Friday 22 Feb 2019 | 00:24 | SYDNEY
Friday 22 Feb 2019 | 00:24 | SYDNEY
Debates

Beyond the Boom

25 Jun 2014 12:01

The Lowy Institute is, first and foremost, a research institution. We publish research that is accessible to policy-makers and non-specialist readers. Often this will mean writing succinct, pithy analyses for readers who are short of time. But the biggest issues require deeper exploration: this is where the Lowy Institute Papers come in.

Since our establishment eleven years ago, the Institute has published over thirty of these monographs. Past Lowy Institute Papers have addressed topics such as the rise of India as a economic power, the growing role of diasporas in the world, the relationship between climate change and security, and Islamism in Southeast Asia.

Today we embark on an exciting new phase of the Lowy Institute Paper series with the launch of our newest Paper, Beyond the Boom, by John Edwards. Dr Edwards takes a provocative look at the mining boom and asks whether it really is over – and how much it has actually contributed to Australia's prosperity.

The Lowy Institute Papers will henceforth be published in conjunction with Penguin Australia, to ensure the widest possible readership. Each Paper will make a lively and engaging argument about the biggest international issues facing Australia. They are handsome little volumes, featuring the Institute's livery and branding, and they sit easily in the hand. Lowy Institute Papers will be available in for purchase in good bookstores and online and as e-books.

In a new feature, each Paper will be accompanied by a debate on The Interpreter so that we can continue the conversation with our readers. John Edwards will kick off the debate today with a short summary of his key arguments. Over coming days some of Australia's best economic minds will respond.

COMMENTS

25 Jun 2014 14:58

In widely reported censures by business leaders and economists, in warnings by politicians, public servants and journalists, we often encounter grim themes about the Australian economy. The mining boom accounted for Australia's apparent economic success in recent times, they say. But Australians wasted the boom through fecklessness and complacency, they continue, and the boom is now over. It follows that Australians face a bleak future as they adjust to falling commodity prices, falling mining investment, and a backlog of painful but necessary economic reform.

In Beyond the Boom I dispute all four propositions.

The investment phase is certainly beginning to wind down but the mining boom is not over – and in some important respects it has barely begun. Anyway, the mining boom does not explain Australia's long run of economic success. Australia's economy grew faster in the ten years before the boom began than it did in the ten years after, and incomes rose more rapidly. Exports increased much more in the ten years before the boom began than the ten years since. Over its first decade the mining boom saw an expansion of the resources sector by something like 3% of GDP and an addition to Australian income of something like 3% of GDP – both useful contributions, but much less than the imagined gain.

Nor has the mining boom been wasted. Household consumption, housing construction and home prices have all increased more slowly since the boom began than in the ten years before it began. By contrast, investment in physical capital and human capital and Australia's total capital stock have increased dramatically during the mining boom. Far from splurging the income gains from the boom, the increase in Australian saving since the boom began matches the income gain from the boom.

It is true that startling federal fiscal deficits opened up in 2009, and they persist today. But falling revenue as a share of GDP rather than rising spending accounts for most of the swing into deficit, with most of the falling revenue in turn explained by income tax cuts entrenched in the early years of the boom. Those cuts added to household saving, however, so that the increase in private saving during the boom years more than compensated for the fall in government saving.

This quite different take on where we are and where we have come from in the Australian economy can in turn usefully inform our views about where we go next. [fold]

Over the next few years we need to adapt to the decline of mining investment. But if the mining boom hasn't been quite as important to us as usually supposed, it will be easier for us to remain prosperous after the boom fades.

Looking beyond the boom, over the next few decades Australia can confidently build on a record of success rather than an alleged failure concealed by temporarily high prices for iron ore and coal. Instead of looking inward to identify the culprits for failure, Australia can look outward to identify the path of continuing prosperity. If we respond cleverly, the growth of the Asian regional economy can support the transformation of the Australian economy and the prosperity of Australians for decades to come.

Within a few years the growth of mining exports will peak and Australia will look to increased exports of farm products, advanced manufactures and (most critically) services to sustain prosperity. Its competitive advantage will not be cheap minerals, efficiently extracted, but the education and work skills of its people – its human capital.

As we rise to the challenge, domestic economic reforms can make useful contributions. It will help if we can encourage a more sensible public discourse on economic policy. The customary style of advocating economic reforms as urgently required remedies to avert catastrophe caused by decades of complacency has lost believability, as have claims for large general benefits for 'reforms' that mostly advantage one group of Australians over another.

To put the economic reform agenda back on track, we should make sensible claims for policies to extend and improve prosperity. Australia needs to develop a public discourse that can recognise the record and causes of its success, recognise too that the decisions of households, businesses and individuals rather than governments will determine whether success continues, and continuously adapt and improve the policy framework within which the economy operates.

