Parko poses conundrum for self

Martin Parkinson, the new Secretary of the Treasury, gave an excellent speech last night. Gone was the uber-bullishness on China and India that has characterised Treasury rhetoric since the GFC and it was replaced with a recognition that we’re in for cycles in China and at times, it’ll be painful. The Australian covered these things well enough.

The high point of the speech, however, was not the shift in candour vis-a-vis China. No, the crescendo came later when, on behalf of the Australian community, Dr Parkinson posed three stonking questions about the commodities boom:

• How will the benefits of the boom in the terms of trade be shared through the community? After all, today we are swapping a non-renewable capital asset – mineral and energy reserves – for an income stream. If we don’t receive an appropriate return, and invest that wisely to build human and physical capital, and to boost national savings, including through superannuation, we could find ourselves having consumed our assets and be faced with lower future incomes.

• Will our manufacturing sector be “hollowed out” and “lost forever” leaving us as “nothing but a quarry”?

• What if the boom suddenly stops, as all previous booms have?

Those are the best three inquiries I have heard from an Australian economic leader in YEARS. It is my fervent hope that Dr Parkinson will now dedicate himself to answering them because sadly, his responses last night did not do the questions justice by half.

Concerns like these are being reflected in calls for measures to protect sectors threatened by the structural shift in our terms of trade. They drive calls for strengthened anti-dumping legislation, intervention to deliver a lower exchange rate and increased industry assistance.

This is simply untrue. As I have noted many times, the non-resource export sector is almost completely dumbstruck at the forces that are consigning them to the grave. Even vociferous protectionsists like BlueScope Steel have openly embraced their own destruction at the hands of the currency, bizarrely aiming most of their invective instead at the carbon tax, a tiny problem by comparison.

Next Dr Parkinson gives us the generic answer:

Why is there is so much discomfort in the community about this transformation?

In part, because it involves change, and change is often difficult. In addition, the short-term ‘costs’ of the adjustment are often concentrated in particular sectors. But perhaps most importantly, what is happening is not well understood.
To make the most of our favourable economic position, we need to understand these concerns and address them – with patience and reasoned argument.

For example, it is important to highlight that a higher exchange rate helps to spread the benefits of the terms of trade boom through the community by reducing the price of imported goods and services. Unless the global environment changes, attempting to lower the nominal exchange rate simply results in the required real appreciation being delivered through higher inflation rather than a higher nominal exchange rate. In other words, a higher nominal exchange rate benefits consumers!

We can remind ourselves, and others, that Australia is, in fact, a diversified, adaptable, knowledge economy as shown by Chart 12 previously. Services comprise around the same proportion of the Australian economy as they do in the G7 economies.

We can also show that the Australian economy is always changing – there are always new jobs and businesses being created as new opportunities are identified. By way of example, in a typical year, around 300,000 businesses are born and a similar number die5; around 2 million people start new jobs and leave old ones; and half a million workers change industries.6

The message is clear. Just as Australia is an economy in transition, the businesses and people who succeed are those that embrace and adapt to changing circumstances.

For the most part, I agree. A flexible economy does mean you can adapt better to shifting times in the most efficent and prosperous manner possible. But, at the same time, it is also this very flexibility that causing the problem just now. That is, markets are driving the big adjustment away from non-resource exporters. So, it doesn’t make a lot of sense to me to point to flexibility as the solution to a problem caused by flexibility. Fact is, if this boom runs for a couple more years and then tanks, we’ll have given ourselves a gigantic headache in trying to recover lost industry. I always thought that one of the lessons of the GFC was not to be wary of pro-cyclicality. Better to manage the boom through HUGE new mining taxes and an SWF. Sigh…

Finally, Dr Parkinson’s last two solutions are, sadly, laughable.

We can highlight how the emergence of major countries in our region will see the gravity of world trade shift closer to our region. The ‘tyranny of distance’ from major markets that has for so long been a limiting factor on the expansion of Australian business will continue to shift in our favour.

And somewhat related, but less well understood, is the changing world economy will present opportunities for the broader Australian economy from the rise of the Asian middle class — a potentially very large market for our goods and services.

