Month: September 2014

GDP growth needs to be higher

Australian output growth halved in the latest June 2014 quarter. Some of the media commentary established that the result was ‘good’, given that the annual rate of real GDP growth of 3.1% is still above the recent average. Implicit in this line of thinking is that growth at above average is good enough and implies that the economy is performing well. Annual GDP growth of over 3% certainly seems like a good number, but is this current rate of growth high enough? The short answer is ‘no’ – and the reason why is because we have experienced slowing and declining real income growth and the pool of unemployed and under-employed persons in Australia has been growing for several years now. These are both important indicators that growth is not high enough. Structural and cyclical factors will continue to weigh on the performance of the economy. Without a clear strategy to address these issues, at best, we will remain in this new world of lower growth.

GDP Performance

The latest quarter of real GDP growth came in at +0.5%, well under half that of the previous quarter, March 2014 at +1.1%. This resulted in the annual rate of growth slowing from 3.3% to 3.1%.

Over the last several decades, the average annual growth in real GDP has continued to slow. Since the start of 2010, the average rate of real GDP growth has slowed further to 2.8% – the current annual rate of growth is sitting above this average.

Source: ABS

The major difference in contribution to GDP growth between the last two (2) quarters was the turnaround in the contribution of net exports from positive to negative and the change in inventories from negative to positive. The growth result this quarter relied heavily on the growth in inventories.

All other elements of GDP expenditure remained fairly stable:-

Source: ABS

Some points on the general outlook:-

  • Net exports should play a greater role in contributing to GDP growth (it hasn’t this quarter) as major resources projects come on line. There is some uncertainty around expected iron ore demand and slower growth figures coming out of China in the short-term. According to the Bureau of Resources and Energy Economics (BREE) June 2014 Quarterly Report, the value of Australia’s iron ore exports is forecast to increase by 3.1%, supported by higher volumes (+13%) which are expected to offset forecast lower iron ore prices in 2014–15. These figures are based on an average spot price of Iron Ore in 2014 of US$105/t – we are currently sitting at that average YTD (source: Indexmundi). In other words, don’t panic yet.
  • Public sector spending is likely to detract from GDP growth given the fiscal tightening agenda, with the bigger part of those spending reductions to hit during the 2014/15 financial year. If the government can get its infrastructure investment agenda off the ground (and assuming it will be well targeted spending), then this would be a welcome addition to growth and likely help support longer term productivity growth.
  • Private investment is likely to detract from GDP growth in the coming quarters due to the slow-down in Mining capex (as the boom shifts into the production and export phase). Indicators so far suggest that non-mining investment is not likely to fill the entire void, but there are some signs of increased spending in Dwelling Construction. It seems much hope rests on igniting the ‘animal spirits’ of our non-resources business sector to step up and start investing.
  • Household consumption is likely to continue at its current pace given the level of unemployment, under-employment, lower wages growth and increased savings rate. There is some potential for upside, considering the role of credit growth in supporting greater household consumption – if lending remains accommodative then any improvements in labour markets could see an increased appetite for credit. Alternatively, we could see a reduction in the savings rate (which might happen regardless).

From an industry perspective, the slow-down in growth was evident across most major industries, with the surprise exception of Manufacturing. In the June quarter, Manufacturing was the single largest contributor to GDP growth. Given the steady decline of Manufacturing-based industries in Australia (share of income, employment etc.), it’s not likely that this will be a driver of output growth into the future.

Of most concern was the pull back in growth in Construction (although remained positive) and the significant turnaround in the contribution of Mining to growth, especially given its importance to the economy at the moment.

Source: ABS

The broader question is whether growing at trend, or just slightly above, is a “good” result. That’s really the purpose of this post. I follow the labour market data closely and have been witnessing the growth in total unemployed persons for several years now as well as the well below average growth in total employed persons and the declining participation rate. These have been red flags that all is not well.

National Income

A more important view of total output and change in economic well-being (i.e. how much we can spend) is the income that output generates. One of the best measures is real net National disposable income per capita (RNDI) as it adjusts GDP for shifts in the Terms of Trade (ToT), which is currently down over 20% from its peak in Sept 2011, nets out depreciation and takes into account net income flows to foreigners.

