COVID-19 recession worsened by ‘coordination failure’ as everyone cuts costs to try and save themselves

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As the Reserve Bank meets on Tuesday, there’s talk of another interest rate cut.

The central bank has been unable to meet its own employment and inflation forecasts and is expected to cut the cash rate from 0.25 per cent to 0.10 per cent on Melbourne Cup Day.

Last week, RBA deputy governor Guy Debelle indicated that Australia’s economy may have performed better than expected in the September quarter, which led to some media outlets asserting that Dr Debelle said the recession was over.

But it could take some time before we see a real recovery.

Australia’s first recession in 30 years started with lockdowns to contain a global pandemic, but now economists warn it’s becoming a crisis of confidence as much as COVID.

When COVID-19 really hit home in March, even before the national lockdowns, the only thing people spent a lot of money on was panic-buying essentials.

And it had business owners like Wes Blundy very worried.

“At the start it was very uncertain,” he tells The Business.

“We were unsure of two things: first of all, are we going to be locked out and not able to fulfil orders? But, secondly, are customers just going to totally freeze up their spending?”

Wes Blundy’s company sells plus-sized bras online and, as it turns out, revenue has tripled since the pandemic.

But he didn’t know that back in March, so he took a razor to costs.

“Although we thought we were running a really lean business, there was actually a lot that could be trimmed,” he says.

He dumped a bunch of redundant software subscriptions, negotiated a cheaper waste collection contract and saved two-thirds on his $1,800-a-month electricity bill by using a government subsidy to install LED lighting.

But his biggest cost saving was rent.

“Warehouse space was still pretty in demand and not really discounted, but there was a huge amount of discounting going on in the office space,” he tells me.

“We’re an e-commerce business, we run a warehouse, but we thought why not run our warehouse out of an office? And we looked around and it was crazy some of the discounting and the deals.”

He split a much bigger office space with a friend who sells ukuleles online, and is now paying 75 per cent less per square metre.

And Wes Blundy is not alone. Davina Lacey’s Pilates studio trimmed down earlier in the pandemic.

“When we first reopened we reduced wages as much as possible, so I worked in the business a lot more than I had previously,” she tells The Business.

“And now that the revenue’s gone up a little bit, we’ve probably been a bit more relaxed with it, but we’re certainly watching wages from now on.”

But not all small and medium businesses have been lucky enough to see their revenue bounce back.

Business Australia, formerly known as the New South Wales Business chamber, recently asked its members nationwide how they were going.

“Nearly three-quarters of all businesses who responded to that survey indicated that revenues were down based on previous years,” says Business Australia’s Richard Spencer.

Like Wes and Davina, he says many business owners have been tightening their belts.

“That has obviously led many of them to start thinking about what they can do to focus on costs, what can they do to reduce costs to try and ensure that they survive through the COVID-19 pandemic,” he explains.

But it’s not just business owners getting lean on expenses.

“Our clients have decreased their average spend with us,” says Davina Lacey.

“We’ve certainly got a lot more clients in, so our gross revenue has gone up, but each client is spending a lot less than they were previously.”

It’s behaviour that Davina empathises with.

Aside from controlling costs at her Pilates studio, she’s also been closely watching her own household budget.

“We didn’t get takeaway or anything like that. Obviously, you couldn’t eat out at restaurants [during lockdown],” she says.

“Online shopping decreased dramatically, for me especially, no dresses or shoes or anything like that for us.”

‘Coordination failure’

It’s what economists call “coordination failure”.

“Because we’re all interconnected — through trade links, our employment links us to others, our purchases link us to others — that means that when other people start doing things differently, our situation changes, our expectations about what’s going to happen when we do something change,” explains Professor Gigi Foster from UNSW.

To put it another way, someone’s spending is another person’s income. When they cut back, that income falls. Then that person cuts back, and so it goes.

Many people cut back even if their income hasn’t fallen, just in case it might.

Beyond the lockdowns that forced much economic activity to stop, it’s a key reason why Australia’s now in its sharpest recession for 90 years.

“We can, as a society, spiral down into a low activity expected environment from what we were previously at, which was high activity expectations,” Professor Foster observes.

“And when we do that it becomes very hard to intervene somehow in that system and unilaterally get it to come back up.”

A circuit-breaking Budget?

Getting spending to rise again is something the Federal Government is trying to do with its business and personal tax cuts in the Budget.

“It is a game changer. It will unlock investment,” Treasurer Josh Frydenberg said of the more than $30 billion of business tax breaks on Budget night.

Professor Foster welcomes the tax cuts, but thinks the Government could be much more ambitious and introduce an income contingent loan program for businesses and households — like the HECS scheme that has funded Australian university places for around three decades.

“It’s a loan program, so it does mean that you have to apply and you have to have a plan for how you’re going to invest — as you do when you borrow money from a bank,” Professor Foster says.

“But it has this lovely aspect that you only repay the Government if your revenue in a future period rises above a certain nominated threshold.

“So, if that happens, things have gone well and you can pay the Government back, so it’s not just a handout the Government’s giving never to see the money again.”

The idea is for Government to take on the risk for a while, so we all feel safer to spend and invest.

The other advantage of the scheme is that it wouldn’t give a handout to businesses or households who turn out to be doing just fine.

Australia’s lack of effective demand

But there’s another economic phenomenon that’s hurting Australia’s economy, and has done for years before the COVID-19 pandemic hit — a lack of effective demand.

It is key to John Maynard Keynes’s Depression-era General Theory and the work of Polish economist Michal Kalecki.

In very simple terms, effective demand is basically how much we can afford to buy, rather than how much we want to buy.

A combination of increasing underemployment, record low wages growth and record high debts had already left many households in a position where they couldn’t afford to spend more and were trying to cut back.

“Many lower and even middle-income Australians do have very significant ongoing expenses — every month they must pay, for example, a mortgage,” observes Professor Foster.

“We know that property prices are very high and even rents are very high, so that means that there’s a large chunk taken out of people’s incomes.”

Add in the income hit to many people from job losses, stand-downs and reduced hours during the COVID recession, and there’s a severe lack of effective demand.

That’s one reason why an overwhelming majority of economists have been calling for a permanent increase in the JobSeeker unemployment payment, which is currently set to fall back to its long-term rate of just $40 a day at the end of this year.

, Mr Frydenberg repeated the Government’s line that, “We’ll make a decision about that level of payment closer to the end of the year, when we have a better sense of the labour market dynamics.”

Professor Foster not only thinks JobSeeker should be higher, but that it’s critical for the Government to make a decision about the rate sooner rather than later.

“The uncertainty, yet again, is a big problem,” she says.

“The main important thing is to provide some certainty for people.

“Because, particularly with Christmas, people need to decide how much they can afford to spend … and if we don’t provide that sort of certainty, we may very well have the worst Christmas for retailers that we’ve seen in decades.”

Reinvesting savings

With her business doing well, Davina’s family is already loosening its purse strings … albeit modestly.

“That’s why we took the holiday in September — we hadn’t planned to, but we just decided that we needed to support those other communities that haven’t really had those visits from the tourists from interstate recently,” she tells The Business.

“So we thought we’d give a little bit back, but probably did it a bit cheaper than we would have done previously.”

Wes is still riding the wave of the accelerated shift to online shopping.

“We’ve been able to redeploy those cost savings into giving us the confidence to hire some new key team members and double down on our marketing initiatives,” he says.

So not all cost cutting is bad — as long as businesses and individuals have the confidence to spend the money they’ve saved somewhere else.

By business reporter Michael Janda (Original ABC Article)

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