Saul Eslake gives manufacturing the bird

On Friday, Saul Eslake released a note condemning Australian manufacturing to its fate, not to mention condemning outright anyone who sees it as not such a good idea to let Dutch disease have its way. The Merrill Lynch note was a near carbon copy of Canberran rhetoric on the issue and as such is worth examining in some detail.

Over the past year there has been much wailing and gnashing of teeth over the purported demise of Australian manufacturing, as a result of the persistent strength of the Australian dollar and, according to some, a failure on the part of the Australian Government to guarantee local manufacturers a share of the fabrication work associated with major resources developments.

These concerns have prompted renewed calls from some quarters for the RBA to seek to push the A$ down (as some other central banks, such as those of Switzerland and Brazil have sought to do with their currencies), and to implement other proposals to “support” Australian manufacturing. A particularly influential trade union leader, Australian Workers Union national secretary Paul Howes (who was intimately involved in the deposition of former Prime Minister Kevin Rudd in  in Australia that regards manufacturing as intrinsically more valuable than other types of economic activity … which for more than 80 years found expression in high levels of tariffs and other forms of ‘protection’

June 2010), this week called for the RBA’s ‘charter’ [sic] to be amended to allow the central bank to target a lower value for the exchange rate (a suggestion which was promptly rejected by Treasurer Wayne Swan). Australians have long harboured the belief that manufacturing is ‘more important’ than other forms of economic activity. Historically, that’s been partly based on the premise that a large manufacturing sector was required in order to provide gainful employment for a growing population on a continent that was otherwise more suited to capital-intensive activities such as farming and mining; and, following Australia’s experiences in the 1914-18 and 1939-45 Wars, on concerns that self- sufficiency in a wide range of manufactured goods was essential for ‘national security’.

Calls have been growing for the RBA to seek to push the A$ down in order to assist the beleaguered manufacturing sector

Manufacturing has also been traditionally regarded as a way of capturing additional value from Australia’s comparative advantages in agriculture and resources; as a means of reducing imports, and hence avoiding the balance of payments difficulties which Australia experienced during the first half of the 20th century; as providing a significant source of ‘flow-on’ demand for other sectors of the economy; and (as in many other countries) as a driver of innovation and the commercial application of advances in scientific knowledge.

In Australia’s case, this enthusiasm for the virtues of manufacturing has traditionally led to a strong constituency for protectionist policies. Most Australians have long believed that tariffs are something governments make foreigners pay to get their goods into the country, as opposed to the reality that tariffs are something that governments force their own citizens to pay in order to keep foreign goods out. A League of Nations study published in 1927 estimated that the average level of Australia’s tariffs exceeded that of all other industrial countries except the United States1. Australia, together with New Zealand, opted out of the post-WW II rounds of multi-lateral tariff reductions under the auspices of the General Agreement on Tariffs and Trade (GATT), the predecessor of the World Trade Organization, on the (spurious) grounds that since other industrialized countries weren’t willing to reduce their barriers to trade in agricultural goods (which at that stage comprised the bulk of Australia’s and New Zealand’s exports), Australia and New Zealand wouldn’t reduce their barriers to imports of manufactured goods. On the contrary, we continued to increase them: by 1970, Australia’s average tariff on imported manufactured goods was more than double that of the US, and half as high again as that for the (then) EEC2.

And, notwithstanding the one-off 25% reduction in tariffs implemented by the Whitlam Government in 1973 (as an anti-inflation measure), during the late 1970s and early 1980s Australia increasingly resorted to non-tariff barriers against imports of manufactured goods – so that by 1983, 25% of Australia’s imports of manufactured goods were subject to non-tariff barriers, compared with an average of 15% for all industrial countries3.

The striking thing is that none of this did any good – either for the manufacturing sector, or for the broader Australian economy. Manufacturing’s share of GDP fell from a peak of nearly 30% of GDP in the late 1950s to less than 15% in the early 1980s, while its share of total employment fell from 30% in the late 1940s to about 18% in the early 1980s. Even in the most highly ‘protected industries’ such as textiles, clothing and footwear – where the effective rate of assistance rose from 72% in 1968-69 to 135% in 1982-83 – employment fell by 44%, and the share of imports in domestic sales rose from 22% to 35% over this period4.

