Interest rate cuts won't be enough to stave off a recession

The Gillard government and its treasurer ignored negative global developments and Australia's dangerous lack of competitiveness. With our mining boom rapidly cooling and other sectors largely uncompetitive, the former "miracle economy" faces serious trouble.

There is little the Reserve Bank can do to address the main issue of lack of competitiveness -- and further cuts to interest rates may worsen that problem.

Henry speaks to a wide range of economists and market commentators, and virtually all agree Australia's economic prospects are grim. Some say there is a possibility that it will experience recession.

Signs of the coming economic firestorm are legion. Most important is the state of the labour market, often trumpeted by former treasurer Wayne Swan as proving Australia has "the best economy in the developed world".

Official employment statistics, and especially the headline rate of unemployment, are misleading, with the major flaw being the assumption that paid work of one hour a week means the person is classified as "employed".

But if one delves into the underlying numbers, one finds a very different picture. Since 2011, three trends have fostered a false sense of economic success in Canberra. The first is the reduction in full-time jobs and its replacement with more part-time jobs.

The second is the reduction in hours worked, partly because of the above trend but also because of reduction of overtime for people in full-time jobs and actual cuts in standard hours of work offered by employers who are not cowed by unions. The third trend is a substantial fall in the number of people seeking work, and therefore dropping out of the workforce.

The cancelling or delay of many resource projects will have enormous adverse effects on employment in the resource sector. Indeed it already is having, with global miners shedding workers, a process that has been under way for some time at the junior miners.

Another source of adverse news for those who care to look is the number of small businesses struggling to survive or going under. Farmers bulldozing fruit trees, retailers offering stock below cost, manufacturers closing shop or reporting plans to close the business when they retire are all trends unlikely to filter to Canberra. The plain fact is that Australia is suffering a double-digit cost disequilibrium relative to both competitor and customer nations.

The broader economic statistics also reveal some alarming developments. Employment in manufacturing has been declining for decades, but retail jobs have recently joined the trend. Exports of wine and processed foods have fallen dramatically. Overseas enrolments in Australian universities have fallen sharply from the recent peak and the number of Australians travelling abroad now greatly exceed inbound tourists.

All these trends have been reported in an important paper by Ross Garnaut. He has calculated the real exchange rate, which adjusts the actual exchange rate for inflation in Australia relative to overseas inflation, and is therefore the best measure of the extent of the overall cost disequilibrium. This measure increased by 69 per cent from the end of 2002 to a peak in March. The currency depreciation since then has perhaps reduced this by 10 per cent, but this leaves a lot of adjustment still to come.

The excessive level of the dollar is widely blamed for trends such as those discussed above, along with ruthless behaviour by monopolistic retail chains and widespread imports of cheap goods purchased over the internet. The dollar looks like it has started a long fall and its level is likely to overshoot any sensible equilibrium level, as asset market often do. This will alleviate one source of pressure on businesses, but it will help only if cost increases are contained.