2020

Here in Australia, the stock market greeted 2020 with a record high, with the ASX pushing through 7,000 for the first time, while a series of key data releases over the past few weeks – retail sales, unemployment and inflation – all came in stronger than expected. And the house price recovery has continued. As a result, markets have now slashed their expectations of a rate cut at next week’s RBA meeting, with the odds at the time of writing slumping to about 13 per cent. At the same time, however, the economy will now have to negotiate the fallout from this summer’s terrible bushfires and any negative spillover effects from the Wuhan coronavirus. Measures of business and consumer confidence remain subdued and could yet take further hits from the bushfires and the uncertainty created by the new coronavirus.

It’s been a similar story at the global level, where world stock markets hit record highs through January, shrugging off the US-Iran confrontation that marked the first days of the year, before fears around the coronavirus prompted a pull back.

The IMF still thinks that global growth in 2020 will outperform 2019’s fairly dismal performance, but that hasn’t stopped it downgrading its forecasts for this year and next. For any readers who would like to hear my views on some of the forces shaping the global and Australian economic outlook for this year, you should be able to view a recording of my 30 January webinar (and access more slides than you could shake a stick at) here.

Finally, today is Brexit day! It would be nice to think that this means that the whole thing is over . . . and I suppose it sort of is . . . but instead of Brexit, analysts can start to debate the implications of the transition period (currently scheduled to run until 31 December 2020) and the likely shape of an UK-EU trade agreement.

What I’ve been following in Australia . . .

What happened:

The ABS said that the Consumer Price Index (CPI) rose 0.7 per cent in the December quarter and was up 1.8 per cent over the year. The trimmed mean – typically treated as the RBA’s preferred measure of underlying inflation – was up 0.4 per cent over the quarter and 1.6 per cent over the year.

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The most significant price rises over the December quarter were for tobacco (up 8.4 per cent), domestic holiday, travel and accommodation (7.3 per cent), automotive fuel (4.4 per cent), and fruit (6.8 per cent). The ABS noted that the tobacco price increase reflected the impact of the annual tobacco excise tax increase and the biannual indexation rise. The impact of the drought was felt in food and fruit prices, while meat prices were also boosted by the spread of African Swine Fever in Asia. And the rise in fuel prices was driven by higher world oil prices.

Why it matters:

The Q4 inflation result surprised on the upside: the consensus had been for a headline annual inflation rate of 1.7 per cent (although the consensus was on the money with the 1.6 per cent annual print for the trimmed mean).

Back at the end of last year, many economists had expected the RBA to deliver a 25bp interest rate cut at its meeting on 4 February (although as noted in the final Weekly of 2019, market pricing had been quite volatile). A strong labour market result for December and a decent retail sales report for November had already seen markets start to scale back the chances of a rate cut next week, and this week’s Q4 inflation print looks to have been the final nail in the coffin for any bets on an early RBA move. At the time of writing, the probability of a rate cut next Tuesday had dropped to less than 13 per cent.

That said, both headline and underlying inflation are still stuck below the bottom of the RBA’s target range. And that’s even with the impact of a dramatic hike in the price of tobacco, the effects of the drought on food prices, and higher world oil prices all helping to push up the CPI in the December quarter. The headline CPI has now been below two per cent for all but two of the last 21 quarters, while the trimmed mean inflation rate has been sub-two per cent for sixteen consecutive quarters. Seen in that context, the RBA is likely to remain under pressure to ease again, even if it now decides to wait until later in the year.

What happened:

The unemployment rate (seasonally adjusted) fell to 5.1 per cent in December 2019 from 5.2 per cent in November. According to the ABS, the underemployment rate remained unchanged at 8.3 per cent, meaning that the underutilisation rate eased from 13.5 per cent in November to 13.4 per cent in December.

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By state, unemployment fell to 4.5 per cent in New South Wales and also declined in Queensland, South Australia, Western Australia and Tasmania, although Victoria saw an increase in joblessness.

The participation rate (seasonally adjusted) remained unchanged at 66 per cent, and the number of people employed increased by 28,900, with full time employment dipping by 300 and part-time employment rising by 29,200.

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Over 2019, employment increased by 263,000 persons with full-time employment up by 153,000 and part-time up by 110,000, while the number of unemployment persons rose by 22,000.

Why it matters:

December’s labour market report turned out to be much stronger than market expectations. Consensus forecasts had been for the unemployment rate to be unchanged at 5.2 per cent at year end, but instead December’s unemployment rate was the lowest since March 2019 and marked a second consecutive monthly drop in joblessness. Employment growth at close to 29,000 was likewise much better than expectations, which had been for an increase of just 10,000, although all of December’s employment growth was in part-time jobs.

