Saturday, January 30, 2016

Economy will look better when mining investment stops falling

Here's a little tip for the start of another working year: if you want to make much sense of the economy, you need a good feel for arithmetic.

Thanks to our obsession with economic growth, we're almost always focusing on the change in economic indicators like gross domestic product and its components, such as consumer spending, business investment, imports and exports. (And the figures we look at are usually "in real terms" – they've had the effect of inflation removed from them.)

So the big focus is on whether indicators have grown or shrunk since last quarter or last year and, if so, by how much. This means I often find myself writing a sentence such as "the growth in X – exports, say – accounted for more than all the growth in GDP".

Almost every time I do I get someone saying "what? how can that be true? How can the growth in a component of the total account for more than all the growth in the total?"

If that objection makes sense to you, you're showing your lack of arithmetic imagination. It's perfectly possible for one component to grow by more than the growth in the total provided some other component shrinks. Oh, of course.

Now consider this: we've been very unhappy with our "below trend" (below average) rate of economic growth in recent years, such as our growth of just 2.5 per cent over the year to September.

But everyone knows our problem is that we're having to make a transition from growth led by mining – in particular, by the massive surge in investment in the construction of new mines and natural gas facilities – to growth led by the rest of the economy.

And rough calculations suggest that the "non-mining economy" grew by about 3 per cent over the year to September.

Since we know the economy overall grew by 2.5 per cent, this means the "mining and mining-related economy" must have contracted over the year. This is hardly surprising: mining investment spending is dropping like a stone.

It's also good news. For a start, it says we've made a lot of progress in getting the rest of the economy growing strongly.

But there's another, arithmetic point. The collapse in mining investment can't go on forever. Eventually you hit bottom and can't fall any further. When that happens, the mining sector stops "subtracting from growth".

And when mining is neither subtracting from growth nor adding to it, the quite-strong growth in the non-mining economy will be all the growth we've got – and it, we can hope, will still be growing by 3 per cent a year.

In other words, the economy should speed up as soon as it loses the drag coming from the big contraction in mining investment. And that should happen by about the end of this year.

Next, have you noticed how popular it's become to measure the budget's performance by looking at the change in the level of government spending as a proportion of "nominal" (that is, before adjusting to remove the effect of inflation) GDP?

In principle, it makes sense to compare nominal government spending with the nominal size of the economy. It's saying that the size of the economy grows for various reasons – inflation, real growth, growth in the population – and it shouldn't worry us that government spending is growing for the same reasons.

It's only noteworthy when government spending is growing faster or slower than the economy.

But here's where it helps to have a feel for arithmetic. When you keep comparing an economic variable to a particular "denominator" (the number that goes on the bottom of the sum) over many years, you're implicitly assuming that the denominator (nominal GDP, in this case) moves in a reasonably steady, reliable way.

If so, any change in the ratio (the percentage) can be attributed to changes in the "numerator" (the number that goes on the top; in this case, government spending). If the denominator isn't moving in a stable fashion, then this instability could be contributing to the change in the percentage, making it hard to be sure what's going on with the numerator.

Trouble is, the resources boom has played havoc with the stability of nominal GDP. Why? Because GDP, being a measure of the nation's production of goods and services, naturally includes our production of exports.

But we know that the prices we were getting for our main mineral exports – coal and iron ore – shot up to unheard of levels in the early part of the boom, then from mid-2011 began falling back to earth.

To see how this has affected the stability of nominal GDP, consider these comparisons (for which I'm indebted to Michael Blythe, chief economist of the Commonwealth Bank). Over the nine years to 2001-02, it grew at an annual average rate of 6.1 per cent. (This would be inflation of 2.5 per cent plus real growth of about 3.5 per cent.)

We can think of that as nominal GDP's "normal" rate of growth. But then the prices boom starts and continues for the nine years to 2010-11, during which it grew at a rapid annual average rate of 7.2 per cent.

In the four years to 2014-15, however, the fallback in export prices caused nominal GDP to grow at a pathetic annual rate of 3.4 per cent – just a bit more than half what's "normal".

Get the point? The ups and downs of our mineral export prices shouldn't have any direct effect on the growth in government spending (though the boost to tax collections may have encouraged governments to be more generous on the spending side).

