IMF Updates Global and National Housing Outlook, Australian Property Overvalued

In the latest release, the IMF have provided data to October 2015, and also some specific analysis of the Australian housing market. We think they are overoptimistic about the local scene, and we explain why.

But first, according to the IMF, globally, house prices continue a slow recovery. The Global House Price Index, an equally weighted average of real house prices in nearly 60 countries, inched up slowly during the past two years but has not yet returned to pre-crisis levels.

chart1_As noted in previous quarterly reports, the overall index conceals divergent patterns: over the past year, house prices rose in two-thirds of the countries included in the index and fell in the other one-third.

house prices around the world_071814Credit growth has been strong in many countries. As noted in July’s quarterly report, house prices and credit growth have gone hand-in-hand over the past five years. However, credit growth is not the only predictor for the extent of house price growth; several other factors appear to be at play.

house prices around the world_071814For OECD countries, house prices have grown faster than incomes and rents in almost half of the countries.

chart2_House price-to income and house price-to-rent ratios are highly correlated, as documented in the previous quarterly report.

chart2_ Turning to the Australia specific analysis, Adil Mohommad, Dan Nyberg, and Alex Pitt (all at the IMF) argue that house prices are moderately stronger than consistent with current economic fundamentals, but less than a comparison to historical or international averages would suggest. Here is just a summary of their arguments, the full report is available.

Argument: House prices have risen faster in Australia than in most other countries, suggesting, ceteris paribus, overvaluation.

OZ-House-Prices-to-GDPCounter argument 1: House prices are in line on an absolute basis – Price-to-income ratios have risen in Australia and now near historic highs. However, international comparisons suggest that Australia is broadly in line with comparator countries, although significant data comparability issues make inference difficult.
Counter argument 2: The equilibrium level of house prices has also risen sharply – Lower nominal and real interest rates and financial liberalization are key contributors to the strong increases in house prices over the past two decades. The various house price modeling approaches indicate that house prices are moderately stronger (in the range of 4-19 percent) than economic fundamentals would suggest.
Counter argument 3: High prices reflect low supply – Housing supply does indeed seem to have grown significantly slower than demand, reducing (but not eliminating) concerns about overvaluation.
Counter argument 4: It is just a Sydney problem, not a national one – The two most populous cities, Sydney and Melbourne, have seen strong house price increases, including in the investor segment. A sharp downturn in the housing market in these cities could be expected to have real sector spillovers, pointing to the need for targeted measures—including investor lending—to reduce risks from a housing downturn.
Counter argument 5: There are no signs of weakening lending standards or speculation – While lending standards overall seem not to have loosened, the growing share of investor and interest-only loans in the highly-buoyant Sydney market, is a pocket of concern.
Counter argument 6: Even if they are overvalued, it doesn’t matter as banks can withstand a big fall – While bank capital levels are likely sufficient to keep them solvent in the event of a major fall in house prices, they are not enough to prevent banks making an already extremely difficult macroeconomic situation worse.

Let us think about each in turn.

Thus, DFA concludes the IMF initial statement is correct, and despite their detailed analysis, their counterarguments are not convincing. We do have a problem.

Be sure to read the fine print in Turnbull’s mid-year economic update

From The Conversation.

Since his swearing in as Prime Minister in September, Malcolm Turnbull has often referred to himself as a “reformer”. In particular, Turnbull has made clear that the time for a change has come.

The Abbott-Hockey plan to “end the age of entitlement” is over, and growth will be placed at the centre of Turnbull’s economic agenda. An expansionary fiscal policy, based on borrowings to fund public infrastructure such as roads, urban public transport, ports and water infrastructure is something the prime minister is seriously considering.

While public spending may intuitively be seen as one of the drivers of economic growth, the academic evidence in favour of it is mixed. True, there’s some evidence in favour of large output returns from fiscal spending. But this evidence typically arises when spending is implemented in particularly severe economic recessions, and not necessarily in mild economic downturns. Moreover, a well-designed fiscal plan should explain not only the spending side, but also the revenue one. How is the government planning to cover public spending?

Of course, if public spending is presented hand-in-hand with expectations of prosperous future growth, public sustainability falls out of the discussion. After all, why shouldn’t we spend now if resources to cover this spending will emerge in the future? However, expectations of prosperous growth must be formulated with care.

As we now know, and as predicted, the Abbott-Hockey plan to return the budget to surplus was conditional on overly-optimistic assumptions regarding future growth – a 3% rate of growth for potential output was envisioned.

In his address to the Australian Business Economists Conference delivered two days ago in Sydney, Treasury deputy secretary Nigel Ray talked about a slowing down of future working-age population growth to 1.5%, lower than the 1,75% growth assumed by the budget last May. The result? Fewer people engaged in working activities, all else being equal, implies a more moderate future growth of Australia’s potential output, which is now expected to be 2.75%, below the 3% assumed by the budget.

And a lower amount of resources in the future, combined with an ageing population, implies more public spending for health care and less revenues from taxation, which means a bigger deficit. Consequently, adjustments must be made to keep the level of public debt under control.

