Philip Lowe: Regional variation in a national economy
Address by Mr Philip Lowe, Governor of the Reserve Bank of Australia, to the Australia-Israel
Chamber of Commerce (WA), Perth, 11 April 2018.
* * *
I would like to thank James Bishop and Andrea Brischetto for assistance in the preparation of
this talk.
I would like to thank the Australia-Israel Chamber of Commerce for the invitation to speak at this
lunch today. It is great to be back in Perth again. I look forward to learning more about how the
Western Australian economy is going. Later this year, the full Reserve Bank Board will be here
for our monetary policy meeting on the first Tuesday in September.
When I was in Perth six months ago I gave a speech titled 'The Next Chapter'. In that speech I
explored some of the likely plot lines in the next chapter of Australia's economic history. I would
like to continue that broad theme today.
For most of the past decade, a common shorthand description of the Australian economy was
that it was a 'two-speed' economy. For some time, Western Australia and Queensland were
growing very quickly on the back of investment in the resources sector, but growth in the other
states was subdued. And then things turned around: growth was weak in Western Australia and
Queensland, and stronger elsewhere. So it's understandable that people have talked about a
'two-speed' economy.
In a country as large and diverse as Australia, it is not surprising that we experience differences
like this from time to time. It is important that the Reserve Bank understands these differences
and, indeed, we devote considerable resources to doing this.
But today, rather than focus only on the differences across regions, I also want to focus on the
similarities.
I would like to do this from two perspectives. The first is from a cyclical perspective and the
second is from a structural perspective. From the cyclical perspective, the good news is that
conditions have improved across most of Australia over the past year. And from a structural
perspective, over time the differences in the structure of output and employment across regions
are tending to become smaller, rather than larger. So I would like to talk about this. There are, of
course, still important differences across the country and I will discuss some of these as well.
Finally, I will finish with some comments about the recent monetary policy decisions of the
Reserve Bank Board.
The cyclical perspective
Over the past year, when discussing the national economy, the Reserve Bank has focused on a
number of themes. I would like to highlight four of these again today (Graph 1).
The first is the strong growth in employment. Over the past year, the number of Australians with
jobs has increased by 31⁄2 per cent, which is a very positive outcome. Labour force participation
has also increased, especially by women. The unemployment rate has also fallen over the past
year, although it has been steady at around 51⁄2 per cent over the past six months.
The second theme is a pick-up in non-mining business investment. We had been waiting a long
time for this to occur, but in 2017 the long-forecast lift in investment finally took place. Over the
year, non-mining business investment increased by 121⁄2 per cent, the largest rise in a decade,
and a further increase is expected.
The third theme is an improvement in business conditions, as reported in surveys. These
surveys are currently more positive than they have been at any time since the financial crisis.
They also suggest that capacity utilisation has been increasing.
The fourth theme has been slow growth in wages. Wage increases around 2 per cent have
become the norm in many parts of the country. This is in contrast to the 3 to 4 per cent
increases that were the norm for most of the past two decades. This change is having a
sobering effect on the finances of many households. It is also contributing to inflation being low.
The latest data suggest that the rate of wages growth has now troughed, with a pick-up evident in
the most recent quarter. A further lift is expected, but it is likely to be only gradual.
So the overall picture for the national economy is one of gradual improvement: businesses are
feeling better than they have for some time and they have increased their investment and hiring. It
is therefore reasonable to expect that economic growth in 2018 will be stronger than the
2.4 per cent outcome we saw last year.
This improvement in the economic climate has occurred across the country, not just in one or
two areas. There are, of course, regional differences, but these four themes are evident across
the country, although to varying degrees.
Over the past year, employment has risen in all states (Graph 2). This is a different picture than
we've seen for some time. Here in Western Australia, there was virtually no employment growth
for more than four years after the peak in mining investment. Over this period, Western Australia
went from having an unemployment rate of two point something to six point something. Recently,
though, the labour market here has begun to improve, with employment increasing by
21⁄2 per cent over the past year and the unemployment rate having come off its peak. There has
been strong growth in jobs in education and health, as there has been around the country.
Turning to non-mining investment, the state-level data are less timely. We do know, however,
that in most states total business investment picked up through 2017, with particularly strong
growth in non-residential construction (Graph 3). Here in Western Australia, the picture is a little
different, given the ongoing unwinding of the mining investment boom. Over the past year, total
business investment in Western Australia has been broadly steady, after earlier sharp declines.
There has, however, been a pick-up in non-residential building approvals, which suggests that a
turning point in non-mining business investment has now been reached. One area, though, that
does remain weak is investment in dwellings, with the level of activity here in the west standing in
contrast to the high level of dwelling investment in the eastern states.
The third theme - the pick-up in survey-based measures of business conditions - is also evident
across the country. For sake of simplicity, this next graph shows business conditions for
Western Australia only and the rest of Australia (Graph 4). The direction of change is the same,
even if conditions here are not as bright as elsewhere. In all states, including in Western
Australia, reported business conditions are now currently above their long-term averages.
