Life on the West Island - Shuffling the deckchairs

By many measures, the West Island economy is in good shape, with unemployment close to record lows, exports booming, the share market pushing all-time highs and a record federal budget surplus. Yet our media is full of reports of a “cost of living crisis” and “a massive housing shortage.” Economic gloom and doom is dominating the national debate. So what is really going on and how did we get to this situation?

The answer lies in the actions of the former coalition government and the Reserve Bank, which distorted the national economy by artificially stimulating the wrong sectors, then cracking down hard on ordinary workers and families. They consciously created property booms, subsidies and tax dodges, which have seen massive cash flows to the rich and to large corporations and away from the poor and disadvantaged. To an extent, the Albanese government is trying to reverse these trends with some measures to reduce cost of living pressures, but without much bolder action, inequality will continue to worsen. So far, the policy initiatives taken could well be described as too little, too late, or even worse as equivalent to shuffling the deckchairs on the Titanic.

There is common agreement that the policy decisions and public utterances of the Reserve Bank have been major factors in creating the current economic problems. Their pronouncements that interest rates would remain at historic lows for at least two further years kicked off a mad boom in housing prices, which saw millions of buyers rush to buy overpriced properties, repayments on which they could not afford if interest rates rose. As well, many of the buyers were property speculators and investors, not the “mum and dad” households claimed to be in the market.

Then the Morrison government made matters much worse, maintaining inequitable tax breaks on capital gains and negative gearing, encouraging dodgy “investors” to lock out first home buyers and ordinary families from buying into housing by pushing prices to ridiculously high levels. To make matters far worse, Morrison then launched a scheme to pay cash subsidies to property owners for house renovations. This had several drastic ramifications: rental properties were withdrawn from the market, upgraded and shifted to Airbnb, while the sudden increase in demand for tradies and materials caused severe shortages in supply chains and inflated the costs of many materials. (An ironic side effect was that many small builders could not fulfil their fixed-price contracts and went into liquidation, leaving jobs unfinished and homeowners out of pocket.)

At the same time, the national government poured almost $20 billion into subsidies to large corporations which, rather than needing such handouts, were garnering record profits, then refused to claim back these windfall payments, leaving ordinary taxpayers holding the bill.

When inflation caused by this combination of misguided policies began to zoom, the Reserve Bank belatedly realised that it had made a mistake and began to lift interest rates at a rapid rate, assuming that unemployment would rise, wages would stagnate and the economy would slow down, thus limiting inflationary pressures. On most counts, it was wrong but it continued willy-nilly with 12 interest rate rises, only to see inflation remain “stubbornly high,” in its own words.

Forced to act, the Albanese government appointed Michelle Bullock as the new Reserve Bank governor, saying she would bring a “fresh perspective.” Respected senior economist Jim Stanford begged to differ: That’s a stretch, given that Ms Bullock has worked at the RBA since 1985. And no one expects her to change course on interest rates. If indeed Ms Bullock brings fresh eyes to this role, let’s hope she uses them to review a broader range of the factors causing inflation – rather than focusing myopically on the dangers of wage growth, like her predecessor Dr Philip Lowe.

From the outset of the current inflation, Dr Lowe focused squarely on labour costs as the biggest worry – while rejecting that record corporate profit margins had anything to do with high prices. He looked only to one side of the tracks in analysing what caused inflation – and what to do about it. That put him out of step with other central banks and many international institutions, which have produced volumes of research confirming higher profits accounted for the largest share of inflation since the pandemic.

This evidence that record profits, not undue wage growth, fuelled post-COVID inflation sits uncomfortably with economic orthodoxy, which asserts by rote that inflation always results from overheated labour markets, excess demand and rising wages.

Will Ms Bullock more honestly consider this evidence, and adjust her policy approach accordingly? Her recent speech claiming that unemployment must rise to reduce inflation does not inspire hope.

International experience is now confirming the importance of lower profits to lower inflation. In the US, for example, profits eased 8 per cent over the past six months, as inflation fell from 9 per cent to 3 per cent. Wage growth has hardly changed at all.

In Spain, an unconventional combination of policies – including price caps, excess profit taxes, and subsidies to low-income consumers and renters – has kept profits at or below historic norms. Spain’s inflation fell last month to just 1.9 per cent, the lowest in Europe.

The UK experience is the polar opposite. There, profits have kept soaring as companies exploit desperate consumers and still-fractured post-Brexit supply chains. Profits grew 17 per cent in the past year, three times faster than wages. Not coincidentally, inflation remains at a painful 8.7 per cent.

Australia, unfortunately, is closer to the British end of this spectrum. Despite falling world energy and commodity prices, corporate profits grew another 13 per cent in the past year, much faster than wages. The profit share of GDP remains at an all-time record high of 29 per cent. Real wages are still falling. And inflation is still high – 7 per cent last quarter.

How do we get profit margins back down, supporting both lower inflation and a restoration of real wages? Many policies would help: Price caps on essential products (like energy and rents), taxes on excess profits, support for wages to catch up, and limits on corporate concentration.

Ms Bullock could turn over a new leaf in RBA thinking by casting her “fresh” eyes more widely over both macroeconomic data and cumulating international research. And she should then acknowledge that the bank’s single-minded focus on suppressing wages has been neither fair, nor effective.

So, will we see a reversal of RBA actions or some bold policy changes by the West Island government to rein in profit gouging and restore some balance to the housing market? The current omens are not good, as we continue to see them simply reshuffling the deck chairs on the Titanic.