Meanwhile, in contrast to every other ‘advanced’ economy (bar New Zealand), the proportion of Australia’s GDP which was internationally traded declined (by around 7 percentage points) between the 1950s and the early 1980s; and Australia’s relative position among industrial countries ranked by GDP per capita slipped from fifth in 1950 to 14th by 19835.

From the mid-1980s onwards, both major political parties began to accept the case which had been put since the early 1960s by a small number of economists, journalists, civil servants and backbench MPs that the Australian economy and Australian people had been ill-served by this long-standing tradition of protectionist policies. Labor Governments under Prime Ministers Bob Hawke and Paul Keating, with the active support of the then Liberal Opposition, began dismantling Australia’s regime of import restrictions, a policy which continued under the subsequent Liberal-National coalition Government led by Prime

Minister John Howard. The effective rate of ‘assistance’ (through trade barriers) to manufacturing fell from 24% in the mid-1980s to less than 5% by 2000.

Manufacturing has continued to decline as a share of GDP and of employment – but at no faster a rate than during the ‘protectionist’ era. In 2011, manufacturing accounted for 8.2% of GDP, down from 13.2% in 1985 (a decline of 5.2 pc points, compared with a decline of more than 15 pc points over the preceding 25 years); while manufacturing’s share of total employment declined from 16.1% in 1985 to 8.4% in 2011 (a decline of 7.7 pc points, compared with a decline of over 12 pc points over the preceding 25 years). Note that this includes periods when the Australian dollar has been very weak (in the mid-1980s, the early 1990s, and the late 1990s-early 2000s) as well as when it has been very strong (as in most of the last four years).

These comparisons highlight the fundamental point that the most important reason for the decline in manufacturing’s share of economic activity (however measured) in Australia, as in other ‘advanced’ economies, is that as people’s incomes rise over time, they typically spend an increasing share of their incomes on services, and a diminishing share on goods.  Thus, in 1960, 48.5 cents out of every dollar that Australian households spent was spent on goods; in 2011, only 24.3 cents of every dollar spent by Australian households was spent on goods.

If manufacturing accounted for the same proportion of the Australian economy that it did fifty years ago, then unwanted goods would be piling up in factories, warehouses and retail stores across the country, and Australians would be complaining about their persistent inability to obtain the services they want (even more than they actually do).

That’s a nice potted history. And I agree with much of it, with the exception of framing Australian manufacturing as the projection of some dated working class neurosis. There are very real strategic imperatives for keeping an industrial base intact, unless you want to argue that war is a thing of the past, in which case I’ll happily doff my hat as you pass into your gleaming utopia. The point is not that strategic imperatives no longer exist, it is how to balance them against the need for a productive and competitive industrial base which, to say the least, Saul Eslake is giving short shrift. Back:

And because Australia isn’t Germany – we haven’t invested (over decades) in accumulating the knowledge and skills required to become internationally competitive exporters of manufactured goods, and (even if we had) a much smaller domestic market (having regard to the fact that Germany’s ‘domestic market’ includes all the other members of the EU) and the much greater distance from potential export markets would have constituted additional formidable obstacles to Australia emulating Germany’s success as an exporter of manufactured goods – it would not have been feasible for Australian manufactures to have exported the difference between what they produced, and what Australian consumers wanted to purchase.

This is a simple inductive fallacy that boils down to ‘because it ain’t been done it won’t be done’ and is not actually an argument at all. As for scale, are Australian manufacturers in Asia? Is Germany? Moreover, are you really telling me that in areas like metals processing we don’t have a competitive advantage in the proximity of the largest input? Back:

A fundamental point which many Australians seem to have difficulty grasping is that the sum of the shares of GDP of all the various sectors of the Australian economy cannot exceed 100%. If Australia is to have a larger mining sector (as a proportion of GDP) than most other ‘advanced’ economies – which is a reasonable expectation given this country’s relatively greater endowment of mineral and energy resources than other ‘advanced’ economies – then by definition one or more other sectors have to be smaller as a share of GDP than in other advanced economies.

No problem here. But the question is, who should wear the adjustment to lower output? Saul has no doubt:

And given that most services are intrinsically non-tradeable (although advances in information and communications technology, and falling travel costs, are altering that at the margin), it similarly stands to reason that the sectors which are going to be smaller, as a proportion of GDP, in Australia than in other countries will most probably be manufacturing and those types of services which are tradeable.

