Australian Government, 2011‑12 Budget
Budget

Statement 2: Economic Outlook (Continued)

The outlook for the domestic economy

Demand and output

The recent natural disasters in Australia, Japan and New Zealand are expected to detract ¾ of a percentage point from Australia's economic growth in 2010‑11 (see Box 1, Box 2). This, combined with recent weakness in household demand, has driven a 1 percentage point downgrade in forecast real GDP growth since the Mid‑Year Economic and Fiscal Outlook 2010‑11 (MYEFO) to 2¼ per cent in 2010‑11. However, the macroeconomic impact of these natural disasters is expected to be temporary and the medium‑term outlook remains strong, with real GDP forecast to grow 4 per cent in 2011‑12 and 3¾ per cent in 2012‑13. The strong growth outlook is underpinned by unprecedented growth in resources investment and strong growth in non‑rural commodity exports, which are surging in response to high global prices for Australia's bulk commodity exports (Chart 5).

The strong expected growth in the overall economy masks some significant divergences between sectors, with conditions outside of mining and related industries expected to remain challenging. Tighter macroeconomic settings and credit conditions, heightened consumer caution and the high Australian dollar are all weighing heavily on some sectors, particularly retailing, manufacturing and tourism.

Chart 5: Contributions to real GDP growth

This chart shows the expected expenditure component contributions to real GDP growth over the forecast period.  Business investment is expected to drive GDP growth over the three years to 2012-13, followed by household consumption and exports.

Note: Business investment and public expenditure are adjusted for second‑hand asset sales from the public sector to the private sector.

Source: ABS cat. no. 5206.0 and Treasury.

Box 2: Impact of recent Australian floods and cyclones

The flooding across eastern Australia, followed by Cyclone Yasi, has had a significant impact on economic activity — disrupting coal production, destroying agriculture, reducing activity in the tourism and retail sectors, and damaging infrastructure.

In economic terms, it is estimated that the recent floods were the most costly natural disaster in Australia's history, larger than the 1989 Newcastle Earthquake and Cyclone Tracy (Chart A).

Chart A: Estimated economic impact of
previous natural disasters

This chart shows the estimated economic impact of previous Australian natural disasters.  Prior to the recent floods, the 1989 Newcastle Earthquake and 1974 Cyclone Tracy were the two natural disasters with the greatest negative impact upon the Australian economy.

Source: Economic Costs of Natural Disasters in Australia, Bureau of Transport Economics, 2001; 2009 Victorian Bushfires Royal Commission, final report.

The direct negative impact of the recent natural disasters is expected to be largely confined to the first half of 2011 — reducing real production by $9 billion and real GDP growth by ½ of a percentage point in 2010‑11, and leading to temporary price rises for affected rural and non‑rural commodities.

In 2011‑12, reconstruction and the resumption of economic activity are expected to add to real GDP growth.

Reduced coal production from Queensland is the largest direct impact, with production losses estimated to be around 25 million tonnes (around $6 billion in real terms — Chart B).

Chart B: Estimated impact of recent floods and Cyclone Yasi
on real economic activity

This chart shows the negative impact of floods and Cyclone Yasi on different sectors of the economy.  The coal industry has been most greatly impacted by these weather events followed by agriculture and tourism.

Source: Treasury.

Floodwaters covered and damaged key rail lines and inundated a large number of coal pits. While much of the affected rail infrastructure is now fully operational, ongoing de‑watering of coal mines means that mine production will take time to return to full capacity. The impact on export earnings is expected to be partly offset by higher prices — with contract prices for metallurgical coal in the June quarter around 50 per cent higher than for the previous quarter. Prices are expected to return to around pre‑flood levels when production capacity is restored.

For the rural sector, the floods and Cyclone Yasi led to significant losses and quality downgrades to a range of agricultural products — with the total real production impact estimated to be $1.9 billion (with Queensland accounting for the majority of this). This has led to what is expected to be temporary price rises for a number of agricultural products — most notably, bananas. It is estimated that these price rises will add around ½ a percentage point to inflation over the March and June quarters. Around two‑thirds of this increase is expected to be unwound by the end of the September quarter — consistent with the experience of previous natural disasters of this sort.

Household consumption

Household consumption growth has moderated since the onset of the GFC. While the labour market has strengthened, household incomes have grown solidly and consumer confidence is around its long‑term average, consumers continue to be cautious. This follows a period prior to the mid‑2000s where growth in household consumption had exceeded growth in household incomes, supported by strong growth in both housing market and sharemarket returns. Since the crisis, the household saving ratio has risen sharply to around 20‑year highs, coinciding with slower growth in household credit (Box 3).

