Morgan’s chief economist, Michael Knox, recently wrote a great piece on one of the dumbest pieces of economics news stories I’ve seen in a long time. Uneducated and biased media people loved the idea of recession per capita but in all my years of writing and teaching economics at places like the University of New South Wales, we never dealt with such rubbish.
So I loved it when Knoxy, who often appears on my TV program, came up with: “Aussie’s per capita recession & other children’s stories” headline.
Michael is a smart guy and sometimes doesn’t know what normal people find easy to digest. But as you’re an investor and can be affected by what you read is happening to the Aussie and global economies, I’ll try and bring his sophisticated analysis down a peg or two so it’s more digestible.
Michael makes the point that our GDP number we use can get distorted when commodity prices boom and population surges, rendering any real GDP per capita numbers misleading.
This is not an easy piece but it’s really important. This is Michael’s story and I’ve added a few extra bits to make it more understandable but please don’t tell him that I doctored his work!
The Australian Bureau of Statistics (ABS) released the Australian GDP numbers for the December quarter of 2018 on Wednesday March 6. These accounts showed a year-on-year growth rate of GDP in trend terms as 2.3%. They also showed GDP growth in seasonally adjusted terms of 2.3%. In any other developed economy, these would be regarded as good numbers.
Nevertheless, some commentators have suggested that Australia is in a “per capita recession”. This is because in seasonally adjusted terms, GDP per capita fell slightly in the September quarter and the December quarter. This didn’t happen in the more reliable trend measure of GDP. In this measure, GDP per capita rose in the September quarter, but fell in the December quarter.
Right there, we can see the two negative quarters of GDP in both the September and the December quarters are probably just because the seasonally adjusted numbers have more random variation in them, than the more reliable trend measures.
What we want to discuss here though, is the broader issue of how to interpret the Australian GDP numbers. The real GDP numbers published by the ABS are regularly taken to be an accurate estimate of what’s happening in the Australian economy.
The problem for most of us is that they have almost nothing to do with the economy as we experience it. These real GDP numbers frequently tell us that the economy is in good shape, when everything around us tells us that it is rotten. These numbers may also tell us that the economy is in bad shape, when everything around us tells us that it’s really good.
How does this happen?
For most of us, the economy that we experience is not the economy “in real terms”. The economy that we experience is the economy in Australian dollar terms. When we are paid, we are paid in Australian dollars. When we pay taxes, we pay taxes in Australian dollars. When the government receives tax revenue, it receives it in Australian dollars. When Australian companies make profits, those profits are published in Australian dollars.
The Australian per capita GDP recession in 2018 is a figment of how the GDP deflator distorts the effect of export prices on the real Australian economy (plus random variation in the seasonally adjusted series).
Back when we were still in the commodity boom in 2010, GDP in Australian dollar terms rose rapidly, but the GDP in real terms, as published by the ABS, told us that the Australian economy was pretty much the same as it is right now. GDP growth in real terms was 2.34% for the year to Q4 2010 when there was a boom and 2.27% for the year to Q4 2018 when the economy is what it is today.
The difference may have been that in the year to Q4 2010, nominal GDP growth or GDP growth in Australian dollar terms, rose by 9.64%. On the other hand, for the year to Q4 2018, nominal GDP growth or growth in Australian dollar terms, rose by 5.5%.
What this tells us, is that nominal GDP, or GDP in Australian dollar terms, tells us much more about how we actually experience the economy, than GDP “in real terms”, as published by the ABS.
Why is the ABS real number so misleading? Blame the Europeans!
The GDP deflator, which is a guide to inflation, and how it’s calculated is the problem. The National Accounts for the GDP under the GDP system were really designed for European economies exporting manufactured products. These products were subject to only modest price variation from year to year. Hence it made sense that when you wanted to calculate the contribution of those exports to a European economy in real terms, then what you would do is divide the total income you got from selling those products, by the price of them. This gave you a reasonably stable understanding of the contribution of exports to a small European economy.
