The economic fallout from a long Iran war would be larger than most people yet realise. Fuel and fertiliser shortages will lead to higher prices and rationing, and this will ripple through the rest of the economy in the form of higher inflation and an economic recession. We can’t control the Iran war, but we can control how we react, and unfortunately, the track record of our government suggests they will do all the wrong things.

Fuel and fertiliser shortages

Australia’s fuel crisis hasn’t really started yet. There’s been some shortages in regional areas, but those were mostly caused by panic buying and logistics issues that would quickly resolve if the Iran war ended tomorrow. We still have enough fuel in the country at the moment, but if the war continues for much longer that is about to change. What next?

We get about 80 per cent of our fuels (petrol, diesel, jet fuel) from refineries in East Asia, but those refineries source most of their crude oil from the Middle East war zone. Our biggest suppliers (South Korea, Singapore, Malaysia) are scaling back their exports, while some Asian countries (China, Thailand, Vietnam) have already stopped fuel exports entirely to preserve their own stocks. We can get some more supply from America, but that will be expensive and won’t be enough to fill the gap.

We have some capacity to produce our own fuels, but that capacity has been significantly downgraded in recent decades, and now only accounts for roughly 20 per cent of our fuel needs. Our domestic production may go down further, given that it relies on imported crude oil, which is becoming harder to find.

The situation for urea (used as fertiliser and diesel exhaust fluid) is even more stark. Almost 70 per cent of our urea comes from the Middle East and is currently blocked, and alternative suppliers like China have stopped exports to preserve their own stock. We can get some more supply from south-east Asia, but that will be expensive and won’t be enough to fill the gap. And unlike fuels, we have zero domestic capacity to produce urea until the Perdaman Urea Project comes online next year.

Australia also has about a month worth of fuel and fertiliser stockpiles. This can be rationed to last longer than month, but obviously it can’t last forever. Unless the Iran war ends soon, we will face shortages.

Looking forward

The likely consequence will be a recession. Higher petrol prices are an unwelcome change, but that will be the least of our concerns. The hit to our trucking, airline, tourism, mining, and agricultural sectors will be significant, and flow through to the rest of the economy. More businesses will fail, jobs will be lost, real wages will decline, and the cost of living will go up.

It won’t be the end of the world, but it will be difficult for many.

The economic shock is mostly out of our control, but the government can determine how they respond, and the wrong response could make things worse. The real point of this email is to be an early warning against the wrong policy response, in the hope that we can avoid repeating the policy mistakes of the past. Here’s what to avoid:

Stimulus spending won’t work. The budget deficit will increase naturally due to automatic stabilisers (more people on welfare and less tax revenue), and that’s fine… But the government should avoid the temptation to introduce so-called ‘stimulus spending’. Extra government spending is always popular with the government as it makes them look like they’re helping, but it cannot boost an economy during a supply shock. It will only rearrange the economy, like the proverbial rearranging of deckchairs on the Titanic, temporarily boosting some sectors at the expense of others. While the spending won’t be effective, it will rack up ever more debt, imposing a burden on future generations.

Artificially low interest rates won’t work. If inflation drops, then so should interest rates, but if underlying inflation remains high then the RBA should avoid the temptation to add more cheap money into the system. As with stimulus spending, artificially cheap credit won’t work in a supply shock, but it will push up inflation and make the cost of living crisis worse. (One small caveat here is that the RBA should focus on permanent underlying inflation, and ignore one-off price spikes from the supply shock.)

Price controls are a political distraction that may backfire. A supply shock means that there is simply less stuff available, and the only options are rationing through higher prices or rationing in some other way. Nobody wants to see higher prices, but that may be the least-bad option. Higher prices work as a signal to ensure supply continues flowing to where it is most needed, and it limits demand to only the most high-need cases. Price controls will benefit those who still have access, but will mean many people simply get nothing, and it doesn’t address the underlying problem.

If politicians feel the need to do something in response, they should focus on policies that will increase productivity and/or improve our long-term supply security. These policies will not fix the short-term supply shock (nothing will do that), but they will help to speed up the recovery and guard us against the next supply shock. Ideas to consider:

• Income tax cuts will provide some immediate relief to workers, but more importantly, they will encourage more private investment and production, putting the country on a higher growth path and therefore speeding up the recovery. This policy is not about macroeconomic stimulus (as often assumed by our clueless media) but about microeconomic reform to boost productivity.
• Reducing business regulation is another response that would help to boost private investment and production. Many businesses will be struggling under the pressure of higher costs and fewer customers, and reducing red and green tape from the government will make it easier to survive and then bounce back.
• Improving infrastructure (especially energy infrastructure) is a third path towards boosting production. Australia’s infrastructure has failed to keep up with our runaway population growth, which is holding back our productivity and quality of life. This response will have a slower impact and will only work if the government prioritises economic returns instead of political daydreams about climate or equity, but it is a crucial part of solving our long-term productivity problem.
• Finally, there needs to be a renewed discussion about supply security for key inputs such as fuel and fertiliser, including domestic stockpiles, domestic capacity, and diversified trade partners. This will inevitably involve trade-offs. Policies that subsidise domestic supply will come at a cost, but if global supply chains are becoming less reliable, that cost might be worth paying.

Hopefully, none of this comes to pass. If the Iran war ends soon then Australia should have enough stockpiles to last until global markets get back to normal. Touch wood. Unfortunately, that is out of our control, so the responsible approach is to start thinking now about how we should respond if the worst happens. Our politicians don’t have a great track record of thoughtful policy-making during a crisis… Perhaps if they started thinking about these issues now, they’ll be able to do a better job when things get tricky.

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