Today’s mid-year economic and fiscal outlook (MYEFO) continues to promise a small budget surplus in 2019-20 and each of the following three years.
But the surpluses are very small, roughly half the size of those promised at the time of the April budget, and highly uncertain.
The forecasts for economic growth and wages growth have been adjusted down, but are still optimistic, subject to downside risks, especially if international economic conditions deteriorate.
The lower wage growth forecast is an acknowledgement of the new reality that wage growth is not climbing and remains low.
One key variable is iron ore prices: these affect both economic growth (gross domestic product) and company tax collections.
Recent high prices due in part to mining disasters in Brazil will not continue indefinitely.
Iron ore prices peaked in July at US$120 per tonne but are forecast to fall back to US$55 per tonne by the June quarter 2020.
The key determinant will be demand from China. Its steel mills might require more, or less, than expected.
MYEFO has a sensitivity analysis showing 2019-20 tax receipts could be lower than expected by A$0.8 billion or higher than expected by A$0.5 billion (and lower by $1.1b or higher by $1.3b in 2020-21) depending on how quickly prices fall.
Housing versus households
Another expected source of increased revenue is a recovery in capital city housing markets.
While this won’t have as large an impact on the Commonwealth as it will on the states which are reliant on stamp duties (see for example the recent NSW budget update) the Commonwealth still benefits.
The assumption on households
that some of the recent weakness in consumption reflects timing factors and that the household saving ratio will fall as households increase their consumption in response to higher after-tax income
However the treasury acknowledges
there is a risk that consumers remain cautious and the fall in the household saving ratio is slower than expected.
It is possible that households will remain nervous about the future and save rather than spend; or that we are seeing deeper shifts in preferences away from consumer spending.
Surplus before spending
MYEFO includes previously-announced new spending on infrastructure projects, drought and aged care, but there were no major additional announcements.
This is in line with the government’s determination to have a surplus this year, even if smaller than expected at budget time.
The underlying cash surplus of $5.0 billion forecast for 2019-20 is indeed small – a fraction under 1% of the total receipts number, $502.5.
MYEFO graphs the confidence we can have in the surplus forecasts: there is considerable uncertainty.
Governments can always introduce either spending cuts or additional revenue raising measures in pursuit of a surplus.
The question is why. It is puzzling that having a surplus has become a sign of good economic management.
Surplus for the sake of surplus
Arguably what is more important is people’s real incomes, whether their chance of unemployment is rising or falling, whether they will be looked after in old age, have their health needs met, and be able to offer their children a good education.
There is a good argument against debt – government debt has to be paid off before the money spent servicing it can be spend on other needs, and excessive debt exposes a country to risk.
Within reasonable bounds though, neither ratings agencies nor international financial markets care if a budget is $5b in surplus or $5b in deficit – these are for all intents and purposes the same number in terms of the government’s impact on the economy.
The government is no longer projecting net debt will fall to zero by 2029-30 – instead, it will fall to 1.8% of GDP (still much lower than the 2019-20 net debt of $392.3 billion or 19.5% of GDP).
This is however a heroic projection, based on estimates of the structural budget position that are unlikely to be be realised.
The structural estimates (estimates of where the budget would be were it not for whatever was happening in the economy at the time) have surpluses growing every year up to 2029-30; an unlikely scenario in the face of an ageing population together with other pressures on government spending.
The impact of ageing will be analysed in more depth in the next Intergenerational Report to be produced by Treasury.
This may explain why the Treasurer today announced the next five-yearly Intergenerational Report will not be published in March next year as scheduled, but held over until July, after the budget and after the report of the government’s retirement incomes inquiry.
There are several gaps in the estimates of spending.
Likely costs left out
There is no provision for additional spending on the new services delivery model, Services Australia, previously known as the department of human services, which runs Centrelink. Modelled on Services NSW, which offers a better customer experience, it will be expensive.
Services NSW meets its costs by charging other government agencies, spreading costs across government. There is less scope for this in the Commonwealth, and therefore a potentially higher direct call on the budget.
The government has shaved its forecasts for both economic growth and the projected surplus for this financial year in its budget update released on Monday.
The Australian economy is now expected to grow by only 2.25% in 2019-20, compared with the 2.75% forecast in the April budget.
The projected surplus has been revised down from A$7.1 billion at budget time to $5 billion for this financial year.
By 2022-23 the surplus is projected to be tiny A$4 billion, a mere one fifth of one per cent of GDP, less than half the $9.2 billion projected in April.
Combined, $21.6 billion has been slashed from projected surpluses over the coming four years.
The revenue estimates have also been slashed, down from the pre-election economic and fiscal outlook (PEFO) by about $3 billion in 2019-20 and $32.6 billion over the forward estimates.
The changes this financial year reflect downgrades to superannuation fund taxes, the GST and non-tax receipts. The downgrade in later years reflects changed forecasts for individual taxes, company tax and GST.
The official documents sought to put as positive a spin as possible on the worse economic figures:
Australia’s economy continues to show resilience in the face of weak momentum in the global economy, as well as domestic challenges such as the devastating effects of drought and bushfires.
While economic activity has continued to expand, these factors have resulted in slower growth than had been expected at PEFO.
The revised figures forecast growth will be 2.75% next financial year.
The impact of the drought is reflected in the fact farm GDP is expected to fall to the lowest level seen since 2007-08 in the millenium drought.