Photo courtesy of Wikipedia.

COMMENTS

27 Jun 2014 11:56

Unemployment remains fearfully high in much of Europe, growth in the US is tepid and China may be on the verge of an unprecedented slowdown. In the midst of all this unpleasantness, Australians look around their bountiful land and ask, Can our luck last?

In Beyond the Boom, John Edwards, says it can. More precisely, Edwards argues that significant reforms in product and labour markets and in social policy in the 1980s and 1990s led to strong growth in the decade before the export boom. Moreover, with a few exceptions, Australians used the boom to make appropriate investments in physical and human capital. Speaking as an admirer of Australia from afar, I agree with a great deal of Edwards' analysis.

Edwards focuses on the past. I will say more about the future. First, a simple point about China. China does not have the institutions — rule of law, honest government, sound property rights and so forth — to push beyond middle-income status. China's growth rate, therefore, while it has been astonishing, will decline. The Chinese economy will get bigger, just at a slower rate. Thus, the demand for Australian exports will remain high even as prices moderate and, with its recent investments in infrastructure, Australia is well placed to deliver exports profitably even at lower prices. Second, mining is not just about getting stuff out of the ground. Mining is about transportation, automation, and logistics. Rio Tinto's driverless train system, for example, is the most advanced in the world. Exporting logistic services is another boom field for Australia.

As Jon Stewart memorably illustrated, every US president since Nixon has called for freeing the US from 'dependence on foreign oil' (within ten years!). Every president has failed. Fracking, however, has delivered the goods. Fracking has reduced the price of energy while generating millions of jobs and reducing net emissions of greenhouse gases. The fracking revolution has only just begun in Australia. Australia has abundant supplies of natural gas and if it creates a national market and avoids parochial calls for price controls and environmental NIMBYism it will certainly become the world's largest exporter. While profiting from natural gas production and infrastructure investment, Australia will also help the world to move closer to greenhouse gas targets. [fold]

Edwards regards substantial productivity improvements over the next several decades as doable. I am slightly more concerned if only because Australia's productivity improvements rely on those produced by larger economies such as the US. Tyler Cowen and Robert Gordon, for example, have argued that the US is in a period of stagnation with no end in sight. If so, Australia will follow that path. I am more optimistic but their warnings are worthy of consideration.

Australia has performed well on innovation policy, most notably on immigration. Immigration is an innovation policy because, as Stephen Kirchner writes, it brings not just more mouths or more hands but more minds, the key to productivity growth. On balance, current and future Australians would benefit from a larger population. In my report for Alliance 21, I discuss in greater detail how Australia can build on its strengths in innovation policy.

When a rational person wins the lottery they don't blow it all on one mad spree. A rational person smooths their winnings over a lifetime. Governments rarely behave like rational people. Edwards argues that during the boom the federal government spent and cut taxes madly, with little thought for the future. The Australian government, however, appears to have been much more rational and far sighted than many others, including that of the US. Should surpluses have been higher in the good years? Sure, but the miracle is that there were surpluses! Moreover, debt is low and the deficits are already in decline.

The Charter of Budget Honesty Act of 1998 requires Treasury to produce an Intergenerational Report every five years. Surprisingly, it seems to have made a difference. But what was the incentive structure that made this possible? Looking to the future, should Australia make more formal use of generational accounting? Should it follow Sweden and include a more explicit requirement for balanced budgets across the business cycle? As someone who looks to Australia for ideas and innovations in policy I wish Edwards had spent more time in comparative analysis.

Edwards is a member of the board of the Reserve Bank of Australia so it's surprising that he says very little about monetary policy and the role of the Bank in Australia's remarkable record of recession free growth. Australia, for example, did not avoid the 2008 recession: exports tumbled and real GDP growth slowed. Australia, however, did avoid mass unemployment and credit for that should be given to the Bank. Most importantly, the Bank has not let inflation and nominal GDP growth fall too rapidly. A little bit of inflation, say 3-4% a year, can be a good thing because it keeps real wages flexible and gives the monetary authority room to adjust interest rates in response to shocks. The Reserve Bank has kept inflation at this level since around 2000 (although there was a worrying drop in 2012 with some recovery since). The mining boom has detracted attention from the success of the Reserve Bank, which remains an understudied source of Australia's advantage.

In short, Edwards has written an excellent counter-point to the view that Australia simply got lucky with the mining boom. Luck favours the prepared and as the mining boom slows, Australia is well prepared for future growth.

Photo courtesy of Wikipedia.

COMMENTS

30 Jun 2014 10:34

There are two phrases that sum up John Edwards' new book, Beyond the Boom, a Lowy Institute Paper released last week. They are:

  • Mining boom? What mining boom?
  • She'll be right, mate.

