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Debt, Deficit, Downturn
Paul Keating used to talk of 'a beautiful set of numbers' whenever the latest economic statistics indicated continued economic prosperity during his period as Australia's Federal Treasurer. Since then we've become accustomed to John Howard gloating - and Treasurer Costello smirking - whenever the latest economic news has appeared positive. And there has often seemed to be plenty to gloat and smirk about. The standard macroeconomic indicators have been looking good for more than a decade now, with annual growth in Gross Domestic Product averaging about 4%, increases in the Consumer Price Index staying low in the 2-4% range and the official unemployment rate dropping from a peak of 11% in the early 1990's to its current level of just over 5% of the workforce.
Underneath those 'headline' macroeconomic indicators have been recurrent signs of a deeper economic malaise - inadequate productive investment and a run-down in the quality of public infrastructure, and insufficient investment in education and training, particularly in TAFE and apprenticeships. There has also been a steady growth in the current account deficit as the nation's imports outstrip its exports and as dependence on capital inflow increases. But critics who dwelled on such matters have been derided by government ministers and their media allies as excessively pessimistic purveyors of gloom and doom.
Now it seems that the economic conditions have taken a sudden nosedive. In the last month we've seen an array of economic statistics that indicate a much less rosy outlook. The economic growth rate has dipped sharply. Interest rates have risen, making borrowing for housing and investment more expensive. The nation's current account deficit has surged, going far beyond the level that caused Paul Keating to issue his famous 'banana republic' warning. The foreign debt has also reached an unprecedented volume. And to cap it all, a survey by the Australian Bureau of Statistics 'found' another 1.2 million unemployed people - people who had been discouraged from seeking work because of current labour market conditions but who have not been formally registered as unemployed. So, on that basis, the 'real' unemployment rate may be closer to 15% than 5% of the workforce.
It is pertinent to recall that at the last Federal election the Howard government pitched its appeal to the electorate in terms of its record of sound economic management. Howard himself boldly proclaimed that the election was 'all about trust', about which political party the electorate would trust to keep interest rates down (and terrorism at bay). The pitch evidently proved to be reassuring to many Australians at the time, particularly those carrying large housing debts. But the decision by the Reserve Bank of Australia to lift official interest rates by just one quarter of one percent in early March seems to have shattered that trust. Of course, the RBA has the power to act independently of the government in this respect, thereby giving the lie to politicians' claims about which party would keep interest rates lower. Certainly, the RBA's decision seems to have had a major 'shock effect'. The official index of consumer confidence plunged by an unprecedented 16% in the following week. And when consumer confidence plunges one can reasonably expect a plunge in investor confidence to be not far behind.
Could we be headed for a significant economic downturn, a recession or even a deep depression? Capitalist economies throughout history have always had 'boom and bust' cycles of course, so it is pertinent to ask whether we are now at one such turning point. Indeed, there are some deeply troubling indications, both within the Australian economy and on a broader global scale, particularly because of the situation in the US economy with which we are now so closely linked.
What about the management of the Australian economy itself? Why should such a tiny increase in the prevailing rate of interest have triggered such a negative response? In part it is because it is widely seen as portent of more interest rate rises to come. The Governor of the RBA has hinted at that likelihood himself. But even if there were four such increases in the official interest rate, that would still only be a 1% rise, leaving the rate well below what it was at the onset of the last major recession - the notorious 'recession we had to have'. Indeed, our vulnerability to small interest rate movements at present seems quite bizarre. It is largely explicable in terms of the over-dependence on household debt.
From a political economic perspective, there is nothing inherently wrong with debt. For example, an individual tradesperson might sensibly go into debt to buy tools, a van or a truck so that he or she can earn a regular income, which can then be used to repay the debt. So it is with nations - borrowed money can be used to finance a 'take-off' into sustained economic development. However, a problem arises, both for individuals and whole nations, if the borrowed funds are unwisely used or if the rate of interest is very high. Then the 'debt trap' looms, as more money has to be borrowed just to pay the interest on previous borrowings. This is the recipe for economic crisis. It is a situation of 'vicious circle' into which some of the poorer countries have become trapped. Hence the current proposals for 'debt forgiveness' for these most heavily indebted nations.
