Good but not that good. The green lights won't last

HOW do we follow up a week like that? For months the economic data here and abroad has been all red and amber lights. Then suddenly we get a wave of green lights, all at once, that seems to clear away the blockages and open up a clear path ahead.

An interest rate cut on Tuesday was followed by the Bureau of Statistics reporting unbelievably strong GDP growth and a sustained rebound in jobs. Then the rest of the world waved us on: China cut its interest rates and announced huge export growth, and European finance ministers agreed to lend Spain up to 100 billion euro($A125 billion) to prevent the collapse of its banks.

If only every week was like that. Then Wayne Swan and the Pollyanna chorus would always be right, confidence would never be short and there would be no point in reading (or writing) columns on economics.

But we know that things are not that simple. We don't usually get waves of green lights sweeping us past every intersection. Good data behind us even if it survives the revisions does not guarantee good times ahead. It's certainly welcome, but while it eases the problems facing Australia and the world in the next 18 months, it does not remove them.

For Australia, the next big test is the introduction of the carbon tax on July 1, along with $2.4 billion of handouts to households in compensation and the school kids bonus. That will be a test of the hyper-emotional, hyper-negative tone that suffocates political debate in these times. Influential forces are trying to derail the tax, and would not mind if they derailed the economy as well.

For Europe, the next big test will be Sunday's Greek election, and the negotiations that will follow, whoever wins, to either rewrite Europe's fiscal austerity pact or remove Greece from the eurozone. At this stage, everyone is taking positions to try to influence the election result. What will happen after it is anyone's guess; the stakes are immense.

Take Australia first. At face value, last week's GDP figures tell us the economy is powering ahead, propelled by robust consumer spending (up 4.2 per cent in a year), quite extraordinary growth in engineering construction (up 53 per cent in that time), strong growth in payrolls (7.4 per cent) and productivity (4 per cent) and booms in sectors from finance to government administration, healthcare, the professions, wholesale trade and agriculture.

Most of that is probably broadly true, if overstated. As I reported on May 11, the Bureau of Statistics has run into technical problems with its jobs data, leading it to overstate jobs growth in 2010 and understate it in 2011 and 2012. Federal and state tax collections confirm that actual job growth has been stronger than the bureau figures show. And that means the economy has also grown more strongly than we thought.

Healthcare and the professions are growth industries. The farmers have had a lot of rain, wholesalers have had a lot of imports. The big banks are shedding staff, but they are also losing market share to smaller banks and non-bank lenders. And migration figures imply that population growth is accelerating.

But there are serious question marks over the two drivers of growth. Growth in consumer spending actually slowed, yet the bureau says that prices have stopped rising, so we've actually hit the pedal to buy more and more. Tell that to High Street.

Even more amazing, it says engineering construction costs are almost flat, despite the mining boom: in the past 3 years they have risen 1.8 per cent (0.5 per cent a year), a sharp change after 24.8 per cent growth in the previous 3 years. Tell that to the Pilbara.

The GDP numbers are likely to be revised down, but to still fairly buoyant levels. The central problem remains: mining is booming while south-eastern Australia is not. In the year to March, spending grew by 10 per cent in the resource states but only 2 per cent in the south-east. The dollar, after three months of welcome falls, has bounced back up to nudge parity with the US dollar. And, like everyone else, our growth depends on what happens in Europe.

The rescue of the Spanish banks buys time for Europe's leaders to negotiate a growth pact, then either exempt Greece from its budget constraints or push it out of the eurozone and risk the fear and uncertainty that would create.

It was a good week for us, and the world, but there are rough times ahead. The best thing is that we are entering this period in stronger shape than we thought. And more than most countries, we are able to make our own fortune.

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Same same but different: Essay on Australia

SINCE Labor took office in 2007, economic debate has been dominated by the global financial crisis. Labor's proudest boast is that Australia has emerged from it in better shape than almost any other developed country. The Coalition accuses it of reckless spending, and running up tens of billions of dollars in deficits and debt.

Labor's boasts are inflated, but basically true. Australia's national income per head is now back in the top 10 of the developed world for the first time in decades. In a world awash with economic and financial failure, it is seen globally as a beacon of success.

Australia had a mild, brief recession: Europe and the United States a deep, lasting one. There, unemployment is around 10 per cent, growth is feeble, governments in massive deficit, and there is a growing risk of double-dip recession as fiscal austerity replaces stimulus.

Australia suffered scars, but they're healing. Growth is only 2.7 per cent growth per head is just 0.7 per cent but it's secure. There are 300,000 more people unemployed or underemployed than in 2008, but unemployment is only 5.1 per cent. The banks are cautious, but they're lending.

Was our success due to the government's handling of the crisis and if so, how much? Or is it proof that, as the Coalition says, the stimulus was unnecessary, over the top, and will leave us burdened with debt?

The Rudd government's handling of the crisis is the economic issue of the election. The government thinks it deserves re-election for steering us out of trouble by its quick, bold spending and bank guarantees. The Coalition urges us to dump Labor for wasting our money on excessive, badly-targeted, mismanaged programs.

NO ROADS TO REFORM

Both are looking backwards. Apart from the National Broadband Network and emissions trading (if it happens), neither has any real reform agenda to take us forward. Labor's aim under Julia Gillard is to camp in the middle of the middle ground, and feel its way forward only where that seems safe.

Tony Abbott, by nature, is more ideologically-driven. Yet now even he has thrice denied any plans for workplace reform an issue that in the Howard government, he held so dear. The Coalition, too, has no reform agenda. Its energy has gone into campaigning against Labor, not generating policies of its own.

The one forward-looking debate is on how fast the stimulus should be unwound. And the difference between them is more in rhetoric than reality.

