Australia needs to focus on the supply side of the economy to manage the ongoing effects of Covid-19 and conflict in Ukraine. 

Despite our isolation during the pandemic, Australia is far from immune from global economic headwinds, Dr Jeffrey Wilson, Ai Group’s Director of Economics and Research, said during our webinar last week: The global economic outlook and the implications for Australian business. 

Fellow panelist Tamara Henderson, ASEAN specialist for Bloomberg Economics, outlined the shocks hitting the global economy. 

“There are five simultaneous shocks currently operating across the global economy, which is pretty staggering; usually it’s just one,” Dr Henderson said. 

These are:  

  • Covid-19

Although the weekly death toll globally has dropped to the lowest since early 2020, new variants may change the situation. 

  • China 

China’s soft domestic demand is hurting the region’s export prospects. Ongoing lockdowns are prolonging supply bottlenecks, keeping price pressures elevated.  

“The global economy will continue to experience headwinds from China’s demand and supply shocks this year but as China reopens, whenever that happens, these headwinds will turn into tailwinds, so we have something to look forward to,” Dr Henderson said. 

  • Europe 

The price of energy, grains and metals have soared, owing to sanctions on Russia plus disruption to Ukraine’s exports.   

“These higher costs are a drag on the recovery from the pandemic as households and businesses find themselves with less spending power to release their pent-up demand.” 

  • US monetary policy  

In the US, headline and core inflation are at a 40-year high – about nine per cent and six per cent respectively.  

“The Fed is working to get its credibility back and looks willing to force a recession to get inflation and inflation expectations under control.” 

  • Markets 

“The prolonged volatility is a dampener for investment appetite, and the losses accumulated by investors, savers and retirees add to the fragility of the post-pandemic recovery,” says Dr Henderson. 

“Once we navigate these shocks, we have other headwinds operating in the global economy which will reinforce insecurity and the desire to save additional income rather than spend freely.” 

These megatrends – structural factors operating in the global economy in the background — include:  

  •  An ageing population 

 This brings slower growth with an increased tendency to save or to spend more carefully. 

  • Rapid technology change  

“Generally, innovation is positive for growth but if it is too fast, it creates a mismatch of labour skills and job opportunities which foster insecurity among households,” Dr Henderson said. 

“Covid lockdowns have accelerated that digitisation push, so it could be a decade or more to address these skills gaps.” 

  • Climate stress 

“Weather shocks hurt growth, deplete policy space and lift costs. They also require more spending for infrastructure, defence and replacement, which takes away from productive investment.” 

  • Financial imbalances 

Years of extreme monetary policy have fostered low returns, requiring savers to put more cash aside and investors to take on riskier investments. Low returns also mean less spending power for retirees, an increasing share of the population. 

  • Deglobalisation  

“We are witnessing a pushback against globalisation which is coming in many forms, such as Brexit," Dr Henderson said.

"The increased nationalism will increase costs and slow growth. 

“Altogether, over the next decade, global growth will likely be slower and inflation higher, relative to what we’ve experienced in the past two decades.” 

Ai Group’s Dr Wilson said these shocks and megatrends were reshaping Australia’s economy. 

He said the three immediate shocks affecting the Australian economy and business were:  

  • labour shortages, 
  • supply chain interruptions and  
  • the rising cost of capital. 

And the megatrends that will shape Australia next year and beyond will be:  

  • migration, 
  • commodities and  
  • investment. 

“Australia has only just emerged from the Covid recession of 2020, which is historically remarkable given its depth and length,” Dr Wilson said. 

“As public health restrictions clamped down in 2020, the economy collapsed at an unprecedent rate, but aggressive fiscal and monetary stimulus aided by closed borders saw an almost as-quick rebound.” 

The Australian economy has since been roaring back to life which poses some of Australia’s major challenges today. 

First, the Australian labour market is “tight as a drum” following border closures. 

“Not only did we fail to get migrants for two years, but many people left Australia, particularly international students who returned home after finishing their studies,” Dr Wilson said. 

It meant extreme labour shortages developed when the economy roared back to life a year ago. The winter Covid wave is causing added stress with a fresh spike in absenteeism. 

A related shock is supply chain disruptions. 

“The whole world has suffered these, but Australia is especially exposed,” Dr Wilson said.  

“As an island, we are subjected to more logistical issues than others. We also have a highly specialised economy more broadly reliant on imports.”  

Surveys show supply chain disruptions have become a major constraint on business activity, with 41 per cent of businesses affected across the economy.  

In every surveyed industry, supply chain pressures today are more intense than they were during the height of the pandemic a year ago. 

