The meeting of the G20 finance ministers and central bank governors in Sydney next weekend provides an excuse to turn the spotlight inwards, towards the domestic economy. The IMF begins its new report on Australia this way:
The Australian economy has performed well relative to many other advanced economies since the global financial crisis. However, a transition phase has now been reached as the terms-of-trade-driven mining investment boom of the past decade has peaked and the economy is moving to the production and export phase.
'Performed relatively well' is a rather downbeat assessment for an economy which came through the 2008 crisis substantially better than other advanced economies (see left; source: IMF). The longer-term record is no less impressive: Australia has had 23 years without recession.
Of course there is never room for complacency; no matter how well a country has done, forecasters can always find plenty to worry about. The transition from the mining investment boom to normality is, as the Fund says, the main challenge. Ten years ago, mining investment was less than 2% of GDP. As coal and iron ore prices rose, mining investment quadrupled. This boom was so intense that resources accounted for over 1% of the total annual 3.3% GDP growth — around one-third of our growth over recent years.
Since late-2011 resource prices have fallen. They are still four times higher than before the boom, but iron ore and coal investment has largely halted (LNG investment still has a couple of years to run). Mining investment is headed back to its pre-boom level.
The coming fall in investment will be softened by the fact that about half the spending was on imports. At the same time the capacity-enhancing results of past investment will produce more exports. The net effect is that, instead of accounting for 1% of our GDP growth, resources will add 0.4%. That's still helpful, but it leaves a big gap if we want to sustain our accustomed pace of growth.
The terms of trade compare export prices with import prices; it's a measure of how much we can buy with our export earnings. Australia has a long history of huge swings in the terms of trade, but 2001-2011 beats all others in size and duration. As the terms of trade rose, so too did the floating exchange rate. In 2001 an Australian dollar bought less than US50c; by 2008 the Aussie was well over parity. The purchasing power of our income rose because imports (everything from petrol to overseas holidays) were cheaper. Our income benefited by 12-15%. Now that windfall is being unwound, although the terms of trade remain historically very high.
Thus the Fund is right in flagging some serious transitional adjustment ahead. How are we placed for this? We'll be relying on the same combination that got us through 2008: competent policy and good luck.
The centrepiece of our luck in 2008 was China's amazing growth. This single-handedly drove the terms-of-trade bonanza. If the Chinese economy had fallen over in 2008, we would have fallen with it. But when its massive 2009 stimulus took growth to 12% in 2010, the terms-of-trade party continued unabated, even though the advanced world was in deep recession.
Of course any sensible forecaster does some ritual hand-wringing about the risk that China might slow dramatically. One day the pessimists might turn out to be correct, in the same way that the stopped clock is sometimes right.
Many observers have misread the China growth profile. Once you recognise that the 12% growth in 2010 was a stimulus-boosted aberration, then you see that the growth inflection occurred five years ago, when China shifted from its pre-2008 unsustainable double-digit growth to grow at an underlying and sustainable 7%. The constant predictions of further slowing made over the past year or two miss this basic point: the slowing happened some time ago and we have already experienced the impact. China has good prospects of maintaining this 7% underlying pace for some years.
If so, it will need even more iron ore, coal and LNG. And as Chinese get wealthier, they'll want more of the sort of clean-and-green agricultural products Australia produces, together with the services (professional, education, tourism) we can offer.
The terms of trade suggest that this is the path we are on – they are off the peaks of 2011, but the fall is moderate so far. We used to export iron ore and coal profitably when prices were a quarter of the current level. Many of our resource exporters are still doing very nicely indeed.
Australia has always been a bit uncomfortable that our luck might be covering up some deeper inadequacies, waiting to bring us down. Sure, we've been lucky. But we’ve built on that luck. Our financial sector never made the egregious errors of America and Europe. Our housing sector never did the mindless overbuilding that has delayed the recovery in America. The budget was in good shape before the 2008 crisis and responded in textbook fashion: a strong stimulus which is gradually wound back afterwards when the economy is growing sustainably again.
Monetary policy was ready to lend a hand when the banks needed liquidity, and has steered a neat path between stimulus and inflation control without resorting to the unconventional monetary policies now proving so problematic to unwind.
The never-ending task of restructuring the economy will deliver more transition pain (we’ve just said a sad goodbye to the car industry). We bemoan our mediocre productivity performance (ignoring the difficulties of measurement) but the key is not just in tweaking the production line to go faster, but in the ability to shift resources into the expanding sectors. We're not too bad at this tricky task of flexibility. In the face of inexorable international pressure, we've trimmed our manufacturing sector back from over 20% of the economy to around 8%.
Export composition illustrates Australia's capacity for adaptation (see graph below; source: RBA). The quadrupling of mining investment without triggering inflation provides another example of flexibility. Despite all this disruption, the unemployment rate has only recently reached 6%.
We’ll need to work hard on making sure the now-dominant service sector has a substantial component of high-skill jobs and that the low-skill end is protected by a reasonable minimum wage (ours is more than twice America's). Education needs to ensure universal opportunity for individual advancement. A still-lower exchange rate would help. Budget commitments to expand welfare spending will require more taxes.
And we'll have to have another go at extracting an equitable return from the minerals sector. The Australian people should have received a bigger share of the resources windfall of the past decade (the sector is three-quarters foreign-owned), ideally through a resource-rent tax used to build up a sovereign wealth fund. A country with our commodity-price dependence should have a tax system that helps to smooth out the enormous price volatility.
We should welcome the Fund's reminders that there is much left to do. But 'performed relatively well' seems like faint praise.