Reasons To Stay Optimistic In 2016

By David Bassanese | More Articles by David Bassanese

After digesting the key economic news events of recent weeks, I’m left with the following impression: I’m pessimistic on our economy in the short-term, but optimistic on the longer-term challenges we face.

Let me explain. For starters, the Mid-Year Economic and Fiscal Outlook revealed that the Federal Budget continues to swim in a sea of red ink, thanks to weak growth in incomes and slumping commodity prices. On the growth and commodity front, moreover, I think conditions will get worse before they get better.

The Treasury has slashed its forecasts for the average iron ore price from $US48/tonne to $US38 – but I suspect prices could drop to around $US25-30 over the first half of next year given further rationalisation in the Chinese steel industry and copious increases in global supply.

As regards the economy, Treasury downgraded its economic growth forecast for this financial year from 2.75% to 2.5% – which is still a modest improvement on the mediocre growth of only 2.2% in 2014-15. That seems pessimistic, but it’s not that bad considering Treasury expect business investment to slump 9.5% this financial year – an order of magnitude not normally seen outside of recessions. The terms of trade are also expected to slump by 10.5% – similar to the decline seen in 2014-15.

Helping hold up the economy, according to Treasury, will be home construction and consumer spending, with each expected to growth by 8.5% and 2.75% respectively. My concerns is that dwelling investment could disappoint, particularly given an apparent peak in home building approvals. I also suspect weakness in both share and property prices, not to mention weak wages growth, will constrain the growth in consumer spending.

All up, I still see more downside that upside in the near-term economic and budget outlook.

That said, I also think we’ve become a bit too pessimistic on the budget situation in any case – and I’ll also throw in climate change in view of the historic agreement achieved in Paris last weekend.

Take the budget. The media love to quote the budget deficit in billions – and an underlying deficit of $37.4 billion for this financial year sure sounds like a lot of money. It is. But it’s still only 2.3% of GDP – which is not bad by global standards. What’s more, net debt even on today’s projections is still expected to peak at just under 20% of GDP – again very good by global standards.

Of course we can’t be complacent – debt would balloon if we kept running deficits at this size of GDP. But current projections also suggest we won’t. Indeed, buried into the tax system is an automatic correction mechanism – the nominal tax scales that apply within our progressive personal income tax system. Budgets are always shown to improve over time because as incomes rise more Australians are pushed into higher tax brackets – raising their average income tax paid through what is known as “bracket creep”.

Bracket creep, together with an assumed eventual lift in economic growth to drive down unemployment to its sustainable level of 5%, is projected to return the budget to surplus by 2020-21.

So provided we can get the economy moving again the budget – at least over the foreseeable future of the next 10 years – the budget should largely fix itself. And our economy should eventually bounce back, if only because a super cheap $A will eventually re-invigorate our once downtrodden non-mining trade exposed sectors.

Of course, whether we want to allow an automatic rise in average personal income tax burdens to help solve the budget problem is another question – which is where talk of tax reform comes in. But on this I agree with Scott Morrison: tax reform should not be about raising the overall level of taxation, but rather re-balancing how tax is collected in a revenue-neutral way.

Similarly, those that worry that the budget outlook could get worse if the economy remains stubbornly weak have got their priorities all wrong. If the economy remains weak – or worse hits a recession – that is a problem in itself that needs to be redressed. The Budget consequences are secondary. Indeed, it’s good that budgets get worse if the economy weakens, as it part and parcel of the automatic stabilisers at work.

Last by not least is climate change. While many are worried that business and government may not live up to their promises, I’m seeing new evidence daily that technology seems likely to solve this problem much faster than many expect. While a global tax on carbon emissions to drive the shift to cleaner energy seemed too hard, the same “price signal” may well be achieved if technology allows the cost of the latter to drop dramatically.

As solar panels and battery storage get cheaper and more efficient, for example, chance are many more households will simply leave the grid and produce their own electricity within the next decade. That will save a huge chunk in emissions. With our own electricity producing plants at home, we’ll also be able to charge up our electric cars – which will reduce emissions further.

These are but two examples I can readily identify. I am sure there are many other innovations also under way which could then be rapidly deployed across the globe.

So while I worry about our economy and environment in the short-term, I remain an optimist on both over the longer-term.

Let’s be happy this Christmas.

David Bassanese

About David Bassanese

David Bassanese is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR)

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