The problem is when you come to a medium-sized commodity exporting economy like Canada or like Australia, this process generates a distortion, which pretty much destroys much of the point of doing the National Accounts in the first place. Much of the information that would exist about the economy is distorted by using this type of price adjustment.
The ABS publication of Wednesday 6 March tells us that GDP for the year to Q4 2018 in A$ terms went up 5.5% (seasonally adjusted). It also tells us, that after the GDP deflator is applied to the data, that GDP for the year to Q4 2018, in real terms, went up by 2.3%. The difference between 5.5% and 2.3% is 3.2%. What we are seeing here, is the size of the GDP deflator. This deflator does as it implies, it deflates GDP.
What is interesting about this is that CPI inflation for the year to Q4 2018, which was also published by the ABS only increased by 1.8%. It is possible that ordinary Australians experience inflation at the rate, as described by the CPI. It is much harder to believe that ordinary Australians experience inflation at the rate described by the GDP deflator.
GDP sold us a lie in 2018!
What was actually happening in the Australian economy, in the last two quarters in 2018, is that the improvement in the Australian economy was masked by a rapidly rising GDP deflator. Rising commodity prices led to a GDP deflator that was rising more rapidly than the CPI. This meant that the increase in output in the GDP number was divided by an increase in prices because of surging commodity prices, which were much higher than ordinary Australians were experiencing.
The real GDP story
What was happening to the Australian economy in Australian dollar terms is a much better description of what was happening, than the real GDP numbers published by the ABS. The real GDP numbers made the economy look much worse than it actually felt at the time.
And our population booms distorts the story further…
When we reduce these lower growth numbers by quarterly population growth numbers to look at GDP per head, the end result is numbers that are lower still. The estimated population growth in Australia in 2018 was 1.6% per annum. This is the highest population growth rate of any developed economy.
The reason that Australia has the highest population growth rate of any developed economy is because Australia has the highest immigration rate of any developed economy. A 1.6% annual growth rate becomes a 0.4% quarterly growth rate. This means to calculate per capita growth rate, you must reduce the quarterly GDP growth number by 0.4%. This is how we got to such low growth.
Rising commodity prices meant that the increase in Australian dollar GDP was divided by a deflator number, which rose more rapidly than CPI. This made the economy look weaker than it actually was. These numbers were further reduced by quarterly population growth numbers.
In the more reliable trend terms, GDP per capita only fell by one quarter last year, and that was the December quarter. This means that the idea of a genuine per capita GDP recession simply does not cut it. This does not mean that there has not been previous GDP per capita recessions in the past three decades. In fact, we find there are four such recessions. The first and the largest of these recessions was the Keating recession of 1990 and 1991. This was the longest per capita GDP recession, lasting a period of eight quarters.
The second such recession followed the crash in US technology stocks in 1999 and 2000. Australia experienced a per capita GDP recession beginning in Q3 2000 and ending in Q1 2001. This was the next longest per capita GDP recession and lasted three quarters.
There are two more such recessions. The next was in Q1 2006 and Q2 2006. This was a shorter period of only two quarters when per capita GDP in trend terms fell in each quarter. The fourth such event happened in 2008. There was a GDP per capita decline in Q3 2008 and Q4 2008 (don’t tell Kevin but it looks like we really did have a GDP per capita recession during his term as Prime Minister).
The Australian per capita GDP recession in 2018 is a figment of how the GDP deflator distorts the effect of export prices on the real Australian economy. In actual fact, the economy in 2018 was doing just fine. Improving commodity prices meant that Australian dollar GDP was growing at 5.5% in seasonally adjusted terms. This rapid growth of the economy, in Australian dollar terms, explains why wages were just beginning to pick up and why Australian government tax receipts were improving at a much better rate that the government itself anticipated.
Per capita GDP recessions may actually exist. Describing 2018 as a per capita GDP recession is just a story to scare children.
(I’ve done my best to make Knoxy more understandable because it’s such an important revelation.)
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