Excess capacity in the labour market was the key to understanding the weakness in the Australian economy and was the driving cause of expected interest rate cuts by the Reserve Bank.
This was one of the main points to come out of an FSC Economic and Market Trends event in Sydney this week, with guest panelists Michael Thomas, Director at Deloitte Access Economics and Su-Lin Ong, Managing Director, Chief Economist & Head of Australian Research at RBC Capital Markets
Under questioning from moderator Michael Potter, the FSC’s Senior Policy Manager for Taxation and Economics, both panelists were in broad agreement: the Australian economy is in a flat spot and is facing significant headwinds, and the Reserve Bank has little choice but to execute one and perhaps two or three cuts in official interest rates.
“I would characterise the economy as being pretty lackluster right now,” said Su-Lin Ong.
“Growth has been sub trend since mid-2018, domestic demand is quite modest and weakness is coming through on household consumption.”
As consumer spending made up around 55 percent of GDP, Su-Lin said it difficult for the economy to grow with consumer’s so subdued and constrained by high levels of debt.
Both Su-Lin and Michael Thomas agreed that while the economy was subdued, they both rated the risks of recession at around 25 percent.
“The risk of recession is pretty low at the moment,” said Michael Thomas.
“The RBA are signaling they are ready to go, we have a Government that is newly elected and can do more on the policy front, and we have a surplus coming along but I don’t think people will really mind if that gets pushed back because the economy needs some spending.”
Su-Lin Ong said that history showed that recessions in Australia were driven by “external shocks” and this presented the greatest current risks in the form of protectionism and the potential fallout from the US/China trade dispute.
While this made Australia vulnerable because of high levels of debt, there were a number of monetary and fiscal policy levers which “can be pulled”, while the RBA had also “done the homework” of what would happen if interest rates were cut to zero.
The RBA, she said, had shown that it was more concerned with the state of the labour market than the fact that inflation had been travelling at below the 2 to 3 percent target rate for some time.
“They have clearly been prepared to tolerate sub target inflation,” Su-Lin said.
“What has changed in the last month is a realisation that growth is so weak that at some point it is going to hit the labour market and we are starting to see some early signs of that.”
Michael Thomas agreed, saying that the inflation outlook hadn’t changed, but the RBA outlook had.
“What has changed is the labour market profile,” he said.
“5.2 percent unemployment is pretty good, but that is the headline rate and there are parts of the country where the unemployment rate is twice that – 10 percent in Townsville and 12 percent in country Queensland.”
Su-Lin Ong said that the headline 5.2 percent unemployment rate masked capacity issues in the labour market.
She pointed to high levels of underemployment, at 8.5 percent, which showed the number of people who had jobs but wanted more work, as a “function of sub par growth.”
“Capacity is unemployment plus underemployment, so you add that together and its 13.7 percent and that is the true measure of capacity and that is why there is slack,” she said.
“You need the labour market to strengthen and the unemployment rate to rise to get to your inflation target and that is definitely not happening, the unemployment rate is going in completely the wrong direction.”
The panelists agreed that the capacity issues were part of the explanation behind slow wages growth, which was in turn inhibiting consumer spending and keeping inflation low.
This was not a uniquely Australian phenomenon, however. Other OECD economies, such as the UK and the US, were experiencing low wages growth and had stronger performing labour markets than Australia.
The reasons for this were not entirely clear, but explanations included issues such as globalisation, persistently low inflation, less bargaining power for workers, and what Michael Thomas described as the “uberisation of the workforce” through the gig economy.
Looking forward, both panelists expected the economy to pick up in 2020, even though they doubted the impact that RBA rate cuts would have on stimulating the economy.
“We question how effective it is going to be in a world where households are indebted, we have tightening lending standards and a soft labour market,” said Su-Lin Ong.
“A cut of 50 basis points is not going to deliver now what 50 basis points delivered at the height of the Global Financial Crisis.”