The Joe Walker Podcast - On Recessions - Andrew Charlton

Episode Date: December 6, 2018

Andrew Charlton is a Rhodes Scholar, economist, author and former prime ministerial adviser.See omnystudio.com/listener for privacy information.

From Swagman Media, this is the Jolly Swagman Podcast. Here are your hosts, Angus and Joe. Hey guys, Joe here. Welcome back to the Jolly Swagman Podcast. This episode is a short conversation I recorded in March of 2018. Originally, we intended for it to be part of a supercut on the Australian housing market, but while that project has stalled, I thought I'd release this conversation as an episode in its own right.

Now, you may have heard my conversation with former Australian Prime Minister Kevin Rudd and how he helped Australia narrowly avoid recession during the global financial crisis. Well, he didn't do it alone, of course, and his senior economic advisor at the time was a young man, a 29-year-old, in fact, by the name of Andrew Charlton, and he joins me as our guest. Andrew has a master's and a doctorate in economics from Oxford University, where he studied as a Rhodes Scholar. He's authored books, including Fair Trade for All, which he co-wrote with Nobel Prize winner Joseph Stiglitz. And he did, as I mentioned, help Australia coordinate its fiscal

response and policy response to the greatest economic and financial calamity the world has seen since the Great Depression. Many regard him as a future Labor Prime Minister, and he's now co-founder and director at his own strategic consultancy, Alpha Beta Advisors. In this episode, I really wanted to hear from him exactly what a recession would mean for Australia in terms of the human cost, how we can avoid one, and what he thinks is likely to happen in the Australian housing market. Now, please bear in mind this was recorded in March, as I mentioned, and a lot has happened for the property market in the intervening eight months. So keep that in mind and please enjoy this chat with Andrew Charlton.

So Andrew Charlton, thanks for joining us. You were in Rod's economic team that helped us avoid the global recession. So we can kind of hold you responsible in part for Australia's, we're now heading into 27 years of continuous economic growth. How's history, but it's also a record for the world. It's the longest period that any advanced nation has ever gone without experiencing a recession. So it's quite an unusual event and one that Australians should be very proud of. I've heard you talk about the metaphor of the twin engines. Can you explain what that means?

Sure. I mean, Australia's extraordinary period of unbroken economic growth is partly a consequence of the dynamics of our economy. We've been particularly lucky over that long period to have relatively synchronised booms in the housing and commodities markets. And if you think of Australia as an airplane, it sort of has twin jets. One is the resources economy, and the other is the housing market. And as a twin jet plane, it can keep flying if one of those is out, and we've performed relatively well through resources busts

thanks to the fortuitous growth of the housing market in those periods, and vice versa. And we've been lucky over the last quarter of a century that when the housing market has been weak, the commodity market has been strong and vice versa. And to what extent is that synchronicity a result of luck or government policy? I think it's a bit of a combination of both. Obviously, the housing market is strongly influenced by monetary conditions, principally interest rates. And for example, during the financial crisis, we had a huge drop in commodity markets. But in response, or at least partly in response to that, the RBA dropped interest rates by 400 basis points

and the government put in a range of fiscal stimulus measures to boost the housing market. And at a time when the global economy was crumbling around Australia, we had a huge uptick in Australia's housing markets, first-time buyers rushing in, lots of activity, house prices going up in Australia when they were going down in many other parts of the world. So it's partly a combination of good timing and partly a combination of policy responses. So how many engines are we running on at the moment? Well, there's no question that monetary conditions are obviously still very accommodative and the housing market in Australia is still very strong, albeit prices are decelerating in some markets. The outlook for commodities is reasonable. Maybe we might see the terms of trade dropping off a little bit

over the next 24 months. Overall, I think the metrics in Australia at a high level are pretty strong. There are some really significant vulnerabilities, but if you think about those high-level metrics, growth, employment, investment, they're all in relatively good shape. So let's talk about the the vulnerabilities um i i turned 26 a few weeks ago and most people in my generation would never have experienced like don't know at a visceral level what it feels like to be in a recession we've known nothing other

than growth um what would it i mean what would it take uh as far as the housing market's concerned to see Australia fall into recession? Well, we don't know what the cause of the next Australian recession will be. We know that one will come, but we're not so good at predicting when or why. Certainly the housing market is a source of vulnerability. Australians have built up very significant liabilities, particularly housing debt. And they've built that up at a time when interest rates are very, very low, in fact, lower than they've ever been in our history.

So a significant rise in interest rates would obviously create a lot of stress in the housing market. But the RBA is alive to that risk and to the extent that they can control it, they'll certainly try to. And if the housing market crashed, we would definitely be in a recession? Yeah, I think a significant deterioration in the housing market would be very challenging for consumers and that would have flow-on effects to other parts of the economy. You know, you asked me what it's like to be in a recession. You know, it's a really unfortunate thing.

It means that people's life opportunities diminish in that time and that often has quite long-lasting effects. Young people coming out of school, graduating from university during a recession, they want to get that first job on the ladder of their chosen career and then they take it from there. In a recession, those jobs aren't available in some cases and so they can't move into the career that they want

or they move into an inferior job or they spend time out of the labour market and that affects them their whole lives. Some recover and go on to have wonderful careers, some don't. But a recession is a very painful time for people, but it also has long-lasting effects, particularly on the young people who are starting their careers in recessionary times. It's long-lasting psychological effects, career effects? Yeah, those young people

who start their career in a recession often aren't able to enter the careers that they want the jobs that they were normally available suddenly shrink and aren't there and that means they walk down a different path in their lives they might take a job that wasn't quite as good as the job they would normally take in better times or isn't in the same field as their optimal job. And because lives are path-dependent things, it's often hard for them to get back on track even over a very long period of time. That doesn't mean they won't find other great things to do,

but it does have a long-term effect on people's lives I've heard you speak about the idea of working on problems with a slow urgency can you first explain what that approach means and secondly is the the housing market and the inherent fragilities there are those problems capable of being worked on with a slow urgency at this point in our history well dealing with problems with slow urgency is about finding solutions to big problems but implementing them gradually the types of problems that I think lend themselves to slow urgency are very big problems that can be fixed over long periods of time.

