Abbott takes aim at Australia’s foot

Don't be fooled by a strong GDP result. There are clouds on the economic horizon, which will darken as the government continues to batter consumer confidence while exports are under pressure.

All the forecasts point to a strong result for first-quarter GDP growth when the national accounts are released on Wednesday, but while the Aussie dinghy is sitting in calm waters and warm sunshine at the moment, there are storm clouds up ahead.

It looks like March quarter GDP was hit by two beams of sunshine: housing investment lifted domestic demand and a burst of iron ore imports by China lifted net exports. Neither will continue.

The Abbott government’s decision to attempt two big, controversial social reforms (university fee deregulation and GP co-payments) at the same time as increasing taxes and freezing welfare indexation has produced a sudden collapse in consumer sentiment, and increasingly looks like a shot to the foot.

China’s problems are also self-inflicted. The authorities there are simultaneously battling air pollution and the credit boom, both of which were allowed to get out of control.

China’s war against credit and pollution, through tight monetary policy and factory closures, will cost it growth and cost Australia exports.

At the same time, both Europe and America are struggling. The European Central Bank is expected to try some more monetary stimulus when it meets this week, to try to force the euro down and get the banks lending, while in the US business investment has stalled and rising inequality is suppressing household demand.

Opening up tertiary education fees to competition between universities might be a wonderful idea and might drive fees down, as Education Minister Christopher Pyne argued yesterday.

Then again, it might be a rubbish idea. The university business might turn out to be what it seems: an oligopoly with a few powerful players able to set prices. Already, one of the most powerful, the University of Melbourne, has foreshadowed fee increases of up to 61 per cent.

Will Monash Uni really slash its fees instead and go after Melbourne’s market share? Hard to say.

Either way, it’s a big reform that is going to cause disruption and uncertainty, and it was a courageous idea to do it at the same time as bringing down the traditional horror first budget.

Likewise, imposing a price signal onto doctor visits with a Medicare co-payment might be a good idea too. Something has to be done to limit health costs.

Except the government has decided to channel the money off into a Medical Research Fund, which is tasked with finding more things to go to the doctor for, instead of improving the budget bottom line. In any case, it seems pretty clear that the Medical Research Fund has not softened the blow to consumers of the $7 co-payment.

Bottom line: the government has taken a mallet to consumer confidence at the same time as exports are coming under pressure.

China’s industrial production growth slowed from 9.7 per cent in 2013 to 8.7 per cent in the first four months of 2014.

The sharpest decline happened in the most polluted areas, in particular Hebei province around Beijing, where IP growth fell to below 4 per cent. The dramatic slowdown in Hebei coincided exactly with the State Council’s introduction of its “Action Plan for Air Pollution Prevention”.

Societe Generale’s economists have surveyed all regional data across China and found that the more polluted the region, the greater the slowdown. The six provinces with the highest level of pollutants accounted for 1.3 percentage points of the 1.7 per cent deceleration in the past seven months.

The Action Plan is resulting in factory closures and a campaign to replace coal with renewable energy. A new Environmental Protection Law becomes effective from January 2015, which will introduce penalties that compound daily for polluting factories in place of the previous one-off charge. Also, local officials have to assume responsibility for the oversight of breaches.

The impact of all this on China’s economic growth and its imports for coal and iron ore from China has been underestimated.

Meanwhile, the monetary authorities are living on a different planet, tightening interest rates even as the economy slows sharply and prices decline. Indeed the risk of deflation in China appears almost as great as it is in Europe.

On top of that, China’s export markets in Europe and America look increasingly challenged, with slow growth and weak consumer demand.

The bottom line is that the Chinese government’s target of 7.5 per cent growth is looking optimistic. Already, growth has slowed to 7.4 per cent in the first quarter of 2014.

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