Stevens thinks things are great, but in Victoria...

VICTORIAN business has sent out a mayday call, warning that the state's economy is deteriorating.

A new business survey reports that conditions have slid to their worst levels since 2009, and are expected to get worse in the coming year.

As Reserve Bank governor Glenn Stevens talked up the economy at a lunch in Sydney, the quarterly survey by the Victorian Employers Chamber of Commerce and Industry (VECCI) and the Commonwealth Bank found a very different message coming up from ground level, in Melbourne and regional towns alike.

The 300 or so employers surveyed said conditions were the worst since the global financial crisis. Sales, profits and business investment were all at their lowest level since March 2009. The only growth was in wages and labour costs, they reported.

Forecasts for 2012-13 were even bleaker. For Victoria, only 9 per cent forecast stronger growth in 2012-13, while 61 per cent tipped growth to weaken.

For Australia, they were only slightly less pessimistic: 13 per cent predicted the economy would improve while 51 per cent expected it to weaken.

VECCI chief executive Mark Stone was almost apologetic, suggesting the results might have been affected by "uncertainty due to global instability (and) . . . the introduction of the carbon tax on July 1". But he said it did reflect recent conditions and urged the federal and state governments to give a lead by:

. Lifting investment in productivity-enhancing infrastructure projects, such as the East-West Link.

. Reducing "unnecessary red tape stifling small business competitiveness".

. Helping more Victorian firms get into export markets.

The survey highlights the reality that Australia is a two-speed economy, growing mostly in the minersphere mining and industries dependent on it. Deloitte Access Economics forecast this week that in the next five years Victoria and the rest of the south-east would grow at barely half the pace of Queensland, Western Australia and the Northern Territory.

"The bulk of the evidence suggests Victoria's slowdown will be modest, with the dangers of its housing setback contained without wider damage," Deloitte said. It predicted that the state's economy would be rebooted by solid growth in consumer spending, sharply rising exports and a housing recovery from late 2013.

Others are less confident. BIS Shrapnel chief Frank Gelber has urged the state government to bump up infrastructure investment, to make it a driver of growth, rather than cut it as planned.

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Australia. It's better in the west

A WIDENING gap between Western Australia and the rest of the country has overshadowed a slight rebound in business conditions in June, after they hit a three-year low in May.

The latest business survey by National Australia Bank shows that conditions and confidence both remained marginally negative in June, but with large divergences across states and industries.

The balance of positive and negative responses in the survey showed that, across the nation, business conditions in June improved to -1, up from -4 in May. But business confidence went down a tad, from -2 to -3.

The bleakest detail was that the balance of companies reporting good forward orders shrank to the lowest level in three years. NAB chief economist Alan Oster said this was "driven largely by a heavy fall in manufacturing orders".

Mr Oster estimates that the Australian economy was travelling well below trend speed in the June quarter, with underlying GDP growing at an annualised 2.25 to 2.5 per cent.

In the June quarter, conditions deteriorated in every industry except retailing. Mr Oster said the standout pick-up in retailing "possibly reflects increased trading as a result of the recent spate of government cash payments to households".

Retailing conditions picked up from -11 in May to -1 in June. Conditions in the construction industry also improved after an exceptionally bad month in May, the balance of survey responses improving from -29 to -16.

Mining had the unusual double of having the strongest business conditions (+14) but the weakest business confidence (-14). Mr Oster attributed the latter to a combination of a weaker outlook for commodity prices and "trepidation over the MRRT [mining tax] and carbon tax".

Confidence picked up in the finance sector (from -10 to +2) after the Reserve Bank cut interest rates a second time. But it fell sharply in manufacturing (to -10), roughly matching the negative reports on actual conditions for the sector (-12).

But the most startling difference in the survey was between the responses from Western Australia and everywhere else. In June, WA business conditions were rated as +27, while the next strongest state was New South Wales with +1.

Victoria (-10) replaced Tasmania (-5) as the state with the worst business conditions, although Queensland (-7) rated lowest on business confidence. No state, not even WA, recorded positive business confidence last month.

Mr Oster said NAB expected the Reserve Bank to make one more rate cut this year, possibly in September, to offset the impact of the sharp budget tightening. But he expects activity to gradually pick up ahead, predicting growth of 3.3 per cent in 2013.

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Good but not that good. The green lights won't last

HOW do we follow up a week like that? For months the economic data here and abroad has been all red and amber lights. Then suddenly we get a wave of green lights, all at once, that seems to clear away the blockages and open up a clear path ahead.

An interest rate cut on Tuesday was followed by the Bureau of Statistics reporting unbelievably strong GDP growth and a sustained rebound in jobs. Then the rest of the world waved us on: China cut its interest rates and announced huge export growth, and European finance ministers agreed to lend Spain up to 100 billion euro($A125 billion) to prevent the collapse of its banks.

If only every week was like that. Then Wayne Swan and the Pollyanna chorus would always be right, confidence would never be short and there would be no point in reading (or writing) columns on economics.

But we know that things are not that simple. We don't usually get waves of green lights sweeping us past every intersection. Good data behind us even if it survives the revisions does not guarantee good times ahead. It's certainly welcome, but while it eases the problems facing Australia and the world in the next 18 months, it does not remove them.

For Australia, the next big test is the introduction of the carbon tax on July 1, along with $2.4 billion of handouts to households in compensation and the school kids bonus. That will be a test of the hyper-emotional, hyper-negative tone that suffocates political debate in these times. Influential forces are trying to derail the tax, and would not mind if they derailed the economy as well.

For Europe, the next big test will be Sunday's Greek election, and the negotiations that will follow, whoever wins, to either rewrite Europe's fiscal austerity pact or remove Greece from the eurozone. At this stage, everyone is taking positions to try to influence the election result. What will happen after it is anyone's guess; the stakes are immense.

Take Australia first. At face value, last week's GDP figures tell us the economy is powering ahead, propelled by robust consumer spending (up 4.2 per cent in a year), quite extraordinary growth in engineering construction (up 53 per cent in that time), strong growth in payrolls (7.4 per cent) and productivity (4 per cent) and booms in sectors from finance to government administration, healthcare, the professions, wholesale trade and agriculture.

Most of that is probably broadly true, if overstated. As I reported on May 11, the Bureau of Statistics has run into technical problems with its jobs data, leading it to overstate jobs growth in 2010 and understate it in 2011 and 2012. Federal and state tax collections confirm that actual job growth has been stronger than the bureau figures show. And that means the economy has also grown more strongly than we thought.

Healthcare and the professions are growth industries. The farmers have had a lot of rain, wholesalers have had a lot of imports. The big banks are shedding staff, but they are also losing market share to smaller banks and non-bank lenders. And migration figures imply that population growth is accelerating.

But there are serious question marks over the two drivers of growth. Growth in consumer spending actually slowed, yet the bureau says that prices have stopped rising, so we've actually hit the pedal to buy more and more. Tell that to High Street.

Even more amazing, it says engineering construction costs are almost flat, despite the mining boom: in the past 3 years they have risen 1.8 per cent (0.5 per cent a year), a sharp change after 24.8 per cent growth in the previous 3 years. Tell that to the Pilbara.

The GDP numbers are likely to be revised down, but to still fairly buoyant levels. The central problem remains: mining is booming while south-eastern Australia is not. In the year to March, spending grew by 10 per cent in the resource states but only 2 per cent in the south-east. The dollar, after three months of welcome falls, has bounced back up to nudge parity with the US dollar. And, like everyone else, our growth depends on what happens in Europe.

The rescue of the Spanish banks buys time for Europe's leaders to negotiate a growth pact, then either exempt Greece from its budget constraints or push it out of the eurozone and risk the fear and uncertainty that would create.

It was a good week for us, and the world, but there are rough times ahead. The best thing is that we are entering this period in stronger shape than we thought. And more than most countries, we are able to make our own fortune.

