Despite the current dichotomy between business sentiment and consumer sentiment, one of persistent issues in the economy is when non-mining investment will pick up to replace the nearly bottomed-out end of the mining investment boom. Despite some positive signs in manufacturing investment in recent quarters, it seems we’re headed for another big year-on-year fall in investment.
So why are our businesses so risk-averse? Is it all because stagnant wages have left consumers not merely hanging on to their money, but churlish toward business more generally? In which case, the answer lies in halting the constant demands for wage cuts when wages growth is already at record lows, and systemic underpayment of workers. Is it because our industrial relations system is too inflexible? That can’t be, given both the Productivity Commission and the Reserve Bank have repeatedly commented on how flexible our IR laws are.
But there’s another possible explanation that’s worth considering: our national superannuation system has made practically every Australian an accomplice in sub-trend growth.
Between 2013 and 2015, Industry Super Australia, which represents the employer and union-run super sector, published a series of reports about how Australia’s financial system had dramatically grown since the 1980s but had also become significantly less efficient at capital formation. While ISA is the avowed enemy of the retail super sector run by the big banks, this report, unusually, raised concerns about the entire financial sector, rather than simply having a crack at the banks.
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The first report found that “in the early 1990s, for every $1 of economic resources allocated to the financial services sector there was about $3.50 of capital formation. By 2012, that same dollar of resources allocated to finance yielded about $1.50 of capital formation.” Subsequent reports examined the issue further and found some concerning trends. Australia’s banks had “increasingly focused on financing the resale of existing housing stock, rather than the creation of new capital. In 1990 and the preceding 15 years, residential loans were just 15 per cent of total bank assets. By 2012, residential lending had more than doubled, to about 37 per cent of total assets.” And much of that additional lending had been funnelled into existing property.
The third report looked at capital markets and found the most concerning aspect. Financial markets were far more focused on the buying and selling of existing assets like equities, rather than investing in new capital. “In the late 1990s, the ratio of primary capital raised to the turnover of secondary equity markets was, on average, about 1:10 (i.e., for every $1 of public capital raising there was about $10 of trading activity). In 2012, the ratio was 1:28.” And despite a deepening in capital markets, raising capital had become more challenging, signalled by “increasing shortfalls in follow-on offerings by listed companies (when an already-listed company returns to the market to raise capital but fails to raise the desired amount).”
So while Australia’s massive pool of superannuation has grown to $2 trillion, a lot of of those savings are simply being used for secondary trading of equities and derivatives, rather than new investment that will produce a meaningful increase in the economy. And the fees on managing this money have created a new class of “entrepreneur”: asset managers, consultants of all types, accountants, brokers, investment bankers — even media finance gurus, and a new class of stars, the fundies on whose words some in the media and business hang — Hamish Douglass of Magellan Financial group, Keir Neilsen of Platinum Asset Management, Anton Tagliaferro of Investors Mutual, for example.
In this kind of market, mediocrity wins. Paying fully franked dividends is the ideal, and missing forecasts or cutting dividends ends up in falling share prices, failure to meet KPIs and missed bonuses. Companies listed on the ASX are rewarded when they meet “guidance” rather than invest in new businesses, factories, plant and equipment, ideas.
The lack of interest of retail super funds in infrastructure is particularly concerning — it has been industry super funds that have invested in new infrastructure projects, and even saved the bacon of conservative governments looking to privatise infrastructure assets, thus freeing up resources to fund new infrastructure projects. It’s also concerning that the self-managed super fund sector has been investing heavily in residential housing, including with borrowings — another example of savings going into existing assets rather than new investment.
The SMSF investment spree in housing was the subject of a recommendation by the Murray Inquiry (which the government ignored); David Murray and co also cottoned onto the fact that Australia’s super sector was inefficient by global standards, without the economies of scale you’d expect from a truly global-scale sector like ours.
The problem with too much of our savings pool chasing existing assets isn’t merely the lack of capital formation. It distorts decision-making. Corporate mergers and takeovers are done in the name of efficiency, when they really are a way of making managements richer — 60% of all mergers fail to produce value for shareholders (the history of the media sector in the last 30 years is a good guide to that). It also means poor managers aren’t punished — some of Australia’s biggest companies and high-profile business figures have a trail of shareholder wealth destruction and multi-billion dollar writedowns behind them, but you’d never know it from their massive remuneration and glowing media coverage.
Australia’s super savings are forecast to grow, by some estimates, to $9 trillion by the 2030s. With diminishing capital formation and the dead hand of inefficiency and distorted incentives, that savings pool may already be weighing down on the economy. And it could get a lot worse without big improvements in our financial system.