Green Shoots for a Forgotten Sector
By St George Bank Economist, Janu Chan
The Australian economy is currently on very solid footing, with enviably strong economic growth, thanks to the mining boom, robust jobs growth and a relatively healthy fiscal position. Rising commodity prices have driven up Australia’s the terms of trade (the ratio of export prices to import prices), to be at an inter-generation high. The estimated near 4 per cent increase in the terms of trade in the March quarter was stronger than what would have been anticipated a few months earlier. For the year to the March quarter, Australia’s terms of trade is estimated to be nearly 21 per cent higher.
The Reserve Bank (RBA) expects the terms of trade to increase further to at least a 140-year high in the June quarter, although the terms of trade could slip from here as commodity producers increase supply, in response to higher prices.
The higher terms of trade has an impact on national incomes more widely than in just the mining industry. It has driven business investment higher, particularly in the resources industry. Further, investment is expected to increase rapidly over the coming year.
The prosperity of the mining industry and mining-related investment has often overshadowed other sectors of Australia’s economy, including the manufacturing sector. Although manufacturing has declined as a proportion of economic activity in Australia over the last few decades, it remains a significant part of the economy. The manufacturing industry comprised of 8.6% of GDP in the December quarter 2010 and currently employs 8.7% of total jobs. Further, the expected boost in investment will drive up manufacturing.
The manufacturing industry has faced a number of challenges in recent years. High commodity prices have increased the costs for raw materials. In addition, it has faced a more intense competition from lower-cost manufacturers overseas.
The strong rise in the Australian dollar is also weighing on the competitiveness of Australian manufacturing exports. Over the past few months the US dollar has depreciated significantly. The Aussie dollar has strengthened, hitting a post-float high versus the greenback and a 26-year high in trade-weighted terms. On a year ago, the Aussie is about 23% higher in trade-weighted terms. Higher commodity prices, higher interest rates, solid economic growth and a comparatively healthy fiscal situation have boosted the currency.
Despite these difficulties, manufacturing has been quite resilient and has adapted to a changing environment. It has shifted towards higher-value added products and a strong improvement in productivity of labour over the last few decades has helped keep the industry competitive.
The manufacturing industry suffered a large decline in production amid weak global demand throughout 2009. However, growth in manufacturing has rebounded last year, averaging year-on-year growth of 5%. Prospects appear positive with domestic growth expecting to remain solid and with a significant amount of investment in the pipeline. In addition, rebuilding after the Queensland and Victorian floods are likely to provide some opportunities for manufacturing firms.
The positive outlook for manufacturing is further reflected in some leading indicators. The Westpac-ACCI Actual Composite Index reached its highest level since 2004 in the March quarter. The survey also pointed to high confidence in the industry with the Expected Composite Index rising to a record high. Reflecting this optimism, new orders were quite strong and are well above the historical average.
The survey also indicated the labour market in the manufacturing sector is solid. The employment index increased and more participants indicated that it was more difficult to find labour, and wages expectations are high. A net balance of 13% of respondents expects wage rises in the next round of negotiations.
Although capital expenditure for manufacturing declined by 4.2% over the March quarter, investment intentions for manufacturing over the next fiscal year are quite firm. We estimate that manufacturing investment will increase by 6.7% in 2011/12 from 2010/11.
It appears that manufacturers are looking through any temporary disruptions as a result of recent natural disasters and are anticipating stronger demand in the wake of rebuilding and an impending investment boom.
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