The downgrades will fuel calls already being made by the opposition and some stakeholders and commentators for economic stimulus.
But the government, which since the budget has brought forward some infrastructure and announced spending on aged care and drought assistance, is continuing to resist pressure for stimulus now, wishing to hold out until budget time.
The budget update – formally called the mid-year economic and fiscal outlook (MYEFO) – contains more bad news for workers’ wages.
Wages are forecast to rise in 2019-20 by 2.5%, compared with the forecast of 2.75% in the budget.
Employment growth remains at the earlier forecast level of 1.75% for this financial year, but the unemployment rate is slightly up in the latest forecast, from 5% at budget time to 5.25% in the update.
In its bring forward and funding of new projects, the government is putting an extra $4.2 billion over the forward estimates into transport infrastructure projects.
Its extra spending on aged care will be almost $624 million over four years, in its initial response to the royal commission. This is somewhat higher than the $537 million announced by Scott Morrison in November.
While the projected surplus has been squeezed, the government continues to highlight the priority it gives it, saying that despite the revenue write downs, it expects cumulative surpluses over $23.5 billion over forward estimates.
Spending growth is estimated to be 1.3% annual average in real terms over the forward estimates. Payments as a share of GDP is estimated at 24.5% this financial year, reducing to 24.4% by 2022-23, which is below the 30 year average.
Treasurer Josh Frydenberg said the update showed “the government is living within its means, and paying down Labor’s debt”.
He said “the surplus has never been an end in itself, but a means to an end. An end which is to reduce interest payments to free up money to be spent elsewhere across the economy.”
The government’s economic plan was “delivering continued economic growth and a stronger budget position.
“MYEFO demonstrates that we have the capacity and the flexibility to invest in the areas that the public need most.”
Shadow treasurer Jim Chalmers said the update showed the government’s economic credibility was destroyed. At its core, there were “two humiliating confessions – the economy is much weaker and the government has absolutely no idea and no plan to turn things around”.
Chalmers said Morrison and Frydenberg “couldn’t give a stuff that Australians are facing higher unemployment and weaker wages and slower growth.
“If they cared enough about the workers and families of this country, they would stop sitting on their hands and they would come up with an actual plan to turn around an economy which is floundering on their watch.”
It doesn’t have much choice. The Parliamentary Budget Office is required to take the government’s surplus and deficit projections for the next four years as given, and to take its economic forecasts and tax and spending announcments for the next ten years as given, whether realistic or not.
What it is allowed to do, and does once a year in a publication entitled medium-term fiscal projections, is to set out the implications of those projections.
Those implications, spelled out on Thursday, show the projected budget surplus to be so fragile as to be unrealistic, except the parts that rely on much higher personal income tax collections.
That’s right: much higher income tax collections per person, even after taking into account the coming decade of legislated tax cuts.
Middle earners hit hardest
But it won’t be higher for all of us.
The middle fifth of earners will pay far more of their income in tax in ten years’ time under the government’s projections, according to the PBO’s calculations. Instead of paying 14.9% of their income in tax, by 2028-29 they will pay 18.8%.
That’s after taking into account the long-term tax cuts the government pushed through parliament in May and went to the election on.
Without those legislated tax cuts, they would have been paying an extra 6.3% of their income in tax. With the legislated cuts (and others pencilled in by the PBO to keep the government’s tax take within its promised ceiling) they will be paying an extra 3.9%.
Put another way, the government’s tax cuts will undo some of the damage caused by bracket creep as more of each pay packet climbs into higher brackets, but not most of it.
It’s the same for pattern for the second-lowest fifth of earners. They will move from paying 5.3% of their income in tax to 9.9%, a near doubling, which is taken is taken into account in the surplus projections.
The second-highest fifth will move from paying 22% of their income in tax to 23.4%, even after the tax cuts. The bottom fifth, who don’t pay much tax, will move from paying 0.6% to 1.2%.
Highest earners escape
But workers in the top fifth, which at the moment is workers earning above A$90,000, won’t pay a cent more, at least not on average.
The government’s projections, as spelled out by the PBO, have them paying less of their income ten years from today than they do today.
Put another way, they are the only fifth of the population that won’t be expected to wear pain to keep the budget surplus.
There are other contributors to the budget surplus. One is a pretty hefty assumed decline in growth in government spending over the next decade, amounting to 1% of GDP, taking government spending from around 24.9% of GDP to around 23.9%.
Much of it is projected to come from tighter eligibility criteria for payments, and measures to constrain their growth, something the PBO believes might be difficult to maintain:
The spending restraint seen over the past few years may be increasingly difficult to maintain over coming years given the length of time over which restraint has been applied, the pressures emerging in some spending areas, and the potential need for fiscal stimulus, noting that the projected improvement in the budget balance is mildly contractionary.
And it is saying the government might need to spend in ways it hasn’t accounted for, including on measures to support the economy in the event of a downturn.
Budget conventions to the rescue
The projections assume the opposite of a downturn.
No blame should attach to this government for them, but our rather odd budget conventions dictate that the worse the economy is, the better the budget’s projections for economic growth. That’s right: the weaker our current economic growth, the stronger the budget’s projections for future economic growth.
The thinking is that over the long term, the economy should grow at roughly its long-term average growth rate. To get there when the economy is weak, as it is now, the budget assumes several years of stronger than normal economic growth to catch up.
