Productivity the destination, not rate cuts

A recent Gallup Analytics survey found OECD households were more dissatisfied with housing availability than any of the 10 other civil society issues canvassed.

The past year or two have been difficult for parts of the Australian economy. The first interest rate cut, expected in February, will help in some ways. But the level of interest rates is a symptom of – not a solution to – the problem. All roads lead to productivity.

Lower interest rates will help those with debt, and all consumers will benefit from prices rising more slowly, which allows interest rates to decline. But the 18 per cent increase in the price levels over four years won’t just evaporate.

The chair of the US Council of Economic Advisors, when discussing the lessons of the inflation surge, suggested “price levels matter a great deal”. Real (after adjusting for inflation) gross disposable income per capita in Australia is 10 per cent below its 2021 peak.

Since 2014, public demand in Australia has risen at twice the rate of GDP and three times the rate of private demand. This accords with a global shift. Concluding an analysis of 65 countries over six decades the IMF recently suggested “parties across the political spectrum … all campaign on ideas of a bigger government and promising more spending”.

This fiscal shift also reflects the emergence of four powerful and resource-intensive secular trends: decarbonisation, deglobalisation, defence and dwelling deficiency. These four “Ds” are intersecting within and across economies.

Electricity-related projects, for instance, account for about half of the $60bn increase in the ANZ major project pipeline between 2020 and 2026. Picture: Getty Images

Decarbonisation’s economic footprint is increasingly visible. Electricity-related projects, for instance, account for about half of the $60bn increase in the ANZ major project pipeline between 2020 and 2026. In the US, motor vehicle insurance is adding three-quarters of a percentage point to core CPI. This reflects, in part, climate policy and the rise of electric vehicles.

The Paris climate commitments imply national decarbonisation ambitions strengthen over time, yet half of countries failed to meet their 2020 commitments. The United Nations suggest current commitments are insufficient to keep global warning below 1.5 per cent.

The number of industrial policy interventions globally rose eight-fold between 2017 and 2022. The CHIPS and Inflation Reduction acts have contributed to a tripling of US manufacturing construction in three years. Australia this year announced the Future Made in Australia policy.

Recent literature reassesses the historical role of industry policy and suggests the sectoral and productivity benefits were often larger than assessed at the time. But when practised at scale, with the intent of reducing supply chain vulnerabilities, industry policy is de-globalist. IMF research suggests returning global integration to 2000 levels would cost around 4.5 per cent of global GDP under “reshoring” and 1.8 per cent under “‘friendshoring”.

Global defence expenditure rose 6.8 per cent in real terms last year, the largest increase since 2009. Global defence companies are already recruiting at the fastest rate in more than three decades. The European Union’s first Defence Commissioner recently called for minimum defence equipment stockpiles across member countries. Australia’s most recent federal budget foreshadowed a doubling in annual defence expenditure by 2033-34.

The final D is dwelling deficiency. Dwellings, as a competitor for resources in the economy, is coming off second best. The Demographia International Housing Affordability Report assesses 94 sub-national markets across eight nations, including Australia. The report found 84 per cent of markets are rated as seriously, severely or impossibly unaffordable. A recent Gallup Analytics survey found OECD households were more dissatisfied with housing availability than any of the 10 other civil society issues canvassed. There is nothing simple about simply adding supply with so many competing demands for resources.

Since 2014, public demand in Australia has risen at twice the rate of GDP and three times the rate of private demand. Picture: AAP

As the demands on resources have risen, demographics and democracy are also complicating supply.

BIS research suggests inflationary pressure rises when the share of dependants in the population increases. Across 22 advanced economies, including Australia, the working age
(20-64) share of the population is undergoing only its second reversal in the last 150 years. The first reversal accorded with the inflation challenges of the 1970s. The four Ds lean heavily on prime-age workers.

Delivering consistent policies is constrained by a growing tendency for governments to change more often. BCA analysis of election results since 2022 suggests the “dominant electoral issue in democracies today is incumbency rather than left/right ideological divide”. It is harder to keep government, it seems, than to win it.

While lower interest rates will be welcome, they will likely worsen the prioritisation challenge because they will strengthen demand. The only modest rise in unemployment and strong aggregate private sector balance sheets suggest the three rate cuts we expect are likely to gain traction quickly.

Even before rate cuts, prioritisation is already occurring. Renewable projects are being delayed by a shortage of skilled workers. The NSW Productivity Commission suggested higher infrastructure spending is slowing housing construction.

There are historical parallels. The US’s late-1930s production build-up required the government’s Priorities Board to divide “America’s raw materials into strategic, critical and essential categories” to try and prevent “starving the rest of the economy”.

But the current poor level of productivity is sharpening resourcing constraints. The more economies raise productivity, the less prioritisation will be required.

The road to future prosperity is paved with better productivity, not rate cuts.

Richard Yetsenga is the chief economist at ANZ