On a per capita basis, real net National disposable income growth has been slowing or declining since March 2011. In the latest quarter, real net National disposable income per capita fell by -0.5%.

Source: ABS

The decline in RNDI per capita has implications for our standard of living in that sustained declines, and even slow growth, in income reduces our ability to grow our consumption of goods and services. Growth in income has slowed considerably from the prior two decades, making it that much harder for business to generate growth (without rapid credit expansion and/or draw down in savings). The issue of low growth is not one limited to Australia.

There is a stark contrast between income growth during the 90’s and 2000’s and during this post-GFC period. During the 90’s/00’s, RNDI per capita grew by over 2% on average. Other features of this ‘consumption boom’ included record low savings rates and higher credit growth. During the 2000’s, household consumption expenditure (excluding the period of the GFC) contributed, on average, 2.2% points to annual real GDP growth, which is fairly significant.

In this post-GFC period (area circled in the chart above), average growth in RNDI per capita has slowed to +0.7% and the savings rate is now over 9%. Credit growth, especially for mortgages, is strong on aggregate, but led by several key markets only. Personal credit growth has slowed. As a result, the contribution of household consumption expenditure to annual GDP growth has slowed to 1.4% points. It’s still a positive contribution to growth, but it has slowed considerably.

“The other thing that is in my mind when I think about the consumer is: I do not think we can expect to go back to the consumer leading aggregate demand in the way that they did in the period up to 2006.” Glenn Stevens, Governor of the RBA, Statement to the Standing Committee on Economics, 20 August 2014

This fall in National income per capita is likely driven by the decline in the ToT and it’s expected that prices of our major resources exports will continue to fall as projects come online and supply expands. The question remains as to whether the decline in prices will be offset by the increase in volumes.

The latest 2014/15 Government budget papers clearly outlines the drivers of income growth, both past and future.

“The main sources of income growth nationally are growth in productivity, changes in the terms of trade, changes in output from increased labour utilisation, and growth in net foreign income.”

Future income growth in Australia will be impacted by two key factors – the ageing population and falls in the ToT. The chart below from the Budget Papers 2014/15 highlights the likely decline in per capita income between 2013 and 2025:-

“For annual incomes to grow at their historical average of 2.3 per cent over the period to 2025, annual labour productivity growth would need to increase to around 3 per cent per year to counteract the effects of population ageing and a falling terms of trade. This is well in excess of what has been achieved in the past 50 years, and more than double what was achieved in the past decade.” Source: Budget 2014/15

Drivers of Growth in Income – The hatched area represents the additional labour productivity growth required to achieve long run average growth in real gross national income per capita.


Source: ABS 5204.0 and Treasury.

“Productivity has consistently been the most significant source of income growth. However, over the past decade or so, it has been the dramatic rise in the terms of trade which has maintained growth in gross national income as productivity growth has waned. Over the next decade, the decline in the terms of trade is expected to detract from growth in incomes. This negative impact will be compounded by a declining contribution from labour utilisation as the population ages.” Source: Budget 2014/15

This also highlights the more structural issues facing the economy in the near term with regards to the ageing population.

There are alternative ways to view this same data. Nominal GDP provides a similar view of National output, but at dollar value. This measure overcomes potential issues where ToT declines are outweighed by growth in export volumes. The results are similar and on any measure, Nominal GDP growth is also tracking well below average. On a per capita basis and deflated by the CPI, nominal GDP growth resumed its annual decline in the latest quarter, declining by -1.2%:-

Source: ABS, The Macroeconomic Project

Growing Unemployment

At the same time that GDP has been growing ‘above trend’, the pool of total unemployed persons has been growing and this has been a most telling feature of the state of the economy over the last few years.

The circled areas in the chart below highlight the growth in total unemployed persons during the recession of the 90’s and that of the current period.

Source: ABS

In terms of duration, this current period of unemployment growth is similar to the recession of the early 90’s, which counted thirty-eight (38) consecutive months where the annual change in unemployed persons grew (using trend data). We are currently up to thirty-six (36) months where the annual rate of total unemployed persons has grown (and counting). Over this current period, total unemployed persons has grown by +180k persons – in the early 90’s recession, unemployment grew by over 400k persons.

