Labour Productivity

Transitioning well? Australian GDP & National Income – Dec 2015

At first glance, the data relating to the 4th quarter GDP was fairly straightforward. The Australian economy grew by +0.6% in the final quarter of 2015, better than the +0.4% growth expected, but well down on the previous quarter. The upward revision to the previous September quarter growth from +0.94% to +1.09% growth resulted in annual GDP growth upgraded to +2.96%. This bumped up annual GDP growth to just above average trend growth for the last 10 years. This got quite a few people excited and soon many had jumped back onto the bandwagon that the economy is transitioning well out of the mining boom. It’s always worth looking deeper into the drivers of growth and this quarter is no exception. Whilst this isn’t a bad result at all, there is still enough in the data to challenge the narrative that Australia is transitioning well.

December 2015 quarterly real GDP growth +0.63%

Despite being well down on the previous quarter, GDP growth for the December quarter was very much in line with the average for the last 10 years. This is clearly not a bad result looking at the quarterly results over the last 20 years.

Source: ABS

Of all the components that make up GDP, household consumption spending made the largest contribution to GDP growth on both an annual and quarterly basis.

Source: ABS

Household spending contributed over half of the growth for the year and two thirds of the growth for the quarter. It didn’t take long before this was labelled the ‘strength in the household sector’. I’ll come back to this point later.

Government consumption expenditure and net exports both made a strong positive contribution for the year, but barely contributed to growth in the latest quarter.

Private investment continued to go backwards for the year and the quarter, but government investment spending made a surprise and welcome positive contribution to growth in the latest quarter.

Inventories made a positive contribution in both the quarter and the year. Inventories represent work in progress, materials and finished goods etc. that are owned by the business, whether they are held at the business premises or elsewhere and are recorded at book value at the end of the quarter. It’s difficult to pinpoint what this means – either inventories were ramped up on higher demand expectations or lower than expected sales resulted in increased inventories. The higher contribution is the result of the ‘change in inventories’ going from negative in the previous quarter to positive in the latest quarter.

But real National Income keeps falling

Real GDP growth is a measure of the growth in the underlying output of the economy. But National Income is a better measure of the income derived from/generated by that output. The ABS recommends Real Net National Disposable Income (RNNDI) as the best measure of changes in our “economic wellbeing”. This measure “adjusts the volume measure of GDP for the terms of trade effect, real net incomes from overseas and consumption of fixed capital” (source: ABS). Using this measure, National Income continued its recent decline, falling another -1.1% for the year and -0.1% for the quarter. A big driver of this decline was the latest 12% fall in our terms of trade (ToT).

The real NNDI measure isn’t broken down into its component parts so that we can understand where/what part of National Income is driving this decline. There are several elements that make up the National Income figure – employee compensation, the gross operating surplus (corporate profit proxy) and gross mixed income (surplus/deficit from the operations of smaller unincorporated enterprises). In order to go to this more detailed level, I need to revert to Gross National Income (GNI) in current prices (nominal). In real terms national income is falling. But in nominal terms, gross national income is growing at +2.6%.

I’ve used the chart below before because it provides perspective on how much our National Income growth has slowed over the last five (5) years.

Each bar represents the annual growth in Gross National Income and shows how each component has contributed to growth in that year. Whilst National Income growth, and the contribution from its component parts, is not on its lows, it hasn’t accelerated higher in the latest year either (and we know that in real terms, National Income is declining).


Source: ABS 5206.11

The annual rate of growth in GNI has remained fairly stable over the last two quarters. But a different picture emerges when you look at the quarter on quarter growth rates.

The latest quarter National Income growth is slowing

The December quarter growth was in fact slower than in the previous quarter. The chart below looks at the same National Income components, but using the quarter on quarter growth for the last eight (8) quarters:-

Source: ABS

There are two important points I want to make about the December quarter results.

Firstly, there was a larger contribution from ‘Gross Operating Surplus’ (GOS) in the December quarter (orange bars in the chart above).

