Chanticleer, The Australian Financial Review
Six interest rate cuts in the United States this year and four by August. Remember those predictions?
It was only a few months ago. Now, the market says two cuts, maybe three at most this year, and conviction is waning that they’re coming at all.
It’s a similar story in Australia. Data trickling out reveals underlying strengths (March house prices, February household spending – both released this week – and data last week showing unemployment back below 4 per cent), and we’re on track for the 12th-straight quarter of inflation above the Reserve Bank of Australia’s targeted range.
Those mooted rate cuts are no sure thing. Why? Because the hard work on inflation still needs to be done.
As former RBA governor Philip Lowe explains it, inflation pressures were always going to ease when the oil price dropped (which it has), goods price inflation slowed (it has), and pandemic-era supply/demand imbalances were fixed (they mostly are).
That was the easy bit.
The harder bit, or “missing piece” in Lowe’s words, is persistent increases in the cost of services – all those things you cannot drop on your foot, as RBA governor Michele Bullock memorably put it in her maiden post-board meeting press conference.
Services prices are a function of two things: wages growth and productivity. When the two move in lockstep, prices should be stable. When wages growth far outpaces productivity gains – and it is, by a factor of four or more – you get services price inflation, as firms push up prices to recover increased labour costs.
And that services price growth, caused by higher wages and a lack of productivity, is what is making it incredibly hard to cut interest rates.
“That piece hasn’t fallen into place yet,” Lowe told us at the Future Generation shareholder presentation on Thursday.
“And if the central bank is going to be able to lower interest rates, we’re not there yet.”
Of the two factors – wages and productivity growth – Lowe is focused on the latter. Productivity came up time and time again in his near hour-long Q&A panel session. He had the full attention of his fellow panellists – fund managers Nikki Thomas (Magellan Financial Group), and Geoff Wilson (Wilson Asset Management).
While productivity is the sort of topic economists love to talk about and can put the rest of us to sleep, his passion relayed how important it would be to anyone feeling the pinch from the higher cost of living and elevated interest rates.
Lowe is clearly still thinking about it despite leaving the RBA, playing more golf and chairing ASX-listed investment company Future Generation Australia – and wishes the rest of us would as well. He says our living standards are at stake.
Four burning issues
The obvious question is how to unlock those productivity gains? Wages growth is running about 4 per cent a year, although the more sustainable number is likely about 2.5 per cent. That means we need productivity growth of at least 2.5 per cent.
Lowe’s solution? “This is a political problem, not an economic problem,” he says.
Politicians need to get better at making long-term decisions in the interest of the country on four important topics – tax, education, energy, and investing to handle population growth (housing, for example). They are his four burning issues.
Lowe says all the solutions are there – he read plenty of productivity reports in his former job – they just need more attention and long-term thinking.
“One thing almost all economists say is that the tax system is not fit for purpose,” he says. “Income generation, wealth generation [is taxed] too heavily, and consumption is too low.”
He says energy should be a national asset, there needs to be better access to education to capitalise on technology advances such as AI, and more investment in houses and infrastructure to keep up with population growth.
Interestingly, it is the same sort of commonsense thinking we’re seeing from other business leaders, including Commonwealth Bank of Australia chief executive Matt Comyn and Business Council of Australia president Geoff Culbert, who have used similar public addresses to advocate for change in the past month.
Comyn, when asked what he would do if treasurer, argued income tax for workers earnings less than $300,000 should be capped at 30 per cent, the GST increased, and tech giants slapped with a levy.
Culbert said Australia was “in an incessant cycle of short-term thinking” caused by governments unable or unwilling to make hard, long-term decisions. He called for longer terms for politicians and a redesign of the tax system.
Future growth
What these business leaders all want is a stronger economic growth outlook.
The government’s Intergenerational Report forecast economic growth of 2.2 per cent a year for the next 40 years, down from 3.1 per cent in the past 40 years.
Lowe reckons there is significant work to be done just to meet that lower 2.2 per cent number before we can even start thinking about getting back to 3.1 per cent.
And where does the work need to be done? Productivity.
He says more than half of that 2.2 per cent forecast is supposed to come from productivity growth – which is more than Australia has been able to achieve in the past 15 years.
“If we can’t get 1.2 per cent productivity growth, that’s going to be really challenging for everyone – investors, workers and the government,” he says.
“It’s the only way business can generate a growing profit stream, the only way that workers can get wage increases faster than inflation, the only way the government’s budget position can get better.”
So, while it is tempting to focus on near-term interest rate calls – for the record, Lowe says the RBA’s next move is likely a cut, although he cannot rule out a rise – he says we need to spend more time thinking about the long term. And that means productivity.
Will the message sink in? It’s a tough sell. Although the longer the cash rate stays at 4.35 per cent, and the further away the supposed cuts seem, the more likely we are to hear about it.
The other thing worth watching is whether other business leaders call for changes to the tax system and for political leaders to make tougher decisions.
While it might be too late for the next election in Australia, it would be good to see substantial policy reform debate blossom in a bid to unlock that elusive productivity growth.
Like Lowe says, much of the work has been done. There are piles of tax and productivity reviews either scrapped or shelved, the ideas are out there, all that’s needed is some conviction and political nous to bring them to the fore.
And if the politicians are looking for someone who’s read all the reviews, and who has a bit more time on their hands, Lowe’s clearly a passionate advocate. And one’s handicap can only go so low.
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