With the RBA focused on labour market developments as a key input into its cash rate decisions, the immediate impact of the December data was for analysts to scale back their expectations of a February rate cut (a judgment then confirmed by the Q4 inflation data discussed above). And there’s no doubt that the November and December unemployment numbers will have come as welcome news to the central bank.

That said, it’s worth remembering that even at 5.1 per cent, the national unemployment rate is still some distance from the RBA’s estimate of the 4.5 per cent rate required to spark wage growth and help get inflation back to target. So, as with the inflation result, the respite for monetary policy may prove to be only temporary.

What happened:

According to the ABS, Australian retail turnover rose 0.9 per cent (seasonally adjusted) over the month in November 2019 and was up 3.2 per cent over the year.

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By sector, there were increases for clothing, footwear and personal accessory (up 3.1 per cent), food (0.5 per cent), household goods (1.2 per cent), department stores (3.4 per cent) and cafes, restaurants and takeaway food services (0.9 per cent). These rises were partially offset by a fall in other retailing (down 0.5 per cent).

The ABS highlighted strong growth in Black Friday sales, both in electrical goods and online sales (with online retail turnover accounting for 7.1 per cent of total turnover) but also in clothing and furniture.

Why it matters:

One of the key stories of 2019 was subdued household expenditure, with growth in real household consumption running an at anaemic 1.2 per cent annual rate in the third quarter of last year and the share of household consumption in nominal GDP sliding to less than 55 per cent. For the economy to deliver a better growth outcome, households need to rediscover their appetite to spend. But the first retail trade number for the final quarter of 2019 had shown retail trade growth running at a subdued rate of only a little above two per cent. November’s stronger outcome was therefore welcome news, and optimistically could be taken to suggest that lower interest rates, tax relief, and the start of a recovery in housing wealth have started to open wallets. That might prove to be the case, but one month’s data is too early to tell. And an alternative story is that ‘Black Friday – Cyber Monday’ sales may have pulled forward sales that would have otherwise registered in December. Next month’s retail figures will give us a better take on that. A further complication for the December and January readings will be the impact of this summer’s bushfires (see below).

What happened:

There were more signs of revival in the Australian housing market. Corelogic’s national dwelling values index rose by 1.1 per cent over December and was up four per cent over the quarter. That translated into the fastest rate of national dwelling value growth over any three-month period since November 2009. On an annual basis, national values were up 2.3 per cent over 2019.

The combined capitals index rose by 1.2 per cent over the month and was up three per cent over the year, with monthly rises of 1.7 per cent in Sydney and 1.4 per cent in Melbourne, taking prices in both cities up by 5.3 per cent over the year. Darwin was the only capital city to experience a price fall in December.

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Meanwhile, the ABS reported that the number of dwelling units approved rose by 11.8 per cent (seasonally adjusted) in November relative to October but was still down 3.8 per cent over the year. Private sector houses were down almost ten per cent relative to November 2018 but approvals for dwellings excluding houses jumped by 22.6 per over the month and rose by 5.5 per cent in annual terms.

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Why it matters:

Big falls in dwelling investment were a significant headwind for Australian economic growth in 2019 and recent ABS data on construction work done in the September quarter of last year confirmed that weakness (the number of dwelling commencements plummeting by almost 12 per cent in Q3:2019 to be down more than 27 per cent over the year while apartment commencements were down more than 40 per cent in annual terms) and that there are more falls to come. Still, the recovery in house prices plus the signs of a turn in building approvals both provide grounds for optimism that dwelling investment may start to recover towards the end of this year. At the same time, higher house prices will also improve the health of household balance sheets, which in turn raises the chances of a positive wealth effect for consumer spending.

What happened:

The NAB monthly business survey for December 2019 showed business conditions dipping by one point to a reading of plus three index points while business confidence fell two points to minus two index points.

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Why it matters:

Business conditions ended last year in positive territory but well below the levels of 2018 and below the long-term average, while the business confidence reading was the lowest since mid-2013.

NAB economists reckon that that the last few monthly readings are consistent with a stabilisation in business conditions following the big drop from mid-2018. But that stabilisation has taken place at a low level, one that implies ‘a stalling in the private sector’, and the forward-looking confidence indicator doesn’t predict any substantial improvement. The December results do not appear to show any marked impact from the bushfires, but the more significant hit from the latter is expected to show up in January.

What happened:

The Westpac-Melbourne Institute Index of Consumer Sentiment (pdf) fell 1.8 per cent in January to 93.4, taking the index deeper into negative territory.

