Global uncertainty up, Australian growth down

Lots of activity on the home front this week. Australia recorded its first current account surplus in 44 years while GDP growth fell to its slowest pace since 2009. The RBA left rates unchanged. House prices jumped in Sydney and Melbourne. Internationally, we saw movement on two big sources of global uncertainty: the latest round of Chinese and US tariff increases took effect as the United States joined the global manufacturing slump while the UK parliament attempted to wrest control of Brexit from Boris Johnson’s government, prompting big swings in sterling.

This week’s readings cover Australia’s tax system, the corrosive effect of cynicism on democracies, the failure of the IMF’s US$57 billion Argentine bailout, and a profile of the co-creator of the ‘elephant chart’.

What I’ve been following in Australia . . .

What happened:

In the June quarter, Australia’s economy grew by 0.5 per cent over the quarter and by 1.4 per cent over the year, according to the ABS.

Strip out population growth, and in per capita terms GDP growth was flat over the quarter and down 0.2 per cent over the year, although growth in real net national disposable income – which is often seen as a more accurate measure of living standards – was much stronger, with quarterly growth of 1.4 per cent and annual growth of 4.4 per cent.1

By component, growth was driven by net exports (with rising exports and falling imports each adding 0.3 percentage points to quarterly growth) and a sizeable contribution from public sector consumption (which added 0.5 percentage points). Household consumption also made a more modest positive contribution. Offsetting that were declines in dwelling investment, private business investment and public investment, along with a sizeable negative impact from changes in inventories.

Once the negative contribution from inventories is considered, gross national expenditure overall made a negative contribution to the quarterly growth total of about 0.2 percentage points, meaning that it was only the contribution of net exports (and the statistical discrepancy) that delivered positive growth for the quarter.

Household consumption expenditure grew at 1.4 per cent over the year. That was the slowest annual rate of growth since 2013 and reflects a continued sluggish performance in growth in household disposable incomes, which fell over the year when measured in per capita terms.

That shortfall in income growth relative to consumption spending saw households dip into their savings, with the household saving ratio falling to 2.3 per cent. That’s the lowest level since households started to ramp up their savings in 2007 in advance of the global financial crisis.

Dwelling investment was again a significant headwind this quarter, falling by more than nine per cent over the year.

Private business investment also weak, falling over the year for a fourth consecutive quarter and undergoing a further decline in its share of GDP. By component, investment in machinery and equipment did increase over the quarter (although it was almost flat over the year), but this was more than offset by a steep quarterly drop in non-dwelling construction, which was also down slightly in annual terms.

By sector, mining investment rose by 2.4 per cent over the quarter in what was the first increase recorded since June 2018. But non-mining investment fell by 1.8 per cent.

For FY2018-19 overall, real GDP growth was just 1.9 per cent, a repeat of the FY2008-09 and FY2000-01 results, which collectively are now the three weakest outcomes this century. In per capita terms, the economy was close to stall speed, with growth at just 0.3 per cent. And the annual rate of productivity growth was again poor, with output per hour falling by 0.1 per cent over the year.

In contrast to the weakness displayed by real output, the nominal side of the economy continues to record decent growth, with nominal GDP up 1.2 per cent over the June quarter and 5.4 per cent over the year. For FY2018-19 nominal growth was 5.3 per cent.

Why it matters:

The Q2 GDP results were exactly in line with consensus forecasts and even prompted a small bounce in the value of the dollar, as foreign exchange markets had feared a downside surprise. But the annual growth outcome was still the weakest since the September quarter of 2009 – during the global financial crisis – and the last time that the annual rate of growth was below this quarter’s sluggish pace was all the way back in the final quarter of 2000. The Q2 print was also weaker than the RBA’s forecast, which had called for a 1.7 per cent growth rate for the second quarter. Similarly, the full FY2018-19 outcome was also considerably weaker than the forecasts for real GDP growth that underpinned April’s budget: the government had looked for growth at 2.25 per cent, instead of the sub-two per cent outcome we have ended up with.

