CBA: Australian economy now a ward of the state

Via Gareth Aird of CBA comes a note to shake the towers of the great:

Overview Economic growth has slowed in Australia. But looking at the economy from a public/private sector perspective shows a marked difference in what has been occurring. Government demand has been strong while private demand has been weak (chart 1). In summary, Australia has been on a trajectory whereby the public sector has been increasing as a share of the economy on all key measures. This has been partly funded by Australian workers who are handing over an increasing proportion of their income to the Government each year.

In this note we take a look at the most recent trends in employment and consumption from a public/private sector perspective. Our findings go some way to explaining the supposed “tension” between the soft GDP and strong employment data. The results indicate that the public sector has been putting on headcount at a much faster rate than the private sector. While growth in public sector employment boosts demand in the economy in the short run, there is a financial cost that is born by taxpayers. And growth in public sector employment is generally not associated with much in the way of a productivity dividend.

Government expenditure must be paid for. Bracket creep means that workers are handing over an increasing proportion of their salaries each year to the Government. As a result, the tax-to-income ratio has been on a solid uptrend over the past four years. This weighs on the ability of households to spend. The Q1 2019 national accounts, published in early June, showed that household consumption growth has continued to slow. In stark contrast, growth in government consumption is strong. The improvement in the Government’s fiscal position is not due to expenditure restraint. Rather, the federal budget is back in the black because the tax take as a share of the economy has risen.

Employment

Employment growth in Australia has been strong over the past few years. Had it not been for a rise in labour force participation, the unemployment rate would have continued to fall. But strong employment growth has not been a feature of both the private and public sectors. Rather, it’s been very much a story of the public sector driving employment growth. The ABS publishes quarterly data that splits employment by the public and private sectors. The most recent data is to May 2019. It indicates that total employment rose by 364k over the year comprising a lift in public sector jobs of 310k (85% of total jobs) and private sector jobs of 54k (15% of total jobs).

The ABS public/private split can be quite volatile. But if we look at the annual average change, which smooths out the volatility, the picture remains the same. It shows that the annual average growth in public sector employment was 11.6% at May 2019 compared with 1.1% for the private sector. It’s been a similar story for a large chunk of the last four years (chart 3).

From an industry perspective there has been a huge rise in government administration and safety employment (chart 4). These jobs essentially relate to: the setting of policy; the oversight of government programs; collecting revenue to fund government programs; creating statute laws and by-laws; creating case law through the judicial processes of civil, criminal and other courts; and distributing public funds. They also include police and fire services, but there has been no noticeable change in headcount for these sub-industries.

Government administration jobs are ‘non-cyclical’ and are not generally associated with raising productivity in the economy. Indeed they circulate wealth rather than create it. Moreover there are other industries that have a high concentration of public workers that are clearly essential, like primary and secondary education and health care, but they don’t deliver much of a productivity dividend (as measured by output per hour worked). There has been a solid lift in headcount in these industries over the past few years.

The RBA has spoken at length of the current “tension” between the soft GDP and strong employment data. Taken at face value, the two pieces of data imply that productivity growth is non-existent in Australia at the moment. Indeed they suggest it is negative (chart 5). While there is likely to be some noise in the data that will be ironed out over time, we think that a lot of the “tension” is explained by the type of jobs that we have been creating. That is, the significant lift in government administration employment doesn’t improve the productive capacity of the economy.

It’s worth noting that public sector jobs only comprise government units and units controlled by government. The big lift in public investment over the past three years, which will help boost productivity in the long run, has largely been delivered by the private sector. As such, the reported lift in headcount in the public sector is understating the direct impact that government policy has had on labour hiring over the recent past.

The big lift in public sector employment is showing up as a big rise in government recurrent expenditure and an increasing share of public spending as a share of the economy. There is a case to be made that it is crowding out household consumptions at present (see below).

Consumption growth and the case for tax reform

Household consumption growth has been slowing despite strong growth in employment and a decline in the savings rate (chart 6). Real household consumption growth was running at 1.8%/yr in Q1 2019 – it’s slowest pace in almost six years. In fact, over the past six years household consumption growth in Australia has averaged a modest 2.4%.

General government consumption growth, however, has been strong. And it’s been significantly higher than household consumption growth over the recent past. More specifically, over the past four years, real general government consumption growth has averaged a touch above 4.5%/yr (chart 7). It was running at 5.1%/yr at Q1 2019. Put another way, recurrent spending by government has significantly outpaced that of households over the past four years. It has been driven primarily be spending at the national level, although both state and local recurrent expenditure growth has also outpaced that of households. The strong growth in public sector employment goes a big way to accounting for the growth in government consumption expenditure.

The data is essentially telling us that the household saving rate has been falling so that households can maintain a modest level of consumption in the face of declining income growth. In fact, the rate of growth in consumer spending hasslowed over the past year to be almost flat on a per capita basis. But growth in general government consumption, which is taxpayer funded, has been strong. Total aggregate demand has therefore been propped up by the government sector, but workers have had to foot the bill.

Bracket creep, where nominal wage inflation pushes people into higher tax brackets, has helped to fund a strong rate of growth in general government consumption. Firmer commodity prices have also helped through higher corporate profits and royalties.

At its most fundamental level, workers in Australia have been handing over an increasing share of their income at a time when the savings rate is low, wages growth is soft and household debt is at a record high. It is no wonder that many households are feeling the pinch.

We are not in the business of pushing a policy agenda. But the trends in employment and consumption from a public/private sector perspective point to the need for some of the disparity to be narrowed. Slowing the rate of growth in general government expenditure while providing income tax relief for households would seem a logical and equitable step in the right direction. The forthcoming tax rebates are a good start. But more should be done including reform to shift the tax mix more broadly.

Relative to the OECD average, Australian tax collections are significantly “overweight” personal income tax and “underweight” consumption taxes (chart 8). This means that workers in Australia are shouldering a disproportionate tax burden relative to most other comparable nations. And that burden is being magnified each year through bracket creep.

The return to surplus at a federal level masks the increase in public spending as a share of the economy. The Australian economy has been sleepwalking towards a state of low productivity and low output per capita. There should be a stronger policy agenda that encourages and channels capital into projects that improve the productive capacity of the economy over the long run. Establishing an efficient taxation system that incentivises innovation and productive investment is one area that could help lift productive investment. The importance of fiscal policy, and in particular tax policy, in creating an environment that supports business investment and household consumption should not be underestimated.

We’re all Keynesian’s now.

David Llewellyn-Smith
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