And they're not, they're often, for example, climate change I think is a case in point. We could introduce big bang policies to address climate change and that would have a big effect on the economy. Or we could implement policies that built up very gradually over time and in 10 years built up from nothing to a significant effect. Now, lots of people will be very dissatisfied with the slow pace of that type of solution,

but it's been 10 years since we tried to implement a carbon pollution reduction scheme in Australia and there's still no scheme. So trying for big bang policies, I think often results in nothing getting done. And the housing market, I think, is another set of issues that lend themselves to this type of solution. If people are worried about negative gearing and they think that's a problem, there are ways to implement that type of policy very, very slowly. And maybe it would come in gradually over a 10-year period or a 15-year period,

but it would mean that over 15 years that problem is substantially addressed rather than the solution we have now, which is constantly arguing about what to do and ultimately doing nothing. Where do you sit personally on the question of the housing market and its future? Are we headed for a crash? Well, there's no question that house prices in Australia are very high and they are prohibiting a lot of young people from getting into the market. The key variable here is what is a house price.

And in my view, the meaningful number here is not the price on the sticker. It's not the half a million dollars or million dollars that a house costs. That's not a relevant number for most Australians because you don't turn up at an auction and hand over a million dollars in cash. The relevant price in terms of your affordability is your monthly servicing bill, which is a combination of principal and interest. That's the price that Australians pay for housing. And the reality is that that number, as a proportion of Australians' income, actually hasn't increased very much.

The real price that Australians pay, the amount that comes out of their bank account each month to service their housing costs, for most people that's a mortgage, hasn't increased very much as a proportion of income over the last 15 years. And the reason for that is that although the sticker price has gone up very materially, interest rates have fallen and have offset that. So the average mortgage bill as a proportion of Australia's income over the last 15 years has been relatively stable.

And so for that reason, I don't expect there is any need for a very significant correction, other things being equal. Of course, if interest rates rise materially or there's some other shock to household incomes, then yes, the housing market would potentially become very unstable. But the key variable here is not the price that you see on domain.com or realestate.com. It's the price that leaves your bank account each month and that actually is no higher than it's been for a decade does the issue of mortgage fraud concern you does a little bit like this UBS report was pretty explosive yeah big numbers yeah look and this is, this is a qualitatively different problem

to the problem that precipitated the subprime crisis in the United States. How so? Well, the low quality of loans in the United States was a much bigger issue than it is in Australia. People with... We're not talking about slightly overstating incomes. We're talking about people without jobs,

on long interest-free or low-interest periods with significant ratchets. These massive perverse incentives in the mortgage broker market, and some of those problems exist in the Australian market, but you would have to say they were of a significantly less severe magnitude. If you just look at those high-level metrics about the number of Australians in mortgage stress, there are people in mortgage stress. It varies a bit by city and by pockets within cities, but right now this is not a widespread phenomenon in Australia.

So just finally, what do we need to do going forward to ensure that this prosperity continues? I mean, I know you mentioned that at some point we will have a recession. I guess that's just regression to the mean. You can't keep growing ad infinitum. But to ensure that when it happens it's not severe or that we at least keep growing into the foreseeable future, what can we do as a country?

Well, you know, over the long run what matters to our national prosperity is our productivity growth and right now that's really low. So, you know, it's fantastic that Australia has recorded a quarter century of unbroken growth. It's terrific that the outlook for commodity prices is okay, but the reality is over the long run, if Australia is going to be prosperous, we need to have high productivity growth.

In the short run, you can deliver prosperity through rising credit metrics, commodity booms, et cetera, et cetera. But in the long run, it's productivity growth that matters. And so for that reason, we should all be very alarmed at the very low rate of productivity growth in Australia today. Australia isn't unique in having low productivity growth. That's a feature of many economies around the world. But it is a concern that some of the major drivers of our economic

growth in recent times haven't been related to those long-term drivers of prosperity. They've been credit, commodity prices, wealth effects from housing. So we need to do everything we can to improve productivity growth, and that's a whole range of small actions around improving the competitiveness of our economy, making sure we have the right skills and infrastructure and other public goods, supporting technology change, driving dynamism in our economy, and taking advantage of the many opportunities for productivity growth that are out there thanks to improvements in innovation and technology. That's the driver of our long-term prosperity. That's what we should really focus on if we want to think forward

for the next 25 years. And you're pretty optimistic that we'll do that? I am more optimistic than most that the opportunity for productivity growth is out there, that technological improvements aren't slowing down in the way some people have suggested, that technology isn't necessarily going to lead us to a future world of low employment and low wages growth. I think we have the opportunity to harness technology in a way that is consistent with rising employment,

rising wages, rising inequality, but I don't think that happens automatically. So there's a lot of policy choices that we need to make to make sure that we do harness those benefits and that those benefits are shared widely. Thanks for joining us. Thank you. Thanks very much for listening, guys. I hope you enjoyed that chat with Andrew Charlton.

You can find him on Twitter at Charlton underscore AB. You can also find me on Twitter at Joseph N. Walker and the podcast at Jolly Swagman Pod. So we'll see you there and I will speak to you again soon. Thanks very much for tuning in. Ciao.