Saturday, January 31, 2015

Economy weak, cash rate steady. The 2015 BusinessDay Economic Survey

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Fresh from its success in forecasting correctly that the Reserve Bank would go an entire year without a moving its cash rate, the BusinessDay forecasting panel is predicting a second year of the same.

The 25 eminent economists who make up the panel are predicting on average yet another 12 months of steady rates, meaning no change until all the way through to December 2015 - a record run of 28 months.

The panel comprises is made up of leading market economists, industry economists, academics and consultants. Over time its average forecasts have proved to be more reliable than those of any of its members.

The Reserve Bank's first meeting of 2015 next Tuesday will be keenly watched. Rate cuts in other countries, a sluggish Australian economy and a collapse in the rate of inflation are ratcheting up pressure on Australia's central bank to cut - but economists are sharply divided on whether the Bank will cut at all. Beneath the surface of the average forecast of a steady cash rate forecast lie sharp differences. Only about half the panel expects the rate to stay steady at 2.5 per cent. The other half expects it to either climb or fall.

Bill Evans of Westpac, James McIntyre of Macquarie Group, and Stephen Anthony of the consultancy Macroeconomics consultancy expect two cuts within months, bringing down the cash rate to an all-time low of 2 per cent, where they expect it will remain for the rest of the year.

McIntyre thinks the bank should have cut rates months ago, with Australia already in a per capita "demand recession", he says.

Steve Keen and Alan Oster expect one interest rate cut in the first half of the year, followed by another in the second. Oster says the weak jobs market and the slide in commodity prices argue for a cut, while the low inflation rate and cooling housing market suggest it can be afforded.

At the other end of the scale, Michael Workman of the Commonwealth Bank and Annette Beacher of TD Securities expect two hikes late in the year, lifting the cash rate to 3 per cent.

Workman says the lower dollar will do a better job of boosting  the economy than would a cut in rates, without the accompanying risk of overstimulating the housing market. He says While consumers and businesses do lack confidence, it isn't because their cost of funds is too high, he says.

Monash University's Jakob Madsen expects only one hike in interest rates, in the second half of the year. He says at 2.5 per cent the inflation-adjusted cash rate is already close to zero. He says The big problems facing the Australian economy are structural rather than than cyclical and a lower interest rate won't fix them, he says.

Saul Eslake and Chris Caton are among those expecting steady rates all year. Eslake says the Reserve Bank will would want to avoid cutting in order to leave something "up its sleeve'" in the event of another global shock. He says it's not clear that another cut of 25 or even 50 points would achieve what cuts of 225 points between November 2011 and August 2013 did, which is a lower unemployment rate. Caton says although he is not expecting it, the bank will would be forced to cut if the unemployment rate goes went through 6.5 per cent "with any velocity".

Housing expert Nigel Stapledon of the University of NSW says the main beneficiary of a lower rate would be housing, which at present needs no stimulus.

All of our panel prepared their responses before the deadline of January 12, meaning none were able to take into account the very low inflation figure released on January 28. While this put them all on an equal footing, it meant they were perhaps less inclined to foresee rate cuts than if the survey had been taken when the low inflation rate was apparent...

Their  average forecast is for a cash rate of 2.41 per cent by December, close to the present 2.5 per cent but slightly lower, meaning they believe a cut is more likely than an increase. The cash rate is only moved in increments of 0.25 per cent.

The panel's views more broadly about 2015 are not encouraging. Most expect weak economic growth and a further rise in unemployment. None expect a recession. Two expect a per capita recession - a shrinking of in the economic pie per person.

As is usual, the panel is forecasting an inflation rate of 2.4 per cent, the centre of the Reserve Bank's 2 per cent to 3 per cent target band. Steve Keen of Kingston University, London, is the only member predicting a headline rate outside the band, of expecting 1.5 per cent through the year, with an underlying rate of 1 per cent. Neville Norman of Melbourne University predicts a 2.05 per cent, with an underlying rate of 1.95 per cent.

Several of the panel expect wages to grow more slowly than inflation, resulting in a year of falling real wages following on the back of a year in which they barely grew. Michael Workman expects inflation of 2.7 per cent, with wage growth of just 2.2 per cent. Jakob Madsen of Monash University expects inflation of 2.5 per cent and wage growth of 2.2 per cent. Steve Keen expects inflation of 1.5 and wage growth of 1 per cent. Saul Eslake, Shane Oliver and Tom Skladzien of the Australian Manufacturing Workers Union expect zero real wage growth. The average forecast is wage growth of 2.6 per cent, just a touch above the average inflation forecast of 2.4 per cent.