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Stevens: Why it doesn't feel as if we're doing okay

GLENN Stevens has three messages for us.

First, the economy is going better than we think: our glass is "at least half full".

Second, don't blame the mining boom for the rest of the economy growing slowly: rather, it's the hangover from our binge during the decade of debt.

And third, the days when "the effortless way to get rich was to gear into rising house prices" are gone for good. House prices and debt will not rise like that again. The Reserve Bank will not act "to pump up speculative demand for assets".

And we might draw a fourth message from the governor's speech in Adelaide: don't expect more interest rate cuts soon, unless things in Europe get really ugly.

The first message is hard to dispute after this week's bonanza of strong economic data even if Stevens hints gently that, like other economists, he takes the estimate of 4.3 per cent GDP growth with a grain of salt.

"The underlying pace of growth is probably not quite that fast, but it is quite respectable, something close to trend," he says. "If the recent data are taken at face value, the non-mining economy has grown at about 2 per cent over the past year."

Yes, but with the population growing at 1.5 per cent, economic growth of 2 per cent does not leave much new money to spread around.

And if the GDP number is revised down, as big growth numbers usually are, it leaves less again. Still, he's right: our glass is half-full.

The second message is his central one. Stevens is puzzled by why Australians don't see their economy as the island of growth it seems to outsiders.

He thinks much of our dissatisfaction really stems from the fact that household wealth is now going backwards, after a decade in which it averaged real growth of 6 per cent per head per year. But its growth was fuelled by sharply rising debt, and that had to end.

As we save more and spend less, Stevens says, real growth in consumer spending per head has roughly halved, but our financial position has strengthened: "A certain degree of thrift" is good for us.

His key point is that that thrift is a return to normal. It was the years from 1995 to 2007 that were unusual.

Retailing, banking, real estate and housing investors won't see those times again.

We need more confidence, he says, but "it has to be the right sort of confidence".

Our growth from here should be based on productivity, "doing things better, in 1000 different ways" not on speculation.

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Those growth figures - they'll be revised down

Wednesday's stunningly high estimate of 1.3 per cent growth in the March quarter is likely to be revised down in future, if past experience is any guide.

Bureau of Statistics data shows that of the past 100 quarterly GDP figures, 18 originally reported growth as being 1.3 per cent or higher. But 12 of those 18 figures were later revised down, most substantially so. Five were revised up, by small amounts, while just one of the 18 ended up as the figure first reported.

The bureau is constantly revising past GDP figures, often changing them dramatically as new data comes to light. But once the spotlight has moved on to the next figures, the public, politicians and economists take no interest. A spectacular example was the 1990-91 recession. The bureau originally estimated that GDP fell 3.2 per cent in the six quarters from April 1990 to September 1991. But now it estimates that GDP fell just 1 per cent in that time. What was said to be the worst recession since the Depression was revised down to be our smallest recession in loss of output - even though it saw the biggest loss of jobs.

The same is true at the top end. Initial estimates showing big GDP growth are usually revised down, on average by 0.4 percentage points.

Four of the past 100 quarterly estimates showed GDP growing by 1.3 per cent. All have since been revised down, on average to 0.9 per cent.

If that happened this time, it would still be a good result, given the strains on the economy revealed by wide-ranging job losses, falling house prices, and weak business and consumer confidence.

But the figures show most of our growth was in two areas - consumer spending and engineering construction - and both rest on very low estimates of inflation.

On these figures, consumer prices rose just 0.1 per cent in the six months to March. In the frenetically busy engineering sector, construction costs rose just 0.1 per cent in the March quarter, and 2.2 per cent in the year.

Despite the anecdotes and mining companies' complaints about the high cost of construction in Australia, the bureau says that in the past 3? years, engineering construction costs have risen just 1.8 per cent or 0.5 per cent a year. That's some contrast to the previous 3 years, when they rose 24.8 per cent.

If correct, that is remarkable, and it sheds a very different light on what a mining boom means for prices.

If it is wrong, then so are the GDP figures, since engineering construction made up almost half the growth in Australia's spending.

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GDP: These figures strain credulity

THERE'S an old saying among economists: if a figure looks wrong, it usually is. Yesterday's estimate that GDP grew 1.3 per cent in the March quarter amid all the job cuts is a good example.

These figures strain credulity. If they are right, then the economy has far more strength than we suspected. If they are wrong, they will be revised down, or followed by a fall.

These are just first estimates. The bigger the first one, the more likely it is to be revised. For June 2010, the first growth estimate was 1.2 per cent; that now reads as 0.6 per cent. Just a year ago, GDP was estimated to have fallen 1.2 per cent in the March quarter: that fall is now just 0.5 per cent.

Suppose the figures are right: what do they tell us that we didn't know? Quite a lot.

They show an economy firing on two engines: mining investment and consumer spending. We knew about the first, and is it firing! Engineering construction, 5 per cent of the economy, now generates half its growth.

In Western Australia, demand (total spending) jumped 14 per cent in the past year. On these figures, WA is growing faster than China. The surprise is the second engine. On these figures, far from being cautious consumers, we have been on a binge.

Consumer spending shot up by 1.6 per cent in the March quarter. We bought 3.7 per cent more food, 5.5 per cent more flights and transport services, as well as big rises in health services, spending in pubs and restaurants, entertainment, clothing, and so on.

But a close look shows something strange. In fact, growth in spending has not risen. In the past six months, it has been the slowest since 2010. What's new is that inflation has disappeared.

In those six months, the bureau says, consumer prices grew just 0.1 per cent. So virtually all our spending growth must have been used to buy more of everything. Really? Yes, we bought more bananas, but all the other stuff?

A second surprise: productivity shot up. With all the job cuts, hours worked fell 0.6 per cent. But output grew 1.4 per cent, so that means we produced 2 per cent more for every hour worked. The bureau estimates productivity shot up 4 per cent in the year, and 5.3 per cent in the market sector. That's hard to swallow.

Third surprise: the bureau says all sorts of industries are enjoying unexpected booms.

Government spending grew a modest 1.2 per cent over the year, yet the output of public administration shot up 5 per cent. You wonder how they work that out.

Mining had the fastest growth (11.3 per cent) and agriculture (10.6) was close behind. Finance recorded 5.4 per cent growth, despite job cuts and little credit growth. The professions, transport and wholesale trade all grew more than 5 per cent. Even on these figures, Australia is still a two-speed economy. Over the year, demand grew 10 per cent in the mining states, and 2 per cent in the south-east, where 70 per cent of Australians live.

The figures suggest Victoria was in recession in the second half of 2011, but leapt out of it in the March quarter, thanks to us consumers. Uh-huh.

Wayne Swan wants us to take pride in these figures. I would if I could believe them.


WHERE THE GROWTH IS:

BY STATE

Growth in demand, year to March

$b %

Resource states

WA 5.8 13.6
Queensland 5.2 7.8
NT 0.7 15.1
Total 11.8 10.2

South-eastern states

NSW 2.1 2.1
Victoria 1.5 1.9
ACT 0.4 3.2
SA 0.2 0.7
Tasmania - 0.02 - 0.2
Total 4.2 1.9

BY SECTOR

$m %

key sectors of growth
Consumer spending 7.8 4.2
Engineering construction 7.7 53.0
Exports 3.9 6.3
Machinery & equipment 1.5 7.5
Fed govt investment 1.1 21.2
Business building 0.8 11.8
and those pulling us back
Imports - 8.3 - 11.5
State govt investment - 2.3 -15.3
Housing construction - 1.1 - 6.2

BY INDUSTRY $m %

Mining 2.7 11.3
Finance 1.7 5.4
Professions 1.1 5.3
Health 1.1 5.5
Construction 0.9 3.5
Transport 0.9 5.1
Government 0.8 5.0
Agriculture 0.8 10.6
Wholesale trade 0.8 5.5
but not
Manufacturing 0.2 0.6
Electricity - 0.1 - 3.0
IT/communications - 0.1 - 1.2

Source: Australian Business of Statistics

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Memo Australians: The IMF dos not agree with you

THE International Monetary Fund has set Australia a challenge. If it is right, in 2012 we will experience the third-fastest economic growth of the 34 rich countries.