To be clear, financial markets still point to the Australian economy being a solid one, and the debt service promised by the Australian government in order to issue its public debt is still among the lowest among industrialised countries.

To support the perceptions held by financial market operators, Turnbull should clearly communicate his fiscal plan, and how it differs from that of Abbott-Hockey, conditional on the latest revisions on Australia’s future growth. This communication should be constructed on two pillars. Firstly, on credible assumptions on the fiscal multipliers the government expects public spending to generate, and secondly, on cautious predictions on economic growth. Figures on future growth coming from independent sources external to the government should be employed to construct future scenarios which account for the inescapable uncertainty surrounding economic predictions.

It’s not surprising this year’s Mid-year Economic and Fiscal Outlook, due mid-December, is being eagerly awaited by so many Australians.

Author: Efrem Castelnuovo, Principal Research Fellow, Melbourne Institute of Applied Economic and Social Research – Associate Professor, Faculty of Economics and Business, University of Melbourne



Glenn’s Crystal Ball Gaze

RBA Governor Glenn Stevens, spoke about the “Long Run” tonight, and made some interesting predictions in the context of changes in both demography and the digital landscape.

It is not very controversial to suggest that China will grow more slowly on average than in the past decade, but it will still be a big deal given its overall size and the extent of transition required in its growth strategy. China’s financial weight will be increasingly apparent in markets. Those days, like in late August this year, when US and global markets are roiled by some event in China, will probably become more common. The growth transition towards services will have implications not just for the value of resource shipments from Australia, but for the Asian regional manufacturing chain.

But China’s demographics are not favourable. To be sure, the continuing process of urbanisation means that the labour available for manufacturing or services production may grow for a while. But, overall, China’s total working-age population will be shrinking over the years ahead. Contrast this with India, another large country, but with vastly different demographics. India’s population of working age will exceed China’s within a decade and continue to grow.[5] So India should become much more prominent in our conversation about the global economy and our own. Are we intellectually prepared for that?

The United States will still be a very large economy and, perhaps more important, still a leading source of innovation and dynamism. It will probably retain its current position of global leadership in international economic governance, though much depends on how two political establishments – the US’s and China’s – behave, including towards each other.

There are no prizes for guessing that the share of services in most economies will continue to increase. Health and aged care are obvious areas for expansion – another effect of demographics. It may be that jobs will be ‘robotised’. But on the other hand, in the long run we may need that to some extent. Demographic factors suggest strongly that, all other things equal, the problem isn’t going to be a shortage of jobs, but instead a shortage of workers.

‘Digital disruption’ will continue. Some of this will be faddish and no great aid to productivity. But other elements will mean fundamental changes to business models. It’s already obvious that models that rely on having an information advantage over a customer are struggling as information becomes ubiquitous. Models that can profit by using more information about the customer will be advantaged – up to the point at which customers decline to reveal any more about themselves. The issue of trust will be key.

On that note, I suspect the already-considerable resources devoted to IT security will grow further as awareness increases of cyber risk and its consequences. Maybe IT security will need to get as inconvenient as airport security and more costly – a whole new meaning of the term ‘digital disruption’. It remains to be seen whether, at some point, the potential risks of further connectedness might be judged to outweigh the benefits. There are, for example, some organisations sufficiently concerned about cyber risk that they construct a duplicated IT architecture – one connected to the world, the other sealed off. The issue of trust in cyber space may turn out to be every bit as problematic as that of trust in the financial system.

My guess is that global interest rates are still going to be very low for a good part of the decade ahead. Clearly there is a likelihood that the Federal Reserve will raise the fed funds rate next month or, if not then, pretty soon. Once it does, intense speculation will begin about a question much more important than the timing of the first increase, namely the timing of the second (and, by extension, the future path of the funds rate). But it seems likely that the pace of increase will be very gradual. The ECB and the Bank of Japan are a long way from even thinking about higher interest rates; the ECB is openly contemplating further easing. So the average policy rate in major money centres may be very low for quite a while.

In a low interest rate world, the problems of providing retirement incomes will become ever more prominent. The very low level of yields on fixed income assets means that it is very expensive today to purchase a secure stream of future income, which is what someone who is retiring is usually seeking. And there are more of such people, living longer.

The retiree can of course respond to this by holding more of her portfolio in dividend-paying stocks – accepting more risk. She may hope for a dividend stream that is fairly stable from year to year but that tends to grow over time. It certainly seems that many Australian listed corporates feel the pressure from shareholders to deliver that, even some whose earnings are inherently volatile.

Can the corporate sector realistically promise growing dividends over a long period? Not without being prepared to take the risk on investment in new products, processes and markets. How much of that risk an older shareholder base will allow boards and managements of listed entities to take is an important question.

Overall, in a world where a higher proportion of the population wants to be retired and living (even if only in part) off the return on their savings, those returns are likely, all other things equal, to be lower. Part and parcel of the same adjustment may be higher real wages for the smaller proportion of the population that is working. These changes, driven by demographics, may require some adjustment to our collective thinking about what is ‘normal’, not just for rates of return on assets but also for returns to labour.

