To succeed, PM Abbott must disappoint us all

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Now that the election is over and it’s clear that we’re not going to receive any further details of planned budget strategies, it’s time to look forward and ask what will be required of Prime Minister Abbott in his first term.

Our first port of call post election will be the traditional hunt and discovery of a Labor “black hole”. This will enable PM Abbott to back flip on any number of commitments on saving and spending. Moreover, the post-election bun-fight over carbon pricing with the Greens and independents in the senate throws up any number of possible policy shifts enabling PM Abbott to reprioritise as well.

The question is, what kind of economy will PM Abbott inherit and will any of these measures be appropriate?

To find the answer let’s examine the demand and supply sides of the economy. For demand, The Australian has a CEO roundtable that nicely sums up what’s in prospect:

“I do genuinely think that people are starting to change behaviour; I think people genuinely are concerned about the future,” CSL and Transurban director Christine O’Reilly said.

“We talk about policy giving us long-term views. I think people are taking a very long-term view whereas there was a time that they had a great deal of short-termism in their spending.

“(Now) it’s about super and it’s about saving and it’s about driving down debt and it’s about leaving something in the cupboard for hard times, and I think it will take a while to change that.”

I’m sure you’ve noticed how strange this perspective is. Why would you want to “change” the sensible habit of saving for a rainy day? You wouldn’t and, as the RBA has already accepted, it won’t.

So, for starters, PM Abbott will face an enduringly prudent consumer. The first thing he should do is accept, embrace and work with this reality. Any return to the Howard/Costello era of consumer over-stimulation via public saving, personal tax cuts and low interest rates will not work this time around. Interest rates traction is slipping and any economic narrative that does not support the changed consumer will fall on deaf ears. If PM Abbott cuts spending too hard the consumer will bunker and any tax cuts will go to waste, perhaps after a sugar hit. Because there is unlikely to be any enduring effect on spending, taxes will not lift and the federal deficit will blow out quickly, further undermining confidence. PM Abbott will need to disappoint those households that are counting on a return to the Howard good times of lower taxes and higher income.

So much for the demand side of the economy, what about the productive side? The Australian article goes on:

NAB group executive, people, communications & governance, Michaela Healey said the key was getting small businesses to start employing people again.

“It will require the lifeblood of our country, small businesses, to start to have that confidence to be willing to put more people on that will then support that underlying confidence and that concern about, ‘Will I have a job next week?’,” Ms Healey said. “So unemployment figures are going to be one of the key indicators that we really need to watch.”

But, in a environment of subdued demand, why would consumer facing industries invest? They won’t of course, which will mean rising unemployment. As well, the planned removal of the carbon and mining taxes will do next-to-nothing about the real problem afflicting most Australian businesses, a lack of competitiveness. To fix that, we’ll need far more radical surgery, getting the dollar down, keeping wages from rising as tradable inflation bubbles up, and deflating property prices. This is tough medicine but it is inevitable as the mining investment boom ends. To illustrate I’ve created a couple of charts comparing past episodes of falling private capex with that in prospect.

The first is the optimist’s scenario in which total capex falls 5% per annum for the next three years. This is an extrapolation of data using the average realisation ratio method (plus a little bit for accelerated declines to cover the LNG mega-projects roll off):

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It is sobering to think that for this scenario to transpire we’re going to need a moderate housing construction boom, a decent rebound in tradables and a few new big ticket mining projects. As you can see, it would still be very tough. Private capital investment is the driver of jobs growth so this scenario would still see materially rising unemployment.

Now to the realist’s outlook. The following chart extrapolates expected capex out over three years using the year on year method (minus a little bit so it’s not quite so scary):

capex cliffs

This is a scenario in which we see no new mining projects, tradables rebound slowly and housing investment rises modestly. That is, the path we’re currently on.

This is the primary challenge facing PM Abbott. It’s not the consumer, it is falling business investment, driven by an historic mining capex cliff that is itself the result of forces in China beyond our control. A more inhospitable environment for an economy fattened on easy gains of debt and endless Chinese demand it would be hard to find. As you can see, falling capex is very often associated with recession.

PM Abbott will receive lots of advice from his keenest supporters, the loon pond that dominates our business media, about how he should let this process run. Our school of mock-libertarians will insist that PM Abbott chase the economy’s tail down the rabbit hole with budget cuts as revenue stubbornly refuses to grow. He will have to do the opposite, using public debt to build a bridge of public investment over the the mining capex cliff. He has some small projects committed already but has also planned to pull half the investment in the NBN, well over 1% of GDP and, just as importantly, off balance sheet. It is an understatement to say that PM Abbott will have to find a lot of new public investment to cover the NBN gap and bridge the private capex cliff.

