Bull run needs red rag of productivity gains
The ice man, a.k.a. the Reserve Bank governor Glenn Stevens, managed to sidestep the markets again last week with a hefty half a percentage point cut in the official interest rate.
The unflappable Stevens repeated his 2008 approach by spending the first third of this year turning a deaf ear to the cacophony to slash rates. Then, last Tuesday, he pulled out Crocodile Dundee-sized knife and cut hard: no messing around, and with maximum impact.
It is never easy to pick Stevens's next move, but if last week's aggression is anything to go by rates might be down to 3.25 per cent by December. This would get investors hot under the collar and divert attention from the present slew of earnings downgrades. The focus would zero in on renewed earnings growth in 2013 and beyond.
Sure, we will still have to worry about sluggish growth in the US and, to a lesser extent, a meltdown in Europe, but at least we can think positively about the domestic economy.
This scenario bodes well for a new bull market. Lower interest rates have been a consistent trigger for share price rallies in Australia. However, for the local bourse to have a multi-year bull market (the likes of 1974-87 and 1993-2007) we need a lot more than a cut in rates. Lower rates will make people reconsider buying shares but they will not be enough to fire a prolonged upwards march in equities.
Stevens is taking care of the short term but he and his cohorts at the RBA are acutely aware that the real driver of wealth creation is a rise in productivity. In simple terms, higher productivity occurs when there is a greater output without a commensurate rise in inputs. Higher productivity is the elixir for wealth creation and a boon for sharemarkets.
After tremendous gains in 1980s and 1990s, productivity stalled in the 2000s. A paper written in 2011 by the economist Saul Eslake, Productivity: The Lost Decade, shows that labour productivity fell from a peak of 91.6 per cent of US labour productivity in 1998 to just 84.2 per cent in 2010. That is a dramatic decline and highlights how uncompetitive Australia has become.
However, to blame the decline purely on workers would be short-sighted and naive. In the 2000s, multifactor productivity stalled and registered no growth. In other words, capital spent by governments and private businesses delivered no real benefits.
Given that productivity gains are so crucial to wealth creation, how can it be that Australia has recorded strong gross domestic product growth in the past decade? In the 1990s gross domestic income rose by 3.2 per cent per annum, of which 2.1 per cent came from labour productivity gains. In the 2000s, GDI reached 4 per cent but only 1.4 per cent of that came from labour productivity. The slack was taken up by a big boost in the terms of trade and population growth.
If Stevens is correct, and the terms of trade have peaked and immigration rates are slowing, we need productivity gains or we will face anaemic economic growth.
Possibly, the productivity drought will correct itself. The mining boom requires massive investment before we see a meaningful rise in output. In addition, agricultural output will rise now the big dry is over.
However, productivity reforms implemented by the Hawke government in the 1980s and the first term of the Howard government in the late 1990s have now passed. The last decade of politics, especially under Howard, was a lost decade in terms of productivity. Tax cuts and first home owner grants stimulated debt levels and excessive consumption. Luckily, this is now unwinding.
The next federal government must place productivity at the top of the agenda if it is committed to driving up living standards for the next decade. This would include overhauling infrastructure, including building a second airport in Sydney; addressing skilled labour shortages, and attempting to break up duopolies and monopolies in areas such as telecommunications, banking, airports and grocery retailing.
This must be matched by a similar commitment by private business. With the exception of the mining industry, Australian corporations have been more interested in protecting their market share than investing for the future.
Technology, the other major stimulus for productivity gains, is heavily dependent on what happens in the US, and Australia ranks very low on innovation.
As we move into 2014 and 2015, sharemarket investors must keep an eye on how productivity is growing. If the terms of trade fall and population growth eases, productivity will need to rise.
If this fails to eventuate, Australia's ranking as the world's No.1 performing stockmarket since 1900, with gains of 11 per cent per annum, may be under serious threat.
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