Household consumption growth is expected to increase steadily over the next two years, supported by strengthened household finances and increasingly favourable economic conditions. With household consumption forecast to grow broadly in line with household income, the household saving ratio is expected to remain at around its current level. Household consumption growth is forecast to be 3 per cent in 2010‑11, before rising to 3½ per cent in both 2011‑12 and 2012‑13.

Box 3: Consumer caution

Australian households have been more cautious in their approach to spending and borrowing since the GFC, even as economic conditions have strengthened.

Household saving was negative in the mid‑2000s, with consumption exceeding disposable income (Chart A). Household consumption growth has moderated though since the GFC. With solid growth in disposable income, this has seen the household saving ratio rise to around 10 per cent.

Chart A: Household saving ratio

This chart shows the household saving ratio over the past decade. In the early to mid-2000s, the household saving ratio hovered around 0 per cent. The ratio rose sharply during the GFC, peaking at 11.6 per cent. Since the GFC, the household saving ratio has remained elevated and was 9.7 per cent in the December quarter 2010.

Source: ABS cat. no. 5206.0.

The boost in household saving has accompanied a substantial reduction in household credit growth from the double‑digit rates seen in much of the past decade. The slowdown in credit growth has been broad‑based, with annual growth in housing credit and personal credit each more than 6 percentage points below their 10‑year averages (Chart B). Lower credit growth has seen a stabilisation in the household sector's debt‑to‑asset and debt‑to‑income ratios, after two decades of increases. The household debt‑to‑asset ratio was 19.1 per cent in December 2010, down from a high of 20.6 per cent in March 2009.

Higher saving and subdued credit growth have enabled a rebuilding of household balance sheets following the decline in household net worth caused by the GFC. This changed behaviour may reflect the subdued recovery in household wealth and a heightened awareness among Australians of the risks associated with high rates of indebtedness, having witnessed the severe impact of the GFC in other advanced economies.

Chart B: Household credit growth

This chart shows through-the-year growth in housing and personal credit since March 2002. Prior to the GFC, through-the-year growth in housing and personal credit averaged well over 10 per cent. However, household credit growth has slowed in recent years, with housing credit growing 6.6 per cent through the year to March 2011, and personal credit growing 1.0 per cent.

Source: RBA.

While putting near‑term pressure on some sectors such as retail, these developments will ultimately benefit the Australian economy. Sturdier balance sheets will buffer households from economic shocks; and a smaller contribution of household spending to domestic demand growth will create room for rising investment in the resources sector, helping to moderate price and wage pressures.

Dwelling investment

Households also remain cautious with respect to their dwelling investment decisions, with tighter credit conditions further weighing on activity in this sector. In the short term, forward indicators are pointing to continued weakness, with housing finance for new dwellings and dwelling approvals falling in recent months. In the medium term, demand for housing is expected to be supported by low unemployment, solid growth in household incomes and past strength in population growth. However, ongoing supply constraints associated with planning and approval processes and land release restrictions are expected to continue to weigh on dwelling investment growth.

Dwelling investment is forecast to grow 1½ per cent in 2011‑12, and 3 per cent in 2012‑13 (Chart 6). There has been little growth in the supply of new dwellings in Australia since 2002‑03.

Chart 6: Growth in dwelling investment

This chart shows annual dwelling investment growth since 1992-93.  Annual growth in dwelling investment is forecast to be below its long-term average over the forecast horizon.

Source: ABS cat. no. 5206.0 and Treasury.

Business investment

Business investment is rapidly gaining momentum, with sustained high prices for Australia's key non‑rural commodity exports driving record investment intentions in the mining sector. New business investment is expected to grow 16 per cent in 2011‑12, and 14½ per cent in 2012‑13, underpinned by strong growth in both engineering construction, and machinery and equipment investment. Non‑residential building investment is expected to remain modest over the next two years. New business investment is expected to reach 50‑year highs as a share of GDP by the end of 2012‑13.

The mining sector is expected to be the key driver of business investment over the next two years, with continuing strong global demand for Australia's mineral resources and record levels of profitability underpinning an unprecedented pipeline of investment activity. The ABS Private New Capital Expenditure and Expected Expenditure (CAPEX) survey suggests that mining investment will reach a record $76 billion in 2011‑12. Mining investment is also expected to remain at high levels over subsequent years, with the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) estimating that the current pipeline of resources investment is over $380 billion (see Box 4).

