Mining and the economy

The Reserve Bank of Australia (RBA) today released its March Quarter Bulletin, which included a paper entitled The Resources Boom and the Australian Economy: A Sectoral Analysis, which attempts to explain the three phases of the resources boom and their effects on the domestic economy. As expected, it provides a fairly benign assessment of the resources boom and includes minimal discussion of downside risks as the mining investment boom and commodity prices unwind.

Below are the key extracts from the paper, which can be read in full here.

Phase 1: the rise in the terms-of-trade and the exchange rate:

Australia experienced a large increase in its terms of trade, rising by 82 per cent since 2003/04 to reach their highest level on record in September 2011; they have subsequently declined by around 17 per cent (Graph 1).

This run-up in the terms of trade has provided a significant boost to the real purchasing power of domestic production, given that a larger volume of imports can be purchased with a given volume of exports. The increase in purchasing power flowing from a rise in the terms of trade can be estimated by comparing real GDP to real gross domestic income (GDI). Since the mid 2000s, growth in real GDI exceeded that in real GDP by around 10 percentage points…

The distribution of these real income gains across the economy depends, crucially, on how much the exchange rate appreciates in response to the increase in world commodity prices (RBA 2005). Since the terms of trade started to rise in 2003/04, the nominal exchange rate has appreciated by around 25 per cent in trade-weighted terms. The appreciation of the exchange rate means that: the increase in the domestic currency price of commodity exports was less than the increase in world commodity prices; the income of the ‘other tradable’ sector declined; and real income gains flowed to the broader economy via the associated decline in the price of imports.

Phase 2: the surge in resources investment:

In Australia, the growth in investment in iron ore, coal and liquefied natural gas (LNG) extraction has been exceptionally strong over recent years (Graph 2).

In contrast, investment growth in the ‘other tradable’ and non-tradable sectors has slowed over recent years. Growth in ‘other tradable’ productive capacity has been particularly soft, which may reflect, in part, the high level of the exchange rate…

Impact on growth:

As the surge in resource investment gathered pace, the output of the broader resources sector, as measured by its total GVA, increased strongly (Graph 3). This is particularly notable for the resource-related construction and business services industries, which have supplied a large quantity of inputs required for resource investment and extraction.

To sustain the growth in the resources sector, factors of production were drawn from the ‘other tradable’ and non-tradable sectors, and GVA growth in those sectors slowed…

Impact on employment:

Following the onset of the terms of trade boom, aggregate employment grew at an above-trend pace. The composition of employment growth also changed significantly (Graph 4).

The share of total employment accounted for by the resources sector doubled since the mid 2000s, to be around 9¾ per cent in 2011/12. Around two-fifths of this growth reflected the expansion in resource investment, which increased the demand for labour in resource-related construction and other industries that provide inputs to these investment projects (such as some types of machinery manufacturing and engineering services). The share of workers employed in the resource extraction sector accounted for only about one-quarter of the overall increase in the resources sector’s share of employment since 2004/05, while the remainder has been due to an increase in employment in industries that service the operations of mines (such as transport of output from the mine site to ports, business services and power generation). Once the peak in resource investment has passed and the extraction of resources increases, the share of labour employed in the more labour-intensive resource related industries is likely to decline and the share employed in the less labour-intensive resource extraction sector is likely to rise further.

In contrast to the strong employment growth in the resources sector, employment growth slowed in the non-tradable sector (particularly in retail and the parts of construction not exposed to the resources)…

Impact on wages:

Wages have risen more rapidly in the mining sector than in the rest of the economy since the beginning of the terms of trade boom, with much of this adjustment occurring between 2004 and 2008. As a result, the relative wage in mining increased by about 9 per cent over the eight years to 2012. This was by far the largest increase of any single industry, after having trended lower over the decade leading up to the boom (Graph 5). It also appears that relative wages increased in industries complementary to resource extraction, principally resource-related construction and business services. There was very little movement in the relative wage in the non-tradable sector overall and a decline in the ‘other tradable’ sector. This has been a key mechanism facilitating the reallocation of labour between sectors, whereby sectors benefiting from output price increases can afford to pay the higher wage rate and so draw labour away from other sectors.

Impact on inflation:

While inflation has been well contained, there were large shifts in relative consumer prices. Non-tradables inflation throughout the period of the terms of trade boom was stronger relative to its pre-boom average, as higher domestic cost pressures fed through to prices. At the same time, the higher exchange rate contributed to a noticeable decline in tradables inflation. Hence, the ratio of non-tradable to tradable prices rose much more rapidly after 2003 compared with the trend of the previous two decades (Graph 6).

Phase 3: mining production and exports:

For some commodities, there has already been a significant pick-up in production and exports. Since the onset of the terms of trade boom, the volume of iron ore extracted and exported has risen at an annual rate of 11¼ per cent (Graph 7). LNG production has also risen strongly. Coal production has expanded, but at a broadly similar pace to its pre-boom average…

The production phase of the terms of trade boom is expected to gather momentum over the next few years, particularly for LNG, which is expected to increase much more rapidly starting from around 2015.

The high level of the exchange rate and the impact of the global financial crisis on external demand have weighed on exports of non-resource goods and services. Exports of manufactured products from Australia remain well below their 2008 peak, even though the volume of global trade has surpassed its 2008 level. Exports of services have also declined significantly over the past four years, although this also reflects the tightening of conditions for obtaining student visas, and more recently there has been some recovery in exports of tourism. How the economy adjusts in the years ahead will depend, in part, on how the exchange rate responds to economic developments; in particular, to the extent that the exchange rate does not depreciate in line with any unanticipated declines in the terms of trade, this will affect the adjustment in other sectors
of the economy, notably the ‘other tradable’ sector.

Conclusion:

Strong growth in Asia is expected to continue to provide significant benefits for the Australian economy. Most notable so far has been the resources boom…

Looking further ahead, there will come a time when the demand for commodities will ease as development of economies in the Asian region continues and the focus of consumption shifts away from goods and towards services. Such a transformation might appear to be disadvantageous for economies such as Australia that have hitherto been focused on supplying these economies with commodities. However, some Australian service industries, such as education and tourism, and parts of the rural sector have already experienced an increase in demand from Asia, notwithstanding the high level of the exchange rate. Rising demand for household, business and financial services more generally in Asia has the potential to be relatively advantageous for the Australian economy, in part because it is closer to this region than it is to most advanced economies, but also because of its well-developed and relatively open services sector.

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