None of the panel expects the present extraordinarily low bond rates to last. The 10-year bond rate has been less than south 3 per cent all year. This week it hit an all-time low of 2.48 per cent, about on a par with the long term rate of inflation implying a zero real borrowing cost. All of the panel but two expect a rate at or more than north of 3 per cent by December. Stephen Anthony expects 2.76 per cent, and Warren Hogan 2.1 per cent. The average forecast is 3.39 per cent.

There is precious little good news on jobs in the BusinessDay survey. All but three of the panel expect the unemployment rate to climb in the next six months. The average has it climbing from its present 6.1 per cent to 6.5 per cent by mid year, ending the year at 6.4 per cent. Stephen Anthony and Steve Keen expect an unemployment rate of 7 per cent.

Household spending is expected to grow no faster than it did last year, climbing by 2.5 per cent in real terms. Business investment is expected to slip another 4.8 per cent. Housing investment is expected to grow more slowly at 4.6 per cent.

Australia's gross domestic product is expected to grow by 2.6 per cent, about around the same as budget forecast but well down on the long-run trend. Population growth means GDP per capita should advance weakly at 1 per cent. Jakob Madsen and Neville Norman expect GDP per capita to shrink.

The panel expects Chinese economic growth to fall to 6.9 per cent in the year ahead, a 25-year low. It expects world growth of 3.5 per cent. Both are in line with the International Monetary Fund forecasts. It expects the recovering US economy to grow 2.9 per cent - a good deal less than the IMF forecast of 3.6 per cent.

On average the panel expects the slide in Australia's terms of trade to slow, with them losing only a further 3.6 per cent in 2015, but the average conceals a wide range from a further slide of 15 per cent to a lift of 7 per cent. None of the panel expects a dramatic recovery in the iron ore price. The forecasts range from a low of $US55 a per tonne to a high of $US86.

The panel expects the Australian dollar to slide lower throughout the year, ending at US77 cents, which is about where the Reserve Bank is said to have long believed it should be. But again the range of forecasts is wide, from a slide to US69 cents (Steven Anthony) to a rebound to US86 cents (JP Morgan's Stephen Walters).

The panel expects the 2014-15 budget deficit to come in slightly a touch worse than forecast at $43.8 billion. All expect it to fall the following year, to an average of $34.2 billion.

Much will depend on the strength of what the panel believes will be a tepid economy, on the Australian dollar, and on nominal gross domestic product, which drives government income. The panel expects nominal GDP growth of 3.7 per cent in 2015, an improvement on the 2.7 per cent recorded in the year to September, but still well down on the 9 per cent a year per annum recorded in the mining boom.

In The Age and Sydney Morning Herald



Wisdom in the crowds. How the BusinessDay 2015 panel got most things right

What our panel got right about 2014 it got spectacularly right. What it got wrong was awfully wrong.

First the spectacular successes. On average last year's BusinessDay panel expected economic growth of 2.7 per cent in the year to December. The most recent figure (for September) is exactly 2.7 per cent. It expected global growth of 3.3 per cent, which is exactly what we got. It expected a December unemployment rate of 6 per cent. The December figure was barely a whisker away at 6.1 per cent. And it expected an entire year without a move in the Reserve Bank cash rate – an extraordinarily rare occurrence and which is exactly what happened.

On these measures the average of the panel's forecasts was right in a way none of our individual panelists were.

But what the panel got wrong was often so wrong that not a single panel member came close.

The panel thought inflation would end the year at 2.5 per cent. It ended at 1.7 per cent, below even the lowest of the panelists' forecasts. The panel thought the 10-year bond rate was to end the year at 4.6 per cent. It ended at an extraordinary low of 2.8 per cent and has since fallen further. None of the panelists expected anything below 4 per cent. The panel thought the dollar would slip to 86US¢. It slid to 82. It thought the terms of trade would slip 4 per cent. They slid 9 per cent.