On monetary policy, there is no difference. Rhetoric aside, both leave it to the Reserve Bank board to decide our interest rates. What might change is the composition of that board, all of whom come up for reappointment in the next three years including Governor Glenn Stevens.

Stevens and Treasury secretary Ken Henry were both chosen by Peter Costello. Yet in opposition, the Coalition seems to view our two top economic officials as part of Labor's team. If Labor is re-elected, Stevens and Henry can expect reappointment. If the Coalition wins, that is far from certain.

There was once a big difference between the parties on industrial relations, but now it's vanished. That, like Labor's decision to postpone indefinitely its core promise to introduce emissions trading, tells you how difficult it is to carry out hard reforms in a political system as polarised as ours. It is now a roadblock to reform.

But there are differences that matter. On emissions trading, the difference between the Coalition's "never" and Labor's "one day" is not insignificant. There is a sharp divide between the parties on the mining tax, and on the tax cuts for business it would finance.

Labor would make employers pay to lift superannuation contributions to 12 per cent by 2020. The Coalition would make them pay for workers to take six months of maternity leave, topping up Labor's 18 weeks.

The National Broadband Network is the most ambitious infrastructure project since the Snowy Mountains Scheme and one of few big political risks of recent times. Work is now under way to bring high-speed broadband to 93 per cent of Australian homes, at a cost of up to $43 billion. The Coalition would abandon the field to the private sector telcos.

But the central issue is deficits and debt. Were they needed? Are they being wound back fast enough?

The global financial crisis essentially had four causes. First, US banks and other lenders lent too much money to people who were bad credit risks, under terms so onerous that default was inevitable (the sub-prime crisis). Second, Wall Street invented, and invested heavily in financial derivatives so complex that financial firms themselves did not fully understand the risks they were taking on.

Third, US regulators, swayed by the deregulatory Zeitgeist, allowed all this to happen. And fourth, European banks awash with savings invested them in derivatives, sub-prime loans, and risky lending to eastern Europe.

CRISIS AVERTED

Australia's banks were remote from that. The crisis proved their own lending sound, with a few high-profile exceptions. This was partly because of the banks' instinctive caution, partly because the Australian Prudential Regulation Authority was an effective and intimidating watchdog, and partly because they had their own lucrative game borrowing cheaply overseas to fuel our house price boom.

Debt drove Australia's long boom in the '90s and '00s. Between 1990 and 2008, household debt soared from 45 per cent of our disposable income to 155 per cent. As the banks borrowed much of that overseas, their net foreign debt soared from 10 per cent of GDP to 40 per cent. That was clearly unsustainable, yet our leaders, officials and the banks shied away from debate on how to change it.

When the crisis came, our dependence on foreign debt made us vulnerable. If global markets failed, we would be in trouble. And fail they did.

In September 2008, crisis turned to panic after Lehman Brothers collapsed. The markets stopped lending; institutions clung to their cash. Australian banks could no longer roll over old loans for new ones. By October, Suncorp, and maybe Bankwest, were within days of default, and collapse.

The Rudd government moved quickly. It guaranteed the banks their deposits, their old loans, and their future ones. Two days later it delivered a $10 billion package of stimulus spending to shore up the economy mostly as $900 cheques to all but the well-off. The crisis was averted.

Over the next 18 months, the banks raised $160 billion, mostly on global markets, guaranteed by Australian taxpayers. The scheme was designed in haste, and seriously damaged nonbank lenders, so the government then had to rescue them too. Some lenders had to merge, but our financial system survived, in good shape.

These initial interventions won bipartisan support from the Coalition, and widespread praise around the world for the "exemplary" speed and scale of the government's actions. But the bipartisanship faded when Rudd and Wayne Swan produced a second, far bigger stimulus package in February 2009, including $15 billion for school halls, libraries, etc, a second $8 billion handout to households, $6 billion to build 20,000 units of social housing, and $4 billion to insulate the ceilings of houses.

Why did Australia survive the crisis so well? There are several reasons, and economists differ over which mattered most. The banks didn't go broke. House prices didn't collapse. Exports didn't collapse, thanks to stimulus in China. Immigration kept the population booming. And the Rudd government's spending propped up demand especially for construction, usually the biggest victim of recessions.

Few economists would argue, as Abbott has, that no stimulus was needed. Without it, Treasury estimates Australia would have sunk deeper into recession over 2009, even with China buying our iron ore.

But it was excessive. It was a mistake to spend so much on the school halls programs that it became an entitlement impossible to unwind. A lot of money was wasted on poorly run schemes. Too much money was committed to schemes drawn up in too much haste. At the time, ministers and officials, like their counterparts around the world, believed they were fighting to avert a second Great Depression. Some economists disagreed at the time; we now know they were right. Fortunately.

The deficits are now being wound back: from a $55 billion deficit in 2009-10, the budget is forecast to be in surplus by 2012-13. Net debt is now forecast to peak at $90 billion, or 6 per cent of GDP. With the US forecast to owe 86 per cent of its GDP by 2015, and Japan 154 per cent, the ratings agencies, economic officials, the IMF and the OECD all agree: Australia's debt is nowhere near problem levels.

There are many real economic problems out there. Last year 21 per cent of men and women of prime working age had no job at all. We have imported a million skilled workers because we don't train enough of our own. We have borrowed $654 billion because we don't save enough of our own. We need widespread tax reforms. We have a growing inequality of incomes, and outcomes. One could go on. But in this campaign, it's pointless. These are issues the parties are not talking about.


READ MORE

The Great Crash of 2008 by Ross Garnaut and David Llewellyn-Smith (MUP) 2009.

Shitstorm by Lenore Taylor and David Uren (MUP) 2010.

This Time is Different: Eight Centuries of Financial Folly by Carmen M. Reinhart and Kenneth S.Rogoff (Princeton) 2009.

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