In this case it’s five years of stronger than normal economic growth.
The PBO contents itself with the observation that economic growth that was merely normal (or worse, remained weaker than normal) for some of those years would have a “significant and compounding effect on the budget position over time.”
The surplus is far from assured, and it shouldn’t be. The government might well find that it can’t and shouldn’t restrain spending on payments as much as is projected in the decade ahead, and it might find it needs to spend to support the economy.
It will almost certainly find that lifting the tax take on middle Australians from 14.9% of income to 18.8% is intolerable.
If there is a surprise in the result, it is that there wasn’t a surplus despite booming commodity prices, stronger than expected employment growth and a massive $4.5 billion saving on the roll out of the National Disability Insurance Scheme.
Company tax receipts haven’t changed much from the April estimate, despite much stronger than forecast commodity prices at the end of the financial year. Tobacco taxes came in at just $12.1 billion despite a forecast of $12.9 billion five months ago.
The tax boost is dwindling
Tax receipts from individuals were a little higher than expected in April, due mainly to higher taxes from capital gains and dividends. Personal income taxes were a little lower than expected, perhaps suggesting that the efforts of the Tax Office to make sure individuals pay more tax may have run its course.
If so, it’s good news for the economy, as it suggests consumers might start to enjoy stronger growth in post-tax incomes.
Here’s how Reserve Bank Governor Philip Lowe expressed his concerns about the Tax Office’s recent success to the Economic Society in May:
Over the past year, tax paid by households increased at a much faster rate than did income; almost 10%, compared with 3.25% – that is a big difference and it is unusual.
Where to now?
With the budget effectively in balance, a surplus in the financial year ahead seems all but assured. With government finances in good health, the next question is what to do with the surplus.
There is, as one commentator said after the release of the final outcome, “a mountain of debt to be repaid”.
That is currently the plan, but there is also a growing call for the government to spend more or cut taxes further to lift consumer spending and economic growth and take pressure off the Reserve Bank.
Neither option grasps the important opportunity that restored government finances present.
The surplus should be used for something special…
Australia’s most serious economic challenge is to reignite productivity growth and get the benefit of that into everyone’s pay packet via higher real wages.
With the election out of the way, now is the perfect time to re-set the economic policy agenda.
Structural reform is politically difficult. Getting out of bad industries and work practices into better ones is painful and hard to sell. But it works. It’s what the Hawke government did for us in the 1980s.
What’s needed is to encourage businesses to invest in technologies and work practises that maximise the output of every hour that people spend at work.
It requires a 20 year view, and it is best done by compensating losers. That’s expensive and can only really be done when finances are in good order, as they have just become.
…not simply spent
Right now the case for short-term stimulus isn’t particularly clear.
We are still waiting to see the effects of the tax refund boosts announced in the 2018 and 2019 budgets. We also need to wait a little longer to see what the impact of rate cuts and the easing of rules governing lending on the housing market and consumers.
The early signs are mixed. The only strong reaction we are seeing is in the Sydney and Melbourne property markets. Auction clearance rates are surging to boom-time levels and property prices are on the rise again.
Consumption seems to have stabilised and consumer attitudes to their own financial positions remain healthy. The latest employment numbers show continued growth while the Treasurer noted that the proportion of working age population on welfare is at its lowest in 30 years.
Until it is clear that the economy is faltering, or employment growth is threatened, I very much doubt that this government will contemplate short-term fiscal stimulus.
It shouldn’t. There are more important uses for its money.
In an enormous week for economic news at the start of the month, parliament passed the government’s three-stage personal income tax plan, and the Reserve Bank cut official interest rates to an unprecedented low of 1%.
It happened against the backdrop of a flagging economy in dire need of stimulus.
As the bank cut rates to a record low, its governor Philip Lowe again warned about the waning power of rates (monetary policy) to lift the economy.
Monetary policy does have a significant role to play and our decisions are helping support the Australian economy. But, we should not rely on monetary policy alone. We will achieve better outcomes for society as a whole if the various arms of public policy are all pointing in the same direction.
Lowe and many others – including yours truly – have repeatedly pointed out that spending on physical and social infrastructure can do what lower rates can’t do well – boost the economy while lifting its productivity. So, too would other productivity-enhancing reforms, particularly in the labour market.
And, of course, the government’s tax cuts will also stimulate the economy when they come into effect.
With tax cuts, timing’s the thing…
The obvious problem is that much of stimulus from those tax cuts will happen years from now, rather than today.
What the government should have done was insist on enacting all three stages of their tax plan immediately. Not staggered over several years, not in 2024-25. Now.
That would have, of course, pushed the budget into deficit in the short run, and that would would have run counter to the government’s narrative about being responsible economic managers.
But how responsible is it to prioritise one’s own political brand over the economic health of the nation?
Let’s not forget where the timing of the government’s tax plan came from. 2024-25 is outside the budget’s so-called “forward estimate” period and thus the impact on the deficit or surplus projections is not apparent.
It was the same rationale that underpinned the glacial, decade-long pace at which the government’s “enterprise tax plan” was to move to a 25% company tax rate. And it is the same set of dodgy accounting tricks that Wayne Swan was a master of for everything from health to education spending commitments.
…and the timing could be immediate
Productive infrastructure spending is hard to enact quickly. Spending on social infrastructure like education and training has a long lead time.
And structural reform of the industrial relations system might is probably the hardest and longest of all to put in place.