What the mistakes have in common is the late-year collapse in commodity prices. None of our panel saw the full extent of what was coming. Those that foresaw something include Tim Toohey of Goldman Sachs (a terms of trade collapse of 9 per cent), Stephen Anthony of Macroeconomics (who had the lowest inflation forecast of 2 per cent), Bill Evans of Westpac (who had the lowest bond rate forecast of 4 per cent), and Melbourne's University's Neville Norman and Macquarie Group's Richard Gibbs, who correctly picked the exchange rate of 82US¢ to the dollar.

But as near to right as about individual outcomes as some of our panelists were, none got the whole picture. The late-year collapse in oil and other prices was simply too dramatic (and perhaps too geopolitical) to see coming.

It's been a BusinessDay tradition for years to bestow the title of forecaster of the year on the panelist who got the most things right. Previous winners include Stephen Anthony, Jakob Madsen and Steve Keen. This year none are deserving of the award. The unexpected took everyone by surprise. Away from the unexpected, the average of the panelists' forecasts did very well indeed. The average was a better predictor than any individual forecast.

In The Age and Sydney Morning Herald



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Sunday, January 25, 2015

Minimal evidence against the minimum wage

There's nothing more Australian than the minimum wage.

Now on the eve of Australia Day it's up for grabs.

As Australian as Vegemite, the bionic ear and the preferential vote, the national minimum wage sprang to life in 1907. Victoria had gone out on its own a few years earlier. Britain, the United States and most of the rest of the developed world followed later. Even now their minimum wages are nowhere near as generous as ours.

It's why on Tuesday President Obama used his State of the Union address to call on Congress to lift the US minimum wage. And it's why on Thursday Australia's Productivity Commission raised the prospect of dumping it.

"What is the rationale for the minimum wage in contemporary Australia?" it asked in the issues paper that kicked off its inquiry into Australia's workplace relations framework.

And: "how effective is the minimum wage in meeting that rationale?"

The minimum wage is $16.87 an hour. The Commission is worried it's going to families that don't need it.

"Not all minimum wage earners are members of low-income households," it says. Only around one third of adult minimum wage earners are in the poorest 20 per cent of working households. The rest are in better off households.

The Commission cites Labor's assistant treasury spokesman Andrew Leigh who as an economics professor before entering politics wrote that high minimum wages might lift inequality if they lowered employment in low income households.

But Leigh's concern, and the Commission's, depends on the assumption that minimum wages boost unemployment.

It's a reasonable assumption. If employers can pay employees as little as they like, they'll have more spare cash to spread around employing more of them. It used to be the conventional wisdom, until researchers went looking for evidence...

Like the Loch Ness Monster, many have now reluctantly concluded that it's not there. Joshua Angrist of the Massachusetts Institute of Technology is one of the world's leading experts in the use of statistics.

He told American radio last year that the burden of proof had shifted from those who wanted to argue for a minimum wage to those that wanted to argue against it on the ground that studies show it cost jobs.

"It's been hard to find those," he said. It wasn't that the evidence against minimum wages wouldn't be found, it was just that "the scholarly work on the minimum wage today is in a very different place than it was before."

Last May The Economist magazine admitted it had been wrong. It had opposed the introduction of a nationwide minimum wage in Britain on the ground that it would cost jobs.

"No-one who has studied the effects of Britain's minimum wage now thinks it has raised unemployment," it wrote. It had "changed its mind".

A few months earlier more than 600 US economists – including seven Nobel Prize winners – signed an open letter to Congress calling for an increase in the minimum wage. They said the weight of evidence now showed increases in the wage had "little or no negative effect on the employment of minimum-wage workers".

One of the key pieces of evidence was gathered in the early 1990s when New Jersey lifted its minimum wage from $US4.25 to $US5.05 per hour.  Neighbouring Pennsylvania did not. Princeton University economists David Card and Alan Krueger surveyed 410 fast food restaurants in New Jersey and in Pennsylvania before and after the change. If minimum wages did hurt employment, employment would have suffered more in New Jersey fast food restaurants than in Pennsylvanian ones. But that's not what they found.

"Relative to stores in Pennsylvania, fast food restaurants in New Jersey increased employment by 13 percent," they wrote. They also examined employment growth elsewhere in New Jersey at stores already paying above the minimum and unaffected by the change. They found no change in employment, suggesting no statewide phenomena was in play.

Their curious conclusion was that higher minimum wages didn't hurt employment. If anything, they helped it.

