Focus on demand ignores it’s the supply side, stupid

Financial markets have spoken, if not screamed. More cuts to official interest rates — now a record low 0.75 per cent — have been locked in by investors. So say overnight index swap rates, forward scouts of cash-rate movements. The markets now are expecting an extreme monetary response, given the central bank has said “unconventional” policy or quantitative easing will kick in when the cash rate hits 0.25 per cent.

The Reserve Bank of Australia board, however, should ignore speculators when it meets on Tuesday. What’s the point of trying to juice up demand this way when monetary policy has run its race? All the RBA would do is pump up asset prices, especially housing in our largest cities. Not an ideal result. Another rate cut would send a message to consumers that things were really crook. It would be an act of self-harm.

The coronavirus outbreak has spooked investors well before it has taken a chunk out of the real economy. Tourism and education services are in the frontline, suffering an income hit. On Wednesday, national accounts are likely to show retail has been weak for a year. Agriculture has been affected by the drought, bushfires and floods. The impact of natural disasters on export sales and employment won’t show up in official figures until later in the year. Yet anecdotal evidence is mounting that the COVID-19 epidemic is disrupting supply chains across a broad front of industries, most of which are dependent on Chinese inputs. The world’s factory is in shutdown mode, with China’s manufacturing purchasing managers’ index plummeting to a record low last month. Our building and construction industry — large and small firms — will soon experience a sharp contraction in materials supply.

As external shocks go, the evolving crisis is about supply disruption. Unlike the global financial crisis, the issue is not liquidity. Plus there’s nothing the RBA can do to calm global fears. Again, the board should hold fire, just in case the economy tanks and confidence takes another dive in coming months.

Scott Morrison’s language has evolved on the evaporating surplus and need for stimulus. The Prime Minister does not favour the post-GFC cash splashes used by Labor. But there is room for a swift fiscal response for the most affected industries, with Treasury developing plans for assistance that is “targeted, modest and scalable”. That means more support for businesses and workers in the tourism sector, which received a recovery package in January following the Black Summer bushfires. For now, the government is resisting additional funds to universities.

As we have argued in this space, a budget in balance gives Canberra a decent starting position to respond. It’s just a pity that the fiscal consolidation under the Coalition — after Labor’s policy excesses and failures across two terms — has been so timid and tardy. The greater lament is that the political class as a whole has been sitting on its hands, living off the fat of the reform era of the 1980s and 90s. Of course, our capital’s elected cohort is sick of hearing about the golden days of reform by Bob Hawke, Paul Keating, John Howard and Peter Costello. The truth is we’ve become used to rising living standards via the surge in national income from the rise of China, rather than lifting our economic game. The current crisis exposes this drift.

Nothing reveals this more starkly than a poor productivity performance. It’s what keeps even serial optimist Philip Lowe awake, although the letters QE soon may figure in the RBA governor’s nocturnal deliberations. We have lost ground in the productivity stakes through a lack of investment, skills, risk-taking and fresh ideas. Our supply side, more than demand side, needs urgent attention. That means less red tape to get projects going, more flexibility at workplaces and incentives for research, among a host of things Productivity Commission officials have listed in a reform road map. The mantra should be “doing things better” with our precious capital and labour, not flogging old tools and ill-equipped workers in the same old ways.

Perhaps this will be the crisis that serves as the wake-up call to both sides of politics to develop game plans that look beyond one term in office or the next election. If we had more dynamic businesses, a diversified customer base for exports, a more competitive tax regime and skilled workers able to chase opportunities wherever they may emerge, we’d be hitting this challenge with revenue in the bank, fuel in the tank and policy options up our sleeve.