What small business owners need to know about the coming recession

On Thursday the federal government unveiled a set of dreary economic forecasts indicating Australia is about to head into a very difficult recession.

For small business owners, many of which have just traded through the most difficult six months in recent memory, there are few positive caveats to takeaway from the numbers.

But understanding how changes in the macroeconomy may affect sales, investment and the labour market over the next 18 months is nevertheless critical.

A caveat: the forecasts parse 2019-20 and 2020-21, but economic forecasts are unreliable at the best of times, and this is probably the most uncertain macroeconomic environment in modern memory.

That said, the government is using these forecasts as a reference for policymaking over the coming 12 months, so even if (read: when) measured conditions turn out to be way different than this modelling, the figures are nevertheless useful for understanding how governments may seek to address economic challenges.

1. The unemployment picture isn’t tipped to get much better anytime soon

The headline unemployment rate is tipped to peak at 9.25% over the December quarter, according to Treasury.

And conditions aren’t expected to improve dramatically next year either. Treasury predicts the unemployment rate will round out 2020-21 at 8.75%.

Currently, with the JobKeeper program supporting more than 3.5 million jobs across the economy, the headline unemployment rate somewhat understates real conditions in the labour market.

The effective unemployment rate, which has been cited by Prime Minister Scott Morrison repeatedly in recent weeks, is thought to stand at more than 11%.

But as workers are pushed off subsidy payments, unemployment is expected to rise, converging with the effective rate over the next 12 months.

The participation rate — a measure of those in work or looking for work against the total working-age population — will fall from 66% in 2018-19 to 63.4% in 2019-20, before increasing slightly to 64.75% in 2020-21.

For business owners, many of which are currently accessing the JobKeeper program, worsening labour market conditions are bad news for household incomes, and therefore likely to impact on discretionary spending.

But it’s increasingly a buyer’s market, and several federal government programs, including wage subsidies for apprentices, are poised to support SMEs in bringing on new labour until March next year.

2. Household consumption is slated to tank, but retail sales are improving

Treasury predicts household consumption will contract 3.75% over the 18 months to the end of 2021, after increasing 2% in 2018-19.

That’s bad news for economy-wide demand, underscoring how important government spending will be in driving economic activity over the coming recession.

Treasury predicts private final demand — a measure of household consumption and private investment — will fall 3.5% in 2019-20, and a further 4% in 2020-21.

Inversely, public final demand — government expenditure on consumption and investment — is slated to increase 5% in 2019-20, and a further 4.5% in 2020-21.

Demand is important from both the perspective of individual businesses and the country as a whole. Lower consumption drives the economy in the wrong direction, towards contraction rather than growth, and that ultimately means additional hardship for households and businesses, further worsening conditions.

Compounding concerns, while Australia famously skated past the 2008-9 global financial crisis (GFC) without falling into a recession (thanks in no small part to the mining investment boom), households borrowed heavily, and this burden has continued to increase in recent years.

Aussie households have almost twice as much debt as they do income, according to 2018 Household Income and Labour Dynamics (HILDA) figures — the bulk of which is associated with housing debt.

While interest rates remain at historic lows and repayment holidays have helped absorb the shock of the pandemic, the prospect of an extended recession is likely to see households cut back on discretionary spending, particularly as income comes under pressure from a weakening labour market and flat real wage growth.

Distilling it down, that means fewer customers, a lower willingness to pay for goods and services, and a harder time finding private investment opportunities.

In the short-term, there’s some more positive news: retail sales are improving, at least from the historic falls the sector has experienced in recent months.

Australian Bureau of Statistics (ABS) figures published on Wednesday revealed the retail sector experienced its second consecutive month of annual growth in June — even the hard-hit restaurant and clothing categories are moving in the right direction, although remain negative year-on-year.

This shows the short-term negative shock to the retail sector is abating, which is undeniably good news. But we also can’t forget the sector was on struggle street before COVID-19, meaning even a return to form is a fairly sour note for small businesses.

3. Fiscal agenda: Deficit politics constrain options

As noted above, it’s clear government spending will be crucial to Australia’s economic prospects over the coming 18 months.

But the federal government remains subject to widespread political pressure about government debt levels — including from within its own ranks — and this will have an adverse impact on the willingness of cabinet to fire to fiscal cannon, so to speak.

Treasurer Josh Frydenberg and Finance Minister Mathias Cormann were grilled about forecast increases in government debt by the federal press gallery on Thursday, outlining their plan to improve government finances by growing the economy.

Treasury expects to book $270 billion in budget deficits this year and next, although Australia’s debt to GDP ratio will remain low relative to other developed economies such as the United States.

“Once the economic recovery is established, stronger growth and an improvement in the fiscal position will help to stabilise government debt as a share of the economy,” Cormann said on Thursday.

Easier said than done, particularly if the government is unwilling to tip in the necessary support in the interim.

The JobKeeper wage subsidy program and JobSeeker payments will be scaled back over the next six months, just as Treasury’s own forecasts have the official unemployment rate peaking.

At the moment more than 900,000 businesses are utilising the JobKeeper program, but several million workers are expected to be kicked off the payments over the December quarter, according to Treasury.

The pare back comes amid sustained calls from economists, including Reserve Bank governor Phillip Lowe, for a significant increase in fiscal spending to combat the recession.

Meanwhile, some JobSeeker recipients are saying the cuts will leave them barely able to pay the bills.

It goes without saying, but anyone unable to pay the bills isn’t heading down to the shops to buy whatever small business owners are selling.

The government is targeting tax cuts and deregulation as policy levers heading into the October budget, but no details are currently available about what those reforms may look like, or how they’ll materialise.

When we know, you will.

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