Saul Eslake: The capex data disaster has not increased the chance of recession

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Saul Eslake, Bank of America Merrill Lynch’s Chief Economist for Australia, was one of the first mainstream economists to identify the headwinds faced by the economy as it transitions away from the mining boom to more domestic-led growth.

But he went further, saying last September after the Q2 GDP numbers that GDP data, and by implication numbers such as the disastrous Capex release yesterday, would be less relevant to judging what is really happening in the broader economy.

At the time Eslake said: “followers of the Australian economy will need to become more familiar with” alternate measure of economic growth such as gross national income (GNI) “in order to get a more complete picture of what’s going on ‘down under’.”

This insight made Eslake the obvious choice to ask about the state of Australian growth and recession risk in the quarters ahead in the wake of yesterday’s poor data.

On recession Eslake said his view hadn’t changed from the 25% chance of recession he thought possible in March this year. He did highlighted that as a migating force, “somewhere between one-third and one-half of the mining investment which did occur during the boom was on imported goods, so the impact on the economy of the winding down of this investment doesn’t fall wholly on the domestic economy.”

When the ABS calculates GDP in any given quarter or year, goods bought offshore subtracts from the calculation which generates the GDP number. So the slowdown in the mining boom is partly being felt by the producer of the goods Australia purchased to create the productive capacity we now have.

That’s good news.

Equally good news is that Eslake says that while Australia’s economic transition is proving to be “rather less ‘seamless’ than hoped for by the RBA and by the previous and current government, that’s not to say there is no ‘transition’ happening at all.”

The key point in all of this and why we can have total employment in the economy near record highs is the structure of the type of growth we are now seeing in the domestic economy.

Eslake told us:

Some sectors clearly are picking up – most obviously dwelling construction, tourism, and some personal and commercial services. And these are quite labour-intensive, unlike mining, which is the least labour-intensive (most capital-intensive) type of economic activity there is. So although growth in real GDP remains noticeably below trend, growth in employment has actually picked up: and unlike the RBA or Treasury we think it is possible that unemployment may have peaked already.

Eslake believes the RBA has had a road to Damascus moment last year on how effective rate cuts can still be in supporting economic growth in Australia. He said that having been “unpersuaded that it could help foster a smooth ‘transition’ from mining-led growth to growth led by other sectors by cutting interest rates further,” this year Glenn Stevens and his colleagues at the RBA “have changed their mind, and now seem to think that cutting rates will foster stronger growth in demand and hence ultimately in business investment outside of mining.”

But he’s not convinced that rate cuts will work any better in Australia to increase business investment than they have anywhere else in the developed world in the past 5-8 years of zero interest rates. Eslake highlighted recent IMF research identifying the main reason for lack of investment being “the difficulty businesses are having in seeing where the increased demand for their products is going to come from.”

So to that extent the work the RBA is doing to shore up consumer consumption and confidence with lower interest rates is gaining traction this could help at the margin.

But, in the current economic environment, Eslake said that “increased infrastructure investment would be a more effective response to the slump in private investment, but governments of all persuasions are reluctant to do that unless they are willing to (and can) fund it by asset sales.”

Which is a big problem for the economy. The RBA can’t do it all on its own.

As for next week’s GDP release Eslake has revised down his forecast for the March quarter from 0.5% to 0.3% after the capex figures. But he highlighted that he is “currently forecasting +0.7% for the June quarter.”

Clearly he still believes the transition is taking place. Just more slowly than everyone hoped.

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