While I disagree with both propositions, I am in heated agreement with Edwards' dismissal of the pessimism of two eminent Australian economists, Ross Garnaut and Bob Gregory. Both predict tough economic times ahead for Australia based on a difficult transition from a mining-investment-led economy to something else.

Should we accept Edwards' assertion that the mining boom was overrated? Of course, he accepts that mining investment shot to close to 10% of GDP – something which is almost without historic parallel – and that pre-2008, mining company profits were making a massive contribution to the ramp-up in company tax receipts.

His two main point of defence are that mining is just not big enough and national income was growing as strongly, if not more strongly, in the decade before the mining boom commenced.

To some degree, it is not important to resolve this argument. Whether the surge in mining investment and production was a boom or not, the real key is that soaring terms of trade propped up per capita net national income in the context of very weak or negative productivity growth. And boom or not, at least we didn't blow up the fortuitous occurrence of the higher and sustained terms of trade, with the exchange rate doing lots of heavy lifting and well behaved wages overall removing any inflationary pressures.

On the second issue (she'll be right, mate), Edwards is adamant that all the important economic reforms took place during the Hawke-Keating era (during which Edwards was a player). He pays some lip service to the introduction of the GST, but essentially, all the really necessary policy reforms are done, according to Edwards, and everything that is left is small beer. [fold]

Some of his descriptions of policy areas are quite inaccurate. It was not Keating who introduced a national industrial relations system – that was Howard. And to say that the industrial relations changes introduced in 1993 were all that is required for the smooth operation of an open and flexible labour market and economy is just risible.

Indeed, introducing a national system was a mistake; we would have been much better off leaving the state systems intact as a means of ensuring that interstate economic differences are recognised. And the changes introduced in 1993 were modest; the game changer came with Peter Reith's Workplace Relations Act, although sadly there has been a fair bit of backsliding with the Fair Work Act.

While Edwards is correct to point out that the largest slab of the economy and employment is in the services industry, his belief that the only scope for higher productivity rests with more investment in human capital is naïve. Take education and health, both sectors riddled with overstaffing and restrictive work practices. There is enormous scope to improve productivity in these sectors which has nothing to do with pouring more government money into education and skill training.

Edwards perpetrates another myth loved by the Left – that the income tax cuts provided in the 2000s were a mistake, robbing the government of valuable revenue. In fact, those cuts made considerable sense both in terms of eliminating insidious bracket creep and spreading the benefits of soaring mining profits to the broader population. If we look at the figures now, we are returning to a situation where the only sustainable growth of government revenue is from income tax, but this is increasingly being derived from bracket creep, which disproportionately hurts the lowest income earners.

Edwards' book is a rollicking read. He nails his colours to the mast, cherry picks the data and imposes his own clear interpretation on economic developments and reform options. It should provide the basis of reasoned debate on a very important topic – how Australia can enjoy ongoing economic prosperity on a sustainable and equitable basis.

COMMENTS

1 Jul 2014 17:03

'We'll all be rooned,' said Hanrahan, 'before the year is out.'  

Pessimism is a key part of the great Australian tradition, reflecting a history of booms and busts. It has infected the debate on the mining boom of the past decade. But how does it make sense to treat a once-in-a-century windfall of astonishing export prices as if we would have been better off without it? John Edwards' Beyond the Boom provides a much-needed antidote to this pessimism.

It's one thing for business leaders and journalists to put forward attention-grabbing gloom. But the hand-wringing has been shared by high-profile economists with rigorous analysis to back their views. John Edwards addresses this group with a detailed deconstruction of what the minerals boom has brought.

The starting point is an increase in our terms of trade, which is unprecedented in size and longevity. This triggered a four-fold increase in mining investment. Remarkably, these extraordinary changes did not unbalance the macro-economy. The economy grew at around its usual pace, inflation remained low and stable, wages have been restrained, and the current account actually improved.

To make sense of this successful balancing act, Edwards takes us through each of the components of the national accounts: income, expenditure and production. Mining investment increased, taking an extra 5% of GDP. This didn't push production beyond the limits of capacity because about half of this extra expenditure was channeled into additional imports. For the rest, there was some reallocation from other possible uses, particularly through restraint of consumption. The income component of the national accounts shows the background to this restraint. In the decade before the mining boom, households had gone on a spending spree, encouraged by booming housing prices. During the mining boom, they repented and saved, making room for some resources to shift into mining investment. 

Why were households so thrifty when the terms of trade delivered an enormous windfall to the economy? [fold]

There is no doubt that the improvement in the terms of trade gave a huge boost to income, but by and large it was not Australians who benefited. The largest part of the increase in income went as profits to the mining companies, which are four-fifths foreign owned. Of course some went to mine workers, but mining is capital intensive and in any case the workers were wage earners, not equity participants in the huge windfall. Federal company tax on mining companies was limited by the favourable depreciation allowances that the miners were receiving on their huge new investment expenditures. Glencore-Xstrata (our largest coal exporter) has gone further, arranging its affairs so it pays no company tax in Australia.  