The expected surge in new engineering construction investment is well underway with growth of 12.4 per cent through the year to the December quarter of 2010. New engineering construction investment is forecast to grow a further 56 per cent over the next two years, led by the LNG sector and with strong support from the iron ore and coal sectors (Chart 7). Over the past year, the oil and gas industry has committed to more than $30 billion in additional investment, including a number of world‑first coal seam gas‑to‑LNG projects in Queensland.

Chart 7: New engineering construction (value)

The chart shows the level of investment in new engineering construction. New engineering construction has increased strongly since the middle of the past decade, and is expected to continue to grow strongly in 2011-12 and 2012-13.

Source: ABS cat. no. 5206.0 and Treasury.

New machinery and equipment investment fell in 2010, in part due to businesses bringing forward investment into 2009 to take advantage of the Small Business and General Business Tax Break. However, the recent CAPEX survey points to strong growth in investment during the remainder of 2010‑11 and 2011‑12, led by mining‑related activity and supported by the resumption of maintenance and replacement spending in other sectors. Investment in new machinery and equipment is forecast to grow 17½ per cent in 2011‑12 and 14 per cent in 2012‑13.

Investment in new non‑residential building is expected to recover modestly in 2011‑12 and 2012‑13. Non‑residential investment declined during the second half of 2010 as Building the Education Revolution activity wound down. While declining vacancy rates and modest growth in building approvals in recent months suggest the sector is stabilising, conditions remain relatively weak with activity still below pre‑crisis levels. Investment in the sector is expected to grow 2½ per cent in 2011‑12 and 8 per cent in 2012‑13, largely supported by growing demand for office space associated with strong employment growth.

Box 4: Mining boom mark II

The Australian economy is in the early stages of the biggest investment boom on record, generating substantial benefits.

The rapid industrialisation and urbanisation of emerging Asia, particularly China, is expected to sustain strong growth in resources demand for some time. Strong demand for commodities is supporting prices for Australia's key non‑rural commodity exports and the terms of trade. In 2010‑11, the terms of trade are expected to reach their highest sustained levels in 140 years on the back of substantial price rises for coal and iron ore.

High prices for non‑rural commodities are generating a significant supply response, both in Australia and overseas. From 2011‑12, the terms of trade are expected to decline gradually as growth in the global supply of non‑rural commodities starts to outpace demand. That said, with demand for Australia's key commodity exports expected to remain strong, the terms of trade are likely to remain well above historical levels for an extended period.

Australia's high terms of trade have supported strong growth in national incomes, particularly in the mining industry (Chart A). Mining's share of total company profits has more than doubled since the start of the boom, notwithstanding a large temporary decline during the GFC.

Chart A: Business profits

This chart shows mining profits trending up strongly since the start of the boom in 2003-04, notwithstanding a temporary fall associated with the GFC. In comparison, non-mining profits have grown at a much slower rate.

Source: ABS cat. no. 5676.0 and Treasury.

Record mining profitability and the prospect of continued strong demand for our non‑rural commodities is reflected in the massive forward pipeline of mining investment.

Mining investment has risen from $12 billion in 2003‑04 to an estimated $56 billion in 2010‑11. This is a precursor to an even larger surge over coming years as a range of large resource projects ramp up, led by the LNG sector. Mining investment is expected to reach record highs as a share of GDP over the next two years (Chart B).

The surge in mining investment will lead to a substantial increase in mining capacity and exports. The annual value of real non‑rural commodity exports is anticipated to increase by around $25 billion over the next two years to more than $203 billion in 2012‑13. This would see non‑rural commodity exports increase from around 10 per cent of GDP in 2009‑10 to around 13 per cent of GDP in 2012‑13.

Chart B: Mining and non‑mining investment intentions

The chart shows actual and expected capital expenditures in the mining and non-mining sector over the past decade. In 2011-12, mining investment is expected to grow very strongly.

Note: Estimates for 2010‑11 and 2011‑12 are from the ABS CAPEX survey, and based on long‑run average realisation ratios.

Source: ABS cat. no. 5625.0 and Treasury.

The high level of mining investment will also significantly increase the demand for labour. While mining is more capital intensive than other industries, employment demand is still expected to be strong. Over the past year, 27,700 jobs have been created in the mining industry, which now employs over 200,000 people. While small as a share of total employment, the mining sector's employment share has almost doubled to 1.8 per cent since 2003‑04.