Adding to that is the shock of interest rates and the rising cost of money. 

This began as an external shock to Australia, driven by global inflationary pressure: steadily building supply chain issues for two years and a dramatic spike in food and energy prices earlier this year owing to the war in Ukraine. 

The Central Bank has been forced to raise interest rates to manage growing inflation from 0.1 to 1.35 per cent in just three months. 

“While necessary, this puts additional demand-side strain on the economy, reducing consumer confidence and spending,” Dr Wilson said. 

Looking beyond 2022, the Australian Government needs to consider the role migration will play in driving the economy, both in terms of supply of labour and skillset. 

“There is intense global competition for migrants, particularly in skilled sectors like IT, engineering and health care,” Dr Wilson said. 

“Every Western government is desperately seeking workers in these areas. Australia will have to compete in a much tougher market than previously.” 

Commodities need to be future proofed.   

Our dependence on commodities export is deep and narrow, Dr Wilson says.  

Three minerals – iron ore, coal and gas — account for the lion’s share, comprising $267billion of exports last year; 58 per cent of the national total.   

“The medium-term outlook for these three is somewhat cloudy: coal has been retrenched from global energy systems as countries transition to net zero and gas will eventually face a similar fate when it runs up against the falling cost of renewables,” Dr Wilson said. 

“The key question is: can Australia pivot its export basket towards new climate-proof resource industries?” 

There might be a new big three to come in: 

  • lithium, to make batteries; 
  • critical minerals such as rare earth to power green technologies such as electric vehicles (EVs) and  
  • green hydrogen.   

“Can Australia move from the old big three to the new big three?” Dr Wilson said. 

Finally, Australia is underperforming when it comes to investment. 

Global foreign investment flows collapsed in 2020, but most countries quickly snapped back to pre-pandemic levels in 2021.  

“Unfortunately, Australia is the outlier owing to its closed borders,” Dr Wilson said. 

“The 2021 Foreign Direct Investment performance is still 42 per cent down on what it had been prior to the pandemic. This is quite a challenge.” 

Foreign investment brings capital, technology and marketing channels to the Australian economy. 

“We’re seeing a lot of weakened economic conditions in major senders of that investment, principally for Australia, Europe and the US,” Dr Wilson said. 

“That’s going to dampen supply, even when commodities prices come off the boil.  

“Australia needs to look at what we can do to maintain our investment competitiveness, given how important this is to our economy.” 

Mark Tierney, AustralianSuper Global Economist Investment, said focusing on the supply side of the economy was crucial. 

“We need to build up employment and investment to boost supply and get the resilience we need,” Mr Tierney said.  

“The prime drivers of inflation globally have almost always been supply shortages, and the only way out of this is going to be a vast increase in supply.” 

The demand for raw materials will be huge.  

“We’re talking about a vast increase in investment,” Mr Tierney said.  

“We need to be cognisant that none of this spending is optional. Whether it is on the energy transition, technological change, defence, climate change adaptation – none of it is optional. It is going to be spent by the private sector with government incentives. 

“Once we get through this period, we are going to go through an investment boom the likes of which the world has never seen.  

“The opportunities are lip-smacking from an infrastructure investment viewpoint. From a domestic viewpoint, that is incredibly exciting.  

“The offset is that the models that businesses have been operating on over the past 30 years are kaput. The idea of huge population inflows through migration and cheap labour – they’re gone.” 

Households will pay the price. 

“This will be decades of history being turned on its head where households – whether it’s through housing or personal consumption — have been such large drivers of growth,” he added.  

“That’s not tenable under this sort of scenario. Policies will have to be maintained to try and suppress household suspending. 

“Even with faster wages growth, it will be necessary to allow this investment to take place.” 

The labour market will also need to be restructured. 

“People will have to shift out of the old industries and into the new,” Mr Tierney said. 

“It’s no different to a century ago when people had to shift from agriculture to manufacturing. Certain industries and certain companies will lose, whether in the household sector or whether in the old industries that can’t get employees.  

“No one should be starry-eyed about this and assume that once we get through this difficult period, the sky’s the limit. Structural adjustment is going to be immense.   

“It’s a great cause for enthusiasm but there are risks coming down the pipeline, as well. 

“It’s going to be up to policy makers to make certain the risks are much lower than the opportunities.” 

 

Wendy Larter

Wendy Larter is the Senior Content Writer at Ai Group. She is a journalist with more than 20 years’ experience as a reporter, features writer, contributor and sub-editor for newspapers and magazines including The Courier-Mail in Brisbane and Metro, News of the World, The Times and Elle in the UK.