In my previous article, I outlined the economic conditions Australia faces as the mining investment boom reaches its end, and how strong headline indicators mask deeper structural issues with the economy. I will now take a thorough look into what these issues are and what factors are contributing to Australia’s unsustainable growth model.
Firstly, what do I mean by the ‘structure’ of our economy? The structure of the economy refers to the various sectors and industries which contribute to growth and overall economic development. Examples of these sectors are services, manufacturing, construction, agriculture and mining, which can be segmented further into other areas.
Over the past decade, Australia’s growth has been driven by the mining and resources sector, which has rendered other industries uncompetitive due to the RBA setting high interest rates to combat inflation and the Australian dollar soaring above parity for a sustained period of time. This structural imbalance was commonly called the ‘two-speed’ or ‘patchwork’ economy in the midst of the mining boom.
Now that mining has run its course, which Australian industry or industries will step up to fill in the gap left by our resources sector?
Before we answer that question, we need to recognise that Australia is a country which likes to borrow. We have maintained a Current Account Deficit (CAD) right throughout the mining boom despite record high commodity prices and terms of trade (Figure 1). This means that we consume in excess to the amount we produce as a country (through negative trade and income balances), with the deficit made up by external financing. Our private debt to GDP is one of the highest in the world, which is a product of strong monetary easing overseas resulting in easy access by our banks and institutions to cheap overseas money. The net income effect from our borrowing and reliance on overseas capital drives the deficit in our current account in the form of interest and dividend payments overseas.
Figure 1: Balance of our Current Account
So what does this excess borrowing, CAD and high levels of private debt have to do with the structural problems of the economy?
The issue with easy access to cheap debt by our banks is that credit growth is primarily being funnelled into property and not being invested into infrastructure and innovation. Property is an unproductive asset and does not add much to the productive capacity of the economy.
Record growth in housing prices, particularly in Melbourne and Sydney, can be attributed to a range of supply and demand factors which fuel speculation growth into the property market. Property loans have been dominating credit growth at 47% of all commercial lending, outstripping credit into other forms of productive investment such as businesses as shown in Figure 2.
Figure 2: Decline in Business Investment
The appreciation of housing prices is a major contributing factor to increasing household debt where the ratio of household debt to income has reached approximately 150%.First home buyers are being forced to leverage higher into mortgages whilst being further enticed by record low interest rates (Figure 3).
Figure 3: Debt to Disposable Income
The availability of cheap debt to our financial institutions, property speculators and households presents a dangerous scenario as systemic risk builds up in the economy. Should there be an unemployment shock, wage shock or global downturn, Australia will be in a very dangerous position and will be unlikely to weather such a storm like we did in 2008.
This housing boom has also been the driving force to some areas in the services sector of the economy. Finance, insurance and rental, hiring & real estate (FIRE sector) are complementary products to housing purchases, and have been growing at a significantly faster pace than other industries as a result of the property boom and less recently, the deregulation of financial markets in the 1980s (Figure 4).
Figure 4: Growth of the FIRE Sector
Essentially, Australia’s growing industries are dominated by speculative investment into housing with the FIRE sector being a key beneficiary. However, it is the dominance of the property market which is destroying the competitiveness of other industries and businesses.
Not only does the housing boom starve productive areas of the economy of investment, it further drives up the already high cost of doing business in Australia and eliminates the productivity of our other industries.
Increasingly large property loans have driven up Australia’s land prices which represent a key input to businesses, increasing costs in the form of rents and wages. Industries such as manufacturing have been in decline as domestic businesses struggle to compete with more productive overseas competitors, illustrated by Figure 5.
Figure 5: The Decline of Manufacturing
Similar to the two speed economy, the crux of Australia’s existing structural problem is a single booming sector choking the competitiveness of all other industries. An excess of cheap global liquidity as a result of close to 0% interest rates and quantitative easing has fuelled our banks’ balance sheets. This financing has been channelled away from productive sectors into property speculation, increasing input costs for businesses and eroding the productivity of our industries.
We cannot rely on a housing boom and the banking sector for our long term economic future. Indeed, appreciation in capital gains and yield seeking investments do not add any tangible benefits – productivity and jobs – to our real economy. Such short term gains can only add to the growing stock of risk held by households and investors, priming ourselves for a severe downturn when the next economic shock arrives.
Thus, the key challenge for Australia is dealing with our lack of competitiveness which has been facilitated by our structural economy. If businesses cannot compete because operating in Australia is too expensive, there is no incentive to invest, increase output or employ more people. This is the key issue driving low consumer and business confidence and cannot be fixed simply by lowering interest rates.
In summary, this current account deficit growth model of the Australian economy relies on high leveraging into unproductive assets to generate economic rents and wealth at the cost of the next generation. Courageous reform will be needed in order to drive Australia onto a more sustainable growth path.
In my next article, I will look at monetary policy setting in light of these structural issues and the necessity for macro prudential reform.
Do you agree with the issues outlined in this article? What areas of the economy take priority and what policy responses are needed to steer the nation as the mining boom fades? Please comment with your thoughts below.