Thursday, May 2nd, 2019
Over the coming weeks, the strengths of the Australian economy will rarely be acknowledged by either side of politics in their quest to hold or take government. Once again, the Australian election campaign will be dominated by negativity on both sides. Neither will acknowledge that the Australian economy has a unique and enduring strength that just requires sensible management.
At this point, the polls suggest that we are destined for a change of government. But we suspect it will be constrained by a hung Senate. Thus we do not have confidence that a new government will drive a policy reset that enhances the natural growth of our economy.
We do know that a new government will attempt to fiddle with taxation rates rather than make strategic changes. There is every indication that a crude attempt will be made to affect a minor redistribution of wealth. It will not be a serious endeavour to propel growth that in turn will actually create wealth. It will not focus on driving Australia’s competitive advantages. It will not acknowledge that our superannuation savings of $2.7 trillion uniquely positions our economy for sustained and funded growth. Thus, our new government will not think independently or act differently from the chaotic management of our peers in the developed world.
If we do have a change of government, there will be a brief euphoric honeymoon period with the predictable promise to govern for every Australian. Within a few months, rigor mortis of policy will set in again and it will be obvious that not much has or will change. The quest for power as always will be more important than the quest to do something with that power.
With that introduction, we will flow into a background brief of the underlying strengths of the Australian economy, balanced by an acknowledgement of the pressing issues that should, but won’t, be discussed and debated in this election campaign.
Let’s start with the population growth rate that underwrites Australia as one of the fastest growing economies in the developed world. The following image is drawn from the Australian Bureau of Statistics’ website and is based on their detailed demographic research that flows from the national census.
Figure 1. Population clock
Let’s be very clear. Australia will continue to grow its population no matter who is governing. The surge in population since the GFC was from two sources: natural net birth rates and acceleration of immigration from 2010. Even a slowing rate of immigration won’t stop our population from growing. But what is a desirable rate of population growth? Has there been any attempt to create a cohesive national policy that dictates to government, whoever they are, what Australia actually needs?
From population growth flows demand for goods and services. Some of these are essential and some are discretionary. It is incumbent on Government to ensure that the costs of essential goods and services are managed efficiently. The default position of both sides of Parliament has been to allow private capital to operate healthcare, aged care, education, energy and other essential services – but these need to be balanced by appropriate regulation. Essential services need to be efficiently delivered but that benefit is lost if average people can’t afford them.
The growth in population is acutely skewed to Australia’s eastern states and this is putting immense pressure on essential infrastructure – much of which sits in private ownership with long concessions.
Figure 2. September Key Figures
The population growth seen in Victoria, mainly in the outer suburbs of a sprawling Melbourne, has created problems because there has been no national immigration plan. The concentration of immigrants into particular areas is caused by their hope or misunderstanding that jobs exist. People will naturally go to where the jobs seem to be, but there is little evidence that Australia is creating highly skilled opportunities consistent with the actual immigration intake or their training. There is a disconnection that can only be rectified by a well thought out bipartisan national policy.
Over the last twenty years, Australia has evolved into a services-based economy – financial, tourism, health care, aged care and education. Our economic output is captured in the following chart that shows that services dominate the output of our economy. Manufacturing output has declined rapidly as a percentage of total output since the 1980s. The exporting industries of resources and agricultural offer limited employment opportunities and it is easy to observe that technological advancements are also driving employment opportunities lower in these sectors.
Figure 3. Australia Output by Sector (%)
Source. Refinitiv, Capital Economics
The next chart shows that our services based economy is inward focused. The services trade account has been a mild contributor to GDP growth for 2 decades. Australia has not been able to effectively export those services which dominate our economy – but that is changing with the emergence of Chinese tourism as a generator of significant foreign income.
Figure 4. Australian Contribution of Net Exports to Annual GDP Growth (%-points)
Source. Capital Economics
The combination of tourism income, elevated resources prices (coal and iron ore), increased export bulk commodity volumes and the emergence of LNG exports, has driven the Australian trade account into sustained surplus.
