How to prevent a recession we don’t have to have

APAC News Roger Montgomery Recession We Don't Have to Have


Tax cuts for lower income earners is something that can be done right now to stimulate the Australian economy

Roger Montgomery

Back in November 1990, with the Australian economy deep in the doldrums, Treasurer Paul Keating uttered his now famous remark that this was “a recession that Australia had to have”. It was, remarkably, Australia’s last recession. Today, with our economy again looking into the abyss, I believe there is a simple measure the government could take to prevent the next one.

The Australian economy is barely growing. Australia’s economy, as measured by GDP, grew most recently at an annual pace of just 1.4 per cent, which was the slowest rate of growth since the 1.7 per cent growth recorded during the GFC, and the lowest rate since the Tech Wreck of 2000. Seasonally adjusted, Australian retail turnover fell 0.1 per cent in July, according to the Australian Bureau of Statistics. In NSW – Australia’s largest economy – state final demand, which is a broad measure of spending, stopped in the quarter to June 30.

Meanwhile, the Reserve Bank reported earlier last month that Australians had nearly twice as much debt as income. Debt-to-income rose 191.1 per cent in the June quarter, up from 189.4 in March. Household debt-to-income jumped to 140.4 per cent from 139.8 per cent.

And its income that is now in recession for many Australians. With term-deposit rates of less than 1.75 per cent, many retirees have been enduring a worsening ‘income recession’ for some years.

It’s a vicious spiral. Rates are cut to spur investment, but for the oldest individuals and couples in the largest cohort of the population – the baby boomers – incomes fall and spending must dry up. The consequent slowing in the economy requires more rate cuts and the cycle continues.

Rate cuts are clearly insufficient to get the economy going and the heavy lifting must be accompanied by fiscal measures, meaning government spending and/or tax cuts.

For Australia, however, it could get a whole lot worse soon.

Residential building approvals, which we have warned about for more than a year, are down 40 per cent. It’s a leading indicator for construction activity, meaning the ranks of those suffering from income reductions will include architects, surveyors, landscape gardeners, brickies, sparkies, plumbers, chippies, tilers, painters and roofers. That’s more than 3.5 per cent of the nation’s workforce who, by Christmas or early in the new year, will be earning less income even if they keep their jobs or their contracts. In turn, that could have an adverse impact on retailing, which is the country’s second largest employer.

As you can see, giving 3.5 per cent of the workforce 40 per cent less work will mean less spending at the shops, which of course could lead to store closures or cost cuts, leading to unemployment in retail. Add to the multitudes of retirees already tightening their belts and Houston we have a problem.

Forget the official definition of a recession, a large portion of Australia is already in an income recession and a bunch more are about to enter one.

It makes perfect sense therefore that our Reserve Bank would cut interest rates. Unfortunately, what I know from my conversation with the RBA’s Assistant Governor is that while the intention – to help keep people in a job – is to be commended, rate cuts incentivise businesses to invest in technology that displaces labour.

As revenues fall, businesses are forced to find cost-out solutions and automation is high up on the list, especially when there are tax rebates for doing it.

The labour displaced by automation and robotics is a major reason interest rates are as low as they are globally. Low rates have spurred a boom, and perhaps a bubble, in AI, 3D-printing, electric vehicles, autonomous vehicles, and the list goes on. The primary purpose of some of this technology, of course, is to lower costs by replacing humans.

So as central banks cut rates, they incentivise investment in technology that displaces labour, forcing central banks to cut rates further.

The other issue of course is that rate cuts are justified on the basis of a global savings glut, the currency war, inflation being low and on the basis of the aforementioned desire to improve employment. Any recession is anathema to central banks; however, more frequent shallow recessions are much better than deep prolonged slowdowns, even if they are less frequent.

Meanwhile, rate cuts also help lift the price of real estate which benefits those who already own assets but does nothing for those bereft of assets. And so, rate cuts widen the inequality gap.

What’s needed are permanent and enduring tax cuts for those on lower incomes. Lower income earners spend a higher proportion of their income and cutting rates for lower income earners increases the velocity of money – the frequency with which it passes through the economy.

As the economy continues to slow you’ll be hearing a lot more about the need for government spending on infrastructure to stimulate the economy. The problem with this, of course, is the long lead times. A better idea is the NSW schools’ maintenance program that has just been announced by the NSW Government. This is more immediate and employs more people than a tunnel project. In its economic effect it should be akin to the school building program run during the GFC. While governments and their advisers might be more inclined to pay for one-off projects, such as a few schools to be fixed, or for a hospital to be given a coat of paint, the pace and potential depth of economic slowing may require something broader and more permanent. A tax cut for lower income earners is a strategy that needs to be considered to avoid a recession we don’t have to have.

Roger Montgomery is the Founder and Chief Investment Officer of Montgomery Investment Management which has A$1.44 billion in funds under management