This will be at the same time as a fiscal tightening 2? times more severe than in Europe, and a sharp fall in our export prices. If we achieve that, it will be heroic, not to say improbable.

Essentially, the IMF has backed Treasury's forecasts - Australia has a history of getting upset if it doesn't - but the absence of any commentary on Australia in the 400 pages of reports released this week is hardly a ringing endorsement.

It predicts that Australia will grow by 3 per cent this year, and 3.5 per cent next year and thereafter. Inflation will stay within the Reserve Bank's target band.

Prices for coal and iron ore, our two biggest exports, will plunge 25 per cent over 2012 and 2013, sending our current account deficit back up again.

The IMF does not say Australia "will outperform every other major advanced economy in the world", as Julia Gillard and Wayne Swan wrongly claimed yesterday.

The IMF does not endorse Australia's bipartisan policy of pushing the budget into surplus in 2012-13, regardless of the effect of growth.

It implies the opposite: its board of directors and its chief economist, Olivier Blanchard, urge low-debt countries (such as Australia) to "reconsider the pace of consolidation" and rely on "automatic stabilisers" growth-lifting revenues and cutting welfare bills to "reduce deficits over time".

Two key points. The IMF's forecasts are just forecasts. Two years ago, it forecast Australia to grow 3.5 per cent in 2011. A year ago, it cut that to 3 per cent.

The real outcome, as Tony Abbott notes, was growth of just 2 per cent. Its forecasts rarely differ significantly from Treasury's: it doesn't work that way.

What matters in the IMF's World Economic Outlook is not what it says about Australia but what it says about the world. And that is very true this time.

For the world economy, it is hopeful, but not confident. It forecasts growth to be a subdued 3.5 per cent this year, rising to 4 per cent in 2013. But Blanchard depicts the global scene as "uneasy calm: one has the feeling that at any moment things could get very bad again".

The IMF sees three main risks. The biggest is Europe's fragile repair job last December. While the progress is encouraging, it says, the problems remain unsolved, and excessive fiscal tightening risks another collapse, potentially breaking the eurozone apart. If that happens, it warns, the financial cataclysm could make 2008 look good.

Second, an attack on Iran might blow global oil prices sky-high, taking the "fragile" recovery with them.

And third, to fix their balance sheets, Europe's stressed banks might impose a credit crunch that would send a shockwave around the world even here.

Blanchard says the top priority is "to durably increase growth and decrease unemployment" in advanced economies.

"We think that wherever it is possible, automatic stabilisers should be left to play," he said. "This is a remark about Spain, and other countries as well."

Are you listening, Treasurer? Prime Minister? Opposition Leader?

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WTO tips growth to struggle

IN ANOTHER sign that the world is in for a rough year, the World Trade Organisation estimates that exports globally will grow just 3.7 per cent in 2012 barely a third of their long-term average growth rate.

WTO director-general Pascal Lamy said the WTO has also cut its preliminary estimate of export growth in 2011 from 5.8 per cent to 5 per cent, and expressed concern at "a steady trickle of restrictive trade measures" being adopted.

"The world economy and trade remain fragile. The downside risks remain high," Mr Lamy said. "We are not yet out of the woods."

China's growth slowdown follows a similar development in India, now Australia's fourth-biggest export market. Official estimates put India's growth in the year to March at 6.9 per cent, the lowest in three years.

New figures show India's industrial production grew just 4.1 per cent in the year to February, amid weakening export demand and rising interest rates. As in China, India's central bank is expected to cut interest rates to revive growth.

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Memo Treasurer: We're not the toast of the G20

Treasurer Wayne Swan is out thumping his chest about Europe. First, he warns us that if we don't have a budget surplus in 2012-13, we could end up like Europe. Second, he tells us that Australia is a standout in the world economy, the envy of the world.

On Sunday, the Treas ascribed Spain's 23.6 per cent unemployment rate to lax fiscal discipline before the global financial crisis. Then yesterday, he confided that at the coming G20 meeting in Washington, ''there's not too many finance ministers ? who wouldn't trade places with Australia in a heartbeat''.

We keep hearing this, but is it true? Was Spain's collapse due to lax fiscal policy? Is Australia the country everyone else wants to be?

Take fiscal policy first. This is Swan last Sunday in his weekly economic note: ''If the events in Europe over the past 18 months teach us anything, it's the importance of budget discipline. Many governments ignored the necessary economic reforms over a long period, allowing their spending to blow out and their budgets to become unsustainable. We see the consequences of this today in the region's sovereign debt crisis.

''The failure to maintain fiscal discipline has undermined confidence and economic growth across Europe. This has led to lengthening jobless queues and unemployment rates that are two, three and even four times our own. In Spain, for instance, the jobless rate is nearly 23 per cent. Australia's continued strict budget discipline is our best defence against this uncertain global outlook.''

But hang on, Treas: did no one tell you that before the global financial crisis Spain was running even bigger budget surpluses than Peter Costello: 2 per cent of GDP in 2006, 1.9 per cent in 2007? Or that from 1996, Spanish governments of both sides more than halved its net debt: GDP ratio, from 60 per cent of GDP to 26.5 per cent?

Spain's crash was not due to a lack of budget discipline. It was brought on mostly by the collapse of a huge real estate boom, which has now turned into a savage bust.

That combined with all the factors that have sent Europe into recession: the big losses of European banks lending into US sub-prime housing and other risky markets; the contagion effects from Greece; and the vicious circle of falling asset prices, falling spending, falling employment and falling incomes and revenue, which is now becoming a vortex dragging it down towards a long depression.

Housing prices have slumped 22 per cent from their peak and are forecast to fall by 12 to 14 per cent more this year. Standard & Poor's forecasts that by Christmas, 25 per cent of Spanish home owners will have negative equity, owing more than their property is worth.

What's the lesson? Avoid booms. They tend to bust in damaging ways. But in Australia, officials are cheering on a mining investment boom, which one day will also bust, spreading its fallout all over our economy.

Spain's new conservative government plans to emulate Swan. On Tuesday it presented a budget that aims to cut the deficit next year from 8.5 per cent of GDP to 5.3 per cent.

Bloomberg reports that ministries' spending will be reduced by 17 per cent on average, with the foreign ministry cut by 54 per cent. Income tax and property tax rates have been hiked. But we saw in the 1930s that fiscal austerity in these conditions simply deepens the downturn.

Yes, there was fiscal indiscipline in Europe before the global financial crisis, but mostly by neglect. Greece was a Third World example of fraud, recklessness and incompetence, but it was unique.

IMF data shows that in 2007, of governments in 18 rich European countries, five (all in Scandinavia) were net lenders. Four, including Spain and Ireland, had brought their debt:GDP ratio to relatively low levels, between 10 and 26 per cent. (Ireland, too, was the victim of a property boom going bust.)

Eight others, ranging from Britain (38 per cent) to Italy (87 per cent), were guilty of fiscal complacency. Some stayed in deficit throughout the good years. Germany and France repeatedly breached the EU's Maastricht budgetary rules, which they themselves had written. Portugal, another crisis state, was among the offenders. And lastly, Greece was in a class of its own.

And how does Australia compare? The IMF figures show that, far from being a world leader in fiscal discipline, in 2007 our surplus ranked only 16th of the 34 rich countries as a share of GDP. Last year, we ranked 18th. That's no standout effort.

