Population growth can't fuel the economy forever

A rising population continues to lift real GDP, but the government will find it difficult to ignore the headwinds on the horizon.

Growth in the Australian economy softened during the June quarter and more timely indicators of activity suggest that below-trend should continue during the September quarter. With iron ore prices declining and the Chinese economy increasingly shaky, we should only give today’s data a casual glance before facing up to new challenges.

Real gross domestic product rose by 0.5 per cent in the June quarter, beating market expectations, to be 3.1 per cent higher over the year. The result reflected a strong contribution from inventories and more modest contributions from consumption and investment.

Graph for Population growth can't fuel the economy forever

However, high population growth remains the dominant feature of Australia’s economy, with real GDP per capita rising by just 0.1 per cent in the June quarter. Population growth has accounted for roughly half of the rise in total real GDP over the past year.

Real national disposable income per capita fell by 0.6 per cent in the June quarter, highlighting the pressure on household and business balance sheets. Australia might be expanding but it sure doesn’t feel that way for a lot of people.

Although the headline result was broadly consistent with expectations, it will be a relief for policymakers. Data over the past couple of days, particularly inventories, saved what at times appeared to be an exceptionally weak quarter.

Household consumption rose by 0.5 per cent in the June quarter -- a bit of an upside surprise given the decline in retail trade volumes -- to be 2.2 per cent higher over the year. The divergence is largely a result of stronger spending on services, which accounts for a high share of household spending but are not captured well by the retail trade survey.

Graph for Population growth can't fuel the economy forever

Business investment rose by 1.0 per cent in the June quarter, which reflected a solid contribution from non-residential construction. Machinery and equipment investment continues to decline, reflecting weakness in the mining sector. The outlook for business investment remains soft, with nominal capital expenditure set to decline by almost 10 per cent in the 2014-15 financial year (A weakening investment outlook for businesses, August 28).

Residential investment rose by 2.3 per cent, following strong growth last quarter, to be 8.6 per cent higher over the year. This was driven by the construction of new properties, which more than offset a decline in spending on renovations.

Government spending fell for the second straight quarter, which reflected a sharp decline in non-government public sector investment. Federal government spending rose moderately, as did spending at the state and local level.

However, tax revenues are set to take a hit with nominal GDP unchanged in the June quarter. Unless iron ore prices and the terms-of-trade improve dramatically in the months to come, the federal government is all but certain to revise down their revenue projections when they release their Mid-Year Economic and Fiscal Outlook in December.

The reason why nominal GDP was so weak? Export prices, which fell sharply throughout the quarter. That is set to continue with commodity prices falling further since June.

Net exports volumes, which are unaffected by shifts in prices, subtracted 0.8 percentage points from real GDP growth, consistent with the data out yesterday (An apartment construction boom chaser, September 2). This reflected both softer exports but also a strong rise in imports, which have been boosted by the stubbornly high Australian dollar.

Finally, real GDP was saved by greater inventory accumulation, which contributed 0.9 percentage points to growth in the June quarter. The outlook for inventories is always uncertain but I suspect they will ease somewhat in the September quarter, particularly if export volumes rebound as expected.

Today’s national accounts features some positive surprises (the headline read above expectations) but also highlights the challenges facing Australians (modest real GDP per capita growth) and the government (nominal GDP unchanged). The results are consistent with an economy that is built on high population growth but continues to rely on the resource sector to drive growth.

The near-term outlook will depend largely on how China develops. Its property market has deteriorated significantly over the past few months and if that continues, then the demand for Australian commodities will ease.

Both BHP Billiton and Rio Tinto plan to ramp up iron ore production, a risky manoeuvre that may work out if it sends their competition out of business. As a result, iron ore prices should decline further and that will weigh on income growth and tax revenues.

Residential investment appears to be the one certainty and the one area where rebalancing is definitely taking place. But housing construction is relatively small at only 3.2 per cent of real GDP; the household sector, exports and non-mining investment will need to do the heavy lifting.

Regardless of whether you are bullish or bearish about the Australian economy, the one undeniable truth is that there is an exceptional degree of uncertainty right now. For me there are too many headwinds to ignore, but to be quite honest I don’t think anyone could be truly confident of their forecasts at the present time.