Australian economic update.

Strong population growth continues to boost Australia’s aggregate growth rates which paint a more positive picture on the economy than what most households are experiencing.

Overview

In October last year we published a note looking at the Australian economy on a per capita basis. Our intention was to better understand how economic developments were affecting household living standards. At the time we felt that policymakers were placing too much emphasis on aggregate growth rates and not enough on per capita measures. When we drilled down to the household level we found that the news was more sobering than the headline growth numbers implied.

As we discussed at the time, most economic commentary in Australia focuses on aggregate growth rates which are heavily influenced by population growth ‑ more people means more spending. But if we want to measure changes in living standards, which ultimately matters most to households, then we need to look at how the economy is going on a per capita basis rather than just reporting and focusing on measures of aggregate demand.

Australia’s population growth rate is significantly higher than most other OECD countries. Australia’s population grew by a strong 1.55% (i.e. 373k) in 2016. Net overseas migration accounted for 56% of that increase. A high population growth rate means that making comparisons of economic performance between Australia and other OECD countries using aggregate growth rates like GDP can be misleading. As Governor Philip Lowe recently said, “our strong population growth has flattered our headline growth figures.”

In this note we update and expand on our previous work looking at the Australian economy on a per capita basis. The evidence continues to suggest that policymakers should focus on reforms that boost productivity and raise living standards rather than measures designed to simply raise headline GDP. We think that better outcomes will be achieved for households if a greater emphasis is placed on measures of living standards rather than aggregate growth rates. This note discusses a few of the measures that we consider to be important.

Read the full report.

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Overview

The CPI is generally considered to be a de‑facto cost of living index. It is the measure of inflation that most policymakers and commentators refer to when making statements about changes in the cost of living. Real wages, for example, are calculated as nominal wages deflated by the CPI. But there is a massive flaw in using the CPI as a proxy for changes in the cost of living. The index ignores price changes in the single biggest purchase a person (or household) is likely to make in their lifetime – a dwelling. For households that do not own a dwelling and aspire to purchase one, the CPI is a very poor measure of changes in the cost of living.

In this report we look at the justification for the omission of dwelling prices in the CPI. We then create a theoretical CPI that includes dwelling prices for illustrative purposes. We conclude with a brief discussion on the relationship between monetary policy, inflation and house prices.

Read the report.

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The quarterly report analyses how the States and Territories are performing across a range of economic indicators and detail our key economic forecasts for each region.

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The surge in non‑rural commodity prices, which began around the middle of 2016, is boosting Australia’s income at the aggregate level, improving the trade position (there was a $1.2 billion surplus in November!) and lifting government revenues. The sector still yet to benefit is households, with higher commodity revenues not yet filtering through to stronger wages growth.

Wages growth has historically shown a strong correlation with commodity prices. For example, the correlation between annual growth in the Wage Price Index and commodity prices sits at 0.8. Other measures of labour costs, like unit labour costs, which have a longer history show a similarly high correlation. Looking at wages growth excluding the mining sector shows the same strong correlation. This shows that the non‑mining sector also typically benefits when commodity prices increase.

It has been suggested that the decline in wages growth in recent years has been larger than would be expected given historical relationships with economic variables such as the unemployment rate (see RBA, 2016). However looking at the relationship between wages and commodity prices shows that declining wages growth in recent years does not look out of line.

So what about 2017?

The historical correlation with commodity prices suggests that wages growth should lift sharply in 2017. However our forecast is for a more modest lift. This is because the latest run up in commodity prices is generally thought to be temporary. Our commodity analysts are expecting bulk commodity prices to ease in 2017. And the latest government budget update assumes a decline in prices later this year. The mining companies must share a similar view with no significant plans as yet to invest to expand capacity.

This is vastly different from the previous commodities boom where mining investment ramped up strongly alongside rising prices. This caused the labour market to tighten and put upward pressure on wages. This time around there is also a lot more spare capacity in the labour market to work through before significant wage pressures are likely to emerge.

Nonetheless it a positive factor. And another positive sign for wages growth and inflation in Australia is that global disinflationary pressures are easing. Producer prices are now rising, not falling in China. And the US economy is running close to potential even before Donald Trump has implemented his expansionary and inflationary policies. We also expect the AUD to weaken a little over the year, which will put upward pressure on imported prices.

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The 5.4% rise in total credit over the year is low by historic standards. But Australia’s stock of private debt is still growing faster than nominal GDP which means overall leverage in the economy is rising. The increase in leverage is being driven mainly by the household sector. And the debt is going into bricks and mortar.

Housing credit has been expanding by around 0.5% a month over the past six months. But the annual growth rate has been falling over that period. The stock of housing credit was growing at 6.4%pa in September. It looks like it will stabilise around this level over the near term.

Despite the annual growth rate of housing credit cooling, the pace of growth is still well above national income growth. This means that the household debt‑to‑income ratio is rising. It is currently at a record high and puts Australia in the top tier of household indebtedness globally. As the RBA noted in its October Financial Stability Review, “household indebtedness continues to drift up and, with incomes growing more slowly than in the previous decade, households may not be able to rely on income growth to make their debt easier to service.”

