A Take on Scott Morrison's State of the Australian Economy Speech

Scott Morrison gave a speech to the American Australian Association outlining his views on the Australian economy. 

It's worth a read because it reflects the positive view of the Australian economy's past present and future performance. 

Scott Morrison (2016) “Australia — The upside economy in a post GFC world”, Speech to the American Australian Association, New York, 5 October <http://sjm.ministers.treasury.gov.au/speech/019-2016/>. 

 

Morrison starts with the phrase that must be the envy of his developed country peers. 

Australia has just completed twenty five years of uninterrupted annual economic growth. An entire generation has now grown up in Australia without ever having known a recession. This is despite a GFC, an Asian financial crisis, global terrorism, SARS, one in a hundred year floods, droughts and a thirty per cent fall in our terms of trade It is one of Australia’s greatest national achievements and was no accident. … 

The assumption is that this success will continue because Australia is transitioning successfully as is China.  

Right now, our economy is undergoing a successful transition, from a once-in-a lifetime mining investment boom to broader-based growth led by other sectors, such as services.
We are assisted, of course, by the synchronised transition of our largest trading partner, China, from a production economy to a consumption economy. And demand from China will only grow as its middle class hits around one billion people by 2030.
That said, our transition is one that requires careful economic management. … 

It is too early to tell whether both of these transitions are going to be successful. China's increase in consumption has been slight and really couldn't have gone any lower. This chart from Jun Nie and Andrew Palmer shows how low consumption got in China. (H/T Timothy Taylor)

Other problems such as the housing market and the level of debt make Morrison's assumption problematic. In Australia, the closure of Ford reminds us that the transition has some significant casualties.

Morrison is keen to point out that Australia is open for investment and that it must remain so because of continuing current account deficits.

We’re a capital-importing economy. Australia needs to fund a current account deficit of around four per cent of GDP on average each year. The demand and opportunities for investment have always exceeded the domestic capital available to realise these opportunities. This is not changing anytime soon, if ever, and that is why it is unquestionably in our national interest to welcome foreign investment.

Australia also operates a sustainable (my term not his) investment regime

with a clear set of practical rules to ensure that foreign investment is not detrimental to our national interest. Rather than hinder foreign investment, our investment screening arrangements play an important role in ensuring that our door always remains open. They help reassure the Australian community that this investment will always occur on our terms and in our interest. And that, in turn, reassures investors that their investments are viewed by Australia as valuable and desirable. In our particular region of the world, our approach to foreign investment is unusually open and welcoming. Unlike many of our neighbours, we don’t have an investment black list that limits foreign investment in particular industries or sectors. … For this reason, rejections are rare. … 

He then turns to the needs of foreign capital needs of Australian financial institutions. 

The stability of our financial system and of our financial institutions is therefore of critical importance to maintaining access to foreign capital.  

Morrison sprukes Australia's performance during and after the GFC, which he slates home to quality regulation.

Australia’s financial system not only weathered the global financial crisis, it proved itself to be both strong and steady. Our prudential framework — which was more stringent than minimum international standards before the crisis — together with a proactive approach to supervision, helped maintain a healthy financial sector domestically. Our financial system has continued to perform robustly in the years since. The major Australian banks, for instance, have remained profitable — far preferable to the alternative – and significantly more so than most of their international peers in the US, Japan and Europe.  

What the macroprudential framework, as late and limited as it has been,  has not stopped is an excessive build up in household debt in Australia, which has inflated Australian property markets. Instead Morrison focuses on the current reasonable level of non-performing assets.

One reason for this performance is that Australian banks also saw a much smaller increase in asset impairments following the financial crisis. The ratio of non-performing assets to total loans peaked at 1.9 per cent in mid-2010, well below the peaks experienced in the US and the UK at around the same time. This ratio has continued to improve, falling to 0.8 per cent as at December 2015. 

