Australia doing it tough?

Structural change noise obscures cyclical story

Nigel Stapledon argues that the popular view of Australia’s recent current performance is distorted by
a confusion over cyclical and structural changes.

If you believed the financial markets and the confidence indicators, Australia had a tough year in 2011 and is heading for another troubled, perhaps even tougher, year in 2012. If I were talking about Greece or Europe generally, that might be credible but what explains this case study of negativity in Australia?

The popular story

Doomsayers, whom the media have a persistent and natural bias to report, will focus on the low business and consumer confidence and the fact that retail sales have had their first soft patch in 20 years and that housing activity has been subdued. But it doesn’t fit with the broad indicators. The best up-to-date indicator of the current state of play is the labour market. It is true that the unemployment rate rose slightly during 2011 but the peak was 5.3 per cent and it is an even bet at the moment as to whether it will fall or rise in 2012. (The latest result was 5.1 per cent — see figure below.) At close to 5 per cent, the ‘glass full’ perspective is that the economy is still running close to its potential.

Figure 1: Australian unemployment 1980-2012: pick the recession in 2011?

The key forward indicator for the Australian economy is commodity prices — they are down on their peak levels in 2011 by about 10 per cent but are still at historically high levels (up by 30 per cent on 2010 levels) despite all the woes in Europe. Importantly, prices are still sending a very powerful message to the resources sector to invest. And there is already a big wave of resources projects still working their way through the economy.

As to the negative indicators, animal spirits (confidence) do matter but most studies show consumer confidence tends to follow activity and financial markets rather than lead anything. And financial markets were taking their cue from Europe. For the retail sector, it is certainly the case that the household saving rate rose in 2011 and that this took a bit out of consumer spending. (Retail sales volumes were up just 1.4 per cent in the December quarter over a year ago.) But the positive aspect to that is that it is a one-off adjustment — at worst the saving rate might stay high in 2012 but, if anything, it is more likely to decline. The big positive (from a spending perspective) is that wage rates are still growing at a 4 per cent pace and, reflecting the shift to higher paying occupations, full-time earnings are growing at closer to 5 per cent (real 2-3 per cent!), so households are now in a strong position to increase consumer spending in 2012. Similarly, in the case of housing, the market is extremely tight (continuing upward pressure on rents) and pent-up demand is building, which probably means there is only one way for activity to go in 2012 and that is up.

Why so much gloom?

The soap opera of Australian politics has certainly not helped matters at all. One can only hope that the leadership in-fighting within the government is over but that is a known unknown. How much damaged it caused to business confidence is a second known unknown but it surely has not helped.

One economic factor reflects an inability to disentangle the short-run negatives from the Queensland floods of late 2010/early 2011 which hit all areas of activity. When, for example, the GDP figures came out for the March quarter showing a contraction of 1.2 per cent on the December quarter, the ABS pointed out the significant impact of the lost production on the GDP figures for the March and also (then coming) June quarters. This also translated on to a 30,000 decline in employment in the agriculture which, with the country now benefiting from excellent rainfall, should be reversed (and perhaps more) in 2012. (Also negative for retail sales, etc.) Somehow until observers actually see the rebound in the figures, the explanations are heavily discounted: perhaps a case of let us not spoil a good piece of bad news!

Another and dominant part of the answer in the second half of the year is that the television news was full of the unfolding Greek tragedy in 2011. Aside from the media bias to those punters with a negative spin on this for China and hence Australia, there was the real, albeit short-term, impact on cost of funds for Australian banks and hence borrowers. Never mind that the US economic story was (in the second half) actually starting to look more positive.

But the real story in 2011 is the magnitude of structural change going on and the difficulty, particularly it seems for most business economists, to distinguish between cyclical and structural factors impacting on the economy. In the labour market, the mining sector has directly generated 33,000 and 38,000 jobs respectively in 2010 and 2011 and similar growth can be expected in 2012. Building the new mining projects has generated 36,000 and 13,000 net additions to construction jobs over those two years, with the peak in construction activity in either 2012 or 2013.