Mining investment will also draw heavily on the construction sector, with around $63 billion planned to be spent on buildings and structures in 2011‑12.

This represents around 70 per cent of planned private non‑dwelling construction in 2011‑12, adding to demand for skilled construction workers and placing pressure on a tightening labour market.

The current mining boom (mark II) is a continuation of the boom that started in the mid 2000s (mark I), but it has some key differences.

The starting point of the economy is now different, with the economy operating closer to full capacity at the start of mining boom mark II, indicating less room for above‑trend growth without generating price and wage pressures.

Consumers are behaving more cautiously, notwithstanding strong employment and incomes growth. Access to credit is tighter, both for consumers and businesses. Policy settings are tighter and the exchange rate is higher. These forces have seen the emergence of a patchwork economy, with a substantial divergence between the performance of the mining and non‑mining related sectors of the economy.

The other key difference is that, compared with mark I, throughout which the terms of trade continued to rise strongly, the terms of trade are now around expected peaks, with gradual declines in prospect. While levels are expected to remain elevated, the strong growth in incomes and Government revenues that occurred in mark I are unlikely to be repeated in mark II. Further details on the impacts on revenue can be found in Budget Statement 5.

Public final demand

Public final demand growth is expected to decline sharply over the next two years, notwithstanding additional spending associated with post‑disaster rebuilding efforts. Public final demand is expected to grow 3½ per cent in 2010‑11, underpinned partly by reconstruction activity, and 1¼ per cent in 2011‑12, before declining 1¼ per cent in 2012‑13 (Chart 8). This decline reflects the conclusion of the Australian Government's fiscal stimulus as well as fiscal consolidation across all levels of government. The withdrawal of the fiscal stimulus is expected to reduce GDP growth by around 1 percentage point in 2010‑11 and by ½ of a percentage point in 2011‑12.

Chart 8: Growth in public final demand

This chart shows historic and forecast growth in public final demand over the past decade. Public final demand growth is expected to decline over the forecast period, reflecting the completion of Australian Government stimulus measures, and broader fiscal consolidation across all levels of government.

Source: ABS cat. no. 5206.0 and Treasury.

Exports and imports

Aggregate export volumes are forecast to increase 4 per cent in 2010‑11, 6½ per cent in 2011‑12 and 5½ per cent in 2012‑13, driven by a significant expansion of production capacity in the resources sector.

Non‑rural commodity exports are expected to grow strongly as ongoing expansions to mine and infrastructure capacity facilitate greater export volumes to meet global demand (Chart 9). Mine and port capacity expansions in Western Australia are expected to boost iron ore exports, while coal infrastructure expansions in Queensland are expected to boost both metallurgical and thermal coal exports. Coal exports will continue to suffer in the near term due to the disruption to mining operations and rail infrastructure caused by the severe flooding in Queensland. However, with the exception of a few smaller mines, coal production is expected to return to around full capacity by the September quarter 2011. Recent disasters in Japan also reduced demand for Australia's non‑rural commodity exports but this is expected to be temporary, with reconstruction activity likely to add to demand for Australia's non‑rural commodities. Non‑rural commodity exports are expected to grow 4½ per cent in 2010‑11, 12½ per cent in 2011‑12 and 7 per cent in 2012‑13.

Chart 9: Mining investment intentions and non‑rural commodity export volumes

This chart shows that mining investment and non-rural commodity export volumes have increased strongly since 1992-93, and are expected to rise strongly over the next two years.

Note: Estimates for 2010‑11 and 2011‑12 for mining investment are from the ABS CAPEX survey, and based on long‑run average realisation ratios.

Source: ABS cat. no. 5302.0 and 5625.0 and Treasury.

Rural exports are expected to increase 13½ per cent in 2010‑11 and remain at a high level over the next two years, in line with a strong outlook for farm production. The growth in 2010‑11 largely reflects favourable seasonal conditions for the winter crop, partly offset by subsequent crop losses arising from the floods and Cyclone Yasi. The major impact of these disasters is expected to be a significant downgrade to crop quality. A bumper summer crop is also expected in 2011‑12, with recent rainfall increasing the availability of irrigation water and improving sub‑soil moisture. In 2012‑13, farm production is expected to decline slightly, under an assumption of a return to more normal seasonal conditions.

