The State of the New South Wales Economy
40Mr Horn conceded that the 2012-2013 Budget concluded that New South Wales growth would be lower than expected than in 2011-2012, but with a resumption of housing investment and strong mining and farming sectors, the broader economy is expected to see growth accelerate through 2012-2013 and return to slightly above trend in 2013-2014.
41In his expert evidence, Mr Richardson gave the following evidence regarding the "global and Australian economic backdrop":
3.Rather, Australia's outlook this financial year and next relies on China (and the prices it generates for what Australia sells the world) and on business capex (as the miners rush to get extra product to market by financing enormous investment projects in various far flung regions of the nation).
4.So far the news on both those latter fronts remains more than comforting. Indeed, the safest bet in Australian economic forecasting over the past decade has been that 'stronger for longer' out of China has trumped many other negatives. Hence although we remain quite nervous on the China front - there are no miracle economies - so far the news from the north continues to be good. And although Australian consumers are huddling in their foxholes, it is capex which is the key.
5.Therefore we aren't yet joining the rush to concern over the current outlook. That said, forecasters are dialling down estimates for advanced economy growth as data disappointments weigh on the outlook in the wake of a surge in commodity prices and Japan's damaging earthquake effects. Out of the six largest advanced economies in the world, only Germany is bigger today than it was three years ago.
6.The key question for global growth was always just how big a letdown the passing of stimulus spending would prove. While global growth is likely to moderate in 2011, the news is generally positive. That said, some very important concerns remain, including the continuing weight of debt and unemployment in the United States and Europe.
7.Solid growth in emerging economies such as China has underpinned the strength of industrial commodity prices, which has created the dominant theme for the Australian economy at present. Although emerging economies may see their growth ease slightly through the remainder of 2011 and into 2012, demand for raw materials is expected to be strongly supported over the medium term, providing an ongoing positive backdrop for Australian economic prospects.
8.The recovery in the United States has faltered, and a number of very important headwinds - including the stubbornly high rate of unemployment, the slow pace of housing construction, falling government spending and a tentative recovery in investment spending by businesses - point to ongoing weakness. Yet there are grounds for optimism too. The weak $US is helping exports (which have accounted for nearly half the US expansion since the recession ended in mid-2009), while business investment and housing construction are likely to improve simply because there is little scope for further deterioration.
9.The situation in Europe is particularly problematic. Negatives such as high sovereign debt and high commodity prices are proving to be notable constraints on growth.
...
11.China continues to lead emerging economy prospects. The twin process of industrialisation and urbanisation taking place there (and other emerging economies) is reinforcing. Indeed, rapid income growth and job opportunities are attracting Chinese workers into cities. In turn, that larger urban population is generating demand for housing, energy, shopping centres, schools, office blocks and transportation. All that construction requires raw materials, and the scale of China's urbanisation which is yet to come offers huge potential for economic growth.
12.That said, there are also risks associated with the pace of growth in China, with inflation on the rise and interest rates lifting as a result. However, attempts to date to tame inflation are modest, with the lift in rates somewhat gentle. So inflation is on the rise, and China is seeing great growth but with too little by way of policy measures to slow it. Accordingly, that poses risks to China's medium term outlook. It is likely inflation will prove stubborn, while property prices remain worryingly high in some cities.
13.The outlook for emerging economies more broadly is strong, with productivity growth associated with rapid industrialisation expected to support income growth over the medium term.
14.The chart below shows the expected rate of average annual economic growth across a range of countries over the next four years, with emerging economies clearly expected to outperform the developed world. As noted above, that outlook and the associated demand for raw materials underscores a positive economic backdrop for Australia.
15.Australia emerged relatively unscathed from the global downturn, and remains one of the strongest economies in the developed world. That was due to a number of factors, including:
·A large and early fiscal stimulus package;
·Sharp monetary policy response - 425 basis points in interest rate cuts over an eight month period;
·The relative health of this nation's banking sector; and,
·The support of emerging economy growth.
16.That last point was critical. China's economy slowed, but its own stimulus package was directed towards construction and investment, which helped to support Australia's resource export volumes and prices.
