Introduction
On the 9th of November 2023, The Australian Financial Review published an article by Michael Read titled “Australia records biggest income decline in the developed world” (Read 2023a). This report will review Read’s article, analyse the microeconomic factors at play, and provide relevant commentary on the article.
Article Discussion
According to Read’s article (Read 2023a), current data shows that Australian households are facing “the largest fall in living standards of any advanced economy over the past year.” It states that OECD Data illustrates that Australian households’ disposable income experienced a 5.1% decrease over the year preceding November 2023. Australia, therefore, saw the most significant decline among developed countries during that time, with the OECD as a whole seeing a 2.6% increase in disposable income.
The article surmises that high inflation, increased mortgage repayments, and rising income taxes drove this fall. In response, economists have called for an overhaul of the taxation system. With cost-of-living being the most important issue for voters (Coorey 2023), the Australian Government is implementing a $23 billion relief package.
Microeconomic Factors
The article outlines the fiscal conditions being experienced by Australian households. Various economic factors are at play in this situation, which leads to a complex situation requiring considerable consideration to counteract.
Decisions at the Margin
A factor addressed in the Article is the decision by consumers on how to compensate for reduced buying power.
During the COVID-19 stimulus, spending, debt reduction and saving were prioritised by households, leading to substantial savings buffers being built up. This was primarily driven by a stimulus package that overcompensated households and businesses during the pandemic (Read 2023b). This random shock changed economic factors substantially.
The 2019-2020 year saw positive net household savings in all states for the first time since 2011-2012 (Australian Bureau of Statistics 2020). At the peak, households saved 24% of their income in the second quarter of 2020, but in the third quarter of 2023, this had decreased to 1.1%, well below the 64-year average of 9.39% from ABS data (Trading Economics).
The Article indicates that once the stimulus was removed and inflationary factors came into effect, households had to decide how to utilise their income best. In many cases, expenses now exceeded income, but the economic effects were not yet felt as households decided to dive into savings and credit rather than sharply curbing spending. They thereby maintained their living standards, further feeding inflation. Hence, demand remained unchanged and unsustainable.
The Reserve Bank then intervened, implementing unforeseen interest rate rises. This, in turn, raised variable rate loan repayments, further reducing households’ ability to spend. Once fixed-rate loans expired and savings and credit were exhausted, households experienced the delayed effects of the removed stimulus, increased mortgage repayments and inflation.
Australian households are now experiencing “the largest fall in living standards of any advanced economy over the past year” (Read 2023a) as they choose to reduce the quantity or quality of the goods and services they purchase to maintain household economic efficiency.
Production Efficiency, Supply & Demand
The ABS Producer Price Index (Australian Bureau of Statistics 2024) saw the Final Demand price rise by 4.1% over the 12 months preceding December 2023. This correlates to increases in the cost of production (including transport and labour costs), triggering a reduction in supply (S1) and the subsequent increase in prices as companies seek production efficiency.
With this reduced supply, we see a price increase, ceteris paribus. However, other factors are at play.
With the high amount of government stimulus in the market during the COVID-19 pandemic buoying household disposable income, household demand (D) had risen. With this stimulus now removed, increased mortgage repayments, and rising taxation, there is a decrease in disposable income (per the previous section on Decisions at the Margin). This leads to a scarcity of available funds and, thus, reduced demand (D1).
With reduced demand, we see a price decrease, ceteris paribus.
However, combining these shifts in Supply and Demand (not considering the scale of the shifts) leads to the same or similar price being paid for fewer goods (Qd). Equilibrium has shifted from E to E1.
Ultimately, this presents as a decrease in consumer buying power, as the same or similar money affords the household fewer goods and services, resulting in reduced living standards, as evidenced by Read (Read 2023a). Households find themselves buying fewer goods and services or switching to inferior alternatives.
Elasticity
Elasticity concepts, such as income elasticity of demand or price elasticity of demand, relate to Read’s article (Read 2023a) by explaining how changes in income or prices might affect consumer demand for goods and services. The Article logically outlines that discretionary spending is affected by a household’s disposable income. While a reduction in income did not initially curb discretionary spending, the Article clarifies that this was because household savings buffers allowed continued spending in the face of inflation.
Several conclusions can be made based on this knowledge:
- Savings and credit availability are external factors affecting a household’s sensitivity to increased prices.
- Many of these discretionary purchases are luxuries, and the reduction in spending indicates that the Income Elasticity of Demand in this scenario is Elastic.