With the economy operating at close to full capacity, the structural expansion of the resources sector is partly at the expense of a structural contraction of other sectors. In 2010 and 2011, the manufacturing sector shed 12,000 and 51,000 jobs respectively, so it can be seen that the pressure on manufacturing has been and remains significant. Not surprisingly, the best news stories are those about the losers when the car makers, aluminium smelters and other firms announce factory closures and job cuts.

Further contraction in manufacturing is inevitable and the key is the decline in investment in manufacturing which, with a lag, will lead to contraction in output and loss of jobs down the track. A high profile case is the car industry. This industry has been in decline since the 1970s and the high Australian dollar looks set to be the final nail in the coffin. Despite robust car sales, this was all captured by imports in 2011 and all three domestic car companies announced cuts in production and jobs. This led to political pressure on the Government which increased industry subsidies under the guise of ‘co-investment’. These subsidies are helping fund short-term investment needed to tweak a few more years out of the current models. But, with the domestic share of the market down to 15 per cent and exports collapsed, volumes are well below economic levels. There is no logic to any car maker committing to the capital spending needed to keep the production lines running when the current model cycles run their course. Ironically, one of the other industries contracting is aluminium, an industry which expanded rapidly in the 1980s on the back of Australia’s bauxite mountains and low energy costs. So it is not just traditional highly protected sectors of manufacturing which are feeling the pressure of the high Australian dollar.

And beyond manufacturing, the services sector is also feeling the heat. Tourism is hurting principally from the high $A. Sure, recessed conditions in Europe and the US matter but, courtesy of growth of outbound tourism from countries like China, the world tourism market grew 4-5 per cent in 2011. Inbound tourism numbers into Australia shrank by about 4 per cent. At the same time, increased numbers of Australians are heading overseas (up 12.5 per cent in 2011) to take advantage of the high $A (and to enjoy some warm English beer).

Closer to home, universities are feeling the pinch as foreign student numbers decline, again courtesy of the high $A but also to some tidying up of visa rules which had provided a significant hidden subsidy to universities — up until 2009, permanent residency was (effectively) given as ‘benefit’ of doing your degree in Australia. Unfortunately, in a bizarre piece of bad public policy, the government has now outsourced decisions to universities on granting student visas — in the short run this will no doubt help boost numbers but the conflict of interest will certainly generate problems in years to come.

The retail sector itself faces structural issues. After a decade of high growth, the industry has been geared to high growth which explains why 1.4 per cent growth seems painful. At the margin adding to the pain is the growth of internet shopping which is exposing high cost Australian retailing to offshore competition. For the department stores, the high growth years also camouflaged the structural decline of this segment of retailing.

But for all these bad news stories, the seemingly unseen creation of new jobs has at least matched all the well-publicised losses. In net terms, jobs grew by 0.5 per cent in 2011. This does represent a significant slowing from the pace of 2010 when full-time jobs grew by an unsustainable 3.3 per cent. That pace, which had the unemployment rate heading to well below 5 per cent, forced the Reserve Bank to apply the brakes. It needed to see employment growth slow to be more in line with the 1.6 per cent growth rate of the labour force. It clearly over-shot which was (wrongly, in the author's view) interpreted as the economy heading into recession. But, if we abstract from the noise of structural change, there is a more than even chance that 2012 will see employment growth continue to re-accelerate from its mid-2011 lows, and move towards that magic 1.6 per cent or better. That could see unemployment staying close to 5 per cent or better.² The early signs are good.


Notes:

1.Nigel Stapledon is at the School of Economics, University of New South Wales, Sydney, Australia

2. The official Australian Government forecast, and that of most market economists in Australia, is for the unemployment rate to edge up to 5.5% in 2012. Note all employment data is trend quarterly from ABS 6291.0.55.003 Labour Force, Australia. Unemployment data in figure is monthly seasonally adjusted data from ABS 6202.0 Labour Force, Australia.

From issue no. 157, April 2012, pp.20-21

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