Chickens coming home to roost

Geelong Advertiser, Thursday 24 January 2008, p. 19.

As the United States home loan debacle continues to bring low major American financial houses and the Australian stock market sheds all its gains over the last two years people are understandably worried about what will happen next. Politicians in both countries intone that the fundamentals of their respective economies are sound and investors should take a long-term view and not panic. They would say that, of course.

Some of the problems faced by both countries are long standing ones which need to be tackled if the sort of volatility we have seen in recent weeks is to be avoided. Both Australia and the United States have been running massive current account deficits for a decade or more. As long as the rest of the world is prepared to continue lending to finance this gap between what we earn from the rest of the world and what we buy from it, then things can jog along. Countries like China, whose cheap manufactured goods sell widely in the Australia and the United States, have an interest in the health of the buying economies and thus continue to support the deficits. But there will come a point when they begin to wonder whether that is supportable indefinitely. It is not necessary for the tap to be turned off completely; just reducing the flow a little can put Australia and the United States in a position where they will have to address issues they have conveniently ignored.

Some people argue that since the share of our exports going to the United States and the proportion of our imports we derive from it have declined in recent decades we have become ‘uncoupled’ from the American economy. The spectacular growth of mineral exports to Asia is supposed to provide a sustaining element for us in the face of a potential American downturn. But the signs are that China is taking steps to slow its growth, revaluing its currency and concentrating more on raising the very low living standards of the mass of its domestic population. Again this does not mean that our exports to Asia and China in particular will cease, but just that the rate of growth will decline, putting further pressure on Australia to reduce its current account deficit by finding alternative markets and improving its domestic productivity.

This is where what will be seen as the wasted Howard years will now have a delayed effect. Though the Howard-Costello team did wonders in reducing government debt and producing surpluses, sometimes much underestimated, in their years in government, they did very little to address the ballooning current account deficit and the underlying productivity of the economy. Shortages of skilled labour are pushing up costs and prices at home making inflation worse at a time when reducing these should be a priority. Kevin Rudd’s plans for an education revolution, strategic investment in productivity improvement and infrastructure development are all long-run policies whose immediate effect will be marginal.

So fasten your seat-belts, don’t panic, but we are in for a rocky ride in the next few months and years. There is a lot of underlying strength in Australia and its economy but it is Pollyanna economics to think that we will not be seriously affected by what is happening in the world economy. Similarly, the remedies for our structural problems will require sacrifices and it would be good to think that the new government will endeavour to see that these are more equitably shared across the whole community, particularly in the case of those who have done very well out of the boom years.

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