Australia’s FIRE economy scorches everyone else

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By Leith van Onselen

While the manufacturing sector continues to gasp for air, with manufacturing employment and capital investment both in the gutter:

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Yesterday’s national accounts release for the June quarter confirmed that Australia’s FIRE economy – Finance, Insurance and Rental, Hiring & Real Estate Services – continues to grow from strength to strength, rising to a new record high 11.1% share of the Australian economy (see next chart).

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In fact, since financial markets were first deregulated in the mid-1980s, the FIRE economy has grown at nearly twice the pace of the rest of the economy:

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The situation is even more extreme if Rental, Hiring & Real Estate Services is removed from the mix, with the Finance and Insurance sector growing at well over double the pace of the rest of the economy since deregulation,, although is share of the economy (8.3%) is a whisker off the all-time high reached in the March quarter (see below charts).

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Anyone seeking an explanation as to why Australia’s FIRE economy has expanded so briskly only has to view the below chart, which shows Australian house prices decoupling from rents at roughly the same time as the FIRE economy’s growth decoupled from the rest of the economy (of course compulsory superannuation has also contributed):

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In short, the deregulation of the financial sector ignited credit growth, most of which has been channeled into housing at the expense of business, inflating Australian home values in the process:

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A key ingredient behind the surge in credit growth, house prices, and the FIRE economy’s growing share has been the explosion of property investors, whose absolute size and share has risen inexorably over the past two decades, and exploded over the past year, of course assisted by Australia’s peculiar tax laws (e.g. negative gearing):

ScreenHunter_4002 Sep. 04 08.18

And with overall housing credit growth expanding at 6.5% in the year to July 2014 – faster than nominal GDP (3.3%) – the FIRE economy is set to continue pushing to new highs.

Like Frankenstein’s monster, the financial sector, which once acted merely as an enabler of the productive economy, is now pulling its master’s strings, killing killing-off the productive economy in the process.

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Unconventional Economist
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    • The thing about big, negative events – a stock market crash, climate change, Jennifer Lawrence photos, terrorist attacks, a housing bust – is you don’t see them coming. But when they happen, you realize how obvious it all was. You wish you’d prepared.”

  1. It’s all good. We’re only 300bp away from fixing this multi decade abomination… just need the RBA to do their job.

  2. The contribution of compulsory superannuation:

    In the year to 30 June 2013, $18.6 billion in fees (certainly more in the latest year) sucked out of the rest of the economy, arguably for doing little more than sticking other people’s money in the bank and into the ASX200/300.

    To put that into perspective, the last Commonwealth assistance package to the car industry was $19 billion . . . over 5 years!!

    Australia is a rent-seeking society.

    And under its increasingly centralised and anti-democratic system of government it can only become more so.

    It is a system which will eventually collapse under the weight of its own inefficiency . . . but not before it has done untold harm to the peoples of Australia.

    • Thats is small minded petty financial nonsense SM. And you know it. Its expensive running an investment business, there is a lot of red tape, regulation, and client activity. On top of all that – its a competitive industry – and you have to hire the best to get the best results.

      Stop being jealous of others, run your own self managed super fund. Chance are you could out-perform them. Then instead if bitching about things you don’t understand – you can crow… and release the inner peacock.

      Linking financial assistance to the car industry (which I support) and legitimate business (that typically charge 1.5-2% pa) working for your financial best interests is so patient stupid, it beggars belief.

      • Well my account/auditor still gets around 1% – and I am self-managed. I know a mate of mine running a small Buffettology fund in the UK charges 5% entry – and then an on-going annual fee on top of that.

        There is fund hyper-competition for tracking funds in the US – but that is like putting your money in bank and earning a basic interest. Swapping some (at times a lot) of volatility for the hope of a greater return. Which incidentally rests entirely on when you retire – too bad if you are in a recession or depression.

        Fees are a spurious red herring in this whole argument. International competition is rising tremendously, and any excess profits will be stripped away. If you want a good fund – guess what, you have to pay for it (up to 20% of profits made above a certain benchmark – and I have been told as high as 33% in others). Thats the beauty of the market. If you don’t perform, you lose your job. Thats why four and a half years is usually a average career (I assume it was referring to a single place of employment) for a rated US fund manager.