I find the reasoning here rather hard to follow. Why, because the boom is in the tradeable sector does that mean that the other components of production that must give way must also to be in the tradeable sector? You could pull any number of levers to change who wears the adjustment. There is no economic rationale apparent in this statement at all.  And in fact, I would argue, that in the new normal – in which national economies are much more risk-weighted based upon their current account performance -such an unsubstantiated statement makes very little sense at all. Given that, surely it makes more sense to correct parts of the economy that are causing the current account to remain in deficit, like, Heaven forbid, financial services!

Back:

Similarly, if the mining sector is to expand as a share of GDP – which it must if Australia is to make the most of the once-in-human-history opportunities associated with the urbanization and industrialization of the two most populous nations on Earth (because if our mining sector isn’t allowed to take advantage of those opportunities, then the mining sectors of countries like Brazil, Canada, South Africa, Kazakhstan, Mongolia and the like surely will) – then some other sector or sectors must shrink as a share of GDP (though not necessarily in absolute terms). And again, common sense suggests that the most likely candidates for that are the manufacturing and trade-exposed services sectors.

Common sense? Is that an argument? Back:

If there were strong grounds for believing that China’s and India’s demand for the mineral and energy resources with which the Australian continent has been so richly endowed by nature would peak within (say) the next two years and then fall away sharply, there might well be a good case for policy to seek to restrain the expansion of the mining sector, in order to avoid what would then be a wasteful mis-allocation of labour and capital.

But there are in fact no grounds for believing that the present mining boom will come to such an abrupt end: on the contrary, it is more likely to last for at least another decade (albeit that it will henceforth likely be characterized by falling commodity prices and rising commodity export volumes, the opposite of the past eight years).

No reason? How about China is a half-caste communist state with a dangerously distorted fixed asset investment growth model that has natural debt limits and a political economy that is nothing more than a grand experiment? We’ve already seen how such grand experiments in political economy can come a cropper, in the EU for example. Doesn’t mean it will, but there is every reason to think that it may. Back:

More than any other single factor, the unwillingness of the Australian people (and their governments) to accept that the sum of the various sectors’ shares of GDP can’t exceed 100% – and hence the desire to prevent some sectors of the economy from shrinking as a share of GDP so that others can expand – lies behind the fact that every commodities boom in Australia’s history has ended in a burst of double-digit inflation.

All of Australia’s previous commodities booms have occurred under a fixed exchange rate regime: and during previous commodities booms, Australian governments either refused to allow the exchange rate to appreciate at all, or allowed it ‘too little and too late’.

Australia’s floating exchange rate regime (which was adopted after the collapse of Australia’s last ‘resources boom’ in the recession of the early 1980s) offers the best opportunity we have of not repeating our history of mismanaging episodes like the present one. A deliberate attempt to push the A$ lower – in the absence of offsetting changes in other areas of economic policy (such as tighter fiscal policy) – would likely instead condemn the country to repeating that history.

The strength of the exchange rate over the past few years clearly has been to the detriment of Australian manufacturing (as it has been for tourist operators and higher education institutions, among others, although they don’t seem to attract the same degree of sympathy and concern as manufacturing, despite employing a roughly similar proportion of the workforce). Manufacturers’ profit margins, for example, have clearly declined since the mid-2000s – although they are still higher than they were in 2000-01, when the A$ was around US50¢.

But since the A$ most recently bottomed – in 2Q 2009 – manufacturing output has actually risen by 9.3% – more than the economy as a whole (the production-based measure of GDP has risen by 7.0% over this interval), and, perhaps ironically, more than output of the mining sector (which as measured by its real gross value-added has increased by 8.1% over this interval).

It’s true that employment in manufacturing has declined (by more than 5%) over this period, during which employment in other sectors has risen (also by more than 5%); and it’s understandable that this is of concern to unions representing manufacturing workers. But this is (in effect) the result of efforts by manufacturing firms to improve their productivity, which is something manufacturers have to do if they are to remain competitive through what may well be an extended period during which the A$ stays at elevated levels by historical standards.