Among the possible reasons is that higher wages might make it easier for firms to attract good workers and lift profitability. It's certainly not a settled question. But the cards are stacked against those who'll want to tell the Productivity Commission Australia's minimum wage costs jobs. The Commission itself quotes a finding by the expert panel of the Fair Work Commission that "modest minimum wage adjustments lead to a small, or zero, effect on employment".

The Commission says it wants evidence. Evidence against the minimum wage is hard to find.

In The Age and Sydney Morning Herald


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Saturday, January 24, 2015

Highly taxed? ACOSS says middle income Australians pay 11 cents in the dollar

Australians pay far less tax than they believe, a new report finds, and certainly far less tax than the Treasurer thinks they do.

Mr Hockey told Fairfax radio on Monday that Australians paid nearly half their income in tax.

"When Australians spend the first six months of the year working for the government with tax rates nearly 50 cents in the dollar it is a disincentive," he said. "You're working July, August, September, October, November, December just for the government and then you start working for yourself and your own household income after that for another six months - it is a disincentive."

A report released on Saturday by the Australian Council of Social Service finds that personal tax as a proportion of a middle-earning household's income is just 11 per cent - a good deal less than other calculations and far less less than the Treasurer's.

High-earning households pay 20 per cent of their household income.

ACOSS arrives at the figures by including all household income in its total, including untaxed or lightly taxed of lightly taxed income washed through superannuation, family trusts and negatively geared properties.

"To get a true picture you need to look at total income rather than just taxable income," ACOSS chief executive Cassandra Goldie said.

The personal tax scale prepared by ACOSS is quite progressive. The bottom one-fifth of households pay 3 per cent of their income in personal tax, the next group pays 7 per cent, middle group 11 per cent, the second-top group 15 per cent and the top group 20 per cent...

But the progressivity vanishes when other forms of tax are included. Including the goods and services tax and other consumption taxes such as petrol and tobacco excise, the lowest earning household pays 24 per cent of its income in tax and the highest earning household only a little more at 28 per cent.

Dr Goldie said the goods and services tax hit low earners far harder than high earners meaning they paid much more in consumption tax than income tax while high earners paid much more in income tax than consumption tax.

"It shows how skewed the tax debate is becoming. We seem to be only talking about the GST, yet our modelling shows that lifting the GST would hit hit the lowest earners far more than the highest earners," she said.

Superannuation tax concessions and those for trusts, negative gearing and capital gains were far more likely to raise money from well off households than the GST

ACOSS has prepared the research paper as part of its contribution to the governments tax review which Mr Hockey will launched early next month.

"We are about to be embroiled in a very contested debate and we have the treasurer suggesting people are contributing half their income to tax which is simply not accurate," she said.  "How can we possibly get responsible debate about reform when we don't even have good transparency about the facts?"

"We are releasing this paper to demonstrate that based on the Bureau of Statistics data and appropriate modelling people on higher incomes are contributing around 28 per cent. They are able to pay more."

In The Age and Sydney Morning Herald


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Wednesday, January 21, 2015

Low bond rates. Abbott prepares to pass up the deal of the century

Who'd say no the deal of a lifetime? Tony Abbott would, and it's our tragedy.

The ten year bond rate is the rate at which the government can borrow for ten years at a fixed rate of interest. Right now its just 2.55 per cent, an all-time low.

By way of comparison in the 1970s it exceeded 10 per cent, in the 1980s it passed 16 per cent, in the 1990s it passed 10 per cent, in the 2000s 5 per cent, and until now in this decade it has usually been above 3 per cent. It dived below 3 per cent at the end of last year and is now just 2.55 per cent, the lowest in living memory.

If Australia was to borrow, big time, for important projects that took the best part of a decade to complete, it would have no risk of ever having to fork out more than 2.55 per cent per year in interest. The record low rate would be locked in, for the entire ten years.

Australia's inflation rate is currently 2.3 per cent. Although it will almost certainly fall in the wake of the collapse in oil prices when it is updated next week, the Reserve Bank has a mandate to keep the rate centred at around 2.5 per cent. That means that right now our government is being offered billions for next to nothing, billions for scarcely more than the expected rate of inflation.

If Abbott was the chief executive of a company with good prospects he'd grab the money and borrow as many billions as he could without impairing his credit rating.

