Saturday, March 5, 2011

Glimmering lights help dispel the gloom and doom

Peering through the statistical mist, the national accounts we saw this week tell us that, contrary to some messages we have been getting, the economy is on track and growing quite strongly. For the foreseeable future, growth will be coming more from business investment spending than from consumption.

Bureau of Statistics figures show real gross domestic product grew by 0.7 per cent in the December quarter. But Treasury estimates that the early days of the Queensland floods cut production, mainly coal production, by about 0.4 percentage points during the quarter.

So the ''underlying'' growth in GDP was probably nearer 1.1 per cent. If we take the actual growth over the year to December of 2.7 per cent and add back the 0.4 percentage points, we get underlying growth for the year of 3.1 per cent.

(Why is it OK to keep adding back the effect of the floods? Because the loss of production is expected to be temporary. After the full effect of the disruption is felt in the present quarter - maybe reducing GDP by a further 1 percentage point - growth will be higher than otherwise as the miners catch up and much money is spent repairing and replacing damaged homes, businesses and public infrastructure. The authorities expect the floods' effect on GDP to have largely been offset by the end of this year.)

The figures for growth in the December quarter continue the recent pattern of very strong growth in one quarter followed by a quarter of very weak growth and then back to strong growth again.

So let's abstract from the volatility by focusing on the figures for the year to December. They show consumer spending growing by 2.8 per cent - below the trend rate of growth, but not by a lot.

If that's stronger than you were expecting, the reason is that, yet again, the monthly figures for retail sales have proved an unreliable guide to the quarterly figures for total household consumption (which is more comprehensive). In real terms, retail sales grew by only 1.1 per cent over the year to December.

The sub-par growth in consumer spending is not the product of any weakness in the growth of household disposable income. It rose by 6.4 per cent in nominal terms.

No, consumer spending is moderate because households are saving more of their incomes, to pay down debt rather than add to it. The household saving rate averaged more than 9 per cent over the year to December, much higher than it's been for ages.

Spending on new homes and renovations grew by a weak 2.2 per cent over the year, which means we are not building enough homes to accommodate the growth in the population. Taken by itself, this puts pressure on house prices and rents.

Turning to business investment, spending on new machinery and equipment fell by 8.2 per cent over the year. That's probably because a lot of businesses brought forward purchases they would have made this year to take advantage of a tax break that was part of Kevin Rudd's stimulus package.

But spending on new equipment actually grew by 4.7 per cent in the December quarter, which suggest the hiatus may now be over.

The other major component of business investment is ''non-dwelling construction'' - the building of office blocks, shopping centres and mines. It has not been doing too well lately, with the exception of ''engineering construction'', which is mainly the mines.

New engineering construction grew by a massive 12.4 per cent over the year to December. And we know from what businesses have told the Bureau of Statistics about their intentions that there's a lot more spending to come this year and next.

Over the year to December, the volume (quantity) of our exports increased by 5.1 per cent, but the volume of imports increased by 8.4 per cent, with the effect that ''net exports'' (exports minus imports) subtracted 0.7 percentage points from the overall growth in GDP.

Turning from export and import volumes to export and import prices, our terms of trade - export prices relative to import prices - improved a little further in the December quarter, to be 22 per cent better over the whole year.

An improvement in our terms of trade makes us richer. This explains why our real gross domestic income rose by 7.7 per cent over the year, compared with the rise in real gross domestic product of 2.7 per cent. As this extra income is spent in coming months, GDP will accelerate.

Because they're so volatile, it's always good to cross-check the quarterly national accounts by comparing them with what we know is happening in the labour market. Over the year to January, total employment grew by a rapid 3 per cent, with 80 per cent of the 330,000 jobs created being full-time. Unemployment fell by 0.3 percentage points to 5 per cent.

This is a healthy economy notwithstanding the caution consumers are showing and the temporary effects of floods and cyclones. The strength is coming from investment in the expansion of our mining industry, and there's a lot more of it to come.