Recession-proof Australia

Through a mix of smart policy and good fortune, Australia’s economy has managed to dodge recession for 25 years

 
Recession-proof Australia
The Sydney skyline: the Australian economy has resisted recession for 25 years 
Author: Callum Glennen
January 10, 2017

In September, Australia passed an economic milestone not many countries can claim to have matched: the country reported its GDP was up 3.3 percent, making it the 100th consecutive quarter without a recession (see Fig 1). This 25-year growth streak is the second longest in the world’s history, only behind the Netherlands’ 26-year run from 1982 to 2008, which was driven by the Nordic Seas oil boom.

australia-fig-1What has made Australia’s run all the more remarkable is it was able to avoid a recession during the 2008 global financial crisis. A mix of strong partnerships with international markets and gutsy policy decisions added up to help the country navigate an international economic climate in which a recession seemed inevitable.

However, runs like Australia’s are destined to come to an end eventually. Its streak was supported by a once-in-a-century expansion from a major trading partner, and the country now looks to be on the edge of what is, at best, far more subdued economic prospects. As international markets are continuing to re-establish themselves after the financial crisis, the future for Australia looks more in line with that of the rest of the world – although, as proved in the past, Australia’s leaders have learned the right decisions made quickly can save an economy that looks certain for disaster.

Ploughing ahead
Australia’s capital has historically been tied to agriculture (see Fig 2). After the establishment of the country as a penal colony by the British, Australia’s economy was initially driven by pardoned convicts establishing farms on the seemingly endless swathes of land that stretched towards the country’s centre. The gold rushes that began in 1851 then spurred significant immigration and generated a swift increase in the nation’s population. Even so, agriculture remained an important commodity for some time, with wool remaining Australia’s primary commodity export from the 1870s all the way through to the 1960s.

In the last century or so, Australia faced two major economic downturns. Its first was in the 1890s, when a mixture of drought, a slowing of international demand for wool, and striking workers demanding better conditions combined to weaken the country’s economy. Along with many other nations around the same time, a recession set in. Australia was also not spared the Great Depression between 1929 and 1932, and suffered due to falling exports, a decrease in overseas loans and a drop in residential construction.

australia-fig-2Professor Jeff Borland is an economist at the University of Melbourne and studies Australian economic history. He said Australia’s small, open economy has traditionally proved susceptible to downturns due to international and domestic imbalances. When these combine, Australia enters its worst declines. Sharp stops in international capital flow have also proved particularly damaging.

“In the 1890s, you had the Baring crisis in Argentina, and European investors really worried about investing money in the newer, smaller economies, so there’s a relatively sudden stop of capital flow that has an adverse effect”, Borland told World Finance, explaining how the same thing then happened again in the 1930s. “That’s a better-known episode where the British bond market started refusing to roll over loans to Australia and [demanded] repayments; that had a bad effect.”

There is a decent chance Australia would have fallen into the same trap during the 2008 financial crisis. However, although unknown to policymakers in the 1990s, a number of lessons learned from these past crises had put Australia in a good position to weather the 2008 storm.

The recession we had to have
By definition, any streak of recession avoidance must have started with one. In the early 1990s, Australia fell victim to the wave of recessions that swept the globe. The country was in a precarious economic situation at the time, and the shock of the international downturn left the country reeling. At the announcement of the grim economic results, the Australian Treasurer at the time, Paul Keating, famously announced it was a “recession that Australia had to have”. The economic effect was disastrous.

“The recession started in the September quarter of 1990 and lasted until the September quarter of 1991”, said the former Governor of the Reserve Bank of Australia Ken Henry in a 2006 lecture broadcast on ABC Radio. “During the recession, GDP fell by 1.7 percent, employment by 3.4 percent and the unemployment rate rose to 10.8 percent. Like all recessions, it was a period of disruption and economic distress. It was particularly deep in Victoria, where a disproportionate share of the financial failure occurred. Victorian employment fell by 8.5 percent compared with a fall of 2.1 percent for the rest of Australia.”

The biggest contributing factor to the early-90s recession – Australia’s worst since the Great Depression – is still up for debate. Borland said disagreement exists as to whether it was down to poor policy decisions or just fallout from the rest of the international slowdown.