The current rate of unemployment is higher now than during the GFC – yet output growth remains ‘above average’.

There are other indicators of labour market weakness as well. Firstly, growth in part-time (PT) employment has been the key driver of overall employment growth and proportion of total PT employed persons is now at its highest point, +30.5% of all employed persons. Overall growth in employed persons is currently 50% below its ten year average. This lower demand for labour is showing up in slower wages growth – the slowest rate of growth since the wage price index was first introduced. Finally, the participation rate has been declining since the end of 2010, and is only starting to stabilize this year. Not all of the people dropping out of the labour force are ‘discouraged’ workers, but the decline in participation understates the rate of unemployment in the economy.

Rising Labour Productivity

One of the interesting features of the National accounts recently is that labour productivity growth has been reasonably strong. Labour productivity is measured as GDP per hour worked. This is one part of overall productivity mentioned in the income section.

There has been a sustained increase in labour productivity since quarter March 2011, which, when sustained over time, should be a key driver of National income growth. That National income has been stagnant or falling over the same time suggests that ToT movements are so far having a greater impact on income growth.

Source: ABS

What is driving growth in labour productivity during this time is not clear, but while labour productivity has been improving, unemployment has been growing. The importance of this is that improvement in labour productivity essentially means that less labour is required to generate a given level of output. Going forward, this may mean an higher level of growth is required to start to reduce this pool of unemployed persons.

Defining a ‘good’ rate of growth

At this stage in our business cycle, a “good” rate of growth could be defined as a level of growth that is high enough to reduce unemployment without adding pressure to prices (inflation). A very broad rule of thumb that can provide an indication as to the level of growth that is required, is to add the current level of labour productivity growth with the current level of labour force growth to provide an indication as to the rate of real GDP growth required such that unemployment would no longer rise.

Growth in labour productivity means that less workers are required to produce a given level of output and on the other side, growth in the labour force adds workers to the economy.

The current annual growth in the labour force (at August 2014) is +2%, which equals the ten year average. The current annual growth in labour productivity is +2.8%, which is well above its ten year average of +1.3%. Therefore, real GDP needs to grow somewhere between 3.3% and 4.8% to ensure that unemployment would no longer rise. This is only a rough rule of thumb intended to highlight the level of acceleration that would be required in growth to start to reduce the pool of total unemployed persons.

Forecast Growth

Various forecasts of real GDP growth provide little evidence to suggest that such growth is likely or expected over the next few years (all other things being equal).

The OECD develops forecasts of the output gap (GDP growth less GDP potential). The most recent measurements from the OECD highlights that the current rate of growth is not reaching potential (roughly based on growth in productivity and labour force). The forecast for 2015 is for a further deterioration in that output gap:-


The forecasts contained in the Federal Government Budget 2014/15 also show that real GDP growth is expected to remain outside of this required range over the next several years at least.

Source: ABS, Aus Dept of Treasury

Its worthwhile noting that real GDP growth in the financial year ended June 2014 came in slightly higher than forecast, but it still wasn’t high enough to keep unemployment from growing.

Under these growth forecasts over the next several years, it’s likely that unemployment and under-employment will continue to grow. National income growth per capita will remain low in the face of further ToT declines and this will add further pressure to growth and government revenues.

The ability of the economy to grow at an accelerated rate will depend on:

  1. Both monetary and fiscal policy working in the same direction to temporarily fill the gap left by the private sector (investment & household spending). Fiscal policy is currently focused on tightening and is likely to remain that way until such time that there is an economic emergency or external shock necessitating a change. For the moment, it doesn’t seem likely that all budget cut measures will pass the Senate either, adding further pressure to the budget, but also reducing the contractionary effect.
  2. Whether current monetary policy can stimulate non-resources business investment and expansion. This is one of the more important drivers. Lower interest rates are helping to fuel higher mortgage growth (mainly investors/speculators) rather than productive growth in economy. Outside of Dwelling Construction and Mining, business investment has been lacklustre in the face of subdued local and global growth. It’s unclear that any further cuts to the official cash rate by the RBA would in fact stimulate business investment.
  3. Demand coming out of China – for the moment it appears that growth is slowing. It’s hard to know what to expect from China and forecasts span a very wide range of growth possibilities. It’s an enormous economy with huge potential for growth.
  4. Depreciation in the exchange rate – this would no doubt help local producers and exporters. But there is a downside in that a lower exchange rate could place greater upward pressure on interest rates – not great news for such an indebted economy, with higher interest payments adding further pressure to disposable incomes.
  5. Whether the government can implement its infrastructure investment plan (and various other structural reforms like taxation). Whilst the infrastructure investment would enhance output and likely employment outside of Housing and Mining in the short term, it would also have long term benefits for business development and future productivity growth. The success of such a program depends heavily on whether the investment is strategic and directed to building the infrastructure that will support sustainable business development, innovation and expansion. Going back to the budget chart on income drivers, future productivity growth will be crucial to offset declines in the ToT and the effects of the ageing population. I don’t hold my breath on this one, but I am hopeful.


Capital Expenditure Survey June 2014

There are two important features of private capital investment in Australia at the moment. The first is the declining contribution of private investment to economic growth over the last three (3) quarters. The second is the unwind of mining capex growth which is currently underway. The two are related, of course. Over the last few years, monetary policy has been geared towards creating the financial environment to encourage a ‘re-balancing’ of private business investment towards non-Mining capex in order to off-set the much anticipated declines in Mining capex. The June survey of private capital expenditure shows that we are, to some degree, seeing growth in non-mining investment via construction, namely dwelling construction. The modest growth in the June quarter should have been no surprise because growth in new credit for business has been accelerating over the last year, as several previous posts have highlighted. But growth in new credit for business still remains well below pre and post GFC highs suggesting that business investment remains subdued. But is it really enough to say that a continued and increased emphasis on dwelling construction qualifies as a ‘re-balancing’ for the economy?

“When we look ahead, a key feature of the outlook, as everyone knows, is that the capital expenditure phase of the mining boom is winding down and the export phase is gearing up. The fall off in investment spending by resources companies has a long way to go yet, and it will probably accelerate in the coming year. This impending further fall is captivating most of the commentators right now. Meanwhile, growth in non-mining activity has been increasing. A recovery in dwelling investment is well underway, with spending in this area up by about eight per cent over the past year. Forward indicators for non-mining business investments suggest a modest improvement over the coming year, though intentions have so far remained somewhat tentative in this area.”

Glenn Stevens, Governor RBA, testimony to the Standing Committee on Economics, August 20, 2014

The survey of capital expenditure is not a complete picture of all sectors actual or expected investment intentions. It’s useful to understand what is included in the survey in order to understand the numbers. One way the survey measures capital expenditure and intentions is by ‘type of asset’, specifically, 1) Buildings and Structures and 2) Equipment, Plant and Machinery:-

Buildings and structures: Includes industrial and commercial buildings, houses, flats, home units, water and sewerage installations, lifts, heating, ventilating and similar equipment forming an integral part of buildings and structures, land development and construction site development, roads, bridges, wharves, harbours, railway lines, pipelines, power and telephone lines. Also includes mine development (e.g. construction of shafts in underground mines, preparation of mining and quarrying sites for open cut extraction and other developmental operations primarily for commencing or extending production). Excludes purchases of land, previously occupied buildings and speculatively built projects intended for sale before occupation. (Source: ABS)

Equipment, plant and machinery: Includes plant, machinery, vehicles, electrical apparatus, office equipment, furniture, fixtures and fittings not forming an integral part of buildings, durable containers, special tooling, etc. Also includes goods imported for the first time whether previously used outside Australia or not. (Source: ABS)

On a real value basis, the capex survey represents approx. 43% of the value (real) of Total Private Fixed Capital Formation (GFCF) and 60% of the Total Business Investment element of total private GFCF (full year at Mar 2014) in the National Accounts.

The other way the survey measures capital expenditure and intentions is by ‘industry’. The National Accounts estimates include capital expenditure by all private businesses including agriculture, forestry and fishing, education, and health and community services industries and capital expenditure on dwellings by households. Data for these sectors are excluded from the capex survey.