It’ll be a tricky balance. Deflating the economy to a point of renewed competitiveness is vital if private capex growth is to resume but letting a chasm open up under national capital expenditure in the mean time will risk severe recession.

The greatest public flash point for this process is going to be labour costs. It doesn’t take Einstein to see that the mock-libertarians of Australian public discourse make no distinction between lower wages and higher productivity, even though the two have a much more distant link. It is perhaps here as well that PM Abbott’s natural inclinations will also lean most concertedly away from the center.  A push back towards the center in industrial relations is needed and, as argued above, wages will need to be held down as the dollar falls.  But how it is done will be vital to the outcome.

The loon pond will want PM Abbott to go to war with the trade unions. This may reduce wages but it will also create a sustained industrial conflict as the trade unions will be spoiling for the  fight. This will sap national confidence as public discussion is overtaken by vested interest squabbles tearing at a shrinking pie. To prevent this kind of social fracturing, PM Abbott will need, rather, to create a narrative of mutual sacrifice, bringing interest groups together to share a project of increased competitiveness in the national interest. This must be matched by policy in which PM Abbott supports Labor’s core constituents, more so even than the rich folks that the loon pond will want to him stroke on the dubious basis of “trickle down” economics.

PM Abbott has shown some encouraging signs that he can embrace centrism when required. His electoral delay of the timetable for surplus is encouraging versus six years of poisonous deficit rhetoric. But he has also shown he will favour interest groups over the nation in the formation of policy – think miners, pregnant women and the rich vis superannuation and health care. This kind of populism won’t cut it either. Only a genuine productivity push can narrow the degree to which increased national competitiveness is achieved by falling prices.

The greatest economic challenge of any new leader in living memory stretches before Prime Minister Abbott. He will have to disappoint his core constituents, disappoint households seeking a return to Howard glory days, embrace and disappoint his enemies’ supporters as he sweeps Australia into a new and painful national narrative. Only then will he make sense of the economy for all and be forgiven for the tough times ahead.

Comments

  1. in all likeliness the RBA will cut every few months which will force “savers” to invest in property and drop the dollar to a lifesaver $US0.6, the level it used to be (great for mining/gas and reduce the overseas competition(save jobs, reduce the online threat, keep the bogans onshore etc..)).

    All good.

    • It’s not all good, dam, you are painting a national disaster scenario in which the RBA will not be able to cut owing to your specufesting.

      As Chris Joye argued on the weekend, the RBA will already be thinking about putting a lid on you and it can’t come too soon.

      • They probably should but only acts matter not jawboning and so far it s a pretty safe bet.and by the way i doubt the RBA would be much concerned as their is pretty much no credit growth in housing.

    • Our dollar will be pushed lower as rates in the USA rise slowly.

      A lower dollar will bring more benefits than further rate cuts.

      • Well I agree, but I’m not sure the populace have that view. Abbot will probably have to be sneaky about running deficits, as you suggest in your OP.

        In a way it’s a little sad that voters have been left behind in the debate.

        The falling dollar will help in the future though.

    • Why would the savers invest in properties? It’s not like the rents are going higher. Even at current dismal rates of return, term deposits have a higher yield than most property minus any potential cap gains.

      Also if the treasuries keep going up (or at least stay put) then interest rates here will have to rise regardless of what the RBA does or wants.

      How long before we start hearing Gail Kelly and Ian Narev talk about funding pressures again?

      • Flyingfox…because in Australia there is nothing else to invest in. What else is there?
        That’s why the economy is shaped like it is.

      • @flawse No that is the perception sold to mum and dad investors and sickeningly backed by the RBA.

        The problem now isn’t that there is nothing else to invest in. The problem is that even the slightest move away from prop investment could be disastrous of the Aus economy and future prosperity.

        Essentially it is too big to fail and everyone looked the other way while it happened.

      • ff…you’re right to that extent…however name me one other thing that one might invest in? We’ll stick to ‘productive’ investments and exclude ‘coffee shops’ et al as they are simply part of the ‘housing ‘ investment scenario.

      • Australian shares. But we are not just limited to Australian investments. On your own or via managed funds you can invest in almost any legal asset class on the planet.