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Why it matters:

The opening month of 2020 saw consumer sentiment stuck at low levels. Westpac economists pointed out that – apart from the lows of the Global Financial Crisis (GFC) which saw confidence levels average only 89 – there have been just seven monthly readings when the index has printed below the current 93.4 level. This gloomy result and its December predecessor need to be set against November’s relatively positive retail trade outcome and provide grounds for treating the latter very cautiously as an indicator that the Australian consumer may be about to start spending freely again.

The January reading was of particular interest because it was expected to show the impact of the summer bushfires. In this context, a further drop in sentiment relative to December’s result was to be expected, and indeed Westpac notes that ‘it is somewhat surprising that the fall in the index was not more severe,’ speculating that the negative impact of the fires on reported sentiment may have been somewhat reduced because the survey took place in a week when there was widespread rain.

What happened:

The potent combination of a very hot and a very dry year has delivered devastating fires this summer, with lives lost, millions of hectares burned, thousands of homes destroyed, and immense damage to the national environment. Economists have been trying to pull together their first estimates of the likely economic impact.

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Why it matters:

While it will be some time before the full costs of the fires are known, it’s already clear that the social and environmental costs have been dramatic, and while narrow economic costs are likely to be modest in comparison, they will still be significant, and go well-beyond the implications for GDP growth.

One starting point for estimating the cost of natural disasters is through the prism of insurance losses. These were around $1.8 billion in the case of the 2009 Black Saturday bushfires, for example, and almost $2.5 billion for 1983’s Ash Wednesday fires (both figures expressed in 2017 dollars). According to the Insurance Council of Australia, as of 23 January 2020 estimated bushfire-related insurance losses since November 2019 were around $1.65 billion from 20,000 claims. Insured losses are only one part of the picture, however, with many losses likely to be uninsured.

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More comprehensive estimates of the total cost of natural disasters have to include both market and non-market losses, where the former refers to losses to assets that have a clear market value (a house, for example) and non-market losses apply to assets where market prices are much harder to find (think of the true value of a heritage building, for example).

A similar way to think about these costs is in terms of tangible and intangible costs – see for example this report (pdf) produced by Deloitte Access Economics for the Australian Business Roundtable for Disaster Resilience and Safer Communities. Tangible costs include both direct costs such as damage to private property and public infrastructure, whether insured or not, and indirect costs including disruptions to economic activity leading to lost wages and profits when businesses are not operational. Intangible costs are those associated with deaths, injuries, and damage to social wellbeing and the natural environment. Insurance will typically only cover direct, tangible costs. Moreover, intangible costs are much harder to gauge than tangible costs, but the Deloitte Access Economics report suggests they can be at least as large. For example, in the case of the Black Saturday bushfires, Deloitte estimates that insured costs were only about 48 per cent of all tangible costs, while tangible costs in turn accounted for just 44 per cent of overall costs. Hence insurance costs will likely serve as a very low-end estimate of the likely total cost of the current disaster.

An alternative approach is to assess the implications for GDP and GDP growth by looking at the distribution of economic activity. So, for example, NAB economists – drawing on regional estimates from SG Economics and Planning – calculate that the regions most affected by the December/January bushfires collectively account for about one per cent of Australian GDP. On the assumption that the fires would put these regions’ economies ‘out of action’ for a month, this could subtract about 0.4 percentage points from national GDP spread over the end of Q4 and Q1, or about 0.1 percentage points from annual GDP.

Given the presence of large tangible and intangible costs, it would seem reasonable to expect a significant, sustained hit to GDP growth in the aftermath of natural disasters. But surprisingly often, that turns out not to be the case. For example, in the United States, New Orleans experienced severe and prolonged economic disruption after the impact of Hurricane Katrina (2005). Yet estimates for local GDP suggest that the GDP of the metropolitan area fell by less than three per cent before fully recovering to pre-Katrina levels by 2007, with the GFC recession doing far more damage to local GDP than Katrina. That’s because while GDP falls in the short run as a result of a disaster, this impact is then often reversed by the subsequent reconstruction activity. Of course, the losses suffered are still real, it’s just that GDP isn’t designed to capture the opportunity cost involved in the reconstruction effort.

It’s also worth noting that the simpler versions of these kinds of calculations don’t consider a range of other adverse impacts. These include the potential damage to national business and consumer confidence that extends beyond the immediately affected areas, the possible productivity-sapping effects of air pollution on cities such as Sydney and Melbourne, and the impact on Australia’s international tourism brand and soft power more broadly. Finally, there is the scope for interaction with other developments occurring in the economy – such as parallel hits to sentiment and tourism from the Wuhan coronavirus (see below).

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

What happened:

The IMF released its latest forecasts for the world economy.

