The Australian economy is going through a massive change at the moment, and yet there is a bizarre belief within the government and Reserve Bank that economic policy can behave as if things are the same as always. The way the differing parts of the economy no longer seem to fit together as they used to and yet there is little change from the old solutions of low interest rates and a return to surplus.
Last week the latest GDP figures found that in the past 12 months the economy grew by just 1.7%. In the March quarter the economy grew by just 0.3%. So weak is the economy running that to stay steady at 1.7% annual growth we need the economy in June to grow by more than twice what it did in March. That is certainly achievable, but it does highlight how precarious things are.
But if you were to look at the statements of the Reserve Bank and the pronouncements in the budget you would assume everything is running as it should.
But things are not as they once were.
The manner in which the economic pieces no longer fit together as they should is perhaps best highlighted by our inflation measures. While the standard measures of the consumer price index and the RBA’s underlying inflation measure have inflation growing below 2%, in the latest GDP figures inflation grew at a sprightly 5.8%.
The issue is that the inflation measure in the national accounts (known as the GDP deflator) doesn’t just take into account the prices of things we consume but also the things we produce – and the price of our resources took off in the early part of this year.
Usually the CPI and the GDP deflator are aligned but that has stopped being the case:
The reason this is important is that it signals that our GDP growth is becoming less dependent upon consumption and production for domestic purposes and more dependent upon export production.
Exports are now contributing as much to GDP growth as is the combination of domestic consumption and investment (known as domestic demand):
Since the end of the mining investment boom in 2012, domestic demand has never contributed more than three percentage points to annual GDP growth – that is a run of 18 quarters in a row. To put that in perspective the next longest such run was 11 quarters during the 1990 recession.
The problem is that while having exports generate growth is no bad thing, they alone are not enough.
Over the past four years exports have contributed as much to Australia’s GDP growth as any time since 1960. But in that same period domestic demand has contributed less than in any other four-year period except the 1990 recession:
This is what I mean when I say that the pieces don’t fit together anymore.
In the past if nominal GDP was growing as strongly as it is you would expect domestic demand to be growing equally strongly. But now because nominal GDP is being powered by export prices the two have split.
And that matters because domestic production and consumption is what drives jobs, and in turn wages growth and then standard of living.
This is also a problem for the government because nominal GDP is usually a good guide for taxation returns because of the link with domestic demand. Strong nominal GDP growth usually means strong consumption and domestic production and thus strong growth of income and company tax.
But if the strong growth is driven overwhelmingly by exports then that link also breaks down. It means the government is going to be relying more than usual on company tax revenue from mining companies – companies who have had a series of poor years to use to reduce their taxable income.
The hope is that we are near the end of the fall in mining investment and thus at the end of the low contribution of domestic investment and consumption to GDP growth.
The RBA certainly hopes so. Last Tuesday when it kept the cash rate at 1.5% it argued that “the transition to lower levels of mining investment following the mining investment boom is almost complete”.
And yet the latest investment projections for 2017-18 released two weeks ago suggest the fall in mining investment will continue over the next 12 months, and that the pick-up in non-mining investment will not be enough to balance it out:
Rather than use the traditional nominal GDP measure perhaps a better indicator of the state of the economy might be one that uses the inflation measure of CPI rather than the GDP deflator. Using this measure the picture of the economy is much less rosy:
Such a measure would have nominal GDP growth at just 3.6% – well below the 5.5% to 6.5% average we experienced in the 15 years prior to the GFC.
Normally, such weak growth would see loud and constant calls for an interest rate cut.
But interest rates are already at record lows and the cash rate is currently lower than inflation growth. The real cash rate has been around 0% for four years. And in that time inflation has not budged:
And further cuts to interest rates would cause concern about the impact on the housing markets in Sydney and Melbourne.
So if interest rates cuts are off the table, that leaves the federal government. In the same period of low interest rates we have also had the constant calls for a need to return to budget surplus. If the pieces fit together like they used to that might be sensible. But with an economy featuring historically weak levels of investment and consumption growth, record low wages growth and record low interest rates, perhaps the missing piece is the government?
Ministers made a great noise before the budget about infrastructure. It’s clear more than noise is needed.