This needs to be broken down further because it doesn’t tell us much in aggregate. The GOS is the sum of private, public and financial corporation surplus (a profit proxy), general government surplus and the surplus generated by dwellings owned by persons. Here is how each of those components has contributed to growth over the last eight (8) quarters:

Source: ABS 5206.07 – the sum of these components represent the “GOS” component of National Income.

The contribution from General Government and Dwellings is fairly consistent. Business profitability, on the other hand, tells us something important about the trading environment.

According to the National Accounts, in the chart above, private non-financial corporations have made the largest contribution to growth only in the last two quarters (light blue bars), which is a large turnaround in performance compared to the prior six (6) quarters. This is the single largest component of the GOS and is probably the most important to look at in relation to underlying business conditions. We know that Mining has a large influence on the outcome of this measure. The ‘Mining’ industry accounts for a substantial 26% of corporate profits (Source: 5675.11) – no other industry group comes close to this.

According to the data in 5675.11 Business Indicators, the performance of Mining in the Sept quarter (versus the June quarter) was actually positive and which made a large contribution to the positive shift in corporate profits. But according to the same data source, Mining profits fell again in the December quarter. That would then mean that Non-Mining business profits would have had to have accelerated in the December quarter in order for total private non-financial corporations to continue to make a positive contribution overall (again I’m referring to the December quarter light blue bar in the chart above). This would be an important insight about the performance and transitioning of the economy. So did non-mining profits accelerate?

We can only get down to industry-level data by looking at Company Gross Operating Profits released by the ABS as a part of Business Indicators (5676.11) data release. You can also use 5676.15 – the direction of the data is the same between the two data sources. According to the ABS:

“Company gross operating profits data are used to compile estimates of gross operating surplus of private non-financial corporations” (Source: ABS Business Indicators)

The two measures of company profit aren’t identical, but are very similar. Comparing the results of the two measure over time, there are consistently differences in the rate of growth between the two measures, but rarely do they point in opposite directions/conflict. Except for this quarter.

Breaking down the result by industry in 5676.11 yields a very different result to that of the National Income figures.

At a total industry level, Company Gross Operating Profits declined by -2.8% in the December quarter versus the National Income figures which shows that the Gross Operating Surplus of Private non-financial corporations grew by +0.9%.

According to the data in 5676.11, the decline in Company Gross Operating Profits was driven by both Mining and Non-Mining industries in the latest quarter:-

Source: ABS 5676.11

The only quarter where Mining profits were positive was in the Sept 15 quarter, which is consistent with the stronger results in the Sept quarter.

Non-Mining is the big news here – corporate profit growth has deteriorated in the last two quarters, so much so that Non-Mining Company Gross Operating Profits declined in the December quarter. So if both Mining & Non-Mining profits declined in the latest quarter according to the Business Indicators data (5676.11), then how can the similar measure of “Private Non-Financial Corporations GOS” from 5206.07) make a larger positive contribution to National Income growth in the latest quarter?

From the ABS website (Business Indicators 5676 page):-

COMPARISON BETWEEN COMPANY GROSS OPERATING PROFITS AND GROSS OPERATING SURPLUS

Valuation changes have had an impact on the value of inventories held by Australian businesses this quarter. An inventories valuation adjustment (IVA) is applied in the calculation of the gross operating surplus of private non-financial corporations (GOS) estimate in the Australian National Accounts. The IVA for the December quarter 2015 is -$1,369m which is $1,974m lower than the September quarter 2015 IVA of $605m.

No adjustment is made to the company gross operating profits (CGOP) estimate in this publication and, as a result, users should exercise caution when comparing CGOP and GOS (my emphasis). It should be noted that there are other differences between the two series. In particular, changes are made to GOS when annual benchmarks are applied and slightly different seasonal factors apply to the two series. Given this, while CGOP movements are an appropriate indicator for GOS, the two series will not have equivalent seasonally adjusted movements from quarter to quarter. (Source: ABS – Business Indicators Dec 2015)

So comparison between the two measures is problematic. If no adjustment has been made to the CGOP in Business Indicators, then did the application of a lower inventory valuation actually increase the GOS in the National Accounts in the latest quarter? Could differences in seasonal adjustment account for all of the difference? Which indicator is then the more accurate representation of underlying business profit performance? As mentioned, non-mining industry performance is an important indicator for how the economy is really transitioning.