Thus Australia’s current account and our net foreign debt position have improved over the last 4 years. Importantly, our current account deficit at 1.5% of GDP is at its lowest ratio for 20 years. Further, we will soon see the emergence of net foreign income as Australian super funds increasingly add to their offshore investments.
Australia’s international debt and trading position has and is improving rapidly – but you won’t hear that mentioned during the election campaign.
Figure 5. Australia’s current account balance (% GDP)
Source. JP Morgan
The rapidly emerging foreign income from offshore investments (from our growing super assets) is becoming important to balance the risk from being a net commodity exporter. However, as the following table shows, Australia is not the country most excessively exposed to commodity prices (compared to Russia, Saudi Arabia, etc) and we are fortunate indeed that our biggest trading partner is the commodity-hungry China.
Figure 6. Trade balance in commodities* (As a % of GDP, 2017)
Source. UN Comtrade, Capital Economics *Agriculturals, Fuels & Metals
The opening of Australia’s economy has paved the way for international trade to grow and allowed our economy to benefit from the competitiveness of China. So while China has pushed our trade account into surplus, it has also exported back to us deflation in discretionary goods.
Australia’s current inflation rate is at its lowest observed rate for 25 years and the following chart shows that it is negative tradable inflation that is the real cause.
Figure 7. Tradable and Non-Tradable Inflation*
Source. ABS; RBA
Australia imports electricals, whitegoods, furnishings and clothing from China at prices that are lower than twenty years ago in real terms. It is telling that Australia’s current inflation rate is dominated by the cost of locally produced goods and services – many of which are government services.
It would be preferable for the next Australian government to focus on the cost of its services rather than changing tax rates or pushing up wage costs as a means to redistributing wealth. Higher wages sounds good for votes, but it is a short term fix that will be frittered away by inflation.
An area where the government can and should have been more proactive is intervening (with the RBA) in the housing market to ensure that house prices do not unfairly escallate.
Figure 8. House Price / Income Rations
Source. CoreLogic, Refnitiv, Capital Economics
The surge in house prices from 4.5 times average household income, to over 6 times, has notionally created wealth but it has also distorted the distribution of Australia’s wealth.
Figure 9. Household Net Wealth & Savings (% of disposable income)
Source. Refinitiv, Capital Economics
Average Australian households (and particularly young families) have been poorly served by successive governments. The debt surge noted in the following chart flows from the poor financial regulation of credit creating institutions.
Figure 10. Australia Household Debt to Income Ratio (%)
There is no real benefit from rising house prices if it is created and sustained by excessive debt.
The next chart shows the clear connection between housing finance and house prices. Thus, while negative gearing has added to household debt, there is no doubt that occupier borrowers have also borrowed excessively.
So while the merits or otherwise of negatively geared tax breaks can be debated, the proper regulation of credit in Australia will not be.
Figure 11. Housing Finance and Housing Prices, Year-end change (%)
Source. Thomson Reuters Datastream, Evans & Partners
It is unfortunate that many young families that bought houses over the last 4 years will find that they have negative net equity as residential prices decline by 20% from their peak. Maybe a property tax break should be transferred to these families and away from negatively geared investors to compensate them for the poor public policy settings of successive governments.
Finally, we predict that this election will be dominated by competing claims of superior economic management. But does either side really have a superior plan to manage our growing economy?
Indeed can either party claim economic success in creating a fiscal surplus as wages growth stagnates and the costs of essential services – many supplied by government – grow at ever compounding rates, and force down the standard of living for many average families?
Figure 12. Underlying Cash Balance (% of GDP)
Source. Capital Economics
Australia’s growth opportunity is superior to many of our peers, who are sustained by massive debt, currency printing and negative interest rates. Yet in coming weeks, we doubt whether we will hear a positive plan for our growth or a plan so sensible that it is indisputable.