The disappointing nature of the headline number is also compounded by much of the detail, as aside from exports and government spending (and a noteworthy bounce in mining investment), the story elsewhere was generally one of weakness, with household consumption still subdued and the rate of business investment yet to pick up, while dwelling investment continues to fall. Optimists, including the RBA, point out that the stimulative effects of two rate cuts and Canberra’s tax relief package have yet to influence activity, so it’s possible that the second half of the year will see the economy start to strengthen relative to the subdued first half. But, at least in part, that outlook remains hostage to a volatile global economic environment.

The main silver lining in this quarter’s national accounts applies to the nominal side of the economy, which bodes well for the government’s fiscal balance. The budget had forecast nominal GDP growth of five per cent for the year, but the economy has managed to do a little better than that. Similarly, while the budget expected the terms of trade to improve by four per cent over the year, the actual outcome was a six per cent increase.

What happened:

The RBA Board decided to leave the cash rate unchanged at one per cent at its 3 September Board meeting.

In the accompanying statement, the RBA noted that the ‘outlook for the global economy remains reasonable, although the risks are tilted to the downside’ as trade and technology wars undermine international trade flows and investment spending plans. As just noted above, growth in the first half of this year has been weaker than the central bank had expected, but it still thinks that growth will return to trend over ‘the next couple of years . . . supported by the low level of interest rates, recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some established housing markets and a brighter outlook for the resources sector.’ In the meantime, however, ‘recent labour market outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment’ and ‘inflation pressures remain subdued and this is likely to be the case for some time yet.’

Why it matters:

The decision to leave monetary policy settings untouched this week was in line with expectations: market pricing had the chances of a rate cut as relatively low, while a Bloomberg survey of economists had 30 out of the 34 polled predicting that the RBA would hold fire. But for now, the market still predicts a 25bp rate cut in either October or (slightly favoured at the time of writing) November this year, with the chance of a further adjustment in the first quarter of next year. And remember, as discussed here, the RBA’s relatively subdued forecasts as presented in the August Statement on Monetary Policy already bake in market expectations of two more cuts to the cash rate.

For its part, the RBA’s messaging remains consistent with its language over the past couple of months, noting that we should ‘expect that an extended period of low interest rates will be required in Australia to make progress in reducing unemployment and achieve more assured progress towards the inflation target’ and affirming that the Board was ready to ‘ease monetary policy further if needed to support sustainable growth in the economy and the achievement of the inflation target over time.’

Finally, it’s also worth noting here that the Treasurer is reported to be seeking to tweak the agreement the government has with the central bank. As part of the RBA’s accountability to parliament, the Governor and the Treasurer jointly release a Statement on the Conduct of Monetary Policy, which sets out the roles and responsibilities of the government and the RBA, including the objectives of monetary policy. The first of these was issued in 1996, and subsequent statements have been released in 2003, 2006, 2007, 2010, 2013 and most recently in 2016. According to the reports, the new agreement might also require the RBA to adopt a Bank of England-style practice and provide a formal explanation when inflation falls outside of the target range (currently two to three per cent): over the past five years, inflation has been inside the target band in just three of 20 quarters. While there has been some debate about the case for changing the target band itself, that kind of adjustment does not (yet?) seem to be on the current Treasurer’s agenda.

What happened:

The ABS reported that Australia recorded its first current account surplus in 44 years in the June quarter of this year, with the current account in the black to the tune of $5.9 billion, or an estimated 1.2 per cent of GDP (seasonally adjusted).

That reflects a record second quarter goods and services trade surplus of $19.9 billion, or more than four per cent of GDP, that was more than enough to offset a (somewhat smaller) income deficit of $13.9 billion. That huge trade surplus is largely a resource export story, reflecting a big jump in the value of exports of metals ores and minerals, which were up 21 per cent ($5.8 billion) in seasonally adjusted terms, with volumes up one per cent and prices soaring by 20 per cent.

A less upbeat part of the story applies to the import side: imports of consumption goods fell two per cent ($529 million) reflecting the subdued consumption story, while imports of capital goods were also down, dropping by $47 million.

For FY2018-19, the current account deficit was just $12 billion, down more than $39 billion from the 2017-18 deficit. That reflected a giant trade surplus of $50.2 billion, up more than $42 billion on the much more modest trade surplus recorded in 2017-18.