So the resources boom has had the effect of causing the government spending-to-GDP ratio to understate the extent of the growth in spending during the boom years, but now is overstating it.

Wednesday, January 27, 2016

Why it shouldn't be a bad year for our economy

Thanks for asking. Yes, I enjoyed my holiday – read some good books I'll tell you about later – but, unfortunately, didn't get far enough away from the media to avoid hearing all the gloomy news about the economy.

The Americans raised interest rates, the Chinese sharemarket fell, oil prices fell, share prices fell around the world, our dollar fell, the Chinese announced their economy was growing quite strongly, which everyone refused to believe.

Anything I've missed? Rarely has a year got off to such bad start, we were told. Might be worse than the global financial crisis, according to some guru whose name I forget. Recession will be knocking on our door, we're told.

Sorry, I'm not convinced. My guess is this won't be such a bad year for us, and next year will be quite good. Why? Because we've got a lot going for us domestically and because the bad things happening overseas won't have as much effect on our fortunes as many people have come to imagine.

It's become fashionable, particularly among our big business people, to take all the foreign economic news terribly seriously, on the assumption it has big implications for us Down Under.

I'm old enough to remember a time when most people believed that what happened to our economy was always of our own making. The Whitlam government tried to blame the recession of the mid-1970s on overseas factors, but everyone knew it was lying.

Since those far off-days, the world economy has globalised, of course, with the Hawke-Keating government doing much to open our economy to the rest of the world, particularly by floating our dollar and dismantling our protection against imports.

Another thing that's globalised is the media. When something bad happens anywhere in the world, we're told about it within an hour or two. Good news takes longer to pass on, if it gets through at all.

In the just-ended summer silly season, all the bad economic news from abroad has been a godsend to the parched local media, and we've played it for all it's worth.

But I think that, in adjusting to the globalised, joined-up world economy, we've gone too far the other way, assuming everything that happens overseas will determine our fate, that our economy is just a cork tossed on a global sea.

It's true that China's economy now has more influence on our future than the American or European economies we know more about, but even this can be overdone.

As can the media's extraordinary preoccupation with the ups and down of local and foreign sharemarkets, about which they – and we – know little. Hardly a news bulletin passes without us being told of the latest movement in the Dow, Footsie​ and Hang Seng.

The advent of compulsory superannuation saving has made our retirements more dependent on the fortunes of the sharemarket and, more to the point, made us more conscious of that dependency.

But sharemarkets have always gone up for a period and then down for a period, gone down for a while and then gone back up. Even during the market's long periods of seemingly steady rise, it's down on at least as many days as it's up.

So people who think they can learn anything useful about their affairs by listening to the nightly news to hear what happened to the market today – and then cursing when it's down – are fools. They've allowed the media to find a new way of making them feel bad.

Almost every economic event has advantages and disadvantages, producing winners and losers. When we allow a panicked global sharemarket and disaster-loving media to interpret those events for us, they soon convince us a fall in oil prices is bad news, not good, and the lower Aussie dollar is more bad news, even though it's what our economists have been praying for.

Perhaps our excessive attention to foreign news is fed by the widespread belief that countries make their living by selling things to other countries. So if other countries' economies are weak, our economy will be too, because they won't be buying much from us.

Fortunately, it ain't true. Or, to be accurate, it's 20 per cent right and 80 per cent wrong. It's true that Australians, like everyone else, make their living by producing goods and services and selling them to other people.

What's not true is that the other people have to be foreigners. Aussies will do just as well. About 20 per cent of what we produce is sold to foreigners, leaving a mere 80 per cent sold to locals.

That's why it's easy to exaggerate the effect that weak foreign demand for our goods and services will have on our economy. And the fact is that although prospects for the biggest export-oriented part of our economy – mining – are poor, the prospects for domestically oriented industries are good.

Unofficial estimates show the mining-related part of the economy is going backwards, whereas the "non-mining economy" has been growing at the healthy annual rate of about 3 per cent.

You see this in our figures for employment. Over the year to December, employment grew by more than 300,000 workers, a strong 2.7 per cent increase. The official rate of unemployment fell from 6.2 per cent to 5.8 per cent.

I'll be surprised if this steady improvement doesn't continue this year.