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Business Mentor


  • Written by The Conversation Contributor

Coming just weeks after the federal budget, the Pre-Election Economic and Fiscal Outlook (PEFO) was unlikely to reveal anything new.

And in general this is the case, with the projected deficit for 2016-17 remaining at $37.1 billion (although the underlying cash balance for the current year has decreased by $1.8 million).

Forecasts for other indicators for growth, inflation and unemployment remain basically unchanged. However, the PEFO papers provide an opportunity for voters and commentators to cast aside the “what’s in it for me” reaction to the Budget to more closely examine the estimates and forecasts of the key economic indicators on which the Budget position is based.

The expected or assumed trends in economic growth, inflation and unemployment feed into the Budget bottom line and government debt into the future. If these expectations and assumptions are wrong, then the estimated deficit and debt numbers will also be wrong.

If these assumed trends are based on optimistic assumptions about the growth of our trading partners, the strength of our currency, the pace of innovation and improvements in labour productivity, then the expected Budget deficit will be lower and the public debt higher than if more conservative assumptions are made. So how realistic are they?

The May 2016 Federal Budget assumes the Australian economy would continue to grow by 2.5% in the next two years increasing to 3% in the following year. This is below the previous trend of 3.1% but higher than the average (excluding 2012) of more recent years of 2.4%. Why would we expect trend growth to increase from 2017/18? The short answer is that we wouldn’t and we shouldn’t.

More than ever before, Australia’s economic growth is tied to what is happening globally. Influences such as renewed volatility in financial markets, uncertainty over the long term growth in the Chinese economy and continued post-global financial crisis slow growth in many developed countries. So if, as PEFO affirms, global economic growth remains slow then Australia too is likely to experience slower growth.

What about our sensitivity to changes in commodity prices? Here PEFO confirms that the risk to economic growth forecasts from commodity price falls mentioned in the Budget papers is unchanged with averages and spot prices showing conflicting pressures on prices.

What about domestic demand? This could be an issue as PEFO queries the expected pick-up in non-mining investment within Australia. If this does not materialise then the economic growth figures are likely to be down by 0.5%, possibly settling at a new trend of 2% per annum for a number of years. Still higher than labour productivity growth of 1.4%, so good growth - but not what Australia is used to.

The outlook for jobs growth, which relies on overall economic growth forecasts, is confirmed by PEFO to have plateaued with only slightly lower unemployment rates into next year.

For the Federal government, lower than expected economic growth means lower than expected tax receipts and higher welfare payments both of which mean higher, not lower, deficits and debt. Unless a new impetus for growth is found. The answer here could be a re-structured economy based on private business growth and diversification, and growth in services.

In the case of business, the Budget recognises that the majority of businesses in Australia are small and half of these are owner-operated. Tax incentives that encourage these businesses to grow and diversify should increase the deficit in the coming year but contribute to tax revenue and lowering the deficit over the long haul if they remain in place and if these businesses respond in the expected way. Two big ‘if’s.

Growth in services, two thirds of the value of our national output, is likely to continue. The growing middle class in countries like India and China will seek overseas education and Australia is well placed to deliver this. More tourists than ever before are travelling to Australia which is a desired destination due to its stable government and attractive exchange rate as well as its tourism hot spots. Population growth as well as an ageing population will also contribute to services growth.

When the Australian economy is doing well, annual inflation runs at about 3%. If quarterly figures suggest that the annual rate is picking up, the Reserve Bank increases the cash rate to dampen business and household spending. However, if the inflation rate is hovering below 2%, then there is little the Reserve Bank can do.

It may lower the cash rate as it decided to do at its May 2016 meeting. But, as we found with the May 2015 decision which also cut the cash rate by 0.25%, it is unlikely to provide sufficient incentive to encourage consumers and businesses to throw caution to the wind and increase their spending. Having low borrowing costs might invite debt-fuelled expenditure but households and businesses also need assurance that that the economy is strong and worth getting into more debt for.

Whether the Budget fulfills the promises of jobs and growth without jeopardising our credit rating, only time will tell.

Authors: The Conversation Contributor

Read more http://theconversation.com/questioning-the-assumptions-underlying-the-pre-election-economic-and-fiscal-outlook-58996

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