...
18.Yet there is a risk of reading too much into these flood and cyclone effects. Yes, the damage was notable, but it was also temporary. And the bounceback may also have taken longer than expected - in particular, pumping out Queensland's mines proved to be slow - but production is well underway once gain.
19.That is an important point to understand: Australia didn't take a hit to its economy because the world stopped being interested in buying from us. Rather than any lack of demand, what we suffered from was a supply side shortfall - an inability to get our output to market both within Australia and to the rest of the world.
20.In addition, there are wider problems in Australia's patchwork economy. Most notably, consumers remain cautious. They haven't had any lack of income growth, but they have been trying hard to save rather more strongly than they did in times past.
21.Another problem is the weakness projected in housing construction. The strong population growth of the last five years occurred across a time when we were building fewer new homes. The upshot is considerable pent up demand for housing, so earlier projections had seen stronger growth in the offing as demographic-driven demand pushed up housing construction. However, the earlier expectation of recovery in housing construction has now faltered under the combined weight of higher interest rates and the relative lack of interest coming from investors and new home buyers.
...
24.Accordingly, the growth outlook for Australia - seen in Chart 2 below - is largely a capex story. The economic forecasts accompanying the Federal Budget saw two-thirds of all the growth in Australia's economy in each of 2011-12 and 2012-13 as dependent on increased business investment spending.
...
26.Accordingly, and despite key caveats related to the risk of renewed recession in Europe and (less likely still) the US, the most likely outcome remains for overall Australian economic growth to recover from the recent hit due to floods and cyclones, boosted by strong business investment in particular. The chart below shows my expectation for the path of Australian output growth over the next five years.
Chart SEQ Chart * ARABIC 1: Australian real output growth
42In relation to the state of the New South Wales economy, Mr Richardson gave the following evidence by his Expert Report:
51.NSW's poor performance of the past decade owed much to a series of factors. Perhaps most notably, Australia's strongest ever resource boom shifted money and materials to Australia's north and west, while leaving the manufacturing States in the nation's south and east dealing with higher interest and exchange rates.
52.High interest rates are particularly bad news for Sydney, given that it has Australia's largest mortgages, while the strength of the $A similarly saddles the State's manufacturers with competitive challenges, as is also true for its tourism and international education sectors.
53.However, it is not just the resource boom which benefited other States more. Some problems hit NSW harder. A good example is the global financial crisis. That struck at Sydney's strength, given that the State capital is home to half of Australia's financial businesses.
54.At the same time the last decade was marked by long running droughts and the poorest ever recorded inflows to the Murray-Darling basin. Although farming is a relatively small part of NSW's overall economy, those difficulties meant that it was particularly hard hit by that combination.
55.However, many of the economic negatives faced by the State have faded, and NSW's performance has lifted over the past year. In the arm wrestle between negatives linked to 'high interest and exchange rates' and the positives linked to 'potential for turnaround', the latter have still been in the ascendancy. Job gains were especially good through 2010, though they have faltered in recent months. The earlier strength helped to drive the State's unemployment rate close to national levels for the first time in some time. It helps too that NSW has not been as affected by others as floods and cyclones, that its slowdown in population growth has been less notable than that seen in a number of other States, and that the past poor performance of housing construction in New South Wales looks like combining with record lows in residential vacancy rates to encourage new housing construction.
56.Hence even though the $A is very high and that interest rates could rise further yet, the State's short term outlook is solid enough - but shy of the gains expected in States such as Western Australia and Queensland. Accordingly, inflation in Sydney is expected to remain either close to or below that seen nationwide, with faster growing States and Territories experiencing higher rates of inflation and pushing up the Australian average.
...
108.Turning to the New South Wales economy, I agree that growth in New South Wales will likely be slower than that in the wider Australian economy in 2011-12 and 2012 13, as is noted in the BIS Shrapnel report (paragraph 36).