In Australia's case that's probably an extra $100 billion. That's enough to build the long-awaited Brisbane to Sydney to Melbourne high speed rail line, or to build Labor's original national broadband network, or to build Sydney's $11 billion WestConnex road project plus Melbourne's $11 billion metro rail project plus Melbourne's $16 billion East West Link plus something big in each of the other states.

And it would cost next to nothing. All each of these projects would need is a positive real rate of return (which several of those listed above lack) and we would get ahead.

All we would need is confidence in the worth of our ideas.

It's rare to be offered money for nothing...

It's happening because interest rates in the rest of the world have dropped to near zero. Japan's ten year bond rate is 0.24 per cent, Germany's is 0.40 per cent, Britain's 1.54 per cent. Even in the United States where the economy is improving, the ten year bond rate is just 1.81 per cent. Without the ability to earn decent returns in the nations to our north investors are flocking to here and buying our government bonds. In order to get them they are prepared to bid down the rates we have to pay them to all time lows.

It mightn't last. In October Reserve Bank assistant governor Guy Debelle warned of a "relatively violent" correction in bond markets. He said as soon as it looks as if interest rates will climb, the purchasers of bonds will demand much higher rates in order to cover themselves for what's likely over the next ten years. The opportunity will vanish.

If we are prepared to grasp it, there's no shortage of projects that would set us up for decades to come. In education, in health, in the delivery to railway lines into suburbs that are at present barely accessible - in all of these areas there are projects whose benefits would exceed their costs and exceed them by more than enough to pay the minimal rate of interest being demanded.

Some are visionary. Bank of America Merrill Lynch economist Saul Eslake says if Australia was to get serious about reducing its dependence on coal it would consider paying coal producers to close, and speeding up the commercialisation of battery technologies that would allow Australians with the next wave of solar panels to live off the grid.

The risk is that bad projects would be chosen over good ones and the money wasted. Abbott himself provides reason for concern. Despite promising during the election to "require all Commonwealth-funded projects worth more than $100 million to undergo a cost-benefit analysis by Infrastructure Australia" his first budget funded scores of road projects without such approval. Some of the cost-benefit studies weren't even published, in others the figures were massaged to make them look better than they were.

The Grattan Institute's John Daley suggests setting up an independent statutory authority along the lines of the Reserve Bank to vet proposals for spending big money. Its members would be appointed by the Governor-General for terms of five to seven years, it would report directly to parliament and it would publish of all of its findings compete with the assumptions behind them. He says even cheap money should be spent well.

Could the Coalition grab the opportunity before it vanishes? There are some good signs. With help from the Greens it axed Labor's debt ceiling. Since taking office it has run up an extra $78 billion in debt. But it is unorganised, behind in the polls and a prisoner of some of the silly things it said about debt while in opposition.

We have a once in a lifetime opportunity. It'll slip through our fingers.

In The Age and Sydney Morning Herald


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Sunday, January 18, 2015

We're living longer. Get over it

Here's the good news: We're living longer. Here's the bad news: There isn't any.

The idea that living longer will make us infirmed for longer and a burden on society for longer has been central to the government's narrative about ever-rising health costs.

It started within months of the minister being sworn in. Preparing the ground for a Medicare co-payment Peter Dutton said health spending was on an "unsustainable path". The cost of the Medical Benefits Schedule (Medicare) was "spiraling".

"The use of MBS services increases as people get older, with those aged over 65 accessing an average of 33 MBS services in a year, while younger people access around 11 services per year," he told the the Committee for Economic Development of Australia.

Combined with talk of an ageing population it made it sound as if living longer was part of the problem, as did his wildly overstated talk about the increased incidence of dementia.

"The fact is 170 people per week today are being diagnosed with dementia, but in a number of years it'll be 7,500 a week," he told Lateline while trying to sell the co-payment.

The ABC fact checking unit ran its ruler over his claim and found that rather than increasing fortyfold over a number of years, as the minister had said dementia was set to treble over four decades...

We are certainly living much longer, and we're set to live longer still. But living longer isn't meaning living longer infirmed or hooked up to machines.

When the Australian Institute of Health and Welfare delivered the good news in the lead up to Christmas you might have  expected the health minister to trumpet it. I would have. It means we've little to fear from our extra years. We might get more bored or have more financial problems, but we are unlikely to be too much more incapacitated. Instead the minister said little, bunkering down yet again to find another way to get us to pay more for visits to the doctor.

