Small gains on a long road to economic recovery

In more ordinary times a budget deficit of $197.7bn, equivalent to 9 per cent of gross domestic product, would give little cause for celebration. In the wake of the coronavirus pandemic, however, the otherwise eye-watering number represents an improvement on the more pessimistic expectations of only weeks ago. Together with new data showing unemployment is expected to peak at 7.5 per cent in the March quarter next year, down from an expected peak of 8 per cent, the mid-year financial update delivered on Thursday by Josh Frydenberg shows that things slowly are getting back on track.

Australia’s real GDP grew by 3.3 per cent in the September quarter after a fall of 7 per cent in the June quarter this year. On a calendar-year basis, real GDP is forecast to grow by 4.5 per cent next year following a fall of 2.5 per cent this year. Rising housing prices and improvements in consumer and business confidence give some promise that the economic recovery will continue to strengthen in the new year.

Announcing the revised budget figures, the Treasurer said Australia was outperforming all advanced economies. Internationally, there has been a loss of momentum because of a resurgence in COVID-19 infections. After falling by 4 per cent this year, global GDP is forecast to increase by 4.75 per cent next year. Australia’s relatively better financial performance is due to its success in suppressing the virus, which is still out of control in many parts of Europe and the US. Australia’s major trading partners are forecast to grow by 5.35 per cent next year following a fall of 2.5 per cent this year.

Mr Frydenberg was quick to caution that the road ahead was challenging. “We have not defeated the virus,” he said. “It still is with us.” To emphasis the point, health authorities in NSW have been on high alert to contact trace and contain a COVID-19 outbreak in Sydney’s northern beaches. The source of the infection is believed to have been a musician who had performed across a wide area. As of Thursday the number of confirmed infections was 17 and authorities had advised residents from the Spit to Palm Beach to stay inside if possible.

Talk of renewed border closures by trigger-happy state governments is one of the significant impediments to rebuilding economic momentum. With state borders now open, the labour market continues to strengthen alongside the recovery in economic activity. About 85 per cent of the 1.3 million people who lost their job or were stood down on zero hours in April are back at work. The unemployment rate is now forecast to fall to 6.25 per cent in the June quarter of 2022, mirroring the view of the Reserve Bank of Australia that getting employment levels back to those before the pandemic will take several years. It took six years for the unemployment rate to recover to its pre-recession level in the 1980s and 10 years to do so in the 90s. This time, Treasury thinks the lost ground will be made up in four years. Nonetheless, this should ensure that interest rates stay low for an extended period regardless of what happens to housing prices.

A faster-than-expected return to work mainly has been responsible for a $15.9bn improvement in the government’s underlying cash balance, bringing the deficit below $200bn. The $15.9bn saving is welcome but, as Tom Dusevic writes, it is merely a rounding error when you realise Canberra’s spending is going to be $2.4 trillion across four years, or 100 times the clawback. Deficits represent additional borrowings. At some point a reckoning will have to be made with the huge level of debt being accumulated. With interest rates low it is a good time for government to borrow if the money is spent wisely. The downgrade of AAA credit ratings for NSW and Victoria is a reminder that economic norms have not been abandoned completely.

With this in mind it is important that the government remains focused on moving past the pandemic and back to a more normal budgetary position. This will require structural reforms including in the hard-fought areas of industrial relations and tax. It also will require some good fortune in the successful rollout of a COVID-19 vaccine to allow the resumption of global travel, and a clearer picture on how future trade relations will be managed with China. The government has done a good job so far in managing the pandemic and it is correct to maintain support until the global outlook is more clear. When the pandemic has passed, the budget repair work must start in earnest.