…Good But Could Be Better
- The Q4 GDP numbers were a little weaker than expected;
- But other indicators suggest that the economy is doing a bit better than Ok;
- For 2017, we upgraded our mark for the Australian economy to a B- ;
- Things are getting better but there is still room for improvement.
‘You say it’s good
But it could be better
It always could always be better
Everything in life could always be better’
In this era of niche marketing and customer focus, Lil Yachty is a sign of the times. Born Miles McCollum, Lil Yachty is a rap singer whose style he has defined as ‘bubblegum trap’ (which according to Wikipedia means hip hop music that is aimed at pre-teens and teenagers). One of his songs is ‘Better’, the theme of which is that things might be good but can get better. And that is very much the story of the Australian economy.
At face value, the Q4 GDP numbers were a bit disappointing. Not only did they print under consensus forecast, but they were lower than the September quarter figures. The annual growth rate of around 2.5% is no better than average rate recorded over the past 10 years. All of this looks disappointing, particularly given the very low level of interest rates and the economic momentum that appeared to be developing.
But you can’t always judge a book by its cover. The RBA recently noted that the December quarter numbers were impacted by temporary weakness in exports. More generally, the GDP numbers appear inconsistent with other evidence. Business sentiment is back to the levels last seen at the peak of the pre-GFC salad days. Growth in the number of hours worked is more consistent with an economy shifting into top gear. And the (modest) decline in the unemployment rate over the past year points to an economy doing a bit better than average.
So on balance the economy looks to be doing better but that is still not good enough. The underutilisation rate (the unemployment rate plus those working part-time looking for a full time job) is still too high indicating that the economy has not run strong enough for long enough. Even taking into account the noise in the data, the economic growth rate in Australia in 2017 was only about mid-table when compared to global peers. Australia has had very strong population growth, boosting the size of the labour force and increasing the demand for houses and roads. But economic growth has only been a little bit faster than population growth. This has resulted in growth of GDP per person being only a bit higher than the pace during the recessions of the 1980s and 1990s.
One of the positive economic surprises from the recent GDP data was that consumer spending picked up a little towards the end of last year. The higher spending was despite disposable income growth still being at a very low level. The increased spending has been partly funded by households reducing the amount of their income that they save. They are comfortable to do this because their confidence about getting a job has risen. But low income growth also means that consumers have had to reduce saving to maintain their standard of living. The good news is that the GDP numbers provided some evidence to support the RBA claim that wages growth has troughed. The big increase in full-time jobs in 2017 has also meant there that are more people with money in their pockets to spend.
The major worry from the GDP data was that recorded productivity growth was apparently weak towards the end of last year. There has been a global debate as to why the productivity growth numbers have been low around the world in recent years despite some big technological changes (big data, AI, digitisation, medical discoveries). The arguments as to why productivity is low ranges from the data not picking up the technological changes to firms not yet adapting their business models to benefit from the new technologies. This debate will run for some time. But it is difficult to understand why firms who are so worried about competition that they won’t increase prices would be hiring so many workers that reduce productivity growth. More likely, measured productivity growth will rise somewhat in coming quarters as the underlying economic numbers improve. But a return to the productivity growth rates seen in the 1990s is unlikely.
An important measure of how an economy is going is its growth rate. But at least as important is the sustainability of that growth rate. One test of sustainability is how much of the economy is directed towards investment rather than consumption. Relative to GDP, capex has picked up a little in recent quarters as mining firms have re-invested to offset depreciation. Higher commodity prices have provided miners with the cash flow to fund increased investment. More generally, the better economy means that non-mining firms have become more confident to invest. The boom in infrastructure spending has required firms to boost their own Capex budgets. Overall while below the peak seen around the mining boom, business investment (relative to the size of the economy) remains above the levels prevalent in the 1980s and 90s.
Another test of sustainability is the size of the current account deficit. Wide current account deficits are often associated with periods when an economy is growing unsustainably quick. Relative to the size of the economy, the deficit widened a little in Q4 but remains around its narrowest level since the 1980s. A narrow current account deficit is one of the reasons why the $A has been trading at a bit above its average level against the $US despite Australia having a lower interest rate structure than the US.
A final sustainability test is the growth in debt. Much of the focus in Australia has been on the growth of household debt that (relative to incomes) is amongst the highest levels in the world. Better full-time jobs growth and signs that wages growth has troughed should make it easier for households to pay-off debt. Regulatory changes also led to slowing in mortgage credit growth over the course of last year. The level of household debt is still an issue, but recently there has been some positive signs. The bottom line is that the Australian economy is doing a bit better than average, and that growth (for now) appears sustainable.
Over the past few years I have graded the Australian economy. In both 2015 and 2016 I gave the Australian economy a C+: it was doing Ok but had the potential to be doing so much better. The unemployment rate was above average, income growth in the economy was too low. Although the economy was improving six months ago I kept the C+ grade. I had some feedback that grade looked low given the structural pluses (strong financial system, relative low government debt) and the improvement in domestic economic momentum that was becoming evident. While true, not enough of the economy at that time had felt the benefits of the stronger growth (evidenced by the still high level of labour underutilisation) for me to give a higher mark.
Following a year when jobs growth was near a record annual high and the unemployment rate declined, it is hard not to give the economy a better mark for 2017. But there are too many people looking for a full-time job, the household debt ratio is too high and wages and productivity growth too low for top marks to be handed out. All up, I have upgraded the mark for the Australian economy to a B-. As Lil Yachty would say, “good but could be better”.
The good news is that momentum in the economy is developing and there is the potential for even better marks to come over the next couple of years. But the highest grades cannot be handed out until there is more substantial improvement in the growth of productivity and household incomes.
We live in interesting times.