Saturday, June 10, 2017

We've slowed a lot, but we're not about to go backwards

There's no denying the economy has slowed down, by far more than we were expecting. But don't conclude it's likely to subside into recession any time soon.

This week's national accounts for the March quarter, from the Australian Bureau of Statistics, show real gross domestic product grew by a pathetic 0.3 per cent during the quarter, and by just 1.7 per cent over the year to March. This compares with its "potential" annual growth rate of 2.75 per cent.

This time last year, the government's budget forecast was for growth averaging 2.5 per cent in the financial year just ending, accelerating to 3 per cent in the coming year.

So what's gone wrong? And why is it unlikely get a lot worse?

First point: don't think the economy's running down like a battery-powered toy. Looking back over the past four quarters, we see OK growth of 0.7 per cent in the June quarter of last year, then a contraction of 0.4 per cent, then super-strong growth of 1.1 per cent and now weak growth of 0.3 per cent.

This unnatural, saw-tooth pattern says some transactions may have been recognised in the wrong quarter. For instance, investment spending by federal and state public corporations leapt by 37.8 per cent in the December quarter, but then contracted by 20.9 per cent in the March quarter.

Neither figure should be taken literally.

Two major drivers of activity at present are home building and exports of coal and iron ore. Both have been disrupted by unusual weather that's not been smoothed away by normal seasonal adjustment. Climate change?

Home building has been growing strongly for several years, but it contracted by 1.2 per cent in September quarter and by 4.4 per cent in the March quarter. Most of this is explained by unusually wet weather in some parts of the country.

The volume (quantity) of exports was up 2 per cent in the June quarter, then slowed to growth of 1.4 per cent, then leapt by 3.7 per cent and now has actually fallen by 1.6 per cent.

Much of this volatility is explained by extreme weather disrupting shipping carrying coal from Queensland or iron ore from Western Australia.

We could expect the figures for the present quarter to be boosted by a catch-up from the weak March quarter – were it not for the further disruption in April and May we know has been caused by Cyclone Debbie.

Note that a sudden build-up in business inventories contributed 0.4 percentage points to growth in the March quarter. Much of this was a jump in mining industry stockpiles, suggesting a lot of coal was produced, but couldn't be shipped.

But to explain much of the quarter-to-quarter volatility in GDP growth in terms of misallocation and wild weather doesn't alter the fact that, when you add up the four quarters, you get only to utterly weak annual growth of 1.7 per cent.

One major component of growth that's unlikely to be affected by either factor is consumer spending. It's been unusually weak in all quarters bar December, growing by a pathetic 1.3 per cent over the year to March.

And this despite households cutting back their rate of saving from 6.9 per cent of household income to 4.7 per cent over the year.

This weakness in consumption ain't hard to explain: growth in household income has been held back by weak growth in employment and, more particularly, negligible growth in real wages, notwithstanding a 1.2 per cent improvement in the productivity of labour over the year.

Real labour costs per unit – a measure of the race between real wages and labour productivity – fell 1.7 per cent in the quarter and 6.3 per cent over the year to March.

Wanna know why the economy's growth is so weak? You won't find a more powerful explanation than that.

Remember, however, that the weakness isn't spread equally across the country.

State final demand is a poor substitute for gross state product, but the best we get each quarter. Across the whole economy, domestic final demand also grew by 1.7 per cent over the year to March.

But state final demand grew by 4.5 per cent in Victoria, 3.3 per cent in South Australia and Tassie, an above-par 1.9 per cent in NSW, and a below-par 1.6 per cent in Queensland.

Now get this: in Western Australia, final demand contracted by 6.6 per cent. So the West is still bearing the brunt of the bust in the mining construction boom. This explains a fair bit of the weakness in the national average.

The West's contraction in the March quarter was just 0.2 per cent, however, suggesting the inevitable end to its contraction phase isn't far off. That's the first reason things won't continue weakening nationwide.

As part of that, the long-running fall in mining investment spending must also be within a few quarters of ending. You need to be good at arithmetic to see that, when our focus is on rates of growth, "the removal of a negative is a positive".

The housing construction boom has a few more quarters to run, and strong grow in infrastructure spending is in the pipeline.

But much depends on what happens to real wages. Certainly, the government's forecast of economic growth returning to our potential growth rate of 2.75 per cent in 2017-18 as a whole, rests heavily on a resumption of real growth in wages.