109.The chart below repeats Chart 3, extending the data to also include my forecasts of New South Wales output and population as a share of the matching Australian totals. The chart shows how the poor relative performance of the New South Wales economy over the past decade. Over the next few years New South Wales' share of the Australian economy is forecast to fall below 31% amid greater relative strength in the likes of Western Australia and Queensland.
Chart SEQ Chart * ARABIC 2: New South Wales as a share of Australia's economy and population
Source: Australian Bureau of Statistics, Deloitte Access Economics. 2010-11 is an estimate.
110.Since 2000, the New South Wales economy has encountered domestic and external challenges, including managing the post-Olympic Games period, strong residential property cycles, the global commodity price boom and the recent global financial crisis. The challenges associated with elevated global commodity prices - such as the associated lift in exchange and interest rates - remain relevant today, and will continue to affect the New South Wales economy over the medium term.
111.In particular, the industry structure of New South Wales relative to resource-rich States such as Western Australia and Queensland, will be (and has been) a key factor holding back the New South Wales economy relative to these States over the medium term. Resource-rich States will continue to benefit from an expected lift in investment spending over that period, and will be the growth engine of the Australian economy. Indeed, as noted in the BIS Shrapnel report (at paragraph 21), "from 2011-12 mining and associated infrastructure investment will drive a further strong phase of private engineering construction activity."
43Mr Richardson also observed:
140.On the second matter (could wage growth be faster if it is accompanied by employee-related cost saving measures?), a brief digression on Bowley's Law may be appropriate. Bowley's Law notes the relative stability of the wage share in the economy over time. Consistent with Bowley's Law, a target for inflation of 2-3% over the course of the economy cycle therefore implies that labour costs will also need to increase by 2-3% over the course of the economic cycle (thereby maintaining labour share in the income of the wider economy).
141.This point is often missed in discussions of wage-setting, as there is rather more focus on wages as an income to employees than there is on wages as a cost to employers, but it is the latter which is the key driver of economic outcomes over the longer term. And the cost to business of labour is not simply and solely reflected in movements in wages, but in movements of wages relative to the productivity of workers.
44Dr Gelber's evidence also went to the state of the Australian and New South Wales economies. Some important aspects of that evidence were as follows:
1.The Australian economy slowed over 2010/11, due to a combination of caution in households and floods in the eastern states. GDP growth is forecast to rebound strongly to 4.0 per cent in 2011/12 and remain robust in 2012/13 (3.6 per cent), before easing to 2.6 per cent in 2013/14. Key drivers of growth will be healthy growth in exports, further increases in mining investment, a renewed upswing in dwelling construction and finally a broad-based strengthening in business investment, although these positives will be partially offset by slower growth in government recurrent spending and declines in public investment. Employment growth will remain solid over the next three years, underpinning growth in household incomes and consumer spending, although high interest rates predicted for 2013 will moderate consumer spending through 2013/14.
2.Growth in the New South Wales economy in 2010/11 is expected to outpace the national average in terms of output (gross state product - GSP), aggregate spending (state final demand - SFD) and employment growth. Prospects are favourable going forward, and although GSP, SFD and employment growth will lag the national average over 2011/12 and 2013/14 - but match the national average in 2012/13 - slower population growth in the state means per capita output and demand growth will actually be marginally higher than national GDP and domestic demand per capita growth. This, combined with strong growth in state final demand, suggests that demand and cost inflationary pressures in NSW will at least be equal to the national average.
...
11.Annual employment growth in New South Wales outpaced national employment growth over the second half of 2010 and in the first three months of 2011, with the state's Unemployment rate close to (or slightly below) the national average. Despite the recent setback in April, the New South Wales labour market is expected to tighten further over the next two years, with solid growth in the state expected to produce a similar decline in the unemployment rate as predicted nationally ie to fall below 4% in 2013.
12.This means that there will be increased competition for labour in NSW, especially for skilled labour. With respect to the proposed wage increase for Crown Award employees, the attraction and retention of employees will become more difficult in the absence of a sufficient wage rise, as the labour market is set to tighten further. Furthermore, this suggests that employers in the state- both in the public and private sectors - will need to at least match the national average in terms of wages growth, or risk losing labour to other industries or to other states.
