There is something of a revolution brewing in Australian economic thinking just now. It began several months ago when the RBA suddenly stopped talking about inflation and started considering stimulus. The change of heart is that the minnig boom is not delivering the kind of inflationary blowoff growth that everyone outside of MB and the Melbourne Institute expected.
And today, from Victoria University’s Centre for Strategic Economic Studies, comes a paper by Peter Sheehan and the father of Australian Dutch disease diagnoses, Bob Gregory, who contend that the benefits of the mining boom, such as they are, will now decline. Futureboom has become Pastboom in the blink of an eye.
The resources boom has had a major stimulatory impact on the Australian economy, as a result of the net impact of four factors which are all of major significance in their own right:
1.Higher domestic real incomes. For example, real compensation per employee hour grew by 2.1% per annum over this period, by comparison with 1.3% over 1979‐2002, and by mid 2011 was 10.5% above the previous trend. Real per capita household disposable income grew by 2.8% per annum over 2002‐11, by comparison with 1.0% over 1979‐2002, to be 17.6% above the earlier trend level by mid 2011.
2.Higher asset values. Strong growth in the value of resource shares and other assets, driving a 44% growth or an increase of $93,000 per capita in the real value of financial and housing assets held by Australian households over the five years from the first quarter of 2003 to the end of 2007.
3.The local content of rising resource investment. A continued rise in both resources investment and other investment as a share of GDP, from 21% in 2001‐02 to nearly 28.1% in 2010‐11, with a reasonably high local content of resource investment on most projects, provided a major stimulus to activity.
4.Competitive pressure on trade‐exposed industries. Intense competitive pressure on trade‐ exposed non‐resource companies from a combination of appreciation of the $A and enhanced competitive from China and other developing countries, resulting in an sharp reduction in the net trade balance on goods and services of 13 percentage points of domestic final demand between mid 2001 and mid 2008.
While the net impact of these factors has undoubtedly been strongly positive for most of the period since 2003, there are good reasons, on the assumption of fixed exchange rates going forward, for thinking that the net stimulatory impact of the resources boom has come to an end. These reasons relate to the changing time path of each of the four impacts noted above.
- While the further path of commodity prices is uncertain, unless the exchange rate rises further the impetus to growth in real domestic incomes from this source will not continue. Since peaking in late July at 79, the trade‐weighted $A index has traded broadly in a 72‐76 band over the last three months. Assuming that the exchange rate is fixed at broadly currently 2011 levels, further real income growth from this source will not continue after the lagged effects have passed through.
- The remarkable growth in real per capita household assets prices over 1995 to 2007, which was boosted to 8% per annum growth in the first five years of the resources boom, seems to have ended. Real per capita assets have trended downward a little over the year to the June quarter 2011, and this seems likely to have continued for the next two quarters at least.
- Resources investment is likely to continue to increase as a share of GDP for up to two years yet, because of a dramatic increase in large LNG projects. But the combination of the high $A and of the shift to large, offshore and heavily foreign‐owned LNG projects means that the local content of resources investment will fall sharply, and this will substantially offset the impact of rising investment on the domestic economy.
With the exchange rate assumed to stay high, the competitive pressure on Australian trade exposed firms will continue, and indeed accentuate in key sectors such as manufacturing, tourism and education, as both producers and suppliers adjust to expectations of high exchange rates for the medium term.
Music to my ears. And they go on:
In short, on the assumption of fixed exchange rates, the stimulus from the three expansionary factors has or will shortly come to an end, while the pressure on trade‐exposed firms remains and in some respects is intensifying.
This conclusion has important implications for macroeconomic policy in Australia. The settings of such policy have been restrictive for some time, mildly so for monetary policy, as acknowledged by the Reserve Bank, and severely so for fiscal policy, as outlined by the Australian Treasury. The Australian Government is overseeing the most rapid process of fiscal consolidation for over 40 years. In the context of a perceived powerful continuing stimulus from the resources boom and in pursuit of a balanced budget by 2012‐13, the Government proposes to take $50 billion or 3.6% of GDP out of the economy (on an underlying cash basis) over 2011‐12 and 2012‐13 (see Table 5). Neither of these concerns is currently relevant to Australia’s economic situation. Partly reflecting the considerations outlined above and ongoing issues in the EU and USA, the outlook for the Australian economy is now much weaker than that presented in May in the 2011‐12 Budget Papers, in spite of the continuing resources boom. Real GDP has grown by 1.9% per annum over the last three years, and GDP growth for 2011‐12 in now likely to be closer to that figure than to the 4% forecast in the Budget Papers, while employment growth will fall well short of the 1.75% forecast.