Here's what the Institute found. Its report is entitled Healthy life expectancy in Australia: patterns and trends 1998 to 2012.

Between 1998 and 2012 the life expectancy for newborn boys grew from 75.9 years to 79.9 years - an extraordinary increase in such a short time. In little more than a decade Australian men gained an extra 4 years.

But how many of those extra years are good ones, disability free?

The Institute's remarkable finding is that men have gained an extra 4.4 years of disability-free life. Not only are Australian men set to live 4 years longer, but less of their lives are likely to be incapacitated.

It doesn't mean that medical expenses aren't climbing. They are climbing because more of us are getting old and also because medicine is getting more expensive. But it does mean that our longer lifespans aren't responsible for that much of the extra expenses. At least not for men.

For women the picture is (slightly) less rosy. Between 1998 and 2012 the expected life for a newborn girl climbed from 81.5 years to 84.3 years - an increase of 2.8 years.

The increase in the number of disability-free years was slightly less (2.4 years) meaning that most - but not not all - of the extra years were disability-free. In terms of value for money whatever is driving those extra years looks like a good deal, an even better deal for men.

Better still, the estimates of 79.9 years for men and 84.3 years for women almost certainly understate how long we will live. The government actuary points in a separate report that 60 per cent of newborn boys and girls live longer than their life expectancies, and that's before likely improvements in medical technologies over the course of their lives are taken into account. That's because life expectancies are averages, and the averages are weighed down the relatively large number of babies who die before they turn one.

The actuary says a boy born today can expect 85.6 years on a not-so-optimistic view about technology, 90.5 on a better view. A girl born today can expect 90 years or 92.2.

A man who is now 30 can expect 84 years or 88, a woman 88 or 90. A man who is about to turn 65 can expect 85 or 86, a women 88 or 88.6.

Around half of us will live longer than those estimates, and we'll do it without putting too much more strain on the health system.

Old age isn't a problem. It's what we are trying to achieve. Dutton's replacement Sussan Ley would get off to a good start by celebrating rather than demonising our incredible good fortune.

In The Age and Sydney Morning Herald


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Thursday, January 15, 2015

Vacancies. The jobs market springs cautiously back to life

The jobs market is reawakening.

The latest Bureau of Statistics figures show that even though Australia's unemployment rate remains at its highest for twelve years, the number of vacancies on offer is steadily climbing.  

The bureau finds employers had 152,400 vacancies on offer in November, up from 140,900 one year previously. The bureau's measure is more reliable than those that count job advertisements because it includes all vacancies on offer, whether or not they are advertised.

NSW is by far the most promising state on Australia's east coast, offering 44,800 jobs for a total of 228,500 job seekers, meaning there 5.1 NSW residents unemployed for each vacancy.

Victoria is the least promising state with 33,300 vacant jobs on offer for 213,600 job seekers, meaning there are 6.4 unemployed Victorians for each vacancy...

The Australian Capital Territory appears to be promising with 5.1 unemployed residents competing for each vacant job, but the ACT figures are distorted because many ACT job seekers live outside the territory.

The Queensland market is almost as tough as Victoria's with 6.1 unemployed locals for each vacant job,  significantly worse than 4.8 a year earlier.

Western Australia remains the best state in which to search for a job, with just 3.1 unemployed locals for each vacancy. In the Northern Territory the number of vacancies slightly exceeds the number of residents who say they are unemployed.

The resurgence in job vacancies is led by the professional and scientific industries (up 4100 in the past year) and by manufacturing (up 3500). Vacancies in the mining industry slipped a further 900. At its peak three years ago the mining industry had 10,300 vacant jobs. It now has 3800.

Although at a two-year high, the number of vacant jobs is well down on the peak of 190,000 reached in February 2011 before the jobs market turned down. The unemployment figures for December will be released on Thursday.

In The Age and Sydney Morning Herald


How many unemployed per vacant job?

Unemployed per vacancy

November 2014 (November 2012)

NSW 5.1 (4.9)

Victoria 6.4 (6.1)

Queensland 6.1 (6.1)

South Australia 6.7 (6.5)

Western Australia 3.1 (3.1)

Tasmania 7.9 (8.5)

Northern Territory 0.9 (0.9)

Australian Capital Territory 5.1 (5.1)

Australia 5.1 (5.1)

ABS 6354.0, ABS 6202.0 (trend)



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Wednesday, January 14, 2015

Kissed by a rainbow. The good news on oil prices we didn't see coming

How'd we get so lucky? The price of oil halved in a matter of months and hardly any of us saw it coming.