...
30.Healthy signs have developed over the past year that the New South Wales economy is finally coming out of its economic malaise. This follows a decade in which New South Wales generally underperformed the Australian average, with gross state product (GSP) averaging 2.3 per cent per annum compared to the national average of 3.1 per cent in the ten years to 2009/10. Growth in state final demand (SFD - which represents aggregate spending in the state by households, business and government on consumption and investment) accelerated through calendar 2010, with a number of key indicators recording strong growth and outpacing the national equivalent.
31.Public investment in the state led the recovery through 2010, but the key driver was the healthy growth in dwellings investment. House prices lifted 14 per cent in 2009/10 and commencements rebounded out of the deep 2008/09 trough. The protracted downturn in the housing market and dwelling construction from 2004 to 2008/09 was a key negative factor contributing to the poor performance of the state economy over these five years.
32.Business investment also increased in 2010. Growth in private non-residential building was surprisingly positive, despite lingering financing problems from the global financial crisis (GFC), although much of the growth came from government stimulus to private schools via the 'Building the Education Revolution' program. Private engineering construction increased strongly through 2010, led by surging coal and minerals investment, accompanied by increased electricity and subdivision infrastructure spending. On the other hand, plant and equipment weakened sharply in the March quarter 2010 (following the cessation of government tax breaks for motor vehicles and other allowable equipment in December 2009), and remained subdued for the rest of the year.
33.Employment growth staged one of the strongest rebounds among the states in 2010- increasing 4.0 per cent through the year-after suffering relatively more during the post-GFC period in 2008/09. The strength of employment and rising wages underpinned the recovery in household spending, although rising interest rates hit the relatively more interest rate-sensitive households in New South Wales (because they carry larger mortgage debt) over the second half of last year.
34.The state's tradeables sector, in particular manufacturing, education and tourism, continued to suffer negative impacts from the high $A. Nevertheless, merchandise export growth increased strongly over 2010 as good rains boosted farm exports; as new mine, port and rail capacity boosted coal and mineral exports; and as machinery exports rebounded, despite the rising A$.
35.Overall, state final demand (SFD) increased 3.8 per cent in calendar 2010 (compared to 2009), despite growth faltering in the December quarter. For financial year 2010/11 SFD growth is expected to ease to 3.3 per cent, compared to 3.0 per cent for Australian domestic demand, while GSP is expected to increase by 3.3 per cent, compared to 2.6 per cent for national GDP.
36.The New South Wales economy is expected to build on the solid growth in 2010/11 and record moderate to strong growth over the next two years, although both GSP and SFD growth is projected to again lag national GDP and domestic demand growth. Economic growth in the state will be underpinned by a relatively buoyant construction sector and improved export volumes and revenues, although higher interest rates will subdue consumer spending.
...
38.Business investment is expected to strengthen further over the next two years, as the improved outlook for dwelling construction and further increases in coal and minerals investment precipitate a broader pick up in overall business investment. A new round of private infrastructure is expected to boost engineering construction, followed by industrial and commercial buildings. From 2011-12 increases in private sector investment will be partially offset by declines in public sector investment as the current round of projects (largely from the economic stimulus package) is completed and not replaced with a new round of projects. But with overall investment strengthening, this will lead to a pick up in demand for finance, property and business services.
39.With the Australian dollar expected at around or above the current levels of parity with the US dollar over the next three years, the negative impacts on the state's tradeables sectors will continue to weigh on the overall prospects for GSP. This includes the rural sector, which will suffer from falling revenues from next year when current high world prices (ie in US$ terms) for a number of agricultural commodities fall back as global supply responds to the current high prices. Falling farm revenues will have regional impacts. However, the key danger is that the prolonged period of the high A$ will lead to a 'hollowing out' of the manufacturing sector, lower levels of manufacturing investment and long term damage to the state's tourism and education services industries.
