Australia is not heading to a recession … yet

It’s official: Australia’s glory days might be truly over.

The Bureau of Statistics yesterday released the latest economic growth figures, and they present sobering reading.

Economic growth for the June quarter was a snail’s pace 0.2 per cent – compared to market forecasts about 0.4 per cent – and growth for the year was a sluggish 2.0 per cent.

The most significant cause of this was a large decline in exports, which fell by 3 per cent during the quarter. Also contributing were reduced mining production (down 3 per cent) and construction activity (down 0.6 per cent). Profits are also down 4.4 per cent. Growth is the worst in more than two years; and yearly nominal GDP growth is the worst in more than 50 years (since 1961-62).

But the news is actually even worse than this. Commentary usually focuses on the economic growth figures (the figures for GDP). This figure essentially measures the amount of economic activity in the economy. But the numbers that matter for living standards relate to income per person. Over the quarter, the best measure of income (real net national disposable income per capita) fell by 1.2 per cent.

This indicates there is a genuine decline in living standards for Australia – and this measure of income is now 2.5 per cent lower than it was in December 2013. This is mainly happening because of declining terms of trade: a measure of what our exports buy overseas.

We shouldn’t be surprised the economy is slowing and incomes are stagnating or falling. This was always going to happen when the mining boom ended. What we should be surprised about is the size and scope of the slowdown, despite the Treasurer saying the figures were in line with budget expectations. We should also be disappointed in the failure of Australia’s political system to adjust to the new realities.

The scope of this slowdown will put added pressure on Tony Abbott’s Government. The budget forecasted that the economy would grow by 2.75 per cent the current financial year (2015-16); if the current annual growth rate of 2.0 per cent continues, the budget hit this year will be approximately $2.2 billion worse off (broadly based on budget sensitivity analysis).

But this isn’t the worst possible scenario. If the current quarterly growth rate of 0.2 per cent continues for the whole of 2015-16, then annual growth will be a glacial 0.8 per cent, and the budget will be $5.6 billion worse off. Of course, growth for the year could be even slower than this. Under any of these scenarios, the options for Abbott to announce plenty of pre-election spending goodies will be limited.

Nevertheless, do the results today mean that Australia is heading to a recession?

No. Not Yet.

Australia has now had 96 quarters without a recession, since 1991 – against many pundit’s gloomy forecasts over the period. We are still growing, albeit slowly. As a result, we are on track to beat theNetherlands’ record for developed countries of 103 quarters without a recession (from 1982 to 2008).

Despite there being less wriggle room, the Reserve Bank still can act and the dollar could fall to absorb major shocks.

Nevertheless, there are many pitfalls ahead, as the ABS figures indicate. For starters, Australia’s growth keeps relying more than it should on government consumption, in spite of interminable – and largely ineffectual – discussion of fiscal restraint. In addition, the switch from mining investment to non-mining is still yet to occur.

Furthermore, a deteriorating terms of trade keeps eroding any gains to income from expanding trade volume. And there is limited evidence of improvements in productivity.

These factors are important for understanding the potential risks of Australia entering a recession. Our inability to tame budget deficits mirrors the difficulty with undertaking much-needed structural reforms. For one, the recent debate on tax reform is a classic example, where most of the talk is about increasing taxes instead of enabling productivity-enhancing changes.

Moreover, the sharp fall in commodity prices is a constant reminder that good trade winds don’t last forever – with dire repercussions for Australia’s living standards.

Most of the recent glory days are due to China and its voracious appetite for anything Australia digs out of the ground. In this respect, recent developments in the Chinese stock exchange are not good omens for what is to come. Granted, the impact of plummeting share prices is somewhat overstated – less than a fifth of China’s household wealth is invested in its share market and much of share price falls were merely a correction.

However, a hard landing in China is not out of the question. Indeed, a mix of bad government responses and high public debt levels (around 250 per cent of GDP, almost doubling since 2008) are much to worry about.

If the worst happens in global markets, Australia is left with the main option to move forward by pushing domestic reform. But make no mistake: better to act early and not wait for a second “recession we had to have” to pave the way for a record-breaking period of uninterrupted growth.

Dr Patrick Carvalho and Michael Potter are Research Fellows at the Centre for Independent Studies.