- The fact that purchases are now being reconsidered due to increased prices indicates that Price Elasticity of Demand in this scenario is also Elastic.
- The fact that increased taxation affects the purchasing of goods and services entails that consumer spending is sensitive to increases in individual taxation. This again shows elasticity in Income Elasticity of Demand and raises interesting questions about the suitability of the current tax system.
Market and Government Failure
The matter of bracket creep on income taxation is one of the focus points of Read’s article. The article surmises that the fact that Australia does not index its taxation brackets to compensate for higher prices is adding to the cost-of-living pressures being felt by households. Economists are urging the government to lessen reliance on individual income taxes and move towards consumption (GST) or land-based taxes. This would lead to a less sensitive (Elastic) market.
The combination of income tax bracket creep and high mortgage repayments has created a situation where households are particularly sensitive to economic shocks, representing both a market and government policy failure.
Government Intervention
The Government is reacting by providing a $23 billion cost-of-living relief package (Grant-Geary 2023). Announced in late 2023, the package will include:
- Increased universal healthcare rebates, ensuring households can afford medical care.
- Recurrent energy rebates for households and businesses, aiming to reduce household costs and the cost of production of goods and services.
- Increased spending on social housing to increase supply.
Australian Treasurer Jim Chalmers indicated that the government were taking this action to ease the cost-of-living pressures being felt by Australian households.
Unfortunately, government intervention currently falls short of:
- Undertaking substantial taxation reform.
- Cutting the cost of transport by reducing the fuel excise. Transport costs have been rising sharply in the face of global factors affecting the cost of oil.
- Adjusting eligibility levels for social benefits to encourage secondary income earners back into the workforce or to increase productivity.
While the measures being taken address critical elements of the household crisis that are currently presenting, they fall short of attempting to reform relevant systems.
Discussion
The factors leading Australia to this current situation have been a perfect storm of market shock from the pandemic and over-compensatory financial stimulus. Australian households took advantage of this situation to improve their living standards, driving inflation. The cost of living became unsustainable once the stimulus was removed and savings were depleted.
As household disposable incomes continue to drop, so will consumer spending. As household consumption is a crucial driver of economic activity, this could adversely affect Australia’s economic growth. If households continue to struggle, spending will decrease, leading to reduced business sales. To remain efficient, businesses will need to reduce their production cost by decreasing output, curbing investment, and reducing workforce. These factors could, in turn, lead Australia’s economy into recession.
Timely and effective government intervention by policy is crucial in stopping this scenario. Future research and policy focus should target overhauling the taxation system, better sizing and targeting of stimulus and social benefit payments, and possibly further developing universal healthcare and a universal income system.
A fall in living standards, as outlined in the Article, need not be detrimental if it is normalising. However, as outlined in Shannon Molloy’s 2023 article (Molloy 2023), the impact of this decrease in living standards is a fall into crisis at all income levels. The government has the daunting task of putting on the brakes.
References
Australian Bureau of Statistics. 2020. “Insights into household income and saving by state and territory.” https://www.abs.gov.au/articles/insights-household-income-and-saving-state-and-territory
Australian Bureau of Statistics. 2024. “Producer Price Indexes, Australia, December 2023.” https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/producer-price-indexes-australia/dec-2023
Coorey, Phillip. 2023. “Voters were focused on cost of living, not Voice, survey reveals.” The Australian Financial Review 2024 (05/02/2024).
Grant-Geary, Belinda. 2023. “Money for millions of Aussies eligible for $23b November cost-of-living relief.” Yahoo!Finance. https://au.finance.yahoo.com/news/money-for-millions-of-aussies-eligible-for-23b-november-cost-of-living-relief-104222216.html
Molloy, Shannon. 2023. “Secret RBA documents reveal even high-income, middle-class Aussies are in financial crisis.” news.com.au 2023 (25/09/2023). https://www.news.com.au/finance/money/costs/secret-rba-documents-reveal-even-highincome-middleclass-aussies-are-in-financial-crisis/news-story/4562872205939edc00e10400e8c2fc84
Read, Michael. 2023a. “Australia records biggest income decline in the developed world.” The Australian Financial Review 2024 (01/02/2024).
Read, Michael. 2023b. “JobKeeper and ‘excessive’ stimulus to blame for high inflation.” The Australian Financial Review. https://www.afr.com/policy/economy/jobkeeper-and-excessive-stimulus-to-blame-for-high-inflation-20230412-p5czrp
Trading Economics. “Australia Household Saving Ratio.” Accessed 05/02/2024, 2024. https://tradingeconomics.com/australia/personal-savings