40.Employment growth is forecast to ease back after the 3.5 per cent growth estimated for 2010/11, growing at around 2 to 2.6 per cent per annum over the next three years. This will underpin further solid growth in household incomes and expenditure. However, over the
medium term, higher interest rates and a lack of tax cuts-as the government looks to restore a budget surplus-will limit growth in household consumption.
41.Indeed, by 2013/14 a string of interest rate rises will begin to stunt growth. As mentioned, NSW is particularly sensitive to interest rate movements due to higher levels of mortgage debt. The strong economic growth forecast for 2011/12 and 2012/13 will see the RBA increase interest rates aggressively to curb inflation and avoid the economy overheating. This will lead to a weakening in output and employment growth in 2013/14. But the weakening in the economy is likely to be relatively brief. A subsequent easing in interest rates, a lower $A and strengthening in residential, public and business investment are projected to lead to buoyant economic conditions over the second half of the decade.
42.To summarise, New South Wales Gross State Product is forecast to grow at 3.7 per cent, 3.5 per cent and 2.5 per cent in 2011/12, 2012/13 and 2013/14 respectively, slightly slower than the Australian GDP forecast of 4.0, 3.6 and 2.6 per cent over the same three years. However, given that population growth in the state is projected to be around 0.4 to 0.6 per cent weaker than the national average, this means per capita GSP growth over the 2010/11 to 2013/14 period inclusive will actually be marginally higher than national GDP per capita growth. This, combined with strong growth in state final demand, suggests that demand and cost inflationary pressures in New South Wales will be at least equal to the national average.
45In their joint report, the experts expressed differing views as to the state of the Australian economy in 2013-2014. As discussed in Police Award (No 1), this was reflected in their different inflation estimates for that year. Dr Gelber's evidence was that the economy would "hit full capacity constraints" in that period. With labour shortages, inflationary pressures would become broadly based. Mr Richardson considered that there would be an easing of global commodity prices in 2013-2014, reducing the growth of national income. This would have a dampening effect on economic conditions and, hence, inflation.
46The Commission received in evidence Chapter 1, 'Budget Overview, Context and Strategy', of the Budget Statement contained in Budget Paper No 2 of the 2012-2013 New South Wales Budget.
47In the introduction to the Budget Statement, some general observations were made about the state of the New South Wales economy and, in particular, fiscal considerations, as follows (at p 1):
In mid-2012, global economic uncertainty and the high Australian dollar continue to weigh down Australian financial markets and confidence, as well as activity in Australia's non-mining sectors.
Consumer caution and changes in spending patterns have resulted in a structural and significant collapse in forecast GST revenue, entrenching the revenue downgrade that occurred in 2011-12. GST revenue comprises around a quarter of the State's total revenue.
Growth in New South Wales will be lower than expected in 2011-12 but a resumption of housing investment, strong mining investment, a strong farm sector and the spread of benefits from the mining boom to the broader economy is expected to see growth accelerate through 2012-13 and return to slightly above trend in 2013-14.
48As to fiscal initiatives, the following was noted in the introduction (at p 2):
Last year's Budget responded to that challenge with a series of savings initiatives which lowered forecast expense growth to levels not seen in the prior decade. For 2011-12, the Government expects to achieve expense growth approaching 2 percentage points below what was forecast in last year's Budget.
But in response to the fall in expected GST revenue of $5.2 billion over the 2011-12 to 2014-15 period, the 2012-13 Budget locks in even lower expense growth, averaging just 3.3 per cent per annum over the four years to 2015-16.
49The fiscal strategy was identified as (at p 3):
The 2012-13 Budget contains measures to restrain expense growth, returns the Budget to significant surplus and slows the growth in net debt, while reducing the infrastructure gap and introducing reforms to improve the State's economy.
50Further, it was noted (at p 4):
The long-term objectives of last year's Budget were to return to a sufficiently large operating surplus to fund a significant part of capital expenditure, build a buffer against adversity and ensure a gradual decline in state debt and unfunded super in proportion to revenues. The strategy to accomplish this was built on the three pillars of expenditure discipline, structural economic reform, and responsible infrastructure planning.
and
The 2012-13 Budget tightens expense control further to restore the balance between revenue and expense growth. This will allow budget results to return to surplus, restrain growth in debt, and provide a more sustainable financing base to support the Government's priority infrastructure program.
