The RBA needs to take care of business

Current financial and tax policy settings have channelled credit away from business towards property investment -- and the economy is struggling because of it.

The growing divergence between property investment and business lending highlights the challenge ahead for the Reserve Bank of Australia and the public sector.

Australia’s economic rebalancing isn’t going quite as planned and, with business lending easing and investor activity skyrocketing, the RBA will have a lot to think about over the holidays.

When the RBA started cutting rates in November 2011, the challenge was simple: it needed to boost activity in the non-mining sector to offset the impending collapse in mining investment. The dollar had to fall and business costs needed to ease; a construction boom in residential or non-residential property would have been great; and of course we had China sitting there, ready to consume as much iron ore and coal as we could produce.

It’s safe to say that this hasn’t eventuated as planned. The market widely expects the RBA to lower rates further, and the truth is the RBA needs to make good on those expectations. The iron ore price has collapsed, creating an existential threat to most of the iron ore junior miners.

The federal budget is a mess, although it looks rather tidy compared to the Western Australian budget. Real wages have been falling and our economy is creating insufficient jobs to absorb population growth. Both the mining and automobile sectors are set to cut tens of thousands of jobs over the next couple of years.

Earlier tightening during 2009 and 2010 weighed on the non-mining sector. That wasn’t entirely the RBA’s fault;  the federal government’s decision to cut taxes and ramp up spending during the initial stages of the boom ensured that the RBA had to step in to ensure the economy didn’t overheat.

The unfortunate reality is that we hollowed out our non-mining sector while wasting the income boom generated by our commodities.

Now the latter is over, and authorities desperately need the former to ramp up production and activity and support the Australian economy. Initially the non-mining sector did as it was told; lending activity rose sharply throughout 2013 and early 2014 but that momentum was short-lived.

The long-term sustainability of Australia’s growth model will be determined by the business sector. The non-mining sector’s ability to expand and find new opportunities, investors and customers will determine whether Australia thrives in a post-mining boom world. Our willingness to invest in and embrace new technologies and new product lines will drive productivity and living standards.

So far, it appears as though this isn’t going exactly to plan. The graph above shows that, as does the fact that business credit outstanding is just 4.3 per cent higher over the year.

RBA governor Glenn Stevens likes to talk about ‘animal spirits’, also known as the ‘confidence fairy’. That’s unfortunate because it gives the impression that the non-mining sector is somehow being silly or acting irrationally. It’s a bit like thinking: “If only they were less cautious, they’d be making a fortune!”

If only it were that simple. Instead, the failure to invest reflects a rational response to established incentives and policies, which have systematically channelled credit away from businesses towards Australian real estate.

Australia’s record-breaking house prices, often spoken about with a touch of pride, act as a considerable barrier to entry for many Australian businesses. Many of us have become paper millionaires due to Australia’s housing boom, but high land prices have eroded the competitiveness of many Australian businesses.

More recently our competitiveness has received a boost due to the sharp decline in Australia’s exchange rate. That will need to be persistent and the dollar will need to trend lower still to prove an impetus for greater investment in the non-mining sector. 

But incentives and policy need to change to ensure that the non-mining sector jumps out of the shadow of Australia’s property parasite. While business lending eases, investor activity in New South Wales and to a lesser extent Victoria continues to surge. 

Perhaps the situation will improve when -- or more appropriately if -- the federal government implements the recommendations from the Murray inquiry into Australia’s financial sector. Perhaps the decision by APRA to monitor investor lending more closely will prompt banks to rebalance their balance sheets.

Ideally these moves will be combined with tax reform that reduces the tax incentives that encourage investors to dump their savings into property.

I don’t know whether the Murray inquiry or APRA will be sufficient to shift banking behaviour but both moves are a shift in the right direction. The Australian economy can’t succeed without a strong and vibrant business sector -- and that’s precisely why we are struggling right now.

Government policy -- whether it is the Murray Inquiry, APRA regulation or other government policy -- should be designed with business investment in mind. The steps we take now to encourage investment in new technologies and ventures, to encourage firms to expand and take advantage of new opportunities will determine whether ten years from now we look back at the decade as a success or failure.