Josh Frydenberg is banking on a post-Covid surge to boost the budget – but here’s what could go wrong
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Josh Frydenberg is banking on a post-Covid economic surge to fund big personal income tax cuts for the rich and a modest infrastructure program while at the same time pushing the budget back towards balance.
Frydenberg finds himself in a similar situation to Wayne Swan in 2009, tasked with rebuilding the economy after a global downturn.
Swan went for a big spend on infrastructure – not just roads and rail but also the National Broadband Network, initially budgeted at $43bn over eight years (it ended up costing a lot more).
But in this budget, instead of spending, Frydenberg thinks the booming iron ore price and a recovery in consumer confidence after the Covid recession will drive the economy back into growth.
Stimulus measures are modest, and consist largely of not taking away benefits people and companies have become used to during the coronavirus crisis, such as the low and medium income tax offset and the ability for companies to instantly write off spending on capital items such as factory equipment or kitchens.
There’s also a small amount of additional infrastructure spending, $15.2bn over 10 years, which Frydenberg touts as adding to an existing $110bn pipeline.
It all seems relatively small beer when set against the $89bn cost of the jobkeeper program, which Frydenberg credits with keeping 3.8 million in work. (Problems such as the diversion of the payment from its intended purpose of keeping employees at Covid-struck businesses away from the dole queue and into the pockets of shareholders and bosses did not rate a mention in the treasurer’s budget speech.)
But Frydenberg has held on to one big-ticket item – stage three of a tax cut program announced before the pandemic, which will reduce the top personal tax rate from 37% to 30%. It has previously been estimated to cost $95bn over five years, with much of the benefit flowing to people earning more than $180,000 a year.
In 2019, the treasurer claimed his budget would deliver “a surplus for the first time in over a decade” – he even had mugs made with “back in black” on them.
Coronavirus made mugs of us all, but Frydenberg is nonetheless projecting the budget will recover dramatically over the next few years, with the deficit shrinking from a peak of $161bn next year to $57bn in 2024.
The broader economy, measured by gross domestic product, shrank 2.5% last year, but Treasury predicts it will bounce up 5.25% this year before growth falls back to 2.75% the year after.
It predicts unemployment is to fall below 5% by “late 2022” and hit 4.75% by mid-2023 – the first time there has been “a sustained period of unemployment below 5% since the years leading up to the Global Financial Crisis”.
Despite the relative modesty of his ambitions – back in 2019, Frydenberg thought GDP would grow by more than 3% a year and unemployment would be 5% – there are still plenty of things that could go wrong. Here are some of them.
The iron ore price collapses
Australia’s two big iron ore producers currently provide the swing factor in the country’s corporate tax take – a good year for them significantly boosts government revenue, while a bad one knocks it down.
Their profits in turn largely depend on the iron ore price. With iron ore currently fetching as much as US$230 a tonne on the spot market, Treasury’s prediction that it will fall to US$55 a tonne by the middle of 2022 seems conservative.
But a sudden fall would rip tax revenue out of the budget, endangering Frydenberg’s glide path towards the ever elusive surplus.
Gallery: The red flags of recession (StarsInsider)
Things get even worse with China
The country we sell much of our ore to is China – the same country with which we are currently engaged in a trade war.
It is also our biggest trading partner.
While China has so far stopped short of putting any restrictions on the import of iron ore, which it needs to make steel needed for the construction boom that is fuelling its recovery from the Covid recession, it is not impossible that too much talk about the “drums of war” could change this.
China would need another source of iron ore, which it doesn’t currently have because supply from the other big mining country, Brazil, is in a poor state right now. But if a giant mine at Simandou, in Guinea, goes ahead, this could change. The project isn’t nicknamed the “Pilbara killer” for nothing.
The vaccine rollout continues to lag
Treasury says its forecasts assume “that a population-wide vaccination program is likely to be in place by the end of 2021”, which Guardian Australia understands means that everyone who wants to be vaccinated would be vaccinated by then.
However, Guardian Australia’s vaccination tracker shows that at the current rate of immunisation, the population will be nowhere near completely vaccinated by the end of the year.
Mass vaccination clinics will hopefully improve the run rate, but on the other hand reluctance to take the AstraZeneca vaccine is not helping.
A lack of mass vaccination makes Australia more vulnerable to outbreaks and less able to open its doors to the outside world.
Resuming the flow of international students is crucial for the education sector, which brings in about $40bn a year as Australia’s fourth biggest export industry.
“The continued economic recovery will rely on the effective containment of Covid-19 outbreaks both here and abroad,” Treasury says.
“This will be a key factor in the timing of the reopening of international borders, which could weigh on the outlook for the tourism and education sectors.”
Borders remain closed
Even if Australia gets its vaccination program back on track, it’s still possible that the international situation will keep borders closed longer than 2022, when Treasury predicts they will start to reopen.
As well as hitting education and tourism – Australia’s sixth-biggest export, worth $16bn a year – that would reduce skilled migration, which helps drive economic growth.
Treasury’s forecasts are wrong
They’ve been wrong before. If the growth forecasts are too high, and the unemployment forecasts too low, the picture will look much worse than predicted. Key things that could go wrong here include assumptions that there will be no fallout from the end of the jobkeeper program in September, that there will be a boom in household spending, and that inflation and interest rates will remain low.
Fears of an inflation breakout are as old as the GFC and have yet to be realised, so that risk seems low.
The Reserve Bank would also be delighted if there was a small to medium-sized inflation breakout – it knows exactly how to combat them, which is by hiking interest rates.
What if Nairu is nonsense?
More fundamentally, Frydenberg’s prediction that unemployment can be reduced to 4.75% is based on a Treasury reassessment of a magic number called the non-accelerating rate of unemployment, or Nairu.
This number is supposed to represent the unemployment rate below which inflation will start to increase, and is used by some economists as a proxy for full employment.
It’s previously been estimated at somewhere around 5% to 5.5%, but in a pre-budget paper Treasury wonks said it could be lower, at 4.75%.
The problem is that like the emperor’s new clothes, the Nairu cannot be directly observed – it can only be detected by its surrounding cloud of econometric papers.
What if the whole idea is nonsense, as JK Gailbraith said as long ago as 1997?
If the link between the unemployment rate and inflation is a fantasy, there would be no downside for Frydenberg to go for a much lower number and get far more Australians back into work.