According to the Fund’s latest estimates, world output only rose by 2.9 per cent in 2019 when output is calculated at purchasing power parity (PPP) exchange rates, and grew at an even more sluggish 2.4 per cent when market exchange rates are used (which give a relatively higher weight to slower-growing advanced economies relative to faster-growing emerging ones). That 2.9 per cent would be the weakest growth outcome since 2009 and the GFC, and since the global downturn of 2001 before that.

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Last year was also a poor one for global trade, with growth in volumes in goods and services estimated to be a meagre one per cent. Again, that’s the weakest outcome since 2009 and 2001.

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The IMF’s latest forecasts see growth picking up this year to 3.3 per cent and then accelerating again to 3.4 per cent in 2021. At the same time, world trade growth is forecast to increase to 2.9 per cent this year and 3.7 per cent in 2020.

Why it matters:

The good news is that after a pretty awful 2019 for global growth, the Fund does expect an improvement in the global environment this year. The not so good news is that the forecast pick up is a very modest one, and mainly rests on a return to ‘normal’ growth for some big emerging markets (India, Mexico, Brazil, Russia, Turkey) that performed well below expectations in 2019. Moreover, the IMF has also continued to downgrade its forecasts for GDP growth for this year and next.

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There is some support for an upturn in the recent data flow. For example, after spending much of the past year in negative territory, the global Citi Economic Surprise index, which tracks whether data releases exceed or fall short of analysts’ forecasts, has now moved into positive territory.

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There has also been a large reduction in the level of global policy uncertainty. A key theme of 2019 was the high level of uncertainty created by the US-China trade and technology conflict, trade protectionism more generally and fears of a no-deal Brexit. As we noted last December, by the end of last year, many of these fears had receded: The US and China had started to negotiate a ceasefire in the form of a so-called ‘Phase One’ trade agreement (since signed on 15 January this year) and the UK general election had delivered a decisive victory for Boris Johnson’s Conservative Party, with a Brexit deal scheduled to take effect on 31 January – today! As a result, by December 2019 measures of policy uncertainty had retreated from the very high levels they had reached in mid-year, although they remain elevated by historical standards.

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High levels of policy uncertainty are associated with higher risk premia, lower investment, lower levels of activity in terms of market entry and technology upgrading, lower business and consumer confidence, lower consumer spending on durables and higher levels of precautionary saving, while large increases in uncertainty are associated with slower growth rates. Lower uncertainty therefore has the potential to deliver some needed stimulus to the global economy.

Another source of stimulus for global growth this year is the lagged impact of last year’s central bank actions, which saw a widespread shift towards easier monetary policy across developed economies, including 75bp of cuts from the US Fed (in July, September and October 2019.

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That combination of lower policy uncertainty and global monetary policy easing contributed to a marked turnaround in financial market sentiment by the end of last year that continued into the first weeks of 2020 and saw global stock markets reach record highs in January, despite the US-Iran confrontation that grabbed the headlines at the start of the month. Stronger equity markets, lower risk premia and increased investor risk appetite in turn have helped further ease global financial conditions, which should all be supportive for growth.

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The past week has seen some of this optimism unwound, however, as the world economy contemplates the potential effects of the Wuhan coronavirus (next story).

What happened:

Global risk aversion has increased as a result of fears about the possible consequences of the Wuhan coronavirus.

Why it matters:

Economists have been scrambling to come up with estimates as to the likely economic consequences of the new coronavirus for China, for the global economy, and for our own economic prospects here in Australia. Unfortunately, with many key features of the new virus (incubation period, infectiousness, fatality rate) still to be determined, any such estimates are subject to a huge degree of uncertainty – even more than the typical economic forecast. Of course, that hasn’t stopped the profession from doing its best.

To date, the most common approach has been to look to recent history for a possible benchmark, with the 2002-2003 Severe Acute Respiratory Syndrome (SARS) pandemic the preferred comparator.

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The SARS coronavirus first emerged in Guangdong Province in China in November 2002 but the peak economic impact was felt in the second quarter of 2003, which saw a marked slowdown in global industrial production and trade growth (although note that it’s difficult to disentangle the impact of SARS from the impact of geopolitical uncertainties - the US-led invasion of Iraq began in March 2003 – and higher oil prices).

