Thursday, June 04, 2015

Belshaw's prognostications on Australia's economic outlook

On Tuesday 2 June the Reserve Bank of Australia decided to leave the cash rate unchanged at 2%. In his statement, Reserve Bank Governor Glen Stevens said in part:
In Australia, the available information suggests the economy has continued to grow, but at a rate somewhat below its longer-term average. Household spending has improved, including a large rise in dwelling construction, and exports are rising. But a key drag on private demand is weakness in business capital expenditure in both the mining and non-mining sectors and this is likely to persist over the coming year. Public spending is also scheduled to be subdued. Overall, the economy is likely to be operating with a degree of spare capacity for some time yet. With very slow growth in labour costs, inflation is forecast to remain consistent with the target over the next one to two years, even with a lower exchange rate.
The next day, the Australian Bureau of Statistics released the national accounts figures for the March Quarter. You can find the detailed analysis here.In seasonally adjusted terms, GDP increased 0.9% in the quarter, through the year GDP growth was 2.3%.On the expenditure side, the increase this quarter (in seasonally adjusted volume terms) was driven by Net exports (0.5 percentage points) and Final consumption expenditure (0.4 percentage points). These increases were partially offset by Total gross fixed capital formation (-0.3 percentage points).

The ABS notes that a broader measure of change in national economic well-being is real net national disposable income. This measure adjusts the volume measure of GDP for the terms of trade effect, Real net incomes from overseas and consumption of fixed capital in trend GDP (volume measure) and real net national disposable income. During the March quarter, trend Real net national disposable income increased by 0.1%. Growth over the past four quarters was flat compared with 2.2% for GDP.

One thing that interested me were the trend movement in real labour costs - (2012-13 = 100.0)

As the ABS describes it: "Unit labour costs (ULC) represent a link between productivity and the cost of labour in producing output. Nominal ULC measures the average cost of labour per unit of output while a Real ULC adjusts the nominal ULC for general inflation. Positive growth in real ULC indicates that labour cost pressures exist. In the March quarter 2015, trend Real ULC decreased 0.7% and the trend Non-farm Real ULC decreased 0.7%. The Non-farm measure is generally preferred as it removes some of the fluctuations associated with Agriculture"

Well, what does all this tell us?

Some economists had expected the national accounts figures to show negative GDP growth in the March. Quarter. That hasn't happened, primarily because of growth in export volumes flowing from the mining investment boom. However, the adjustment phase following the end of the mining investment - the shifts in the economy required to compensate for the decline in mining investment - has been far slower than hoped. Greg Jericho had a useful piece yesterday on the ABC's The Drum looking at the investment side of the equation.

Consumption expenditure has held up, up 2.4% on on the same quarter twelve months ago despite soft personal income growth. It is not clear how long this might last.The trend in real non farm unit labour costs is interesting. You can see the rise associated with the mining investment boom from 2010 before the index starts to fall away again.

Australian real incomes are likely to stay stagnant or even fall over the next year. This is an inevitable result of the potential decline in the value of the Australian dollar with consequent rises in import prices. The same money income buys less..

This is another interesting graph, this time from Business Spectator's Callum Pickering. It shows the decline in growth rates for both real GDP and real GDP per capita from around 2003.

I am not in the business of making forecasts, but a few things are reasonably clear.

The mining investment boom means that export volumes will continue to increase. The issue the becomes the price received.

During the mining boom, policy makers (and commentators) constantly underestimated future prices. Then as prices fell, they constantly overestimated prices. Now there is a bit of a game around between the optimists and the pessimists in the forecasting community that's actually quite funny to watch   To my mind, downsides and upsides are probably evenly balanced, so call the  growing export volumes a continuing positive.

I have no idea what will happen to the Australian dollar and in what time horizon because of the number of variables involved. My best guess is that it will fall further against our major trading partners and then rise again, perhaps quite sharply round two years out. If you are going overseas as I plan to in September, assume a fall. Its the safest course. Otherwise, the safest course is just to take the current level as a given and not worry about it too much.

At the current level, the adjustment process will be slow. The precipitous fall in manufacturing investment means that that sector will be slow to expand. There are some green shoots, but call it neutral for the moment. However, in services the lower dollar has already had a clear impact. Australia has had more visitors, more students, has been able to sell more services, because we are more cost competitive. Call this a positive.

The current Sydney and to a lesser extent Melbourne housing boom will end in pain. Apartment construction will decline. But overall investment spending? Fairly clearly, the decline in mining investment will act as a drag. Beyond that, I'm not so sure.

For reasons I have written about, Australian Governments do not handle infrastructure well. However, there has been a slow build-up in what had become a very empty infrastructure pipeline. I would call this a positive, if with a ramp-up that means that the next peak might actually coincide with the next boom! Call this a positive.

Other Government spending will act as a drag for the moment, but the round of public sector cuts that began a few years ago will end as it already has in some jurisdictions.Then, as always happens, there is expansion. Call this negative in the short term, neutral in the medium term, positive in the longer term.

I can't see how private consumption spending on which so much of the economy depends can grow significantly unless the savings rate drops.If you have no or very low growth in cash incomes, people's ability to grow spend is limited. In the short term, it's hard to see much growth in money incomes, with real incomes declining for reasons I have given. So no growth here.

One thing I haven't worked out is the likely impact of the Abbott Government's small business cash splash. It's quite clever. Mr Rudd would be proud of it! It wouldn't have been a bad initiative at GFC time. I would call it a short term economic activity positive whose scale has still to be measured.

How do I pull all this together? Well, I think Australian economic activity will stay "below trend", to use the RBA's phrase, for the next six to twelve months.Then I think that we will see expansion.

I haven't mentioned the international economy. I think it likely that it will remain much as it is now. If so, it becomes a neutral in the equation.


The current movements in iron ore prices are interesting. I said that I thought chances of rises and falls were about evenly balanced.and that consequently we should focus on volume. That remains my view. On the surface, present US dollar values combined with a lower Australian dollar should be a plus.             .          

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Scott Hastings said...

There are so many problems with only building major infrastructure projects during the good years. Wages and materiel costs are at the peak of the cycle, skilled labour is particularly scarce, and the stimulatory effect only makes the concerns about inflation and overheating at the top of the cycle worse. It means missing out on the lower costs and needed stimulus during the slow years. All in all, it makes for very poor policy.

Anonymous said...

The decline in real unit labour costs is Interesting. If you put that together with the fall in the $A it suggests that there are grounds for optimism about investment. And that would be good for job prospects during the next few years.
So we might have to get used to the idea that Tony Abbott might be around for aquite a few more years.

Winton Bates said...

That last comment was left by me.

Jim Belshaw said...

Hi Scott A key point in having an infrastructure pipeline is the ability to bring projects forward during the down years. You also still have to spread things out with spend at all times to keep capabilities.

Winton, timing is everything! I think that August next year is the earliest time for a simultaneous Reps/Senate election. By then, things may well have changed.

Scott Hastings said...


So I should be happy to get 30 hours instead of 20, even though the pay is the same? Work is a means to an end, not an end in itself!

Jim Belshaw said...

Not quite sure that Winton was saying exactly that, Scott. But, like you, I don't like the thought of working more hours for the same pay. That is, after all, a pay cut. It's actually more of a pay cut than the simple reduction in nominal hourly rates, for the fall in the value of the dollar itself acts to reduce real wages.