Australia’s Bright Recovery Masks Clouded Horizon, Gregory Says

(Bloomberg) -- Australia’s powerful economic recovery is the center of attention for policy makers in a pandemic environment that demands focus on the short-term, but it overshadows darkening clouds on the horizon, says Bob Gregory, a veteran economist who once sat on the Reserve Bank’s board.

“The tension between what’s best in the short run and what’s best in the long-run hasn’t ever been as sharp as it is now,” said Gregory, a professor at Australian National University in Canberra who has studied the economy for more than half a century. “We are going in directions which are going to make it hard down the track.”

Top of Gregory’s list of long-term issues is the downward spiral in relations with China that’s set to see Australia locked out of the next round of growth for the world’s largest middle class. Gregory is sanguine about iron ore and other commodities that trade on world markets, but worried about being cut off from millions of potential Chinese students and tourists and other services for the next generation.

“I’m firmly of the view that a lot of the positive things that came for Australia’s economic growth over the last two decades came out of China,” he said. “The cost of us losing wine, potentially students, is perhaps not the end of the world today, but it’s the growth you’ve got to look at.”

Australia’s rebound from recession has been very rapid, underpinned by the early containment of Covid-19 to limited outbreaks. That’s boosted confidence, which together with a massive fiscal-monetary injection has encouraged households to spend and firms to hire and invest.

Inflation menace

Yet that very stimulus leads to the next concern for Gregory, who was an RBA board member from 1985-1995. The central bank is now going all out to stoke wage growth as it tries to return inflation to the 2-3% target band. But history shows once consumer-price growth is unleashed, it isn’t easily controlled

“Clawing it back is going to be really difficult,” Gregory said.

Most global attention on the inflation risk is focused on the U.S. due to its combination of massive fiscal programs and emergency monetary stimulus in a rapidly recovering economy. If inflation breaks out there, it’s likely to make its way Down Under, too.

“I can guarantee the following: If inflation was to develop in the U.S., then it comes here, it doesn’t matter what we do,” Gregory said. He cites the historical correlation charted below:

Other worries on the horizon include:

• The shift from 200,000 migrants a year -- mostly adults needing a house, car and goods -- to closed borders for about three years; trying to turn it back on will be “a really big structural adjustment,” he said
• The government’s commitment to holding taxes at 23.9% of GDP, which could be difficult given the country’s aging population, a significant disability scheme and government plans to address aged care. “I don’t see how you can do that,” Gregory said

Government’s focus on the short-term is understandable during a once-in-a-century pandemic and in the political context of an election that needs to be called by next May.

But at some point gaping deficits and rising debt will need to be addressed, Gregory said.

“You can be optimistic about the Australian economy in the short run because you can say all government action, virtually, is to make sure the next year is a really good one,” he said. “The bad or worrying things aren’t hurting at all in the next year. But when you look ahead, the tradeoff is going to become quite difficult.”

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