Election 2022: The nation’s 30-year economic party is over

RBA governor Philip Lowe speaks on May 3, the day the central bank turned down the music by raising interest rates. Picture: Getty Images

Many an economic shift has been caused by unexpected events; a black swan such as a war, pandemic or terrorist attack. Other shifts are seen coming a mile away, like a pink flamingo, and are the result of poor choices topped with a layering of denial.

Australia and much of the world are soon to enter a period of sustained inflation and slowing economic growth. It will not have been caused by the Russia-Ukraine war or the pandemic, which have been mere bumps on a long road of irresponsible economic policies by many governments.

In response to the economic drag caused by productivity slowing, mostly the result of anti-productivity government policies, expansionary fiscal and monetary policies were employed to mask the problem. And now it’s time to pay the piper.

In the first quarter of 2022, the US economy recorded an annualised inflation rate of 8.5 per cent and negative growth of 1.4 per cent. One more quarter of negative growth will not only be a technical recession but will be technical stagflation. China is suffering from an ageing population and lockdowns, and its annualised rate of inflation was 8.3 per cent. Europe is feeling the weight of the Ukraine war through increased energy prices, military spending and migration. Its annualised rate of inflation was 7.4 per cent.

To imagine Australia will be spared this inflation is denial. Last month Australia recorded a relatively low 5.1 per cent rate of inflation, itself a 20-year high. But despite the waves of inflation lapping on our shores, the government and opposition continue to hit the inflation pedal in an election where they are trying to outbid each other’s irresponsibility.

How did we get here? We were here all along. Increasingly, especially at elections, Australians voice concerns about the cost of living. Cost-of-living pressure is a political euphemism for inflation. Yet until recently the Reserve Bank was churning the monetary policy machine to stimulate inflation because it believed (wage price) inflation was too low. It is not possible for there to be at once no inflation and cost-of-living pressures. What has happened is that the true level of inflation has been deliberately masked.

Business masks inflation so consumers think prices are not increasing. This is done via things such as “shrinkflation”, where fewer goods and services are provided for the same price. Have a look in your pantry and you will see the number or size of biscuits in the packet have been reduced. Or perhaps the weight of butter in the tub or the volume of juice in the bottle have all lessened all while the sticker price remained the same.

Government masks inflation through statistical manipulations such as the Orwellian-sounding hedonic adjustments. For example, it will look at the price of a computer today and last year, and even if the price has increased it will assess no inflation because it determines that quality has improved. This despite the obvious that a more expensive computer needs to be purchased, reducing a consumer’s purchasing power.

Price is where supply meets demand. But in response to rising prices, governments continue to stimulate demand assum­ing, perhaps praying, supply will keep up. This is analogous to treating cancer with pain killers; it may mask symptoms but does not treat the disease.

Monetary policy has been the go-to inflation management tool of government. It moderates the demand side by increasing interest rates, thus reducing liquidity in the economy. The objective is a slowing economy. But if inflation becomes endemic, larger rate increases will be needed, possibly large enough to push Australia into recession, as in the 1990s. How deep a recession will depend on how bad inflation is, but also on what other responses the government employs. The level of pain the RBA imposes on the economy will be linked to whether and when the government seeks to implement supply-side reforms.

Lost in the history of the inflation wars of the ’80s (the US and Britain) and ’90s (Australia) were the extensive productivity-enhancing reforms: tax reform, deregulation, wind back of industry policy and reductions in government spending. The Hawke-Keating and Howard-Costello governments reduced government spending as a proportion of gross domestic product to 22-23 per cent, whereas it has been consistently over 25 per cent for the past 10 years.

These reforms promoted economic growth, increased supply and lessened inflationary pressures. Notably, the Hawke-Keating economic reforms received bipartisan support yet it has been the economic deforms of the past 20 years that have received bipartisan support.

American economist Thomas Sowell observed “the first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.” This election certainly is validating Sowell. Despite last month’s high official inflation figures, the Liberals and Labor continue to make irresponsible com­mitments in the guise of relieving cost of living. But stimulatory fiscal policy easily will be overwhelmed by inflationary effects.

Governing is hard. Tough decisions and trade-offs must constantly be made. But in cutting rates and increasing spending in response to a slowing economy, governments were absolved from making tough and necessary decisions about spending, taxing and economic reform. Without economic reforms, additional government spending and centralised wage increases will do nothing more than further slow the economy and make inflation worse.

Stein’s Law, coined for US economist and former chairman of presidents Nixon’s and Ford’s Council of Economic Advisers, states that if something can’t go on forever it will stop. Australia’s 30-year economic party is about to stop, and the first sign was the RBA turning down the music by raising interest rates. Whoever forms government on May 22 will have a difficult task. But if they want to maintain or increase real wages, the only pathway is through economic reform.

Dimitri Burshtein is a Sydney-based former government policy analyst.