Despite recent improvements in business lending, it is clear that the excessive focus of Australian banks on real estate has negative effects on business lending and ultimately productivity.

Banks are also continuing to lend more and more to businesses, with business credit growth remaining strong over this year. In August 2016, bank loans to businesses were up 8.2 per cent from a year earlier providing further positive evidence of our ongoing economic transition. 

Morrison is not worried about the potential for debt to cause an eventual collapse in consumption.

It’s a similar story when it comes to the funding and capital positions of the Australian banking system. Since the crisis, the funding position of Australian banks has continued to improve, with an increased focus on stable sources of funding — such as deposits and long-term wholesale debt — and a reduction in the use of short-term sources of funding. 

Banks have also taken steps to improve their capital positions since 2008, with the total capital ratio of Australian banks improving from around 11 per cent in September 2008 to 14 per cent today. 

As of December 2015, the judgment of the Australian prudential regulator was that our major banks had capital ratios that are within the top quartile of international peers. That is where we want our major banks to be.  ... Now, that said, these results aren’t accidental. They reflect efforts by the Government and Australian regulators to ensure Australia’s financial system is strong now and into the future.

He then turns to the housing market. Inflated prices he argues are mostly due to supply constraints.

unlike many overheated real estate markets in the US in the past, our real estate asset prices have predominantly been underpinned by genuine under supply. In addition, unlike in the US, borrowers cannot just walk away from loans and throw their keys in the door. Our lending model is based on full recourse financing, with low doc loans a very small component of our housing credit market. This puts the necessary tension in the chord to hold our real estate markets together.  

This might be true but recent reports show that large percentages of loans can be characterised as "liar loans".

an anonymous survey of more than 1200 Australians who have taken out a residential mortgage over the past two years, investment bank UBS has uncovered an epidemic of “liar loans” despite tougher lending standards imposed by the banks. The study found 28 per cent of mortgagors said their application was “not factually accurate”. Only 72 per cent said their loan application was “completely factual and accurate”, 21 per cent said they were “mostly factual and accurate”, 5 per cent said they were “partially factual and accurate”, while 2 per cent “would rather not say”. 

That not surprisingly wasn't in Morrison's speech, but it does imply that borrowers may not be as sound as the documents suggest. To be honest I'm surprised the figures for obfuscation or outright lies are not higher.

Morrison reflects the general financial policy-maker complacency about house prices:

prices are growing, but are doing so at a more moderate pace compared with the peak around a year ago.  

I imagine that we'll have a different assessment of the wisdom of Glenn Stevens and his merry band of financial optimists in the Reserve Bank in coming years when it all turns to tears.
 
Morrison argues that it will all be alright because increased supply is coming on the market and this will mean a return to balance and greater affordability.

Housing supply is also responding to longstanding shortages. The number of dwellings under construction has increased by almost 20 per cent in the last year. Further, in the next two years we will see an unprecedented volume of dwelling supply come online — particularly in the medium-high density segment in CBDs of Sydney, Melbourne and Brisbane. This will have a moderating influence on growth in dwelling prices, supporting a better outlook for housing affordability. 

Rising household debt is not a worry.

Low interest rates have contributed to house price growth but, together with higher rates of saving, households can pay off the principal on their mortgages more quickly, or to build up a buffer through loan offset and redraw facilities. And macro prudential management, such as requiring banks to limit investor lending to 10 per cent annually and to tighten their lending requirements, supports sustainable lending in the housing market.   

Morrison then turns to immigration, where he argues that Australia's immigration program has been rightly focused on

migrants with high rates of workforce engagement and employment in skilled areas. This not only supports population growth but also lifts participation and productivity in our economy that also drives growth. More than two thirds of our annual permanent migration intake is skilled.

The program is helping to create a nation of contributors rather than takers.

Because our immigration program is built around attracting those who make a contribution rather than take one, today we can claim to not only have one of the highest proportions of foreign-born citizens in the OECD, but also one of the lowest levels of unemployment amongst our foreign born population amongst OECD countries. 

