Saturday, June 6, 2015

A far from wonderful set of growth numbers

The economy may have grown faster last quarter than business economists were expecting, but that tells you more about their forecasting ability than the economy's strength. Despite what Joe Hockey says, the numbers weren't all that wonderful.

According to the national accounts released by Bureau of Statistics this week, real gross domestic product grew by 0.9 per cent in the March quarter and by 2.3 per cent over the year to March.

This, of course, is well below the economy's "trend" (long-term average) rate of growth of 3 per cent a year, the rate needed just to hold unemployment steady in an economy with a growing number of people wanting to work.

But that's just the first reason the figures aren't as good as they initially appear. Another - one economists perpetually forget to remind us about - is that we have a population growing at the rapid rate of about 1.5 per cent a year, thanks to high immigration.

So we need quite a bit of growth just to stop average income per person falling. Turns out real GDP per person grew by just 0.8 per cent over the year to March.

Another thing to remember is that the growth in real GDP - the quantity of goods and services produced in Australia - is just one way, the most common way, of measuring economic activity.

It's usually assumed that the growth in the nation's production is the same as the growth in its income. But, first, the assumption breaks down if there's a significant change in Australia's terms of trade - in the prices we're getting for our exports relative to those we're paying for our imports.

That's because changes in our terms of trade affect the international purchasing power of the nation's income. When our terms of trade improve, the goods and services we produce are worth more when we buy goods and services overseas; when our terms of trade deteriorate, the stuff we produce is worth less when we're paying for imports.

With the prices we received for our mineral and energy exports rising greatly in the years before their peak in 2011, our "real gross domestic income" grew a lot faster than our production, real GDP.

Now, however, with coal and iron ore prices falling sharply, our real gross domestic income is growing much more slowly than our production, even falling. In the March quarter, real GDP grew by 0.9 per cent, while real GDI grew by only 0.2 per cent.

Over the year to March, real GDP grew by 2.3 per cent, but real GDI fell by 0.2 per cent. This matters because the real value of our income has an indirect effect on future real GDP, which is what drives growth in employment.

But a second assumption implicit in our almost exclusive focus on real GDP is that all the goods and services produced in Oz belong to Australians. They don't. In particular, maybe as much as 80 per cent of the value of the minerals and energy we produce and export is essentially the property of the foreign owners of our mining companies.

The Bureau of Stats highlights gross domestic product in conformity with international convention. But the fact is we'd be better off using gross national product, which measures how much of GDP actually stays with us rather than going to foreigners in interest and dividend payments.

And, because the deterioration in our terms of trade arises mainly because of the fall in prices of mineral exports, real GDI overstates the fall in our income. Real gross national income grew by 0.4 per cent in the quarter, and by 0.6 per cent over the year to March.

But, turning back to real GDP and its components, another reason the figures aren't as good as they appear is their heavy reliance on growth in exports. The volume (quantity) of our exports grew by 5 per cent in the quarter and by 8.1 per cent over the year to March.

This means exports contributed 1.7 percentage points to our overall growth of 2.3 per cent for the year. That's almost three-quarters of it.

Normally, this wouldn't be a worry. But when you remember that most of the export growth came from mining, and that mining is highly capital-intensive, you see there is a worry. It means that real GDP growth of 2.3 per cent isn't contributing as much to employment growth as we usually assume.

The figures show that the Reserve Bank's efforts to stimulate growth in the "non-mining" economy are having mixed success. They're working well with investment in new housing, which grew by 4.7 per cent in the quarter and 9.2 per cent over the year.

But they're getting nowhere with encouraging non-mining business investment to offset the sharp fall in mining investment. Overall, business investment fell by 2.7 per cent in the quarter and by 5.4 per cent over the year.

And get this: fiscal policy (including the budgets of the state governments) is hindering, not helping. Public investment in infrastructure fell by 2.4 per cent, its fifth successive quarterly decline, to be down by 9.1 per cent over the year, which subtracted 0.4 percentage points from overall growth over the year.

Consumer spending grew by an improved, but still below-trend, 2.6 per cent over the year, despite weak growth in wages and employment, and a rising tax bite from household disposable income.

What's keeping consumption reasonably strong is a falling rate of household saving. It fell from 8.8 per cent of household disposable income to 8.3 per cent in the quarter, down from 9.6 per cent a year ago.

It's normal and rational for households to adjust their saving to smooth their consumption spending as the economy moves through the ups and downs of the business cycle.

Even so, it's yet another respect in which the numbers weren't all that wonderful.