        However the main difference is leverage. Got 5% deposit, good, here is your title sir.

        Getting anywhere near that sort of leverage with other investments is impossible (commercial property too).

      • BTW I am not opposed to property as an investment. It can be a great investment. The problem with prop in Oz is the investment model. One that is all about capital gains and forsakes income at the expense of cap gains. This is unsustainable.

        If prop was returning 6-8% net, I would be all over it.

      • Ff…I think you are reinforcing my point.

        I agree offshore shares are a possiblity. However in an Australian context there is only property. As you rightly point out that’s what the whole economy is built around. We don’t need anything else….according t5o us!

      • “If prop was returning 6-8% net, I would be all over it.”

        +1

        Precisely.
        After allowing for agents fees, rates, maintenance, insurance and sometimes body corporate, I’d be surprised if most landlords are yielding more than about 3-4% net.

        And that doesn’t even take into consideration un-tenanted vacancy periods.

        On top of that you have the associated stress of getting a potential “tenant from hell” so rationally you would want some kind of PITA premium, a few points above the risk free term deposit rate.

      • And that’s why government policies are all about ensuring that prices keep going higher and higher, so that the capital gains keep growing. It has to end at some stage, but the question is when?

  2. Yes, that is a good summary.

    One of the great unknowns is whether the ALP in opposition will understand that in order to be taken seriously they need to understand the importance of economic reform to create opportunity for those who are not already asset rich.

    Conservatives can be expected to tilt the table to protect the status quo but a progressive party’s job is to facilitate the smart, the hungry and the ambitious with opportunities to compete and challenge the economic status quo.

    Sadly the ALP did not do this after 1996 and instead slid back into old school ALP:

    1. Organised labour

    2. Redistribution of the existing pie.

    If the ALP want to get back in the game and fast they need to understand that the greatest foe a conservative faces are herds of young ambitious people with energy and the smarts and the desire to compete with them.

    If they attract those who can help themselves they can ensure that those that can’t can be assisted as well.

    That should be the real distinction between left and right side of centrist politics.

    Of course to do this the ALP needs more than union hacks and the welfare lobby.

    It needs people who understand that uncompetitive markets in land, barriers to entry to markets including services and the array of regulations that stymie new entrants and which existing players are quick to endorse are the very things that a progressive left of centre party should fight if they are serious about social and economic mobility.

    Letting Howard look like an ‘economic manager’ was the greatest own goal the ALP kicked.

  3. ‘To fix that, we’ll need far more radical surgery,
    (i) getting the dollar down,
    (ii)keeping wages from rising as tradable inflation bubbles up, and
    (iii) deflating property prices.’

    (i) Getting the dollar down is surely just of a function of RBA action (who incidentally don’t believe we have a housing bubble) and the unwinding of the Australia-as-a-safe-haven play. Hopefully the latter will do the lion’s share, in a very fast stabilising fashion.

    (ii) Tradeable inflation was around 0% last time I looked. Even if that share went up and overall inflation went up to say 3-4% wouldn’t that help sustainable deleveraging. Also, wage spikes? C’mon. Just look at these charts pleas
    http://mattcowgill.wordpress.com/2013/03/05/labours-shrinking-share/

    (iii) If the RBA can’t cut then the only tools you’re left with are hard to use. Abolish negative gearing, FHOGs? Can’t see Abbott doing that ever…

    • Alex…that is some sort of fantasy world….
      Just for a start tradable inflation took a good kick along in the last numbers and that was with a very fortunate dip in fuel prices at the end of the period and before the fall in the dollar could even begin to take its toll.

      Inflation of 3 to 4% with tradable inflation at what 10% ? How do you work that out?

    • If the RBA doesn’t believe we’re have a housing bubble, then why did they bring interest rates down to 2.5% ?
      The lower rates are killing the people without a mortgage :
      # young people saving for a deposit, and
      # 55s and over, either saving for retirement or living from savings.

      • I think this escapes many. SF retirees are a natural, welcome outcome to reducing welfare blowout with the ageing of the population. We want to help our kids and grand kids but our incomes are reducing dramatically. I don’t know why the Govt doesn’t issue infrastructure bonds at say 2.5% above the cash rate. Would get Australia building key infrastructure faster? Maybe an incentive by banks for SFRs offset by Govt benefits for them? Surely some creative thinking here to get Win Wins other than raising rates?

