The risk is real, but it’s not a recession we have to have

The recession, if or when it comes, will have its epicentre in one of two places: Melbourne or Sydney. The rival capital will get pulled into the downturn, but the landing might not be as hard.

Let’s call it the federation rule of economic crisis because it reflects a clear pattern that dates back to the 1890s when the Melbourne land bust triggered our longest depression. Victoria was responsible for half the 330,000 jobs lost across the nation during the recession of the early 1990s, while NSW bore the brunt of the recessions of the early 1980s and mid-1970s.

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The nightmare scenario facing Anthony Albanese’s government is that the Reserve Bank’s shock therapy of higher interest rates to fight inflation will eventually break the housing sectors of our two largest capitals, and their respective states, and condemn them to a synchronised crash.

The risk is accentuated by the long shadow of COVID. Our federal and state leaders, and treasurers, don’t want to mention the pandemic anymore. But it has created a perverse situation for our big two economies as they play catch-up with the resource-rich states of Western Australia and Queensland.

The Victorian and NSW budgets are deep in deficit as a result of the lockdowns of 2020 and 2021. They are caught in the pincer of unavoidable spending – to bolster their stressed health systems and fund major infrastructure projects – and the slow crawl back to surplus.

The vulnerability of the big two was underlined by the state budgets released in Queensland and South Australia this week. While Victoria and NSW will be stuck in deficit until 2024-25, Queensland has just returned a record surplus of $12.3 billion for the current financial year – almost treble the size of the federal surplus of $4.2 billion – while South Australia is forecasting a surplus for 2023-4. Queensland and South Australia can count themselves alongside Western Australia as the resilient states which have best managed the past 3½ years of fire, flood, plague and inflation.

The nightmare scenario facing Anthony Albanese’s government is that the Reserve Bank’s shock therapy of higher interest rates to fight inflation will eventually break the housing sectors of our two largest capitals.

WA is the undoubted star of the trio. It entered the pandemic with a surplus budget and has continued in the black ever since. WA enjoys the greatest buffer heading into any recession, while Victoria is the most exposed.

The fiscal gap between WA – the state that lived virtually lockdown-free behind its hard border – and Victoria – the pandemic’s greatest victim – can be seen in their relative debt burdens. Victoria’s net debt as a share of gross state product stands at 20.6 per cent – more than three times the WA figure of 6.3 per cent. It is forecast to reach 24.5 per cent four years from now, in 2026-27, compared with 9.7 per cent in WA.

This reflects the other side of the federation rule of economic crisis, which began with the West Australian gold rush of the 1890s: one or both frontier states will act as a safe haven in a national recession as internal migration props up their local economies. Queensland actually added a handful of jobs during the 1990s recession, and had a soft landing in the early 1980s, while Western Australia held its jobs losses to about 1 per cent of its workforce in both episodes.

The latest jobs data, released on Thursday, confirm that Victoria and NSW are leading the open-borders phase of the recovery – the very phase that the RBA has targeted with 12 interest rate rises since last May. The big two accounted for 63 per cent, or 294,000, of the 466,000 jobs created across the economy over the past 12 months.

It should come as no surprise that the reopening of the international border would tilt the economy’s playing field back in favour of Australia’s cosmopolitan south-east. NSW and Victoria received 66 per cent, or 255,000, of the 387,000 migrants who settled in Australia in net terms over the course of 2022.

But NSW and Victoria remain behind their respective neighbours to the north and west. Consider the division of the employment boom. NSW and Victoria entered the pandemic with 57.7 per cent of the nation’s workforce between them. But they have claimed just 47.9 per cent of the one million new jobs added since January 2020. The NSW workforce is a third larger than Queensland, yet Queensland created more jobs than NSW in absolute terms over this period (289,000 versus 261,000). A similar story has played out between the AFL states. Victoria’s workforce is a third larger than the combined totals for Western Australia and South Australia. Yet WA and SA have also created more jobs between them (231,000 against Victoria’s 227,000).

The prime minister will be keenly aware of the political implications of the realignment in the economy. As the ABC’s poll guru Antony Green wrote on Friday, the latest population figures mean that WA will gain an extra seat at the next federal election, while Victoria and NSW will lose one each.

The redistribution of boundaries will reduce the total number of seats in the federal parliament by one to 150. NSW will hold 46 seats; Victoria, 38; Queensland, 30; WA, 16; SA, 10; Tasmania, five; the ACT, three; and the Northern Territory, two. For the first time, the frontier states of Queensland and WA will have as many seats between them as NSW.

Labor presently holds 78 of the 151 seats in parliament following its victory in the Aston byelection. The loss of a seat in metropolitan Melbourne will effectively cancel that gain.

As COVID reminded us, Australians can revert to their colonial identities at a time of crisis. It is also the reason why Labor has a governing majority; WA’s resentment of Scott Morrison’s Sydney-centric government delivered nine of Perth’s 11 seats to Labor, and another to a teal independent.

Those lockdown tensions between states, and within them between the capitals and regions, may return if there is a recession. But there is another memory which might protect us all against the nightmare scenario of a joint Melbourne-Sydney crash. Every business in Australia has been confronted with labour shortages at some point over the past three years. If the RBA overshoots with interest rates and delivers a recession we did not have to have, the question for business is whether to risk letting go of staff that a competitor might pick up in a recovery.

We have been here before. One of the key reasons why Australia avoided a hard landing during the global financial crisis in 2008-09 was the memory of labour shortages during the first phase of the mining boom between 2004 and 2007. Inflation was rising at the time, and the RBA was still increasing interest rates in early 2008 before the GFC forced it to abruptly change course.

The stimulus of lower interest rates and the Rudd government’s cash splashes certainly saved the economy then. But employers deserved credit for hanging on to their staff by reducing hours, instead of showing them the door. Let’s hope this lesson is recalled because the RBA has signalled that it expects to keep raising interest rates until inflation is killed.

George Megalogenis is a journalist, political commentator and author.