The first half of the equation is Australia’s domestic market. “During the 1980s, we deregulated financial markets, and that had led to sort of a credit boom, which led to asset price inflation, and probably to some extent a bubble in commercial real estate prices”, Borland said. This resulted in a readjustment of overvalued assets leading into the 1990s, breaking a lot of confidences.

Strong partnerships with international markets helped Australia navigate an international economic climate in which a recession seemed inevitable

Borland explained Australia’s banks were also partly to blame: “Essentially in the 1980s, with the deregulation of banking markets, the banks were really aiming for market share. They were able to expand, so they worried a lot more about getting market share than they probably did about lending standards.”

Inflation was also a contributing factor, according to Borland: “Most countries around the world, to try and get rid of the inflation that had been created in the 1970s, ended up following the approach of tighter monetary policy, and that ended up causing some degree of downturn. In Australia, that downturn was made even bigger, I think, but the fact is that the government misjudged the lags with which monetary policy would operate.”

Australia’s reserve rate was regularly driven up in the years before the recession, and efforts to correct it simply didn’t come fast enough.
Australia’s economic situation was by no means isolated, with the US also struggling with a weak economy. This transfer of slower economic growth no doubt dogged Australia as well, and as in the past, the country’s local and international economies were simultaneously hammered.

Going for growth
The end of the 1990s recession, which marks the beginning of Australia’s current streak, happened with a bang. A period of booming growth immediately after a recession can often be expected as an economy catches up to previous expectations, assuming any sort of major economic shock doesn’t occur. In the case of Australia, it managed to set up its recovery as it shed its economic deadweight. The nation’s bad loans worked their way out of the system, and the government applied fiscal stimulus measures. However, Borland said that, while this effectively engineered a recovery, it is nowhere near enough to explain the full extent of the last 25 years.

Perhaps the major economic driver behind Australia’s fiscal success was not on its own shores, but a little over 4,500 miles north; at the same time, China entered a phase of remarkable economic development, as a manufacturing boom created an insatiable demand for iron ore and coal. Australia had the benefit of being both abundant in these resources and geographically quite close.

Borland said this development largely came as a surprise to Australian policymakers: “I guess if you were a real China expert in the early 90s, you would have seen the Chinese economy growing for about 15 years and you might have forecast that it was about to move into a real phase where it would be heavily reliant on iron and steel, the production of infrastructure, and that Australia would benefit from that. Though I think even people who said they foresaw that would say they were surprised by the scale of the benefits Australia derived.”

With China’s economy transitioning away from infrastructure and construction, demand for Australia’s raw materials
has slowed

The appetite for these resources prompted a mining boom the likes of which will probably never be seen again. Mining companies rushed to invest in the construction and operation of new sites, creating a multitude of job opportunities in rural Australia. While this explosion of economic activity created the foundation for growth, smart decision-making was ultimately what allowed Australia to avoid the worst of the 2008 financial crisis.

Support to households
At a time when much of the rest of the world fell into the economic doldrums, Australia walked away from the global financial crisis comparatively unscathed; while not a time of booming growth, a mixture of savvy policy and strong foundations let Australia avoid the worst. Borland said there were three main reasons Australia avoided a recession in the late 2000s: China, banks and stimulus.

The Chinese Government, fearing a recession of its own, poured what was the biggest fiscal stimulus ever into its economy to accelerate construction. This meant demand for Australia’s minerals remained high, and the softening of international markets was not felt as much as it could have been.

The second reason was Australia’s banking sector. Still scarred from the 1990s recession, the industry had been extremely cautious with its lending up until 2008. Many had suffered severely under that recession, with Westpac in particular teetering on the edge of insolvency. Determined to not let this happen again, Australian banks had avoided the risky lending practices that ultimately crippled the US market, and focused instead on their retail divisions.

Australia statistics:

100

Quarters without a recession

5.6%

Unemployment rate, October 2016

$56,327

GDP per capita, 2015

One of the biggest factors, however, was the Australian Government’s quick decision on various stimulus measures to keep Australia’s economy ticking along: Kevin Rudd’s Labour Government and Treasurer Wayne Swan committed Australia to becoming a guarantor for any loans made to Australian banks from international lenders. This was unlike the situation in the US, where banks became cautious of one another’s solvency and so stopped lending to each other. “That basically meant that we never experienced any dry up of liquidity or any issues about the inability of Australian banks to keep financing their operations”, said Borland.