Why it matters:

The shift to a current account surplus had been expected after the recent run of record trade surpluses and the associated spike in iron ore prices.

Even so, given that the last time Australia was in the black was all the way back in the June quarter of 1975, this week’s news makes for an historic moment for our balance of payments. But aside from breaking a run of more than four decades of deficits, what does it mean? There are several potential implications:

• For some countries – mainly emerging markets and especially those with managed or fixed exchange rate regimes – current account deficits are often seen as a potential source of economic vulnerability. That’s because an external deficit requires external financing, making the economy dependent on the ‘kindness of strangers.’
• Admittedly, this view of the world is much less applicable when applied to developed economies like Australia, where a ‘consenting adults’ view of deficits has tended to prevail in recent years, viewing external deficits that reflect private sector decisions over savings and investment (as opposed to, say, unsustainable government budget deficits) as of little concern. Still, all else equal, a lower deficit / larger surplus probably still implies a lower level of perceived external vulnerability, and therefore a lower level of country risk.
• A smaller external deficit / larger external surplus also implies (again, all else equal) a stronger exchange rate. In our case, developments on the external side of the economy are therefore working to offset some of the impact of slower growth and lower interest rates on the level of the Australian dollar.
• Finally, the current account balance is also a reflection of the net balance of overall savings and investment in the economy. When investment exceeds national savings, the current account will be in deficit and the economy will be a net borrower from the rest of the world to make up the difference. When savings exceed investment, on the other hand, a current account surplus indicates that the economy is a net overseas lender. To the extent that this outcome reflects subdued investment rather than high savings, it can be interpreted as a negative signal about current growth and future prospects.

For a recent look at trends in Australia’s overall balance of payments, including the current account but also taking in the capital account and our external assets and liabilities), the Debelle piece flagged in last week’s readings is worth a read.

What happened:

Australian house prices gained further ground in August, according to CoreLogic, with the combined capital index up one per cent over the month and the national index up 0.8 per cent.

Dwelling values increased across five of the eight capital cities over August, although they fell in Adelaide, Perth and Darwin. The rate of monthly increase was particularly pronounced in Sydney (up 1.6 per cent over the month) and Melbourne (up 1.4 per cent). Values have now increased for three consecutive months in both cities.

Note also, however, that national values are still more than seven per cent below their peak, while values in Sydney (off more than 13 per cent) and Melbourne (off 9.5 per cent) are even weaker than that.

Why it matters:

We’ve been noting signs of housing market stabilisation for several months now, but this month’s figures were perhaps less suggestive of stabilisation than they were of an early recovery, at least as far as Sydney and Melbourne are concerned. Granted, it’s just one month’s data at this point, but that take is also consistent with improving auction clearance rates and what CoreLogic describes as a ‘deeper pool of buyers’, even if overall market volumes are still below normal. Falling house prices have likely been one of the factors depressing household spending, so it will be interesting to see if the turnaround starts to show up in stronger retail sales numbers over the coming months (see below).

The rise in house prices also prompted the first stirrings of a discussion over the implications for monetary policy, with commentators pointing to RBA Governor Lowe’s remarks in Jackson Hole last month, when he warned that ‘easier monetary conditions will push up asset prices, which brings its own set of risks.’ It’s much too early yet for the housing market to be acting as a constraint on monetary policy due to fears of runaway house prices, of course. But the combination of of sluggish growth and rising asset prices has been a familiar and unwelcome story across the global economy in recent years, and policymakers will not want Australia to end up mired in the same malaise.

Finally, it’s worth remembering that, despite what now looks to be a turnaround in buyer sentiment, the outlook for dwelling investment remains very weak. Last Friday, data from the ABS showed the number of dwellings approved in July slumped by 9.7 per cent (seasonally adjusted), with big drops in Victoria (down 24.3 per cent) and New South Wales (down 17.5 per cent). Approvals for private dwellings excluding houses plummeted 18.4 per cent while approvals for private houses were down a much more modest 3.3 per cent. That suggests that the quarterly slump in dwelling investment that featured in the Q2 national accounts won’t be the last.

