Australian growth a developing story

The advanced economies still matter to us … but our biggest partners are now developing economies.

Summary: Historically, when our major trading partners have experienced strong growth of 4% or so, Australia has had boom times. Our major partners are now predominately developing economies, rather than Europe and the US, and they are forecast to post strong growth of over 4%.
Key take-out: The fact our key trading partners are expected to post ongoing strong growth is a good reason not to expect weak growth outcomes.
Key beneficiaries: General investors. Category: Economics and strategy.

I mentioned in my April 22 piece The slowdown lowdown: No cause for alarm, that the US sequester was unlikely to lead to the jobs destruction that the Congressional Budget Office and other economists thought it would. And last Friday we found out that is indeed the case, so far.

The soft number in March that got everyone worried was revised up, and April jobs were strong. The average over the last three months is 212,000, which is extraordinary growth.

Still, the debate over US growth prospects is ongoing and, regardless of the US or any individual country’s growth prospects, many people are obsessed with this idea that the global economy is only experiencing tepid growth – with little in the way of a meaningful pick-up expected. As a nation, we spend a lot of time talking about it to the point where it seems that we often forget or overlook our own good fortune. It’s not without good reason: as a small, open, economy we should be spending a lot for time pondering the globe. In fact, I think it was an ex-RBA governor, perhaps Ian MacFarlane, who said that if economists had only one variable to look at to gauge the prospects for the Australian economy, then it would be global growth.

The problem is that the debate in Australia on global growth has become quite confused. For instance, when we read the papers what are they full of? Austerity, and debates over its efficacy. The need for the European Central Bank to print. The US sequester. Japan’s depression and the need for truly incredible amounts of monetary stimulus. A Chinese hard landing or bubble. Our own Treasurer piping up with his 5 cents of advice, urging the Europeans to abandon austerity and promote growth. The obsession with all of the above has meant that many commentators and economists in Australia have missed the big picture. And this has allowed people to get away with throwing up charts like the one below, to argue their case that global growth is tepid.

You can see from the chart that when the advanced economies go into recession (the shaded columns) we tend to too. Of the five synchronised global recessions since the 1960s, we’ve shared in three of them. The 2000-01 period and the GFC were the major exceptions, although our economy didn’t escape unscathed and slowed sharply.

Now, look to the far right of the chart and note the divergence in growth rates. Australia is still experiencing reasonable growth rates while the advanced economies (as a group) struggle. In addition to that, both the International Monetary Fund and OECD don’t expect much to change, with growth rates over the next two years averaging 1.7% (1.2% this year and 2.2% next). These are still effectively recessionary growth rates. This bodes ill for us, as historically Australia has only been able to maintain solid growth rates if advanced economies posted growth of 3% or more.

Now, of course, many of you will have probably already noted the fatal flaw in the above – it’s outdated and reflects the old world. In the new world, we must include the rise of the developing world – China, India, Brazil etc. As we already know, China et al have changed the world enormously over the last decade and the above chart no longer captures the true dynamics. This doesn’t stop people trying to dismiss this fact though by noting that China is not immune to economic cycles, or that it is headed for slower growth anyway – even a hard landing.  Again, comments like these miss the point, as will become clear below.

Chart 1 made sense, and our current economic obsessions with austerity and stimulus and the old world (and so tepid global growth) could be justified, when the advanced economies made up the vast bulk of the global economy. Over the decades it has fluctuated between something 75-90% of the global economy and about the same again terms of a contribution to growth. The thing is, these days the advanced economies make up only 50% of the global economy, and in recent years have only provided about 15% of its growth.

This suits Australia perfectly, because we need to remind ourselves that the vast bulk of our trade is actually with the developing world now – almost two-thirds. That’s a far cry from the previous 50 years or more when at least 50%, sometimes as high as 70% of our exports, went to the UK and US. Even in the 80s the US, Japan and UK accounted for 50% or so of our exports cheque, and two-thirds of our exports went to a US-centred OECD . That’s now something like 40%.

That’s not to say the advanced countries are unimportant – Japan is still our second-largest export partner (22%) and the US and the UK between them take an additional 10%. But the developing world is by far the greatest share of our export wealth, and the US isn’t doing badly in any case as we found out on Friday.

Now, at this point we need to take another look at chart 1. You can see that when the growth of our major trading partners, or what used to be our major trading partners back then (the advanced economies) experienced growth of around 4%, we typically had strong growth in Australia. Boom times actually.

The good news for Australia now is that this is exactly what is forecast – not for the advanced economies as a collective, but for our new major trading partners. In the table below I’ve shown growth of our major trading partners as forecast by the IMF (reweighted according to their importance to Australia as an export destination) alongside advanced economy growth. As you can see, growth is expected to be around 4% over the next two years.

Don’t forget, our major trading partners collectively account for over 50% of the global economy and closer to 90% of its growth. They take the vast proportion of our exports. So does it matter that they will grow at 4% over the next few years?  You bet. The position is very similar to that of the OECD though the 1960s, 70s and 80s. Back then, if growth of our major trading partners was 4%, we would have all been very excited and we should be as equally excited now.

That we’re not reflects in part the fact that we’ve become conditioned to extraordinarily strong growth outcomes for some of our larger new trading partners in the developing world, and especially China. It also in part reflects our inability to adapt to the new global economic reality.

We’re used to double-digit growth rates in some cases, and anything below that is disappointing. But this is unreasonable, as it overlooks the extraordinary wealth gains we’ve seen for those countries over that time. China’s economy, for instance, is more than twice the size it was in 2005.

The developing world has grown so fast that it is now as wealthy in terms of GDP as the developed world – and this has all happened in less than a decade . So does it matter that average growth will slow to 4.1% from a pre-GFC average of 5.5% over the next two years, when countries like China are twice the size? No. And, in any case, our major trading partners aren’t just developing countries. The above growth rate of 4% includes some big advanced economies as well – the US, UK and Japan. Even so, we’re still pumping out 4% growth in aggregate and are hitting that magic 4% line that you see in chart 1. The implications for growth here are fantastic, whichever way you cut it.

If you recall last week, in my article Recession calls are ringing hollow, I discussed the idea that a recession in Australia was a low probability, even in the absence or unwinding of the mining boom.

Mining investment only accounts for 6% or so of our economy after all, and while we may have had 100% growth per year for nearly 10 years on the way up, you can appreciate we’re not going to see falls of 100% per year. That’s not mathematically possible. The fact that our trading partners, who provide the vast bulk of global growth, are now expected to post ongoing strong growth is another reason not to expect weak growth outcomes over the forecast horizon.