Is Australia getting into that state now? Certainly, the total volume of foreign debt, equivalent to more than 50% of the Gross Domestic Product, is at a high level relative to past history and to the levels of debt prevailing in most other advanced industrial nations. And there are grounds for thinking that some of the borrowings have not been wisely used - hence the deficiencies in public infrastructure and investments in human capital to which reference was made earlier. What about interest rates? By historical standards, the general level remains quite low. On the other hand, by comparative standards, Australian interest rates are currently a little on the high side. Indeed, they have to be a little on the high side in order to attract the capital inflow necessary to match the deficit on the current account of the balance of payments.
So what really is the problem here? The most obvious concern is the vulnerability of many households to even quite small changes in interest rates because they have become so dependent on debt. In part this 'economic brinkmanship' is driven by consumerism and wasteful consumer spending, including expenditure on clothes that are never worn, food that is not eaten, books that are never read, CDs that are never played, and so forth. The Australian Institute in Canberra has estimated that perhaps as much as $10 billion annually of Australian household spending has this wasteful character. Much of the consumption is financed by consumer credit. The credit is often pushed by retail stores who sometimes stand to make more out of the interest on the 'finance' that they offer their customers than they do directly from the sale of goods.
Credit card purchases have also ballooned. As reported in the Sydney Morning Herald ('Credit Card Binge Sets a Record', 18.2.05), the total credit card bill in Australia exceeded $30 billion for the first time in December 2004. Card debt has doubled in the past four years. Of course, to the extent that people are now using credit cards rather than cash, this simply facilitates more convenient shopping. However, there is strong evidence, coming from the Australian Consumers Association and the Consumer Credit Legal Centre, that many people are getting into their own 'debt traps'. Excessive use of credit cards leads them to saddle themselves with high interest costs, thereby making themselves particularly vulnerable to even quite modest interest rate rises.
In the aggregate though, the main feature of household debt is borrowing in order to buy housing. 88% of the total household debt is housing debt: ($628 billion out of the $744 billion total, as of March 2005). This is not surprising because housing has become so very expensive over the last two decades: who could now afford to buy without recourse to mortgage finance? A median-priced house in Sydney cost the equivalent of over 12 year's worth of average wages in 2003, compared to just 4 years of average wages in 1986. So enormous debt is the usual precondition for home-ownership. The average new home loan in NSW in March 2005 was $262,500, which was $69,000 higher than in June 2002.
Those who can afford to buy - or to renovate and expand - are consuming more housing too. In the mid 1950's the average size of a new house was 115 sq metres, only about half the current average in suburbia where 'McMansions' have become the norm. In 1970 the average house had 40 square metres of space per occupant: now the corresponding figure is 85 sq metres of space per occupant. The average house size has risen while the average family size has fallen (from 3.1 persons per household in 1984 to 2.6 people in 2003).
These trends towards high housing expenditures are not altogether surprising. Many consumers aspire to bigger and better housing, and are evidently willing to access whatever credit facilities they can to achieve those goals. But the tax advantages of owner-occupation also encourage pushing expenditure on housing to the max. The exemption of owner-occupied housing from capital gains tax and land tax makes it a good investment, even if going deep into debt is necessary. Concurrently, negative gearing has encouraged purchase of additional houses and units for rent. Many people on quite most incomes have been drawn into this process, seeing it as a means of providing retirement incomes and some prospects of capital gains to augment their wage incomes. The overall effect is to add significantly to housing demand, leading to pressures for further increases in housing prices. Increased household debt is a predictable consequence.
The Howard Government has implicitly encouraged this trend. In so doing it has effectively continued the policy that originated with the Menzies government in the 1950's, a policy that encouraged home ownership as a 'bulwark against bolshevism'! The Hawke government in the 1980s promised to help those left out of the home-ownership process, by doubling the quantity of public housing. This would have meant raising the share of public housing from about 5% to 10% of the housing stock, but the share actually shrank during the period of the Hawke government. Now we are in the situation where public housing in an option effectively only available to those who can make a case, on grounds of need and personal hardship, for priority housing. Public housing has largely become welfare residual housing. Meanwhile, private rental housing is the principal alternative. This is not an inherently unattractive option, particularly for those keen on personal mobility. However, it is characteristically very expensive relative to income, cause households in this sector of housing tenure to experience the highest average incidence of housing stress.
So an awful historical 'logic' has led us to become a nation of home-owners, aspiring home-owners, aspiring owners of rental property, aspiring owners of ever more property with bigger rooms, more bathrooms, and so forth. The prolonged real estate boom of the 1990's and early 2000's was the culmination of this process. And now a mere quarter of one percent rise in interest rates evidently threatens to plunge this society into despair and depression, causing fear and loathing in 'middle Australia'.