The combination of skilled immigration and a tough border control regime helps to make Australia more cohesive.

Our skills based migration program, combined with arguably the world's most effective border protection regime, has enabled us to achieve the twin goals of economic growth and social cohesion. This makes Australia the most successful immigration nation on earth, providing our Government with the license to confidently pursue positively controlled immigration policies into the future.  

He declines to mention that "the world's most effective border protection regime" has involved enormous costs and severe, punitive measures for asylum-seekers. The focus on boat arrivals and the need for harsh measures to stop asylum-seekers dying at sea has focused the population's gaze on a small section of possible Australian immigration. Continuing immigration

means Australia needs a significant infrastructure push to support a growing population, drive productivity growth, maintain and enhance our standards of living, and make sure our cities remain world-class. There will be opportunities for governments, businesses and international investors to work together to fund Australia's future infrastructure initiatives. The Australian Government is investing in productivity-enhancing infrastructure across the country.  

Our $50 billion national infrastructure plan includes, for instance, large-scale projects like the WestConnex Motorway in New South Wales and a new airport in Western Sydney to expand on our potential as an international gateway for the region. 

While $50 billion might sound quite the sum, it's important to remember that borrowing costs for governments are unlikely to ever be better than now. If you want popular support for immigration, the cost is improving infrastructure both physical and mental.

Morrison's solution to economic woes does not lie in monetary or fiscal policy but in private sector investment and exporting.

The Australian Government is also working to increase exports, reduce taxes and encourage innovation through implementing our national economic plan for jobs and growth.  

While so much of the global economic discussion focuses on monetary and fiscal stimulus, we believe that these options have largely exhausted their effectiveness, at least from an Australian perspective. By contrast, we believe the answer to our global economic challenges is to focus on what is needed to boost private investment and trade.  

That is reduce taxes and encourage innovation by using words such as "agile", "innovative" and "productive". Actual investments in these things have been limited. Morrison points to the National Innovation and Science Agenda, which comprises "initiatives worth $1.1 billion over four years".

This package of measures, championed by our Prime Minister, is aimed at supporting a culture of innovation and entrepreneurship — similar to what exists here — and rewarding risk-taking. …

Once again, while this might sound like a reasonable investment $275 million a year for 4 years is not a great commitment for a policy that is a cornerstone of the government's development rhetoric. But it's the government's weak spending on all levels of education that undermines the development of long-term innovation. The abridged NBN managed by Malcolm Turnbull is also a blight on Australia's innovation potential.

Morrison then tells us that he's coined a new term for protectionism.

We cannot afford to allow what I call 'doona economics' to overtake our domestic economic debates. In Australia we talk about jumping into bed and pulling the doona – a heavy bed covering – over your head in the hope your problems will go away. This is akin to the protectionist mindset that thinks we can all retreat from engaging in the global economy and somehow not leave our citizens poorer. We must all work to keep the doors open to global trade, including supporting the Trans Pacific Partnership as agreed. … 

No mention of the fact that governments will actually have to improve the redistribution of the costs and benefits of openness if populations are going to support it. Instead the government believes you can get poorer sections of the population to support freer trade by cutting their jobs, wages, benefits and opportunities.

Then there's the problem of debt, not the real problem of private debt, but the perennial concern about public debt.

Lastly, I want to say that the Australian Government is committed to reducing our debt. Australia's gross debt to GDP will soon peak at around 30per cent. This is low by international standards, including for other triple-A rated economies. But it is high for Australia. The Turnbull Government is committed to arresting our debt by first restoring our Budget to balance. The Budget I delivered in May projects a return to balance in 2020-21 subject to parameter variations, with expenditure to fall from 25.8 per cent of GDP to 25.2 per cent. 

Although it sounds heretical in the Australian context, Australia needs less private debt and more public debt, wisely invested in infrastructure that will enhance Australia's productivity in years to come.