To the extent the present weakness in wage growth is merely cyclical, wages will recover soon enough. This is hardly the wildly optimistic expectation that some, who've forgotten the economy moves in cycles, have claimed.

But to the presently unknown extent that the weakness in wage growth has deeper, structural causes, we won't get back to a decent rate of growth until the government acts to fix the problem.
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Wednesday, June 7, 2017

Turnbull must act on climate if he's not to be a Trumpette

We are trying – admittedly, without much success so far – to make our home a Tr*mp-free zone. It's just too depressing. Watching a great nation disgrace itself before the rest of the world.

The former proudly self-proclaimed leader of the free world suffering a loss of confidence and applying for early retirement.

A nation that every year scoops the pool of Nobel prizes, electing a crazy, ignorant, wilful old man, not so much Trump as Chump.

His latest stroke of genius – reneging on America's commitment to the Paris climate agreement – has been almost universally condemned, including by a great number of Americans, especially many business leaders.

But, congenital optimist that I am, I see some perverse comfort in all this. The American people are being brought face-to-face with what it means for their future when the world's second biggest emitter of greenhouse gases decides that the minor disruption of doing something to protect itself from the huge disruption of continuing global warming just isn't worth it.

This rational self-interest?

I'm prepared to bet that the next elected president will have climate protection at the top of his to-do list. Indeed, Donald Trump's becoming such an embarrassment to his compatriots I'd bet the next president's platform will be to do the opposite to Trump on 'most everything.

Then there's the band of American state governments – led by the two most powerful, California and New York – willing to step into the leadership vacuum their federal government has left. And the mayors of many cities.

Of course, as we know from earlier this year – when our federal government sought to use South Australia's blackouts for political point-scoring rather than a cue for policy correction, thus obliging the SA Premier to step in with expensive local interventions to a national problem – having states try to make up for a federal government's refusal to accept responsibility is far from ideal.

Which bring us to Malcolm Turnbull, whose statements and actions as Prime Minister contrast markedly with what every voter knows are his long-held views on climate change.

One thing to be said for Trump is that at least he's made an honest man of himself. He has no concern about global warming and isn't willing to do anything to combat it, but doesn't pretend otherwise.

Here, Turnbull professes eternal loyalty to the Paris Agreement and reaffirms our (inadequate) target to achieve a 26 to 28 per cent reduction in emissions by 2030 from 2005 levels, without having any credible policy by which to achieve it.

Actually, we haven't had a credible policy to reduce emissions since Tony Abbott abolished Julia Gillard's carbon tax-cum-emissions trading scheme in July 2014.

Abbott's professed reason for doing so was the claimed huge increase in the price of electricity and gas the scheme caused, and the massive economic damage this would lead to.

Prices did come down a bit, but soon continued on their upward way. Truth is, the carbon tax – and the renewable energy target – were never a major part of the reason for the big increases in energy prices since the turn of the century.

Even so, concerns about climate change are at the heart of the problems we're having maintaining an energy system that avoids blackouts without costing the earth (in the earlier sense of that phrase).

That, plus the various problems that have emerged with that finest flower of micro-economic reform, the national electricity market (the greatest source of price increases).

Ancient coal-fired power stations are being closed down, while no business in its right mind would invest in new coal-fired stations that are unlikely to be used for much of their 30 to 50-year potential working lives.

At the same time, however, businesses are reluctant to invest in industrial-scale renewable energy when the Coalition government has displayed such hostility to renewables and created such uncertainty about their future.

Have you noticed how our response to climate change and our problems with electricity have morphed into the same issue?

There's little concern to limit emissions except from the generation of electricity. And there's no solution to reliable, reasonably priced power that doesn't involve controlling emissions.

On Friday the chief scientist, Professor Alan Finkel, will deliver his long-awaited report on "the future energy security of the national electricity market".

What's needed is a mechanism to regulate the transition from fossil fuels to renewables in a way that reduces emissions while providing certainty to both kinds of energy providers.

Last year all the key players agreed the best approach would be an "emissions intensity scheme". All bar the Turnbull government, which ruled it out the moment its climate-change denying backbenchers objected.

So now, we're told, Finkel has come up with a compromise, a "low emissions target", or LET, which sets the proportion of electricity production that must come from low-emission sources.