Back in 2003, the Asian Development Bank (ADB) estimated that SARS imposed total costs of around 0.6 per cent of GDP for East and Southeast Asia. The most important channels for the transmission of the economic shock were tourism flows and consumer confidence, which led to falling services exports and consumer spending, which then in turn had secondary effects on the local economy including job losses, lower investment and reduced overall demand. National vulnerability to SARS therefore tended to reflect the shares of tourism and consumption in GDP along with the composition of consumer spending (with face-to-face consumer services most vulnerable to SARS-related damage). The ADB’s estimates of the cost of SARS to regional economies range from 0.5 per cent of GDP for China and Taiwan, to 2.9 per cent of GDP for Hong Kong and three per cent for Singapore. Large falls in services exports lie behind the relatively big numbers for Singapore and Hong Kong, while Hong Kong also suffered from a large fall in consumption. The ADB also reckons that if the economically damaging period of the outbreak had lasted for two quarters instead of one, economic losses could have been two or three times larger than those reported here.

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Alternative estimates of the economic costs of SARS are available from this paper by Lee and McKibbin. They focus on three main channels of economic influence: (1) fear of infection leading to substantial falls in consumer demand, especially for retail sales and travel, which means that the economic damage is larger in regions with larger services sector exposure; (2) higher uncertainty reducing business and investor confidence in the affected economies; and (3) increases in the cost of disease prevention These are then modelled in the form of increases in the country risk premium, sector-specific demand shocks to the retail sector, and increases in costs in those services sector most exposed to SARS. Their results find the largest economic impacts on China (about one per cent of GDP) and Hong Kong (more than 2.6 per cent of GDP), followed by Taiwan and Singapore (both with losses of a bit less than 0.5 per cent of GDP).

What about the impact of SARS on Australia? Lee and McKibbin estimate that the economic cost was modest – perhaps 0.07 per cent of GDP. Similarly, work by the Australian Treasury at the time judged that the overall economic impact of SARS on the Australian economy was quite limited. Tourist arrivals from East Asia did fall quite sharply, with steep month-on-month declines in April and May 2003 (although the Iraq War would also have dampened travel), but the impact of this was partially offset by Australians deferring or cancelling overseas travel in favour of local destinations.

In a more recent review (pdf) of the SARS experience, the authors conclude that while the outbreak did impose large economic costs at its peak, those losses only lasted one or two quarters with all affected economies recovering by the third quarter of 2003, and with total costs for most countries in the range of 0.5 per cent to one per cent of annual GDP. Disproportionate damage was suffered by the tourism, leisure, transport and retail sectors. There were severe short-term disruptions to private consumption, particularly for face-to-face services such as dining, along with dramatic falls in air traffic, hotel occupancy rates, and the incomes of restaurants and entertainment venues.

The largest economic impacts of SARS, then, were due to indirect effects arising from the actions of individuals seeking to avoid infection, which generated major, albeit short-lived, changes in consumer behaviour. Moreover, it seems that much consumption was postponed rather than cancelled.

To the extent that we can use SARS as a benchmark, then, the evidence suggests that a possible scenario is for a sharp but temporary economic shock that would impose particular damage on the tourism and retail sectors. To put some numbers around that for Australia: tourism accounts for about three per cent of GDP and Chinese visitors account for 15 – 16 per cent of all arrivals (but a higher share of visitor spend). As already noted, however, SARS may not turn out to be a good model for the Wuhan coronavirus. Moreover, even if it is an appropriate comparator, other factors today are very different than in 2003. The Chinese economy is much larger and much more inter-connected with the global economy, for example. Again, Australia’s economic linkages to China are much deeper and much broader than they were in 2003. All of which means we need to be very cautious about drawing 2003 SARS-based lessons for today.

What I’ve been reading: Summer reading

I have to confess that much of my summer break was economics-free and taken up with light holiday reading (I’m deep into the Abir Mukherjee series of books set in Raj-era India, I’ve dipped my toes into Mick Herron’s Slough House series, and I’m just about to complete Ian McDonald’s Luna trilogy) but I did manage to do a bit of ‘on topic’ reading, too.

I strongly recommend Thomas Philippons’ The Great Reversal: How America Gave Up on Free Markets. While the main theme is the rising concentration of corporate power in the United States and its consequences for economic performance and consumer welfare, I was particularly impressed with two other aspects of the book. First, it works as a great introduction to many of the key themes of microeconomics and how they apply in practice. And second, it’s a terrific primer on many contemporary economic debates about productivity, competition, innovation and network effects.

I’m still working my way through Acemoglu and Robinson’s The Narrow Corridor: States, Societies and the Fate of Liberty, and so far, so (very) good. As a new experiment for me, I’m listening to the audio book version of this, which provides quite a different experience to reading the text, and at times the concentration required to keep up with Solon’s reforms in Athens or the kin relations of the Tiv in Nigeria while listening can be quite challenging - it’s a bit like attending a series of lectures. Still, there’s so much of interest here that it’s mostly easy enough to keep tuned in.