Medium Term Macroeconomic Expectations Sees GDP Lower

A significant speech by Nigel Ray, Deputy Secretary, Macroeconomic Group, The Treasury.  The latest data on the population and labour force trends suggest that potential output will be lower than estimated at Budget. So potential GDP will grow by around 2¾ per cent over the next few years, lower than the 3 per cent estimated at Budget.

There was criticism of the Budget that the projections for real GDP growth over the medium term were too high.

Some have suggested these projections were raised in order to improve the Budget position. Can I say at the outset that this claim is simply not true. In fact, when Treasury introduced the current methodology in the 2014-15 Budget, we published analysis in a separate Working Paper showing that the impact of these changes on the underlying cash balance was very small – an increase of just one-tenth of a per cent of GDP by the end of the medium term.

It is true that Treasury’s framework assumes that the economy will grow faster than potential for a period into the medium term.

This reflects our estimates that the economy is currently operating well inside the limits of its productive capacity, following a period of below-potential growth over recent years. This view is supported by the slow growth in wages and prices that we are currently seeing.

We expect the economy will still be operating with excess capacity by the end of the forecast period in June 2017, even factoring in a modest pick-up in growth over the next two years.

In these circumstances, we assume that necessary adjustments in prices and wages will see the economy’s spare capacity absorbed and the unemployment rate decline towards the non-accelerating inflation rate of unemployment (NAIRU) over a number of years. Similar approaches are used by the Congressional Budget Office in the United States and the UK’s Office for Budget Responsibility.

Our previous approach was to assume that the unemployment rate returned to the NAIRU in the first year of the projection period. This assumption had the considerable benefit of simplicity. And so it had merit when the unemployment rate was not far from the NAIRU. But it was (rightly) criticised as being an unrealistic assumption in circumstances where the unemployment rate was expected to be significantly above the NAIRU by the end of the forecast period.

And in such circumstances, the methodology suffered from internal inconsistencies. While the unemployment gap was assumed to close, the output gap was implicitly retained.

Another alternative is to assume that an output gap will exist indefinitely, and that the unemployment rate will remain above the NAIRU. Apart from also being unrealistic, the assumption that cyclical unemployment will last indefinitely would seem odd given that policy settings are designed to avoid this very thing.

Instead, our approach is to assume that the economy’s output gap will be absorbed over a period. History suggests this takes about five years. For simplicity, we assume that the adjustment takes place evenly over these five years.

By definition, the closing of the output gap requires real GDP to grow faster than potential over this time.

While involving some necessary simplifications, this approach is consistent with historical experience where the economy has tended to grow above potential for a number of years in a row following a period of sustained weakness.

Chart 10: Real GDP growth


Source: ABS Cat. No. 5204.0 and 2015-16 Budget forecasts.

To implement the methodology we need estimates of the level of potential GDP now and into the future. Potential GDP is not a quantity that we – or anyone else – can directly observe, either now or over history. Instead, we have to use the best methods at hand and the best available data to estimate it. To do this, we estimate trends and make assumptions about each of the economy’s supply side drivers – population, participation and productivity.

Once we have estimated the current level of potential GDP, the next step is to project how potential GDP will evolve over time – that is, we estimate the future growth rate of potential. Again, we do this for each of the 3Ps separately.

Population projections are based on the latest population figures from the ABS and net overseas migration estimates from the Department of Immigration and Border Protection, together with our estimates of fertility and mortality. Projections of the trend participation rate and average hours are built up from age and gender-specific labour force data.

For labour productivity, we assume trend growth of 1.6 per cent, which is the 30-year historical average and is consistent with our approach in the Intergenerational Report.

But none of these numbers is set in stone.

And like similar national economic advisers overseas, Treasury continually reassesses its estimates of potential growth and the size of the output gap in light of new data and new methods.

New evidence on the size of the population suggests that Australia’s current productive capacity is slightly lower than we estimated at the time of the Budget in May.

Australia has experienced rapid population growth over the past ten years, fuelled by solid increases in net overseas migration. This came on the back of our relatively strong economic performance and low unemployment compared to other countries. But as economic growth has softened, recent immigration outcomes have come in lower than the Department of Immigration and Border Protection initially expected. This mainly reflected declines in temporary visa holders and lower net migration from New Zealand.

Chart 11: Revisions to growth in working-age population


Source: ABS Cat. No. 6202.0 and Treasury.

The revised data from the ABS – shown in the blue line in the chart – showed that growth in the working-age population slowed to 1½ per cent over the year to June 2015, well below the Budget assumption of 1¾ per cent and for that matter well below its average yearly growth over the past ten years (also 1¾ per cent). Like the Reserve Bank, we expect Australia’s population to continue to increase at around its current, slower rate of growth over the next few years.

This has immediate and unavoidable consequences for the economy’s potential: fewer people means a smaller supply of employees. So for a given capital stock and level of productivity, we can now produce less output overall than we previously estimated.

We have also reconsidered the contribution of average hours worked to potential GDP going forward In light of new data. The latest quarterly data suggest that a larger portion of the decline in average hours reflects trend rather than cyclical factors, implying that the previous recovery in average hours factored into our projections may be too large. Our revised estimates of trend are shown in the solid red line in the chart.

