Saturday, July 13, 2013

Yes, we are going through a weak patch

The economy is going through a weak patch. The resources boom is coming off, but the rest of the economy has yet to take up the slack. That's partly because the dollar has been so high until recently and partly because business and consumer confidence have been weaker than they should be.

I was lecturing an interviewer on our tricky transition when he stopped me in my tracks by asking what "metrics" I based this judgment on. Since he was used to interviewing business people, I suppose it was a fair enough question.

I could have said I based it on the high rate of company tax, the carbon tax or some other fashionable business complaint.

But being a boring economics writer, the "metrics" I was using were the obvious ones: what the Bureau of Statistics' quarterly national accounts are telling us about the rate at which the economy's growing and what its monthly survey of the labour force is telling us about employment and unemployment.

The two indicators act as largely independent checks on each other. The latest national accounts, for the March quarter, showed real gross domestic product growing by 2.5 per cent over the year to March, and by about the same annualised rate in the March quarter itself.

How do we know whether 2.5 per cent is good or bad? Well, it's well short of the economy's "trend" growth rate of about 3 per cent. The economy's trend rate of growth is its "potential" growth rate: the maximum rate at which our production of goods and services can grow over the medium term without causing inflation pressure.

Our potential growth rate is set by the average rate at which our productive capacity is expanding as a result of growth in "the three Ps" - the population of working age, that population's actual rate of participation in the workforce and the productivity of its labour (determined by business investment in equipment, public investment in infrastructure, the skill levels of the workforce through education and training, and technological advance).

The econocrats' estimate of our potential growth rate has recently been cut from 3.25 per cent to 3 per cent a year because the continuing retirement of the baby boomers is reducing the participation rate.

As the word "trend" implies, our potential growth rate is a medium-term average. When the economy's coming out of a recession it can grow faster than its trend rate until all its spare production capacity (including unemployed and underemployed workers) is taken up.

So when the economy is growing below its trend rate, this implies it isn't growing fast enough to create sufficient additional jobs to stop unemployment rising.

And that's just what the labour force figures confirm is happening. The figures we got this week for June, for instance, show the rate of unemployment creeping up from 5.6 per cent to 5.7 per cent.

In truth, it's been creeping up for some time. Using the bureau's much clearer smoothed seasonally adjusted figures (also confusingly known as the "trend" estimates), the unemployment rate was 5.2 per cent in June last year, but 5.7 per cent in June this year.

Last December it was 5.4 per cent, implying its rate of worsening is a little faster in recent months. This, in turn, suggests the economy's rate of growth in the June quarter may have been a little slower than a 2.5 per cent annualised rate.

Note that employment is still growing, though at a slower rate - only about 7500 jobs in June, compared with about 18,000 jobs a month around the turn of the year - with almost all the new jobs being part-time.

The trick is that size of the workforce keeps growing - as a result of natural increase and immigration - so if the economy isn't generating enough additional jobs, unemployment must rise.

Just how long the economy goes on slowing and by how much are questions we can only guess at. It will be determined, obviously, by how quickly the resources boom comes off, on the one hand, and how long it takes the non-mining economy to pick up speed on the other.

The huge growth in investment spending on new mines and natural gas facilities looks like it's at its peak, but we don't yet know whether it's reaching a plateau or will fall away quite quickly. Since mining investment has been the biggest factor driving economic growth in recent years this is a key question.

Similarly, it's hard to predict how long it will take the rest of the economy to recover its mojo and return to normal rates of growth. In particular, non-mining business investment has been a lot weaker than usual, as has households' investment in home building.

What reason is there to expect the non-mining economy to return to more normal rates of growth? One reason is the belated (and, as yet, still insufficient) fall in the dollar following the retreat in our mineral export prices.

This will act as a stimulus to our export and import-competing industries. Another source of stimulus is the easing in monetary policy. The Reserve Bank has been lowering the official interest rate since November 2011, cutting it from 4.75 per cent to 2.75 per cent. Monetary stimulus takes a fair while to have its full effect on the willingness of businesses and households to borrow and spend.

It's always possible the economy could slow to the point where it was contracting rather growing, but it's rare for growth to simply peter out in such a way - partly because it can be seen coming, leaving the economic managers time to take corrective action.

Just as the Reserve has been doing, of course. With this week's evidence of further weakness - and assuming it's confirmed by a low inflation report on July 24 - it won't be surprising to see the Reserve cut rates again.

After that, the next stimulus weapon would be fiscal policy - the budget. The new Treasurer, Chris Bowen, would be well advised to keep his options open.