Back in September when the oil price was $US93 per barrel Australia's Bureau of Resource and Energy Economics forecast "a gradual decline" to a figure still north of $US90. What happened was a collapse to $US46.

If it stays near $US50 (and there's talk or $US40 or less for two or three years) the typical Australian family will save $14 a per week according to the AMP's Shane Oliver.

He bases his calculation on an average petrol price of $1.13 per litre (it's already fallen to to 99.9 cents in some places) and an average top up per week of 35 litres.

Put in perspective, $14 per week is more than the benefit per family from another cut in mortgage rates. It's around $730 per year, worth as much as a pay rise of $1100 to someone on the typical tax rate.

There's every reason to believe families will spend some of it, giving businesses the confidence to put on more workers.

Not only will the new much lower oil price boost the economy directly, but by cutting inflation to as little as 2 per cent (that's what's expected when the next figure comes out) it'll give the Reserve Bank more than enough room to cut interest rates as well if it wants to do more.

It's like the sudden emergence of the resources boom all over again, except that where that showered Australia with income, the halving of the oil price will slash costs, for businesses as well as consumers. The mining industry, the makers of plastics that feed their way into almost everything we buy, the trucks that deliver them to shops - all of them rely on oil and all of them will face much lower costs.

The other (not so good) difference from the mining boom is that whereas that boom brought the government more revenue and repeated budget surpluses, this one will eat into government revenue. The prices of Australia's liquefied natural gas exports are contractually linked to oil prices. They will slide with the oil price, cutting the tax take from those projects...

Since September the share price of Santos has halved, the price of BHP has slid 22 per cent and the price of Woodside has slid 16 per cent

The December budget update factored in the slide in the oil price to that point and revised down revenue from the Petroleum Resource Rent Tax by $760 million. In the four weeks since the oil price has slid a further 20 per cent.

So why did the experts miss it? Partly because the oil price had been unusually steady for an unusually long time. For three years from mid 2011 to mid 2014 it was usually stuck between $US100 and $US110 a barrel.

But the apparent stability was deceptive. Beneath the surface the high price was making it economic for the United States and Canada to extract oil in ways they once never could have. The United States did it by fracking - using high pressure water to fracture rocks. Canada did it by refining tar sands, both expensive processes.

American production climbed to within striking distance of Saudi Arabia's. At the same time wars in Iraq and Libya cut production from the Middle East leaving the worldwide total little changed.

Until Iraq and Libya returned to production and demand from China tapered off.

Then a sudden oversupply pushed prices south until the Organization of the Petroleum Exporting Countries met in November. The US and Canada are not members of OPEC. It could have decided to wind back production to restore prices as it had done in the past, and many experts expected it to again. But that would have been a gift to the upstarts and also to Russia which isn't a member. Instead it decided to destroy their business model. Maintaining production and allowing the oil price to plummet would hurt the US and Canada far more than it would hurt OPEC.

New Canadian tar sands projects are thought to be uneconomic at prices of between $US70 and $US60 a barrel, new US fracking projects at prices between $US60 and $US50. Saudi Arabia makes money all the way down to $US25.

The latest price of $US46 is sufficient for the Middle East to rid itself of its North American rivals. When their existing projects close they won't open new ones. But that will take a while, suggesting we are set for low prices for years to come.

It is possible that the Middle East will lose its nerve, but unlikely. Qantas lost its nerve after years of a capacity war with Virgin in which it kept piling on extra seats to match Virgin's extra seats. It gave up after evaporating its profit, and prices climbed back.

But Middle Eastern producers such as Saudi Arabia are different. Unlike Qantas they have very low costs and (barring political turmoil) the ability to keep prices low for years.

And unlike Qantas there's something in it for them if the entire world grows more strongly. The International Monetary Fund says the new lower price will boost global economic growth by between 0.3 and 0.7 per cent in the year ahead. That'll mean more oil is sold, and make a fresh economic crisis less likely. Except in high cost producers such as Russia, Venezuela and Nigeria. Their economies are now in deep trouble, collateral damage of the oil war between the Middle East and North America.

For Australia it's on balance good news, news we've scarcely begun to come to grips with.

In The Age and Sydney Morning Herald


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