Wednesday, September 3, 2014

She'll Be Right Mate? Australia's Economic Future

Real GDP per Capita is an important measure of real aggregate progress. While it doesn't tell us anything about the distribution of growth, it does tell us how much an economy is growing per person so that it removes the impact of population growth and immigration. Remember that in a country with a rapidly growing population, growth can be, at least in part, a consequence of that population growth.

The Reserve Bank Governor Glenn Stevens recently gave a speech highlighting Australia's relatively good performance in comparison with other developed countries.

In comparison to the US, UK, Euro area, Canada, Japan and New Zealand. The graph measures performance since 2005 by making all countries equal (100 on the Index) at this point.

As the Governor notes, these figures don't tell us what's coming but he outlines three possible sources of future growth.
Which sectors would be available to lead such an expansion? In the broad, there are three. There are households, governments and firms. Let's think about each briefly.
Households being willing to increase their debt and lower the share of current income being saved was a striking feature of Australia's economic landscape from the early 1990s until just prior to the financial crisis. Consumption spending consistently rose faster than income and the ratio of debt to income went from about 60 per cent in 1993 to 150 per cent by 2006. Households are servicing that higher debt quite well – mortgages make up most of their debt and arrears are running at about one half of 1 per cent, which is low by global standards. But as I have argued before, it seems unlikely that household debt can rise like that again. Nor would it be desirable. So while we can expect that household consumption spending can grow in line with income, or maybe a little faster given the rise in net worth over the past two years, the odds are against households being a driver of strong growth the way they were a decade ago.
What about the government sector? Most governments in Australia are trying to strengthen their own balance sheets by containing the build-up in debt that has been occurring. Public final spending is scheduled, according to the stated intentions of federal and state governments, to be subdued over the next couple of years. In fact, it is forecast to record the most subdued growth for a long time. By and large then, the public sector is not in the phase of using its balance sheet to expand demand faster than normal. 
That leaves the business sector. ...
My conclusion would be that many businesses are in a position to play their part in the growth dynamic over time. The fact that in some areas outside of mining the level of gross fixed capital spending is barely above depreciation rates suggests that, over time, capital spending in those areas will have to increase. The forward estimates of non-mining business capital spending released recently do show a further upgrading of intentions. That won't offset the impending fall in mining investment and it would be good to see further, and more substantial, upgrades over time. But the available data suggest that things are at least heading in the right direction.
Stevens canvasses the external environment in the first part of the speech and it appears that he is fairly sanguine about future possibilities.
Overall then, the global environment remains ‘interesting’, with significant challenges, uncertainties and puzzles. All that said, from Australia's point of view, the world economy continues to grow, inflation remains contained, our terms of trade though falling remain high, and financial conditions are remarkably accommodative.
Our external environment is heavily shaped by China. China is our biggest export partner and it is our other biggest export partners' biggest export partner, which means that any Chinese growth slowdown or rebalance towards consumption will have a negative effect on us and indeed all of Asia.

As Stevens points out:
For Australia's particular group of trading partners, weighted by export shares, growth is running at about 4½ per cent, which is somewhat above the 30-year average. This strength reflects the continued increase in the weight of China as a destination for exports. Even though China is growing more slowly than it used to – at a mere 7½ per cent this year – the fact that its growth is so much stronger than most others combines with its increased weight to push up the weighted-average growth of our trading partner group. 
The determined pessimists among us [that's me!] will see the increased weight of China as a concern: what if something goes wrong and the Chinese economy experiences a sharp slowing in growth? In fact this is a question that could be put for most economies now – nearly 50 economies, including the United States, European Union, Japan, Russia and Canada, now have China as their number 1 or 2 trading partner. The full ramifications of the continuing rise in the weight of China's economy and, in time, its financial system in world affairs will be the topic for numerous lengthy books. But in short, the whole world is now more dependent on China than it was. 
For today, probably the most important point to note is that the near-term task of the Chinese authorities is to manage the desired slowing in credit growth and moderation in asset values. Housing prices are falling in many Chinese cities at present. This is not unprecedented – it is the third time in the past decade this has occurred. (Yes, house prices can fall, even in China.) This area – the asset price and credit nexus – is the one to watch, more than the monthly exports or PMIs and so on. 
Another pricing puzzle is exchange rates. Many in Australia have commented at length about the relatively high value of the Australian dollar against the US dollar. The Bank has made its views on this pretty clear and so I won't reiterate them today. But it's worth noting that many other countries have had a similar puzzle to ours – so the real question is why the US dollar has remained as low as it has.
Yes you read correctly. Nearly 50 countries have China as their number one or two trading partner.

What this means is that Australia is now more affected by Chinese conditions than ever before and what happens to the US dollar will affect the competitiveness of the tradable sector (exporters and import-competing firms).

We need China to keep growing strongly and for the US to increase growth so that the US dollar strengthens. The rest of the world economy also needs the US economy to increase its rate of growth.

Remember that measured by exchange rates the US is still the world's largest economy. The fact that about 70 per cent of the US economy is consumption means that the US remains the vital final destination of a whole lot of goods (and associated services) that have been initially traded between the countries of Asia (think the iPhone etc).

I have long thought that the decoupling of the overall Asian economy from Europe and North America could only be a temporary phenomena. China needs the developed world to keep buying Chinese goods (as does the rest of Asia) but, in turn, the developed world requires China to shift to higher levels of consumption.

In the absence of a shift towards higher consumption in China, it is doubtful whether Europe and North American economic policy-makers will be happy with enhanced export-led growth in China. A revitalised Chinese current account deficit will mean increased exports of Chinese capital and probably higher unemployment in the developed world.

Australians should hope that the world economy can rebalance and avoid the sort of recoupling of the Asian and developed world economies that would lead to an Asian growth slowdown.

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