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Infrastructure vital to construction recovery

Monday, 22 July 2013

Now that the mining construction boom is coming to an end many of us are wondering what will replace it, so that Australians can keep experiencing low unemployment, rising incomes and a strong economy. Will the falling exchange rate and low interest rates be enough to enable the rest of the economy to expand or is something more going to be needed?  Are the right conditions in place for a property led recovery? Will the property sector recover soon enough or is something else needed?

In addressing these questions the Reserve Bank recently made the point that “a good way to begin is to have a reasonable starting point”. What they are saying is that compared with previous episodes where a sector of the economy was heading for a downturn we are in much better shape. Often the end of a strong period of growth in any one sector is followed by a collapse with dramatic consequences. This is set to be much more orderly.

Households have increased their savings levels from 1% of household income to 10% of household income since 2005, providing many with a valuable mortgage safety net. Inflation at 2.5% is well under control. Housing is more affordable and prices of assets (such as housing) are stable or slightly increasing. Equity prices are generally increasing and superannuation balances have recovered to pre GFC levels.  A strong fall in asset prices, business collapses and a strong increase in unemployment are not on the cards.

The exchange rate is coming down and this will gradually give a boost to exporting businesses and will help commodity earnings.

Population growth is solid, there is a need to build more houses after several years of under-building, and the interest rate settings favour this.

All this means that a big slump is very unlikely. We still have at least a year of high resources capital expenditure before it starts to taper off. Then it’s going to be up to other sectors of the economy to take over. The lower exchange rate will help. Tourism, education, financial and professional services, and health care are all likely to keep growing.

However it will be up to the property and construction sectors to take up much of the slack. This transition is by no means assured. Building approvals and commencements are taking a long time to recover. Confidence indicators have shown several false starts.

The Construction Forecasting Council (CFC) has indicated growth in annual residential construction investment from $68bn to $95bn by 2017.  The problem with forecasting residential construction growth is that it is much more difficult to forecast than engineering because it is harder to count committed projects. You can look at population growth and dwelling shortfalls. However the missing and most mysterious factor is confidence and we haven’t seen that improve much yet at least with respect to property. The risk is that the growth forecast does not eventuate.

Given the uncertainties of a construction led recovery infrastructure can play an important part. Unfortunately in Australia state governments are in fiscal consolidation mode as state revenues have been falling and deficits increasing. So fewer new building initiatives are being announced just at a time when a boost in infrastructure expenditure would be very welcome.

The federal government should be prepared to do more to help to expand infrastructure given the reluctance of the private sector and the states to expand construction.  Australia’s AAA credit rating allows the federal government to raise funding on the bond markets for as low as 2.8%. We should be taking advantage of this to help the states build productivity enhancing infrastructure, even if it means going into a little more fiscal deficit. As the economy grows and domestic construction recovers increased tax revenues will tend to fix the deficit better than any short term tinkering with budgets.

Construction costs are set to remain flat for another year or two. As the mining construction boom slows there will be less of the competition for construction labour that has pushed construction wages up so strongly in recent times.  Low finance costs and flat construction costs make the next few years an ideal time to expand infrastructure.

 

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