I can only ask where Dr Parkinson thinks the capital is going to come from for any substantial push for our goods and services into Asia. Dutch Disease is not only about a high currency. It’s about the relative power of the boom sector to draw in capital ahead of, and at the expense of, all other sectors. It’s part of Rybczynski’s  theorem. Finally, Dr Parkinson makes the eminently sensible suggestion that we:

“…require more change in the structure, and perhaps more importantly, the mindset of Australian businesses and the skill sets of Australian workers.

It will also be important to build on our relationship with the Asian region to ensure that we embed ourselves in this vast market place.

Asian studies departments in Australia have been ignored, run down and destroyed for a decade. The eighties generation of excited young Australians with a curiosity for Asia are now a curiosioty in themselves. The rest of Asia rightly now perceives us as a small fortress on its southern flank.

John Howard killed Asian integration. Kevin Rudd promised much and delivered little. Julia Gillard doesn;t care about foreign policy. If our compaines are going to find these skills, they’ll have to go further away from Asia than here to acquire them.

No, Dr Parkinson, the rudder is stuck. The spinnaker is set. We’re running before a gale and high sea. You might as well have said damn the lifeboats. It’s commodities and bust.

David Llewellyn-Smith
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Comments

  1. I agree. I made a comment on your first post on this – “Basically, get used to it”.

    Commodities must be the new religion because Dr Parkinson and Treasury are asking for blind faith.

    Sorry, I don’t have it.

    • H&H.

      Boom. Bust. But maybe this time it is different!

      Given Treasury’s scenario of the boom continuing for some 15+/- years – how much of this entails the development and construction of new projects is not addressed.

      The development stage is, to my mind the most beneficial in terms of employment and flow-on effect. Once projects are operational, apart from maintenance and upgrades, they are largely ‘self-contained’ in financial terms. After current and proposed projects are complete here in WA (say around 5 years), mines are then basically digging the dirt, not generating exceptional employment nor requiring massive infrastructure development and government tax revenues from profits will be impacted by depreciation. Don’t get me wrong, these are still big operations by any global standard. Likely toward the end of this 5 year timeframe, multiple operations globally will come on line with possible effect on price and of course, profit.

      Treasury maintain that the services sector will step into the economic void left by the destruction of the manufacturing/export sector not affected by commodity prices. I find it almost impossible to envisage how this will occur. I am of the view that the service sector grows in times of economic prosperity and stagnates or declines otherwise. The charts given by Treasury demonstrating that the rise of the service sector is a common factor in developed countries manages to ignore that this ‘transition’ to services has occurred during a period of rapid globalisation and relative economic prosperity in these countries. Potentially we may be about to see some reversal in the importance of this sector in some of these countries. It may be too late for them, they too have greatly reduced their manufacturing capabilities by moving such industry to developing nations. If, as Treasury suggests, Asian growth is as sustained and strong Treasury forecasts, surely there will be an equally impressive growth in the Asian service sector, after all, it’s not rocket science. And English is no barrier!

      There is no discussion on the future of export/manufacturing companies adversely affected by the high AUD, which Treasury advises is “not a temporary appreciation, but a sustained drift” – as I said before, it appears Treasury’s advice is – Get Use To It. This suggests to me some preparedness for fallout, but no assistance.

      Furthermore, the paper does not adequately explain how the windfall from commodities will, in a meaningful way, filter through the broader economy. Superannuation is surely one of the poorer ways to protect the wealth gained from the mining boom. A SWF would be the preferred model but no-one has the balls. (And that’s not the fault of the anti-RSPT campaign, I too opposed the RSPT as presented, it was a shabby piece of work).

      Yep – it commodities all the way. Blind faith.

  2. Nice work H&H.
    In addition to the SWF I would suggest we need to remove taxes on labour and impose them on Land. I know this idea has been around for a while but it is apparent that this commodities boom is a direct result of the FED rescuing the US economy from the Housing bust after they ploughed enormous amounts of capital over a generation into a non productive asset. Housing.
    The FED prints money the Asian economies with their currency pegs import the monetary inflation which delivers us the commodities boom. We are guilty of the same thing everyone wants low interest rates to make the debt burded easier. I am sure if we had a significant land tax and much reduced taxes on labour we would not be in this predicament. How can we have a thriving manufacturing sector when so much of our human and physical and financial capital is consumed by housing ?

    Imagine what we could have achieved if we had not gone down this ponzi path.