Credit to owner‑occupiers grew by 0.5% in September and is up 7.3% through the year. The stock of debt to investors rose by a slightly higher 0.6% over the month and annual growth lifted a little to 4.8%. Investor credit growth has been accelerating month on month for the past six months which is consistent with other indicators of activity in the housing market. The lift in investor‑related credit shows that the May and August rate cuts had a stimulatory impact on the housing market.

Business credit growth has been limp over the past five months after accelerating earlier in the year. The trend in business credit is a little concerning because it suggests that non‑mining private capex is likely to be soft over the near term. Fortunately public capex is starting to lift after falling as a share of GDP for most of the past six years. This will need to continue to support aggregate demand if private investment is going to remain soft.

The “deleveraging” in other personal credit continues. Personal credit is down 1.3% over the year and reflects the lack of appetite for consumer debt outside of housing.

Broad money was flat over September and stands 5.8% higher through the year.

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The big picture

Australia’s population is estimated to have clocked 24 million during the March quarter. The annual growth rate has been tracking around 1.4% for the past six quarters. It is quite a bit lower than the pre‑GFC boom years when population growth was running around 2.0%pa. But it remains high by OECD standards and is considered to be a strong pace.

Robust population growth means the economy needs to be expanding at a faster rate than otherwise to achieve full employment. That of course means that the economy has the capacity to expand at a faster rate too. The slowdown in Australia’s population growth rate is a contributing factor to why most estimates of trend growth for the economy have been lowered in recent years – both Treasury and the RBA have lowered their estimates of trend growth to be in 2¾‑3% range. In the short run, however, the economy can expand above that pace because; (i) the unemployment rate is above the non‑accelerating inflation rate of unemployment (NAIRU) and can move lower; and (ii) productivity in the resources sector will continue to lift as production comes on stream.

The major driver behind Australia’s population growth continues to be net overseas migration (NOM). However, its contribution to growth has come down over the past few years. Both sides of federal politics favour high levels of immigration to partially offset some of the effects from the ageing of the population. It also allows the economy to grow at a faster rate than would otherwise be the case which boosts aggregate demand. And it has significantly boosted demand for housing which flows through to higher prices.

The ‘grey army’ – those aged 65 and over – has continued to grow as a share of Australia’s population. The growth of this age cohort underpins the structural decline in labour force participation. The ageing of the population has increased the dependency ratio (the age‑to‑population ratio of those typically not in the labour force) which underpins the need for fiscal reform, particularly tax policy.

The detail

Australia’s population is estimated to have risen by 328k in QI (+0.4%). The lift takes the population to 24.1 million as at March 2016. NOM was 181k in the year to March 2016, up from 177k in the year to March 2015. But well down from the peak of 315k in 2008.

Population growth is well above the national rate in Victoria. This underpins very strong employment growth in the Garden State, robust residential construction and strong State Final Demand (SFD). It does little for per capita SFD growth, however. The decline in mining investment and associated downturn in mining‑related employment has contributed to a sharp slowdown in WA’s population growth rate.

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Overview

Investment is essential to both long run job creation and productivity growth, which ultimately drives real income growth. For most economies, investment is generally divided into two groups – public and private.

In Australia, however, we tend to think of capital expenditure as split into three strands – mining and non‑mining private investment (such is the size of the resource sector) and public investment.

Over the past few years, capex in Australia has been falling as a share of the economy. Mining investment was always going to decline as the once‑in‑a‑century mining boom ended. But non‑mining investment has not picked up over that period despite incredibly low interest rates and a significantly lower AUD.

At the same time, public investment has also been soft. There are a myriad of reasons why non‑mining investment has been weak and we covered them back in February.

But the same constraints don’t apply to public investment. Given soft private investment and robust population growth in Australia, it makes economic sense for public investment to fill some of the capex pothole, particularly given the overreliance on monetary policy to stimulate growth.

In this note, we shine the spotlight on public investment to look at what has been happening over the recent past. We then trawl through the latest budget papers to examine what we can expect over the period ahead.

Our findings lead us to conclude that the contribution to growth from public investment will be around 0.4ppts in 2016/17.

We argue that more can (and should) be done, particularly given borrowing rates are at record lows, monetary policy is being stretched and the economy is operating below its potential. It requires, however, the political will and a co‑ordinated policy response between the three tiers of government.

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Employment

The reported increase in jobs was modest. But the composition shows that there was a big lift in full‑time jobs partially offset by a sizeable decline in part‑time jobs. Policymakers will welcome these latest developments because they buck the trend observed over the past year in which part‑time job creation materially outweighed gains in full‑time employment.

Unemployment

The unemployment rate lifted a touch to 5.8% but the participation rate also edged higher. The Australian economy needs to generate around 15k jobs a month to keep the unemployment rate flat on an uncharged participation rate. In that context, a rise in the unemployment rate was inevitable based on modest employment growth and a lift in the participation rate.

The trend

Cutting through the volatility shows that monthly jobs growth over the past four months has averaged 13k. Normally such an outcome would be associated with a flat (or possibly increasing) unemployment rate. But a downward move in the participation rate has meant that the “trend unemployment rate” has been moving lower. We expect the unemployment rate to move sideways over the rest of 2016.