Chart 12: Average hours worked – trend and cycle


Source: ABS Cat. No. 6202.0 and Treasury.

Taken together, the latest data on the population and labour force trends suggest that potential output will be lower than estimated at Budget. We now think potential GDP will grow by around 2¾ per cent over the next few years, lower than the 3 per cent estimated at Budget.

It’s also worth noting that the ageing of the population means that the economy’s potential growth rate is projected to fall slowly over time, reaching 2½ per cent by 2050.

As a consequence of these changes, the output gap will be smaller than estimated at Budget. The chart shows our latest estimates of the history of the output gap, compared with Budget.

Chart 13: Output gap estimates


Source: ABS Cat. No. 5206.0 and Treasury.

We will finalise our forecasts for MYEFO after the national accounts are released next week and in light of our latest business liaison round, which we completed last week. Those forecasts will inform our estimate of the output gap at the end of 2016-17 and so the pace at which the economy will need to grow to close it over the following five years.

But it is likely that, on average, we won’t have to grow quite so fast to get there as we previously thought. The economy will of course, by definition, still have to grow a bit faster than potential.

It needs to be remembered that Treasury forecasts the economy predominantly to inform the budget. While our analysis of the economy also informs policy development more broadly, it is the need to prepare estimates of revenue and expenditure over the forward estimates and beyond that drives our approach.

And it is nominal GDP that matters for revenue.

When unemployment is above the NAIRU, it is reasonable to expect that wages and prices will grow more slowly than usual. That effect was one of the main reasons why the change in methodology in 2014 had a smaller fiscal impact than many commentators expected.

The slower price growth drags directly on the dollar-value of the economy’s output, muting the effect on revenues of strong growth in output volumes.

And whereas the economy fully recovers lost ground on output volumes over the assumed period of cyclical adjustment, this is not the case for nominal GDP. The dollar value of the economy’s output that is lost to slow price growth over the medium term is lost forever.

Changes in population, prices and the number of people unemployed will all affect estimates of expenses. The Government will publish revised estimates of the projected medium-term fiscal position in MYEFO. Compared with the Budget base, it is reasonable to conclude that the changes to population and hours worked that I have outlined would, everything else equal, lower the path of the projected underlying cash balance.

It is important to reiterate that this all rests on our economic projections, which are based on a set of assumptions about how the economy works:

  • assumptions about the supply-side drivers of Australia’s productive capacity – about population, participation and productivity; and
  • assumptions about the time it takes to return the economy to potential output through adjustments in prices and quantities in the labour market.

There are a number of reasons why our projections could be wrong.

The output gap might be smaller than our estimates. Our revised projections reflect the recent downgrades to historical population data. But if trend participation is lower than our estimates, this might mean potential output, and the output gap, is smaller than the projections assume. As a result, the economy might not need to grow as fast to return to potential. Present conditions in the labour market – the wage price index is growing at its slowest pace on record – and measures of underutilisation suggest there is a large amount of spare capacity in the economy. To us, this signals that there is currently a large output gap even when we factor in lower population growth.

The NAIRU might be higher than our estimated 5 per cent. This would also narrow the output gap as it would erode Australia’s available labour resources. Our experience during the mid-2000s provides some reassurance that the NAIRU is about 5 per cent and that we can operate with an unemployment rate around this level without inflation rising too much.

On the other hand, long periods of high unemployment, and in particular, widespread long-term unemployment, could cause a structural lift in the non-accelerating inflation rate of unemployment. You might expect this outcome in periods of excessively high unemployment where the long-term unemployed lose skills and their connection with the labour market. However we are not now in a recession. And Australia’s current long-term unemployment rate is nowhere near what it was in past recessions.

Productivity growth could be slower than it has been in the past. Our projections assume labour productivity will grow in line with its average rate of growth over the past 30 years. Productivity could grow more slowly because of structural shifts in the economy. As services become a bigger part of our economy, productivity growth could ease. Equally, breakthrough innovation and the realisation of productivity gains from current technologies could see productivity grow faster than it has in the past.

This heavy reliance on this set of assumptions highlights the need for Treasury to continue to expose our frameworks and assumptions to outside scrutiny.

We regularly check our methods against the best approaches used by forecasters both domestically and overseas. And our methodologies are published in working papers that are freely available online – this includes our methodology for the medium-term projections. We are releasing today a short note that sets out in more detail our updated estimates of potential growth and the output gap.

Housing Affordability Falls – Moody’s

The current low mortgage interest rates have failed to offset the impact of rising house prices over the past year, and the implementation of interest rate hikes this month will further increase delinquency and default risks for mortgage loans says  Moody’s analyst Natsumi Matsud.  Specifically, the less affordable a mortgage becomes relative to household income, the higher the risk of delinquency and default.

The out-of-cycle interest rate hikes by the big banks will put further stress on housing affordability once they hit in November. Sydney and Melbourne will be worst hit says Moody’s.

In Sydney, where house prices climbed over the last year, households spent an average of nearly 40 per cent on monthly mortgage repayments, up from 36 per cent a year ago. Households with two income earners spent an average 29.3 per cent of their monthly income on mortgage repayments in October, up from 28.2 per cent at the same time last year.