        Focus on returns – in that context, fees don’t matter, nor do they count.

      • Strange Economics

        Hire the best?
        Knowing what it is to be one of the best, they would give themselves the enormous salary I deserve.
        And the bank CEOs do.
        Why do they need the “best”. Surely the best should be researching something challenging like biomedical instead?
        A CEO of a govt protected bank, in an oligopoly, with prices set by the RBA, rules set by the govt, guaranteed punter mortgage customers – worth $ 20 million /year to do this.
        Any graduate accountant could advise the strategy.
        Lend only to mortgages, don’t loan to any businesses.

        Banks are actually IT and administrative companies – just need a good manager, not a $20 million a year one.

      • I remember the good old days when banks etc paid their bills with the difference in the interest charged between depositors and borrowers. Then deregulation happened and banking profitability grew along with the fees and this happened in spite of the fact that many transactions were now done in the cheaper electronic medium (which was meant to reduce costs to us for banking services – not increase them). SM is probably closer to the mark than you would give him credit for.

        Edit: Incidentally, many things get in the way of competitive markets. One of them is a stickiness in relationships that comes from lock in costs et al. This is one of the reasons why our domestic financial markets are dominated by local and not global players. ie: the B4 here.

      • PS: I will qualify what I said above. There were some transaction fees but not the other administrative fees that have since been introduced.

      • No, it’s actually not that expensive at all to run an investment business, and it is totally scalable. It’s just there is so much system wide inefficiency and duplication and piss-taking. There are investment shops running $20bn in risk, renting B grade office space in city fringe suburbs, staffed with no more than a dozen people.

        Then there are the fifty different super funds and implemented consultants, allocating to that one asset manager, located in A grade office space, each staffed with between a dozen and 200 staff, the vast majority of whom staring blankly at spread-sheets all day, confident that every other super fund is going to chalk up the same performance with a small degree of variance, because they are all using the same consultants, all applying the same asset allocation thinking, and selecting from the same universe of vastly similar asset managers.

        Those rare managers that are able to consistently demonstrate skill comprise a tiny portion of the super industry’s aggregate risk allocation. The vast majority are just overpaid mediocrities, erstwhile private sector bureaucrats propped up by government mandated revenue; complacent, confident in the fact that the vast majority of their clients can be easily bamboozled by glossy, nebulous commentary explaining away their most recent under-performance. Forget about a five year career span if they underperform, the same mediocrities will move from one shop to another to another to another for decade after decade. And there is not a chance in hell that the majority of these people will ever outperform a passive approach over the long-term. But these same charlatans will clock up three times the average salary without ever breaking a sweat or having an original thought in their entire career.

      • spleenblatt

        I’ve addressed some of these issues below in terms of pecuniary diseconomies and allocative inefficiency.

      • To get an estimate of overcharging, we may compare internally managed LICs with externally managed LICs.

        The seven listed internally-managed LICs (AFI, ARG, AUI, BKI, CIN, DUI and MLT) publish their total expenses. These are the total expenses for running a semi-active portfolio weighted towards the AS300 (which is what most of the super funds do). It includes all expenses of funds management, audit, running a share registry, and distributing dividends.

        The MERs are amazingly consistent, not only over time but over the spread of internally-managed LICs. They range from 0.1%pa to 0.2%pa. (In the latest year one of them – I think it may have been MLT – fell to 0.09%!)

        Other estimates may be gained from looking at wholesale index tracking funds. True index funds (such as Vanguard) charge 0.28% pa. Some synthetic index funds (which use derivatives to mirror the index) are as low as 0.20%.

        The very cheapest externally managed LICs charge 0.35% pa. Most are at 0.75%pa and above.

        The average fee ratio for superannuation funds in 2012/13 was a staggering 1.23%!! It makes Australia’s pension system the third most expensive in the world.

        Some of this is admittedly red tape. But it is unnecessary red tape created as a consequence of central government politicians promoting a rent-seeking industry for their influential Mates. It could be avoided by moving to a “notional defined contribution system” as discussed on other occasions here.

        Moreover, there is no sign of fee rates dropping as fund sizes increase. (See LvO’s recent article here.) Any economies of scale are simply being ripped out to line the pockets of the influential fund managers.

