Climate heats up the productivity challenge

The October and May federal budgets contain AUD$29.5 billion in climate-related spending measures, a fourfold increase from the 2021-22 budget. The Safeguard Mechanism reforms of 2023 cover about 30 per cent of Australia’s total emissions.

"In a domestic, and global, economy already struggling with excess demand, climate-related effort is likely to sustain inflationary pressure, which crowds out other forms of economic activity.”

Meanwhile, Australia is a signatory to the ‘30by30’ target -- a target to protect at least 30 per cent of the world’s land and 30 per cent of the world’s oceans by 2030.

Yet at the same time, the demand for resources at a global level is intensifying. The US Inflation Reduction Act was pitched as a USD$391 billion package over 10 years but Brookings Institution research suggests it is likely to be closer to USD$900 billion. Europe has offered its own Green Industrial Plan in response but is under domestic pressure to do still more.

The EU’s Carbon Border Adjustment Mechanism (CBAM) will begin administrative operation in October 2023 and in 2026 begin collecting tax on the carbon emissions embedded in imports from sectors including steel and aluminium. The US is expected to respond with its own CBAM.

In a domestic, and global, economy already struggling with excess demand, climate-related effort is likely to sustain inflationary pressure, crowding out other forms of economic activity. That pressure is also prompting a monetary policy response to return inflation to the 2-3 per cent target.

If private balance sheets were less robust, that crowding out might be able to occur at more modest levels of interest rates. But in aggregate, private balance sheets in Australia are the strongest in two decades.

In 2022 the RBA suggested the proportion of mortgages to those households living pay-cheque to pay-cheque had nearly halved in the last 15 years. It may be those most vulnerable to cost-of-living pressures don’t carry as much debt as they perhaps used to.

The net asset position of the household sector has deteriorated over the past two years but it is still higher than at any time before 2020.  The corporate sector in aggregate is also in strong shape with corporate debt as a share of GDP the lowest since 2005.

The strength of the demand of recent years has been beneficial in some areas. This year, for instance, there has been a sweep of female labour market records: the highest participation rate, share of hours worked, share of full-time employment, and lowest female unemployment rate. There are more gains to be had. Immigrants, for instance, often struggle to have their qualifications appropriately recognised.

The resources required for history’s largest infrastructure swap, in other words, are competing with resilient consumer and business demand.

In response to economic challenges Australia is again looking to immigration to add to the economy’s inputs but constraints are emerging. Housing supply hasn’t kept pace.

The March ANZ/Property Council of Australia Survey found housing supply and affordability are critical issues for the federal government. Yet in the current year immigration is expected to contribute to the strongest population growth since 2009 and, before that, 1974.

The natural environment transition is likely to worsen this constraint both through the competition for resources and perhaps also from the application of more stringent environmental standards to the construction sector.

While this isn’t yet a widespread discussion in Australia, a recent study in the Journal of Building and Environment examining Germany might give a sense of the orders of magnitude involved. The study finds the cost of retrofitting existing dwellings for Germany’s environmental standards to be between AUD$96,000 and AUD$155,000 (at current exchange rates). Bear in mind Australia also has an average house size 38 per cent larger than Germany - and the largest in the world.

Productivity growth can help ameliorate these challenges to some degree but the Productivity Commission’s recent five-year stocktake gives a sense of how much more difficult raising service sector productivity is, relative to the goods sector efforts of past decades.

Natural environment spend, as well as housing, defence, aging and other imperatives, are facing down resilient private balance sheets in a tussle for resources. This has implications for the future of interest rates. While much of the debate concerns how many more hikes the RBA has to deliver, the real story is the likely absence of substantial easing on the other side.

Richard Yetsenga is Chief Economist at ANZ

This story originally appeared in The Australian