boomers and generations X and Y and Z will fight among themselves over who should pay the most. Rapidly rising incomes are a lubricant - they stop people rubbing up against each other.

The fighting has already started. Instead of embracing tax reform as our leaders used to, the present lot are frightened, knowing that unless incomes are rising rapidly, tax reform is close to a zero sum game. It isn't possible to make everyone better off.

The former treasury secretary Martin Parkinson said the enormity of what was in store amounted to a recession every decade, as each decade lost 5 percentage points of expected GDP. "It means willingly accepting the impact of a recession," he said. "We are actually going to find ourselves sleepwalking into a real mess."

We might get a foretaste on Wednesday when the Bureau of Statistics releases the June quarter national accounts. One bank is tipping economic growth of just 0.2 per cent in the quarter; another, 0.4 per cent. Either result is pitifully low by the standards we have come to expect and if sustained would drive annual growth below 2 per cent.

It might be something we will have to get used to. Highly aged societies such as Japan and Italy have long been used to low income growth. Highly aged individuals get used to it as well. The transition has probably been under way for some time. Until now it has been masked by the mining booms.

It won't be catastrophic, but it won't be pleasant. Things that have been easy will become more difficult. It would be nice if our leaders even acknowledged the possibility.

In The Age and Sydney Morning Herald