Recession is a risk in the slow lane of the two-speed economy.
Ten years ago, mining investment in Australia began rising sharply. By 2005-06 it had trebled in just five years. Over the next five years it doubled again. On current plans, it will double again in just two years to mid-2013.
It is being driven by what Treasury deputy secretary David Gruen calls ”a once-in-a-lifetime boom” in commodity prices and Australia’s terms of trade: the ratio of the prices of the things we sell overseas to the prices of the things we buy overseas. We all know the story, but even so, the numbers are staggering.
The terms of trade index has almost doubled, from 66.2 in June 2003 to 131.5 in September 2011. In other words, the same volume of exports today buys us twice as many imports as in 2003.
The Reserve Bank’s index of commodity prices in $US has shot up from 34.2 in June 2003 to 157.0, last August, before ebbing back to 142.0. That means that a typical tonne of coal or iron ore exports today earns its owners four times as much as in 2003.
And where commodity prices go, the $A follows. Between 1985 and 2005 it averaged 70 US cents. In the past year, it has averaged $US1.05. That’s made local production 50 per cent more expensive in $US, and imports 33 per cent cheaper in $A. So firms are shutting down and jobs are going overseas.
The scale of this shift is colossal. And it is a tribute to our policymakers, and the policy framework they inherited, that Australia has kept on the rails. Past resources booms always ended in tears, because inflation got out of control. This time the Reserve has focused on keeping inflation down and, apart from a flare-up in 2007-09, has succeeded.
There has been a price for this. The economy is growing more slowly; Australia’s average growth since 2004 has been 2.75 per cent, or just over 1 per cent per capita. We’re still stuck in third gear. Unemployment is back over 5 per cent, low in our terms, but well above the 2 and 3 per cent of success stories such as Singapore, Korea and Norway.
But there’s been a bigger cost that policymakers are reluctant to admit, or tackle. Australia has fractured into two economies.
The growth is overwhelmingly in minerals development, in Western Australia, Queensland and the Northern Territory. The south-eastern states – Victoria, New South Wales, South Australia, Tasmania and the ACT – are now going backwards on some indicators, growing slowly on others. Australia has been a two-speed economy since 2005, but now the two speeds are 100km/h on one side of the country, and 10km/h on the other.
Treasury anticipated this. In a recent speech, Gruen said its budget forecast of 4 per cent growth in 2011-12 assumed the non-mining economy would grow just 1 per cent. The first forecast was way out. Economic growth is now likely to be between 2.5 and 3 per cent, which implies the non-mining economy is virtually flat.
The pain is being felt where the non-mining economy is concentrated: in the south-east, where two-thirds of Australians live and work. The risk of recession in south-eastern Australia is now real. In the past year, that two-thirds of the country has seen falls in jobs, job vacancies, newspaper job ads, construction activity, home building approvals, retail sales volumes, and now, a sizeable drop in business investment plans. Growth is almost at a standstill. What should the government do? The word from Treasury and the Reserve is: do nothing. High mineral prices are here to stay, maybe for a decade, maybe for many decades.
That implies that the high dollar is also here to stay. It may not stay quite as high as it is now, but their message to business is: if you can’t find a way to compete with the dollar at something like parity (with the $US), you’d better find another life.
(To be fair, Treasury secretary Martin Parkinson told a Senate committee last month the best way to help manufacturers is to improve education, workplace relations, management skills and infrastructure. But all of them are things we want to do whether manufacturing is in boom or bust. For manufacturing, Treasury’s advice is: do nothing.)
If Treasury and the RBA are right in assuming that mineral prices and the dollar will stay high, then their advice makes sense. Australia’s car industry cannot compete globally with the dollar at parity. To try to keep it going would be expensive, and probably futile. Better to cut it off now and retrain its workers for jobs elsewhere.
But there are two problems. First, this advice is based on forecasts, not facts. Treasury and the RBA have not covered themselves in glory in recent forecasting; it’s a long time since either has got a call right. They’re human like the rest of us.
Chris Richardson of Deloitte Access Economics once called it ”a pure punt that China and India will keep growing faster than the world’s miners can keep digging deeper”. It is a gamble that the global supply of minerals will never catch up with the growth in demand. And that’s a big gamble.
If it’s right, then you save money you might have spent trying to salvage industries that are beyond saving. But if it’s wrong, the manufacturing firms you shut down will not come back. We would permanently lose economic capacity that we will need when mineral prices subside.
The second problem is that by doing nothing, you risk sending Melbourne, Sydney and two-thirds of Australia into recession or near-recession, so that the Pilbara and Bowen Basin can be developed at top speed. That is not just bad economics. It is bad politics.
Let me try a forecast: if that’s Labor’s policy, it will end 2013 back in opposition.