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.
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.
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:-
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.
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.
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%.
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 http://www.budget.gov.au/2014-15/content/bp1/html/bp1_bst4-03.htm
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 http://www.budget.gov.au/2014-15/content/bp1/html/bp1_bst4-03.htm
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
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.
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.
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.
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:
- 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.
- 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.
- 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.
- 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.
- 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.