Saturday, September 8, 2018

A beautiful set of numbers gets you only so far

This week’s national accounts don’t leave any doubt that the economy grew strongly in the first half of this year. But whether it can sustain that growth rate is doubtful.

According to figures issued by the Australian Bureau of Statistics, real gross domestic product grew by 0.9 per cent in the June quarter and an upwardly revised 1.1 per cent in the March quarter, yielding growth of 3.4 per cent over the year to June.

For once, the bureau’s “trend” (smoothed) estimates tell the same story.

Annual growth of 3.4 per cent is well above the economy’s medium-term “potential” growth rate of about 2.75 per cent, suggesting we’ve started making inroads into our unused production capacity.

It also means we’ve now completed 27 years of continuous growth since our last severe recession of the early 1990s. (We had recessions too small to remember in 2000 and again at the time of the global financial crisis in 2008, but let’s not spoil the party.)

The figures vindicate the Reserve Bank’s steadfast forecast of growth returning to “a bit above 3 per cent” in 2018 and 2019.

This growth of 3.4 per cent from one June quarter to the next amounts to growth averaged over the whole of the 2017-18 financial year of 2.9 per cent – meaning that (contrary to what I was expecting) the government has comfortably exceeded its budget forecast of 2.75 per cent.

Where’s the growth coming from? Over the year, the biggest contributions came from consumer spending and government consumption spending (mainly the wages of people working in health and education), business investment spending and public investment in infrastructure.

Since the volume of imports grew a lot faster than the volume of exports, the external sector subtracted from growth.

It was, however, a financial year of two halves, with growth at an annualised rate of less than 3 per cent in the last half of 2017, but more than 4 per cent in the first half of this year.

Trouble is, no one sees the economy continuing to grow at an annualised rate as high as 4 per cent – not private forecasters or the Reserve Bank, nor even the government.

Why not? Because the biggest contributor to growth – whether over the year to June or in the latest quarter – has been strong consumer spending.

Consumer spending accounts for more than half of GDP. And its growth does much to stimulate growth in business investment spending, particularly non-mining business investment. (It’s when demand for your product threatens to exceed your production capacity that you expand your business.)

Growth in consumer spending is driven by growth in households’ disposable income. Household disposable income, in turn, is driven mainly by growth in wages. That’s real growth in wages – wages growing a per cent or so faster than prices are rising.

But this is just what’s not been happening over the past three or four years. And although Reserve Bank governor Dr Philip Lowe remains confident we’ll get back to heathly real wage growth eventually, he keeps warning the recovery will be a long time coming.

This gives us good reason to doubt that the rapid growth of the first half of this year will be sustained. But, before we get to that, how’s it been achieved so far?

The first part of the explanation is the extraordinarily strong growth in employment. As you may have heard (many times), employment grew by a calendar-year record of 400,000 in 2017, about double the annual average.

This week the new Treasurer, Josh Frydenberg, noted that 2017-18 saw jobs growth of more than 330,000 – the largest jobs growth in a financial year since 2004-05.

Notice the diminishing superlatives? If you use trend figures to break that into half years, you find 70 per cent of it occurred in the first half and only 30 per cent in the second. Hmmm.

While wage rises are the main source of increase in household disposable income, the secondary source is increased employment – more people earning income in more households.

To illustrate, total wages paid to households (“compensation of employees”, in the jargon) rose by 0.7 per cent in nominal terms in the June quarter, whereas average wages per worker rose by 0.1 per cent. Get it? Increased employment accounted for almost all the growth in total wages.

But that employment growth is not the main thing that kept consumer spending growing strongly despite weak growth in household income. The bigger factor was households cutting their rate of saving.

The ratio of household saving to household disposable income continued its fall, dropping from 2.8 per cent to 1.4 per cent (using trend figures). This is down from a peak of 9 per cent after the financial crisis.

Note, this means households added to their savings at a lesser rate, not that they reduced the amount of their savings.

This is what economists call “consumption smoothing”. If the growth in your income is weak, you reduce your rate of saving to avoid having to tighten your belt and consume less.

Nothing wrong with that. But there’s not much scope left for further cuts in the saving rate.

Dr Shane Oliver, of AMP Capital, offers this summary of the outlook for the economy: “While housing construction will slow and consumer spending is constrained, a lesser drag from mining investment [because it’s almost hit bottom] along with solid export growth provide an offset, and are expected to see growth of between 2.5 and 3 per cent going forward.”

I’m more optimistic than that. I hope the Reserve’s “a bit above 3 per cent” will be on the money.

But be clear on this: no matter how wonderful the latest figures look - and there are two more quarterly announcements to come before an election in May - strong growth in the economy isn’t sustainable until workers are back to getting their share of the benefits of national productivity improvement in the form of real wage growth of a per cent or two a year.

Until then, voters aren’t likely to be greatly impressed by "a beautiful set of numbers”.