In annual terms, total approvals were down 28.5 per cent relative to July last year, with approvals for private houses down 16.6 per cent and for private dwellings excluding houses down more than 44 per cent.

What happened:

Retail turnover in July fell by 0.1 per cent (seasonally adjusted) over the month and only grew at a relatively subdued 2.4 per cent over the year.

The ABS data showed monthly falls in retail trade in Queensland (-0.2 per cent), New South Wales (-0.1 per cent), South Australia (-0.5 per cent), Victoria (-0.1 per cent), the Australian Capital Territory (-0.5 per cent), and Tasmania (-0.1 per cent). Only Western Australia (up 0.6 per cent), and the Northern Territory (up 0.3 per cent) saw increases.

Why it matters:

The story of weak consumer spending that had been a feature of the first half of this year, and which again contributed to a disappointing quarterly GDP print, has carried over into the first month of the third quarter. Back-to-back rate cuts in June and July have yet to make their influence felt, and the government’s tax rebates will have only just started to hit households’ bank accounts, so policymakers will be hoping that the rest of the second half of the year will see a stronger performance, particularly if the turnaround in house prices is sustained. But for now, that’s just a hope / expectation, and there’s no sign of that kind of recovery in the data.

What happened:

Australia recorded a substantial $7.3 billion (seasonally adjusted) trade surplus in July, according to the ABS. Exports of goods and services were up one per cent over the month while imports were up three per cent.

Why it matters:

While July’s bumper trade surplus was down slightly from last month’s record, it still beat market expectations of a $7 billion outcome and continued the run of trade results that have helped to deliver the rare appearance of an Australian current account surplus.

. . . and what I’ve been following in the global economy

What happened:

China and the United States implemented their latest rounds of planned tariff increases on 1 September. Washington imposed tariffs of 15 per cent on more than US$125 billion of Chinese imports, with the targeted goods including a range of consumer products such as smartwatches, headphones, tv sets and footwear. For its part, Beijing imposed increased tariffs of between five and ten per cent on a range of US products, including soybeans and crude oil. These are the tariffs that were promised by both sides during the latest (July-August) escalation in their trade dispute, arriving on schedule.

Later in the week, China’s Ministry of Commerce said that Washington and Beijing had agreed to hold high-level trade talks in early October, following preliminary meetings between officials later this month.

Why it matters:

Initially, much of the damage created by the current bout of global trade conflicts took the form of high levels of uncertainty, even as the actual level of interference with global trade flows remained relatively modest. Increasingly, however, the already-sizeable economic costs being imposed by high levels of uncertainty are being further exacerbated by growing levels of actual trade protection. For example, economists at the US Peterson Institute estimate that the new tariffs will increase the average US tariff on Chinese goods to 21.2 per cent, and the average Chinese tariff on US goods to 21.8 per cent.

This week also brought signs that the trade wars are having an increasingly adverse effect on the US manufacturing sector, with the Institute for Supply Management (ISM) reporting that its index of national factory activity had fallen below fifty in August – indicating that the sector is contracting – for the first time since August 2016. This was also the fifth consecutive monthly fall in the index and represented the lowest reading since January 2016, although the index remains above the 43 level, which is the usual benchmark for declaring the sector to be in outright recession.

We’ve noted in previous editions of the Weekly that PMI readings have indicated that the manufacturing sector has been contracting in economies including the Eurozone, Japan and the UK. The United States has now joined the club.

What happened:

It has been a week of high political drama in the UK, with parliament working to take control of the Brexit process away from the government of Prime Minister Boris Johnson, apparently spurred on by last week’s decision by the PM to suspend parliament for five weeks in order to squeeze the time available for dissenters from his hardball negotiation strategy with the EU to muster any opposition. If that was the plan, then it appears to have backfired rather spectacularly, with Johnson becoming the first British premier since the Earl of Rosebery in 1984 to lose his first parliamentary vote. The House of Commons has now voted to require the UK government to seek a three-month extension to the current Brexit deadline of 31 October if it cannot reach an agreement with the EU. And the House has also voted to reject Johnson’s subsequent push for a snap general election on 15 October. At the time of writing, the proposal to seek an extension still had to make its way through the House of Lords, although the expectation was that the Lords might delay, but not derail, the decision.

