Over the past year, I have written extensively on how the ongoing decline in commodity prices and the falling terms-of-trade would weigh heavily on Australian income growth in the years ahead and how over the next decade, incomes are unlikely to grow at anywhere near the pace experienced over the 2000s when the once-in-a-century boom in commodity prices took place.
In order to illustrate this point, I have presented a number of charts that draw upon data from Australia’s national accounts.
First, is the below chart showing Australia’s terms-of-trade, which surged to record highs in the decade to 2011, but has since begun to retrace back towards longer-termed averages:
This inexorable rise in the terms-of-trade was driven primarily by the big pay rise Australia received for the goods that it sold to the rest of the world, including: iron ore, coal, gold, and natural gas.
In turn, this pay-rise over the past decade meant that Australia’s national disposable income (NDI) grew at a much faster rate than output, as measured by GDP, making Australians much wealthier, since a far larger amount of imports could be purchased from a given amount of exports (see next chart).
These facts been acknowledged by the Australian Treasury, which last year published research estimating that around half the growth in average incomes over the 2000s was caused by the one-in-a-century rise in Australia’s terms-of-trade (see next chart).
When explaining this to people in person, they often don’t understand how the huge rise in Australia’s terms-of-trade in the decade to 2011 has benefited the average Australian. To illustrate this point more clearly, I have produced the below charts showing the per capita rise in Australia’s household disposable income, as published in Australia’s national accounts.
The first chart tracks real inflation-adjusted household disposable income per capita since 1982:
As you can see, real income growth remained relatively stagnant in the 1980s, grew solidly in the 1990s as microeconomic reforms boosted productivity, grew even more strongly over the 2000s as the terms-of-trade boost kicked-in, and have since slowed down over the past three years.
The below chart, which plots the annual growth rates in per capita household incomes and the average growth rates for each decade, illustrates the situation more clearly:
As you can see, the terms-of-trade induced surge in household incomes over the 2000s was indeed remarkable, with real per capita income growth averaging an extraordinary 2.6% over the decade, well above the 0.4% average growth rate experienced over the 1980s or the 1.25% average growth rate experienced over the 1990s.
Note also that real per capita household income growth between 2010 and 2013 has averaged just 1.4%, despite the terms-of-trade index (89.1 as at March 2013) still sitting above its level at the beginning of this decade (78.6 as at December 2009).
The purpose of this analysis is to show that the surge in incomes over the 2000s was extraordinary – driven primarily by the once-in-a-century lift in commodity prices – and that income growth will be much slower going forward. Indeed, to the event that the terms-of-trade continues to retrace back towards its longer-term average level (see first chart), it will detract from household income growth, unwinding much of the gains enjoyed over the 2000s.
In the years ahead, Australians will have to get used to much slower income growth than they have become accustomed to and will instead have to earn pay rises the old fashioned way: via improved productivity.