Exports of elaborately transformed manufactures (ETMs) are expected to increase a little over the next two years, but remain below pre‑crisis levels. While demand is expected to rise in line with strong forecast growth in Australia's major trading partners, the high exchange rate is expected to continue to weigh on ETMs export growth. ETMs exports are expected to be flat in 2010‑11, decline by ½ of a percentage point in 2011‑12, but increase by 4 per cent in 2012‑13.

Exports of services are also not expected to recover to pre‑crisis levels over the next two years, again largely due to the strength of the Australian dollar. Tourism exports are expected to remain weak, as are education‑related exports. Services exports are expected to fall ½ of a per cent in 2010‑11 and 3½ per cent in 2011‑12, before growing 1½ per cent in 2012‑13.

Imports are expected to grow strongly over the next two years, driven by strengthening domestic demand and a high Australian dollar. While growth is expected to be relatively broad‑based, the largest contribution is expected to come from capital goods imports. This reflects the expected ramp up of construction activity on major resource projects, particularly in the LNG sector where more than two‑thirds of capital investment comprises imported products. Import volumes are forecast to grow 9 per cent in 2010‑11, 10½ per cent in 2011‑12 and 8½ per cent in 2012‑13.

Terms of trade

The terms of trade are forecast to increase 19¼ per cent in 2010‑11, underpinned by strong increases in the prices of Australia's key non‑rural commodity exports, before declining gradually over 2011‑12 and 2012‑13 as increasing global commodity supply starts to match growth in demand (Chart 10).

Chart 10: Terms of trade

This chart shows Australia’s terms of trade since 1961.  The terms of trade gradually trended downwards from June 1961 to around the beginning of the current century. Since the beginning of 2004, the terms of trade have increased markedly - by around 60 per cent - notwithstanding the fall during the global financial crisis. Over the forecast period the terms of trade are expected to increase by 19¼ per cent in 2010-11 and decline slightly in the following two years.

Source: ABS cat. no. 5206.0 and Treasury.

Prices for Australia's non‑rural commodity exports have increased significantly in 2010‑11, reflecting ongoing strong global demand, coupled with supply disruptions in Australia and abroad. Iron ore spot prices have increased by more than 50 per cent since mid‑2010, reflecting strengthening global demand and weather‑related disruptions to global supply (Chart 11). The Queensland floods severely disrupted both the production and transportation of coal — leading to strong price rises, particularly for metallurgical coal. Contract prices for metallurgical coal for the June quarter 2011 are around 50 per cent higher than for the previous quarter. Coal prices are expected to decline as affected supply is restored.

Chart 11: Bulk commodity prices

Iron ore

The charts show prices for iron ore and thermal coal since April 2005. After falling during the GFC, the prices of bulk commodities have increased sharply, with the price of iron ore returning to pre-GFC levels.

Thermal coal (Newcastle)

The charts show prices for iron ore and thermal coal since April 2005. After falling during the GFC, the prices of bulk commodities have increased sharply, with the price of iron ore returning to pre-GFC levels.

Source: Bloomberg and Global Coal.

The terms of trade are forecast to decline gradually over the next two years, but remain at historically high levels. Global commodity demand is expected to continue to grow solidly, driven by strong economic growth in emerging Asia, coupled with reconstruction activity in Japan following the earthquake. However, increasing global supply is expected to begin to weigh on commodity prices over the next two years, with further gradual commodity price declines projected over the medium term. The terms of trade are forecast to fall ¼ of a per cent in 2011‑12 and 3 per cent in 2012‑13, largely reflecting a modest fall in non‑rural commodity prices.

Current account balance

The current account deficit is expected to narrow to 2 per cent of GDP in 2010‑11, the smallest deficit as a share of GDP since 1979‑80. The trade balance is expected to move from a deficit of 0.3 per cent of GDP in 2009‑10 to a surplus of 2½ per cent of GDP in 2010‑11, largely reflecting a strong rise in non‑rural commodity prices and volumes. With a large share of mining profits repatriated to overseas investors, a wider net income deficit is expected to more than offset the trade surplus, leaving the current account in deficit.

The current account deficit is expected to widen to 4 per cent of GDP in 2011‑12 and to 5¼ per cent of GDP in 2012‑13, as non‑rural commodity prices fall slightly and import volumes increase strongly (Chart 12). From a saving and investment perspective, the widening of the current account deficit reflects the expected increase in national investment, driven by record high capital expenditure intentions in the mining sector. National saving will be supported by the Australian Government's fiscal consolidation and an expectation that household saving will remain elevated.