On the economic front, we are doing better than most European countries, worse than most Asian ones. Last year, our growth rate of 2.1 per cent put us just equal 13th of the 34 rich countries.

Around the G20 table, Swan will find that 13 of his 19 counterparts can boast higher growth than him. They include South Korea (3.6), Germany (3.0) and Canada (2.5), as well as all 10 developing countries.

Australia ranks better on unemployment, but even there, our 5.2 per cent rate is just the ninth best of the 34 rich countries.

Surely we lead in something? Yes: the OECD estimates our growth in unit labour costs last year was the highest in the Western world, at 5.9 per cent.

Maybe the Treasurer can wear that gold medal in Washington.

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Budget cuts will bring on recession

The government has revealed that with growth at just 2.5 per cent, it will reject calls for tough budget cuts, raise spending in areas that need stimulus, and extend its deadline to put the budget back in surplus to 2015-16. You didn't hear that?

LAST week was budget week. The government revealed that with growth at just 2.5 per cent, it will reject calls for tough budget cuts, raise spending in areas that need stimulus, and extend its deadline to put the budget back in surplus to 2015-16.

You didn't hear that? Perhaps that's because that budget was in Canada: the country and economy most like Australia, but at the other end of the world. Facing similar problems, it has come up with a very different solution.

Canada is run by conservatives. Prime Minister Stephen Harper's government is the closest thing the world has to the Howard government. Finance Minister Jim Flaherty is a tough, no-nonsense social conservative who earned his fiscal spurs by shutting down the tax break for trusts. In his budget speech, along with familiar rhetoric - ''Canada has outperformed most other industrial countries … Our net debt to GDP remains the lowest in G7, by far'' - he anticipated the criticisms from the right for not cutting more from spending:

''We remain concerned about the number of Canadians out of work … Because of our government's responsible choices, we can eliminate the deficit through commonsense, moderate restraint. We have no need to resort to drastic cuts … We have no need to undertake radical austerity measures … The savings we have identified are moderate, less than 2 per cent of federal program spending.''

I suspect John Howard, were he still in power here, would do the same. And I suspect Tony Abbott, were he in power, would do much the same - whatever he says from opposition.

Take New Zealand: the other country most like Australia, except that its mines are forests and sheep farms. On Sunday NZ Prime Minister John Key declared he will stick to his timetable to get the budget back in surplus in 2014-15. Key, too, is from the conservative side.

Canada and New Zealand do not lack shock jocks and right-wing ideologues demanding a budget surplus ASAP. Rather, as economist Saul Eslake of Merrill Lynch Australia puts it, Labor's leaders are afraid of being seen as being another fiscally irresponsible Labor government:

''Labor craves the approval of the financial markets in a way the Liberals don't need to,'' Eslake says. ''Labor has to show that it can govern responsibly. The Liberals don't.''

It is the only plausible explanation for the tragedy we are about to experience. Next month Julia Gillard and Wayne Swan will give us a budget that will probably send most of Australia into recession.

In one year, we will go from a deficit of 2.5 per cent of GDP or more, to a surplus. By a mix of revenue rises and spending cuts, Labor will pull 2.6 per cent of GDP out of the economy. That is 2½ times the fiscal contraction imposed by the Hawke government in 1986-87, or the Howard government in 1996-97. It is the stuff recessions are made of.

Why do it? Because Labor has pinned its credibility to its pledge to deliver a budget surplus in 2012-13. The promise it made in 2009 has become a mantra, repeated 1000 times over, and to be delivered regardless of economic conditions.

In 2009, Treasury had assumed that by now the economy would be booming, and the government would pass the baton to the private sector to take Australia on. It projected economic growth in 2011-12 and 2012-13 of 4.5 per cent, each year. It projected almost 600,000 new jobs. Would the private sector be ready to take the baton? You bet.

Now 2012-13 is almost here. Growth is just 2.5 per cent, with most of that in outback mines. In south-eastern Australia, except mining areas, activity is weak. Much of the country is close to recession. Job growth has stopped. Retailing is flat, manufacturing is weak, housing in free fall. The high dollar is slowly strangling trade-exposed sectors; high interest rates are cramping the rest.

Is the private sector ready to take the baton? Into these headwinds? No way.

But it won't be that bad, we're told. Treasury points to an IMF study last year of 173 serious ''fiscal policy changes'' in Western countries in the past 35 years. The study, Expansionary Austerity: New International Evidence, found that, on average, budget savings equivalent to 1 per cent of GDP will lower GDP itself by 0.62 per cent after two years. The penalty rises with bigger savings, but more slowly, with each percentage point of extra budget savings cutting GDP by 0.5 per cent.

Assume that our budget savings will be 2.6 per cent of GDP. On the IMF average, that would cut 1.4 percentage points from GDP growth by mid-2014. If you assume that we would otherwise grow at our trend rate of 3 per cent a year, that would still give us growth of 2.3 per cent.

But no: the detail of the IMF study suggests Australia's budget cuts will intensify the divide between mining and the rest. It implies that over two years, domestic demand would shrink by 2.75 per cent. There would be gains in net exports, but the regions and sectors hurting now would hurt much more. And the IMF found the damage was twice as big when the country is seen as low risk - as Australia is. This implies that over two years, we face a loss of almost 3 per cent of GDP, and 5 to 6 per cent of domestic demand.

The study cited to play down the risks of Swan's strategy in fact shows how high they are for the non-mining states and sectors. Which is more important: keeping a promise or keeping us out of recession?



WAYNE SWAN April 4, 2012

MUCH has been said in recent days about why the government is returning the budget to surplus in 2012-13.

That's only natural and indeed it's very important we have a strong debate about our economy.

Recent opinion pieces by The Age's economics editor, Tim Colebatch, have claimed returning the budget to surplus would put the economy at risk.

Mr Colebatch is a highly respected observer of the economy and I always read his opinions with great interest, however, on this occasion he ignores some crucial facts, which help explain why delivering a surplus is such a vital economic imperative.

But first, some context. In the face of the worst global meltdown in about 80 years, the government stepped in to support demand, protect jobs and keep the doors of business open. This ensured our economy did not go into recession, virtually the only developed economy not to.

Our response to the crisis underpinned growth in our economy, which is now more than 7 per cent larger than it was pre-GFC. Not only have some advanced economies not even returned to their pre-crisis output level but some are again going backwards after contracting in the December quarter.

With solid growth, healthy public finances, low inflation and low unemployment, we are already the envy of many other advanced economies.

In a couple of weeks I'll be attending my 20th G20 meeting and I can confidently say there's not too many finance ministers around that table who wouldn't trade places with Australia in a heartbeat. Just as it was right to step in and support demand when it was needed, it is right to step back and provide space for the private sector to grow and that is what we have been doing.

Indeed, it's exactly because our economy is moving back towards trend growth that returning to surplus is the responsible course for fiscal policy.

Crucially and this is what Mr Colebatch overlooks the Treasury forecasts for growth in the next financial year already take into account that the budget will return to surplus.

Obviously, our consolidation has a dampening impact on growth but this is offset by the strengthening growth in the private sector.

In other words, the Treasury's forecasts of growth around trend are based on our announced policy setting including our commitment to return the budget to surplus.

The most constructive contribution fiscal policy can make to a patchwork economy with uneven growth across sectors is to move the budget back to surplus. When setting interest rates, the Reserve Bank takes into account all the economic influences on monetary policy, including the stance of fiscal policy.

Moving the budget back to surplus in 2012-13 also ensures we're not adding to price pressures in the economy, providing monetary policy with maximum possible flexibility to respond to economic developments.

It is Australia's best defence in these times of global economic uncertainty. When asked about the government's plan to return the budget to surplus in 2012-13, the deputy director of the IMF's research department, Jorg Decressin, said: "Where you have these strong investment plans in the pipeline, where the growth prospects are still quite good, this strikes me as appropriate."

