It seems Australian exceptionalism has extended beyond our shores, with US observer, Matthew Yglesias, arguing that Australia doesn’t have recessions anymore thanks to the great work of the Reserve Bank of Australia (RBA), and that the rest of the world should take note:
You see, even though nobody seems to care about Australia it’s a fascinating economy. What’s fascinating about it is that they don’t have recessions anymore – it’s been over 20 years since an economic contraction.
Since apart from the recession thing, Australia seems in many ways similar to the United States – a rich, low-density, high-population-growth, English-speaking federal state with a structural trade deficit – you’d think people would be eager to learn recession-fighting lessons from Australia. In particular, the lesson I think they should learn is that if you strategically allow inflation to overshoot as your response to shocks then you don’t have to have recessions.
My theory, in other words, is that Australia doesn’t have recessions thanks to the good work of the Reserve Bank of Australia. But the conventional wisdom is that we should thank mineral exports. The three big problems with the mineral-centric view, it seems to me, are this. One is that though the 2008 global recession came at a time of high commodity prices, the 2000 global recession did not. The second is that if rapid Chinese economic growth automatically led to economic growth in China’s trade partners, you’d expect to see this impact in Japan as well as Australia. The third is that Australia is not a net exporter and in fact has never been a net exporter so it’s hard for me to understand how you could credit their export sector as the key to full employment. It has to be a story of domestic demand.
No doubt, the Australian economy has performed admirably over the past two decades, avoiding much of the pain felt by other developed and developing economies.
That said, Yglesias’ view looks eerily like a derivation of the “this time it’s different” argument run during the Great Moderation, when many of the world’s economists thought that the low inflation, low volatility, high growth global economic performance in the decade or so leading-up to the Global Financial Crisis (GFC) was the “new normal”.
It’s also worth examining Yglesias’ claims to see if they hold much weight.
First, Yglesias suggests that Australia’s avoidance of the 2000 global recession is proof that its policy settings are superior. My own view is that Australia’s strong performance over that time can be put down to two specific factors: 1) delayed dividends from the widespread program of micro-economic (structural) reform pursued from the mid-1980s and into the 1990s; and 2) the huge run-up in household debt.
On the first point, consider the below chart from the Australian Treasury showing Australia’s contributions to average incomes by decade:
As you can see, Australia’s labour productivity growth was spectacular in the 1990s, owing to earlier reforms undertaken by the Federal government. Such reforms created a highly competitive and growing economy, which held it in good stead when the 2000 recession came.
However, while Australia’s strong productivity performance was important, it pales in comparison with the huge surge in household debt from the mid-1990s, which turbo-charged growth, consumption and asset prices. Between 1990 and 2006, Australian household debt to disposable income skyrocketed, increasing by around 220% (see next chart).
In a similar vein, Australian household savings rates crashed through the mid-1990s and mid-2000s as households rapidly increased their leverage, which again fed asset prices, consumption and growth (see next chart).
So what about Australia’s performance in the five years since the GFC? Again, it has been spectacular when compared against other nations. However, much of Australia’s success can be put down to our unique set of circumstances, rather than superior monetary policy settings by the RBA.
First, just as the epic credit boom began to fade, Australia was fortunate to experience a massive surge in the value of its key commodity exports – namely, iron ore, coal, natural gas, and gold – on the back of the China-induced commodity price boom (see next chart).
The share of Australian merchandise exports to China also surged, rising from around 7% of total exports in early 2003 to around 35% currently (see next chart).
Thanks mostly to China, Australia’s terms-of-trade surged to its highest ever level in 2011 and still remains highly elevated (see next chart).
In turn, due to the huge growth in prices received for our exports, Australia’s national disposable income (NDI) per capita grew much faster than GDP from 2003, making us all much richer than would have been the case if export prices had remained the same (see next chart). In fact, according to the first Australian Treasury chart shown above, roughly half the growth in average household incomes over the 2000s came from the higher terms-of-trade.
Australian employment and GDP growth has also benefited immensely from the huge lift in mining-related capital expenditures (capex), which surged from around 1% of GDP pre-boom to around 6% of GDP currently as miners have attempted to boost production to cash-in on high export prices, with around half of this growth occuring over the past three years alone – again sheltering us from the ill effects post-GFC (see next chart).
For Yglesias to claim that Australia has not benefited disproportionately from China’s growth is just plain wrong, based on any objective reading of the data.
A final criticism of Yglesias thesis is that Australia’s headline economic performance has been juiced by Australia’s world beating population growth, mostly from immigration. Since 2005, Australia’s population has grown by 1.7% per annum, well above its long-run average growth rate of 1.3%. While Australia’s economy has grown by around 12% since the onset of the GFC, per capita GDP has grown by just under 4% (see next chart).
Moreover, if recessions were measured how they should be – by looking at the growth in per capita GDP (amongst other measures) – then Australia did in fact experience a shallow recession when trend per capita growth fell for three consecutive quarters between December 2008 and June 2009.
All of this is not to say that Australia’s economic performance has not been good over the past 20 or so years when measured against other developed nations. It has. Rather the point of this analysis is to show that Australia’s performance cannot simply be put down to good management by the RBA, and that a wide range of other factors have played important roles, some of which are not sustainable.
Australia’s big test will come over the next five years as it deals with the unwinding of the once-in-a-century commodity price and mining capex booms. If it survives these events will little trouble, then Yglesias can claim that we are different.
Finally, as an aside, Yglesias central theme that the RBA can manage the Australian economy is inherently flawed. Monetary policy is a demand management tool only, aimed at smoothing the economic cycle. Real economic progress requires ongoing micro-economic (structural) reform aimed at boosting competition, innovation and productivity, not continual tinkering of the cost of credit. Australia undertook reform in the mid-1980s and early-1990s to great effect. If it wants to enjoy ongoing rising living standards, it must do so again.