The same week also saw Johnson sack 21 Conservatives after they voted against the government, helping turn what had been a tiny working majority of one into a potential shortfall of 43, another Conservative MP having crossed the floor to join the Liberal Democrats during the process of the PM’s first vote. While the current PM does not look like getting his wish for a 15 October election, a relatively quick move to what would be a third general election in five years now seems inevitable (although, frankly, who knows what will happen next).

Why it matters:

Along with trade wars, instability in the Persian Gulf, unrest in Hong Kong and (at least until recently) political instability in Italy, Brexit has been one of the key sources of risk hanging over the global economy this year. This week’s events demonstrated once again that the whole Brexit process has become even more ridiculously unpredictable, with financial markets scrambling to keep up with events. For example, on Tuesday the pound briefly dipped below US$1.20 for the first time in more than three decades before staging a sharp recovery on Wednesday when the government lost its votes in the House of Commons.

Moreover, for all the sound and fury of this week’s events, the epidemic of uncertainty triggered by the June 2016 vote seems unlikely to fade any time soon. Instead, we can now add another unpredictable election into an already turbulent mix (and in this context, see this week’s readings for a look at what a Corbyn election win might entail for the UK economy).

All that said, by mid-week markets seemed to be in a relatively bullish mood, pulling together a fall in the chance of a no-deal Brexit, signs of an official backdown in Hong Kong, the news of resumed US-China trade talks and some earlier resolution of the political situation in Italy to make the case for a kind of temporary geo-political sweet spot. They should probably enjoy it while it lasts.

What I’ve been reading: articles and essays

Two speeches from the Treasurer, both given last week but only making it on to the Treasurer’s web page in the last few days. This address to the Business Council of Australia (BCA) on Australia’s productivity challenge generated a lot of interest and media commentary, asking ‘With Australian corporates enjoying healthy balance sheets, record low borrowing costs and strong equity market conditions, the question is are corporates being aggressive enough in the pursuit of growth?’ and calling for Australian business to ‘back yourself and use your balance sheet to invest and grow’. Several days later the Treasurer also spoke on ‘The Age of Disruption’, which covers both the opportunities (‘automation technologies could add up to $4 trillion to the Australian economy over the next 15 years’) and challenges (‘Cyber security, privacy concerns, competition issues, the integrity of the future of our tax base and the future of work’) posed by digital disruption.

The BCA’s Jennifer Westacott makes the case for an investment allowance in the AFR.

The Treasury published a new working paper looking at recent trends in personal income tax progressivity (a tax is progressive if the average rate of tax increases as the tax base – in this case income – increases, is proportional if the average rate of tax is constant, and is regressive if the average rate falls as the base increases). The paper also points out that deciding ‘how much’ progressivity should be in a tax system involves judgments about any trade-off with efficiency and with other, potentially conflicting, measures of fairness. The analysis covers changes in taxable incomes and average tax rates between 1994/5 and 2015/16 and finds that their combined impact has been (1) lower average tax rates for the bottom three deciles; (2) approximately the same or small increases for the middle four deciles; and (3) higher average tax rates for the top three deciles, including a significantly higher increase for the top decile. This all suggests that the overall progressivity of the tax system has increased. The data also highlight a narrowing of the taxpayer base, with the share of personal income taxpayers in the over-18 population falling by almost five percentage points over this period, along with an increasing concentration of the personal tax incidence on those in higher income groups: the top ten per cent of taxpayers contributed 45 per cent of personal income tax revenues in 2015-16 (about one million taxpayers earning more than $126,000), while the top ten per cent’s share of tax receipts in 1994-95 was quite a bit lower, at about 36 per cent.

The RBA’s September Chart Pack is now available.

Grattan’s Tony Woods proposes three ways to start fixing Australia’s energy policy mess: (1) integrate energy policy with emissions-reduction policy and go beyond electricity to encompass transport, industrial and export energy; (2) Revise the Australian Energy Market Agreement to set out clearly the responsibilities of each level of government as well as of the collective COAG Energy Council; and (3) Reform and strengthen the model of separate and independent market agencies, including via a joint statutory obligation to collaborate on common objectives.