        As Alan Kohler remarked:

        Superannuation is the only utility that you are required by law to buy and whose prices are not set by regulation…

        You could not invent a better gravy train, so it’s perhaps not surprising that it fails both its customers and the nation.

        The history of central government in Australia is a history of rent-seeking, whether it be futile tariff protection of Victorian manufacturers under the Victorian Liberal Establishment of the post-war era, or protection of the Sydney finance industry today.

        Centralism, rent-seeking and a hatred of Democracy go hand-in-hand. They all involve the “few” ripping off the “many”.

        For that to occur it is essential that the “many” be prevented from having any effective redress to prevent. Thus the hatred of any system of genuine Democracy.

        Similarly, for rent-seeking to persists over time, it is advantageous to have a larger political entity to exploit. Victorian tariff protection couldn’t have lasted nearly as long as it did if it had had only Victoria’s economy to feed off. Having the whole of Australia to feed from allowed it (and allows the Sydney finance industry) to survive longer before collapsing under the weight of its own inefficiency.

        Centralism, rent-seeking and a hatred of Democracy go hand-in-hand. You can see it very day . . in the comments on this site!!

        p.s. I’m off running for a couple of hours. Won’t be back till this afternoon.

      • You are not comparing apples with apples! Most of the funds in London are far higher than 1.23%. Yes they may not be designated “pension” funds. But a part of their investment capital is predicated on that part of the market. Likewise, the big high profile US active funds charge way above that figure too. Again – not “pension” funds – but all the US pension authorities use them.

        Check your numbers…

      • So does comparing us to two messed up financial markets where the FIRE sector is on steroids make sense? How about other markets where the FIRE sector hasn’t grown to such an extent?

      • Trust me – a domestic banking system is far more powerful and beneficial than you think. Even conquerors such Napoleon misunderstood its reach. The UK today would be nothing without its banking system. And London is sooooo coooool.

        Its business… we all need them sometime or other.

      • Vanguards Oz index fund is now down to 0.18% .

        Is 1.23% super fees just account management?

        There’s trustee, account reporting and perhaps some strategy yeah?

        Also, at this point in time there’s about 0.2% in the expense recovery fees being used to pay for FOFA talking heads in Canberra.

        That said, I agree there is a lot of fat in financial services, but a lot of its gone out of funds management.

        Platinum international is not an outlier at 1.54%, but they’re charging a premium due to their past performance.

        Look at insurance, with 30%+ distributions costs, CBA makes most of its profit not from the punters mortgage, but by every government agency using CBA, and CBA charging eftpos and BPay fees.

        What I’m asserting is funds management may be charging $18.2 bil in fees, but not all $18.2 bil is an extracted rent

      • Trust me – a domestic banking system is far more powerful and beneficial than you think. Even conquerors such Napoleon misunderstood its reach. The UK today would be nothing without its banking system. And London is sooooo coooool.

        Its business… we all need them sometime or other.

        I am not disputing that we need business and banks. I am simply saying we shouldn’t be conned into believing we don’t have choices in how business/banking is conducted. I am also questioning whether these markets are operating as they should (ie: as a competitive market) as domestic banking profits and fees suggest otherwise.
        London may be cool but, it’s an altogether moot point whether that financial hub is really going to enable the UK to remain prosperous (perhaps the financial elites and their technocrats but that’s about it). In any case the growth model the UK and US has chosen isn’t one we should blindly copy as I believe our circumstances are different enough to demand a more tailored approach and that history indicates FIRE sector driven growth may not be sustainable.

      • “What I’m asserting is funds management may be charging $18.2 bil in fees, but not all $18.2 bil is an extracted rent”

        Indeed. I never intended to suggest it was. However, nor was the assistance paid to the car industry entirely rent.

        While we talk about “rent-seeking” and “rent-extraction” the more important issue is actually “allocative inefficiency”: the misallocation of resources that is consequent to rent-seeking activities.

        Let us begin with “pecuniary diseconomies”. An individual firm in the industry may not be earning “rents” for its owners/shareholders. But if it is drawing on the same inputs as other firms in the industry (office staff, office rentals, accounting services, etc, etc) the price of those input is driven up also. This is pecuniary diseconomy.

