What is the Biggest Risk to the Australian Economy?

The global economy has entered its first coordinated upswing since 2006. But while current indicators show the path ahead looks clear, the potential for disruption remains.

Speaking at the opening session of Aon’s Advanced Risk Conference 2018 in Melbourne, the Dean of Melbourne Business School and senior advisor to Deloitte Access Economics, Professor Ian Harper, described how the world economy was growing strongly, with even a slight slowing of growth in China posing no real cause for concern.

But while overall global growth is contributing to growth in full-time employment, and even pushing some countries to a state of full employment, it is not translating to wages growth. This bucks historical trends, where high employment has traditionally led to labour shortages which in turn pushed wages up, and in turn put upwards pressure on inflation, with higher interest rates being the eventual result.

Prof Harper said in today’s economy labour shortages were not leading to wages growth, and no one knew why.

“It is nothing like the pattern we have experienced before,” Prof Harper said. “And you need to think about that carefully as you plan forward for what this might mean.”

As an example, he described how historical evidence showed that, when wages failed to increase, people watched their standard of living decline, and that led to social and political instability.

“And that feeds itself through to political unrest very quickly,” Prof Harper said. “There is a lot of historical evidence.”

Prof Harper said the market’s outlook for stable interest rates for at least the next five years demonstrated that no one expected this situation to change quickly.

Prof Harper also talked about the importance of managing population growth as a key issue governing Australia’s long-term prosperity. As much of Australia’s economic growth reflects additional demand and supply generated by new arrivals, any significant reduction in immigration could be problematic. At the same time, population growth presents a critical challenge in ensuring that infrastructure investment keeps up.

“So making our cities work is a driver of non-mining investment and a driver of economic welfare,” Prof Harper said. “That will be the future for us.”

To better understand future risk, Prof Harper also outlined three possible ‘what if’ scenarios that could negatively impact Australia’s economic performance.

The first of these was an escalation of the current trade war between the US and China. While he described the current level of tariffs as very low, even stepping up to full-scale trade war would only have a minor impact on Australian GDP, stripping just 0.3% off the economy ten years from now. This minimal impact reflected Australia gaining some benefits from the redirection of Chinese trade away from the US in our favour.

His second scenario was based on a sudden diminishment of immigration, which he posed as a genuine risk to the Australian economy. Whether this was driven by the response to a terrorist attack, or simply the ramping up of existing political rhetoric, it would lead to an immediate fall in consumption and break the cycle that has been propelling the economy forward, where jobs have been created from new arrivals. Government spending would be forced upwards, the dollar would fall, and interest rates would decline further. Ultimately this would see living standards fall, with 12% of the economy stripped away in ten years’ time.

His final scenario examined the often-speculated potential of a sudden collapse in housing prices. Prof Harper said that, while this would cause the economy to contract by 4% over ten years, he said it was also unlikely, due to some of the heat having left the market already thanks to tightened lending criteria and some limitations on foreign investment.

Prof Harper concluded by saying that, while none of these scenarios were likely, they provided interesting models through which to view the impact of current political discourse.

“The economy is going extremely well and looks like it will continue to do so into the future,” Prof Harper said.