Australia Drops The Ball
Stuart Dear

The Australian economy hits its fourteenth consecutive year of expansion this year, having avoided, among other potential recession-creators in that period, the impact of both the Asian currency crisis of 1997 and the tech boom fallout post-2000. And one could imply from the daily records being set by the All Ords that the country's economic future is also bright. But things are not as rosy as they seem. Particularly, there is reason to be concerned about Australia's future productive capacity.

By the end of 2004 Australian GDP (the measure of the level of production) growth had slowed to only 1.5%, versus 3-4% in prior years, but our spending was still up at 4%. National accounts arithmetic tells us that the difference is our net export drain, approximately 2.5% in 2004. We have been importing heaps and not exporting enough, and this has been going on for years. Adding together balance of trade deficits with recurring negative income items (such as paying away interest and dividends to overseas investors) gives you a very big current account deficit, currently of the order of 7% of GDP.

We fund this big deficit by borrowing from overseas, largely by issuing lots of bonds to offshore investors who love buying them because the yield is comparatively high and who in the last few years have had the additional lure of an appreciating Australian dollar. This 7% deficit number is actually better than it may have been because we have had a very favourable terms of trade shock ' that is, our export prices have risen significantly versus our import prices in recent years, courtesy of both the China'driven commodity price boom and falling import prices due to global competition in manufacturing. Without the favourable price moves the current account deficit would be out over 10%. Coming back to GDP, the rising terms of trade essentially tells us that our income levels have been a lot higher than our production levels, which partially explains why we have been able to spend so much. But its only a partial explanation because we have actually been spending more than our incomes ' the saving rate as a percentage of disposable income has been negative the last few years ' by borrowing more, for example by drawing down equity in our homes. A lot of people have justified this extra borrowing by virtue of their wealth, rather than income, increasing faster than their spending ' mainly due to the huge bull run in Australian property prices over the 5 years ended 2003.

A growing trade imbalance and growing debt is all fine from a national economics standpoint so long as you can keep funding them, including potentially via a depreciation of the currency. The Reserve Bank was pretty worried about the pace of growth in housing debt in late 2003, not because the debt was simply getting too big, but because they were worried the a possible bursting of the property bubble would leave a lot of mess to clean up after the party. To date the bubble has lost a little air without imploding, which is of course good news for everyone except those trying to get into the property market. The RBA's latest rate rise, however, was not directed at debt, but appears directed at slowing demand (read income plus extra borrowing) down towards production so that inflation doesn't rise. The problem is that we are close to productive capacity (the unemployment rate of 5.1% is its lowest since 1971 and equipment capacity use is at decade highs) ' so demand must be brought lower to close the gap rather than move production higher.

Congratulations for reading this far ' your reward now is the meat of the argument. I worry that Australians have collectively dropped the ball by not investing enough in enhancing our future productive capacity. Australia's investment to GDP ratio at about 16% is the lowest since the 1990 recession and when you strip out property investment (arguably non'productive) then we are talking lowest since the 1950s. Part of this is due to government budget responsibility in the 1990s, and not surprisingly 'infrastructure' has become the latest buzzword for opposition politicians. However, while it seems obvious we need to expand the infrastructure servicing our resource exports (witness the 40 ships waiting off Newcastle to be loaded with coal), building more roads, railways and ports (wait for the national budget in May for announcements) is to me, tackling only part of the issue.

To be fair, politicians have identified the need to improve skills and perhaps increase the labour force participation rate as means of increasing the productive capacity of labour. But there hasn't been much action. In terms of skills, Australia's 1980s ideal to be the 'clever country' has fallen well short of the mark: witness the falling university enrolment levels and the commonwealth'state wrangling over funding for private'public schools as examples. In terms of participation, increasing tax incentives to work is an identified measure however increased skilled migrant intake is a more pragmatic solution to labour number shortages. (Another issue with participation is that there are a large number of people (770k) on the disability pension or who are underemployed, masking the true unemployment level).