The tax system can play a role in Australian innovation

From The Conversation.

Australia’s quest to develop a stronger innovation ecosystem has seen a growing focus on the income tax system, and whether it should be used as a lever to help achieve this goal.

Some have argued the government should not use tax incentives to spur the shifts needed to make Australia an innovation hub. This view is based on the argument that tax incentives have never been central to the success of Silicon Valley or Israel’s innovation ecosystems. However, there has been little analysis of why this is so and no-one has stopped to ask whether this analogy is apt for Australia.

Australia is in a very different position now to where the US was from the 1970s through to 2000 when Silicon Valley went through the biggest phase in its development. One part of this difference is the level of military expenditure available for investment in technology.

In the US, between 1970 and 1992, the lowest level of military expenditure as a percentage of GDP was 4.6%. At the start of the 1970s, the level was much higher (7.8%), and that was a decrease from the level in the 1960s (in 1962 and 1968, the level was 9.0% and 9.1% respectively). Between 1992 and 2001 in the US, the level steadily fell from 4.3% down to 2.9%.

There are various reasons for the fluctuations across time, including engagement in war (the Cold War and the Vietnam War) and changes between Democratic and Republican administrations. But the broader point is that the baseline of military spending in the US at the crucial stage in the development of Silicon Valley was very high. The same is true of military spending in Israel – in 2014, military expenditure accounted for 5.2% of GDP. That is the lowest level of military expenditure there for at least 15 years.

By comparison, the level in Australia in 2014 was much lower, at 1.8% of GDP. This is nothing near the historic levels in the US or the relatively recent levels in Israel. While only a small proportion of military expenditure will be invested in new technology in any country, countries that have had high levels of military expenditure have had higher levels of investment in new technology.

Submarines alone won’t do it

Some have pointed out that, given the importance of military investment to the ecosystems in Silicon Valley and Israel, Australia’s next submarine contract is vital. However, one contract is unlikely to be enough to single handedly develop technology that can dramatically transform the existing landscape and provide a backbone for the future of innovation in Australia. (No pressure, right?) This also raises a broader question about whether it’s possible for Australia to increase its current level of military expenditure and whether that is what we want.

In addition to the disparity between military expenditure in Australia and the US, there is a huge difference in scale of GDP. In 2014, Australian GDP was approximately US$1.454 trillion and US GDP was US$17.419 trillion. The sheer scale of US GDP is significant due to the failure rate of startups. Anecdotally the failure rate for tech startups in the US is around 90%. A lot of capital is lost in the quest to find the next Facebook or Snapchat. Scale helps innovation.

Further, an important part of the success of US startups has been the scale of their domestic market. Exporting to international markets has tended to come much later (although this temporal lag was more pronounced in the 1980s than it is now).

In Australia, the relatively small size of the domestic market means Australian startups will need to export much earlier in their lifecycle. Ian Maxwell has previously suggested that a startup tech sector in Australia could be successful if startups were acquired by the corporate sector, and established corporations then went through the process of commercialising and exporting the process or technology globally. This point is worth exploring further. His broader point – that Australia is going to need to come at the problem differently to the US – is compelling given we are building from a different baseline, in different conditions and with very different parameters. We need to work with our strengths.

Given the figures above, it’s highly unlikely investment from military spending alone will be able to sustain an innovation ecosystem in Australia. Given the capital required to commercialise research and innovation and the size of our economy, we will need to be clever about how to drive capital towards such an ecosystem.

Tax concessions may not be the silver bullet. Based on past experience, e.g. with concessions for film, R&D and infrastructure bonds, any concessions would need to be tightly controlled to prevent manipulation and avoidance. However, it seems unwise to completely dismiss the tax system as playing a role in achieving the economic shift we are seeking.

One idea worth exploring further is whether it is valuable to undertake some rebalancing between the level of concessions and subsidies that are currently directed towards individuals and those directed towards business vehicles, even if this is only temporary. The rationale is that a flourishing and productive private sector may remove the need, or assume responsibility, for providing some of the benefits to individuals. The UK seems to have had some success with that strategy.

In this vein, some have recently argued that the revenue lost to negative gearing and the investment in real property that it has encouraged would be better redirected towards the startup sector.

In 2015, NATSEM estimated that Australia currently foregoes A$3.7 billion in revenue each year to negative gearing of residential property (A$7.7 bn when combined with the CGT discount) and there’s also evidence negative gearing mostly benefits higher income taxpayers.

Abolishing the Australian tax sacred cow of negative gearing would be unpopular. But it is the type of change we should be considering if we really want to direct investment towards innnovation.

Author: Alex Evans, Lecturer in Tax Law, Australian School of Business, UNSW Australia

FactCheck: are average earners the main beneficiaries of negative gearing?

From The Conversation.

Average income earners largely are the people who do get to take advantage of negative gearing – nurses, policemen and women on an average wage, investing, for instance, in a property. Most of them hold only one property, which adds to the housing stock that’s available for people as well. – Assistant Treasurer and Small Business Minister Kelly O’Dwyer, speaking on ABC TV’s Insiders, October 25, 2015

Negative gearing is a tax break available for people who own at least one other property in addition to their primary place of residence. This tax break applies only if the costs associated with the investment, including interest payments and other expenses, are greater than the rental income. Any loss made on the property can be offset against other income, thus reducing personal tax.