Manufacturing has been in recession for eighteen months. It bounced along with all other countries in the post-GFC stimulus period which is distorting the figures. Manufacturing exports are running at close to 05/06 levels. At the same time, I agree that piecemeal intervention is not the answer. Most especially because that will achieve nothing so long as the economy remains close to capacity. But interest rate protection is an answer that would still enable competitive forces to determine competitive advantage. Finally:

In other words, reports of the ‘death of manufacturing’ are (like those of the death of Mark Twain) somewhat exaggerated. There’s no compelling reason to think that Australian manufacturing will not survive, as long as governments don’t handicap the efforts manufacturing firms are now making to improve their productivity and competitiveness. But nor are there any valid reasons to alter the RBA’s mandate, or provide other forms of preferential policy treatment for the manufacturing sector, out of a belief that it is an inherently more valuable form of economic activity than any other.

There are two reasons why we should not let Dutch disease take its course. Strategic imperatives and the fact that manufacturing is in the tradeable sector. Destroying exports to make room for other exports is not very sensible in the new normal.

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46 Responses to “ “Saul Eslake gives manufacturing the bird”

  1. The Lorax says:

    But there are in fact no grounds for believing that the present mining boom will come to such an abrupt end: on the contrary, it is more likely to last for at least another decade

    Terrifying.

    I don’t know whether the mining boom will end abruptly or not (or whether it will be a good thing or bad thing for Australia) but I do so desperately want such blind confidence to be punished.

    • Hmmm, such schadenfreude would hurt a great number of people, I wouldn’t put it that way. But some sense of risk would be welcome and Saul’s one of our better thinkers.

      • 3d1k says:

        +1. Re a ‘sense of risk’, I would imagine he has considered the risks, but discounted them somewhat.

      • 3d1k says:

        Overriding confidence!

      • The Lorax says:

        Let me clarify:

        Its Saul (and like-minded contemporaries) I’d like to see punished, not everyday people working in the resources sector.

        IMO its downright irresponsible for a household name economist to support the idea that the mining boom is riskless bet for Australia. Pettis and Chanos may or may not be right, but they’ve put forward some pretty fine arguments that suggest putting all your chips on China is a pretty risky strategy.

      • 3d1k says:

        To continue the gambling analogy, when you have so few chips of redeemable value left, you go in big. All or nothing.

      • Goldilocks says:

        You’ve usually screwed up your game by then -in poker that is.

      • 3d1k says:

        Lol. Tell me about it!

        But in fact another good analogy. As HnH has said without the boom we’d be toast (or Ireland). We have screwed up our game by massive credit fuelled over-consumption, massive build-up of foreign debt largely to finance housing speculation (to paraphrase Hudson, instead of lending to create the means to repay debt, lending that instead adds to the overhead).

        We are very fortunate to have the golden chips of the resource sector to play. At least we’re still in the game and compared to nations less naturally blessed, thus far, doing OK.

      • Goldilocks says:

        Agreed.

    • flawse says:

      +1 I don’t think it’s blind confidence so much as total foolishness. You can put all your money on the favourite on the nose but it’s best to keep in mind the favourite, not only sometimes but often, loses!
      Eslake is old enough to know the truth of that.

  2. 3d1k says:

    It’s a tricky one alright and maybe what is ‘right’ comes down to nothing other than belief systems or ideology. He may have also been influenced by this paper:

    “When and why worry about real exchange-rate appreciation? The missing link between Dutch disease and growth”
    http://www.voxeu.org/index.php?q=node/6212

    “…to show that Dutch disease reduces growth needs a strong assumption that the manufacturing tradable sector is somehow “special”….Dutch disease only depicts an equilibrium real exchange-rate appreciation reflecting stronger fundamentals and de-industrialisation, but would not necessarily be bad for overall growth.”

    “Shocks that trigger foreign exchange inflows (such as natural resource booms, surges in capital inflows, foreign aid, remittances, etc.) lead to an appreciation of the real exchange rate, generate factor reallocation, and reduce manufacturing output and net exports. However, crucially, we do not find evidence that Dutch disease reduces economic growth.”

    “In sum, the evidence on the impact of Dutch disease effects on growth is mainly inconclusive. Moreover, it is worth noting that shocks that cause Dutch disease – large capital inflows, export price booms, etc. – are usually associated with periods of economic bonanza. Dutch disease effects are an unintended consequence of foreign exchange abundance, but these negative effects would not necessarily offset the beneficial effects of the inflow. The challenge for policymakers is to adequately manage the booms and the risks they come with. Therefore, the optimal policy response would consist of taking advantage of the boom, while at the same time dealing with the undesired consequences that it may cause. When thinking about “what to do” about Dutch disease, policymakers should beware – in responding to the effects of the disease – of killing the goose that laid the golden egg.”

