Dog days for Australia after the boom

Author: Ross Garnaut, University of Melbourne

Australia is enjoying its 22nd year of economic growth without recession — an experience that is unprecedented in any other developed country. For the first decade of expansion, growth was based on extraordinary increases in productivity, attributable to productivity-raising reforms from 1983. In the early years of this century, reform and productivity growth slowed sharply and then stopped. For a few years, increases in incomes and expansion of output came from a housing and consumption boom, funded by wholesale borrowing overseas by the commercial banks.

Unlike other English speaking countries and Spain, Australia avoided recession with the end of the housing and consumption boom (earlier in Australia than elsewhere). This was largely the result of a China resources boom. The boom emerged when the exceptional metals and energy intensity of Chinese growth in response to Keynesian expansion through the Asian financial crisis and again in response to the global financial crisis took markets by surprise, and lifted prices of iron ore and coal continuously and immensely from 2003 until the Great Crash late in the September quarter of 2008. China’s fiscal and monetary expansion put iron ore and coal prices back on a strongly rising trajectory in the second half of 2009, and new heights were reached in 2010 and 2011. The high prices for coal and iron ore flowed quickly into State and especially Commonwealth government revenue and was mostly spent as it was received — raising the Australian real exchange rate to unusual and by 2013 unprecedented levels. The high commodity prices induced unprecedentedly high levels of resources investment after the recovery of the Chinese economy from the Great Crash of 2008, adding to the expansionary and cost-increasing impacts.

The China resources boom created salad days of economic policy, in which incomes could grow even more rapidly than community expectations. The expansionary effect of the resources boom — taking expenditure induced by high terms of trade, resource investment and resource production together — reached its peak in the September quarter of 2011, when the terms of trade began a decline that continues today. The terms of trade fell partly because Chinese growth fell by about one quarter within a new model of economic growth. A bigger influence was the new model of growth, which caused energy and metals and especially thermal coal to be used less intensively. Huge increases in coal and iron ore supplies are also putting downward pressure on prices and will be increasingly important in future.

The declining impact of the China resources boom ushered in the dog days of economic policy from late 2011, when government revenue and private incomes growth sagged well below expectations and employment grew less rapidly than adult population.

The maintenance of high employment and reasonable output growth without external payments problems requires the restoration of investment and output in trade-exposed industries beyond resources. And yet the real exchange rate by early 2013 was at levels that rendered uncompetitive virtually all internationally traded economic activity outside the great mines. A substantial reduction in Australian cost levels relative to other countries is required — a large depreciation of the real exchange rate — to maintain employment and economic growth.

The more that productivity growth can be increased the better. Helpful policy measures include the removal of artificial sources of economic distance between Australia and its rapidly growing Asian neighbours to allow larger gains from trade — removal of remaining protection and industry assistance at the border as the real exchange rate falls, and investment in transport and communications infrastructure.

While China’s new model of economic growth ends the extraordinary growth of export opportunities for iron ore and coal that characterised the first 11 years of this century, new patterns of growth in China and elsewhere in Asia are rapidly expanding opportunities in other industries in which Australia has comparative advantage — education, tourism and other services, high quality foodstuffs, specialised manufactures based on innovation. But in contrast to iron ore, coal and natural gas, Australia does not have overwhelming natural advantages over other suppliers of these products. It must compete with the rest of world on price and quality — especially with developed country suppliers with hugely depreciated real exchange rates in the aftermath of the Great Crash.

Even with the return of productivity growth to the world-beating levels of the 1990s, maintenance of output and employment growth would require a large reduction in the nominal value of the dollar, accompanied by income restraint to convert this into a real currency depreciation.

A new economic reform era is required. That requires social cohesion around acceptance that all elements in society must share in restraint as well as commitment to productivity-raising structural change. Achievement of this outcome is blocked by changes in the political culture of Australia since the reform era. Now, uninhibited pursuit of private interests has become much more important in policy discussion and influence.

The new Australian government will succeed in building the political culture that is necessary to deal with the problem only if it is effective in persuading the community of the importance of reform, and in confronting the Great Australian Complacency of the early 21st Century. This will be hard, as the government will have to change the 21st century tendency for private interests to outweigh the public interest in policy discussion and choice. Harder still, the new government will have to disappoint its strongest supporters along the way to leading Australia into a new reform era.

Ross Garnaut is Vice-Chancellor’s Fellow and Professorial Fellow in Economics at the University of Melbourne. This article is based on the author’s book, Dog Days: Australia After the Boom (BlackInc, Melbourne, 2013). The article is a part of an EAF special feature series on 2013 in review and the year ahead.

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  • james

    Low levels of innovation and manufacture of high quality products? Lower the exchange rate. Skills shortgage? Bring in more immigrants. What they are really saying is we dont want to pay people much money because we lack the ability to deliver high quality products.

  • Ross
    You might care to note that Australia has vastly inflated its cost base by abandoning land value rating for infrastructure. Water cots 47 cents per kl in the ACT in 1990 and now costs $5.10 per kl. Australia has sold off and corporatized monopoly infrastructure to licensed rapacious public and private monopolies – basically, just re-invented tax farmers. The ACT water case is replicated for gas, roads, electricity and gas – and we wonder why manufacturing heads for the exit door? The workers are pikers compared to investment bankers when it comes to raping the community. When I was in China in November last, I did explain the sad Australian history and remarked that all things West are not best.
    Also, you should consider that the CPI is rigged. By changing parcels of goods all the time, following the US Boskin precedent, true monetary depreciation is being hidden. Adam Smith was smarter where he measured money’s purchasing power in terms of the amount of common labour it could buy. He would have regarded the RBA as a public disgrace if judged in terms of stability of the currency.
    If Australia had any common sense, it would realize the land value rating system was the natural way to finance infrastructure so production costs to users and producers can be kept at optimal short run marginal cost, as Hotelling, Vickrey, Stiglitz and others have recognized.
    We used to compete and we still could without cutting the value of the currency (and selling our resources off cheaply)

    Terry Dwyer

  • Wil

    A timely article, I’ve been preaching Oz currency was too over-leveraged to all things Sino the past 3 years, but no one cared. When a friend of mine in Townsville was making the equivalent of $110,000 US a year in 2012, with a bachelors degree (then AUD:USD 1.10), fruit was being left to rot in the fields around Armidale unpicked (due to no labor mobility) and a Big Mac Set cost the equvalent of 10 USD, something was seriously out of kilter with labor wage rates, that were creating a highly import dependent, non-competitive OZ. Then Swan was trying to ‘talk’ the Ozzie down to .85, what a joke these politicians are, as long as there is any whiff of OZ exporting its way to prosperity on the backs of China or Lord knows who else, Abbott and coterie will never make serious changes.