The Grattan Institute has released an interesting report on the impact of the mining boom on the Australian economy, and the prospects for the economy as the once-in-a-century boom unwinds as evident by falling commodity prices (terms-of-trade) and mining investment (capital expenditures). Let’s take a look.
The mining boom significantly boosted incomes and employment:
First, the Grattan Institute has provides a neat summary of the positive effect of the mining boom on national incomes and employment:
The mining boom has provided Australia with one of the largest income boosts in its history…
The historic increase in Australia’s terms of trade – the prices paid for Australian exports, divided by the prices paid for imports – increased national income, government revenue, and the income of ordinary Australians (Figure 1.2). From 2000 to 2012, Gross Domestic Product (GDP) – the volume of what Australia produced – grew by around 44 per cent, but real Gross National Income (GNI) – the value of ‘dollars in our pockets’ – grew by around 63 per cent. The terms of trade improvement alone directly increased national income by around 13 per cent over that time…
Since 2000, Australian GDP, wages, household incomes and employment have all grown steadily and strongly. The mining boom has contributed directly to wage and income growth in two main ways.
First, the doubling of the terms of trade – the prices paid for our exports compared to the prices we pay for imports – has raised national income substantially, as Figure 1.2 shows. In the 2000s the terms of trade kept real income growth above 2 per cent, despite slowing productivity growth (Figure 2.1). The additional income ended up in people’s pockets via wages, business income and dividends, and through the tax-transfer system.
The rising real exchange rate has transferred income from miners and from the producers of other trade-exposed goods and services to consumers. Consumers pay lower prices for traded goods and services. As incomes have risen, so has household spending on discretionary items.
…wages and incomes have grown faster in the mining states. In the decade to 2012-13, real wages grew by 2.7 per cent in the mining states, almost triple the 1.0 per cent a year in the nonmining states. Strong wage growth attracted international and
interstate migration and fly-in, fly-out workers.15 Household income per person grew faster in the mining states: over 4 per cent per year, compared to 2.8 per cent in other states. Nevertheless, wages and household incomes have continued to grow even in non-mining states. Wage growth has been just as rapid in the non-mining states during the boom as before.
Household incomes in non-mining states grew significantly faster during the mining boom years than in the seven years before, as Figure 2.6 shows.
Second, increasing mining activity and the very large increase in investment have contributed to steady growth in employment and output well beyond the mining sector, particularly in the period after the global financial crisis…
As a result of the mining price and investment surge, nearly a fifth of all production in Australia is now in or for the mining sector, by dollar value. Mining’s direct share of GDP more than doubled in the past decade, to 11 per cent. When the output of sectors such as construction and professional services that sell to mining is added, the sector is responsible for around 18 per cent of nominal GDP, up from just 9 per cent before the boom.
…unemployment [hasn’t] differed much between non-mining and mining states. Figure 2.7 shows that from 2002 to 2008, unemployment fell faster in the mining states than elsewhere, before rising more sharply from 2008 to 2010, during a pause in mining investment. By 2012, unemployment rates in the two groups of states were almost identical.
A recession is not guaranteed, but it may feel like one:
The Grattan Institute then turns to Australia’s prospects as the mining boom unwinds:
Economic growth tends to be more variable in countries with larger resource sectors. Yet Australia has long been different, achieving remarkable stability in recent decades. Its relatively well-designed economic institutions and policy practices contributed to stability. Preserving them will help manage any instability caused by the resources sector…
We analysed twelve episodes of rising and falling terms of trade in nine countries comparable to Australia (Note that this set of countries is different to the comparator countries with big changes in exchange rates…
The analysis samples only economies that, like Australia, are middle or high-income, resource intensive and economically diverse. It identifies every episode of over two years in length in which the terms of trade rose by at least ten per cent, then fell by at least ten per cent, and remained low for at least two years thereafter…
GDP per capita growth was typically lower after the terms of trade peaked. Recessions were more frequent and rapid growth less frequent in the years following a terms of
trade peak… Three-quarters of the sample experienced at least one year of negative year-on-year growth…
Terms of trade booms that were followed by slower or negative economic growth were almost always associated with high inflation in the boom period, as Figure 4.5 shows. Countries that had high inflation during the boom struggled to deal with the shock of lower prices for their exports at the end of a boom. A larger boom (and bust) of the terms of trade is also associated with slower subsequent growth…
The Australian resources boom will not inevitably end in recession. In comparable countries, downturns in the terms of trade were followed by more frequent recessions and, in some cases, prolonged downturns. But countries that pursued good macroeconomic management while their terms of trade were rising had faster growth after the terms of trade peaked. Australia’s economic stability through the boom provides grounds for optimism that it will avoid a deep recession.