An Economist leader arguing that cynicism risks undermining Western democracies, with the claim that ‘Politics used to behave like a pendulum. When the right made mistakes, the left won its turn, before power swung back rightward again. Now it looks more like a helter-skelter.’

The Bank of England has updated its estimates (pdf) of the cost of Brexit to the UK economy. It now thinks that ‘advancements in preparations for a No Deal No Transition scenario mean that the Bank’s assessment of a worst case No Deal No Transition scenario has become less severe’ (the other scenarios remain unchanged from its November 2018 assessment). The worst-case scenario now sees an initial peak-to-trough decline in GDP of 5.5 per cent, a rise in unemployment to seven per cent, and inflation peaking at 5.25 per cent. Back in November, the Bank’s estimates were for a decline in GDP of eight per cent, unemployment up to 7.5 per cent and inflation peaking at 6.5 per cent. Related, this new working paper looks at the impact of Brexit on UK firms, drawing on survey data. It finds that the impact of the June 2016 referendum has had three main consequences to date: a big increase in uncertainty; a reduction in investment by about 11 per cent over the three years following the vote; and a decline in UK productivity of between two and five per cent over the same period.

An FT Series on the Corbyn Revolution, looking at the potential impact of a Corbyn-led Labour government on the UK economy, including an estimated GBP26 billion in tax increases, the possible confiscation of GBP300 billion of company shares and grand ambitions to restructure shareholder capitalism.

From the same paper, an FT Big Read on Argentina and how the IMF’s biggest ever bailout crumbled. The Fund made the ‘brave’ decision to give Argentina a US$57 billion package. Anyone who has spent any time with emerging market finance will be struck with a sense of déjà vu reading this one – in fact, part of my first role as an economist in the Bank of England’s international divisions involved looking at Latin American economies with financial difficulties and later my MPhil thesis at Oxford was on Argentina’s Convertibility Plan. For a great look at some of the recent history here, I recommend Paul Blustein’s book, And the money kept rolling in (and out).

The latest edition of the IMF’s Finance & Development magazine is now available. The focus is on ‘hidden corners of the global economy’ and looks at tax havens, phantom investments and money laundering in the art market. There’s also a good profile of Branko Milanovic, co-creator of the famous elephant curve that graphs changes in the global income distribution and author of the very nice Global inequality.

Robert Gordon (who wrote The Rise and Fall of American growth, which should perhaps be my third book recommendation this week – a record, I think? – except that I have to confess it has been stuck on my ‘I really should read this’ list for several years now and has never quite made it into the ‘I’ve now read this’ pile) and Hassan Sayed on the industry anatomy of the transatlantic productivity slowdown. They argue that cross-Atlantic industry comparisons show that slower labour productivity has been driven more by decelerating technical change and a reduced contribution from innovation than by lower investment rates.

1 A quick recap: growth in real GDP is the standard measure of economic growth but has several shortcomings when it comes to measuring changes in living standards. Real net national disposable income (RNNDI) adjusts GDP for changes in the terms of trade, the impact of net income flows (including interest, profits and dividends) between us and the rest of the world, and depreciation of the capital stock. When measured in per capita terms it captures the impact on individual Australians. The key difference between real GDP and RNNDI in the case of Australia is usually found in movements in the terms of trade, where big swings in commodity prices can have a large impact on incomes vs output. RNNDI also has its critics, and for household welfare a useful alternative is real household disposable income, which is discussed below.

2 A quick reminder: the current account balance is the sum of the balance on goods and services trade and the income balance. The former is pretty self-explanatory: it’s the difference between Australia’s exports and imports of goods and services. The latter – the income balance – comprises the net balance on the so-called primary and second income accounts. Primary income refers to payments made to (and received from) non-residents in return for the use of (financial) capital and labour and covers compensation of employees, dividends, reinvested earnings, interest payments and receipts, rents, investment income from insurance and pension funds, and taxes and subsidies. The bulk of investment income relates to payments and receipts associated with the stocks of inward and outward direct and portfolio investments. Secondary income captures current transfers (that is one-sided transactions such as gifts or grants) and includes items like food aid, workers’ remittances and the remuneration received by international students.