We are now one of only eight countries to be awarded the coveted AAA status with a stable outlook by all three major credit rating agencies.

This is the first time in Australia's history this has been achieved and has been repeatedly described as partly a result of our strict fiscal policy.

It didn't happen under Howard and Costello, despite what the Liberals would like you to believe. Returning the budget to surplus also allows us to make the investments our country and our community need for the future.

In more general terms, any government must decide its policy setting on the basis of its best assessment of the state of the economy and our economic prospects.

Yes, we face challenges such as those flowing from a high dollar, but with probably the strongest economy in the developed world, I'll stand by our record and our assessments of the economy so far.

I'm an optimist about our country and I firmly believe it's a very bright outlook as we stand at the start of this Asian century, as long as we're up to the task of continuing our record of responsible economic management and embracing the vast opportunities that lie before us.

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Swan's foolish surplus fetish

WAYNE Swan's determination to deliver a budget surplus, regardless of the state of the economy, is seriously reckless. Labor has chosen to risk sending most of Australia into recession in order to keep a promise it should never have made.

No Australian government has ever proposed such a huge withdrawal of spending from the economy. On his own published figures, Swan plans to take us from a deficit of $37 billion this financial year, perhaps more, to a $1.5 billion surplus in 2012-13.

On Treasury's estimates, that would take at least 2.6 per cent of GDP out of the economy in 2012-13. That is equivalent to shutting down the entire electricity industry, all arts and entertainment venues and all airline travel for a year.

Why on earth would you do this in an economy that has added just 10,000 jobs in the past year, where the growth rate is just 2.5 per cent, and most of that is in mining and related industries, and with Victoria and south-eastern Australia on the verge of recession?

What Swan is planning for 2012-13 goes far beyond any previous budget cuts. In 1986, the hairshirt Hawke-Keating budget cut away 1.1 per cent of GDP. The first Howard-Costello budget in 1996 took out 1 per cent of the economy.

Labor now pledges to deliver cuts two to three times as large as those landmarks of fiscal austerity - at a time when most sectors of the economy are already going backwards or sideways under pressure from the high dollar and low demand.

Swan says it will be OK because ''the economy is moving back towards trend growth''. Not if you take away 2.5 per cent of it, it won't be.

We heard the same claims made in Britain when its Conservative/Liberal government slashed public spending and forecast that the economy would bounce higher. Instead, it hasn't grown for 15 months and unemployment is now at 8.4 per cent.

Just do the sums. Suppose Treasury forecasts trend growth of, let's say, 3 per cent in an economy when it's already taken out 2.6 per cent of activity. That would imply that it thinks growth would have been 5 to 6 per cent had the budget bottom line remained unchanged. In the position we're in now, that is ludicrous.

Swan's economic case for this hara-kiri is, first, that the economy is ''on the way back up''; second, that it will create room for the Reserve Bank to cut interest rates; and third, that it will ''send a strong message of confidence to investors around the world''.

The first claim is clearly wrong. The second is misplaced: the Reserve already has plenty of room to cut interest rates, given low inflation and low growth. It doesn't need an excuse; it just needs the honesty to admit it was wrong.

And the third case is counter-productive. It is because investors are so confident in Australia that they have driven our dollar to levels that have made Australian producers uncompetitive. That's why Victoria has lost 42,000 full-time jobs since last April.

This budget is Labor's last chance to get it right. Its complacency about the real state of the economy is breathtaking; 60 of its 72 MPs are in the south-eastern states, which are being flattened to allow the mining boom to go full speed without triggering high inflation.

The focus of this budget should be on targeting a stimulus to recharge the south-east, including south-east Queensland.

The risk is that, instead, it will end up with most of Australia in recession, the budget still in deficit and Labor losing power in a landslide.

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Irish nightmare: Prepare

MARIAN Wilkinson's absorbing Four Corners report this month on the collapse of the Irish economy was a powerful reminder of two fundamental truths. Booms tend to end in busts. And the busts do more harm than the boom does good.

It could be a valuable lesson for the Gillard government - which desperately needs to reconnect with the voters and economic reality - for its advisers, for the Reserve Bank, for the federal opposition, now in effect a government-in-waiting, and for all of us.

A day after Queensland's electoral massacre, Treasurer Wayne Swan began his weekly note with another enthused spiel on how good things are - ''an economy that is growing solidly, low unemployment, very low debt, sturdy public finances, and contained inflation'' - and above all, '' a resources sector that is going from strength to strength''.

''New (resources) investment has risen from $47 billion in 2010-11 to $95 billion this year, and will rise again to an expected $120 billion in 2012-13'', he said, momentarily confusing facts and forecasts. ''The boom in investment isn't surprising given the boom in exports ? (which) are likely to reach nearly $200 billion this financial year, and climb to around $258 billion in five years.''

And all this is good for us? Remember the property boom in Ireland, and how rich it made the Irish feel - until it bust?

Our boom, too, is likely to bust: most booms do. The bigger the boom, the bigger the bust.

Don't worry about it, officials say. This time is different. This boom will last for years, maybe decades. The growth of China and India will see to that.

Uh-huh. Take a look at the graph, produced by the Reserve Bank. The terms of trade is a measure of export prices, expressed as a ratio to import prices. As you see, this is not the first big boom in our export prices. There was one in the 1920s, which ended in the Great Depression. There was one in the Korean War, which ended with 20 per cent inflation and recession in 1952-53.

As the graph shows, those booms ended with a hard fall, and prices then resumed their long-term trend decline (the blue line slanting downwards). This is our third export price boom: how will it end?

Frank Gelber, director of Sydney economic consultants BIS Shrapnel, has been thinking about that. BIS Shrapnel has had an outstanding forecasting record, winning the Palme d'Or as the best tipster in The Age midyear survey seven times since 1993.

Gelber has looked on with alarm as mining investment has risen from 1 per cent of GDP to 4.4 per cent last year, and perhaps 7 per cent by 2012-13. He sees at least five years of strong mining investment ahead. He has seen the Reserve Bank jack up interest rates in response, to rein in the economy so that this boom doesn't lead to an inflationary breakout. And he's seen the dollar soar to its new peaks in response to the mining investment, the high interest rates and the uncertainty over the big Western economies.

But if mining investment is booming by 50 per cent a year, and the economy's growth is held to slightly above trend, that means other sectors of the economy have to shrink to make way for it. Long-established businesses are dying, factories closing, jobs going overseas - all to accommodate a boom that is only temporary and will give way to a bust.

''The boom will end when the supply of minerals catches up with the demand,'' Gelber says. ''I don't know when that is. We've now locked in projects that will underpin investment activity for the next five years, so the question is: what are the probabilities that it will proceed beyond that?

Gelber and BIS Shrapnel estimate a 25 per cent probability that the boom won't continue once these projects are built. They estimate an almost two-in-three probability that the boom will end within 10 years, and 90 per cent that it will be over within 15 years. Whenever it ends, he warns, Australia faces a major recession.

Why? Because the real boom is not in mining, a capital-intensive sector, but in mining investment, which reaches out far more into the economy. Treasury deputy secretary David Gruen estimates that while mining is only about 10 per cent of GDP, the ''mining-related'' economy is now about 20 per cent of GDP. That puts far more jobs at risk when the boom goes bust.

''Half of all the office space in Perth is now tied up with people servicing mining investment,'' Gelber says. ''The same is true for a quarter of the office space in Brisbane. Think of all the jobs in the construction sector, the back-line employment. The fall in investment will see a major decline in growth.''

But can't we then just bring back the industries now shrinking because of the high dollar? No, says Gelber. ''We're burning our bridges. We are losing the skills, the equipment and the markets. When the Australian dollar collapses, we won't have the industries any more. We will have to go through a total reversal of the process of structural change we are seeing now. We will see a big drop in our standard of living.''