June Survey Results – Actual Private Capital Expenditure

Where possible, the figures used are ‘chain volumes’ to remove any price effects.

There is a significant difference in direction between the trend and the seasonally adjusted headline growth figure for the June quarter – I’ll present both throughout this post.

  • Seasonally adjusted, total capex grew by +1.1% (Jun ’14 v Mar ’14)
  • Using trend data, total capex declined -1.7%

Looking at both measures over time provides a better sense of how they move together and how the seasonally adjusted data tends to be a little more volatile.

Source: ABS

No matter which data you look at, trend or seasonally adjusted, there is a common theme at an industry level – Mining and Manufacturing continue respective recent declines and the growth trajectory continues for Other Selected Industries:-

Source: ABS

Below is a more detailed breakdown at industry level looking at both seasonally adjusted and trend data from the recent capex survey:-

Annual $’s M Annual % Chg Qtr % Chg
(Jun 14 v Mar 14)
Qtr Chg $’s M’s
Total Capex
Seasonally Adjusted
$153,413 -3.5% +1.1% +$399
Mining $86,824 -6.5% +0.2% +$42
Manufacturing $8,820 -6.8% -6% -$134
Other Selected Industries $57,769 +2.0% +3.4% +$491
Total CapexTrend $153,609 -3.8% -1.7% -$665
Industry View
Mining $87,207 -6.8% -4.1% -$872
Manufacturing $8,796 -8.5% -2.8% -$61
Other Selected Industries $57,591 +2.0% +1.8% +$263

Source: ABS

The impact of the decline in Mining capex over the last year is evident with total capex declining by -3.5% (seas adjusted). Only Other Selected Industries has been a positive contributor to capex over the last quarter and over the last year (looking at both measures), but this hasn’t been large enough (yet) to fill the gap left by the decline in mining investment (when using only the survey values).

Rebalancing underway?

There are two ways to drill down into the composition of growth in Other Selected Industries. The first is by breaking down Other Selected Industries into asset type. Using this view, its clear that Buildings and Structures have been the major driver of growth over the last four (4) quarters and growth continues to accelerate. Growth in Other Selected Industries – Equipment, Plant and Machinery remains lacklustre. The bigger of the two elements is Plant, Machinery & Equipment, but the majority of the growth in Other Selected Industries is coming from Buildings and Structures.

Source: ABS

The second view of Other Selected Industries is by industry type. Using this view shows that the main contributor to growth was from Construction.

Source: ABS

Cross referencing these results with the respective elements of the more complete view of Private GFCF in the National Accounts highlights the role that dwelling construction is playing overall. There has been a significant reversal between the growth in dwelling and the growth in non-dwelling construction & investment over the last two years. Note – I’ve used the ‘non-dwelling construction – new buildings’ element of the total ‘non-dwelling construction’ component of Private GFCF in order to remove the large influence from Mining in the construction engineering component.

The slowing growth in non-dwelling construction and the accelerating growth in dwelling construction over the last two (2) years, suggests that so far, ‘re-balancing’, or accelerating growth, has been focused on residential dwellings. Over the last year, GFCF dwellings has contributed twice the amount to total growth in Private GFCF than non-dwelling construction. Over the latest quarter (v. same qtr PY), that figure jumps to just over 7 times the contribution to GFCF growth. The circled area in the chart below highlights the shift in growth between the two elements:-

Source: ABS

The National Accounts breaks down investment spending into Dwellings (new and used dwellings and alternations and additions made by households) and Total Business Investment, which includes the non-dwelling construction.

In the recent past, total Private Business Investment has been the major driver of the historically high levels of investment growth – due to Mining. Over the last ten (10) quarters though, we’ve started to see the contribution of total private business investment to growth completely reverse. Its gone from driver of growth, to driver of decline in total Private GFCF (grey bars in the chart below):-

Source: ABS

Over the same last 3 quarters, you can see that the dwellings component (blue bars, above) has started to make a much larger, and growing, contribution to overall growth in Private GFCF.

Is the growth in ‘Other Selected Industries’ the start of the rebalancing that the RBA has been looking for?