The final of the four themes is weak wages growth. This, too, is a national story. Over the past
year, the wage price index increased by around 2 per cent or less in all states (Graph 5). For a
number of years, growth in wages in Western Australia was running considerably above that in
the rest of the country, with the result that the average level of wages here rose noticeably above
that in other states. In the past couple of years, this differential has narrowed, with growth in
wages here below the national average. It is also worth pointing out that the most recent data
show slightly stronger growth in wages in all states. This is a positive development.
So the cyclical themes that we are seeing at the national level are playing out right across the
country, although to differing degrees. We are now all moving in the same direction.
The structural perspective
I would now like to turn to the structural perspective. The main point is that, abstracting from the
cyclical dynamics, there is a longer-run trend towards more similarity, rather than more
divergence, in the underlying economic structure across the country.
An important area where this can be seen is the labour market. Over time, there has been a
marked reduction in the dispersion of unemployment rates across the country (Graph 6). In
particular, the standard deviation of the unemployment rate across the 87 individual regions for
which the Australian Bureau of Statistics (ABS) publishes data is markedly lower than it was at
the turn of the century.
It is also worth noting that the average unemployment rate outside the capital cities is lower than
the average unemployment rate in the capital cities for the first time in a long while (Graph 7).
The gap between the participation rates for prime-aged workers in the capital cities and outside
the capitals has also narrowed. So there has been a convergence of sorts.
There are a number of possible explanations for this. One is that the labour market has become
more flexible, including through the movement of people. Another is that the economic shocks
experienced have become less region specific.
1
It is hard to be definitive, but both explanations are likely to have played some role.
The improved flexibility of the Australian labour market is no doubt part of the story, and the
willingness of people to move for jobs is part of this. However, the propensity of people to move
interstate, or within their state, has declined over the period that the dispersion in unemployment
rates has declined (Graph 8). For the two decades to the mid 2000s, around 2 per cent of us
moved states each year. Over recent times that share has fallen to 11⁄2 per cent.
Another important part of the story is overseas migration. This is evident in this next graph, which
shows the contribution to employment growth from interstate migration, overseas migration and
2
people already living within the state (Graph 9). The role that overseas migration played in the
adjustment process here in Western Australia is clear. When the boom was in full swing the
workforce in Western Australia was boosted significantly by workers from overseas. And then
after the boom, the flow of immigrants slowed considerably. It is also clear that, over recent
years, more people have been moving from Western Australia to other states than vice versa.
This is in stark contrast to the boom years. The overall conclusion here is that the movement of
people has helped even things out across the economy.
The other possible explanation for the reduced dispersion in unemployment rates is that many of
the economic shocks we experience nowadays are less regionally concentrated - with the
mining investment boom being an obvious exception! - perhaps because of less variation in the
structure of regional economies.
It is difficult to test this idea rigorously, especially the nature of the shocks. But we can look at the
variation across the country in the industries in which people work and the type of jobs they have.
My colleagues at the RBA have done this using Census data for the more than 300 separate
3
geographical areas in Australia. Using these data, they have constructed indices of how
different the various regions are in terms of the industries that people work in and the
4
occupations that they have. I will spare you the technical details of these calculations. My
colleagues have also calculated how these indices have moved through time and they have
conducted the exercise both including and excluding the regions with a heavy concentration in
mining. The results are shown in this next graph (Graph 10).
The main conclusion from this work is that, on average, regions are becoming more similar.
Over time, the industries we are working in, and our occupations, are becoming more alike
across Australia, not more different. There are, of course, still large differences across regions,
but they are smaller than they once were.
One important reason for this is the increasing relative importance of service industries, and the
decline in the relative importance of manufacturing. Both of these are national phenomena. Using
the data from the 300-plus individual regions, it is clear that the variation across the country in the
share of the workforce employed in the manufacturing industry has declined since the early
2000s (Graph 11). In 2016, the distribution is more tightly clustered around a lower average than
it was in 2001. It is also clear from the Census data that those regions that had a relatively high
share of workers employed in manufacturing in 2001 have tended to have faster growth in
services employment than have other regions. So we are becoming more alike.
None of this is to say that there are not big differences across our country. There clearly are, and
I will come to some of these in a moment. But, on average, the growth of the services industries
has meant that the differences in industrial structures across regions have narrowed over time. I
would expect that this would continue.
As I have spoken about on previous occasions, the growth of services and increasing investment
in technology mean that investment in human capital is critically important to the country's future
success. This needs to be a national focus. We are making progress, but there is more to be
done, with investment in human capital central to building comparative advantage. This next
graph shows the distribution across regions in the share of the population with an advanced
qualification, defined here as a Certificate III or higher (Graph 12). There has been a marked shift
to the right in the distribution. By 2016, there were only a few regions in which less than half of all
25-44 year olds held an advanced qualification. This is a noticeable change from the early 2000s
and suggests the lift in qualifications is broadly based across regions. If anything, the dispersion
across regions has also lessened over time.