    Steve

  3. I disagree when people say that we are selling off our “finite” assets and that we are essentially robbing from future generations by spending our mineral endowment. I just dont think coal and iron ore (the big 2 commodities that drive most of the terms of trade) are as finite as people think. I dont think the average person on the street realises just how much physical iron ore and coal we have.

    They are finite by definition of course, just not in a human conception. We have hundreds, if not thousands of years of production. Of course current “resources” and “reserves” will suggest otherwise, but when you have explored to find 100 years of production ahead of you, why would you bother spending money exploring to find the next 100 years right now? Its there – trust me.

    • There’s plenty of iron ore in the Earth’s crust, but not coal, unless you’re a believer in abiotic coal. But then coal has other problems, like being the enemy of the human race. Cue torrent of denialism … now.

      Put it this way, we’re digging up the easily accessible iron ore and coal today. By definition, the iron ore and coal available to future generations will be less accessible (and more energy-intensive to extract) than the resources we extract today.

      So its definitely a one-off bonanza the miners are profiting from. Its not like the iron ore and coal they’re digging up today, is going be there tomorrow.

      • Acknowledge we will disagree on this issue, but in my view coal is an uplifter of the human race from poverty. Cheapest form of large scale energy. I find it interesting that the western world always tries to keep the developing world down. Refer to EU through subsidies of farmers or Carbon tax/ets. I find the hypocrisy laughable “we developed our economy using cheap energy, which polluted the world. But now we are here lets all reduce our CO2 emissions by x%?” Then the western world tries to convince the 3rd world of expensive renewables….

        • I think you’ll find the latte sippers are of the view that the developed world should reduce their emissions before asking the devloping world to. They call it contraction and convergence. Politically impossible in the West of course, but us lefties like fantasise about it over a Chardonnay or three.

          BTW, I’m pretty sure the climate scientists made up this global warming thing because they thought it would be an easy sell. I mean, which government wouldn’t want to be told they can no longer use an easy to extract, relatively abundant source of energy that powers most of the world’s electricity generation?

          • Not really, but I was thinking a guy who keeps posting links to barnabyisright.com would be a bit of fun.

            Don’t get me wrong, I have soft spot for Barnaby. He’s kinda like a young Bob Katter — passionate but completely mad — but thankfully a spin free zone.

            However, I can’t get past his climate denialism and scare-mongering over the carbon tax … and really, we’re in a pretty good position as far as government debt is concerned, compared to just about anywhere.

            I’m not saying we shouldn’t be paying down govt debt — the RSPT would have helped — but Barnaby makes out we have a similar problem to the US, UK, Greece etc, which we don’t.

          • “Barnaby … passionate but completely mad..”

            Care to elaborate on the reasoning for “completely mad” accusation? Or is it merely blanket ad hom labelling because he sees through your pet cargo cult 😉

            “Barnaby makes out we have a similar problem to the US, UK, Greece etc, which we don’t.”

            Yet.

            And that’s his whole point and purpose. Trying to ensure that we don’t keep heading down the path towards that point.

            Give the man some credit for actually having average Aussies best interests at heart, and being prepared to cop a pasting from all and sundry for saying so.

            “but thankfully a spin free zone.”

            In our world of double-speaking snakes and liars for politicians, your acclamation right there is alone sufficient reason to like the man.

    • I agree with you there that number of zeros that accompany our reserves and resources are unfathomable for man on street, but what I am skeptical of is the prices we are receiving for it. I may draw some criticism for it but if and when US economy normalizes due to the productivity improvements it has achieved (and innovation in particular…..i have always wondered why the next big thing is always there), then the parabolic march that commodities have received will simply not be sustainable due to absence of liquidity.

      I am no expert by a long shot, but whatever the case is, the marginal boost that we are currently receiving today is totally reversable in direction when and if the capital markets of developing world start maturing. I believe that China and India have plenty of unexplored coal resources (more than happy to be corrected on this) to fall back on, if they allow the private sector to take on the risk inherent in the projects.

      Enron built one of the largest power generation plants in India 11 years ago that never earned a cent! They need to be able to afford this power over the long-term if the boom is to continue. Yes middle class is rising up to the task, but subsidies far and by engulf the daily necessities there.

      Wait and see game I guess! But even after this long rant, agree that there is no running out in a decade of our coal specifically as you point out to.

