AUSTRALIA'S PLACE IN THE GLOBAL ECONOMY

Lockdowns and Slowdowns in Australia's Service Sector

Insights

What Has Happened?

In 2019, Education, Tourism and Financial Services were the strongest growing Australian exports, employing 75% of the workforce whilst comprising 20% of exports, contributing to Australia’s narrow export base. This was largely driven by Chinese Australian bilateral trade facilitated through ChAFTA (2015) and their increasing middle-class, anticipated to increase from 300-600million people by 2025. Since the global COVID pandemic, tourism and education services in particular have been significantly damaged.

   

Figure 1: Upward growth in services mirroring that of Resources (albeit at a lower value), prior to a COVID induced slowdown (RBA, 2020)


The Australian tourism sector generated $60b in direct GDP increases.Supported by international travel, Chinese tourists spent $12b in Australia(2018), where 44% of all tourism earnings are channelled into regional destinations, supporting local economies. Under severe travel restrictions projected to last into 2021, tourism’s economic benefit has been squashed.

 

Australian education exports are the economy’s third largest export, valued at $32b, only behind lucrative iron ore and coal sales. In 2019, Australia hosted 6% of total global international students, notably from the Asia Pacific including India and China, boosted by increased domestic educational attainment rates. As travel is restricted and education has undergone dramatic changes to maintain service, Education exports are anticipated to significantly contract. In April, Sydney University’s reliance upon international students is expected to cause a $470m loss, a stress commonplace in the entire education sector.

Moreover, the Australian Industry Group’s ‘Performance of Services Index’ (PSI), which measures overall domestic services performance, has fallen by more than 60% over the past 6 months, therefore confirming the dire outlook for employment in Australia’s most important and impactful industry. 

Figure 2, PSI Graph: significant contraction from Jan 2020 to Apr 2020, reinforcing the fall in service performance.

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Unemployment

Australia’s service industry has been a long term ‘safe haven’ employment centre, where those with limited skills can find jobs and improve through training, shifting into higher paying roles with greater efficiency, improving occupational mobility. 

Global travel restrictions and reduced economist confidence will significantly increase sector unemployment; In hospitality, accommodation and food services, closely related to tourism exports, unemployment increased by 33% (April 2020). Further, education and financial services will both experience a 12.5% increase at minimum, in industry unemployment (Grattan Institute)

Additionally, the large proportion of unemployed individuals are in low skilled positions, thus worsening income distribution as those with lower incomes are increasingly subject to economic contractions and the threat of a domestic recession. Over 25% of all employees under the age of 20 have become unemployed, often the group with the lowest skill and income levels, whilst higher skilled employees maintain a high degree of employment.

However, the significant majority of these unemployment increases are cyclical in nature. This means that once the economy returns to its medium-term growth targets, unemployment will likely subside as individuals return to work. It is integral that the government manages the threats of ‘hysteresis’, where short term cyclical unemployment transforms into long term structural unemployment considered a costly economic ‘wicked problem’ resistant to change.

Balance on Goods and Services and Trade

External stability refers to the ability of the Australian economy to finance its external financial obligations with the rest of the world, whilst supporting its own internal financial obligations.

Increased unemployment and reduced export volumes will contribute greater to the Balance on Goods and Services (BoGS, (X-M) deficit, therefore increasing the cyclical component of Australia’s long-term Current AccountDeficit. This effect is likely to materialise as imports remain constant - Australia is a net importer of Simple Transformed Manufacturers, electrical goods and capital goods, which are still in demand as Australia is anticipated to experience a fast-domestic economic recovery. Thus, exports are likely to reduce without any changes to imports. 

The government may also increase fiscal support to secure employment inAustralia’s fastest and most important exporting industry. This will worsen Australia’s existing budget deficit, and via the twin deficits’ theorem, increase Australia’s CAD. This is because the twin deficits theorem, given as;

(M-X) = (G-T) + (I-S)

This states that an increase in a budget deficit (where government expenditure > taxation) leading to an increase in CAD, represented as (M-X). 

Aggregate Demand and Aggregate Supply

Reduced sectoral employment will constrain economic growth in two ways

  1. As unemployment increases, income reduces, and consumption decreases as more individuals increase savings. Because consumption contributes on average 60% to total Aggregate Demand levels this will reduce AD, reducing national income/output and price level

Figure 3 Decrease in AD: results in a decline of quantity/national income from Q1 to Q2 and correspondingly, a decrease in the price level from P1 to P2.
  1. Unemployment and Inflation have an inverse relationship via the Phillips Curve. Under the past treasury view, the government often prioritised inflation control over unemployment.However, in the modern economy, unemployment is prioritised as a more important issue. This often leads to government fiscal expenditure such as JobKeeper to regulate unemployment, as a budgetary expense. Consequently, this draws valuable resources away from potential government sectoral investment which increases dynamic and technical efficiency, therefore reducing Aggregate Supply whilst increasing price level and decreasing output.

Figure 3 Decrease in AS: often considered economically ‘worse’ than a decrease in AD as there is both a decrease in Q from Q1 to Q2and an increase in price level from P1 to P2

Moreover, Australia’s potentially worsening external stability may impact economic growth levels through fiscal expenditure. As the government increases net government debt to support growth and employment in Australian services, the government may increasingly borrow from the private sector to fund spending.

This increase in the quantity demanded for loanable funds increases the equilibrium price of loanable funds, the interest rate, from P1 to P2. The higher rate of interest may be perceived too costly and may incentivise domestic producers to reduce/cease investment. A decrease in private sector investment will result in a decrease of AD, and therefore output levels. Thus, the crowding out effect can undermine the government’s ability to stimulate economic growth and the service sector. 

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