So far I have spoken about the commonalities in the cyclical and structural stories. It is important,
though, to recognise that there are significant differences across regions. One illustration of this
is the different average level of wage income across the country, which we can calculate from
individual tax returns (Graph 13). There is considerable variation across the country, with some
regions having average wage income more than 50 per cent above the national average. Wage
income also tends to be higher in the capital cities than elsewhere. In part, this is explained by
the types of jobs available in larger cities. For example, the capital cities are home to over
80 per cent of all IT, business, HR and marketing professionals, while only around 65 per cent of
people live in these cities. On average, these business-service roles attract higher wages than
many other occupations.
Another notable difference across regions is the level of housing prices. This reflects not just
differences in average incomes, but the underlying demand and supply dynamics. This next
graph shows the standard deviation in housing prices across the country, using data for around
330 separate regions (Graph 14). The picture is pretty clear: the dispersion in housing prices is
currently larger than it has been in a very long time. This mostly reflects the big run-up in housing
prices in Sydney and Melbourne at a time when price growth in the rest of the country has been
subdued.
It's clear from this graph that, in the past, this measure of variation has had a cyclical element: it
increases for a while and then declines. It is understandable why this happens. When prices
increase a lot in one area, relative to another, some people relocate to where prices are lower,
especially if jobs are available. This certainly happened in the late 1990s/early 2000s, when there
was a marked pick-up in people moving from New South Wales to Queensland following the big
increase in housing prices in Sydney. It's too early to tell whether the same type of adjustment
will happen this time, but the number of people moving from New South Wales, where housing
prices are highest, to Queensland (and, to a lesser extent, Victoria) has begun to pick up.
Monetary policy
I would now like to turn to monetary policy.
The Reserve Bank's responsibility is to set monetary policy for Australia as a whole. We seek to
do that in a way that keeps the national economy on an even keel, and inflation low and stable.
No matter where one lives in Australia, we all benefit from this stability and from being part of a
national economy. This is so, even if, at times, in some areas, people might wish for a different
level of interest rates from that appropriate for the national economy. In setting that national rate, I
can assure you we pay close attention to what is happening right across the country.
As you are aware, the Reserve Bank Board has held the cash rate steady at 11⁄2 per cent since
August 2016. This has helped support the underlying improvement in the economy that I spoke
about earlier.
In thinking about the future, there are four broad points that I would like to make.
The first is that we expect a further pick-up in the Australian economy. Increased investment and
hiring, as well as a lift in exports, should see stronger GDP growth this year and next. The better
labour market should lead to a pick-up in wages growth. Inflation is also expected to gradually
pick up. So, we are making progress.
There are, though, some uncertainties around this outlook, with the main ones lying in the
international arena. A serious escalation of trade tensions would put the health of the global
economy at risk and damage the Australian economy. We also have a lot riding on the Chinese
authorities successfully managing the build-up of risk in their financial system. Domestically, the
high level of household debt remains a source of vulnerability, although the risks in this area are
no longer building, following the strengthening of lending standards.
The second point is that it is more likely that the next move in the cash rate will be up, not down,
reflecting the improvement in the economy. The last increase in the cash rate was more than
seven years ago, so an increase will come as a shock to some people. But it is worth
remembering that the most likely scenario in which interest rates are increasing is one in which
the economy is strengthening and income growth is also picking up.
The third point is that the further progress in lowering unemployment and having inflation return to
the midpoint of the target zone is expected to be only gradual. It is still some time before we are
likely to be at conventional estimates of full employment. And, given the structural forces also at
work, we expect the pick-up in wages growth and inflation to be only gradual.
The fourth and final point is that, because the progress is expected to be only gradual, the
Reserve Bank Board does not see a strong case for a near-term adjustment in monetary policy.
While some other central banks are raising their policy rates, we need to keep in mind that their
economic circumstances are different and that they have had lower policy rates than us over the
past decade, in some cases at zero or even below. A continuation of the current stance of
monetary policy in Australia will help our economy adjust and should see further progress in
reducing unemployment and having inflation return to target.
Thank you very much for listening. I look forward to your questions.
1
For discussion of other explanations of the convergence in unemployment rates over time, see Gruen D, B Li
and T Wong (2012), 'Unemployment disparity across regions', Economic Roundup, Issue 2, pp 63-78.
2
Within-state factors that contribute to employment growth include changes in unemployment and participation
rates and natural increase in the population.
3
This work has been conducted by James Bishop and Mary-Alice Doyle. They have also conducted this exercise
for the more than 2 100 smaller geographical areas for which data are available, with similar results to those
discussed here.
4
In broad terms, the Theil information-theory index of segregation measures the extent to which industries and
occupations are geographically segregated across regions (Theil and Finizza, 1971). It compares the
distribution of occupations or industries in each location to the national distribution. The index ranges from 0 to
1, with a higher value indicating more segregation and a lower value indicating more similarity. These estimates
are constructed using single-digit industries and occupations. For more details, see Kaplan G and S
Schulhofer-Wohl (2017), 'Understanding the long-run decline in interstate migration', International Economic
Review, Volume 58, Issue 1, pp 57-94.