The bigger question is whether this truly represents a rebalancing of investment for the future of Australia. This is a matter of opinion. Most of the growth in private sector credit is already going into residential mortgages (both owner occupier and investor) – so this private construction investment data seems to suggest that we are merely continuing to focus on residential dwellings. The upside is that new dwelling construction is likely to result in employment growth. But continued growth in residential dwellings will rely on continued acceleration in household debt – and there is some risk associated with that given that we are already close to historically high levels of household debt.

The issue remains that business investment has continued to make a negative contribution to growth over the last three (3)  quarters. If business investment on aggregate is not growing, and business is not increasing its productive capacity, then this will likely have important implications for the growing pool of underemployed people in the Australian economy (see latest post on employment). The economy is currently growing, but below the level required to start to absorb some of this growing underemployment.

“But the thing that is most needed now is something that monetary policy cannot directly cause. What I mean is we need more of the sort of so-called ‘animal spirit’, or confidence if you like, that is needed to support not just a repricing of the existing stock of assets, but the investment that adds to that stock of physical assets. There are some encouraging signs here, as you said, Chair. Nonetheless, if reports are to believed, many businesses remain intent on sustaining a flow of dividends and returning capital to shareholders and are somewhat less focused on implementing plans for growth. Any plans for growth that might be in the top drawer remain hostage to uncertainty about the future pace of demand. That is actually not a new phenomenon; it is in some respects pretty normal at this point of the cycle. There is always a period in which people can see that many of the conditions for expansion are in place but are not yet fully confident that it will happen. This is not confined to Australia: the gap between financial risk taking, and there is plenty of that in the world, and real economy risk taking is a gap that we observe around the world.”

Glenn Stevens, Governor RBA, testimony to the Standing Committee on Economics, August 20, 2014

Expected Capex 2014/15

We continue to pin our economic future on dwellings and so far, expected capex for the 2014/15 financial year sees little change in that direction. At June 2014, the survey shows that expected total capex will come in at approx. $14b lower than 2013/14 financial year. This figure has been adjusted using the realisation ratios.

Source: ABS

Taking a longer term view, this is how the growth of the 2014/15 financial year growth (decline) compares to the historical growth in total capex in the survey.

Source: ABS

There is no doubt that the major contributor to the year on year decline is the slow-down in Mining capex. The worrying element is that, based on the capex expectations, the recent growth in Other Selected Industries – Buildings and Structures is not forecast to accelerate in the 2014/15 period.

Note that some totals will not add to the full amount due to the application of realisation ratios.

Est 3 – Total 2014/15 Fin Year $M Realisation Ratio Adjusted 2014/15 Total 2013/14 Fin Year Actual Diff in $’s
Total Capex 145,158 0.99 143,706 157,869 -$14.1b
Total Mining 81,405 0.87 71,636 90,340 -$18.7b
Mining Buildings/Structures 70,758 0.89 62,974 80,911 -$17.9b
Mining Equip/Plant/Mach 10,646 0.86 9,155 94,29 -$0.3b
Total Manuf 8,032 0.96 7,710 9,201 -$1.5b
Manuf Buildings/Structures 2,607 0.87 2,268 2,675 -$0.4b
Manuf Equip/Plant/Mach 5,424 1.02 5,532 6,526 -$1b
Other Selected 55,722 1.15 64,080 58,328 +$5.7b
Other Sel Buildings/Structures 25,564 0.99 25,308 23,154 +$2.1b
Other Sel Equip/Plant/Mach 30,157 1.28 38,601 34,048 +$4.5b
Total Buildings & Structures 98,930 0.91 90,026 106,740 -$16b
Total Equip/Plant/Mach 46,228 1.12 51,775 51,129 -$0.6b

Source: ABS

The only forecast increase in capex for the 2014/15 financial year is for Buildings & Structures in Other Selected Industries in the table above (before the application of the realisation ratios). Based on the size and direction of these figures, it’s hard to see how the non-resources sector will in fact fill the gap created by the slow-down in Mining capex. It’s true that the survey isn’t the entire view of capex, but I wonder to what degree it’s indicative of the general direction of intentions and sentiment across the economy. We can only hope that the sectors not covered in the capex survey – agriculture, forestry and fishing, education, and health and community services – will take a far more optimistic and aggressive approach to capital investment in the coming year.