They are real constraints.
The Reserve Bank faces another, the so-called “zero lower bound” of conventional monetary policy and the complexities and uncertainties of unconventional policies such as quantitative easing.
But a government which won a mandate for its tax policies, and who frankly has the Labor opposition in a tailspin, could have insisted on all three stages of the tax cuts immediately.
The only thing standing between the economy and the aggressive fiscal stimulus it needs is the government’s obsession with balancing the budget regardless of the circumstances.
We’re not in the best of times
Don’t get me wrong, I think debt and deficits most certainly do matter. The government deserves credit for chipping away at the structural budget deficit, and we shouldn’t be running deficits in good economic times.
But we’re not in good economic times. We’re standing on the precipice of the first recession in nearly three decades. We’re looking at highly uncertain global conditions, domestic economic growth that has slowed to a trickle, sluggish wages growth, persistently high underemployment, and even the possibility of Japanese-style deflation.
The irony is that if, with the failure to enact sufficiently bold stimulus, we do tip into a recession, the red ink will flow all through the budget. Unemployment benefits and welfare payments will rise, personal and corporate income receipts will fall, GST revenue will drop. And young people who enter the labour market during a recession will suffer for years to come.
The downsides of not enacting sufficient fiscal stimulus far outweigh whatever benefits there are of a glide to path to budget balance while avoiding a recession.
It’s certainly not the time for hand-wringing
Coming back to Lowe’s admonition that we need the “various arms of public policy…pointing in the same direction”, here’s where we currently stand: The bank has acted, but far too late. For years it told us that 5% unemployment was as good as it could get long-term, to be patient and to wait for higher wage growth and inflation.
It’s been a mere five weeks since Lowe stopped impersonating Charles Dickens’ character Wilkins Micawber, who was fond of saying “something will turn up”.
Now the treasurer Josh Frydenberg is giving us his version of the same routine. On one hand he says personal income tax cuts are crucial to boosting employment and spending. On the other hand, he says we’d better wait.
The Australian economy can’t afford to wait for aggressive stimulus. The government has shown more concern for its political brand than for our economic health.
The Australian economy will remain healthy for long enough to enable the government to claim it as a strength in the lead-up to the May election, but the first Conversation Economic Survey points to a fairly flat outlook beyond that, with a 25% chance of a recession in the next two years.
The Conversation has assembled a forecasting team of 19 academic economists from 12 universities across six states. Among them are macroeconomists, economic modellers, former Treasury and Reserve Bank economists, and a former member of the Reserve Bank board.
Taken together their forecasts point to no recovery in the share market during 2019, no recovery in wage growth, no further improvement in the unemployment rate, further modest home price falls in Sydney and Melbourne, and to a budget deficit next financial year despite the official forecast of a surplus and Treasurer Josh Frydenberg’s commitment that the government will fight the election continuing to forecast a surplus.
Weighing heavily on Australia’s economy during 2019 will be a much weaker US economy, with what the forecasting team says is the possibility of a US recession, and weaker growth in China. Australian consumer spending is forecast to continue to grow during 2019, but no faster than it did during 2018. The best measure of living standards is forecast to advance at a crawl.
Most of the team expect the Reserve Bank to sit on its hands throughout all of 2019, leaving its cash rate unchanged at the all-time low of 1.5% for what will be a record 40 months.
The panel expects the Australian economy to grow more slowly in the year ahead, by 2.6%, down from recent annual growth of 2.8% and 3.1%. None of the panel expects growth to exceed 3%. One, Steve Keen, formerly of the University of Western Sydney and now at University College London, expects growth of only 1%.
Most of the panel expect China’s growth to continue to slow, from the annual growth of 6.7% typical over recent years to just 6.2%, the weakest growth since the 2008 global financial crisis and the weakest calendar year growth since 1990.
Former Treasury economist Nigel Stapledon now at the University of NSW nominates China as the biggest threat to Australian and global growth. He says it has a good record of stimulating its economy to get out of difficult corners but one day it might get it wrong.
The panel expects US economic growth to hold up at 2.8% during the year ahead but to weaken or go into reverse by year’s end as the “sugar hit” from the Trump tax cuts goes into reverse.
Former Treasury and International Monetary Fund economist Tony Makin points to US high public debt that will need to be rolled over, soaking up funds that could have been more productively used for investment, to higher US interest rates imposed by a central bank concerned about inflation, and to the escalating trade war with China.
ANU modeller and former Reserve Bank board member Warwick McKibbin says the US economy is “very likely” to begin to go backwards towards the end of the year. Craig Emerson, a former Australian trade minister now with Victoria University, says the US is likely to enter a recession in 2020. Former Treasury economist Mark Crosby at Monash University says if there is a US recession, it won’t hit until late 2019, with the impact greatest in 2020.
Rebecca Cassells from the Bankwest Curtin Economics Centre says a lot depends on the outcome of the US-China trade war: “The two biggest economies are going head to head, but both are almost as reliant on the other to sustain their growth trajectories,” she says.
Australia should look to other parts of the world to drive its economic growth. “India is one of them, and is rising rapidly with no downgrading of its growth trajectory of 7.75% for 2019.”
Nominal GDP, the money earned in Australia unadjusted for price changes, is forecast to grow more slowly in 2019, by 4.5%, down from recent growth in excess of 5%, reflecting weaker iron ore prices.