  4. Why try to solve a problem when you can “kick the can down the road”? This is what I expect from the next government : spending like a drunken sailor on tax cuts and middle class welfare. The problem of the structural deficit is someone else’s problem!!

  5. Agree it’s a great summary however there lies within it the very message that none of it is possible.
    All the ‘loons’ are in business! Strewth! The reality is going to be very different!

    The lunatic element that totally dominates the Trade Union movement and all it’s branches including WHS are going to have another field day. Their’ Hard Won Rights’ are going to be eroded and it cannot happen! “Your Rights at Work” will dominate the landscape. “How much is a human life worth?” will be a constant mantra. The powerful like the Watersiders will be out there, as the vanguard, defending ‘worker’s rights’ by demanding more money and less work at the expense of their fellow workers. We will have tens of millions, possibly hundreds of millions, of member’s money spent on a concerted TV advertising campaign of ‘Worker’s Rights’ The old automatic winner ‘working families of Australia ‘ will be back big time!

    The lawyers, accountants, etc will be compensating themselves for inflation…and then some. I mean really as the currency falls the Benz’s and BMW’s are going to get really expensive!
    Appeals for co-operation in the interests of the community will be wasted.

    Further there is the implication that to cut the Whitlam induced massive duplication and waste in the PS is wrong. The powerful PS Unions will become also be out there as the vanguard of workers rights demanding more money and better conditions. There will be nothing that will be too much! The current inanity will be exaggerated.

    On the other hand ‘yes’ the loons on the business side will be back screaming for lower interest rates to boost RE and consumption. Dam is right.
    Can you imagine the spit Hardly Normal is going to have in a year or two? The Govt will have to ‘do something’ Bill Evans, along with a whole raft of current and ex-bankers, will be out every week calling for interest rate cuts as the solution to all things!

    We’ll have continuous calls for ‘infrastructure’ to build our cities, new urban rail links, new freeways, to link even more housing development and grand shopping malls…the symbol of our prosperity. We’ll get5 them along with more foreign debt to finance that goes with it all.

    We’ll have demands for more money for education to reinforce the broken model we already have. ‘Gonski’ will be quoted day in day out…what for?

    And so it will all go on funded by sales of natural resource assets to foreigners. Nothing will change other than to accelerate towards the day of reckoning in whatever damned form that is going to take.

    • Nothing will change other than to accelerate towards the day of reckoning in whatever damned form that is going to take.

      That might just happen in this term of government.

  6. Our school of mock-libertarians will insist that PM Abbott chase the economy’s tail down the rabbit hole with budget cuts as revenue stubbornly refuses to grow. He will have to do the opposite, using public debt to build a bridge of public investment over the the mining capex cliff.

    How many times do I have to explain this to people?

    Tony Abbott will do both! He will cut budgets (or at least appear to cut budgets). AND he will (effectively) increase public investment.

    How will he perform this magic trick?

    He will dress up “public” spending as “private” spending by using public-private “partnerships”, tax-farming deals, and the sale of whatever monopolies are left over after the Howard/Costello era.

    The risks will still be borne by the public through take-or-pay contracts, or guarantees, or selective subsidies to raise rates of return to the levels required by the private financiers.

    And the rates of return required by private financiers will be reduced by introducing a new private-sector version of the old “20/30 Rule” which will require complying superannuation funds to invest a minimum proportion of their funds in qualifying private infrastructure investments.

    New taxes (such as new road tolls) will be imposed but will not be applied until projects are completed, which will be after the next election. Thus, it will be possible to borrow – and spend – against new taxes without the taxes actually having been implemented.

    All of this will be a hugely wasteful way of financing public works. It will misallocate risks (like traffic risk). It use illiquid and expensive financing instruments (like project finance) when liquid government bonds would be cheaper, even after adjusting for risk transfer. It will involve vast arrangement fees and other fees. It will entrench monopolists who will gouge the taxpayer for generations to come. It will replace transparent price-based contracting with opaque build-finance-operate packages.

    But it will also line the pockets of the people who matter: the finance industry (mainly in Sydney), their support industries, and the major (but not minor) contractors.

    Like any form of industry protection, it will be allocatively inefficient and it will permanently and unnecessarily raise both the cost of living and the cost of doing business in Australia.

    But those rent-seekers who are benefiting from it will hail it as a marvel of private sector prosperity.

    There is nothing that can be done to prevent this. Under the system of “franchised monopoly government” – which adversely selects the most megalomaniacal political agents – it is all but inevitable.

