04 Sep 2019
We’re told the Australian economy is the weakest it’s been since the global financial crisis. But is it really?
Growth certainly has weakened. Only the surge in China’s demand for Australia’s mineral exports has kept the economy from contracting. An acceleration of non-mining business investment is now needed to fill the gap in growth left by mining and housing investment.
"Australia’s politicians may be starting to take seriously the need to re-accelerate productivity-enhancing reform.”
Yet, you might have wondered why the feeble economy depicted in the headlines bore so little resemblance to the generally very prosperous economy you may see when looking out the window. Looking at per capita national income should help solve the puzzle - it looks like we're rolling in it.
Per capita national income is running at levels we wouldn’t dare dream about, not even when the productivity surge ignited by the Hawke-Keating reforms of the 80s and 90s was at its peak.
National output and income have grown dramatically with the emergence of China. Per capita real disposable national income is now almost 40 per cent higher than it was at the beginning of the 2000s.
The challenge, of course, is to build on that. China’s growth is slowing as it reduces its dependence on exports and investment and increases the roles of its own consumers and the services sector.
Accelerate and balance
Fortunately, a major speech last month by the Treasurer, Josh Frydenberg, suggests Australia’s politicians may be starting to take seriously the need to re-accelerate productivity-enhancing reform in this country.
In the meantime, the Australian economy must rebalance its growth from its heavy dependence on mining investment and debt-driven housing construction to a broader-based and more sustainable expansion of exports, non-mining business investment and consumer demand.
The big swings in the economic data and the accompanying headlines are part of this bumpy transition.
The mining investment boom was the biggest in our history, it contributed more than half the economy’s growth in 2012 and 2013. But all investment booms must come to an end. When you build enough new capacity to meet the increase in demand, the investment spending must wind down. If it doesn’t, the boom turns into a bust.
Mining investment peaked in 2013 and the decline in spending has been subtracting from the economy’s growth ever since. According to the Reserve Bank, the decline in mining investment cut around 0.5 percentage points from the economy’s real growth in the year to March.
Fill the gap
This mining investment cycle was accompanied by a smaller cycle in housing investment. Spurred on by the Reserve Bank’s rate cuts, housing construction helped fill part of the gap left by the downturn in the terms of trade and mining investment. But, again, there was a limit to the number of new apartment blocks Australia needed.
Over the past year, housing investment has also subtracted from gross domestic product (GDP) growth. But when the mining and housing investment downswings come to an end, so will their detraction from GDP growth.
Had the downswings finished in time for the June quarter, annual GDP growth would have been around 2 per cent.
Of course, both the mining and housing investment cycles also are making lasting impacts on demand and output. The legacy of the mining investment is increased export capacity, while the housing boom was accompanied by a substantial increase in household debt and wealth. As a group, Australian households are now carrying debt equal to 190 per cent of disposable income and many are also feeling the pain of the decline in house prices.
The household saving rate has been falling since 2014 but there are signs that it may be starting to flatten out, which might be bad news for retailers in the short term, but good news for everyone in the longer term.
The minor economic miracle is that, so far, we have maintained the per capita national income gains from the China boom. For that we must mainly thank China’s renewed fiscal stimulus but successfully absorbing a mining investment boom and downturn of that magnitude was no mean feat. We weren’t always so clever: the resources investment boom after the Iranian revolution at the end of the 1970s was cut short by a wage explosion.
A wage explosion is not our problem now, of course. Wages growth is not even strong enough to push inflation back up into the Reserve Bank’s 2-3 per cent target range.
Everyone would like wages growth and inflation to be stronger. If wages grew more quickly, so might consumer spending which represents more than half aggregate demand. And, if inflation were higher, real interest rates would be lower and investment would be a more attractive proposition for business.
However, consumer spending may not be quite as weak as the June quarter national accounts make it appear. Everyone noticed the big slump in new car sales but car sales are easily deferred and can be very volatile. Sales of another big set of durable goods - furnishings and household equipment - looked more stable.
Moreover, spending on non-durable goods and services (food, recreation, personal services etc) probably gives us a better guide to consumer confidence and future spending behaviour. That’s growing a bit below its long-run average but it seems to be cycling around a pretty steady trend.
But let’s get back to the weak wage growth. While there’s no disguising the problem, we can be grateful for one not-so-small mercy. There has been no big increase in unemployment.
Wages growth has been weak for a while, not least because of increased international competition and automation.
China and the other emerging market economies are estimated to have added 1.6 billion people to the production of internationally traded goods and services and manufacturers have been migrating out of high-income economies like Australia.
The decline in Australian manufacturing employment accelerated after the global financial crisis. Service sector jobs also are feeling the effects of automation, information technology and offshoring.
Yet, employment growth has been strong and the unemployment rate has stayed low.
That combination of strong employment and weak wages growth is indicative of a shift in the labour supply curve: workers have accepted lower wages growth in return for increased employment and job security.
By far the best way to increase wages growth is to increase the demand for labour. Of course, that is harder when the Reserve Bank is short of conventional monetary-policy ammunition and business is being bombarded with negative news about the global economy.
That is why economists have been urging the government to add to the fiscal stimulus of its announced tax cuts and infrastructure spending.
It is also why the Treasurer is turning the government’s attention to the need for a new round of productivity-boosting reform.
A renewed commitment to reform would encourage non-mining business investment that would increase productivity and wages and thereby build on the legacy of Australia’s China boom.
Alan Mitchell is Former Economics Editor of the Australian Financial Review
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
04 Sep 2019
07 Aug 2019