The best measure of living standards, real net disposable income per capita, is expected to barely grow, climbing just 1.1% over the year to December, much less than recent growth in excess of 3%, but much more than its performance in the dismal years between 2012 and 2016 when it went backwards.
Forecasts for the unemployment rate cluster around its present 5.1%, with only four below 5% and one above 6%.
Wage growth is forecast to climb no further in 2019, finishing the year at its present 2.3% instead of climbing to 2.75% on its way to 3% by mid 2020 as forecast in the budget update.
Rebecca Cassells points out that much of the increase we have had has been driven by the Fair Work Commission’s decision to lift the minimum wage 3.5% from June 2018, suggesting very low growth elsewhere. Disturbingly, she says more and more enterprise bargains are being terminated, with employees falling back on awards.
Overwhelmingly, our panel is of the view that the only thing that will lift wage growth out of its slump (and budgets have been incorrectly forecasting a bounce out of the slump for eight years now) is higher productivity: producing more per worker.
Victoria University economic modeller Janine Dixon notes that the December budget update actually downgraded its forecast of productivity growth, from 1.5% to 1%, and so is not optimistic.
She says even if productivity growth did pick up, excessive market power in some industries combined with weakness in labour market institutions means it might not easily be passed on to workers.
Tony Makin, a supporter of company tax cuts, says the best thing to lift productivity would be new (perhaps foreign) investment embodying productivity-enhancing technology.
The saving grace for workers facing yet another year of historically-low wage growth is that price increases will also remain low.
Inflation has been right at the bottom of (or below) the Reserve Bank’s 2% to 3% target band for four years now, meaning that even at the continuing low rates of wage growth forecast, wages should continue to climb just faster than prices.
The panel expects consumer spending to climb by only 2.5% in real terms in 2019, most of which will reflect population growth of 1.6%.
The average forecast for inflation is at the very bottom of the Reserve Bank’s target band. Only two panel members expect inflation to edge back up to the middle of the band. They are Warwick McKibbin and former Treasury and ANZ Bank chief economist Warren Hogan, at the University of Technology Sydney.
Interest rates and the budget
Without either a lift in inflation or a substantial weakening in the economy there is little reason for the Reserve Bank to move interest rates in either direction.
Governor Philip Lowe took the job in September 2016, just after the board cut the cash rate to a record low of 1.5%. He hasn’t moved the cash rate since, although on several occasions he has said the next move is most likely to be up.
Five of the panel do expect at least move up this year, including the two who think inflation might approach the bank’s target. Three expect cuts, taking the rate below 1.5%.
The government says it will deliver a budget surplus next financial year, of A$4.1 billion, the first surplus in a decade.
The panel doesn’t think so, all but one member predicting a lower budget surplus than the government, and seven predicting deficits. The average forecast is for a deficit of A$3.5 billion rather than a surplus of A$4.1 billion.
Monash University macroeconomist Solmaz Moslehi identifies optimistic wage growth, weaker than expected mining investment and a hit to consumer spending from the housing downturn as the biggest risks to the forecast surplus.
Julie Toth, adjunct professor at Deakin University’s Master of Business Administration program and chief economist at the Australian Industry Group, says the latest indicators suggest that neither employment nor wage growth will accelerate by as much as the government expects.
Michael O’Neil from the South Australian Centre for Economic Studies says the biggest immediate risk to the forecast surplus is thermal coal prices, given China’s efforts to cut coal imports and the shift to renewables in China and India.
The biggest long term risk is the scale of the company tax cuts and the ongoing shift of income from highly-taxed labour to more lightly-taxed capital.
Margaret McKenzie of Federation University identifies the biggest risk to the surplus as a change of government, something she says she welcomes because with extensive idle capacity and underemployment, a surplus would be unhelpful.
The panel expects Sydney home prices to fall by another 5.8% and Melbourne prices by another 5.1% in 2019, taking the slides over two years to 14.7% and 12.1%.
Only Macquarie University and former Reserve Bank economist Jeffrey Sheen expects prices to move back up throughout 2019, by 2% and 3%.
Reassuringly, none of the forecast falls are bigger than 10%. The biggest are predicted by Steve Keen, Tony Makin, Margaret Mckenzie and Craig Emerson.
The lower prices will be accompanied by much slower growth in housing investment, expected to climb only 2.1% in 2019 after climbing more than 7% in the year to September 2018.
Non-mining business investment is forecast to grow more slowly this year, by 5.7% instead of 11.4%, and mining investment is expected to keep sliding, losing a further 3.4% after losing 11.2% last year rather than climbing as the government’s budget update predicts.
Five of the team believe that mining investment to turn the corner in line with the budget forecast. Nine expect it to fall further.
The Australian share market will for practical purposes not grow not at all during 2019 according to the average forecast, which is for barely perceptible growth of 0.1%. A steady share market would come as a relief to super funds and share owners after last year’s slide of about 7%.
The range of forecasts for the ASX 200 is wide, from slides of more than 6% to gains of more than 6%.
Fortunately for a government the panel expects to need to continue to borrow more in order run continued budget deficits, what it pays for to borrow via the 10-year bond rate is expected to remain little changed at 2.6%. Only Warwick McKibbin expects a much higher bond rate, of 3.5%.
The panel’s average forecast is for an broadly unchanged Australian dollar, of around 70.5 US cents. The highest forecast is for US$0.80, the lowest for US$0.62.
