Wednesday 03 September 2014
Non-mining business investment: searching for signs of life
Wednesday 03 September 2014
The key challenge for Australia's economy over the next few years will be how the downswing phase of the mining investment boom is managed, and whether the transition back to non-mining activity is a smooth one.
Sharp declines in mining investment are expected and will weigh on overall business investment. Following previous rate cuts, a strong upswing in residential construction activity is underway and will provide some offset. But for the overall economy to achieve strong growth, a pick-up in non-mining investment is needed. So far, non-mining investment has failed to show concrete signs of responding to rate cuts.
Business investment is a major driver of cycles in the economy. The capacity of firms to produce output, and the economy to grow, is determined by the combination of a stock of capital investments, suitably skilled employees to operate them and the availability of intermediate inputs.
Australia's economy has been driven by a major expansion of the capital stock over the past few years, as strong commodity prices led to a major expansion of mining production assets. But the surge in mining investment - along with high commodity prices - contributed to the high Australian dollar ($A). This had the effect of crowding out investment by other industries through a range of transmission mechanisms.
In some industries, the decline in investment has significant implications for a potential post-mining recovery in output. In his recent testimony to Parliament, the Reserve Bank of Australia (RBA)'s Governor Glenn Stevens highlighted that "the level of gross investment in some sectors is barely above depreciation rates".
What this means is that under investment is resulting in a reduction in the productive capacity of some industries. If this continues, it will lead to reduced employment, production and export potential from those sectors.
The recently released second quarter 2014 (2Q14) capital expenditure (capex) data showed signs that this continues to be the case for the manufacturing sector. Manufacturing output has been relatively steady over the past few years, but has recently declined from 2009/10 to 2012/13. Weak demand and capacity utilisation has led to a decline in the rate of investment. For the first time since 1975/76, investment in new capital by the mining sector looks to have run below the rate of depreciation in 2012/13.
In other words, the manufacturing capital stock shrank. The 2013/14 capex outcome, and surveyed investment expectations, point to further contraction. Based on expectations for 2014/15, total manufacturing investment is expected to decline well below the rate of depreciation.
Looking further out, the prospective closure of Australia's major car manufacturing plants through 2016 and 2017 is likely to see continued reductions in manufacturing capacity. The Productivity Commission's report into the automotive manufacturing Industry estimated that the closures may result in the loss of up to 40,000 jobs.
Surveyed capex expectations for mining companies also suggest a large decline in capex in 2014/15. However, the mining investment boom is not yet fully spent. At the reduced rate of investment, the mining capital stock will still be expanding, which should lead to further increases in output and exports.
How big the decline in mining investment is likely to be is an important question for the economy. Previous (albeit more modest) downswings in mining investment have seen the level of spending find a floor at the level where capital expenditures matched depreciation.
Given the expanded mining capital stock, a fall in the rate of mining investment back to the capital sustainment (depreciation) rate would see mining investment decline to around 2.5 per cent of gross domestic product (GDP), which is close to double the pre-boom level of mining investment in the economy.
The RBA will closely scrutinise the latest capex data, particularly for the "Other Selected Industries" component. Investment outside of mining and manufacturing sectors will be the major driver of the economy, and most importantly jobs growth, over the next few years. To date, the signs have been tepid. Capital expenditures by Other Selected Industries rose 3.5 per cent in 2013/14, but remains below the 2008/09 peak. A 10 per cent lift in investment is expected in 2014/15. Whilst this will not fully offset the decline in mining and manufacturing investment, it does provide a sign that the prospective rebalancing in the economy is underway. The RBA will be hoping that over coming quarters those prospects are realised.