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A transitional economic moment: is the RBA left by itself?

The May Budget should be focused on ensuring the transition to a post-boom economy. It currently looks like anything but, report Glenn Dyer and Bernard Keane.

There are two key economic challenges for Australia this year: coping with the impact of the high dollar, and managing the transition to the post-mining boom. The government understands the first challenge and, judging by his economics speech last week, Joe Hockey is starting to as well, although it still seems like he’ll be in for a shock on that front when he finally gets his hand on the treasury portfolio.

On the second challenge … hmmm.

A confident government should be drafting policies to avoid a shock to the economy as the mining investment boom slows, having recognised that the Reserve Bank has done just about everything it can to kickstart the economy’s decidedly mixed domestic sector.

The RBA is trying to make sure the pick up in domestic demand from a housing-led recovery (an old fashioned Australian rebound, but also one we are seeing gathering more and more strength in the US) arrives roughly at the same time to start replacing the easing demand from the resources investment boom. That’s the challenge for policymakers in Martin Place and Canberra.

Yes, the boom still has a long way to go and will still be outsized compared to normal in three to five years time.¬†Mining investment will total an estimated $105.1 billion this financial year, up from $82 billion in 2011-12 ,and $46.8 billion the year before, and the first estimate for 2013-14 is a still solid $100.2 billion. But once the peak has passed, the long tail of the boom will in effect be withdrawing its powerful stimulus from economic growth. RBA monetary policy has been aiming at this transition point in the economy to try and kick start housing and non-residential construction to expand and pick up the emerging slack in the non-mining sectors of the economy. In yesterday’s RBA statement, Governor Stevens said “looking ahead, the peak in resource investment is approaching. As it does, there will be more scope for some other areas of demand to strengthen.”

But the problem for the RBA is that the monetary policy loosening it has driven since late 2011 has yet to work its way through the wider economy, so it can’t really do much more. As yesterday’s statement from Glenn Stevens notes:

The Board’s view is that with inflation likely to be consistent with the target, and with growth likely to be a little below trend over the coming year, an accommodative stance of monetary policy is appropriate. The inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand. At today’s meeting, taking into account the flow of recent information and noting that there had been a substantial easing of policy as a result of previous decisions, the Board judged that it was prudent to leave the cash rate unchanged. The Board will continue to assess the outlook and adjust policy as needed …”

Which leads us from Martin Place down to Canberra, and what role fiscal policy can play in managing the transition. Manufacturing capital expenditure is forecast to fall 16% in 2013-14, after a 29% drop in 2012-13. Construction is expecting to invest $1.9 billion next financial year, down from $4.2 billion this year. Wholesaling expects spending to fall from a forecast $3.5 billion for the year to June to $2.3 billion in 2013-14, down a third.

But there’s better news elsewhere: so far in 2013, retail sales were solid in January. ANZ job ads showed more jobs were advertised in January and February. Car sales jumped 8% in February from the same month in 2012 (to more than 90,000), housing approvals overall (including apartments and units fell), but new home approvals rose 3.2% in January, reversing December’s 3.3% fall. The growth in inventories slowed sharply in the final quarter of 2013 compared with the three months to September. But wages and salaries grew in the December quarter, against a fall in the three months to September, while company profits again fell, but the seasonally adjusted fall of 1.0% was far better than the 2.9% drop reported for the September quarter. New home sales continue their weak, but steady rebound.

Today’s national accounts for the December quarter and 2012 showed what the RBA expected; an economy growing around trend at 3.1% (and 0.6% in the final quarter) over the year to last December, with domestic demand fairly solid, the labour market a bit weak, but some areas of consumption (car sales) very strong. A fall in private investment knocked gap by 1.0%, but a rise in “public investment” helped lift output (there’s some mystery about that — ¬†Tim Colebatch explored it today), along with a 0.6 of a point rise in exports, according to analysis from the Australian Bureau of Statistics.

The ABS said the industries driving the rise in GDP in the quarter were manufacturing, mining, health and finance, with each contributing 0.1 per cent to the increase. The terms of trade fell 2.7% in the quarter to be down 13% over 2012 and thesavings ratio was steady at just over 10%, indicating continuing consumer caution. The ABS also noted that GDP per hour worked (in trend terms) rose 0.5% and Gross Value Added (the market sector) per hours worked rose 2.3% through the year. Clearly that productivity crisis is still raging along!

But more than ever the national accounts are more backward looking than normal because there are tentative signs of a small uplift in the level of activity in the economy. So, all the more reason for the RBA to sit on the sidelines for now, waiting to see how much impact its previous cuts will have, a stance supported by the december quarter’s figures.

Now, in the good old days of spendathon election campaigns and “budget bounces”, the RBA could have relied on a Budget just a couple of months out from an election to provide some domestic stimulus. But both sides are instead trying to convince voters the other can’t be trusted on spending.

The focus of the beleagured Gillard government is to use the May budget to construct the “structural savings” needed to pay for its Gonski education reforms, and the national disability scheme. Both will take heroic efforts of long-term budget cutting and rebalancing.

That’s appropriate in the long-term, yes, but the May budget also needs to complement the RBA’s focus on kickstarting a housing-led recovery and lifting the performance of the non-mining economy. The Government would argue its recent ‘manufacturing package’ will help boost investment, but, that package, where it will be effective, is more about making our manufacturing sector more innovative and competitive in the long-term.

If the government had kept its eye on the housing supply issue after that went off the boil in 2010, it might not need to rely on fiscal measures to help kick start the housing sector. But that issue was put on the backburner once the headlines about Asians buying Our Homes disappeared from the papers.

And the Coalition’s fiscal policy is a bizarre mix of magic pudding and ferocious discipline. We’re being told savage cuts are needed to end the Labor profligacy and voters can’t have things there’s no money to pay for, but somehow that everyone will come out better off at the same time. If you listen to Joe Hockey, a new Coalition government will be slicing a huge whack of demand out of the domestic economy with further big spending cuts. If you listen to Tony Abbott, everyone will somehow come out ahead.

But Oppositions have the privilege of irresponsibility and confusion. Governments have to govern, even when they’re campaigning. A key test of the Budget will be whether Labor takes on challenge on working with the RBA to engineer the transition to the post-mining boom economy.

In the early 1990s, another Labor government was tasked with managing the climb-down from a period of unsustainably high growth brought about by the unleashing of Australia’s finance sector by the Hawke-Keating reforms. “Soft landing” was the mantra from the Hawke government as the RBA ratcheted rates up and the government applied the brakes and embraced further reform. But there was no “soft landing” — policymakers both in Martin Place and Canberra botched it, badly, and gave us a recession that people now joke about as “the one we had to have” but which cost hundreds of thousands of Australians jobs and left many unemployed for years.

Engineering the transition to the post-boom economy doesn’t — we hope — come with quite the same risks of human misery. But it demonstrates what can happen when these key transition points aren’t handled well.

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