  3. Jack says:

    He is missing the point with this one

    “Australians seem to have difficulty grasping is that the sum of the shares of GDP of all the various sectors of the Australian economy cannot exceed 100%”.

    This is true but what about having a bigger GDP.

    • snagard says:

      This is exactly what I was thinking – the concern is not just about manufacturing as a proportion of GDP, it’s about manufacturing in absolute terms. I think most would willingly accept a decline in the former, especially if it came about due to growth in other sectors. However, the arguments are usually for a decline in the latter, and in fact not just a decline but outright elimination,

  4. Jumping jack flash says:

    Saul Eslake is onto something.

    We can’t have everything.

    We can’t produce average quality, non-niche items while demanding high wages, cushy working conditions AND implement free trade, then expect to survive in current global market conditions.

    So, of course the problem is mining.

    And, of course, the solution is to become another Germany! Produce high quality, niche items and charge top dollar so we can continue to demand our high wages and cushy working conditions in the free market.

    I guess that would probably work if we were all Germans…

    Australians don’t seem to have that kind of ethos. Maaaaaate.

    Take it up with the union, maaaaaaate. I pay my fees.

    • Point taken but you have to ask yourself if it makes sense to kill off those manufacturers that did have the get up and go to succeed as exporters when global pricing wasn’t distorted by a currency war.

      • flawse says:

        Exactly…we don’t have Dutch disease so much as a hollowing out of our economy that results from worldwide reckless monetary policy combined with our own extreme desire to live high on the hog short term while we mortgage the future of the nation long term.

      • SSEC says:

        What is the RIGHT exchange rate then? We could control it and set it to 0.50… would that be better for Australia? Or more realistically to 0.75… would that be better for Australia? Would we want the RBA to set an exchange rate monthly?

      • flawse says:

        SSEC

        Our exchange rate is not fixed by a free market. It is fixed by the ECB and the FED and a bunch of hedge funds who have no interest in this country but to rip some short term speculative money out of it. Note I don’t blame the Hedge Funds, that is just business. We just allow them to do it.
        I’d be a lot happier with the RBA setting the exchange rate than this particular cocktail that sets it now.

        Australia needs to be in a position where it is not incurring more and more foreign debt month after month and selling off whole industries just for current consumption. How can that possibly be good for Australia? Oh it allows us to currently consume more in teh short term. I guess if that is your criterion for a successful nation you’re right. If it isn’t then the problem needs to be thought through a bit more.

    • 3d1k says:

      Well said :)

    • SSEC says:

      Soon the uncompetitive manufacturers will be gone. You could argue that the AUD has been too low in the past decade.

    • dumb_non_economist says:

      JJF,
      If you think that German unions are “relaxed” to deal with, you’d be wrong!

      • Jumping jack flash says:

        No, that wasn’t the point. The point was that we need to change our attitudes.

  5. flawse says:

    How so????

    We totally depend on both speculative short term capital and long term investment capital to survive. It’s been so for 50 years.

    • SSEC says:

      Right, but so far we are obviously meeting expectations. A high currency is indicative of a good economy, not of a bad one.

      • flawse says:

        SSEC
        JMO it’s an indication that we are willing to sell off our nation’s industries and mines to finance consumption.
        Without the capital flows, if we weren’t selling the mines and industries, we’d have a crisis. Avoiding a crisis by liquidating capital doesn’t seem like a good idea to me either from a Government or business viewpoint.

        Anyway to each his own! Cheers

  6. Sweeper says:

    “A deliberate attempt to push the A$ lower – in the absence of offsetting changes in other areas of economic policy (such as tighter fiscal policy) – would likely instead condemn the country to repeating that history”.

    It would be more helpful if Saul Eslake discussed the pros/cons of pushing the A$ lower *in concert with* tight fiscal policy (ala Prof Cordens option 3) – instead of focusing on the fixed exchange rate straw man.

    • 3d1k says:

      Corden also wrote an article at The Conversation:
      http://theconversation.edu.au/max-corden-on-taxing-mining-tackling-dutch-disease-and-depreciating-the-dollar-5852

      “Does the Dutch Disease require policy action by the government designed to moderate the appreciation – and thus to depreciate the exchange rate somewhat? This is a big issue and a difficult question to answer.”