It should be noted that Australia’s fiscal position is very strong, with Australian Government net debt at only 6.1% of GDP at the end of 2010‐11. It will be strengthened further over the next decade, even under the current taxation regime, as tax revenue from higher resource prices and from projects currently under construction begins to be received. Such revenue is currently being delayed by capital losses incurred in the global financial crisis and by depreciation allowances being generated by high levels of capital investment. The scale of both the investment and of the depreciation allowances being generated is massive, but tax revenues from the resources sector will rise strongly when these allowances are used up.
It is no longer appropriate in current circumstances for the Australian Government to pursue a budget surplus in 2012‐13. It should move away from this target and adopt a much less restrictive fiscal policy, more supportive of economic growth.
Here is where I start to get a little hazy. This paper is great reading but at no point does it mention the words “private debt”. I’d like to see an easing in fiscal policy. Who wouldn’t? Maybe some new infrastructure would be nice. But what about the private debt mountain that the Federal Budget backstops? Australian bank CDS are flying wild and free and there is a real chance that Europe will keep wholesale debt rollover too expensive for the banks next year. Keep your powder dry for the wholesale guarantee, I say. Back to the piece:
Monetary policy has been ‘mildly restrictive’, in the words of the Reserve Bank, being directed to offset the presumed net (incremental) expansionary impact of the resources boom and by concern about inflation running above the target band. In our view both of these concerns are no longer relevant, the first for the reasons outlined above and the second because it is clear that there is now no inflationary problem in Australia that needs to be addressed by a restrictive monetary policy. On 1 November 2011 the Bank recognised that the economy was slowing and the threat of inflation was easing, and cut interest rates accordingly, moving to a more neutral stance.
Over the three years to the June quarter of 2011, five sub‐groups, out of a total of 90 in the CPI and accounting for about 12% of the index, have provided 40% the growth in the CPI and 44% of the growth over the past year. The five groups are lamb and mutton, fruit, vegetables, utilities and tobacco. These five groups in total rose have risen by 11.9% per annum over the past three years, while the rest of the CPI rose by 1.8%; over the past year the five groups rose by 16.7% and the rest of the index by 2.2% (see Table 6). Thus excluding these items, inflation has been well within the Reserve Bank’s target range of 2‐3% on average over the cycle. It is difficult to extend this analysis to the September quarter data, as a new CPI series was introduced in that quarter and the full data have not yet been released. But these trends appear to have broadly continued – utility charges rose by 7.2% for the month and tobacco prices by 1.8%, but the food items fell back a little.
There is no reason for thinking that the rapid growth in prices for these items can be significantly influenced by monetary policy. Prices for the food items reflect seasonal conditions affecting supply, while increases in tobacco prices are driven by regular increases in tax rates. The reasons for the rapid growth of utility charges (11.5% per annum over three years) are far from clear, but it is unlikely that price changes for this group would be greatly affected by a restrictive monetary policy. The move on 1 November 2011 to a more neutral stance may prove to be the first in a series of adjustments of monetary policy.
This CPI cherry picking doesn’t serve the argument well. The CPI is the sum of its parts so you can always deflate something to offset inflation elsewhere.
But I agree with the cut rates argument, though again, because there is no mention of private debt, I’m kind of wondering what the authors have in mind vis-a-vis easing. Theirs is an argument for structural easing to boost growth post mining boom. That could be achieved by cutting rates and lowering the dollar, which will boost the earnings of the external sector and growth. But it will also be hijacked by the banks and turned into another round of asset speculation quicker than you can say “here’s a loan, mate”. So, if you’re going to cut rates responsibly, then you’re also going to have to intervene with the banks. Why not use the new macroprudential rules available at APRA to contain mortgage lending?
If you don’t, you are asking for the kind of debt-growth trouble that the world is very happy to punish just now. But if you do, we could have a thriving and diverse external sector and I could enjoy some economic sunshine for the first time in ages.
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.
Latest posts by Houses and Holes (see all)
- Scummo union integrity bill really about crushing wages - November 20, 2019
- NSW launches economic blueprint to nowhere - November 20, 2019
- China to declare trade war on Europe and vice versa - November 20, 2019