On Friday evening, Treasury boss Ken Henry delivered his final public address before stepping down in March. At the University of Tasmania Giblin Lecture, Henry delivered his magnum opus, a broad review of Australian economic history spanning three centuries (full transcript below, h/t The Lorax).
The document is a must read in full, but the pivot of the speech is Henry’s use of the sweep of history to argue “the case for optimism” on Australia’s economic future.
The mining boom is the most remarkable consequence for Australia of the rapid growth of China and India. Many commentators, in Australia and elsewhere, have expressed concern about our economy appearing to be so heavily dependent upon continued Chinese demand for our natural resources. What happens when Chinese growth slows down or, even worse, collapses as Japanese growth did at the end of the 1980s? What happens when global extraction of mineral resources catches up with Chinese demand and commodity prices collapse? And what if, when these things happen, we find that we have “hollowed out” our manufacturing sector and have nothing to fall back on?
These are understandable, if somewhat bleak concerns. But I would suggest that they are exaggerated.
This blogger noted recently that Treasury is in danger of exchanging a defunct one-eyed growth narrative – the Pitchford thesis – for a new one-eyed growth narrative, endless Chinese demand. It is a relief therefore to see the possibility canvassed that China may not grow in perpetuity.
Having broken the seal on this question, let’s see what Henry does with it:
Indeed, there is instead a strong case for optimism. At the end of the 1980s, Japan was our largest trading partner. After 20 years of poor macroeconomic performance, characterised by several recessions, Japan remains our second most important export destination – only very slightly less important than China, despite that country’s stellar economic performance. For the Australian economy, Japan remains a very big market, even when it is growing slowly. A weakly growing Chinese economy would present an even larger market than Japan.
OK, given we’ve been invited to, let’s try to quantify, at least roughly, what a slowdown in Chinese growth would do to Australian exports. Every miner in the world is currently investing huge sums into expanded capacity. BHP’s $80 billion schedule is one example. Or take Rio and its myriad ore expansions including the Pilbara, Orissa in India and Simandou in Guinea. These firms are not expanding capacity on the presumption of a stalled China.
And if it does stall, the prices for all the metals with all customers will fall, not just China. Which explains in reverse why exports to Japan have continued to grow over the last decade despite a lacklustre economy. That growth has largely resulted from the rising price they’ve paid for raw commodity imports because of Chinese demand, not because their own volumes have been growing strongly.
As a hypothetical, let’s say China slowed to permanent annual growth of 6% and the prices of iron ore and metallurgic coal found a new equilibrium 30% below ABARE’s projected 2011 totals (which is still historically high). Even if volumes were maintained, it would punch a $30 billion hole in Australian exports. And similar would happen to all base metals and soft commodities.
Let’s go back to Ken Henry:
A second observation is that, given the very long term trends in industrial structure that we have already observed in the past half century – with services growing strongly as a proportion of total employment and manufacturing employment falling from about one-third of the labour force to less than 10 per cent today – it is a bit odd to be referring to this as a China-induced “hollowing out” of manufacturing.
Henry himself admits early in the address that the mining boom has accelerated the decline in manufacturing so we needn’t labour the point. Suffice to say that in the last six months the world economic recovery has been driven by manufacturing booms across Asia, Germany and US, whilst Australian manufacturing shrank for six straight months. On top of that we had the recent disastrous capex projection figures for the year ahead. That is evidence enough of manufacturing’s intensifying struggle.
Elsewhere in the speech, Henry also praises Australian manufacturing’s proven flexibility and no doubt it would bounce back if the dollar fell. But as Henry says himself, the structural decline offers little prospect of any offset if commodities correct. Henry goes on:
A third observation goes back to the points I was making at the start of this address, concerning the consequences for industrial structures of real incomes growth associated with economic development. Today, we see China as a manufacturing powerhouse, reliant upon raw materials that we happen to have in abundance. But, at the Chinese economy develops, its industrial structure will also change. It won’t become a smaller producer in manufactures in absolute terms. Indeed, Chinese manufacturing output will probably grow at least as fast as the Australian economy grows for as long as any of us can project. But other sectors of the Chinese economy will grow even faster, in time. As with all other stories of economic development, real income growth and the emergence of a large middle class will generate a demand for an almost endless variety of goods and services. What sorts of goods and services? Who knows? It could be premium tourism, it could be fine wine, financial services or it could be some other good or service not yet invented.
At other times in our history we have witnessed some of the opportunities that income growth in emerging markets presents for Australian exporters.
Consider tourism services, for example, and the strong Japanese demand that drove its development. With increased demand for tourism services from emerging markets, there is considerable potential to attract a greater share of increasingly wealthy travellers to Australia for business tourism, holiday packages and to visit family and friends.
According to the United Nations World Tourism Organisation, the number of international tourist arrivals globally reached 935 million in 2010. That’s an increase of 58 million, or seven per cent, from 2009. Emerging economies continue to drive global outbound tourism expenditure growth — for example, 17 per cent for China in 2010 — outstripping growth in traditional markets like Japan, the United States, Germany and the United Kingdom.
Australian tourism stands to benefit from these global developments.
We have also already seen a greater appetite for particular goods produced by Australian exporters. For example, while Australia’s largest wine export markets continue to be the United States and the United Kingdom — and while there is currently pressure on this industry from the high exchange rate — wine exports to China have grown strongly, increasing from 1.9 per cent of total wine exports in 2007-08 to 6.1 per cent in 2009-10.
Back to our hypothetical, could Henry’s exporters of tomorrow make up the $30 billion plus black hole?
The argument that tourism stands to benefit in the years ahead has good evidence. If we refer to the DFAT Composition of Trade report, we can see that tourism and education make up an rougly two-thirds of Australian services exports.
The growth in China’s imports of Australian services has been very impressive too, rising from third to first in the past three years:
DFAT doesn’t break up China’s services imports by category but it’s a sure bet that its dominated by education and tourism, just as it is with the rest of the world.
But put the two graphs together and the positive story starts to fray. I mean, if education and tourism are so dominant, what’s left to benefit from China’s move up the value chain?
Japan is again a painful comparison. Check out the table of Australia’s services exports to Japan, down three year’s running. If China slows similarly, and moves up the value chain, the experience of Japan suggests services will play little role in boosting Australian exports.
Henry’s other example, wine, is no better, earning Australia a little over $2 billion in 09/10 with ABARE projecting more falls for this year.
Finally, this blogger will ask that if the departing Treasury boss is so optimistic about Australia’s ability to maintain strong enough exports to sustain its income and standard of living in all future circumstances, why did he risk his career last year overseeing a tax review that included a resources rent tax aimed at funding a five per cent cut in general corporate tax rates, as well as a raft of small business concessions?
If that’s not concerned about hollowing out, over-reliance on resources and Dutch Disease then what is?
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
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