Trouble ahead for the economy- 24th January 2003

Gerry van Wyngen - Australian Financial Review

Our model economic management is a myth. Exports have not grown for two years, the worst performance since the credit squeeze years of the early 1960s. Exports to Asia's new dynamos are falling. The feelgood property boom has diverted attention from this and other growing dangers that will spill over into financial markets.
It is some time away, possibly as much as a year, but the Australian economy might be headed for trouble of a type not seen since Paul Keating's ``banana republic" days. That will come as a shock to most Australians, as we have been brainwashed into thinking we have a model economy and top economic management. Not so.
Australia rose above the Asian crisis of 1997-98, the tech-boom collapse of 2000, and the post- September 11 economic malaise. While other countries suffered slow or even negative growth, our economy boomed. It seemed Australia had found a magic formula and we basked in our self-congratulation.
But the result has been complacency and neglect. A warning of this came from the export statistics for the September 2002 quarter. In the past two years, exports have been flat as a pancake. In the previous 20 years, they grew at an average of 7 per cent a year and included a significant portion of manufactured items, underpinning our growth as an internationally competitive economy.
Unfortunately, there are no excuses. The major effects of the drought have yet to flow through into the statistics. And it is not the Olympic effect either. I've stripped that out. Leaving it in shows September 2002 exports 2.4 per cent below 2000.
Incredibly, exports to the fastest-growing economies in Asia are barely steady or falling.
Higher wool, nickel and gold prices might add a little gloss to future export figures. Unfortunately, the effects of the drought will be much worse. And in the distance is the higher parity of the Australian dollar, which will make Australian goods more expensive and imports cheaper.
The flat export performance is not offset by imports, which are growing at double-digit rates. It appears Australia is heading for a record current account deficit.
The warm glow we have felt during the past two years comes not from better economic management or increased efficiency or international competitiveness. Indeed, it is the reverse. It comes almost solely from the housing boom.
By pumping some $84 billion of new funds into housing over two years, an increase of 29 per cent over the period, a price boom was created that, according to the Real Estate Institute of Australia, had the following effects on median prices of housing (in the two years to September 2002):
Sydney + 35 per cent.
Melbourne + 41 per cent.
Brisbane + 52 per cent.
Adelaide + 41 per cent.
Perth + 21 per cent.
Canberra + 34 per cent.
Hobart + 25 per cent.
Darwin + 14 per cent.
These price rises had little to do with underlying demand for instance, Hobart has practically zero population growth but prices rocketed 25 per cent and everything to do with the 29 per cent credit growth.
About 10 per cent of the credit for housing was used to buy new homes, the construction of which has accounted for up to a third of GDP growth in the past year or two. This spending orgy has left us over-indebted and bereft of savings. According to investment bank ABN Amro, household liabilities are now 1.3 times income. Ten years ago it was 0.7 times.
The savings picture is worse. Twenty years ago, it was 14 per cent. Ten years ago, the norm was 5 per cent to 7 per cent. Now, our savings ratio is 0.5 per cent. This is important as household savings are the main source of seed capital for small businesses, the largest sector of employment and the most innovative.
Nor does this reflect international trends. In the over-indebted, under-saved US, household liabilities are 1.1 times income, and the household savings ratio is about 3.5 per cent.
Federal Treasurer Peter Costello recently excused the lower savings ratio by referring to wider superannuation coverage. Perhaps he was not briefed that there are pension schemes in other countries, too, and indeed public pensions in some cases as well. Or that superannuation funds do not provide the essential seed capital for new businesses.
Australia has not, in fact, been a good economic manager. And this has been hidden in an interesting way. A politically astute Reserve Bank of Australia cut interest rates to the point where a housing-induced consumption boom offset the slowing economic growth on the production side of the economy. It was a fair bet, as it seemed a US-led economic rebound would kick in soon and therefore this was at best a very temporary operation.
Unfortunately, it has not turned out that way. US growth has floundered and our housing boom is coming to an end. There is still a huge current book, but new commencements will fade during 2003. Some of the lost momentum will be taken up by other types of construction, where orders have increased sharply. Nevertheless, the building boom has peaked.
GDP growth will ease to 3 per cent, at which rate unemployment will stop falling. As residential property prices peak and drift lower, the wealth effect, which made consumers confident and aggressive spenders, will reverse. Australians will feel constrained by their huge debt loads and their susceptibility to interest rate increases. Many people may seek to rebuild some of their savings.
Paradoxically, the best thing that will result from this is that the extra interest rate increase that should have been implemented last June to prick the housing bubble, but was deferred, will now drop from the agenda completely.
As the current account deficit increases and growth slows later in 2003, the economy will come under scrutiny. Eventually, our dollar may begin to wobble, and the model economy may be put on credit watch by an international ratings agency for possible downgrade.
That these events are still some time away does not mean we should delay remedial action.
The economic reform process petered out before the last federal election and the last dividends from past reforms have been spent. Fiscal reforms have been reversed with populist spending on election-winning policies. Micro reform has lapsed. Labour market reform was exhausted with the reform of the wharves. Cutting business red tape has been superseded by a Corporations Act so complex even corporate lawyers are familiar with only small portions of it. And the promise of tax simplification has been quietly abandoned.
That the opposition parties and states are as guilty as the government is history. The question is, what are we going to do about it?
The fact is that business is becoming more competitive and less profitable and investors are more risk-averse. The temptation is always to take the easy money, rather than accumulate risk capital and innovate or invest in new markets or products. That is what the past property boom on the one hand, and the past two years' export figures on the other, prove.
Once again, Australia is coming to a crossroads. The stimulus from the property boom is running its course. Employment that was increasing comfortably is about to fade. Economic growth will drift lower.
Will the Howard government react by introducing more populist palliatives? Or will it return to making the necessary hard decisions, the promise of which first swept John Howard to power?


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