Opinion & Commentary
Can't stop the music
The March quarter national accounts show that Australia has skirted the conventional and necessarily arbitrary definition of recession as two consecutive quarters of negative growth.
Arbitrary definitions aside, there should be little doubt that the Australian economy is in recession. The most fundamental measure of economic and social welfare, real GDP per capita, has contracted for four straight quarters to be down 1.6% through the year ended in March. On this measure, the recession began from the middle of 2008.
The national accounts show that there is only so much a small and open economy like Australia can do to buck a global economic downturn. The returns to domestic policy stimulus have so far been modest.
Domestic final demand contracted 1.0% in the March quarter, largely reflecting weakness in investment spending. Import volumes, which are highly correlated with domestic activity, fell 7% over the quarter following a 7.6% decline in the final quarter of 2008.
One of the perverse aspects of national accounting is that a decline in import volumes contributes positively to measured GDP growth, adding 1.6 percentage points to the headline growth figure in the March quarter following a 1.9 percentage point contribution in the December quarter.
Together with a 0.6 percentage point contribution from export volumes, net exports contributed 2.2 percentage points to growth in the March quarter.
While it may seem surprising that export volumes are holding up in the context of a global economic downturn, it highlights the fact that the transmission mechanism from the world to the Australian economy is somewhat different to the one many people assume.
There has been a much closer relationship between the world and Australian economy since the early 1980s, as lower trade barriers have resulted in closer ties with world markets and a larger traded good sector. However, it is difficult to account for the strength of this relationship based purely on trade linkages.
A more important transmission mechanism from the world to the Australian economy comes from our increased integration with global financial markets following financial market liberalisation and deregulation in the early 1980s. Changes in global interest rates and other asset prices are transmitted directly to the Australian economy via global financial markets.
This has a more powerful and immediate impact on the Australian economy than international trade in goods and services and has been particularly important in the context of the recent global financial crisis.
It helps explain why domestic demand has contracted, even while external demand has proven resilient.
Australian interest rates and credit conditions are determined in world rather than domestic markets. Those who argue that tighter credit conditions reflect an insufficiently competitive domestic banking industry fail to appreciate this basic point.
In the United States and the United Kingdom, there has been only very limited transmission of reductions in official interest rates to retail borrowers. Australian borrowers have done well by comparison, with the lowest mortgage interest rates since the late 1960s.
However, the transmission of monetary stimulus to the broader economy is still subject to Milton Friedman’s ‘long and variable’ lags.
Compared to monetary policy, fiscal policy has been remarkably ineffective. The fiscal stimulus is concentrated in the first half of this year. Yet public sector investment spending actually fell in the March quarter, long after the downturn began in the middle of last year.
This shows the difficulty of mobilising public investment spending in a timely fashion. Attempts by the government to speed-up this process have only resulted in poor quality spending, such as the government’s ‘community infrastructure’ program, which will do little to enhance Australia’s productive potential.
Much of the government’s spending will simply reallocate already employed resources to different sectors of the economy, without bringing unemployed labour and capital back into employment.
Private dwelling investment also contracted over the quarter, highlighting the lag before the enhanced First Home Owners Grant translates into actual building activity. Even then, much of the grant will be capitalised into house prices, benefiting incumbent property owners at the expense of new home buyers. This is an inequitable wealth transfer rather than a stimulus.
These delays aside, the contraction in domestic final demand in the first quarter points to very low returns from what has been an unprecedented fiscal stimulus.
Prior to 2001, Reserve Bank modeling pointed to a long-run equilibrium relationship between the Australian and US economy. Where the US economy went, Australia was sure to follow.
That relationship broke down following the 2001 recession in the United States, which largely bypassed Australia. As a net consumer and importer of information and technology goods, Australia if anything benefited from the global downturn in the technology sector. The subsequent boom in Australia’s terms of trade owed much to the downturn in the prices of the tech and manufactured goods that Australia imports and not just the boom in Australian commodity export prices.
The long-run equilibrium relationship between the Australian and US economy may well reassert itself in the context of the current global downturn. Like the recession itself, recovery will ultimately come via global markets rather than domestic policy interventions.
Dr Stephen Kirchner is a Research Fellow at The Centre for Independent Studies.