It's similar to the present RET – renewable energy target – except the list of low-emission sources would be expanded to include gas-fired power and "clean" coal-fired power with carbon capture and storage (should such a thing ever exist).

This compromise has been widely canvassed, and has a lot of support in business. Even the Labor opposition has indicated its willingness to accept some form of mechanism rather than continuing inaction.

The heat will now be on Turnbull to get his Trumpettes across the line.
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Monday, June 5, 2017

Radical policy change may be needed to fix wages

It's too early to be sure, but not too early to suspect that, if we and the other developed economies keep travelling the way we are, conventional wisdom about what constitutes good economic policy may soon need to be turned on its head.

We're living through very strange times. Each developed economy has its own story, but there are strong similarities. One is exceptionally low inflation, which doesn't seem temporary.

Another is surprisingly weak rates of measured productivity improvement, although our rate of improvement in the productivity of labour isn't too bad.

My guess is a fair bit of this is mis-measurement arising from our quite radical shift to a digital economy.

But the other explanation may be a decline in price competition in many industries, thanks to several decades of both natural and government-facilitated rent-seeking by big businesses, in ever-more concentrated industries.

Next, wages. It's too soon to conclude that wage growth – which in Oz has been slowing since mid-2012 and been pathetically weak for three years – is down for the count.

We don't yet know how much of the weakness is merely cyclical and how much is due to deeper, longer-lasting, structural causes.

Even so, it's hard not to suspect that a fair bit of the wage weakness is structural. My guess is that while we've been busy decentralising wage-fixing and removing all provisions thought to favour unions, globalisation and technological change have conspired to rob the nation's employees of any collective bargaining power.

This may sound like a dream come true for business and its high-paid executives but, if it's true, it's deeply destabilising overkill.

Wages are a key variable in the economy. Allow them to be either too high or too low and the economy gets out of kilter.

Allow the profits share of national income to keep continually expanding at the expense of the wages share and expect to pay a price economically, socially and politically.

And that's before you remember that wages are the chief source of governments' tax revenue. Not only personal income tax, but all the indirect taxes – notably, the goods and services tax – that households pay when they spend their labour incomes.

Low nominal wage growth isn't necessarily a worry if, at the same time, the rise in consumer prices is low.

What matters to working households and the rest of the economy (but not governments) is what's happening to real wages.

In a healthily functioning economy, real wages should rise pretty much in line with the improvement in the productivity of labour.

That way, both labour and capital get their fair share of the fruits of economic progress.

Trouble is, in the US this relationship broke down maybe 30 years ago, explaining why the top few per cent of households have captured most of the growth in the nation's real income over that time.

This doesn't just widen the gap between rich and poor. By directing so much income growth away from the high spenders at the bottom and middle to the high savers at the top, it slows growth in consumption and thus production.

It also adds to the disillusionment of ordinary voters, making them more likely to lash out and vote for the cunning wacko celebrity-de-jour candidate, such as Clive Palmer, Pauline Hanson or Donald somebody​.

Get this: there are tentative signs the relationship between real wage growth and labour productivity may be breaking down in Oz.

The relevant indicator, the index of real labour costs per unit, should hover around 100. It fell by 3.3 per cent during 2016, reaching 98.1, equal lowest since the series began in 1985.

If this weakness persists, it will raise the question of whether the formerly healthy relationship was a product of market forces, or the industrial relations system's achievement of a fine balance between employer and union bargaining power.

If it does persist, how could we return to a healthy relationship? By reversing the dominant wisdom of many decades, that governments must never do anything that adds to the regulatory burden on employers. By acting (very carefully) to strengthen the hand of union collective bargainers.

Final point: governments of all colours secretly rely on bracket creep to help tax collections keep up with the inexorable growth in government spending.

But bracket creep depends on both reasonable inflation and real wage growth to work its barely noticed fiscal magic.

What happens if inflation stays low and real wages stop growing? You have to junk your rhetoric about smaller government and keep doing what Malcolm Turnbull did in this budget: justify explicit tax increases.

Either that, or get wages growing properly.
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Saturday, June 3, 2017

How and Why we've escaped recession for so long

When Glenn Stevens took over from Ian Macfarlane as governor of the Reserve Bank in September 2006, both men knew the new boy was being handed a poison chalice.

