Slower growth could be the new normal

Australia's growth prospects look set to turn worse in 2014 and with an ageing population, deep budget cuts and a decline in mining investment it may be quite a while before it gets better.

The Australian economy enters 2014 facing a number of significant challenges, which if navigated successfully could reinvigorate the economy. But unless productivity improves we are set for a long period of below trend growth. 
There are three central realities that Australians and policy makers will have to become familiar with:
1.      The participation rate will continue to decline.
2.       A budget surplus has become increasingly difficult.
3.       Below trend growth will become the new trend growth.
For much of the past decade Australia has relied on the mining sector to drive the broader economy. Two commodity price booms have led to unprecedented riches for the Australian economy. 
Times have been good – albeit not for everyone – but those good times have come to an end. The outlook for 2014 and beyond is much more challenging than those over the past decade.
For many the biggest concern is weak labour market conditions, which are set to deteriorate further over 2014. The unemployment rate rose to 5.8 per cent in November, from 5.4 per cent in December 2012, and I expect it to push up to 6¼ per cent over 2014.
But in reality we will face labour market conditions consistent with an unemployment rate around 7.0 per cent. Poor job creation in 2013 has been joined by a decline in the labour market participation rate, reflecting an ageing population as well as some unemployed leaving the work force. This has effectively put downward pressure on the unemployment rate.
The participation rate will continue to trend a bit lower over 2014 and employment growth will likely run below population growth. Declining participation is something that we will have to get used to; it will become a frequent feature of an increasingly older population distribution.
Household incomes and spending will be constrained by job losses, poor job creation and caution due to an uncertain employment outlook. The uncertain outlook suggests that households will look to maintain their savings rather than taking risks. I expect real household consumption to rise by between 2¼ and 2½ per cent over 2014.
Employment prospects will also weigh on house prices. Expect house price growth to slow towards household income growth over the next few years, although we could see weaker conditions unless prospective first home buyers enter the market. Investors are largely driving the Sydney market and to a lesser extent prices in Melbourne and Perth, and unless first home buyers jump in I expect the gravy train to come to a stop during 2014.
Business investment is perhaps the biggest unknown for the Australian economy entering 2014. Mining investment has driven growth over the past decade but that has peaked and is now set to decline. The problem is we have no idea when that will occur.
According to the ABS, it probably won’t happen in the 2013/14 financial year but what about towards the end of next year? If it does, expect significant flow on effects, including greater job losses and lower interest rates.
The RBA will desperately hope that mining investment can avoid its inevitably sharp decline until 2015, thereby giving the economy greater time for household spending, non-mining investment and exports to pick-up and fill the gaping hole that will be left.
The recent mid-year economic and fiscal outlook (MYEFO) suggests that government spending could boost growth by more than expected in 2013/14. Government spending is set to be over $20 billion higher in 2013/14 than previously anticipated and although some of this will be used in unproductive capacities (such as the $8.8 billion grant to the RBA) this will still help to boost growth.
The big concern is further out when blind political ideology may result in the Coalition cutting expenditure at a faster pace than is healthy for the rest of the economy. Austerity has failed in Europe and if the Coalition proceeds to drastically cut spending during a weak economy they will find it fails here as well.
I’m particularly concerned because it will become increasingly difficult to obtain a surplus in light of an ageing population and the prospect of a declining terms of trade. With the onset of the global financial crisis came the end of easy budget surpluses but many have yet to realise this. When they do I hope to see a more sensible line of thinking on government spending and a more nuanced approach by the federal government.
International markets provide the best hope for next year. Exports are set to pick-up, as completed mining investment boosts our productive capacity and push volumes higher.
Exports will be supported by the Australian dollar, which I expect to fall to between US$0.83 and US$0.86. Growth in our major trading partners is expected to continue at a similar pace to 2013, although that could be compromised if growth in China slows.
Helping to push the dollar lower is the Federal Reserve, who should continue to taper and may have completely wound down their asset purchasing program by the end of 2014. Naturally there is considerable uncertainty surrounding the Fed’s actions and the process remains data dependent. I wouldn’t be surprised to see the process stop following a few months of poor data but for now I expect the Fed to wind it down and boost growth next year.
Overall I expect the economy to grow at a below trend pace of between 2.3 and 2.6 per cent next year. But I see the biggest risks – mining investment cliff, delayed taper, unnecessary budget cuts – to be on the downside. If one or more of these factors go against conventional thinking then the RBA will be required to do some heavy lifting to keep the economy afloat.
These forecasts should be viewed as a sign of things to come for the Australian economy. With an ageing population, this level of growth will eventually become regarded as the new level of trend growth for the economy. Favourable demographics kept growth chugging along for decades but now we will have to rely on improving productivity to maintain the type of growth that we once took for granted.