Professor Ross Garnaut, commonly referred to as the ‘grandfather’ of Australian economics after advising the former Hawke Government on its 1980s structural reforms, has delivered a sombre outlook for the Australian economy as the once-in-a-century mining boom unwinds. From the Weekend Australian:
“If we continue with the current economic policy settings and current mentality, then a recession is very likely and the economy may kick along the bottom for a long while. It doesn’t matter who is in government, they will have to manage a set of very difficult circumstances.
“The coming requirements are going to be the need for broad-based restraint, shared sacrifice across-the-board and an emphasis on reforms to deliver productivity.”
Garnaut’s message is the salad days are over and the dog days are coming…
The economic convulsion Garnaut sees arises not from the end of China’s growth but the demise of its particular resources boom that dramatically boosted Australia’s national income. China’s economy is shifting, with a structural move to domestic consumption and services and less intensity on energy and metals.
“The consequences for Australia are that the terms of trade will come off and they have a long way to fall,” Garnaut says. “Secondly, our resources investment boom will come to an end. That means instead of having 8 per cent of GDP in resources investment, it will return to about the long-run average of 2 per cent. This will be a hit to the Australian economy that we have not experienced in modern times.”
Warning about the adjustment, Garnaut says the terms of trade boom meant “Australian incomes have grown out of any semblance of parity with other developed nations”. His message is that “our costs and incomes kept rising” while the rest of the world was pulled back by the global financial crisis.
Australia now faces the agonising task of returning to the norm. How much living standards fall is an issue of choice for the nation and its leaders: the more reforms lift productivity, thet less the required fall in living standards…
Contrary to the Keynesian fashion, Garnaut dismisses fiscal stimulus as a weapon to meet any new downturn. The reason? Because of the current account deficit constraint.
“We cannot sustain a discretionary spending a la 2008,” he says. There is “no room” for any repeat since Australia’s external position is not strong enough.
While Garnaut’s prognosis is dire, it should come as no surprise to readers of MacroBusiness. For a long time, we have warned that the unwinding of the mining boom – both commodity prices and mining-related capital expenditure – are the key risks facing the Australian economy, threatening to punch big holes in disposable incomes, employment, economic growth, government revenues, and asset prices.
Overall, Garnaut wants policy action on multiple fronts to manage Australia’s transition as the mining boom unwinds:
Garnaut says the suite of policies to make the great transition work are broad-based income restraint, “uninhibited pursuit” of productivity growth, regulatory reform, efficient and fairer taxes, reduction of middle-class welfare and retaining immigration with a high skilled bias.
Professor Garnaut believes that the Australian dollar will necessarily depreciate sharply due to the falling terms-of-trade and mining-related investment (read capital inflows), eventual monetary tightening overseas, and further interest rate cuts at home, and that this depreciation will be required to restore domestic competitiveness. But in the process, tradeable goods inflation will rise significantly, requiring the Reserve Bank to loosen its inflation target.
In sum, Garnaut’s prescriptions amount to an argument that Australia should be seeking to hand-off of investment growth not to housing, as planned by the RBA and Treasury, but to tradable sectors. Indeed, I spoke with the Professor this morning and asked what Australia should do in the event that cutting interest rates fired up the property market? He replied:
…if a housing boom is getting in the way of easing because of risk, it is appropriate to raise the risk rating of housing for capital adequacy purposes.
In other words, although macroprudential policy is not generally favourable, in these circumstances it is appropriate. The battle for Australia’s economic future has been joined at the highest levels.
Below is a recent PowerPoint presentation by Professor Garnaut, which outlines his thesis in further detail. It’s well worth a read, preferably with a stiff drink.
Managing the End of Australias-China Resources Boom – Ross Garnaut (April 2013)