By the time of the deep recession of the early 1990s, Australians – like the citizens of most developed economies – had got used to enduring a recession roughly every seven years.

But Macfarlane had been governor for 10 years, and had been extraordinary lucky to get through all that time without a severe downturn.

It was obvious to both men that Stevens wouldn't be as lucky. We were overdue for a recession and it was bound to occur sometime during Stevens' term, probably early on.

Except that it didn't. When, after his own 10-year stint, Stevens handed over to his government-chosen successor as governor, Dr Philip Lowe, in September last year, he was leaving the job with his record unsullied.

This time there were no forebodings about a doomed inheritance, even though it's only natural to fear that each successive quarter of this world record run must surely increase the likelihood of it coming to a sticky end.

Certainly, there would be few economists so foolhardy as to predict that their profession had finally conquered the booms and busts of the business cycle. Most remember that such bouts of hubris had afflicted – and in the end, mightily embarrassed – the dismal scientists before.

No one wants ultimately to be caught having made that stupid mistake a second time. So, a commercial message sponsored by your local friendly economist: rest assured, we'll have another bad recession sooner or later.

Human nature being what it is, keeping in the forefront of their minds the very real risk of another recession is the best way the managers of our economy can avoid the negligent overconfidence that could bring our record run to an ignominious end.

Of course, the politician with the strength of character to avoid complacency and self-congratulation for a remarkably good performance has probably yet to be born.

That's why this story began, and will continue, as a story about the people who have most say over the day-to-day management of the economy: not the politicians, but the bureaucrats in our central bank.

It's important to remember that Australia's run without a severe recession became a personal best, so to speak, many years ago, and for many years has exceeded the records achieved in all other developed countries – bar the Netherlands, with its freakish record of 103 quarters, almost 26 years, of continuous growth. Until now, as the world record passes to us.

An obvious question to ask is how Australia managed to avoid serious damage from the global financial crisis of 2008, when almost every other advanced economy was laid so low by the Great Recession.

The short answer is first that, thanks partly to the bureaucratic bum-kicking Peter Costello did after the collapse of the HIH insurance group in 2001, our bank regulators kept our banks under a tight rein, preventing them from doing all the risky things the American and European banks were allowed to.

Second, the Reserve Bank positively slashed interest rates the moment it realised the severity of the crisis, while the Rudd government ignored the dodgy advice it was getting from then-opposition leader Malcolm Turnbull and sections of the media, and splashed around a lot of cash.

Both the rate cuts and the cash splash had the intended effect of steadying the badly shaken confidence of businesses and consumers, thus quickly arresting the self-reinforcing downward spiral of fear and belt-tightening that causes all deep recessions.

Third, whereas many employers had previously responded to a downturn in demand for their product by laying off staff, this time many of them, hoping the downturn would be temporary, limited themselves to putting all their staff on a period of short-time working.

This restraint on the part of business proved a much less damaging approach for everyone.

But remember this: most advanced economies have suffered not one, but two or three deep recessions since the world recession of the early 1990s.

So there has to be more to our 26-year record than just our deft response to the GFC.

The deeper reasons for our success start with the factor already alluded to: our politicians' decision in the first half of the 1990s to hand control of interest rates to the central bank, acting independently of the elected government.

Turns out moving interests rates up and down in response to the business cycle, as opposed to the proximity of elections, is a big improvement in keeping the economy chugging steadily along.

The other beneficial change was all the "micro-economic reform" undertaken mainly during the term of the Hawke-Keating government, often with bipartisan support from the opposition, led by John Howard and Dr John Hewson.

Deregulating the financial system, floating the dollar, rolling back protection against imports, decentralising wage fixing and the deregulation of many particular industries had the combined effect of making the economy more flexible, less inflation-prone and better able to reduce unemployment.

The era of micro reform didn't achieve the hoped for continuing improvement in productivity, and had various adverse side-effects, but it did make it much easier for the central bankers to keep the economy on an even keel.
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How Treasury hides big infrastructure spending

One of the most significant, but least remarked upon, features of this year's budget is Malcolm Turnbull's decision to greatly expand the federal government's involvement in the construction of public infrastructure.

He did so under unprecedented and sustained public pressure from the Reserve Bank, seconded by the International Monetary Fund and the Organisation for Economic Co-operation and Development.