What can we do to avert it? Gelber is pessimistic. The mining tax has been neutered. He sees value in governments investing in ''productivity-enhancing infrastructure'', such as the NBN, and in ''soft infrastructure'' such as research and development, and skills training.

But he warns: ''This is a long war of attrition.'' Firms in trade-exposed industries will be fighting for survival. Gelber wants policy makers to grasp that this boom, too, will end, and Australia will need a very different economy then. ''We've got to have an eye to what will happen after the mining boom. I'm aghast at how we are walking over the cliff, like lemmings.''

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Recovery. Victoria is in danger of missing out

AUSTRALIA will slowly move into a broad-based economic recovery in 2012-13 but Victoria is in danger of missing out, leading forecaster Frank Gelber of BIS Shrapnel predicts.

Unveiling new forecasts in Melbourne yesterday, Dr Gelber predicted that Australia's growth rate would slowly accelerate from 2.2 per cent in 2011 to 3.5 per cent in the 2012-13 financial year. If realised, that would be its best performance for five years.

But there would be two downsides. Interest rates would start rising again, with the Reserve Bank likely to deliver seven rate rises in the next 15 months. And apart from New South Wales, the south-east of the country will continue to struggle.

"The Australian economy is expected to strengthen further on the back of improving consumer spending and continuing heavy investment in the mining sector," BIS Shrapnel said. "However, the recovery is expected to be slow to set in. We expect the increased activity to prompt businesses outside mining to start increasing investment from later this year, after an extended period of underinvestment.

"However, the high Australian dollar, relatively expensive business credit, negative news from abroad, fiscal restraint and political uncertainty domestically will continue to weigh heavily on many industries and regions."

Mining investment would continue to boom, while trade-exposed sectors such as manufacturing, education, tourism and agriculture would continue to shrink. Government would also shrink, while the great mass of other service industries would keep struggling. Victoria would be main casualty.

"We look out two or three years and it's difficult to see where Victoria's growth is going to come from," Dr Gelber told BusinessDay. "We see investment in Victoria falling."

BIS Shrapnel predicts building starts in Victoria will plunge 20 per cent in the two years to 2012-13, while all other states would grow by between 6 and 21 per cent. Housing starts would fall 28 per cent, bringing Victoria back to the pack after years of outperforming the rest, while non-residential building would shrink 10 per cent.

"Victoria has weakened considerably over the past six months. It's lost its drivers of growth," Dr Gelber said. BIS Shrapnel predicts that a big influx of mining construction workers will lift population growth nationally, but NSW and Queensland will overtake Victoria in growth, with even WA coming close.

"There will be a broadening of investment in Victoria, but what is really missing are infrastructure projects," he said. "Investment is the primary driver of growth and Victoria needs better infrastructure to lift its productivity.

"These are things [the Victorian government] could do. But we can't see the next round of infrastructure projects coming through. Victoria is just falling behind the pack."

Dr Gelber hit out at the federal government's pledge to deliver a budget surplus in 2012-13, but said the collapse of its revenue base would see it fail to get there. "Fortunately, they won't achieve it. But they shouldn't even try," he said.

He urged the federal government instead to invest in "soft infrastructure", such as the CSIRO and other forms of research and development, and to take an axe to the jungle of over-regulation that is clogging up business.

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Victoria's economy has gone cold, neither government will fix it without a budget deficit

Victoria's economy has gone cold, and neither the federal nor state government can do much to stop it without putting their budgets in deficit.

Ted Baillieu has the bigger problem. Victoria is copping the brunt of job losses and stagnant spending caused by the high dollar, excessive interest rates, and a range of other factors.
Victoria is now either in recession or close to it. Yesterday's figures show the state is losing 5000 jobs a month. Since April, 42,000 full-time jobs - one in 50 - have been wiped out.

Wednesday's figures showed total spending in Victoria shrank in the December quarter.

Our economy needs stimulus. But Tuesday's figures told us the state's revenue base has collapsed. And on Wednesday, Treasury secretary Martin Parkinson said the federal tax base had collapsed too.

Victorian Treasurer Kim Wells is facing a perfect storm. Job losses mean less payroll tax. Cautious consumers mean less GST. Falling house prices mean less stamp duty. Even gambling has stopped growing. It wasn't why Team Baillieu decided to scrap 3600 public service jobs, but it's a good reason to do it.

But to do it now risks making the state's downturn worse. In the '90s Victoria's unemployment rate peaked, not under Labor, but under the Kennett government, because of its job cuts. The lesson from that was: take your time and deliver the pain when it's most easily absorbed.
Wayne Swan has locked himself into a surplus in 2012-13. Now he has to deliver it in an economy already slowing and with company tax revenues flat, which requires even bigger spending cuts. That will add to unemployment, and it makes no economic sense.

Both treasurers should listen to International Monetary Fund chief Christine Lagarde: don't make things worse by cutting spending hard now, she says. Instead, deliver reforms that make your budget stronger over the medium and long term. Australia and Victoria have low debt levels. That gives them the flexibility to make their budgets fit the circumstances.

Baillieu and Wells have options. First, their staff cuts could be made a medium-term goal, to be implemented as the economy picks up. Second, they could turn up the tap of spending on productivity-enhancing transport infrastructure: road, rail, level crossings. And third, they should say a firm ''no'' to the inflexible budget rules proposed by the Vertigan inquiry. The state must be free to respond to the economic situation.

Swan, alas, has already bound his own hands, and will therefore inflict a contractionary budget on an economy needing stimulus. A bolder government than his would break its budget pledge, and tell us honestly why it matters more to keep the economy going than to balance the 2012-13 budget.

Instead, it would seize its chance to tackle the big long-term threat to the budget: the ageing population. The pension age should be raised to 70, not 67 - and start rising before the baby boomers retire, not after the horse has bolted.

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Jobs riddle hints at weakening economy

Australia's jobs market is still flat. Jobs are growing strongly in Western Australia, but collapsing in Victoria. That's the real message coming out of the labour force figures released by the Bureau of Statistics today.

On the seasonally adjusted measures that people are used to focusing on, job numbers zagged after last month's zig.

In the past few months, job numbers rose in November, fell in December, rose in January, and now fell in February: down by 15,000, to end up back where they started.

The headline unemployment rate climbed back to 5.2 per cent.

This shows the naivety of comments last month by Treasurer Wayne Swan and the Reserve Bank seeing the January figures as a sign of improvement, rather than the statistical static you get when you try to use figures for the wrong purpose.

The Bureau keeps warning us that its monthly job movement figures are too imprecise to rely on, and urges us to use its smoothed trend data instead.

Pity the Treasurer and the Reserve don't listen.

And the trend figures this month tell us pretty much what they told us last month: there's virtually no job growth going on out there.

Every month, the potential labour force of people aged 15 and over grows by 18,500, but on average, only 1000 new jobs are created.

Soft spots

That fits with what the Bureau told us yesterday: economic growth has gone soft, above all in the south-eastern states with no coal, iron ore or new natural gas fields.

The economy's output grew at an annual rate of just 2.5 per cent in the second half of 2011, with the great bulk of that going into developing new mines in WA and Queensland.

They don't employ that many people, since much of the equipment is imported, and mining is a capital-intensive industry that employs just 2 per cent of the workforce.

By contrast, the jobs are going from labour-intensive sectors such as manufacturing, retailing, finance and government, which are mostly in the south-east.

That's why Victoria has lost 30,000 jobs since last April, while WA has added 30,000. NSW, South Australia and Tasmania are also losing jobs on balance, but at a slower rate.

In the past couple of months, even Queensland has gone backwards.

Jobs riddle

But if job growth has virtually stopped, and the potential labour force is growing by more than 200,000 a year, why is the unemployment rate stuck at 5.2 per cent instead of rising into the 6s?

Because more than 100,000 people who would normally be in the workforce have stopped looking for jobs, and hence don't count in the figures.