It’s true many nurses and police officers and other middle-income (and even much lower) people have negatively geared properties. But are these occupations and incomes the typical beneficiaries of negative gearing?

Checking the data

When asked for a source to support her statement, a spokesperson for O’Dwyer sent the following statistics.

• Taxation statistics show 66.5% of taxfilers who declare a net rental loss have a taxable income of A$80,000 or less.

• Those who use negative gearing include 22.6% of police officers, 19.2% of ambulance officers and paramedics, and 18.9% of train and tram drivers.

• Of the Australians who use negative gearing, the majority only hold one additional property.

• 73% of people with a rental property interest have only one property and 18% own two.

A$80,000 per year is not a typical taxable income. Around 84% of non-investors have a taxable income below $80,000. This compares with the 66.5% of people with negative geared property.

It is true that a relatively high proportion of the listed occupations have negatively geared properties. While it may be the popular belief that these are low or middle income occupations, these are actually reasonably highly paid occupations. For example, 73% of train and tram operators earn more than A$80,000 per year.

In our analysis, we looked at the income distribution of people who negatively gear compared to that of people who do not invest in rental properties.

The data set we used is called the 2012–13 individuals sample file. To collect this data, the Australian Taxation Office (ATO) sampled 2% of all individual tax returns filed in 2012-13.

According to this ATO data set, there are 1.26 million (10%) taxpayers who negatively gear. Their average loss was A$8,930 per year. A further 700,000 with a rental investment are positively geared (meaning their rental income was greater than their costs). About 85% of taxpayers don’t have a rental investment.

The chart shows what statisticians call the “smoothed” probability distribution (which is a smoothed histogram of the income distribution) of taxable income for people with negatively geared properties and people without rental investment properties. Marked also on the chart are the median and top 10% (P90) income points for both people with negatively geared properties and those without property investments.

The median income for negatively geared investors is A$60,000 per year, compared with $40,000 for non-investors.

A similar gap (50%) exists at the top end of the income spectrum. The taxable incomes of the top 10% of earners with negatively geared investments is around $150,000 compared to $98,000 for non-investors.

The chart shows clearly that, typically, people with negatively geared properties have significantly higher incomes than people without property investments.

In an April 2015 analysis commissioned by GetUp! for the Australia Institute, NATSEM found that 34% of the tax benefits of negative gearing accrues to the richest top 10% of families, as this chart from the report shows.

Top Gears: How negative gearing and the capital gains tax discount benefit the top 10% and drive up house prices. Published by The Australia Institute.

Only around 20% of the tax benefits go to the bottom half of the income distribution.

High-income families invest more money than low-income families. The tax system benefits high-income earners more than low-income earners due to higher marginal tax rates amplifying the effectiveness of deductions.

The role of capital gains

Negatively gearing property implies that the investor is making a loss on their investment. As the chart below shows, the tax savings are greatest among those in the higher tax brackets. However, it remains the case that these investors continue to make an overall loss on their investment, even after accounting for tax deductions.

Top Gears: How negative gearing and the capital gains tax discount benefit drive up house prices, published by The Australia Institute.

The success of negative gearing as an investment strategy is reliant upon capital gains. In a property upswing, this strategy can be highly successful with lucrative gains on often minimal equity investment. During a property downswing or period of limited price growth, these strategies are very poor investments.

A recent analysis by the Grattan Institute shows that while police and nurses do invest in property, it is the higher-income occupations, such as doctors and mining engineers, who are much more likely to invest.

Adding to the housing stock?

Property investment only improves housing affordability when the purchase adds to the stock of newly constructed dwellings in affordable housing.

According to CoreLogic RP Data, in 2014 there were just under 500,000 property transactions and ABS building completions data suggest only around a third of those were newly built dwellings. It therefore stands to reason that most property transactions each year are probably existing stock.


O’Dwyer’s assertion is not supported by the data. ATO data shows that, typically, negatively geared investors have higher incomes than people without rental investments.

The same data shows that negatively geared investors have typical incomes around 50% higher than non-investors – even after deducting their losses from negative gearing.

The top 10% of the income distribution for negatively geared investors earn around 50% more than non-investors. Incomes for this top 10% are around $150,000 per year, compared with $98,000 for non-investors, according to the ATO. – Ben Phillips and Cukkoo Joseph


While I agree with everything in the above FactCheck, I would go further in criticising Kelly O’Dwyer’s statement, particularly the reference to investors adding to the housing stock.

The figure cited above for the ratio of housing purchases for new housing stock includes owner occupiers.

The impact on housing stock is tiny, but the effect on housing affordability of all those investors bidding up the prices of existing housing is likely to be substantial. – Warwick Smith

Authors: Ben Phillip, Principal Research Fellow, National Centre for Social and Economic Modelling (NATSEM), University of Canberra; Cukkoo Josep, Research Assistant, University of Canberra.

