A sad economy without much hope

The quote in today's title is from EY's Cherelle Murphy, who used the phrase to describe last week's uninspiring national accounts data and how "this level of spending" by our various governments, while flattering the overall figure, "won't deliver macroeconomic stability and drive sustainable long-term growth":

"The private sector needs more from their governments than short-term fixes to today's problems. While policies like the $900 million productivity incentives fund and the National Competition Policy initiative are welcome, a focused agenda that drives GDP growth from the private sector is crucial – now more than ever."

I agree, and it's a bit disheartening that Murphy could only name two positive policies (for what it's worth, that's where my list stops too). But it also gets to a point I made last week: namely that everyone should be less concerned about Australia's ongoing per capita recession because of the compositional changes that have distorted those figures, and more worried about the ongoing private sector recession and what's (not) being done about it.

Indeed, given the recent upward revision to farm output, Australia may already be in a technical recession this quarter despite strong population growth and record government spending:

Unfortunately Treasurer Chalmers doesn't appear to care, preferring to take credit for the small amount of growth in real GDP:

"Without the contribution from public final demand, the economy would have gone backwards, and that's been a common feature of the national accounts this year. Our view is that we would rather be part of a soft landing in our economy than to clean up after a hard landing."

Chalmers is technically correct that public final demand, i.e. government spending, is raising GDP. After all, the GDP equation is C + I + G + (X-M), so if you increase G and hold the others constant, you will by definition raise GDP.

But that's also where his claim falls apart. Everything else is rarely constant, so accounting identities tell us precisely nothing about empirical questions like whether Australia would have grown in the absence of Chalmers' profligacy.

For all we know, the increase in G might be reducing C and I by an even greater amount than the growth in G, because of what economists call crowding out. Basically, when aggregate demand is running hot – as it has been in Australia – the money the government is using to build its infrastructure projects, or pay for its cost of living handouts and other gimmicks, often comes at the expense of private spending.

Moreover, because our governments are borrowing to pay for it all, they're not only pulling resources from other sectors of the economy (e.g. goods, services, labour) but are also driving up borrowing costs for private actors through competition for capital.

Put it all together, and the contribution to GDP from public final demand may well have reduced private consumption and investment by an even greater amount, explaining at least part of Australia's private sector recession. And given what our governments are spending on, it's also well within the realm of possibility that they're making inflation worse, ensuring that interest rates stay higher for longer.

Hear me out. The equation of exchange is MV = Py, where M is the money supply, V is the velocity of that money (how often M is exchanged), P is the price level, and y is real output (real GDP). To the extent that government spending is reducing real output by crowding out the private sector with its consumption, y will be lower than otherwise. That means if M and V haven't changed, then by definition P – prices – must increase.

Essentially, if our governments had shown restraint and not crowded out the private sector to the extent that they have, the recent inflation wouldn't have been as severe.

And boy have they spent. Excluding the pandemic when the government's share of GDP reached 29.2%, September 2024's 28.8% was officially the highest on record. It's not like it was all investment, either; public consumption also hit a record high in September (again, excluding the pandemic), as state and federal "cost of living" support really kicked into another gear:

The large increase in public consumption, which is now 23% of the economy, is crowding out the private sector and does not bode well for future growth and productivity. And given that it's all being paid for with borrowed money we're essentially eating the seed corn, leaving very little for a future crisis.

Yes, it's miserable

Australia's economy isn't just sad; it's miserable. My preferred version of the so-called Misery Index is the rate of inflation (trimmed mean to avoid cost of living shenanigans) plus the unemployment rate minus the real GDP growth rate. It has never looked so bad as it does today:

At no point this century has Australia's Misery Index been this high above the long-run average for this long. It was higher at the start of the pandemic, during the peak of the global financial crisis, and very briefly during the dot-com bust. But in all of those episodes, it promptly reversed.

Really the only comparable period is the terms of trade bust that ran from 2013-15, although even then the deviation from the mean was considerably lower than it is today.

So, what can be done about it? Instead of obsessing over GDP and a "soft" or "hard" landing the focus should be on raising living standards, and unless you're spending big on infrastructure that will raise future productivity, you don't do that by increasing the government's share of the economy from already-elevated levels.