The AMP’s chief economist, Dr Shane Oliver uses this week’s Federal Budget as an opportunity to examine the Australian economy.
The Federal Budget this week is a good time to reflect on the Australian economy over the last year.
Just over a year ago it seemed Australia was riding high: the economy had come through the Global Financial Crisis in good shape, most sectors of the economy were strong or picking up, mining boom was on the way back, and reflecting all this the Australian share market had pushed back above the 5000 level.
It seemed the good times were set to roll again in Australia, much as they had through the first part of the mining boom last decade over the 2001-08 period.
However, one year down the track it all seems very different. While the mining boom is back with a vengeance, those in manufacturing, retailing, construction and tourism are starting to think this is the exact opposite to a boom.
The weakness is mirrored in profit growth outside the mining sector. This in turn has been reflected in the budget deficit for this year blowing out to $49.4bn from an estimate of $40.8bn a year ago.
With the terms of trade at near record highs, one would think the Federal Government should be rolling in money.
The malaise is also reflected in the fact the Australian share market is still struggling below the 5000 level reached last April, whereas global shares have gone on to new recovery highs.
Of course the floods have played a role, but the malaise extends well beyond flood affected areas.
So what happened?
Why is this mining boom feeling so different to the first one?
Drivers
Several factors help explain the relative underperformance of Australian shares over the last year or so.
These include concerns about China’s outlook as authorities there battle to control inflation, Australia’s relatively high and rising interest rates, the strong Australian dollar and the likelihood it has gone beyond a pinch point for many companies, and political uncertainty.
The latter started with the controversial Resources Super Profits Tax, reinforced by the advent of minority Government in Australia and the more recent moves towards a carbon tax.
But at its core is an increasing realisation the latest incarnation of the mining boom (MB II) is turning out very differently to the first leg of the mining boom (MB I) that ran from 2001 to 2008.
Mining Boom I
The first leg of the mining boom saw the terms of trade, or the ratio of export prices to import prices, rise to its highest level since the early 1950s.
While the two speed economy was clearly evident in mining sector strength relative to other sectors, the gap wasn’t perceived to be that great, particularly with strong Government revenue flows allowing the Federal Government to provide significant income tax cuts year after year at the same time it ran budget surpluses.
However, the period was also associated with an ongoing fall in household savings and rise in household debt levels as households adjusted to low interest rates by 1980s standards, easy credit availability and an increasingly relaxed attitude to debt.
This in turn helped fuel solid growth in consumer spending and continued strength in house prices.
This, along with the tax cuts and solid jobs growth, helped ensure reasonable profit growth in the non-mining sector of the economy – banks benefited from solid credit demand and domestic cyclical stocks benefited from strong growth in domestic demand.
The end result was a decade of outperformance by the Australian share market.
However, imbalances started to build up:
- The household debt to income ratio rose towards the top end of other comparable countries;
- House prices became progressively overvalued, rising from around 20% overvalued in 2003 to around 29% overvalued by 2008 on our estimates;
- Productivity growth slowed to a crawl as the benefit of the reforms of the 1980s and 1990s wore off and the huge boost to national income from surging export prices meant we didn’t have to work as hard to keep living standards rising.
Real GDP per hour worked rose 1.2% pa over the last decade compared to 3.6% pa in the 1990s;
- The current account deficit (or Australia’s reliance on external savings) as a percentage of GDP rose to a peak of 7% of GDP in the March quarter of 2008, its highest level since the early 1950s; and
- Inflation rose to its highest level since the early 1990s with underlying inflation rising to a peak of 4.7%.
Of course these problems were nothing compared to those seen in the US and parts of Europe.
For example, Australia has not been saddled with excessive public debt.
Nonetheless, they left a sense the mining boom could have been managed a lot better.
Enter Mining Boom II – very different to MB I
After a brief pause in 2008-09 the mining boom has returned with a vengeance.
The terms of trade has risen to new near record highs, unemployment has fallen back below 5% with renewed talk of skilled shortages and we keep hearing about a boom.
But this time around it feels very different.
There are essentially four reasons why.
These relate to consumers, house prices, interest rates and the Australian dollar.
First, consumer attitudes have fundamentally changed.
Consumption is out and saving is in.
After the GFC consumers seem