Chart 12: Current account balance

This chart shows the annual current account balance, trade balance and net income balance as a percentage of GDP over the past two decades.  The current account has consistently been in deficit since 1991-92. The net income balance has also remained in deficit over the period. In comparison, the trade balance has recorded some small surpluses over the period. The current account deficit is forecast to narrow sharply in 2010-11, before widening over 2011-12 and 2012-13. The trade balance surplus is expected to narrow while the net income deficit is expected to widen over the next two years.

Source: ABS cat. no. 5206.0 and 5302.0 and Treasury.

Labour market

The labour market has strengthened over the past year and this is expected to continue in 2011‑12 and 2012‑13 (Box 5).

Employment has grown well above trend over the past year with over 300,000 jobs created. The unemployment rate has declined below 5 per cent and the participation rate has increased to around record levels. While employment growth slowed in the aftermath of the recent natural disasters, the impact is expected to be temporary, with labour demand indicators pointing to a rebound in coming months. Employment is expected to grow 1¾ per cent through the year to the June quarter of both 2012 and 2013.

Labour force participation has increased over the past year, notwithstanding the demographic drag associated with the first of the post‑War baby boomers turning 65. This reflects the return of job seekers previously discouraged during the downturn and also the trend rise in the participation of females and older workers. The national participation rate is expected to remain at around record highs of 66 per cent over the next two years, before commencing a long gradual decline associated with the ageing of the population.

The unemployment rate is expected to continue declining, reflecting the strong growth in employment. The unemployment rate is expected to fall to 4¾ per cent in the June quarter of 2012 and then to 4½ per cent in the June quarter of 2013.

Box 5: The Australian labour market and the global financial crisis

Unlike most advanced economies, the Australian labour market was remarkably resilient during the GFC and, following a short period of weakness, has since strengthened. Over the past 18 months, employment has grown strongly, the unemployment rate has fallen steadily, and the participation rate has reached record highs. The long‑term unemployment rate remains low and continues to decline.

In the lead up to and during the GFC, the unemployment rate rose by a total of around 1¾ percentage points (from 4.0 to 5.8 per cent) in Australia, compared with around a 2¾ percentage point rise in Canada, a 3½ percentage point rise in New Zealand and a 5¾ percentage point rise in the United States (Chart A). Not only was the increase in Australia's unemployment rate relatively modest, but the subsequent recovery has been substantial, with the unemployment rate falling to 4.9 per cent as at March 2011, lower than all the major advanced economies except Japan.

Chart A: Unemployment rates

This chart shows that the peak in Australia's unemployment rate during the GFC was much lower than it was in other key advanced economies such as New Zealand, the United States and Canada. Australia's current unemployment rate is also substantially lower than it is in these countries.

Note: New Zealand data are quarterly.

Source: ABS cat. no. 6202.0, national statistical agencies and Thomson Reuters.

Australia's record on unemployment during the GFC is all the more impressive in the context of the increase in labour force participation that has occurred over this period.

After a short decline during the downturn, Australia's participation rate rebounded strongly, reaching a record high of 66.0 per cent in November 2010. Since March 2007, Australia's participation rate has increased around ¾ of a percentage point, compared with no change in New Zealand, a ½ of a percentage point decrease in Canada and a 2 percentage point decrease in the United States (Chart B).

In Australia, this reflects the return of previously discouraged job seekers, as well as a trend increase in the participation of females and older workers. The participation rate of those aged 55+ has increased by around 4 percentage points since March 2007.

Chart B: Participation rates

(change since March 2007)

This chart shows that Australia's participation rate has increased since March 2007. This compares with Canada and the United States where participation rates have decreased since March 2007 and New Zealand where the participation rate is unchanged since March 2007.

Note: New Zealand data are quarterly.

Source: ABS cat. no. 6202.0, national statistical agencies, Thomson Reuters and Treasury.

The decline in the unemployment rate at a time of increasing labour force participation reflects an impressive increase in employment. Since March 2007, employment has increased by around 9¼ per cent in Australia compared with around 3 per cent in Canada, 2¼ per cent in New Zealand and a decrease of 4¾ per cent in the United States (Chart C). Whereas Australia has added around 750,000 jobs since the end of 2007, there are 7.2 million fewer jobs in the United States.

Chart C: Employment

This chart shows that the level of employment in Australia has increased substantially since March 2007. This compares to Canada, where the level of employment has increased slightly, New Zealand where the level remains around the same and the US where the level has decreased significantly.

Note: New Zealand data are quarterly.

Source: ABS cat. no. 6202.0, national statistical agencies, Thomson Reuters and Treasury.

