Economists love talking about declining growth rates in polite terms. You’ll often hear them use euphemisms like ‘new normal’. As if lower standards of living are something we should aspire to.
But what’s normal when it comes to economic growth anyway? Is it 3% as some would have you believe? Or is it closer to 2%?
Before the current downturn in the global economy, most people assumed the former. In fact the Federal budget for the five years from 2017 works on the assumption that growth will hit 3.5% a year. Getting a consensus on what the new normal should look like is no easy task. The way the Aussie economy is faring today, even 2% growth represents an achievement.
Yet all these numbers matter little without context. A few percentage points of difference doesn’t sound like much, does it? And yet, in real terms, it makes an enormous difference to Australia’s prosperity.
PricewaterhouseCoopers (PwC) looked into the effects of this growth slowdown. They modelled a ‘new normal’ based on 3% GDP growth, instead of the trend 3.25%. It might surprise you to learn how big a difference even 0.25% makes to the economy’s wellbeing.
PWC estimates the Australian economy will see just one more budget surplus of 0.2% in 2019. After that, the news gets worse. If its modelling is correct, the nation faces decade long budget deficits. Remember, that assumes growth rates of 3%, which looks hopeful if nothing else.
Of course, Australia is just one of many nations grappling with this problem. The entire developed world is suffering the same fate. Growth is weak. Productivity is even weaker. Debts are worsening. And government budget deficits are ballooning. Since 2008, Australia’s debt to GDP has grown from 11.7% to 33.88%. And with a decade of deficits looming, those figures will only worsen.
This low growth cycle seems set. In fact, no one knows how to change it. It’s why the developed world depends so much on emerging markets to plug the gaps. But that’s becoming a less reliable source of global growth, as the commodity price rout drags on.
What the Australian economy stands to lose
According to PwC, Australia will miss out on some $288 billion worth of growth by 2025. That equates to 2% of GDP every year over the next decade.
Even if the Aussie economy grows at an unlikely 3% a year, the government budget will still take a hit. Maintaining this rate leaves the government with a budget shortfall of $5 billion a year.
And this assumes we manage to hit 3% GDP growth. Yet the new normal is likely to be closer to 2% than 3%. If 2015 is any indicator, 3% is too optimistic a target. Economic growth in 2015 is a measly 1.6% through to September. It’ll take some effort to get to 3% again in the coming years.
Now, if growth ends up hitting below 3%, which is likely, then those deficits will be even larger. PwC forecasts suggest budget surpluses will return at some point in the 2030s.
Another commodity boom would help reverse this. But there’s as much a chance of that as finding water on the moon. Which means the days of regular budget surpluses are over.
We’re entering a prolonged period of deficit spending. The cost of paying for services will only grow in time. We’re getting older as a nation. That means more funds going to welfare and aged care. And that’s without factoring in the burden of education, defence and other government spending.
Is there any way to avoid the outcome of this? As PwC explains, there’s no clear path forward (emphasis mine):
‘It’s easy to assume you revert to the long-run average, but you have to do things to get back there. There are big bills and that reinforces why growth has to be part of the agenda. We need growth to stimulate the economy to pay for some of these things.
‘The healthy pace of growth was built on history when we did a lot of reforms that were maybe more attainable than some of the challenges at the moment. Lower global growth is a hand-brake on the domestic economy as well’.
It’s true that we need growth to stimulate the economy. But finding this growth is easier said than done. The government is placing its faith in non-mining services to lift economic activity. And there’s some evidence the sector is picking up. NAB [ASX:NAB] announced this week it’s corporate lending is up to $2 billion a month. That’s roughly double the amount it was pledging in late 2014. As the biggest business lender, that’s a step in the right direction.
Yet this alone isn’t enough to offset the falls in mining capital investments. In the year to June 2015, mining expenditures fell 10%. Almost 4% of that came in the second quarter of this year alone.
The truth is that we wouldn’t be talking about a new normal if non-mining could lift us towards 3% growth. It can complement economic growth, sure, but it can’t make up for what’s being lost.
Because of this, budget cuts and taxes are likely to dominate this new economic era. When you can’t create growth, you seek shortcuts elsewhere. Cutting spending and raising taxes is the likeliest outcome because it’s also the easiest.
But we have to give the Aussie economy its fair dues. Almost a quarter of a century of continuous growth is nothing if not impressive. You won’t find many other success stories like ours anywhere in the world. We ‘beat’ the tech and mortgage bubbles. And we bested both the Asian and global financial crises.
But economies that stand still are doomed to fall back. We need to stop pretending that things can be as good as they’ve been since the turn of the century. To stop believing that 3% growth is achievable over the next 10 years, when it isn’t.
The lucky country has lost some of its sheen. And short of another once in a lifetime commodity boom, we may never get it back.
Contributor, The Daily Reckoning
The Daily Reckoning’s Greg Canavan says we’re on course for its first recession in 23 years. In a free report, ‘Australian Recession 2015: Unavoidable’, Greg reveals how we’ve found ourselves in this position.
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