Recent events in the Middle East, including the US intervention last weekend, will have implications for the Australian economy. Bear in mind, economic conditions here are already weak. While the direction of the impact is clear, we can’t be sure of the magnitude.
According to the most recent national accounts, the Australian economy grew by only 1.3 per cent in the year to the March quarter; it was a mere 0.2 per cent in the quarter. Were it not for the growth of working hours, output would have gone backwards.
GDP per capita – a reasonable proxy of living standards – fell by 0.4 per cent in the March quarter, making this the eighth fall in the past nine quarters. GDP per capita is a reasonable proxy of living standards.
It is against this backdrop that events in the Middle East are playing out. Unsurprisingly, Jim Chalmers, in his speech last week to the National Press Club, recognised the potential importance of global turbulence and uncertainty to our economy. “The international environment and the global economy will be the main influences which shape and constrain our choices this term,” he said. “This month the World Bank warned global growth is on track to be close to its weakest in nearly two decades.”
Notwithstanding this note of caution, the Treasurer bragged about the Labor government’s economic record. “In our first term we stabilised and strengthened our economy, got inflation down, got real wages up, kept unemployment low and improved the budget position. In important ways we outperformed our peers.”
The trouble with this analysis is, in the most important way, we didn’t outperform our peers. Among OECD countries, Australia recorded the largest fall in real per capita household disposable income between 2019 and 2024.
This record is something Chalmers doesn’t talk about.
Incidentally, inflation has been brought under control in most advanced countries and more quickly than us; unemployment remains low in many countries; and our budget position is rapidly deteriorating, having enjoyed the windfalls of high commodity prices and revenue surge from bracket creep. Unemployment here also is being kept low because of the tsunami of government-funded jobs in the so-called care economy.
Getting back to the economic impact of global conditions, there are several angles to consider. The direct effects on the Australian economy are not large because we are not major trading partners with Middle Eastern countries directly affected. Indirectly, the issue to consider is the impact on the Chinese economy; China is our largest trading partner by a country mile.
The Chinese economy has already been slowing because of the wall of tariffs imposed by the Trump administration. The effect has been less substantial than may have been expected, but the impact is still apparent. Redirecting trade to other countries has helped to dampen the effect.
China does have economic links with several Middle East countries, with shipments of oil from Iran reported in violation of the sanctions imposed by Western countries. Because China is dependent on other countries for oil and gas, any disruption to the flow of these commodities would have implications for the strength of the Chinese economy.
The bigger issue here is the price of oil and how this affects the world economy. The oil shocks of the 1970s caused havoc and initiated a long inflationary cycle that caused direct economic damage as well as the requirement for punishing policies. These days, the world economy is much less oil-dependent. As Ambrose Evans-Pritchard has noted in Britain’s Daily Telegraph, “The ‘oil intensity’ of global GDP has fallen by 60 per cent since the energy crisis of the 1970s.” The dominance of the oil cartel, OPEC, also has weakened, in part because of the close to self-reliance of the US.
Until recently global oil prices had been relatively subdued, hovering at less than $US60 a barrel. In the past few weeks prices have fluctuated higher, with the recent price above $US80 a barrel. There is talk of prices rising above $US100, but the Middle East accounts for less than 20 per cent of global oil and gas supplies. There may be, however, a substantial impact on global equity markets.
At this stage Iran’s oil export facilities are intact, although the closure of the Strait of Hormuz by the Iranian government would have an impact on the global oil market.
We are likely to see an uptick in the price of petrol at our bowsers, and this will feed through to the Consumer Price Index. Apart from squeezing household budgets, the way the Reserve Bank interprets any impact on the CPI will have an important bearing on decisions it will make in coming months about lowering the cash rate.
It still looks reasonably certain that the bank will lower interest rates at least twice this year, in part because of soft economic conditions. (The Fed in the US is likely to do the same.) Having said this, the bank will be watching updated inflation figures.
A broader point relates to incentives for business investment in the context of heightened global uncertainty. The weakest link in the Australian economy has been sluggish business investment, with rates of spending at decades low. Recent events will not assist decision-makers considering large investments, particularly those that ultimately service global markets.
It’s a case of hang on to your hat when it comes to the Australian economy. There are always headwinds and tailwinds, but the balance now is clearly on the net negative side. It will be important to watch what happens in the Chinese economy, given the importance of that country as our major trading partner.
Inflation may tick up slightly, but soft economic conditions are likely to persuade the RBA to cut the cash rate in coming months, possibly several times. It’s close to impossible to see any improvement to productivity in the near term as business investment remains in the doldrums. Our Treasurer is best advised to change his tune from triumphal achiever to cautious manager of a difficult economic situation.
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