The other factor was the quick adoption of efforts to sure up spending by giving away money. In total, AUD 42bn ($31.3bn) was handed out to families in the form of AUD 900 ($670) cheques to those earning less than AUD 100,000 ($74,430) per year, and AUD 950 ($710) to families with school-age children. The cash came with no strings attached, except for the encouragement that it should be spent at the time, rather than saved. The Labour Party and Henry, then the Secretary of the Department of the Treasury, championed the aggressive measure.

The injection of cash had its intended effect, with families pumping the money back into the economy almost immediately. The construction industry, which usually suffers particularly badly during a recession, was also supported with $14.7bn in cash grants available to schools for the construction of performance halls.

The packages worked so well because of how quickly they were implemented. While it may have been tempting to make construction projects a major focus of stimulus measures, by the time the economic benefits would have been felt, Australia probably would have already slipped back into recession. With the no-strings handouts of cash happening at the same time, consumer spending picked up immediately.

It was a lesson learned from the last recession. In an interview with ABC’s current affairs programme 7:30, Henry said he saw the effects of the 1990s recession first-hand, and was determined to act with the speed needed to avoid what seemed like an unavoidable recession: “That experience was seared on my brain, I think I’d say, and I was very keen that we not have a repeat performance of that. In fact, my recollection of that period of the early 1990s recession is that treasury stood on the side lines, and as Secretary of the Treasury I was not going to stand on the side lines.”

Henry coined the phrase “go hard, go early, go to households” as a philosophy for the spending, and pushed to get the rapid injection of cash to move ahead of infrastructure projects so the effects could be felt before recession set in.

Running out of luck
But while Australia has so far continued its recession-free streak, the economic climate for the country is now looking substantially more fragile. With China’s economy transitioning away from infrastructure and construction, demand for Australia’s raw materials has slowed.

The impact of this slump is perhaps most noticeable in Western Australia. Australia’s largest state in terms of size and home to many mines, Western Australia was riding high during the boom years. Since then, the region’s unemployment rate has risen to 6.5 percent (see Fig 3) and real estate prices have slid 8.3 percent from a 2014 peak. Some commentators have concluded that, on its own, Western Australia is already in a recession.

Despite this, Australia’s eastern states have so far proven more resilient. According to figures from the Australia Bureau of Statistics, the economies of New South Wales, Victoria, South Australia and Queensland are all still growing.

Borland said that, as well as the end of the mining boom, there are a few other challenges in Australia’s immediate future. One is reducing the budget deficit that was generated during the global financial crisis. Another is the changing nature of the international energy market, which could potentially erode Australia’s dominance in the area.

“Another issue for Australia is making the adjustment from being a world leader in energy economics, in the sense of mining lots of coal, to trying to be a world leader in energy economics in new technologies. That’s going to be a big challenge for Australia as well; maintaining the competitive advantage in being a source of energy supply.”

Certain of uncertainty
Commentators have long been predicting the end of Australia’s growth streak, but while the country no doubt has challenges to face, speculating as to the state of its future is always difficult.

According to Borland, making any sort of definitive prediction is unwise, but at least currently the country appears to be posting steady – albeit very slow – growth: “I can’t see prospects of a major downturn, but the problem is that the big bad episodes are the ones you don’t see. If things keep going along the way that they are, it may not be the period of most rapid growth, but I guess the point is there is nothing definite you could say at the moment is sort of the cause of a major recession.”

In his 1964 book The Lucky Country, social critic Donald Horne attributed Australia’s success (as the title suggests) to luck, rather than any sort of competent decision-making from the country’s leaders. While some critics might attribute Australia’s financial prowess to the same good fortune, luck just isn’t enough to prompt a streak of this length.

“There’s that thing historians talk about called hindsight bias”, Borland said. “When you look back, it makes sense that things happened, but that doesn’t mean that it was inevitable that it would happen. I think it is clear that it was not inevitable that Australia would have
had growth for 25 years.”

Australia, while no doubt having been fortunate, also made the right decisions at the right time to avoid recession for 25 years. While it is now no longer in as comfortable a position as it was during its mining boom – and while the streak clearly cannot go on forever – Australia has learned from its past mistakes, and should be able to manage more modest prospects.