Reviewer, Warwick Smith,Research economist, University of Melbourne

Emerging Asia in Transition

Fed Vice Chairman Stanley Fischer spoke on “Emerging Asia in Transition“.  After a long period of rapid economic growth, Asia’s emerging economies appear to have entered a transitional phase. For decades, emerging Asian economies have been among the fastest growing and most dynamic in the world. Supported by an export-oriented development model, annual growth averaged 7-1/2 percent in the three decades leading up to the global financial crisis. Will developments in the global economy permit the continuation of the export-centered growth strategy that underlies the Asian miracle or will we later conclude that this period, the period after the Great Recession and the global financial crisis, marked the beginning of a new phase in the economic history of the modern global economy?

Emerging Asia has played an outsized role in commodity markets for some time now. Specifically, China, with its investment-heavy growth model, has accounted for a substantial amount of incremental commodity demand over the past two decades. Since 2000, China has accounted for roughly 40 percent of the increase in global demand for oil and 80 percent of the growth in demand for steel. For copper, all of the incremental rise in global demand has come from China, with demand excluding China falling over the period.

The strength of emerging Asian demand growth pushed commodity prices up sharply over most of the past decade, at least temporarily reversing what seemed to be an inexorable decline in both commodity prices and the terms of trade of commodity producers in the preceding two decades. Higher prices were a tremendous boon to commodity producers and supported a decade of strong growth in a number of emerging market economies, as well as commodity sectors in certain advanced economies, including Australia and the United States.

Since mid-2014, commodity prices have plummeted, with oil prices falling almost 60 percent and a broad index of metals prices losing about one-third of its value, dragging down growth in many commodity producers. Although rapid commodity output growth in recent years, which has reflected in part the response of producers to previous price increases, has certainly contributed to the fall in commodity prices, the slowing of demand growth from China and emerging Asia has also been an important factor.

While the path ahead for commodity prices is, as always, uncertain, declining investment rates in emerging Asia, particularly China, present the prospect of a prolonged decline in the growth rate of commodity demand. And prices could remain low for quite some time, which seems particularly true for metals, such as copper and steel, used heavily in construction and investment. However, for oil, the implications of a shift from investment-led growth to a consumption-led model are less certain. On a per capita basis, China’s consumption of oil remains far below that of advanced economies, in line with China’s lower rate of car ownership. Per capita oil consumption tends to increase with wealth, such that further income growth in China has the potential to provide strong support for the oil market in the coming years.

Indeed, more generally, the world stands to benefit from a transition to more consumption-led growth in emerging Asia. Under a successful transition toward more-balanced growth, emerging Asia can be expected to import a broader array of goods and services both from within the region and globally. Whether a country benefits from or is harmed by emerging Asia’s transition is likely to be determined by the flexibility of that country’s economy in adapting to shifts in Asian demand away from commodities and inputs for assembly into the region’s exports and toward services and goods to meet Asian final demand.

To recap, the transition to slower growth in the emerging Asian economies, as well as a shift toward domestic demand and consumption and away from external demand and investment in the region, is likely to have profound implications for the global economy. For one, trade growth is unlikely to resume its rapid pace of recent decades, and the long climb in commodity prices, which has benefited commodity producers, appears to have come to an end.

Can India Recharge Growth in Emerging Asia?
One source of uncertainty in this outlook, as alluded to earlier, is the prospect for India to provide a new growth engine for Asian development. In principle, India has enormous potential to recharge the Asian growth engine. For one, India is relatively unintegrated into global production-sharing networks. For example, machinery and electrical products, which feature heavily in production-sharing and which make up about half of exports in other emerging Asian economies, account for only 15 percent of India’s exports. Foreign direct investment into India is about half the size of similar flows into China as a percentage of GDP, and GDP per capita, at $1,600 in 2014, remains considerably below emerging Asia’s average.

All told, while the export-led growth model that propelled growth in China and other economies in emerging Asia has matured, pushing down growth rates, India remains at a relatively early stage of its development trajectory. Further capital deepening and the potential for further productivity gains suggest that India could maintain rapid economic growth for a number of years. As mentioned previously, India is also a young country, with a relatively low dependency ratio and a growing workforce. By United Nations estimates, India is set to overtake China during the next decade as the world’s most populous nation.

In the 1960s and 1970s, the Indian economy grew at around 3 to 4 percent. In subsequent decades the growth rate averaged close to 6 percent, and in the early years of this century it rose further, as can be seen in Table 1. In 2015, growth in India is expected to be 7-1/4 percent, the fastest among large economies, and the IMF expects growth to pick up from this already rapid pace through the end of the decade. Growth has been supported by an improved macroeconomic policy framework, including a strengthening of the framework for conducting monetary policy, as well as legal and regulatory reform. And the authorities have embarked on an ambitious program to improve the business environment.

That said, significant roadblocks need to be overcome for India to reach its full potential. The economy continues to suffer from a number of infrastructure bottlenecks that will be alleviated only through a pronounced increase in investment rates, a process that would likely be helped by a relaxation of restrictions on foreign direct investment. Likewise, efforts at difficult reform will have to be sustained. There is much hard work ahead if India is to come closer to fulfilling the potential that it so manifestly has.

