Investment is the missing piece in economic puzzle

The equities rally continues apace, with the local market hitting a record high at the close of trading on Monday. Someone should tell the Australian bourse to pull its head in: the market price to earnings ratio is at more than 18 times. Despite the less than bullish outlook for company profits and GDP growth, that won’t happen in a hurry. Frothy markets are being led by the US Federal Reserve’s easy money regime. At home, the Reserve Bank’s ultra-low interest rates — the official cash rate has been cut three times since June to be at 0.75 per cent — have not sparked a recovery in consumer spending or business investment. But Martin Place’s monetary easing has seen highly indebted households repair their balance sheets, as well as an escalation in asset prices, including for shares and homes in Sydney and Melbourne.

Another central bank rate cut is expected, possibly as early as next month, given the sluggishness of the economy, made worse by the drought and bushfire disaster. Wise heads, such as former RBA board member and economics professor Warwick McKibbin, have called for the central bank to hold fire on further reductions, warning lower rates would deepen fears about the prospects for growth. A reminder about the broader economy’s softness comes from the International Monetary Fund. As we report on Tuesday, the IMF has revised down its forecasts slightly for global output for this year and next, due in part to weakness in India, which is plagued by social unrest. Although the US-China trade dispute is being dismantled and the cloud over Brexit is lifting, there is uncertainty around exports and commodity prices.

Australia is meandering in the slow lane. The economy is expanding but growth is neither broadbased nor strong enough in those areas that will underpin our future prosperity. GDP growth is being driven by exports and Canberra’s social spending while being held back by weak consumer spending, the drought and slumps in housing construction and business investment. The Mid-Year Economic and Fiscal Outlook, issued in the week before Christmas, revealed a huge writedown in projected budget surpluses off the back of weaker expectations for output, wages and export prices. Treasury has pared back its GDP forecast to 2.25 per cent this financial year, rising to 2.75 per cent in 2020-21. A collapse in business and consumer confidence will see the nation treading water, according to Deloitte Access Economics.

We need policies to break a mood of gloom and “can’t do”. Josh Frydenberg argues the sombre outlook confirms the importance of prudent management. If needed, the Treasurer says, “Australia can use fiscal firepower in a way few other nations can.” On Monday, Mr Frydenberg said it was too early to tell the effect of bushfires on the budget. In truth, the budget is in balance and claiming to be “back in black”, a goal we wholeheartedly endorse, is more a political branding exercise than a precise economic setting when the ensuing fiscal quantum is so meagre.

A possible circuit-breaker is a tax incentive for investment, which is being pushed by Australian Industry Group chief executive Innes Willox. Writing for us on Tuesday, Mr Willox calls for a “generous investment allowance” to bring forward and increase business investment. “The government should act immediately to get private sector investment moving to stimulate the broader economy, reignite jobs growth and lift flatlining productivity,” he argues. The way Mr Willox sees it, the measure would allow businesses to deduct for tax purposes a larger proportion of their spending on capital equipment in the year of purchase rather than wait until later years to claw back the expenditure. He believes the government should not wait for the budget in May but should announce and implement the measure as soon as possible. Labor supports the move.

The proposal is in the same policy territory as one advocated by the Business Council of Australia. In its pre-budget submission, the lobby for big business called for a new permanent broadbased investment allowance, set as a bonus deduction of 10 per cent in an asset’s first year. In simple terms, the effect is to increase the after-tax return on an investment so projects that may not be viable now will get the go-ahead. We support this in principle but fear revenue will be lost on projects that would have gone ahead anyway. These ideas, variations on previous policies, are likely to find their way into Mr Frydenberg’s second budget in some form. They will improve the economy’s supply side, leading to innovation in products and productivity growth over time, as the capital base is enhanced.

Yet, like the business groups, we see such tax breaks as ad hoc, second-best policy measures. A better, enduring reform would be to lower the company tax rate for all enterprises. The BCA framed its investment allowance as an interim measure, before an across-the-board company tax rate of 25 per cent could be achieved. As Mr Willox has argued, the company tax rate needs to be simplified because it is “out of whack with our competitors”. Such a potent move is politically out of the question for a government with a wafer-thin majority, facing a fractious Senate crossbench and a Labor opposition that under its previous leader waged a war on the “top end of town”, capitalism in general, and refunds for excess franking credits in particular.

The Coalition government over the past two budgets has cut taxes by more than $300bn but has ruled out revisiting tax cuts for big businesses. It is now relying on a modest productivity agenda, based on new infrastructure, better skills and tax breaks for smaller businesses. The government is moving quickly to help repair communities shattered by bushfires, with more than $500m in emergency funding already announced. But the economy needs game-changing moves. To restore confidence, the government must craft a fresh message on the economy and a few bold policy reforms to kickstart investment.