Five reasons to worry about the economy

This opinion article by Business Council chief economist Adam Boyton was published in the Financial Review on Thursday 21 February 2019.

The economic mood in Australia has turned over the past few months. The Reserve Bank has, for example, moved from saying the next move in interest rates is likely to be up, to a more balanced position. No doubt the Governor will have more to say on this when he testifies on Friday.

After writing last month about five things across our economy we should be celebrating; in light of this mood shift it would seem appropriate to look at five aspects of our economic performance in need of improvement.

That's not to dismiss 27 years without a recession, a coming budget surplus, an ability to deal with change, the strong jobs growth of the past year and the benefits of economic growth being distributed to all income groups. But it is important to ask the question: what are our economic shortcomings today?

One obvious shortcoming is the persistence of weak wages growth. The most recent data from the ABS show that across the economy wages rose just 2.3 per cent over 2018. And while private sector wages showed the fastest yearly increase in four years, the pace of wages growth nonetheless remains weak.

Of course we can't regulate our way to faster wages growth. That would end up coming at the cost of jobs. But there are ways to stronger wages growth. In the short term, faster GDP growth would help. In the long term, we know the only way to sustainably deliver real wages growth is through productivity growth.

Unfortunately, another shortcoming would seem to be a waning in the pace of GDP growth. After the excitement from some quarters accompanying the 3.4 per cent pace of growth reported over the year to the June quarter 2018, a more sober assessment appears to have set in. The Reserve Bank forecasts GDP growth to run around its current softer pace of 2.75 per cent through 2020 and into 2021. The problem with growth remaining at its current level is it becomes harder for wage growth to lift and harder to make inroads into unemployment. Both these things are much easier to do with faster GDP growth.

Part of the reason for soft GDP growth has been weakness in productivity growth. This brings us to shortcoming number three. Over the past year, productivity growth has run at just 0.7 per cent, well below what Australia has been able to average in the past. In the market sector – which is where the ABS thinks it can best measure productivity – outcomes have been even worse. Here productivity growth has been just 0.4 per cent. Productivity is how we underpin higher living standards. So accepting weak productivity growth means accepting only gradual and grinding improvements in our standard of living.

What's the path to faster productivity growth? One answer is investment. Productivity is not about a cost‑cutting race to the bottom, it's about investment and innovation. Over Australia's history, it has been investment that has had the biggest impact on productivity. Unfortunately, investment spending remains weak - shortcoming number four. New business investment fell over the year to the September quarter 2018, while the Mid Year Economic and Fiscal Outlook downgraded Treasury's forecasts for business investment over the current financial year.

Giving rise to the animal spirits that spur investment isn't necessarily easy. Still, there are some simple things we can avoid. One would be having the third highest effective marginal company tax rate across 74 different economies surveyed by the OECD. Another would be the decade-long policy uncertainty in energy, which flows through the economy and impacts consumers and businesses. Our inability to attract investment and uncompetitive policy settings in areas like tax must rate as one of our economic shortcomings. Without some improvement we will end up with less investment in Australia than would otherwise have been the case; and more in other countries.

Ultimately these things are related. Faster economic growth lies at the heart of solving a lot of our challenges. Unfortunately, the outlook from the Reserve Bank is for more of the same. But a stronger investment outlook and faster productivity growth could paint a very different picture.

As for wages, what's more conducive to faster wages growth? An economy growing strongly with fast productivity growth, a strong investment outlook and a competitive business environment? Or an economy with lacklustre growth, struggling to attract investment and with weak productivity growth?

The answer to that seems fairly clear.

So let's deal with our shortcomings so we can again focus on our successes.