Saturday, June 8, 2013

Economy yet to make transition to post-boom world

The economists' buzzword of the week - and probably the year - is "transition". If it's not in your lexicon add it immediately. You'll need it - because this week we learnt how tricky it's likely to be.

As the construction phase of the resources boom nears its peak, the economy needs to make a transition from mining-led growth to growth led by all the normal sources: consumer spending, home building and non-mining business investment.

This week the national accounts for the March quarter from the Bureau of Statistics showed growth in real gross domestic product of just 0.6 per cent for the quarter and 2.5 per cent for the year to March.

For once this seems a reasonably reliable reflection of how the economy's travelling. It's not disastrous, but nor is it satisfactory.

The economy needs to be growing at its medium-term trend rate of about 3 per cent a year. Growth of that order is needed just to hold unemployment constant. And since we've been falling short of it for about a year it's not surprising that, over the year to April, the unemployment rate has drifted from 5.1 per cent to 5.5 per cent.

(If you had it in your mind our trend growth rate was nearer 3.25 per cent, you're not wrong, just out of date. The econocrats have lowered it to 3 per cent to take account of the ageing of the baby boomers, which means a larger proportion of the population is now in an age range with lower participation in the labour force.)

The worrying thing about this week's figures is that they reveal the pressing need for a transition from mining-led to broader growth, but not much sign it's about to happen.

As best he can determine it, Kieran Davies, of Barclays bank, estimates mining investment spending fell about 7 per cent in quarter. Rather than rising, however, non-mining investment spending fell about 3 per cent.

At the same time, new home building (including alterations) was flat. Consumer spending strengthened to grow 0.6 per cent, but this was still below trend.

Public sector spending grew 1.1 per cent, but this followed a much bigger fall the previous quarter and with all the pressure on state and federal governments to balance their budgets, we shouldn't expect much help from the public sector.

According to the opposition, the Gillard government's been doing far too much to help.

It turned out a lot of the growth in the March quarter came from "net external demand". The volume (quantity) of our exports grew 1.1 per cent, whereas the volume of imports fell 3.5 per cent, meaning "net exports" (exports minus imports) made a positive contribution to growth of 1 percentage point.

Some silly people have been saying if it hadn't been for net exports the economy would be in a bad way - which is a bit like saying if we cut off one of our arms we'd be in a bad way. What they're missing is that the growth in export volumes will be lasting (they grew 8.1 per cent over the year to March) because it's coming from strong growth in exports of coal and iron ore, as new mines come into production and the third phase of the resources boom kicks in.

In other words, it's wrong to imagine the boom's about to leave us high and dry. Mining production and exports have a lot further to grow in coming years. Even the fall in imports (which constitutes a reduction in their negative contribution to growth) is linked to the boom: reduced investment in new mines means reduced imports of capital equipment.

As for the second, construction phase of the boom, spending from quarter to quarter is too variable to allow us to conclude this quarter's fall means the peak has been passed. Maybe, maybe not. Nor is it clear how precipitous the fall will be when it arrives. It may be fairly gentle since the miners' pipeline of committed projects still stands at a record high of $268 billion.

What reason is there to hope the non-mining sources of growth will strengthen? The main one is that the Reserve Bank has cut the official interest rate 1.5 percentage points in a little over a year, taking the "stance" of monetary policy to its most stimulatory in many a moon.

Everything we know tells us lower interest rates encourage borrowing and spending, particularly in interest-sensitive areas such as housing and the purchase of consumer durables. We also know it often takes a while to work. In my experience, it's just when people are running around saying it isn't working that it starts to.

Of course, a significant fall in the dollar would help a lot by improving the international price competitiveness of our export and import-competing industries, particularly manufacturing and tourism. It would help them produce more for export and replace imports in the domestic market. (So much for those who think it makes sense to assume away net exports.)

The dollar does seem to have fallen about US7? in the past few weeks. This may be some help, but it's far short of what would be justified by the deterioration in our terms of trade (the passing of the first phase of the boom) and what our traders need to restore their competitiveness.

The best hope for further falls in the exchange rate is not further cuts in our official interest rate (its role is widely overrated) but better prospects for the US economy leading to expectations of the cessation of "quantitative easing" (metaphorically, printing money), which has the side effect of putting downward pressure on the greenback. The Reserve has been cutting rates since November 2011, not to induce a fall in our dollar so much as to offset the contractionary effect of its failure to fall as export prices have fallen.

Should the dollar keep falling the Reserve won't cut rates any further. Should the dollar fail to keep falling, it probably will.