Yesterday Bloomberg ran an interesting article by Edward Glaeser, Harvard professor and land-use/city specialist. He used Australia as shining example of why mining is bad for long term prosperity.
America became great because it transformed its vast natural resources — Iowa farmland, Mesabi iron, Texas crude — into human capital, equipped with skills to succeed in the Information Age.
Now, when human capital is king, some look toward Texas and North Dakota and see natural-resource extraction as a path to economic rejuvenation. But if we look at Australia, the model of a major mineral producer, we see that widespread prosperity comes not from the stuff beneath the ground but from the stuff between our ears.
Yes, the U.S. would be fortunate to exchange its painful 8.2 percentunemployment rate for Australia’s healthy rate of 5.1 percent. According to the International Monetary Fund, at current exchange rates, Australia had the highest per-capita gross domestic product in the world in 2011, among all countries with more than 10 million people.
…The popular explanation for Australia’s economic success is that it is Wyoming with good weather, and has the luck to be China’s energy supplier. In this view, fortunes are made by billions of tons of coal and iron ore, carried from the Pilbara mines in Western Australia by mile-and-a-half-long trains to cargo ships headed for the factories of Shanghai.
…Yet mining plays a relatively modest role in the overall Australian economy, and employs a positively tiny share of its people. The Australian Bureau of Statisticsshows that mining and mining services together contribute less than 10 percent of the country’s GDP. Only 2 percentof Australians work in the mining sector.
…Australia is lucky to have its mining revenue, but that cash has a cost. For decades, economists have fretted about the Dutch disease, which can occur when natural-resource exports push up exchange rates. Australia has experienced a steady increase in the value of its dollar, and a high exchange rate makes it more difficult to export other products. The really dangerous dynamic occurs when high exchange rates crowd out more innovative industries that employ more typical Australian workers.
A recent paper I co-wrote with William Kerr and Sari Pekkala Kerr examined the long-run impact of mining across the U.S. Fifty years ago, the economist Benjamin Chinitz noted that New Yorkappeared even then to be more resilient than Pittsburgh. He argued that New York’s garment industry, with its small setup costs, had engendered a culture of entrepreneurship that spilled over into new industries. Pittsburgh, because of its coal mines, had the huge U.S. Steel Corp. (X), which trained company men with neither the ability nor the inclination to start some new venture. A body of healthy literature now documents the connection between economic success and measures of local entrepreneurship, such as the share of employment in startups and an abundance of smaller companies.
Our new paper documents Chinitz’s insight that mineral wealth historically led to big companies, not entrepreneurial clusters. In Australia, iron ore and coal are mined by giant corporations such as Rio Tinto Plc and BHP Billiton Ltd., and giant enterprises typically work best with other big companies. Across U.S. metropolitan areas, we found that historical mining cities had fewer small companies and fewer startups, even today in sectors unrelated to mining or manufacturing, and even in the Sunbelt. These mining cities were also experiencing less new economic activity.
Australia’s economic future depends on using its mineral wealth wisely, following the example of Iowa farmers who once used their corn profits to fund high schools. Yet Kevin Rudd, a former prime minister of Australia, was ousted in a backdoor political coup in 2010 partially because of his support for an extra mining tax. I’m against almost all industry-specific taxes, but the share of miners’ “resource profits” returned to the Australian government in the form of taxes and royalties fell from about 40 percent in 2001 to less than 20 percent seven years later.
I obviously agree with Glaeser on the effects of a high currency on other entrepreneurial ventures; on two fronts, both competitiveness and capital starvation as money is drawn into the boom sector.
But Glaeser does underestimate the positives impacts on entrepeneurialsim from mining. No doubt it produces monster companies, which then become another problem for the nation to manage (think tax). But there are smaller clusters of innovative firms around the big firms doing such things as engineering services. We have developed some world leading expertise in such areas.
At the same time, Glaeser also overestimates the innovative power of Australian services, which have an average export record (outside of education and a brief flourish for the REITs) and without mining supporting the external balance would sink into a nasty debt-deflation faster than you can say “bust”.
Still, the Glaeser paper has a point.
Twitter: David Llewellyn-Smith. He is the Editor of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.