    But let no-one say they weren’t told in advance.

    • And the ALP will be standing slack jawed on the side lines as they have drunk the same kool aide of modern economic management and their only regret will be that they are missing out on the bells and whistles of public office.

    • a brilliant take on the future…and I have no doubt 99% correct. You missed the bit about bread and circuses…

      • And there’ll be bread and circuses!!!

        When are the next Olympic Games? Commonwealth Games? World Cup?? APEC?

        Other suggestions welcome.

    • I think that is a plausible (and probably inevitable) arc. But Stephen Morris, re: super funds investing in infrastructure, do you think it is more likely this process will accelarate under a future Labor government ? I can’t see ‘free market’ liberals being too keen on compelling superannuation funds to invest in infrastructure. There also seems to be a lot of groundwork yet to be laid for this before that is viable on a large scale. Given the Coalition seems to have a general antipathy towards what it sees as union controlled industry funds, given they are often the highest investors in infrastrucrture, I would have thought this would have the potential, if anything, to slow the march towards increased investment in infrastructure ?

      • It is likely that the LNP will hold their noses and deal with the Industry Super Funds if the objective is to direct super money in the direction of infrastructure ‘projects’ that are riven with ticket clippers of every description who know the importance of buying expensive seats at the appropriate fund raising dinners and offering retirement postings for ex-pollies who have taken one for the team.

        It is just too tempting.

        Using the motherhood war cry of “infrastructure” to direct the investment decisions of the custodians of the retirement savings of the average citizen.

  7. One thing that is worth remembering is that 2007 was a long long time ago.

    Back when Howard was PM there were far far fewer sources of independent news and comment available on the internet.

    It is easy forget that Twitter was only founded in 2006 and most Australian blogs on politics or economics post date the GFC.

    More and more people are broadening their sources of information and thus there is some cause for hope that our politicians (and our main stream journalists) will find it a bit harder to get away with complete rubbish or parroting received wisdom.

    It will be interesting to see how successfully Federal Government can continue to spin ‘reality’ in the event we do experience a recession in the next few years.

    Pollies may find spinning just gets too difficult to manage and may try something novel – focus on good policy.

    • Just as the printing press broke the power of the Monarch/Church to monopolise and control information in medieval Europe, so may the internet break the power of the politicians/media barons to so today.

      Some of the early pamphleteers might have seemed crazy, but amongst the cacophony were the ideas that led to the world we know today.

      Tha Panglossian Conservatives (and the semi-Panglossian Conservatives) will go on insisting that we live is the best of all possible worlds, and that the present institutions of government must go on for ever, and ever, and ever, and ever without change. Presumably until the sun grows cold and oceans freeze over. These are the solipsistically narrow-minded people who believe that “the end of history” occurred just as they reached adulthood.

      But the modern world is . . . well . . . modern! It has changed in the past and it will change in the future. We hope for the better.

      We are the foot soldiers. The battle starts here!

      • Hear Hear!

        Changes at the margins can make all the difference.

        Releasing the public service from their contractual vows of silence where no genuine public interest is being served would be a good project.

        In most cases debates on public policy should be conducted in public with the public servants who have detailed knowledge of the issues as key participants.

        Having regard to the excesses of the executive/cabinet we can no longer rely on the executive to be the ‘managers’ of the Public Service mediating the public interest in its activities.

        The public service should report directly to parliament, with regard to its consideration, advice and implementation of government policy, with as much information as possible freely available to the public at all times.

  8. There are a number of structural and systemic issues Abbot must deal with in order to accomplish any kind of reform of the economy.

    These centre around taxation, regulations and workplace restrictions as well as Unions influence, control and jurisdictional distortions that have been legacied by Labor. For the Coalition to make any headway with restructuring our economy those things need urgent addressing. So I certainly hope he does not disappoint in that regard.

  9. Increasing taxes is what we should be doing. Just so long as it goes to targeted infrastructure, improving efficiencies on an economic and environmental basis. But I like Martin Fergusons take-increase the size of the pie and maintain the community share. Then you get sustainable growth. The trouble is we have to pay back what we owe sometime. Surprisingly I like the direct action approach of solar power. This initiative has singlehandedly reduced the growth in electricity generation. The companies are bleating their return is diminishing. So? Guess what it works, why shouldn’t Australia stand for something? Germany leads the world in solar power but sunlight isn’t their strength.