As a nation we evidently need to redress this crazy cycle of over-investment in housing financed by debt. Land taxation warrants more attention in this context, as does the phasing-out of negative gearing. Of course, it would take considerable political courage for any political party to try to reverse this trend towards seeking capital accumulation through debt-financed housing purchases. It should have been done a decade or more ago before so many people's personal finances become locked into expectations of continuous rises in property prices. Now the NSW state government has got itself into an awkward political mess as a result of the ill-thought-out changes to its land tax and 'vendor tax' policies introduced in the 'mini-budget' of last year. Some might think this to be an appropriate political legacy from Treasurer Michael Egan, the advocate of eliminating government debt who evidently felt no qualms about the ballooning private debt!
A government that really wanted to stabilise land and housing prices and eliminate the boom-bust cycle in the longer term would apply a low rate of land tax to all property without exemptions. That would reduce the speculative element in the property market and produce more equitable treatment of different types of property owners. The revenue thereby generated could be used to finance an expansion of public housing, not concentrated in large estates on the urban fringe but integrated into a more mixed pattern of urban development. It goes without saying that such a policy would take political courage and require careful implementation. It is the sort of policy that, logically, the neo-liberals should embrace, but never will. At present only the Greens are seriously considering it as they seek to develop progressive economic policies alongside their more long-standing commitments to issues of social justice and ecological sustainability.
Meanwhile, international political economic relationships need reconsideration too. A radical redress of the nation's current economic woes cannot be sought simply in terms of domestic policies. It also needs to take account of the global context. The Australian economy has become ever more closely linked to USA in particular. The US-Australia Free Trade Agreement comes into operation this year, with potentially awesome long-term consequences, as outlined in a new book by Linda Weiss, John Matthews and Liz Therborn, called How to Kill a Country. It is a deal, incidentally, that completely undermines Australia's legitimacy in global trade forums: going down the road of bilateral agreements like this is simply not compatible with broader free trade principles.
As a nation, we are now ever more vulnerable to the ups and downs the US economy, indeed in the world economy in general. The resulting problems are multi-dimensional:
Sacrificing control of the national economy on the altar of neoliberal economic theology has made our collective economic future more uncertain than ever. My own view is that now is a very dangerous time for the RBA to be 'stepping on the brake' with a more restrictive monetary policy. In this respect I fully agree with former Liberal leader, John Hewson (I never thought I'd say that!) when he said this the RBA would be crazy to raise interest rates at this particular time. The economy, nationally and internationally, is currently at a particularly uncertain phase in the economic cycle. Economic growth has slowed and it is always possible, in a capitalist economy, that this can lead to recession. The broader situation in the world economy is deeply troubled. The USA is running a massive trade deficit that is simply not sustainable. Something has got to give. So is a recession likely, even inevitable? At this point my crystal ball clouds over ... I don't want to emulate the un-named economist who predicted six of the last three recessions! Suffice to say that the preconditions for a significant economic downturn are evidently now present.
Whatever the current economic prospects though, some serious rethinking of the direction of economic policy is warranted. An economic boom kicked along by high consumption spending, and by tax-induced and debt-financed housing expenditure in particular, was always going to prove troublesome in the end. And closer international integration, which looked good from a neoliberal perspective when the economic conditions of our major trading partners were buoyant, now starts to look much less attractive in the downturn of an economic cycle. The principle of greater national and regional self-reliance, consistently derided by the neoliberals, evidently warrants serious consideration as a basis for more secure long term Australian economic development. Drawing on the savings held in superannuation funds in order to finance investment in infrastructure and industry is the sort of progressive political economic alternative that now beckons. Productive investment, systematically linked to goals of social justice and ecological sustainability, has to be the top priority.
The neoliberal economic strategy is in tatters. The underlying economic problems, nationally and internationally, are becoming increasingly evident. Public debt has been reined in only at the expense of creating the conditions for unsustainable levels of private debt. We have become highly vulnerable to small fluctuations in monetary policies and international financial markets. It is time to change track. Wake up Australia!
Frank Stilwell is Professor of Political Economy in the School of Economic and Political Science at the University of Sydney. He is the coordinating editor of the Journal of Australian Political Economy and author of various books including Changing Track: A New Political Economic Direction for Australia.
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