      “I want to tell the readers of The Conversation that I favour a mining tax, but don’t expect one that only affects foreign owners of the mining industry to reduce the Dutch Disease”

      On page 25 of the working paper Corden unambiguously says he favours a COMBINATION of options 1 (do nothing) and 3 (fiscal).

      • Sweeper says:

        He definitely favours option 3. But – being a realist who understands the unwillingness of Canberra to cut spending and risk votes – he says that given a choice between option 2 (protection) and option 1 (do nothing), option 1 would be preferable.

        In his conclusion he says:
        “Focusing on this third option, significant fiscal surpluses are hard to obtain for obvious political reasons. But they could moderate the Dutch Disease effects in a relatively non-discriminatory way, at least for a transitional period. One might even consider it as a long-term stabilizing macroeconomic policy”

        To me, this is academic speak for: “pursue option 3″.

        The mining tax is a separate issue (which has unfortunately muddied the waters in the dutch disease discussion). What he says is clever – large foreign ownership of mining probably means that a mining tax would not prevent real appreciation and may even compound it. A mining tax should be considered on equity, not macro stabilization grounds.

      • Mav says:

        He definitely favours option 3.
        To me, this is academic speak for: “pursue option 3″.

        +100 . I have been trying to persuade 3d1k that is the case. But I think option 3, for some vague, unspecified political reasons, is unacceptable to the resources industry.

      • Sweeper says:

        I have know idea why the mining industry would be against option 3, or for that matter anybody else.

        10 years of budget stupidity has built tens of billions of waste into the budget – we are not talking about cutting useful services and infrastructure.

        A better way of framing Eslakes “one sector has to shrink so that another can grow otherwise you get double digit inflation” thesis; is “a surge in spending due to the mining boom must be offset by a fall in spending elsewhere… otherwise double digit inflation” – “elsewhere” should be the the government.

      • 3d1k says:

        Sweeper, that is just Mav’s flight of fancy. Why he thinks that, I have no clue.

      • 3d1k says:

        Agree that it is possible to interpret his position in that manner. Nonetheless, what he said is what he said. He certainly could have clarified a single preference in The Conversation…and remember, there are benefits to doing nothing.

        I couldn’t resist including his comment re the mining tax as it is often cited as part of a mechanism for currency depreciation. :) And once you really argue the equity element of a tax placed on ‘windfall’ profits you quickly get into murky waters.

        Gittins summed it up nicely: There’s no easy, costless way to ameliorate the downside that comes with the blessing of the mining boom. There are just options that carry more disadvantages than others.

  7. rob barratt says:

    At the risk of being bombarded by the more socialist bloggers I would have to point out that Australia’s Industrial Relations issues alone would prevent us from being competitive.
    To take a well known case as an example, a certain QLD minister was blamed for the Queensland Health payroll debacle, the more informed view would be that QH has been a cork floating in a storm, buffeted by poltical interferance on one hand, but also by a set of union driven award regulations that are truly labrynthine in complexity & that will make the maintenance of that system a black hole of public money for years to come.
    Looked at from the perspective of anyone trying to start their own business in Australia (and large businesses have to start as small businesses) it is truly frightening. Add this award mountain to the onerous health & safety fest & you can clearly see that Dutch disease here is already terminal. We won’t compete because we can’t, until a good percentage of the population change their mindset. That will only happen following the crash when the mining needle is finally withdrawn from the national vein.

  8. tsport100 says:

    It is true that we shouldn’t ‘bail-out’ manufacturers by manipulating RBA interest rates and by result the exchange rate to suit, but being exclusively pro mining and anti manufacturing is extremely short sighted.

    An ‘advanced’ economy must retain and continuously develop internationally competitive IP. There is precious little IP in Mining as most of the plant is imported.

    Consider the long term future of resource dependant middle east nations once their oil reserves run out. Some are rushing to invest in R&D and high IP industries, but from a much lower base than Australia.

    If we allow our already well established manufacturing IP to waste away due to neglect, we’ll be a one trick pony ridding commodity prices like a 3rd world nation.

    A huge chuck of the resources wind-fall needs to be INVESTED into assisting manufacturing R&D to ensure future prosperity.