  4. Rather than an all encompassing land tax, the idea that by plowing huge amounts into your 5 million dollar home and by sheer good fortune the supply of excess credit drives the value to 10 million , you then sell and pay no tax, surely the capital gains tax regime needs to be revisited.
    Actually , the whole bloody tax and economic system needs a good going over, I suppose this what Ken Henry the previous incumbent was trying to do. Good luck trying to do it in the current political and economic environment.

    • Fair point Jack.
      I actually believe it will happen out of sheer desperation to right the country in next couple of years. If the RBA follows through and makes two more rate hikes or God forbid the Fed does QE3 and they are forced to go further the average punter is going to be decapitated.
      But out of Hell lead up to light. I am a believer in Scumpeter’s creative destruction. Only after all the Ponzi schemes have been liquidated can we move forward to genuine growth. And its not just property the car industry stands out as one that wont survive the coming Tempest.

      Steve

      • Steve, allow me to rephrase your comment:

        “Only after THE TRUE SOURCE OF all [the] Ponzi schemes have been liquidated can we move forward to … “

    • The major outcome of any tax reform must be that residential property is re-regulated as a security asset, to change its current status as an investment asset.

      That is, property should not go up in monetary value as this sends the wrong price signals to the (wrong) people.

      A Mt Doom climb to be sure to change this system, but it makes for a more robust society and economic system.

      Investment properties should yield 6-8% at a minimum and the focus of the investor should be on the rental return ALONE.

      Taxing capital gains on a time scale is one broad measure to use. I’ve said it before, but CGT on property (and share!) trades within the first 10 years (with a few minor exemptions) should be between 75 and 99%) of any increase in monetary value. And there should be no exemption on the family home.

      So in your example, if they sold their home for a $5 million monetary gain within 10 years, they pay approx. $4 million of that as tax.

      Kinda stops the whole house flipping and speculating for gain thing doesnt it – and you wouldnt need to “ban” negative gearing, because NO ONE would bother.

      Changing this attitude is nearly impossible. Thinking it can happen from one tax summit is optimistic in the extreme.

      • Lighter Fluid

        On the topic of turning property investment into an annuity type security, I can see a scenario where this will eventually happen if the current trajectory in the US plays out.

        A reasonable estimate is that the US housing market is poised about half-way through the bubble deflation. More pain is expected and foreclosures are expected to build up on the bank’s books faster than they can clear them.

        Banks, rather than administrating loans on real estate, will increasingly have their hands full with the reclaimed assets. As Chris Whalen puts it – burdoned down by the sheer weight of administration, they essentially become REITs.

        By this stage real estate will be the worst possible investment you can make in the eye of the public. House prices will never go up again. The banks either learn how to manage property for long-term yield, or they palm them off to institutional investors and pension funds – the only capital left in the market large enough to absorb the assets, and the only ones left willing to settle for the rental returns.

        Alternatively, the state intervenes and purchases the assets off the banks, but I don’t see that happening in the current political environment over there.

        Personally, I wouldn’t mind it if a portion of my industry super fund was earning 6-8% for perpetuity.

    • I am sure they could find something productive to do besides latte’s that does not require massive taxpayer assistance. My point is with all this when the house of cards falls over it will be apparent that we have totally skewed the economy to a non productive investment. If we focused our efforts on production instead of speculation we would not need so much corporate welfare.

      Steve

  5. “What if the boom suddenly stops, as all previous booms have?”

    Trick question. With all the new mining production that’s coming in the next few years, the boom *will* end, and as usual it will take everybody by surprise.

  6. And in breaking News.

    Sydney, May 18, 2011 — Moody’s Investors Service has downgraded to Aa2
    from Aa1 the long-term, senior unsecured debt ratings of Australia’s four
    major banks.

    The banks affected are the Australia and New Zealand Banking Corporation
    (ANZ); the Commonwealth Bank of Australia (CBA) — and its subsidiary,
    the Bank of Western Australia (BWA); National Australia Bank (NAB); and
    Westpac Banking Corporation (WBC).

  7. I can only ask where Dr Parkinson thinks the capital is going to come from for any substantial push for our goods and services into Asia. Dutch Disease is not only about a high currency. It’s about the relative power of the boom sector to draw in capital ahead of, and at the expense of, all other sectors.