Concluding Remarks
The performance of the Asian economies–notably those of East Asia, particularly China, Japan, and Korea–especially in the past six or seven decades, is an outstanding, if not unique, episode in the history of the global economy.

What lies ahead? In the relatively near future probably some major central banks will begin gradually moving away from near-zero interest rates. The question here is whether the emerging market countries of Asia–and, indeed, of the world–are sufficiently prepared for these decisions, to the extent that potential capital flows and market adjustments can take place without major macroeconomic consequences. While we continue to scrutinize incoming data, and no final decisions have been made, we have done everything we can to avoid surprising the markets and governments when we move, to the extent that several emerging market (and other) central bankers have, for some time, been telling the Fed to “just do it.”

Further ahead lies the answer to the question of whether developments in the global economy will permit the continuation of the export-centered growth strategy that underlies the Asian miracle or whether we will later conclude that this period, the period after the Great Recession and the global financial crisis, marked the beginning of a new phase in the economic history of the modern global economy.7 Either way, the question of the economic future of India is of major importance not only to the 18 percent of the world’s population that lives in India, but also to the other 82 percent of the global population.

At a more structural level are three recent developments whose potential importance is currently difficult to assess: the setting up of the Asian Infrastructure Investment Bank; the likely inclusion of the Chinese yuan in the Special Drawing Rights basket; and the possible establishment of the TPP, a partnership in which China is not expected to be a founding member.

These are interesting and potentially important developments. Underlying the answer to the questions of what they portend, is the answer to the basic question of whether the economic center of gravity of the world will continue its shift of recent decades toward Asia–in particular, to China or, perhaps, to China and India. This shift would represent a return in some key respects to the global order of two centuries ago and earlier, before the economic rise of the West.

A partial answer to that question is that China is for some time likely to continue to grow faster than the rest of the world and thus to produce an increasing share of global output. Its importance in the global economy is likely to increase, and it is probable that, one way or another, its growth will result in its playing a more decisive role in the international economy and in international economic institutions.

Finally, we need to remind ourselves that geopolitical factors will play a critical role in the unfolding of that process.

Fed Minutes Point To Rate Rise … Sometime…

The last FED meeting suggests it could well be time to raise short-term interest rates at the December policy meeting after keeping them at near zero levels for more than seven years, according to released minutes.  Whilst they voted to change the wording of their policy statement leaving the option to lift in December; it is not a sure bet.

From the Fed minutes for October.

After assessing the outlook for economic activity, the labor market, and inflation and weighing the uncertainties associated with the outlook, all but one member agreed to leave the target range for the federal funds rate unchanged at this meeting. Members generally agreed that, in light of some weaker-than-expected readings on measures of labor market conditions and in the absence of greater confidence about the inflation outlook, it would be prudent to wait for additional information bearing on the medium-term outlook before initiating the process of policy normalization. One member, however, preferred to raise the target range for the federal funds rate by 25 basis points at this meeting.

In its postmeeting statement, rather than framing its near-term policy path in terms of how long to maintain the current target range, the Committee decided to indicate that, in determining whether it would be appropriate to raise the target range at its next meeting, it would assess both realized and expected progress toward its objectives of maximum employment and 2 percent inflation. Members emphasized that this change was intended to convey the sense that, while no decision had been made, it may well become appropriate to initiate the normalization process at the next meeting, provided that unanticipated shocks do not adversely affect the economic outlook and that incoming data support the expectation that labor market conditions will continue to improve and that inflation will return to the Committee’s 2 percent objective over the medium term. Members saw the updated language as leaving policy options open for the next meeting. However, a couple of members expressed concern that this wording change could be misinterpreted as signaling too strongly the expectation that the target range for the federal funds rate would be increased at the Committee’s next meeting. While members differed in their assessment of the likelihood that incoming information will warrant an increase in the target range for the federal funds rate when the Committee meets in December, they agreed that, in making the decision, the Committee will evaluate progress toward its objectives, taking into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. It was noted that the expected path of the federal funds rate, rather than the exact timing of the initial increase, was most important in influencing financial conditions and thus in affecting the outlook for the economy and inflation. The Committee reiterated its expectation that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

The Committee also maintained its policy of reinvesting principal payments from its agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Private Sector Wage Growth The Lowest On Record

According to the ABS, the seasonally adjusted Wage Price Index (WPI) rose 0.6 per cent in the September quarter 2015 and 2.3 per cent over the last year, according to figures released today. It is an all time record low for the Private sector, though Government servants are doing rather better. This data underscores the continued pressure on rentals from investment properties, because rentals are more linked to income than house prices.

In the September quarter 2015, Private sector wages grew 0.5 per cent and Public sector wages grew 0.7 per cent (seasonally adjusted).

Wage-TrendsPrivate sector seasonally adjusted wage growth of 2.1 per cent over the last year is the lowest rate of wages growth since the start of the WPI series. The through-the-year series was first published in September quarter 1998.

In the Public sector, wages grew 2.7 per cent over the last year.

In the September quarter, the largest rise (original series) of all industries is 1.6 per cent in Accommodation and food services. Finance and insurance services had the smallest rise of 0.2 per cent.