Dear prudence, you’ve come back to stay

June 13, 2012
The Age

It’s better for businesses to adapt to the way the world now works.

ONE of the first lessons economists teach us is that the economy moves in cycles of boom and bust. A second, trickier, lesson is that although most of the changes going on in the economy at any moment are ”cyclical” (temporary), there may also be changes driven by ”structural” (longer-lasting) forces.

In a speech last week, Glenn Stevens, governor of the Reserve Bank, implied that much of the ”unrelentingly gloomy” public discussion about the economy may be caused by people mistaking structural problems for cyclical ones.

Despite the official statistics saying the economy is quite healthy, people think it is weak and want the economy’s managers to get it moving by such standard remedies as a tax cut or a cut in interest rates.

But if the problem is structural – if it arises from deep-seated changes in the economic environment – such remedies will make little difference. Structural change is rarely painless, it often involves people losing their jobs and businesses failing, but it is almost always better to adapt to the way the world now works than try to resist it.

The boom in export prices and the construction of new mines arises from the historic re-emergence of the Chinese and Indian economies and is a classic example of structural change. The accompanying high dollar is helping to bring about a long-term shift of workers and capital into mining and away from manufacturing, tourism and overseas education.

But Stevens argues the resources boom is getting blamed for the problems of industries whose tough times are the product of a quite different source of structural adjustment: the markedly changed behaviour of Australian households.

In the mid-1970s, households began reducing the amount they saved, meaning their spending was able to grow faster than their income. This went into overdrive between 1995 and 2005. Over that decade, households cut their rate of saving by a cumulative 5 percentage points. In consequence, their consumer spending grew at an average annual rate of 2.8 per cent per person, after allowing for inflation, even though disposable incomes grew at a real annual rate of just 2.3 per cent.

Why did so many of us feel we no longer needed to save much? Largely, it seems, because we saw ourselves getting wealthier as each year passed. The gross value of assets held by households – mainly the value of our homes – more than doubled between 1995 and 2007. That involved a real annual increase of more than 6 per cent per person.

Only a small part of this increase came from the building of additional homes. Most of it was just the rise in the prices of existing homes.

So why did housing prices rise so dramatically? Mainly because we went through a decade-long frenzy of competing with each other to move to better homes, which bid up prices.

In the process, of course, households took on a lot more debt, including for investment properties. Total household debt rose from 70 per cent of total annual household income in 1995 to about 150 per cent in 2007. This unprecedented ”gearing up” by households was made possible by the deregulation of the banks and the return to low inflation and, hence, low mortgage interest rates.

All this borrowing could not have gone on forever, and households began to call a halt a year or two before the global financial crisis reached its peak in late 2008, after which they began saving a lot more and trying to get on top of their debts.

While households were increasing their rate of saving, their consumer spending grew more slowly than their incomes. But the saving rate has been relatively stable – at a level last seen in the ’80s – for about 18 months, meaning consumer spending has returned to growing at the same rate as incomes.

As part of the return to prudence, the rate at which homes change hands has fallen by a third from its average over the previous decade. And now the demand for housing has slackened, house prices have fallen back. They won’t keep falling forever, but nor are we ever likely to see them shooting up the way they used to.

The return of the prudent consumer is causing adjustment pains for various industries: the banks aren’t doing as much business (I know your heart bleeds), nor real estate agents.
Last but not least are the retailers. The halcyon days of rapid growth in consumer spending are gone for good and they’ll just have to get used to it. Retailers selling the sorts of things people buy when they move into a new home are finding life a lot tougher.

But the end of the ”platinum age” is just one source of structural change. Another is that retailers sell goods, but as each year passes more of the consumer dollar goes on services and less on goods.

Yet another is the digital revolution. While shopping in one store, people are using their smartphones to check the prices being offered in rival stores, then demand they be matched. And the internet is giving people access to the cheaper retailers in other countries.

None of these various structural changes is the fault of the government and there is little the managers of the economy can or should do to halt or even alleviate them.
Business has little sensible choice but to adjust. In any case, most are for the better.

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