At best there is a question over the real direction of profit growth at an industry level. I have put this to the ABS for clarification.

The second point relates to the slow-down in growth of Compensation of Employees.

Employee compensation is the largest proportion of National Income at 50% and provides some basic context for the scope of spending growth in the economy.

The accelerating growth in employee compensation since the December 14 quarter has been consistent with an improving labour market at the same time. Except in the latest quarter, when growth in compensation more than halved between the two quarters.

Source: ABS 5206.44

I’ve compared the growth in Sept (Sep v June) and Dec (Dec v Sep) by state (5206.44) in the chart below. Breaking the data down to state level gives some indication of performance differences between mining and non-mining states. It’s not a perfect proxy.

Only in WA and ACT did the growth in compensation of employees improve over the last two quarters. In WA, the best thing you can say is that employee compensation didn’t continue to fall.

Source: ABS 5206.44

Most of the slow down between the two quarters can be attributed to the private sector which accounted for two thirds of the slow down.

Private sector employee compensation growth slowed the most in NSW – again, the engine room of the so-called transition – from +2.5% to +1.1%. This is actually consistent with my previous labour market update highlighting that NSW labour market was no longer looking as strong as it had been.

VIC had the highest quarterly rate of employee compensation growth in December of all the states. Although growth has been slowing for two quarters now, it is still around the average:-

Source: ABS

The main problem state is QLD – the decline in private sector compensation of employees has been accelerating over the last two quarters – the first time since the GFC:-

Source: ABS 5206.44

This is unfortunately at odds with the previous labour market update, which showed employment growth in QLD still at its peak as of the end of 2015.

The situation is similar in South Australia – private sector employee compensation growth has slowed over the last three quarters and has now turned negative in the December quarter.

Growth in employee compensation in WA has been negative for the last four quarters, but in the latest quarter, it has stopped declining, which means it’s still on its lows. In TAS and NT growth in employee compensation also slowed to virtually zero in the latest qtr.

Only in ACT did the growth in compensation of employees accelerate higher in the latest quarter:-

Source: ABS

Across most of the larger states, growth in employee compensation looks like it is slowing, if not outright declining. I’m using the eastern seaboard states (especially NSW and VIC) as proxies to gauge the ‘transition’ from mining states to non-mining states. The original point was about highlighting the slowdown in employee compensation growth between the two quarters. Most of this slow down can be attributed to NSW, VIC & QLD, with NSW by far the biggest contributor to the slow down between the two quarters. It could be a one off for NSW as there is no established trend there at the moment, but this outcome is consistent with my previous labour market outlook for NSW. This puts a dent in the narrative that the economy is transitioning well.

But there is more.

This slowdown in the growth of employee compensation in the December 15 quarter came at a time when growth in hrs worked has been accelerating higher over the last 3 qtrs. The growth in hours worked in the latest quarter is the second highest since the GFC and growth accelerated from 0.4% in the September quarter to +1.17% in the December quarter.

Source: ABS

This has brought the annual rate of growth close to pre-GFC highs. Growth in hours worked has been accelerating since late 2012.

Source: ABS

Yet, output hasn’t grown along with hours worked. In fact, output per hour worked (labour productivity) has been slowing since late 2012 and has started declining.

Source: ABS

In the December quarter, labour productivity declined by -0.6% to bring the annual decline to -0.4%.

