There’s a growing debate underway in Australia about what lies ahead for the economy.
It’s largely centered around the residential construction sector, the third-largest employer in the country behind healthcare and retail.
With residential dwelling approvals now starting to trend lower, a lead indicator for activity levels on the ground, it’s got more than a few people nervous about the impact it will have on the broader Australian economy.
Some believe that falling dwelling investment will see economic growth undershoot optimistic forecasts offered by the Reserve Bank of Australia (RBA) by some margin, driving unemployment levels higher and weakening household spending growth, a key cog in determining Australia’s economic fortunes.
Others, however, have a more optimistic view, acknowledging that while activity across the sector will almost certainly decline over the coming years, the slowdown is likely to be modest and shallow, leaving total dwelling commencements at relatively elevated levels.
Safe to say, Kristina Clifton, economist at the Commonwealth Bank, is among the latter cohort, releasing a comprehensive note today on why, in her opinion, the slowdown in residential construction won’t be anywhere near as severe on the economy as some currently suggest.
“We think the downturn in the latest residential construction cycle will be gradual, and we expect an extended plateau where residential construction activity remains at a high level over 2017 and into 2018,” Clifton says.
“This is because a much larger share of approvals have been for multi-units than in previous booms. Multi-units have a much longer build time, averaging 6 quarters, compared to two to three quarters for detached houses. Indeed some high rise apartments can take two to three years or more to build. This prolongs the construction cycle.”
The Commonwealth Bank is forecasting that dwelling commencements will slow to 200,000 in the current financial year, down from 217,000 last year, before declining to 185,000 in the 2018/19 financial year.
Along with an elongated cycle for apartment construction, it says that strong population growth, helping to support housing demand, along with the likelihood that official interest rates will remain at current levels until at least late next year, will help to cushion the size and speed of the residential construction downturn.
And, as such, Clifton says it’s unlikely to deliver an economic drag to the same magnitude seen in previous housing construction downturns.
Here’s her assessment as to why:
Firstly, the jobs downturn will be largest in NSW, Victoria and Queensland, the States where the lion’s share of building activity and gains in residential construction jobs have taken place. These States all have decent population growth. And two out of three of these States, NSW and Victoria, have strong jobs markets. In NSW the unemployment rate is under 5%, and at a level consistent with full employment. In Victoria, employment has been growing a solid pace and well above the national average. Employment growth has also picked up in Queensland in recent months.
Secondly, both NSW and Victoria have also seen a lift in non-residential building approvals. So additional employment in the non-residential sector may provide a partial offset to some of the jobs losses in residential construction. In fact the ABS estimates show that the multiplier effects from non-residential construction activity are even larger than for residential construction. They estimate that $1m spent on non-residential construction generates 24 jobs on a full-time equivalent basis. And for every $1 spent on non-residential construction, $1.47 worth of spending is generated elsewhere in the economy.
Thirdly, all three of these States have a large pipeline of infrastructure spending still to come from their respective State governments which should also add to jobs growth, especially construction. The Federal government is also planning a large amount of infrastructure spending over the next 10 years which will also boost employment across the country.
Renovation activity should also provide an offset to lower new residential construction activity. Renovations usually account for a little above 40% of residential construction activity. However the share is now very low by historical standards. Current rates of spending on renovation activity also look low relative to house price growth. Strong house price growth usually encourages more spending on renovations. There should be some catch up in renovation spending over the next few years.
So, in Clifton’s opinion, a combination of strong labour market conditions in New South Wales and Victoria, a pickup in non-residential and infrastructure construction, along with the potential for a lift in renovation activity following years of strong house price growth in Australia’s heavily-populated southeastern corner, will all help to keep the impact of the unwinding residential construction boom on the broader Australian economy to a minimum.
“On average, residential construction downturns have subtracted 1.5ppts [percentage points] from growth. Our forecasts running to the June quarter 2019 have dwelling construction subtracting just 0.5ppts from growth,” she says.
As for the expected impact on the labour market, an area that more pessimistic forecasters have pin-pointed as something that could drag growth in household consumption levels even lower, Clifton remains optimistic, suggesting that “job losses will occur fairly gradually alongside the gradual decline in activity”, adding that “this will help the labour market better absorb these workers”.
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