Australia's success during this episode reflected the relative shallowness of our domestic downturn and the flexibility of our labour market. In Australia, much of the labour market adjustment occurred through reduced hours worked and lower wages growth rather than through the large‑scale job losses that occurred in many other advanced economies.

By limiting job losses, Australia also significantly reduced the economic and social costs associated with large scale longer‑term unemployment.

In Australia, the long‑term unemployment rate, defined for the purpose of international comparison as the proportion of the labour force that has been unemployed for six months or more, increased by much less than it did in the United States and started to decline earlier.

In the lead up to and during the GFC, the long‑term unemployment rate rose by a total of 1 percentage point (from around 1 to 2 per cent) in Australia compared with around 3¾ percentage points in the United States (Chart D).

Australia's long‑term unemployment rate has fallen over the past 18 months and now is a relatively low 1.7 per cent compared with 4.0 per cent in the United States.

Chart D: Long‑term
unemployment rates

This chart shows that the peak in Australia's long-term unemployment rate in the most recent downturn was much lower than it was in the United States. The United States long-term unemployment rate was similar to Australia's long-term unemployment rate prior to the downturn but is now substantially higher than Australia's long-term unemployment rate.

Note: The long‑term unemployment rate is defined as the proportion of the labour force unemployed for six months or more.

Source: ABS cat. no. 6291.0.55.001, Bureau of Labor Statistics, Thomson Reuters and Treasury.

Wages

Wages growth increased during 2010, driven by a strong recovery in private sector wages (Chart 13). Wages growth is now around trend, and is expected to increase gradually as the labour market tightens. However, solid growth in aggregate wages is expected to mask considerable divergences between industries, with resource‑related industries likely to continue to experience much stronger wages growth than other sectors, supported by extremely strong growth in labour demand.

The Wage Price Index is expected to grow 4 per cent through the year to the June quarters of 2011 and 2012, and 4¼ per cent through the year to the June quarter of 2013.

Chart 13: Growth in the Wage Price Index

This chart shows growth in the Wage Price Index for both public and private sectors over the past decade. While public sector wages growth remained at or above its long-run average, private sector wages fell sharply in 2009.  Over the past 12 months, private sector wages growth have recovered to around its long-run average, while public sector wages growth remains at its long-run average.

Source: ABS cat. no. 6345.0.

Consumer prices

Inflation is contained, but is forecast to rise steadily over the next two years as the economy starts to push against capacity constraints.

Treasury's most recent estimates of the non‑accelerating inflation rate of unemployment (NAIRU)1 — the rate of unemployment at which inflation pressures start to emerge — range between 4½ and 5 per cent. With the unemployment rate expected to decline to the bottom of this range, and the economy forecast to grow strongly, wage and price pressures are expected to build. Moderating these pressures are the withdrawal of monetary and fiscal stimulus and the high Australian dollar. However, recent historical experience suggests that, with such a low expected unemployment rate, inflationary risks remain on the upside.

Underlying inflation is currently at around 10‑year lows, but is expected to rise from 2½ per cent through the year to the June quarter of 2011, to 2¾ per cent through the year to the June quarter of 2012 and to 3 per cent through the year to the June quarter of 2013.

Headline inflation is expected to increase similarly after an initial spike due to the impact of the floods and Cyclone Yasi on fruit and vegetable prices and the recent rise in oil prices. Headline inflation is forecast to be 3¼ per cent through the year to the June quarter 2011, 2¾ per cent to the June quarter 2012 and 3 per cent to the June quarter 2013 (Chart 14).

Chart 14: Headline and underlying inflation

This chart shows through-the-year growth in headline and underlying inflation since June 2003 and over the forecast period. Headline and underlying inflation are expected to reach 3 per cent in through-the-year terms by June 2013.

Note: The underlying inflation measure is the average of the RBA trimmed mean and weighted median.

Source: ABS cat. no. 6401.0, RBA and Treasury.

The main driver of inflation over the past decade has been rising domestic goods and services prices. Non‑tradables inflation averaged around 4 per cent over the past 10 years, while tradables inflation averaged close to 2 per cent. Australia's tightening labour market, combined with rising prices for health, education and utilities, suggest that non‑tradables inflation will remain firm over the period ahead. In addition, while the recent appreciation of the exchange rate will continue to dampen tradable prices in the near‑term, import prices may be less of a deflationary influence over the medium‑term as advanced economies recover from the GFC and rising wages in emerging market economies add to global manufacturing costs and demand for food and other consumables. This represents a medium‑term risk to Australia's inflation outlook.