Why? That's the real riddle in these figures, and no one can fully explain it. Most of the people dropping out live in NSW or Victoria.

About a third of them seem to be teenage students deciding not to look for a part-time job. Some of it reflects the ageing of the population, although that is offset by the rapid rise in the proportion of older people staying at work.

But it wasn't happening a year ago. It's another sign of a weakening economy.

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Victoria on brink of recession; SA, Tasmania in it

VICTORIA is on the brink of recession and South Australia and Tasmania are already in one, as the high dollar, high interest rates and government spending cuts slowed Australia's economic growth in the December quarter to just 0.4 per cent.

A day after Reserve Bank governor Glenn Stevens left interest rates on hold, telling Australians that growth was ''close to trend'', the Australian Bureau of Statistics reported that growth in the year to December slowed to 2.3 per cent. Even in the six months to December, annualised growth was just 2.5 per cent.

Virtually all of the growth was in the coal and iron ore states of Western Australia, Queensland and New South Wales. Victoria, South Australia and Tasmania all went backwards.

The figures came as Treasury secretary Martin Parkinson revealed that federal and state revenues are now in crisis, with tax collections down by 4 per cent of GDP - almost $60 billion a year - and unlikely to return to former levels ''for many years to come''.

He warned of more pain ahead, saying: ''For both levels of government, surpluses are likely to remain at best razor-thin without deliberate efforts to significantly increase revenue or reduce expenditure.''

Dr Parkinson blamed the revenue collapse partly on tax breaks for mining. He revealed that mining companies earn about 20 per cent of all corporate profits, but pay only about 10 per cent of all corporate taxes, thanks to their huge deductions for depreciation.

Yesterday's figures show that in the first half of 2011-12, company tax collections rose just 1 per cent year-on-year. Last May the federal budget papers forecast an increase of 29 per cent. If the gap persists, it implies a revenue loss of $16 billion a year.

The bureau said state governments' revenue across Australia rose just 1 per cent in the first half of the financial year, while their spending rose 5.4 per cent. The state revenue collapse - mainly due to the slump in house prices - turned a combined surplus for the states of $4.15 billion a year ago into a deficit of $500 million.

The Baillieu government is implementing deep spending cuts to keep its budget in balance, cutting 3600 public sector jobs. The Gillard government has told departments and agencies their budgets will be cut by 4 per cent next year, implying thousands more jobs lost.

Treasurer Wayne Swan said that the poor revenue and weak growth figures would force the government to make ''significant'' spending cuts and/or revenue increases in the May budget to achieve its goal of a budget surplus in 2012-13.

''There's no doubt that there'll have to be significant savings,'' he said. ''But we think we absolutely need to do it ? to send a signal to the world that we're in good fiscal nick.''

Yesterday's figures show spending cuts are already dragging growth down. Cuts in state government investment wiped $2.5 billion off the nation's output for the December quarter, falling 15 per cent year-on-year as federal stimulus payments end and governments put off projects to stay in the black.

Victoria was less affected than most. But in seasonally adjusted terms, the bureau estimates total spending in the Victorian economy fell 0.5 per cent in December, after growing just 0.1 per cent in the previous quarter. On its preferred trend measure, Victoria's bottom line fell marginally in the December quarter.

Victoria, SA and Tasmania are being dragged down by the combination of a very high dollar, relatively high interest rates and government spending cuts. NSW is being kept going by coal investments, while WA and Queensland are booming.

The bureau figures show a very sharp divide across Australia. Spending in Queensland, NT and WA combined grew 11.3 per cent year on year. In Victoria, NSW, SA, Tasmania and the ACT, combined spending grew by just 1.4 per cent.

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Nation's growth at crossroads

AUSTRALIA is heading for a fifth consecutive year of below-trend growth in 2012, with weakness in most of the economy offsetting spectacular growth in mining investment, Westpac chief economist Bill Evans predicts.

As the nation's commodity price forecaster told farmers that 2011-12 will be as good as it gets for farm incomes, Mr Evans, the first last year to tip that the Reserve Bank would have to cut interest rates, said the Reserve will deliver two more rate cuts in 2012 as job losses mount.

Speaking at the Outlook conference of the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES), he predicted that Australia would grow just 3 per cent in 2012, with unemployment rising to 5.75 per cent.

Mining investment would be ''spectacular'' but 40 per cent of it would go on imports. Household spending would be held back by the ''very unnerving'' combination of ''world-class'' household debt and falls in the value of the real estate assets supporting it.

''We need lower interest rates to arrest that disturbing trend,'' Mr Evans said. ''That would help with the labour market. I don't think Australia needs the highest rates in the Western world.''

Unveiling ABARES' annual forecasts, executive director Paul Morris said farmers are now enjoying ''the most positive incomes for about 30 years'' and should use their time at the top of the hill to plan for tougher days ahead.

Mr Morris urged farmers to focus production on ''the highest-value markets, the middle-income countries to our north''. They want to eat more meat, fruit and vegetables, he said, which implies that farms should move away from cereals back to sheep and cattle.

The conference heard sharply different short-term forecasts for the world economy, although similar concerns for the medium to long term. Mr Evans predicted China's growth would slow to 7.5 per cent this year, bringing world growth down to 2.8 per cent - apart from 2009, its weakest year since the ''tech wreck'' of 2001.

But chief economist of J.P. Morgan in New York Bruce Kasman said the world economy is lifting already, with the US likely to grow at 2.5 per cent to 3 per cent, and China growing at 9 per cent by mid-year.

But he warned that this was under threat from the ''unsustainable'' budget cuts demanded in Europe and from the political impasse in the US over deficit cuts.

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Recession a risk in slow lane of two-speed economy

TEN years ago, mining investment in Australia began rising sharply. By 2005-06 it had trebled in just five years. Over the next five years it doubled again. On current plans, it will double again in just two years to mid-2013.

It is being driven by what Treasury deputy secretary David Gruen calls ''a once-in-a-lifetime boom'' in commodity prices and Australia's terms of trade: the ratio of the prices of the things we sell overseas to the prices of the things we buy overseas. We all know the story, but even so, the numbers are staggering.

The terms of trade index has almost doubled, from 66.2 in June 2003 to 131.5 in September 2011. In other words, the same volume of exports today buys us twice as many imports as in 2003.

The Reserve Bank's index of commodity prices in $US has shot up from 34.2 in June 2003 to 157.0, last August, before ebbing back to 142.0. That means that a typical tonne of coal or iron ore exports today earns its owners four times as much as in 2003.

And where commodity prices go, the $A follows. Between 1985 and 2005 it averaged 70 US cents. In the past year, it has averaged $US1.05. That's made local production 50 per cent more expensive in $US, and imports 33 per cent cheaper in $A. So firms are shutting down and jobs are going overseas.

The scale of this shift is colossal. And it is a tribute to our policymakers, and the policy framework they inherited, that Australia has kept on the rails. Past resources booms always ended in tears, because inflation got out of control. This time the Reserve has focused on keeping inflation down and, apart from a flare-up in 2007-09, has succeeded.

There has been a price for this. The economy is growing more slowly; Australia's average growth since 2004 has been 2.75 per cent, or just over 1 per cent per capita. We're still stuck in third gear. Unemployment is back over 5 per cent, low in our terms, but well above the 2 and 3 per cent of success stories such as Singapore, Korea and Norway.

But there's been a bigger cost that policymakers are reluctant to admit, or tackle. Australia has fractured into two economies.

The growth is overwhelmingly in minerals development, in Western Australia, Queensland and the Northern Territory. The south-eastern states - Victoria, New South Wales, South Australia, Tasmania and the ACT - are now going backwards on some indicators, growing slowly on others. Australia has been a two-speed economy since 2005, but now the two speeds are 100km/h on one side of the country, and 10km/h on the other.