        If there are proximity benefits (as there plausibly are in the finance industry, both between firms, and between firms and their politician sponsors) then the supply of inputs is limited. It may even be “positional”: only a certain number of firms can be closest to the centre. Only a certain number of people can have the ear of the relevant Minister. These are things the supply of which cannot be increased even in principle.

        Thus does some of the “rent” bleed out to the suppliers of inputs in the immediate vicinity.

        The same was true of vehicle industry. Not all of the rent from protection went to the car company shareholders. Much of it was bled out to local labour, components suppliers and the like.

        Indeed, that was the purpose of the exercise! Even the Victorian Liberal Establishment wasn’t in the business of simply enriching foreign car companies. It was in the business of enriching Mates much closer to home.

        If corrupt politicians could simply pass a law levying a poll tax on the population and transferring the cash to their Mates, then the system would – paradoxically – be far more efficient. There would be no misallocation of resources, only a transfer of cash.

        In practice such extortion is not feasible – even under the corrupt system of elective government. In order to facilitate rent extraction for their Mates, politicians must set up vastly complex systems (import tariffs for cars or compulsory defined contribution superannuation for the finance industry) to conceal what they are doing and give the appearance of acting for the “common good”.

        It is those consequential arrangements which are so damaging. They involve people running around doing things which are fundamentally pointless (the “red tape” of the superannuation scam) or which could be done in much more efficient ways (importing cars from countries which enjoy a comparative advantage in car production).

        Resources are misallocated – sometimes on a continental scale – and it is this misallocation which undermines prosperity. Having people running around in Sydney dealing with the red tape of a pointlessly complex superannuation system contributes nothing to the prosperity of Australia. That is not to say that they’re not actively employed. It’s just that they’re employed doing things pointlessly or inefficiently – in order to provide cover for the rent-extraction going on below the surface.

        The damage done by Australian politicians in helping their Mates might be better assessed by comparing the cost of Australia’s pension system with “world best practice”. Even if half of the $18 billion (and growing) each year is pointless, that is still $9 billion of pointless activity that contributes nothing to prosperity.

        And all of this occurs because centralisation and the absence of genuine Democracy prevent the victims from organising to prevent it.

        That is why centralisation, rent-seeking and hatred of Democracy go hand-in-hand.

  3. Do you remember the name of the gentleman who deregulated the financial sector, floated the dollar, made superannuation compulsory, cut wages and conditions for workers and re-installed negative gearing?

      • At least he realised the benefits of recession and inflation-reflective interest rates. Look at what happened after. The same should have been aimed for since Howard/Costello.

      • Nah – don’t be biased, they did a sterling job. Top notch. Rudd sold himself as another Howard, and the public fell for it… and guess what!

      • Mr Keating was a useful entity for the FIRE sector.
        I think they flattered him then used him to get what they wanted. The above graphs showing growth of money-shufflers (and decline of manufacturers) is surely one for the true believers.

  4. TheRedEconomistMEMBER

    The hurdles for for getting a significant investor visa just got smaller.

    Elsewhere, the state government had also loosened its approval criteria for its significant investor visas.

    Having scrapped its required minimum investment in Waratah bonds, applicants are eligible if they invest $5 million in any other complying investments from the start of this month.

    • Depends on what sort of accounting you’re talking about. If you’re consulting individuals or working closer to a financial planner and taking a percentage cut it can be seen as that. But accounting is more than that.

      It can be argued though that the law is so complex in regards to the corporations act or the income tax assessment act is why some of them end up earning a good living.

  5. The parasite is consuming the host til there’s no life left then will turn on each other in desperation.

    • The FIRE sector will next consume the federal government’s borrowing capacity by allegedly requiring liquidity when foreign lenders pull the plug on that $880 billion borrowed.

      Why would foreigners do this? For fun. Clipping 3% interest coupons is boring. So engineer a crisis. First shorten the term of loans and make a repayment hump then shrug when the Oz banks seek renewal/extension of loans.

      And somebody, somewhere is holding the currency risk on the hundreds of billion swapped into $A.

      We rely on the kindness of strangers.