Priority one call from Treasury secretary Steven Kennedy to save good times

In a candid post-budget speech, the Treasury secretary urges the Albanese government to pursue a wide-ranging reform agenda to lift the economy’s speed limit.

Steven Kennedy has warned Jim Chalmers that stagnant productivity will make it more difficult to grow the economy without stoking inflation.

Australia’s abysmal productivity performance will wipe out more than half the expected economic bounty from full employment, record migration and the commodity price boom, Treasury secretary Steven Kennedy has warned, as he said faster budget repair would be required if borrowing costs rose more than anticipated.

In a frank post-budget speech on Thursday, Dr Kennedy laid out the nation’s economic to-do list, including rebuilding fiscal buffers before the next crisis, improving the quality of taxing and spending, encouraging business investment, better competition policy to support dynamism, and stricter limits on social programs, particularly the National Disability Insurance Scheme.

“While employment and participation are moving in the right direction, productivity is not,” Dr Kennedy told a gathering of business economists in Melbourne.

“Halting and reversing this decline in productivity growth is a long-term structural challenge that has implications for the fiscal position and living standards more broadly. “Tackling this challenge will require continued investment in the productive capacity of the economy.”

The candid appraisal from the federal government’s top economic adviser comes after unanimous and robust criticism last week from business groups that Jim Chalmers shirked a bold productivity reform agenda in his second budget.

In March, the Treasurer dismissed the Productivity Commission’s proposals for workplace flexibility and market-based climate policy in its mammoth five-yearly performance review.

This week Dr Chalmers said the commission was a key institution and would be revamped to provide a better evidence base to shape structural policies.

As well, the Treasury chief pushed back against claims by economists the budget would add to inflationary pressures and require a harsher interest-rate response from the Reserve Bank, which has raised its cash rate target from 0.1 per cent to 3.85 per cent over the past 12 months.

Dr Kennedy argued that this financial year and next would see “relative tightening” in the budget position, and welcomed ongoing debate on fiscal policy “to be primarily about the quality of spending and taxing decisions and the sustainability of these decisions – especially given the ongoing challenges we face in these areas”.

Dr Kennedy noted smaller deficits in this year’s budget would result in a lower level of debt to GDP, which is now expected to peak at 36.5 per cent, or 10 percentage points lower and five years earlier than previously thought. “This is a welcome development,” he said. “However, debt-to-GDP is expected to remain higher than prior to the pandemic, even 10 years from now.

“It would not be unusual for another economic downturn to come along in that time. Australia has not achieved a period of ­sustained reductions in debt to GDP since before the global financial crisis.”

Dr Kennedy said the build-up of debt since the GFC had made the fiscal position “increasingly sensitive to borrowing costs, which have been more volatile recently”. The 10-year bond yield, which approximates the average cost of new debt issuance, has risen as high as 4.2 per cent over the past year, but has fallen to about 3.3 per cent of late.

“If yields are higher than budget projections assume, larger improvements to the primary balance will be necessary to reduce debt-to-GDP,” he said.

According to sensitivity analysis in the budget, if yields were 150 basis points higher in four years, gross debt-to-GDP would peak three years later and would be three percentage points of GDP higher by 2033-34.

“It is important that Australia continues to rebuild its fiscal buffers to ensure the government can respond effectively to future crises,” he said.

Dr Kennedy said the fiscal projections in last week’s budget relies on an assumption of 1.2 per cent labour productivity growth over the coming decade. “But achieving this rate of productivity growth is not assured,” he said.

Dr Kennedy’s address follows repeated calls from RBA governor Philip Lowe for collective actions to raise productivity growth, which has been stagnant for three years. In the decade before the pandemic, the nation recorded its worst productivity performance in 60 years. Minutes from the RBA meeting this month – which raised the cash rate an 11th time – warned unless productivity growth was revived, higher borrowing rates would be required to tame inflation.

In his address, the Treasury secretary said robust migration, record rates of workforce participation and booming commodity prices had raised the level of potential GDP by 2.75 per cent by 2032-33. But given recent productivity performance had been “disappointing”, Treasury downgraded the level of long-term potential GDP by 1.5 per cent, or almost $40bn in today’s dollars. To raise productivity growth, Dr Kennedy said a well-functioning skills system would “help build human capital”.

“A clear policy environment, and enabling infrastructure, will allow individuals, businesses and communities to plan, invest and adapt to change,” he said.

“And responsive policy settings will foster dynamic and competitive markets, encourage the diffusion of best practice in the public and private sectors, and allow workers and capital to flow to their most productive uses.”

As well, he said the surprise surge in foreign students and working holiday-makers put “little pressure on many government services given the age of migrants and family characteristics”.

But Dr Kennedy said the short-term record migration inflow would produce an increase in demand, including for housing and infrastructure services, while the pandemic-related fall in household size was making things difficult in the rental market.

“It is clear that the wash through of policies such as HomeBuilder and the impact of monetary policy, in addition to persistent supply constraints, are creating a difficult housing cycle,” he said. “Recent responses by governments to increase housing supply are a sensible no regrets response to the pressures, particularly commitments to accelerate reforms to planning and zoning.”

Dr Kennedy said one of the stories of the 2023-24 budget that risked being lost was full employment. “Near-record low unemployment and near-­record high participation are increasing the size of our economy, helping to address, but not solve, our structural budget challenges,” he said.

Dr Kennedy said the post-pandemic period had shown “we need not settle for an unemployment rate with a 5 in front of it”.