The iron ore price, at present close to US$74 a tonne, is expected to fall to around US$64. Only one panelist, Warwick Mckibbin, expects it to stay near where it is, at US$75. The government itself is cautious, using a price of US$55 in its budget forecasts, a number it might lift in the April budget, allowing it to forecast more revenue.
A recession is conventionally defined as two consecutive quarters in which gross domestic product falls instead of rises. Australia hasn’t had two consecutive quarters of negative growth since 1991.
The most recent negative quarter was in September 2016. Before that there was one in March 2011, and before that in during the global financial crisis in December 2008.
Ross Guest of Griffith University makes the point that his estimate of 20% should be considered low. There will always be a risk of a recession. By itself two quarters of negative growth needn’t be a disaster. The impacts on the government and on consumer and business confidence would be more important than the downturn itself.
Guay Lim of the Melbourne Institute of Applied Economic and Social Research assigns the lowest probability of any of our panel to a recession, 5%, saying the most likely catalyst would be a global trade war.
Warren Hogan assigns the highest probability to a recession after Steve Keen, 40%, saying Australia is facing the end of a major construction boom and has heavily indebted households. It will be vulnerable to any negative shocks and especially vulnerable to higher inflation and interest rates.
Steve Keen says the only thing that has kept Australia afloat since the China boom has been the housing bubble, which the banking royal commission has been discovering was built on fragile, and in places fraudulent, foundations.
Nigel Stapledon says the biggest drag on the economy will be the collapse in the construction of residential investment units. Labor’s proposed increase in capital gains tax will make it worse, notwithstanding Labor’s decision to exempt new construction from its crackdown on negative gearing.
Rebecca Cassells says on the bright side Australia is set to become the world’s biggest exporter of liquefied natural gas, the biggest exporter of iron ore to India and the world’s biggest producer of lithium, needed for batteries.
And if there is a global economic downturn within the next few years, she says another positive is that Labor is likely to be in power, making the successful deployment of a stimulus package more likely than if the Coalition had been in office.
Yesterday morning, the mid-year budget update unveiled research funding cuts of A$328.5 million over the next four years. This budget raid on research was more than double the size expected by the university research community.
This new freeze on growth in research funding and PhD scholarships follows last year’s freeze on funding for student places.
The effect will be felt immediately by the nation’s researchers and their research projects in positions lost and projects slowed, limited or not started. But the damage done will be felt for much longer – in inventions, ideas and opportunities missed.
Why has it been done?
As yet, there has been no adequate public explanation from government, save for two paragraphs in Education Minister Dan Tehan’s media release yesterday:
The decision to pause indexation of research block grant programs for 12 months, along with adjusting growth for RSP (the Research Support Program), will allow the government to prioritise education spending, including on regional higher education.
And this further par:
We have invested over A$350 million since the 2018-19 Budget to support students in regional and remote Australia.
In truth, most of Australia’s regional universities will lose millions of dollars more under the 2017 funding freeze than will be redistributed to them via this latest research cut. And under this new research freeze, they, too, will lose scholarships for PhD students – our next generation of brilliant research talent.
Nationwide, the government will fund up to 500 fewer of these scholarships for PhD candidates next year due to the research funding freeze. That’s 500 fewer people who will dedicate their talent to the creation of new knowledge in the national interest.
The education minister has tried to repair the damage inflicted by the 2017 decision of his predecessor – Simon Birmingham – only to compound the damage with this second freeze. That’s throwing bad policy after bad.
Regional universities were among those hardest hit by the 2017 MYEFO decision to cut funding for student places. And that decision continues to cut deeper each year – it will be felt more in 2019 than 2018, and more in 2020 than 2019.
How this will affect Australian research
The harm this will inflict is manifold.
First, it will cut the research funding program. This scheme enables universities to pay the salaries of researchers and technicians whose work enables ground-breaking discoveries. It also funds keeping the lights on in labs and libraries.
These overheads of research are not funded by competitive grants. For every A$100,000 an Australian university secures in competitive research grants, it must find an extra A$85,000 to be able to deliver that research. Where will universities find these funds?
Second, it will cut the research training program. This funds scholarships for PhD students to enable them to complete their higher degrees – a necessary first step on the way to a career in research. This is a cut into their brilliant careers, and Australia’s future research capacity.
Third, it damages Australia’s standing as a global research leader. Why would a great researcher come to or stay in Australia, when the government has sent a message that, in a time of budget surplus, it’s prepared to cut into research?
Fourth, it will further undermine Australia’s position in research and development investment relative to our economic competitors. China now invests 2.1% of its GDP in research and development – while Australia’s total investment from all sectors in research and development (government, business and research institutions) is now just 1.88% of GDP. China’s economy is ten times bigger than Australia’s, but they’re investing 30 times more than we are.
Our government only spends A$10 billion on research and development each year. Only last Friday, it was revealed Australia’s government spending on research and development was already forecast to fall this year to its lowest level in four decades as a percentage of GDP – to 0.5%. This new research funding cut only worsens this situation.
With the budget in surplus, it makes no sense
University leaders knew research funding was at risk, and so jobs for researchers, technicians and researchers were at risk. But beyond these jobs are the projects they support and the Australians from all walks of life whose lives have or will be transformed by Australian research.
