Michael Blythe outlines the risks and opportunities facing Australia as it enters a new economic phase.
The tendency to downplay the economic “good news” and accentuate the “bad news” continues and this bias at the global level is understandable. Many countries and regions are still dealing with the difficult clean up from the “great recession” and many central banks have taken further steps to stimulate economic growth. Domestically, the Reserve Bank of Australia (RBA) has lowered its own growth projections and cut interest rates as well.
But some perspective is required. The Australian economy, for example, has just completed its 23rd year of continuous economic growth: this track record is unmatched in the post-great-recession era. The imbalances that worry global investors and the ratings agencies are manageable and our AAA rating looks secure. Policy-makers retain some firepower, interest rates can be cut further and government debt levels are low enough to allow some fiscal stimulus if needed. Our financial system is well-run, well-regulated, well-rated and profitable.
It is fair to say, however, that some of our economic glitter is wearing off. Real economic growth is respectable but the flow through to incomes is weak, while the unemployment rate has lifted to near a 12-year high. The key requirements for the economy is to find new sources of income and new sources of jobs.
Resource export growth as we transition from the construction to operation phase of the mining boom will provide more income (potentially equivalent to four per cent of GDP when all the current projects are up and running). But for this income to appear the rest of the world needs to be strong enough to buy this new production and pay us a decent price.
China is the key from a demand perspective. Chinese growth of greater than 6.5 per cent per year is sufficient to support commodity demand and this sort of growth rate seems achievable. The real threat to some commodities, especially our biggest export iron ore, is extra supply. For Australia, as a low cost producer of iron ore, there is scope to win market share as higher cost production closes. And the current focus on cost cutting means more income from each tonne of iron ore even if prices remain low.
Net jobs growth is positive, so rising unemployment is mainly a reflection of strong population growth, but job losses are coming as resource construction winds down. There is a pressing need for other parts of the economy to pick up and fill the gap left as mining capital expenditure (capex) subsides. The growth transition to residential construction, non-mining capex and infrastructure needs to succeed to offset the damage to the labour market.
The transition is underway, but at varying speeds. Residential construction activity is strong, and a record number of dwellings will be built over the next couple of years. Non-residential capex, after some earlier encouraging signs, looks to have stalled – political concerns are weighing. Government infrastructure spending is yet to ramp up in any significant fashion. The transition would be aided by a lower Australian dollar (AUD). A stronger US dollar is helping and we expect the US Federal Reserve will lift interest rates from mid-year, which should give the adjustment a further nudge along. We put the AUD at US 70¢ by year-end.
A lower AUD by no means dilutes the need for other arms of policy to play a role in supporting activity and infrastructure should be the focus. The stock of infrastructure relative to the size of the economy, for example, is at the lower end of the range of the past 50-plus years.
Public capital spending fell by 12 per cent during 2014, reducing GDP growth by 0.6 percentage points. This lack of support from the public sector is particularly disappointing. Just maintaining the public capex share of GDP would have seen economic growth running at trend at the end of 2014. Against this backdrop, the RBA may well see itself as the policy maker of last resort, pushing interest rates beyond their comfort level.
One offset to any shortfall in the growth transition may be the consumer. Low interest rates, a lower AUD, lower petrol prices and higher housing wealth are a potent mix for consumer spending. To unlock this stimulus, job security fears need to ease. A combination of income and demographics offers plenty of opportunities for agriculture, education, tourism, health and financial services in the years ahead.
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