    Didn’t you read Budget Paper No. 1: Statement 4: Opportunities and Challenges of an Economy in Transition? The Dutch Disease doesn’t exist and besides, in the Asian Century we’re gonna sell the Asian middle class education, holidays and wine!

    Note to Parko: Those three industries are getting smashed right now. If they’re our future, we’re in serious trouble.

  8. “Asian studies departments in Australia have been ignored, run down and destroyed for a decade. The eighties generation of excited young Australians with a curiosity for Asia are now a curiosioty in themselves. The rest of Asia rightly now perceives us as a small fortress on its southern flank.”

    Couldn’t have said it better myself. Lee Kwan Yew was right: we are the poor white trash of Asia… and that was before Boganomics!

  9. Yep,it isn’t fresh…and
    Seems it doesn’t matter,How many cheap
    Eatery levels or mirror balls and ATM’s,
    the Casino Refit ,spent,spends,lost or commits…
    If it keeps laying off ,Cleaners,Guards ,Cashiers
    Maintenance and Car-park attendants alike..too
    Biget refits,their economy will be an S-bend utility block…Not a Rhyme to Reason…Just stacks of cards and paper,a
    movement sensitive match explosive reliant …that reminds me, gotta go turn a light on…Don’t you wish you could stop the Flicker..Best of Luck..you’ll be hard ,pushing interest…cheers never the less….
    Nice one h2…JR

  10. Alex Heyworth

    A couple of things I found particularly interesting in Parko’s speech were his explanation of structural balance estimates and the difficulties inherent in them; and his remarks towards the end about productivity, which seemed to be a veiled hint to the government to stiffen their spine in dealing with unions.

  11. “What if the boom suddenly stops, as all previous booms have?”

    Treasury knows exactly what happens when the boom stops – everybody knows – it is called a bust.

    Of course, treasury can pretend and extend for a few years more and then say: “Nobody saw it coming”. Not the RBA, not Treasury and certainly not politicians.

  12. Hmmm… maybe the 200 million for religious instruction in the budget is not such a mystery after all. This could be Wayne’s fall back position.

  13. China Watcher

    Fascinating.
    A couple of points to add:
    – When commodity prices retreat, so too will the AUD, lets say from 1.05 to 0.70 (or less), making all our exports much more competitive. Go look at whats driving US manufacturing activity right now – its exports, due to the weak USD. And I don’t buy the “capacity is being destroyed, we won’t be able to capitalise”. Under the right incentives, capacity will be created once more as our comparative advantage shifts. Why do we subsidise our auto industry at the higest rates in OECD while the resources industry struggles for labour?
    – Do you know what happens if we assume that the world population ends up consuming the same amount of steel per annum as developed economies do today? (in other words, rest of world develops to western europe standards today by, say, 2100) World annual steel make needs to go from 1.4 billion tonnes to 3-3.5 billion tonnes. That is very strong demand growth for iron ore, coal and scrap steel and won’t be achievable without major technological innovation.
    – The “crisis” that will come to the federal budget when commodity prices do retreat will lay the foundations for real tax and spending reform…finally.
    – There is nothing wrong with supplying raw materials that come with economic rent if that is our comparative advantage. We do, however, need to work out how best to capture and intergenerationally redistribute the benefits. And its probably from a mixture of high AUD lowering import prices, more domestic savings, new investment in productive infrastructure, etc. Sadly, policy in this regard is sadly lacking due to the political leadership vacuum. I struggle to identify more than a few individuals with the intellectual leadership to drive a real sense of where we want to be on this measure.

  14. C&C, mentioned here, is widely cited and supported: –
    http://www.gci.org.uk/Documents/endorsements_high_res_.pdf

    UNFCCC veterans predict again ‘no-outcome’ at COP-17 as the process remains stuck in the politics-of-blame initiated by the NGOs in 1995. COP-15 didn’t succeed in escaping from that, though moderate rates of C&C were argued: –
    http://www.gci.org.uk/public/COP_15_C&C.swf

    The worry is that this time [COP-17] it is when the Kyoto Protocol expires. So we are looking at a ‘black-hole’, more than the ‘white-whole’ offered by C&C.

    Negotiating the ‘rate of convergence’ is the only way to break out of this vicious cycle: – http://www.candcfoundation.com/pages/whatis.html