Incomes

Nominal GDP is expected to grow strongly in 2010‑11, underpinned by a sharp rise in the terms of trade. While nominal GDP growth is expected to ease in 2011‑12 and 2012‑13, it will remain solid, underpinned by strong growth in real activity (Chart 15).

Chart 15: Nominal GDP growth

This chart shows through-the-year growth in nominal GDP growth since June 1995.   Nominal GDP growth trended upwards until the downturn in 2009.  GDP growth recovered in 2010 and is expected to be solid over the next 2 years.

Source: ABS cat. no. 5206.0 and Treasury.

Following 8 per cent growth in 2010‑11, growth in nominal GDP is forecast to ease to 6¼ per cent in 2011‑12 and 5¾ per cent in 2012‑13, with a declining terms of trade partly offset by rising growth in domestic prices and strong growth in real GDP (Chart 16).

Nominal GDP is distributed throughout the economy mainly as compensation of employees, gross operating surplus and gross mixed income.

Gross operating surplus is expected to grow 5 per cent in 2011‑12 and 4¾ per cent in 2012‑13. Growth in 2011‑12 is largely underpinned by strong mining profits reflecting strong non‑rural export volumes growth. While growth in gross operating surplus is expected to be more broadly based in 2012‑13, it is expected to ease further, in line with the forecast decline in the terms of trade.

Compensation of employees is forecast to grow 7¼ per cent in 2011‑12 and 6½ per cent in 2012‑13, underpinned by strong employment and wages growth. The strong growth in compensation of employees is expected to result in an increase in the wage share and a fall in the profit share of income over these years.

Gross mixed income, which includes the wages and profits of farm and other unincorporated enterprises, is forecast to grow a modest 3¾ per cent in both 2011‑12 and 2012‑13.

Chart 16: Components of nominal GDP growth

This chart shows the component contributors to annual growth in nominal GDP since 1994-95.  In 2010-11, the terms of trade are expected to the main contributor to nominal GDP growth.  In 2011-12 and 2012-13, real GPD is expected to be the main driver of nominal GDP growth.

Note: The small discrepancy between nominal GDP and the sum of its components is due to interactions which cannot be attributed to individual components.

Source: ABS cat. no. 5206.0 and Treasury.

Medium‑term projections

The fiscal aggregates in the Budget are underpinned by a set of forward estimates consisting of short‑term economic forecasts and projections based on medium‑term assumptions.

The economy is projected to remain at full capacity over the projection period. Real GDP is projected to grow at its trend rate of around 3 per cent per annum over the two projection years of the forward estimates (Chart 17).

Beyond the forward estimates, real GDP is projected to grow at around 3 per cent until 2017‑18, when growth is projected to slow to around 2¾ per cent as population ageing generates a gradually falling participation rate.

The unemployment rate is projected to be 5 per cent over the medium term, the assumption that has long been used for medium‑term projections, and near the top of the band of current estimates of the NAIRU (4½ to 5 per cent). Inflation is projected to be 2½ per cent, consistent with the Reserve Bank of Australia's medium‑term target band.

The terms of trade are projected to decline by a total of around 20 per cent over a 15‑year period, settling just above their 2006‑07 level. This reflects an expectation that current levels of commodity prices will not be sustained in the longer term, as supply increases gradually bring down prices over time.

The exchange rate is assumed to remain at its current average level during the forecast period. Over the projection period, the exchange rate is assumed to move in line with the long‑term historical relationship between the terms of trade and the real effective exchange rate. This technical assumption has been introduced to provide greater internal consistency during the projection period. This is in contrast to the 2010‑11 MYEFO, where the exchange rate was assumed to remain constant at its then current level over the medium term. The current terms of trade projections imply a fall in the real exchange rate of 0.9 per cent per annum over the projection period.

Chart 17: Real GDP growth over the forward estimates period

This chart shows Australian annual GDP growth over the past thirty years, including the forecast period. Growth is forecast to be above trend over the next two years, and is then projected to grow by 3 per cent a year.

Source: ABS cat. no. 5206.0 and Treasury.


1 Treasury's estimates are based on a methodology detailed in Gruen, Pagan and Thompson (1999), 'The Phillips curve in Australia', Journal of Monetary Economics, and updated in Kennedy, Luu and Goldbloom (2008), 'Examining full employment in Australia using the Phillips and Beveridge Curves', The Australian Economic Review.

 

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