But how could the government be stimulating demand at a time when it still had a big budget deficit it needed to get back to surplus ASAP?

By distinguishing between the deficit arising from recurrent spending on its day-to-day operations, and the deficit arising from its investment in capital works, whose benefits to the community would flow for decades.

With the economy's downturn long past, the government should certainly be striving to get its recurrent finances – summarised by the budget's "net operating balance" – back to a healthy big surplus.

But no such stricture should apply to borrowing to improve the nation's infrastructure – always provided the money is well spent.

There's nothing new about this. The state governments have divided their budgets between operating expenses and investment in capital works for years. The national governments of New Zealand and Canada do the same.

So why haven't the feds been doing it? Because Treasury's never liked the idea. That's why, if you read the budget papers carefully, you find Treasury's found a way to do it and not do it at the same time.

The papers say they've always told us what the recurrent budget balance is, it's just that it's been buried somewhere up the back and called the net operating balance, or NOB.

But Treasury has had to admit that, for reasons that make sense only to accountants like me, the NOB regularly overstates recurrent spending by treating as an expense the cost of the feds' annual capital grants to the states to help with their infrastructure spending.

In the coming financial year, this overstatement is worth more than $12 billion, meaning the true recurrent deficit is actually quite small –  $7 billion – and expected to be back in balance in the following year, 2018-19.

So, no great worries there.

For the first time, Treasury has been obliged to reveal clearly exactly how much the feds have been, are, and expect to be, spending on capital works for the 14 years from 2007-08 to 2020-21 (see budget page 4.10).

In 2007-08, the last of Peter Costello's budgets, total federal capital spending was allowed to fall below $10 billion, but generally it's been between $30 billion and $40 billion a year. That's roughly 10 per cent of all the feds' spending.

But here's the big news: in the coming financial year, it's expected to rise to a (nominal) record of more than $50 billion, up from about $43 billion in the year just ending.

This will represent 12 per cent of total federal spending, and be equivalent to 2.8 per cent of gross domestic product.

Again for the first time, the budget papers give us the breakdown of the feds' total capital spending. First there's "direct capital investment" of $13.5 billion, which is mainly spending on defence equipment.

Next is "capital grants" of $14.2 billion. This is money given to other entities – predominantly, the state governments – to help them pay for their own capital works spending, mainly roads.

Last is an odd one, that Treasury usually prefers us not to notice: "financial asset investment (policy purposes)" worth $22.9 billion, up almost $6 billion on the year just ending, and the main cause of the coming big increase.

What's that financial asset investment thingy​? It goes back to 1996 and a loophole Treasury carefully built into the budget figuring at the time of the Charter of Budget Honesty (!) and the introduction of the "underlying cash balance" as the preferred measure of the budget's deficit or surplus.

Get this: if the government simply pays some private construction company to build some infrastructure for it, the cost is counted as part of the underlying cash deficit.

But if the government sets up its own company and gives it the same money, in the form of share capital or a loan, so the company builds the infrastructure (or pays another company to do it), the cost isn't counted in the underlying deficit.

Rather, it's tucked away in the "headline cash balance" that few people notice (see budget page 3.36). (The other big item stashed in the headline deficit is the net increase in the stock of HECS HELP student debt owed to the government, expected to be an extra $8 billion in the coming year.)

It's by this means that the Labor government was able to spend many billions constructing the national broadband network without a cent of it showing up in the underlying deficit.

In the coming year, the Turnbull government expects to buy $1.5 billion more in NBN shares and lend it $9.3 billion – all to finance further construction spending.

As well, it's setting up a company to own and build the second Sydney airport, and another to own and build the Melbourne to Brisbane inland freight railway.

Combined, these two new projects are expected to cost $1.8 billion in the coming year, rising to an annual $3.2 billion in 2020-21.

But if spending on infrastructure is now regarded as "good debt", why is Treasury still using this legal hair-splitting to conceal the cost of the new infrastructure spending push?

Because it's fighting a rear-guard action. Although it's agreed to give the NOB "increased prominence" in the budget papers, the underlying cash balance "will continue to be the primary fiscal aggregate".

And just to prove Treasury's lack of repentance, no modification has been made to the wording of the government's "medium-term fiscal strategy" to "achieve budget surpluses, on average, over the course of the economic cycle".
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