Nevertheless, the current Australian terms of trade boom is one of the biggest experienced by any comparable economy in the last half-century. Investment in Australia’s resources is one of the highest, as a share of GDP, of any developed economy. So the historical record does not guarantee that an economic contraction will be avoided if the terms of trade fall sharply. Even if a recession can be avoided, a fall in the terms of trade would reduce national income and government tax receipts…
Australia did not save enough of the windfall from the boom:
The Grattan Institute argues that the Federal Government wasted the proceeds of the once-in-a-century mining boom by not saving enough of the tax windfall and over committing to unsustainable expenditure:
Governments in resource-intensive economies are usually advised to build a buffer during the initial period of elevated resources prices. As a recent IMF report put it, “a cautious approach – which maintains fiscal buffers while gradually incorporating new information to allow a smooth adjustment to potentially permanently higher prices – is a sensible way forward”.
There are three main rationales for higher public sector saving when the terms of trade are unusually high. First, saving during the boom means that levels of government expenditure on welfare and services are smoother over time, instead of payments rising during the boom and falling afterward. Saving reduces the risk that governments will need to make painful spending cuts or raise taxes increases if the terms of trade fall…
The second rationale for higher public sector saving during a terms of trade boom is that it reduces the risk that governments will run up large liabilities should the terms of trade fall. Governments find it difficult to prune expenditures and entitlements and to increase taxes. Their budgets can easily fall into deficit as the terms of trade fall, even if output growth continues at normal levels.
Finally, saving while the terms of trade is high may also relieve pressure on trade-exposed industries by reducing the real exchange rate…
Governments that enjoy resource windfalls tend to give away or consume too much, and save too little. In the first decade of the current boom, the Commonwealth Government has followed this pattern…
Figure 4.8 shows that the Commonwealth Government cash budget balance can be considered as the result of three factors: the business cycle (and other temporary factors affecting revenues, such as asset prices); the terms of trade; and so-called ‘structural’ factors, including the combined effects of policy settings (whether stemming from active decisions or not) affecting tax revenues and expenditures.
The business cycle boosted the cash budget position until 2008, peaking at over 1 per cent of nominal GDP. Since the downturn, the business cycle has tended to drag on budget outcomes.
The business cycle affected the cash budget position mainly through lower tax revenues and the cost of the stimulus packages.
The strengthening terms of trade also provided a boost to the budget over the decade, peaking at just under 2.5 per cent of GDP, also shown in Figure 4.8. The elevated terms of trade increased the real value of taxable income and potential tax receipts.
The estimated ‘structural balance’ of the Commonwealth budget progressively declined each year until the most recent year, as Figure 4.8 shows. It declined almost 5 percentage points of GDP over the nine years from 2002-3. Most of the decline occurred in the five years from 2004-5, at a steady pace of about 0.8 of a percentage point of GDP a year. There was a 1.5 percentage point improvement forecast in the May 2013 budget papers for the 2012-13 financial year, but even so, the structural balance remained more than two percentage points in deficit. Current policy settings would result in a cash deficit of over 2 percentage points of GDP in 2012-13 if the terms of trade were at their preboom level and the business cycle were ‘at neutral’.
The estimated structural deficit has exceeded the terms of trade uplift every year since 2007-08, as Figure 4.8 shows. The uplift from the terms of trade has not been converted into improved cash budget outcomes since then.
Less than a tenth of the cumulative boost provided by the terms of trade to Commonwealth budgets over the decade to 2012-13 translated to better cash balances. Figure 4.9 captures the accumulated net effect of the three drivers on annual budgets over the decade.
Figure 4.9 shows that:
The uplift in the terms of trade over 2002-3 levels provided support to accumulated budgets over the decade of about $190 billion.
Structural budget balances summed to an accumulated deficit over the decade of about $180 billion.
The business cycle (including the value of the stimulus in recent years) produced a net drag on accumulated budgets of about $100 billion.
The cash budget was in net deficit over the decade of about $100 billion.
Income decreases and expenditure increases both contributed to the deterioration in the budget position, as Figure 4.10 shows.
The estimated ‘structural income’ of the Commonwealth government declined by over 3 per cent of nominal GDP from 2002-03 to 2010-11, before starting to improve (see left panel of Figure 4.10). ‘Structural income’ is the income that would have resulted if cyclical influences on taxation (and other income) were zero. Major contributions to the declining income share were reductions in personal income tax rates, more generous tax concessions to superannuation, and shifts in the economy towards activities that attracted lower taxation.
The estimated ‘structural expenditure’ of the Commonwealth also increased over the period. Structural expenditure is an estimate of the expenditure that would have resulted if there had been no cyclical or temporary influences. Estimated structural expenditure rose by around 3 per cent of GDP over the decade, if the terms of trade increase since 2002-3 is considered temporary, as the upper line in the right panel of Figure 4.10 shows.
In other words, there was a large increase in Commonwealth expenditure that was effectively masked by the increase in nominal GDP due to the strong terms of trade. Contributions to increased expenditure include increases in family allowances and pension rates and expenditure on health, education and
infrastructure.
Even if all of the terms of trade uplift were assumed to be permanent, estimated structural expenditure still increased by about 1 percentage point of GDP beyond the rapid pace permitted by rapidly growing nominal GDP (as the lower line in the right panel of Figure 4.10 shows).
Overall, it’s an interesting report that captures many of the themes articulated on MacroBusiness over the past year.
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness.
Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.
