Trend growth – a heady mix of assumptions

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Trend growth – a heady mix of assumptions

Garry Shilson-Josling, AAP Economist, AAPJune 11, 2013, 3:14 pm

Let’s talk about the latest trend.

No, not shoes, clothes, music, social media or smart phones.

Let’s talk about the trend in gross domestic product.

If it makes you feel better, be assured that GDP includes shoes, clothes, music, social media and smart phones.

Along with lots of other stuff.

Stuff made by people.

People with jobs.

Accordingly, the trend in GDP is important, more important than anything else, in creating jobs.

More GDP equals more jobs.

But that means too much GDP creates too many jobs, a squeeze in the labour market and, potentially, a surge in wage costs feeding through into rising prices and, Hey Presto, you have rising inflation.

At least, that’s how it works in the nightmares of central bankers, and that’s important because central bankers decide whether interest rates are high or low.

Too-fast GDP growth means rising interest rates, in order to slow things down, and too-slow GDP means falling rates.

But just what growth rates for GDP would be seen as too fast, too slow or just right – or “trend” – is subject to a lot of guesswork.

You have to guess how fast the population will grow.

And the proportion of it in each age group.

And the proportion of each age group active or “participating” in the jobs market.

Then, once you’ve guessed all that, you need to guess how much stuff can be produced by each worker.

To do that, you have to guess how many hours each worker will put in.

And their productivity – how much they produce per hour.

Put all those guesses in the pot, give it a stir and Bob’s your uncle, you have a trend rate of GDP growth.

Chances are, it will be much like the average annual growth rate of the past few decades, somewhere in the 3.0 to 3.5 per cent range, depending on the time frame you’re looking at.

Policymakers have become rather gloomy in the past few years about the trend growth rate from now on, though.

First, we had a bout of slow productivity growth, largely the by-product of the mining boom.

But in the past two years labour productivity growth has been at its fastest for a decade, so those fears – always overblown – have mercifully died down.

And then there’s the ageing of the population.

Older people are less active the labour market.

That’s lowering the growth rate of the available labour force by about a fifth of a percentage point a year and, if nothing else changes, will reduce the potential or trend GDP growth rate by the same margin.

But there are some cross currents at work.

The participation rate for women, for example, is still inching higher, and so is participation by older workers.

At last count in April, for example, 55 per cent of the 60 to 64-year-old age group was active in the labour market, compared with 47.5 per cent five years earlier.

Those factors alone will offset much of the effect of the ageing of the population.

And then there’s population growth.

In the past two decades, mainly thanks to changes in immigration rates, working-age population growth has varied from 1.1 per cent to two per cent a year.

It’s very easy for the government of the day to turn on the immigration tap, inducing a minor variation in the rate of immigration that would overwhelm the effect of the ageing of the population.

Whether it will or not is another matter.

But it’s too early to assume the ageing population has lowered the potential for economic growth over the coming few years.

In their official forecasts these days, the RBA and Treasury are taking a conservative line and pencilling in three per cent as their trend growth rates.

And, who knows, maybe their guesses will be right this time.

But always bear in mind that they’re just that – guesses.

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