51The Statement gives particulars about the planned expense management, noting (at p 5):
Control over expenses is one of the keys to restraining debt and restoring fiscal sustainability, and the revenue downturn has accentuated the need for such discipline. Forecast expense growth in 2011-12 has been revised down to 5.3 per cent from the 7.1 per cent estimate in last year's Budget.
52The Budget Statement refers to the significance of employee related expenses and describes the introduction of a "Labour Expense Cap" to limit employee related and contractor expenses across the whole of Government. This is an additional initiative to the NSW Public Sector Wages Policy 2011 and directs attention to employee savings through staff reductions and other strategies such as improving the efficiency of staffing arrangements to better manage overtime and reviewing the current contracting levels, needs and arrangements.
53The Budget Statement deals with the "Fiscal Outlook". In broad terms, that outlook is described as follows (at p 8):
As a result of these measures, the Budget remains on a trajectory to a strong surplus notwithstanding the revenue collapse and increased spending on important priorities.
On a GFS basis the operating result shows a budget deficit of $824 million in 2012-13 returning to a surplus of $289 million in 2013-14 and increasing to $562 million in 2014-15 and $1,172 million in 2015-16.
54These results were described as "headline results". The Budget Statement identifies that there may be distortion resulting from certain economic steps taken by the Australian Government. When looked at in net terms, the following position was reached (at p 8):
Netting out those transactions the underlying deficit in 2011-12 would be larger at $1,118 million (not $337 million) but the 2012-13 deficit would be smaller at $94 million (not $824 million) in 2012-13 (see Chart 1.4).
55These statements are reflected in the following chart (Chart 1.4) which appears in the Statement:
Chart 1.4 Headline and Underlying Budget Result
56The Budget Statement also dealt with infrastructure spending, State owned capital spending, State funded infrastructure, the overall fiscal balance and the projected growth in commercial public enterprise capital spending. In relation to housing, the following observation was made (at p 12):
Housing construction in New South Wales has slowed significantly over the last decade, particularly in comparison to similar states such as Victoria. The widening gap between demand and supply has driven up house prices, lowered affordability, reduced disposable income and repressed demand for non-housing goods and services.
57As to infrastructure spending, the Budget Statement provided the following information (at p 16):
The State's infrastructure plan (described in Budget Paper No. 4) aims to provide and maintain the infrastructure that underpins state economic growth (such as transport and utilities) and essential services (such as schools and hospitals).
Over the four years to 2015-16, infrastructure spending will total $61.8 billion, with 42 per cent in the general government sector and 58 per cent in the public trading enterprise sector. The program is funded predominantly from the State, with Commonwealth grants contributing only around 10 per cent of the total. If the Commonwealth maintains the existing 80:20 share of funding for the Pacific Highway, the total infrastructure program would be $64.1 billion or an increase of 2.8 per cent on the program announced in the 2011-12 Budget.
58The Budget Statement also dealt with the 'State-Funded General Government Infrastructure Program including Public Transport'.
59The overview provided for the Budget was expressed in the following terms (at p 1):
A Budget deficit of $824 million is expected in 2012-13 in the context of a renewed global economic slowdown, weaker consumer and business confidence and a significant structural deterioration in GST revenue.
A return to significant operating surpluses over coming years is forecast on the basis of a strengthening economy and even greater discipline on expense management. This will enable a continued emphasis on rebuilding infrastructure without unsustainable debt growth.
The Budget contains measures to restore economic growth by stimulating the housing construction sector and boosting State-funded infrastructure in the general government and public transport sectors.
The Government has confirmed its fiscal strategy to focus on maintaining the State's current triple-A credit rating and has formalised it in the Fiscal Responsibility Bill 2012 currently before Parliament.
Structural reform will continue within government to improve public sector capability and productivity through the implementation of the interim Commission of Audit findings.
Improved performance of state owned corporations is being targeted while tighter capital expenditure management will help to keep the cost of living down.