Treasury anticipated this. In a recent speech, Gruen said its budget forecast of 4 per cent growth in 2011-12 assumed the non-mining economy would grow just 1 per cent. The first forecast was way out. Economic growth is now likely to be between 2.5 and 3 per cent, which implies the non-mining economy is virtually flat.

The pain is being felt where the non-mining economy is concentrated: in the south-east, where two-thirds of Australians live and work. The risk of recession in south-eastern Australia is now real. In the past year, that two-thirds of the country has seen falls in jobs, job vacancies, newspaper job ads, construction activity, home building approvals, retail sales volumes, and now, a sizeable drop in business investment plans. Growth is almost at a standstill. What should the government do? The word from Treasury and the Reserve is: do nothing. High mineral prices are here to stay, maybe for a decade, maybe for many decades.

That implies that the high dollar is also here to stay. It may not stay quite as high as it is now, but their message to business is: if you can't find a way to compete with the dollar at something like parity (with the $US), you'd better find another life.

(To be fair, Treasury secretary Martin Parkinson told a Senate committee last month the best way to help manufacturers is to improve education, workplace relations, management skills and infrastructure. But all of them are things we want to do whether manufacturing is in boom or bust. For manufacturing, Treasury's advice is: do nothing.)

If Treasury and the RBA are right in assuming that mineral prices and the dollar will stay high, then their advice makes sense. Australia's car industry cannot compete globally with the dollar at parity. To try to keep it going would be expensive, and probably futile. Better to cut it off now and retrain its workers for jobs elsewhere.

But there are two problems. First, this advice is based on forecasts, not facts. Treasury and the RBA have not covered themselves in glory in recent forecasting; it's a long time since either has got a call right. They're human like the rest of us.

Chris Richardson of Deloitte Access Economics once called it ''a pure punt that China and India will keep growing faster than the world's miners can keep digging deeper''. It is a gamble that the global supply of minerals will never catch up with the growth in demand. And that's a big gamble.

If it's right, then you save money you might have spent trying to salvage industries that are beyond saving. But if it's wrong, the manufacturing firms you shut down will not come back. We would permanently lose economic capacity that we will need when mineral prices subside.

The second problem is that by doing nothing, you risk sending Melbourne, Sydney and two-thirds of Australia into recession or near-recession, so that the Pilbara and Bowen Basin can be developed at top speed. That is not just bad economics. It is bad politics.

Let me try a forecast: if that's Labor's policy, it will end 2013 back in opposition.

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A crisis looms in south-eastern Australia

LAST week the Bureau of Statistics revealed that more business investment in Australia now goes into mining than in all the rest of the economy put together. In 2012-13, on companies' present plans, investment in the rest of the economy would shrink while mining's share would swell to 70 per cent. Investment in the south-east, where two-thirds of Australians live, would shrink, and three-quarters of all business investment would be in WA, Queensland and the Northern Territory. Treasurer Wayne Swan hailed the figures as ''a resounding vote of confidence in our economy''.

We believe it is quite the opposite. The investment figures and other data suggest the south-eastern states - Victoria, NSW, South Australia, Tasmania and the ACT - are heading towards recession. In the past year their full-time jobs have shrunk by 38,000, and total employment by 26,000. Their newspaper job ads have shrunk by 21 per cent. Their job vacancies have shrunk by 15 per cent. Their construction activity has shrunk by 1 per cent. Their home building approvals have shrunk by 20 per cent; their retail sales volumes by 0.2 per cent. Their trend level of business investment was still rising, but December's slump and the sharp fall in investment plans suggest that too is turning. All these indicators tell only part of the story. But to see all of them heading down together is ominous. We are now two economies, and one of them is in deep trouble.

The mining economy of the north and west is running red-hot. The everything-else economy of south-eastern Australia has gone cold. The government's economic advisers meant it to be that way, although they have clearly overdone it. They believe Australia is going through a ''structural transformation'' from a diverse economy to one dominated by mining. A global shortfall of minerals has driven up commodity prices, and where commodity prices go, the Australian dollar follows. The dollar is now 50 per cent above its long-term average, making much of the economy of south-eastern Australia globally uncompetitive - in manufacturing, tourism, international education, areas of agriculture and office work that can be done more cheaply overseas. Treasury says we are still only in the early stages of this transformation.

Yet what are the government and the Reserve Bank doing? They are set on slowing the economy further. Federal and state governments are giving the budget surplus priority over jobs and growth. Treasury estimates that federal and state budget cuts will reduce Australia's growth in the two years to mid-2013 by 4.25 percentage points. The Reserve Bank cash rate is at a neutral 4.25 per cent, but governor Glenn Stevens says that is only because the banks are doing its work for it. Had bank margins remained unchanged since 2007, the cash rate would now be at least 5.5 per cent. The bank, the Treasury and the Treasurer believe that if the mining economy is running red-hot, then the rest of the economy has to run cold to prevent things overheating. They did not want it to run as cold as this, but there is no sign yet of any policy shift.

There should be. The floating dollar served Australia well for decades, but it is not serving it well now. When good businesses built up on sound plans are sacrificed because currency dealers make them uncompetitive, then policies must change. In the successful economies of Asia, governments intervene in currency markets to shield local producers. They set budget policies to moderate booms and busts, not to deepen them. They build diverse economies, not bet everything on one industry.

Our policymakers should focus on bringing the dollar down, and bridging the divide between the Pilbara and the rest of Australia. There are ways to do it: lower interest rates, intervention in currency markets, a deeper and wider mining tax and slower budget cuts. Australians will not forgive them if they just stand back and watch us hit the wall.

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Victoria slumps as mining soars

AUSTRALIA is fracturing sharply into two economies. Mining investment boomed in the December quarter, but investment in the rest of the economy shrank even more sharply above all, in Victoria.

In a stunning development, the Bureau of Statistics reports that mining companies are now investing more money than all other sectors of Australian business combined. A decade ago, mining accounted for just 20 per cent of business investment.

The boom is confined to just two states, with 86 per cent of mining investment going into Western Australia and Queensland, primarily to mine natural gas, iron ore and coal.

Victoria is taking a battering. Business investment in the state in the December quarter was down 7 per cent from a year ago. Companies' investment plans for the next 18 months have shrunk 10 per cent from this time last year.

Other new figures yesterday showed home building approvals remained in free fall in January, plunging 25 per cent in Victoria year on year, and 17 per cent across the nation.

The one bright spot for Victoria in yesterday's figures was that non-housing approvals were bumped up by final approval being given to the $1 billion Victorian Comprehensive Cancer Centre in Parkville, and two large retail/wholesale centres.

On current plans, the divide between mining and the rest will become even sharper over the next 18 months. In 2012-13, if companies' plans are realised, 70 per cent of all business investment in Australia will be in mining, with the rest of the economy going backwards.

Similarly, 72 per cent of all business investment planned for 2012-13 would be in Western Australia and Queensland. Just 25 per cent would be in the south-eastern states.

The deep fracturing raises serious problems for other industries, reflected in their shrinking investment plans. Commonwealth Bank chief economist Michael Blythe estimated that to allow the mining industry to meet its goals without sparking inflation, growth in the non-mining economy must be kept to 1.5 per cent a year.

The fracturing also raises problems for the Labor government, which has 60 of its 72 House of Representatives seats in the south-east.

But Treasurer Wayne Swan described the investment figures as a "reminder of the strength of our economic fundamentals".

On initial estimates, the bureau reports, mining companies plan to increase their investment in 2012-13 to $120 billion 52 per cent higher than their original forecast for 2011-12.

But investment plans for all other sectors combined are just $53 billion, 5 per cent less than this time last year.

The prospects for New South Wales and South Australia are also grim. Businesses now plan to invest just $51 billion in the three states in 2011-12, down from $54 billion in the same survey last year.

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