Universities Australia has stories of survivors of stroke, cervical cancer and family violence speaking about how crucial university research has been in the lives of people like them at #UniResearchChangesLives.
With a government budget surplus in sight, it makes no sense to cut the research capacity that will create jobs, income and new industries for Australia.
The government’s final budget outcome for 2017-18 is a deficit of A$10.1 billion. That’s an extraordinary A$8.1 lower than the May estimate just months ago, and more than A$19 billion lower than when the 2017-18 budget was originally put together the previous May.
The deficit, a mere 0.6% of gross domestic product, is the smallest in the run of ten that began in the global financial crisis of 2008-09.
The result tells us something important about the Australian economy ten years on from the crisis.
Not only is it growing faster than most forecasters expected, it has been producing more jobs and less inflation than such growth would have produced in the past.
This has allowed much low interest rates than would have once been the case and supported investment across the economy.
Back to normal
So good is the government’s financial position that the heavy lifting has been all but been done.
A return to budget balance is entirely possible this financial year.
Indeed, for most purposes the budget is already balanced.
Federal government revenues and expenses are each about 25% of GDP. Given the complexity and natural variability of the budget and the economy, an outcome within 0.5% of GDP from balance is basically in balance.
The fact that two-thirds of the originally projected 2017-18 budget deficit has vanished due to “forecast error” makes the point.
Fiscal policy is effectively back to normal, with plenty of spending power in reserve should the economy deteriorate.
Better confidence, for now
Solid government finances will support confidence, not least among households that are used to worrying about large deficits boosting future tax burdens or eating away at government services.
That isn’t to say that everything is baked in.
The economy and government finances can go the other way. But the task of budget repair, which started years ago under Treasurer Wayne Swan, is virtually complete. Any further substantive budget tightening will produce growing surpluses rather than shrinking deficits.
More profits, less welfare
Over the past 15 months the big improvement in the government’s financial position has come in two phases.
The first surprise was a revenue windfall received last summer. This was mostly because of higher commodity prices and the boost this gave to corporate profits.
Corporate income tax receipts are 8.7% higher than originally projected, resulting in an almost A$7 billion windfall for the budget. This represents about a third of the A$19 billion budget improvement.
This was well known by the time of the May budget and was responsible for most of the improvement in the budget bottom line between May 2017 and May 2018.
The next phase was a substantial drop in government payments near the end of the financial year just concluded.
This was not factored into the May 2018 budget. Most of it is made up of lower welfare and social security payments, partly in response to the stronger economy, and partly due to much lower than anticipated spending on disability assistance.
Disability-related payments, both in terms of payments to states and National
Disability Insurance Scheme spending, are about A$3 billion lower than expected in May last year.
And improvement all around
The rest of the good news is spread across the board. Income tax receipts are higher due to stronger employment growth. The government has collected more duties and excise than it expected. Pension payments have been a little lower than expected, as have infrastructure-related payments to the states.
Because the presentation of the final budget outcomes does not come with any formal update of budget forecasts, the treasurer and his finance minister had very little to say about the government’s fiscal strategy other than to reinforce that its jobs, growth and budget repair strategy is on track.
They’ll say more in the midyear economic and fiscal update (also called MYEFO) in December.
Ministers Frydenberg and Cormann were asked a number of questions at their Tuesday press conference that they chose not to answer properly.
I thought I would take the liberty of doing it for them.
REPORTER: So does this outcome increase the likelihood that you will return to surplus sooner than predicted?
MY ANSWER: It most certainly it does. The better result is mainly due to a stronger-than-expected economy. At the time of the budget in May 2017 the government had forecast economic growth of 2.75% for the 2017-18 financial year. As it turned out, growth came in at 2.9% and we are taking strong momentum into 2018-19.
It won’t take much to nudge the budget into surplus this year, that is, a year earlier than forecast. Simply factoring in the better baseline performance of the budget from last year should produce a deficit for 2018-19 of around A$5-8 billion. If the recent trends of higher commodity prices, a lower Australian dollar and stronger domestic economic activity persist, as they appear to be doing, then we will easily get a surplus this year.
Complicating the picture is the political cycle. With a government well behind in the polls and an election due in the next six months or so, it will be hard to resist the temptation to spend some of this recent budget improvement.
It will become a political judgment for the new prime minister and his cabinet. Is the political benefit of presenting a budget surplus greater than the electoral impact of new spending measures?
REPORTER: And do you continue to adhere to the budget discipline that all new spending must be accompanied by savings in equal amount?
MY ANSWER: The government should be commended for keeping real spending growth to just 1.9%, the lowest in a generation. It is projecting it to fall even further, to around 1.6% over the next few years. With a tough election contest ahead, my guess is that we may see some slippage on government spending.
REPORTER: You are out by 40% to 45% on the deficit you published in May this year. That’s a wild variation in just 6 weeks. Should Treasury be doing better than that, basically?
MY ANSWER: Revenues total just under A$450 billion and expenses total just over $450 billion. The deficit figure is the result of the calculation of the small difference between those two big numbers.
Rather than thinking about an A$8 billion miss on a A$18 billion deficit we should be thinking about A$8 billion on the $450 billion revenue and expense base.
Instead of a 40% variation, the real variation is less than 2%.
Given that the Treasury only had the March quarter national accounts at its disposal when pulling together the May Budget forecasts and considering the propensity of the Bureau of Statistics to revise the national accounts, the fact that the misses are less than 2% is actually pretty amazing.
