Between the lines: Three factors that helped Australia avoid recession

Published on Thursday 20 August 2009 21:33

RECESSION has gripped every developed country in the world, right? Wrong. Australia has escaped recession and its economy, though fragile, looks as though it will show growth, not contraction, this year.

There are three main reasons: luck, shrewder bankers and some far-sighted policy thinking. This last point is extremely interesting, for it offers a clear lesson in what our government should have done. This carries a big "but" though, for if Gordon Brown as chancellor had followed the Australian prescription, Labour would almost certainly have lost the last election.

The facts are these. After recording a fall in GDP of 0.5 per cent in the last three months of 2008, the economy then grew by 0.4 per cent in the first three months of this year. And since a recession is defined as two successive quarters of negative growth, Australia has avoided the great recession plague.

That's what the statistics say anyway, though there are plenty of voices pointing out that out on the streets of Sydney and Melbourne, it still feels like a recession. That is because other figures on the number of hours being worked, the country's total wage bill and money being spent by households have all been heading downhill since last October. Unemployment is steadily rising and is forecast to peak next year at 7.5 per cent.

This is where the luck comes in. Australia is well endowed with natural resources, one of which is iron ore. China is now consuming vast quantities of iron and is still growing at a fast clip. And in the first quarter of this year, the Chinese bought a record quantity of Australian iron ore, enough to boost the quarter's GDP by a record 2.2 per cent. Without that boost, Australia would have been in recession.

No wonder Aussies refer to their homeland as the lucky country. This, it should be noted, stems from the title of a 1964 book by Donald Horne, an intellectual and journalist. Actually, it is meant to be an ironic reproof to his countrymen, for relying too much on mineral exploitation and failing to invest in new technologies. Luck, however, is only part of the story.

The second part is that the major banks have, for the most part, escaped largely unscathed from the financial crisis. They were heavily exposed to the wholesale money markets and required support from the government to see them through the money market seizure of 2007-8.

The need for that support eased off pretty quickly, however, as it emerged that Australia's banks were not heavily exposed to the subprime mortgage securities that weighed down American and European banks and gave them crippling losses.

A lot of that was because Aussie bankers had some bad experience of the US mortgage market long before the credit crunch. National Australia Bank, for example, owner of the Clydesdale Bank, lost several billion dollars through the purchase of Homeside, an American mortgage company. The brutal lesson from this episode was that the Australians did not fully understand how the American mortgage market worked, which served to warn them to stay out of it.

The third part of the story concerns government and central bank policy. Like Gordon Brown, Australian prime minister Kevin Rudd produced a big spending stimulus package of 26 billion last winter and he cut personal taxes and increased pensioner payments this spring. While a lot of the fiscal stimulus has been used by Australians to reduce debt and increase savings, enough is filtering through in spending to keep retailing afloat.

But what marks Australia apart is interest rate policy. While the British and American central banks kept interest rates relatively low at about 5 per cent in the early part of this decade, Australia's central bank edged its interest rate up until, by September 2007, it was 7.25 per cent.

Like other central banks, it has since cut rates in response to the recession, but Australia's central bank rate is still at 3 per cent. While most central banks use interest rates to control consumer price inflation, Australia's appears also to have had an eye on asset price inflation.

The effect of the higher interest rates was not to dispel the house price boom experienced in Britain and America, but to damp it down. Like everywhere else, the Australian housing market suffered a contraction last year, but now it appears to be picking up again quite sharply, having the knock-on effect of ensuring the building industry has not suffered too much damage.

An interesting lesson. But what do you suppose would have happened here if the bank of England had pushed interest rates up to, say, 7 per cent?

The screams from manufacturing industry and the trade unions would have been deafening and manufacturing bankruptcies would have multiplied. There is still no easy answer to how to manage the economy and avoid crises.

Comments and criticisms welcomed at: [e-mail]