Time for calm, not alarm, over the economy

The Australian economy can meet the real challenges ahead.

Treasurer Josh Frydenberg in Canberra on Wednesday. Picture: AAP

The overall picture of the Australia economy is one of weakness but not catastrophe. Gross domestic product growth is still positive; it was 0.5 per cent in the June quarter this year and 1.4 per cent across the year to June. Mind you, if we look at per capita GDP growth, the result for the June quarter was zero. This tells us population growth is making a major contribution to the GDP growth figure. (GDP per capital growth was negative in the September and December quarters last year.)

The most interesting aspect of developments is the widely divergent contributions made by various sectors of the economy: household consumption expenditure, investment, dwelling investment, government final consumption expenditure and net exports (exports minus imports).

The summary position is that household consumption expenditure is sluggish, reflected in recent retail sales figures; mining investment is relatively strong but other investment is weak; dwelling investment is weak (but with signs of a recent pick-up); government spending is growing very strongly and net exports contributed strongly to the June result.

What this means for businesses, in particular, is that the economic outlook is very different depending on the sector in which they are operating. Take household consumption spending, which is the largest component of GDP by far. It increased by 0.4 per cent in the June quarter, with annual growth 1.4 per cent. In other words, household consumption neither added to nor subtracted from GDP growth.

But even here there are divergent patterns, with non-discre­tionary spending rising more rap­idly than discretionary spending. There were falls in the purchase of vehicles during the quarter.

There was a further decline in the household saving ratio in the June quarter, falling to 2.3 per cent. The fall in relative saving has been dramatic in the past few years, with the ratio having peaked at more than 8 per cent in 2015. Low wage growth has meant many households have been able to maintain their living standards only by running down their saving.

When it comes to investment, it is a picture in two halves. Mining investment rose by 2.4 per cent in the quarter, having fallen from a peak in late 2013. The robustness of commodity prices, particularly iron ore, has been associated with an upswing in mining investment.

By contrast, non-mining investment fell by 1.8 per cent in the quarter, driven in particular by non-dwelling construction. The main components of investment in the June quarter were machinery and equipment, the Australian Bureau of Statistics says.

Two bright spots are government final consumption spending — not everyone would call that a bright spot — and net exports. The standout is government spending, which rose by 2.7 per cent in the quarter and 6.2 per cent across the year. It’s reasonable to say government spending and, to a lesser degree, net exports are propping up the economy.

When it comes to government spending it is mainly state and local governments that are contributing to economic growth with increases in employee and non-employee expenses. This result is hardly surprising given the information that is revealed at the time of state budgets. Public sector employment continues to burgeon in Queensland and Victoria. Federal spending on disability services and aged care is also contributing to the high rate of growth of government spending overall.

Export values grew strongly across the quarter, with exports contributing 0.3 per cent to GDP growth. Export growth was dominated by mining commodities. Import growth was negative — a sign of a soft economy, particularly consumer demand, with imports of consumption goods falling by nearly 3 per cent.

The big picture is an economy that is struggling but is not in dire straits; an economy that is patchy with some bright spots but many gloomy parts; and an economy that is reliant for growth on continuing strong population growth associated with immigration and growth in government spending.

To be sure, GDP is a backward-looking indicator and the more interesting question is: What is the outlook across the next year? Will the 50 basis point reduction in the cash rate implemented recently by the Reserve Bank lift consumer spending and investment? Will the recent income tax refunds that are the result of the government securing its tax package through parliament lead to a pick-up in the economy? Note that the proportion of taxpayers who have already filed tax returns this year is much higher than the norm.

One thing is clear: the lowest point in the dwelling investment cycle is behind us, with house ­prices moving up, particularly in Sydney and Melbourne. And the number of transactions is beginning to rise. Having said that, building approvals, particularly on apartments, have continued to decline, although the diminished reputation of newly constructed apartments is playing a role in the loss of attractiveness of that sector.

With the pick-up in the housing market there is a possibility that the wealth effect may kick in once again and underpin (slightly stronger) growth in consumer spending. The argument here is that people are likelier to spend if they perceive the wealth tied up in their homes is rising. The partial collapse of the housing market from late 2017 to early this year may have been one of the factors behind the sluggish growth of consumption spending.

One big question that hangs over the Australian economy is the impact of the global turbulence associated with the China-US trade wars and any associated decline in global trade volumes. Australia has been relatively unaf­fected — recall the contribution of the net export sector — but there are clearly some serious risks. These include a slowing in the Chinese economy and the related fall in China’s demand for our exports.

The numbers of international students also could be affected by current events. The economic contribution of international students is approaching $40 billion a year and is one of the largest elements of our exports.

Hang on to your hat because the downside risks outweigh the upside ones. But it’s not the time to panic — and this includes the federal government.