The economy is complex and ever changing.
Economic forecasting is hard. Understanding the relationship between government revenues and an economy experiencing significant industrial structural change is far from a perfect science.
The budget outcome for 2017-18 shows a deficit of A$10.1 billion –
dramatically less than expected in May, and just 0.6% of GDP.
In this year’s May budget, a mere four months ago, the outcome for the last financial year was forecast to be just over A$18 billion, already revised well down on the more than A$29 billion estimate in the 2017 budget.
The drivers of the better-than-anticipated result were stronger
revenue and lower spending than earlier expected.
Treasurer Josh Frydenberg and Finance Minister Mathias Corman said in
a statement: “At A$10.1 billion, just 0.6 per cent of gross domestic
product (GDP), the underlying cash deficit is the smallest in ten
“Stronger economic growth and much stronger employment growth than
anticipated at the time of the 2017-18 budget have driven increases in
personal income tax and company tax receipts, with total receipts
$13.4 billion higher than expected at the time of the budget.
“Total payments were A$6.9 billion lower than forecast at budget time,
including as a result of lower welfare payments with more Australians
in paid work. Welfare dependency for working age Australians is now at
its lowest level in 25 years and in 2017-18, there were 90,000 fewer
working age Australians on welfare,” they said.
“Real GDP in 2017-18 was stronger than anticipated in the 2017-18 budget.”
Last week Standard & Poor’s ratings agency reaffirmed Australia’s
triple A credit
rating. Frydenberg said Australia was one of only 10 countries with a AAA
credit rating from the three major agencies.
He told a news conference that the budget outcome confirmed the budget
was on the path back to balance in 2019-20.
The mid-year budget update will come in December, with the revisions
at that time setting the scene for the run into the election a few
months later, with the government making economic and fiscal
management a key plank in its campaign.
Shadow treasurer Chris Bowen said the final budget outcome “shows the
deficit came in almost four times worse than forecast in the Liberal
Party’s first budget. This is after the Liberal Party’s massive cuts
to schools, hospitals and the pension.”
First, the good news. The Parliamentary Budget Office’s latest medium-term budget projections provide
independent reassurance that the government’s personal income tax cuts, announced in the May budget and passed through parliament in June, can be funded without pushing the budget back into deficit.
But they also sound warnings about the downside risks from weaker-than-assumed economic or wages growth, and from any relaxation of the spending restraint
that successive governments have maintained since 2012.
More income tax
The PBO projects the federal government’s “underlying” cash balance to improve from 0.8% of GDP in 2021-22, the last year of the latest budget’s forward estimates period, to 1.3% of GDP in 2028-29.
That’s after allowing for the revenue forgone by the tax cuts. Without these, and in the absence of any other spending or revenue measures, the surplus would have reached 3.7% of GDP (my calculation, not the PBO’s), largely on the back of the “bracket creep” that would have occurred without some form of personal income tax cuts between now and then.
Even so, there’s an awful lot of bracket creep.
The average tax rate across all taxpayers is projected to increase from 22.9% to 25.2% – that is, by 2.3 percentage points. For taxpayers in the second and middle quintiles (the middle fifth and the second-to-bottom fifth) it’s even worse. They will see their average rates rise by more than 4 percentage points. The average tax rate for those in the top and bottom quintiles will climb by less than 1 percentage point.
The PBO’s projections allow for only slight additional relief; small reductions in 2027-28 and 2028-29, worth about 0.4% of GDP, to ensure tax receipts remain within the government’s “cap” of 23.9% of GDP in the final two years of the 10-year projection period.
A helpful backdown on company tax
The PBO’s forecasts don’t allow for the government’s recent decision to abandon
the previously proposed cut in the corporate tax rate for companies with annual turnover exceeding $50 million, which it had been unable to pass through the Senate. That would add the equivalent of almost 0.5 of a percentage point of GDP to the surplus by 2028-29, unless offset by other measures (which it probably will be).
By law, the PBO is required to use the same economic assumptions in framing its medium-term projections as those used in the most recent federal budget.
Wishful economic thinking
These requirements mean the projections are conditioned on, among other things, “above-trend economic growth for much of the period” and “a return to close to trend wages growth” by 2021-22.
This week’s national accounts data lend some near-term support to the first of these assumptions, but they (and other data) cast further doubt on the likelihood of wages growth returning to trend in line with the budget assumptions.
The PBO notes that, as a direct result of the government’s personal income tax plan, any weakness in future tax receipts flowing from “weaker economic circumstances” will “flow through directly to the budget bottom line”.
A decade of tight spending
The report highlights the importance of policy decisions in stemming the flow of new spending decisions and tightening eligibility for benefit payments since 2012.
Much of the impact of these will show up more clearly over the next decade. Apart from three areas – the National Disability Insurance Scheme (NDIS), aged care and defence, on which spending is projected to rise by a little over 1 percentage point of GDP over the next decade – other government spending is projected to
fall by around 2 percentage points of GDP between 2017-18 and 2028-29.
The PBO notes that “the spending restraint seen over the past few years … may be
increasingly difficult to maintain with an improving budget outlook”.
(Unintentionally) highlighting that risk, the PBO explicitly notes that the proposed further increase in the pension eligibility age to 70 between 2023 and 2035 – which the government abandoned this week – was “projected to have a significant impact on Age Pension spending … over the next decade”.