Hours worked

Hours worked fell by 0.3% to be just 0.6% higher over the year. This is consistent with stronger growth in part time employment (+134.1k) relative to full time (+94.1k). Average weekly hours worked in full‑time jobs has been steady in recent months at 38.4, after trending down over the first three months of the year. This move lower can be explained by the shift away from mining sector jobs where overtime is common. Average hours worked in part‑time employment remained steady at 16.8 hours.

Rotation impacts

Economic boffins love to analyse statistics and the ABS has provided some statistical fodder in its commentary today on rotation impacts. Each month the ABS surveys about 26,000 households for the labour force release. One‑eighth of the group, about 3,250 homes, leave the survey each month and a new 3,250 household are ”rotated” in. This has the potential to cause big volatility in the numbers because on any given month the employment status of the new households rotated in could be quite different from those rotated out. We were expecting a soft headline number today (i.e. CBA below consensus on employment change) because the group being ‘rotated out’ had a much higher employment to population ratio than then the average of the sample. That is, the odds lay with the incoming group having a lower employment to population ratio than the group going out. Indeed, the ABS confirmed this to be the case yesterday.

The ABS stated that the group being ‘rotated’ in for the June employment report had a lower employment to population ratio than the group it replaced (63.1% vs
63.6%). They also went on to add that the proportion of full‑time workers was
also lower for the group being rotated in compared with the group being rotated out.

In other words, the net impact of group rotation in June was a negative for both the level of employment and the number of full‑time workers. Yet despite this, the overall level of employment lifted in June and the number of full‑time workers rose. To us, that suggests a stronger underlying pulse of job creation than today’s headline numbers imply.
States: Across the States, there was solid jobs growth in Victoria (+24.2k) and SA (+5.9k). Employment declined the most in NSW (‑11.9k) and WA (‑10.3k). Over the year, NSW and Victoria have accounted for the lion’s share of jobs growth, while employment in the mining states of QLD and WA is broadly unchanged compared to a year ago

Leading indicators

The leading indicators of employment growth are mixed. The vacancies series are pointing to only modest growth but the NAB business survey continues to suggest solid employment growth. On balance, this points to modest jobs growth and we tend to agree with the RBA’s assessment that “labour market indicators have been mixed of late, but are consistent with a modest pace of expansion in employment in the near term.

RBA

Yesterday’s figures on their own don’t really shift the dial from an RBA perspective for the August meeting. The report was decent enough for policy to be left on hold. But if their focus is on inflation, as we suspect, then it’s all about the QII CPI report published in two weeks. Essentially the employment data isn’t strong enough to fend off a rate cut but it’s not weak enough to justify one on its own either. The decision around rates in August will come down to the Bank’s assessment of inflation. We expect a soft CPI report in two weeks which is likely to result in the RBA responding with further policy easing. But a rate cut in August is far from guaranteed, particularly given the recent lift in activity in the housing market. Roll on the 27th of July for the QII CPI.

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For the past few years, economists and policymakers have assumed that a lift in non‑mining business investment was forthcoming. A trawl through RBA documents and speeches shows that policy officials have been anticipating a lift in non‑mining investment for a few years. And yet despite incredibly low interest rates and a significantly lower AUD, the lift remains elusive. It has felt a lot like waiting for Godot.

Fortunately, however, there has been a greater than expected pickup in services activity which has generated a fall in the unemployment rate despite weak non‑mining capex. This has supported the economy and employment growth over the past two years. But for the productive capacity of the economy to lift over the longer term, a lift in business investment outside of the resources sector is required.

In this note we ask the question why non‑mining business investment has been so weak. We propose a number of reasons why we are yet to see a lift in capex. And we argue that the reason for a lack of investment goes beyond the level of interest rates and the AUD ‑ these cyclical drivers of business investment are at levels that support rather than hinder investment. Rather, it is a range of other forces at play which are holding investment back. We then take a look at the outlook for business investment in 2016 and what it is likely to mean for growth and monetary policy.

What’s been happening?

There is no shortage of information and literature covering Australia’s mining investment boom. In a nutshell, Australia had a once in 150yr mining investment boom that saw business capex as a share of GDP soar to a record high. During the mining investment period, non‑mining investment fell. But there was an assumption amongst policymakers and economists that non‑mining investment would lift again once mining investment peaked. Low interest rates and a lower exchange rate would help.

The mining investment peak has occurred (late 2012), but since then there has not been a pickup in non‑mining capex. RBA estimates conclude that in the year to QIII 2015, mining investment fell by 28.9% while non‑mining investment fell by ‑0.1%. So non‑mining investment has been flat over the past year which means it has fallen as a share of GDP. Naturally, the question to ask is why? We explore a few possible explanations.

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This report digs below the headline numbers and compares outcomes across Australia’s States and Territories.

CBA Economics analyses how the states and territories are performing across a range of economic indicators and details their key economic forecasts for each region.

This report is published quarterly.

Click here to read the report.

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