The concept of “unrequited input growth” was raised in a Productivity Commission report into falling Australian productivity (source: Productivity Commission Report, “Australia’s Productivity Growth Slump: Signs of Crisis, Adjustment or both?” April 2012):-

“And so, in proximate terms, the decline in MFP [multi factor productivity] growth was associated with ‘unrequited input growth’ — strong acceleration in input demand that was not matched (or stimulated) by an acceleration in output growth. This is the key to understanding Australia’s much poorer productivity growth. Explanations must tell us why Australian businesses used a lot more inputs, without getting more growth in output ”

This was from a paper written in April 2012, so is not referencing this current labour productivity situation. The quote goes on to say that such a situation is not sustainable:

“The notion of unrequited input acceleration does raise the question of how such a phenomenon could be sustained. Typically, output growth provides the additional income needed to fund additional growth in inputs. Consequently, unrequited input growth does not make financial sense, unless there is another source of income growth. Chapter 2 also shows that profitability not only held up, but actually increased in the 2000s. The extra input accumulation was fuelled at least in part by increased profits and profit expectations. Clearly, productivity was not the source of growth in output and income that it was in the 1990s. Rather, the broad productivity trends of the 2000s seem to have been more the outcome of strong input growth driven by marked changes in prices and profits.”

In other words, the ‘returns’ were generated by increases in, and expected increases in, prices including commodity prices, rather than higher productivity generating greater profits.

We no longer enjoy those ToT benefits. Which brings me back to the idea of sustainability of input growth (increasing hours worked) without getting more output growth as a result. The annual growth in hours worked chart suggests that in recent times, when growth in hours worked has resulted in negative labour productivity, hours worked has started to fall. We are now at that stage of the cycle where labour productivity growth has turned negative and we’ll see whether this higher growth in hours can be sustained.

So far ‘rebalancing’ or transitioning has seen higher hours worked but no discernible increase in output growth, and in fact, if you use the Business Indicators data, declining company profits across mining and non-mining in the latest quarter. In the absence of price growth, this is not likely to be sustainable.

So how can Household consumption be the main driver of economic growth?

My final point on the December GDP result and the idea of the transitioning economy, relates to our single largest driver of economic growth at the moment – households.

The big news from GDP was the strength of household expenditure and its resilience in the face of our transitioning economy.

Whilst the contribution from households is large, the direction of spending growth has remained fairly steady over the last few years – not accelerating growth. The current annual rate of growth in real household consumption expenditure is now +2.9% (+4.6% in nominal terms). On a quarterly basis, growth pulled back only slightly from +0.9% in September to +0.8% in December.

Source: ABS

Compared to recent history, growth in household spending has been growing at a fairly consistent rate of just under 3% for the last 18 months.

This rate of growth is not great when you consider that the rate of household consumption growth has been much higher in previous years. But how could household spending be any higher? The context from National Income shows that employee compensation growth (and wages) has slowed considerably over the last five years and in some states, employee compensation has recently turned negative. This has translated into slowing growth in household gross disposable income as well.

Gross disposable household income growth has been slowing since it peaked in 2007 at +12% annual growth – growth is now running at +3.1%. Adjusted for CPI, gross disposable household income is only growing at 1.4% in real terms. This rate of growth is low and is slowing:-

Source: ABS

Maybe the real question is how household consumption expenditure growth has remained at this constant level while household income growth has been slowing?

One reason is due to falling net household saving. Note that the ‘net savings’ measure is actually a calculation of the difference between income and spending of households. As spending increases faster than income, net saving falls. This is what has been happening since the peak in net household saving since mid-2012. In the last year, net household saving has fallen 15%.

Source: ABS

This fall in net saving is partly funding the growth in household consumption.

The other important source funding household spending growth is household debt. While growth in household disposable income has been slowing and is now at a relatively low point, real mortgage debt as a % of real GDP has been rising to its highest point – accelerating in fact since mid-2014. The stock of outstanding housing debt now represents 85.5% of real GDP (total real private debt represents 140% of real GDP):-

Source: ABS, RBA

Compared to household disposable income, household debt now represents in excess of 175% of disposable income.

It seems we might be pinning our hopes on a transition based on continued spending by households that have been facing lower income growth and greater levels of indebtedness. Whilst the GDP top-line results look good, the underlying factors say that the success of the ‘transition’ is on shaky ground.

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 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

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:-

Source: http://stats.oecd.org/Index.aspx?DataSetCode=EO#

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.