The government and taxpayer-backstopped banks will ultimately decide which businesses survive and which die.
The Reserve Bank of Australia has become the lender of last resort by providing at least $90 billion of ultra-cheap 0.25 per cent loans to commercial banks to lend to business and households. Banks, underwritten by the central bank, will provide six-month loan repayment holidays to home borrowers and small business.
European welfare state levels
The RBA is buying the government’s bonds in financial markets – in effect “monetising” government debt and making it cheaper for politicians to finance coronavirus spending.
Free childcare will be provided to parents as the government pays the centres to stay open during the crisis.
Federal and state government spending will – at least temporarily – soar to European welfare state levels of 45 per cent to 50 per cent per cent of the economy, from about 33 per cent before the virus struck in Australia.
A Liberal prime minister and treasurer, in effect, have embraced a philosophy of Depression-era economist John Maynard Keynes, who advocated an active role for government intervention in recessions.
“When the facts change, I change my mind. What do you do, sir?” Keynes reputedly once said.
Morrison and Treasurer Josh Frydenberg, advised by Treasury, had originally resisted direct payroll subsidies for businesses and their employees affected by the coronavirus crisis.
We are working now to a whole new set of rules.
— Australian Prime Minister Scott Morrison
But by the middle of last week, that hard-headed economic rationalist thinking was no longer sustainable – politically or economically – as a once-in-a-century pandemic slammed the economy.
The states, led by NSW and Victoria, moved faster than anticipated to halt business activity in a bid to slow the spread of the virus.
Retailers such as Solomon Lew’s Premier Investments, Myer, Country Road, footwear maker Accent Group, jewellery chains Michael Hill and Lovisa, fashion retailers Mosaic Brands, outdoor leisure group Kathmandu, homewares specialist Adairs and autoparts retailer Bapcor all announced store closures and laid off more than 50,000 workers.
Morrison says we are living in unprecedented times with the twin battles against the SARS-CoV-2 virus and economic “ruin”.
“This calls for unprecedented action, governments making decisions like they never have before,” Morrison said this week. “And I hope and pray they never have to again. We are working now to a whole new set of rules.”
The handouts are not about “entitlement”, but “need”, he says.
The $1500 fortnightly wage payments are intended to keep workers connected with their employers. This will be crucial for Morrison’s “hibernation” strategy.
The strategy is predicated on an eventual economic recovery, whereby businesses will not be saddled with unsustainable debts to banks, landlords, energy companies, workers and governments. Everyone is being asked to take an income cut.
The government hopes the wage payments for businesses suffering at least a 30 per cent drop in revenue – 50 per cent for large businesses with turnover exceeding $1 billion – will keep employees on the books until the crisis passes.
History shows employment goes down steeply like an elevator during recessions and goes up like a staircase during the recovery phase.
During the 1990-91 recession, the jobless rate jumped quickly from less than 6 per cent to above 11 per cent, but it took another 11 years to sustainably sit under 6 per cent.
During the global financial crisis, the American jobless rate peaked at 10 per cent in 2009, and it took six years to fall back to its pre-crisis level of under 5 per cent.
A study by American-based economists Steven Davis and Till Von Wachter of cumulative earnings losses associated with job displacement between 1974 and 2008 shows men lose an average of 2.8 years of earnings if they lose work when the unemployment rate exceeds 8 per cent.
“Job displacement leads to less stability in earnings and employment, worse health outcomes, higher mortality, lower educational achievement by the children of displaced workers, and other unwelcome consequences.”
The JobKeeper subsidies to full-time, part-time and casual workers – covering almost half the 13 million person workforce – may also prove important for the nation’s economic psychology and people’s esteem.
Workers will be paid by their bosses, instead of joining long queues at Centrelink. There is dignity in that. The unemployment rate will not surge as high, tempering the prospect of confidence-sapping news headlines.
Westpac chief economist Bill Evans estimates the government’s JobKeeper payments will restrain the peak unemployment rate at 9 per cent, rather than a potential 17 per cent.
Nevertheless, there will be a substantial hit to household incomes from widespread wage cuts now extending to major accounting firms. The income fall will cut people’s spending across the economy.
Federal government gross debt to hit $800 billion
Canberra-based Outlook Economics director Peter Downes says the government has no choice but to step in with unprecedented spending to fill the void left by the private sector.
“If you’re shutting down one-third of the economy, you need to replace a huge amount of income to stop the economy collapsing.”
Federal government gross debt will jump to some $800 billion, about 40 per cent of GDP, from $560 billion, or 28 per cent of GDP, and total public debt will hit 60 per cent of GDP, including state and territory deficit borrowing. That is relatively low by the world’s profligate standards.
Debt will reach the highest share of the economy since the 1940s after World War 11, when Commonwealth gross public debt hit 120 per cent of GDP. Total Commonwealth and state debt reached about 180 per cent during this era.
Back then, it took 20 to 30 years to pay down the debt.
Australian National University history professor Frank Bongiorno says the recovery might be like the post-war reconstruction.
“Money is cheap at the moment, but how we repay that enormous public debt is going to be a huge issue in Australian politics for years to come.”
Governments and central banks could be tempted to try to inflate their way out of the debt or further monetise it.
If the 10-year government borrowing rate stays low at the current 0.80 per cent, the debt should remain manageable in the long-term.
“Although the dollars are unprecedented, what’s even more unprecedented are the [low] interest rates we’ll be paying on this new debt, Deloitte Access Economics partner Chris Richardson says.
“Never in the 2000 years of recorded history of interest rates has it been cheaper for governments to borrow.”
Once the immediate crisis passes, a major overhaul of taxation, government spending and the social welfare system will be debated.
Younger workers who have lost their jobs – to protect the lives of overwhelmingly older people – will inevitably pay higher taxes when they return to work.
KPMG chief economist Brendan Rynne says the government is spending our future money now in order for our future to be better than a no-policy-response option.
“As the likely beneficiaries of this response is the whole household and business sector – not specific parts of it – then the tax collection mechanism needs to be one that fairly and equitably recovers the cost of the policies across the whole country.”
The recovery is likely to be long and painful. The economy will not open up quickly, even if workers manage to stay connected to employers. A widely available vaccine is probably one to two years away.
Travel restrictions will remain in place for some time, robbing the tourism, airline and university sectors of export income.
Weaning the economy off government life support will prove incredibly difficult.