  9. Saul Eslake says:

    Thanks for all these comments on the piece I wrote under the BofA Merrill Lynch masthead last week. BAML employees of which I’m one these days) aren’t allowed to distribute their publications to people who aren’t clients (without authorization) but there’s nothing to stop ‘authorized recipients’ from distributing it more widely.

    My piece wasn’t intended to be giving manufacturing “the bird” as the headline on here suggests – indeed my headline had a question mark at the end of it (intended to convey, as I said explicitly later on the piece) that reports of the death of Australian manufacturing (like that of Mark Twain) had been exaggerated. I was neither predicting nor welcoming the demise of manufacturing in this country. What I was seeking to do was to point out the folly of Paul Howes’ suggestion that the ‘charter’ (as he called it) of the RBA ought to be amended to ‘require’ the RBA to direct monetary policy towards securing a particular (lower) level of the exchange rate, and also querying the assumption implicit in Howes’ suggestion (and in a lot of other commentary) that there is something inherently more worthy about manufacturing than other forms of economic activity (including others that have also been adversely affected by the strength of the exchange rate).

    I genuinely do believe that the forces driving the current ‘mining boom’ are more likely to last at least another decade than to end in the next two years. That’s emphatically not meant to be an endorsement of the way China runs its economy, or a statement that there are no risks around the Chinese economic growth profile. Nor is it meant to be an assertion that commodity prices will either continue rising, or even remain at their present level (indeed I said quite the opposite of that).

    But I would also add that (in my view at least), in a ‘market economy’ producers exist to meet the needs of consumers, not the other way around – and if particular producers can’t meet the needs of Australian (or foreign) consumers then they have no intrinsic right to a continued existence.

    My comments about the folly of “a deliberate attempt to push the A$ lower – in the absence of offsetting changes in other areas of economic policy (such as tighter fiscal policy)” were indeed (as suggested by the exchanges between ‘Sweeper’ and ’3d1k’ suggest) a conscious allusion to the options canvassed by the esteemed Max Corden in his paper published last year (which I have read).

    And indeed Corden’s option 3 is the only valid reason I can think of for insisting on returning the budget to surplus in 2012-13 (as opposed to some other year).

    However, the RBA aren’t fools – and if a surplus is obtained in 2012-13 solely, or mainly, through what I’ve termed “accounting chicanery” (ie, shuffling expenditures out of, and revenues into, 2012-13 from surrounding year) then that’s not going to result in any additional easing of monetary policy over and above what might otherwise have occurred.

    And it’s perhaps also worth noting that even if the RBA were to cut rates some more, there’s no guarantee that the A$ would oblige by falling as some would hope. After all, the A$ didn’t fall when the RBA cut rates twice at the end of last year; it hasn’t fallen in response to the renewed anticipation by financial markets of a rate cut next month (the A$’s decline over the past few weeks has got more to do with a general strengthening of the US$ than to Australian factors); and it’s even been remarkably unmoved by a 10% fall in commodity prices (as measured by the RBA’s US$-denominated index of Australian export commodity prices since last September).

    So, notwithstanding Paul Howes’ demonstrated ability to determine who the leader of the Parliamentary Labor Party is, not even he can dictate the value of the A$. And I, for one, am rather grateful for that.

    • 3d1k says:

      Well said. Thanks for the clarity. Timely to see someone investigate the validity/efficacy, or otherwise, of Paul Howes’ ‘advice’.

    • Sweeper says:

      Thanks for the interesting feedback.

      I just wanted to comment on this point: “And it’s perhaps also worth noting that even if the RBA were to cut rates some more, there’s no guarantee that the A$ would oblige by falling as some would hope. After all, the A$ didn’t fall when the RBA cut rates twice at the end of last year; it hasn’t fallen in response to the renewed anticipation by financial markets of a rate cut next month”

      For what it’s worth, I believe there are two reasons why recent cuts haven’t weakened the AUD:
      1. The ‘world rate’ is stuck at 0% and is expected to stay there.
      2. Despite cuts, the direction of monetary policy is very much up in the air.

      Nothing can be done about point 1. However Corden’s option 3 would address point 2. If the government was prepared to adopt tight fiscal policy – or (ideally) a policy rule linking surpluses and the mining boom – the likelihood and expectation of future RBA hikes would be (partly) taken out of the equation and this would prevent AUD strengthening. This is based on the theory that exchange rates are impacted by long-term interest rate differentials.

      I would like to see more discussion of Corden’s option 3, because I think it has merit.