Demographer David Harvey theorised in the late 1980s about how investments move through a capitalist economy. Harvey suggested there were three circuits to money flows: the primary, secondary and tertiary circuits.
Furthermore, Harvey believes these were the key drivers of economic growth. However, he warned that if any of the three circuits were propped up by debt for too long, they would create unsustainable bubbles that had severe ramifications for an economy.
The three phases are simple enough to understand.
The primary circuit is when an economy is expanding during the production phase. The secondary circuit is when investment returns in production are exhausted and there is a move into construction.
Once gains from the secondary circuit weaken, the tertiary circuit is where money moves to. This final stage is more of an investment in society overall. Money flows into science and technology, creating a healthier population, while innovation looks for more efficient methods for production and building.
Then the circuits begin again.
Australia’s primary circuit was our mining boom, which we can safely say is done and dusted for now. For the past five years, Australia has firmly transitioned into the secondary circuit.
The chart below records new ‘starts’ in construction in Australia. In other words, each month the Performance of Construction Index (PCI) records how many new buildings were started for that month. It’s worth noting that the chart considers all housing, apartments, commercial and engineering starts as construction.
Anything above a reading of 50 points indicates expansion in the industry. Anything below 50 suggests PCI growth is shrinking.
Australian Performance of Construction Index (PCI)
Source: Housing Industry Association (HIA)
[Click to enlarge]
As you can see, the Aussie construction sector has been firmly in the expansion phase since mid-2016. Rising 4.5 points, to 60.5 points, in July, both commercial and house constructions were major drivers of growth. As the Housing Industry Association put it, ‘The rate of expansion in commercial construction lifted to its highest level in 12 years amid an increase in the number of projects entering the work pipeline. House building recorded its fastest pace of growth in 3½ years on the back of a solid backlog of work and ongoing strength in demand.’
What isn’t evident on that chart, however, is the significant contribution that engineering starts have played for the past month, as HIA points out: ‘The engineering construction sector also posted a stronger performance in July with the sector’s sub-index rising by 6.9 points to 57.5 points reflecting the boost from greater government infrastructure spending, particularly transport projects on the eastern seaboard.’
Apartment and housing construction have been significant contributors to growth over the past few years. Yet while the new ‘starts’ that are reflected in the above PCI chart look promising, approvals for housing are down. And while trend data from the Australian Bureau of Statistics (ABS) shows new dwelling approvals rose 0.7% for the month of July, year on year it’s actually down 11.4%.
Government Steps In
And that is where the government has decided to step in.
With the private sector no longer rushing into property, the government must work out some ways to keep the secondary circuit still humming. If it doesn’t, as demographer Harvey suggests, the whole thing gets wobbly.
Chances are, though, if you live in Melbourne or Sydney, you’re already aware of the government’s plan. Both cities feels like half of them are ‘under construction’.
BIS Oxford Economics have confirmed that the massive spending on infrastructure is going to keep things going. Sarah Hunter, the head of Australian macroeconomics for BIS, says the public sector works will ‘definitely’ prop the Aussie economy up as housing construction slows. BIS Oxford Economics also reported that building in the public sector rose 14% for the 2016–17 financial year. And that it’s projected to rise again by 5.4% for the 2017–18 financial year.
In fact, the government is spending an incredible amount of money. The June quarter alone saw $8.2 billion of taxpayer money spent on engineering construction. Which was 15.1% more than the same period last year. And a whopping 30.2% higher than two years prior.
The Australian even pointed out: ‘Government spending on infrastructure is rising at the fastest pace since the Rudd government’s response to the global financial crisis eight years ago and is taking over from apartment construction as a key support for economic growth.’
Put simply, this is an astounding amount of money to be spending all at once.
So much so that the Wall Street Journal reported Australia was spending ‘…more public money on public infrastructure than any other OCED country.’
One company keen to profit from all of this government spending is Boral Limited [ASX:BLD]. Mike Kane, the chief executive of Boral, is bullish about the infrastructure construction, and has bold plans to take advantage of the capital flooding into the industry. He even suggests this infrastructure boom could last for seven to 10 years. Rather than the initial five to six Kane forecasted some time ago.
Traffic gridlock annoyances aside, this does create exciting investing opportunities.
Property is no longer a driver of economic growth. Which is why the Aussie government is throwing public money into infrastructure. How long they can keep this up is anyone’s guess.
But we know now that there’s no way they are going to let the Aussie economy get out of the secondary circuit just yet.
Editor, Markets & Money
PS: Tricky capital circuits aside, property guru Phil Anderson, editor of Cycles, Trends and Forecasts, says all markets move in a cycle. After analysing hundreds of years of data, and studying thousands of charts, Phil discovered something no one else has noticed before: 18.6 years. Why is this number significant? Details here.