This skewed distribution of mining income may reconcile John Edwards' narrative with that of leading academic Bob Gregory. Professor Gregory calculates that the terms of trade increase boosted our income by a whopping 14%. He (and many of the rest of us) worried about what would happen when the terms of trade fell (as was inevitable). But if the greater part of the benefits have gone to the foreign miners, we won't miss what we never had. 

In fact, the terms of trade haven't fallen much so far, so the point has not been tested. But we might take a kind of perverse comfort from this paradox: Australians may have avoided the problem of the well-known 'resource curse' by giving a large part of the windfall to foreigners.

How did we avoid a blow-out of the current account deficit, which usually accompanies a boom? Export prices saved us. We didn't produce much more or export substantially more in terms of volume, but with iron ore and coal both fetching seven times their pre-boom price, enough foreign currency was being earned to keep the deficit from growing. Why didn't the huge profits show up as capital outflow? They did show up in the detailed accounts, but were offset in the aggregate figures as the miners funded most of their new investment by ploughing back their profits.

Edwards is clearly right in saying that things have turned out well enough for Australia so far (what other advanced economy has maintained 22 years of sustained growth?). Looking ahead, our prospects are good. We have ended up with a lot more investment (albeit, still predominantly foreign owned), with much more to come in the LNG industry. Additional export volumes are starting to flow (again, with much more to come from LNG). 

When the miners have used up their depreciation allowances, federal company tax will take around 14c in every dollar the miners produce and state royalties about six cents. Australian workers will receive nearly 20c. Australian shareholders own a fifth of the mining investment, and will get the benefits of this. In total, Australia will end up with around half of the long-term export income stream. 

In addition, we're well placed to benefit from China's ongoing expansion, when exports of high-end food and services (tourism, education, technical expertise) will keep exports growing even when iron ore demand slows. If the terms of trade fall back further (which is quite likely), most of the impact will be felt by the mine owners — mainly foreigners. The exchange rate will depreciate, increasing the competitiveness of non-mining sectors.

That said, could we have done better? And did we make any obvious mistakes? With hindsight, the most serious error was the failure to put in place a resource-rent tax that would capture a large share of the mining boom, as we had done earlier with petroleum and gas.

The belated effort to do so, when the boom was well underway, was an abject political failure. The miners, despite having billionaires as their spokespersons, were able to convince the public that if they were asked to pay a resource-rent tax, they would shift their investment to rival resource-rich countries. Rio Tinto's painful experiences dealing with the governments of these countries (with Simandou iron ore in Guinea, Riversdale coal in Mozambique and Oyu Tolgoi copper in Mongolia) were ignored as the CEO warned us that Australia was his largest sovereign risk. The Rudd resource-rent tax was renegotiated by the former BHP chairman, with predictable outcomes for expected tax revenue. The current government is removing even this feeble tax. Mining royalties, a state government domain, fall victim to special relationships and inter-state competition to attract projects.

If government had been able to get hold of more of the mining revenue, this would have opened up opportunities to address the other sore point of the resources boom: its effect in pushing up the exchange rate to levels uncompetitive for traditional industries, particularly manufacturing. The awkward consequence of big cyclical swings on mining prices is correspondingly big swings in the exchange rate. The Australian dollar was worth much less than 50c in 2001 and well over parity ten years later. An effective resource-rent tax could have funded a sovereign wealth fund (as has been done by many other resource-rich countries), to be used to counter cyclical swings in commodities. Perhaps some could have been put aside to soften resource depletion. The result would have been a lower exchange rate and a more balanced economy; perhaps less investment in mining, and more in a variety of other industries. 

In short, we had more than our share of the luck. We didn't blow the opportunity presented. We did well in macro-management of the boom. With better politics we could have done a lot better, but looking around the world, we've done better than most and we're well placed to keep up the good performance. John Edwards has set out this story with clarity and precision, providing the counter-case to the modern-day Hanrahans chanting 'we'll all be rooned'.

Photo by Flickr user josh.

COMMENTS

2 Jul 2014 13:30

The 'end of Australia's mining boom' is one of the most anticipated developments in geo-economics. The writing has been on the wall for a while: in the next few years China's metal consumption will peak and then decline, and all the while Australian mines have expanded aggressively. There will not be another customer to replace China. It may all end badly.

The jeremiads have a tone of schadenfreude, as the 'Lucky Country' finally gets its comeuppance. Amid the countless commentaries (The Carnival is OverEnd of the Boom, A Hard Landing Downunder, etc) is a serious assertion that Australians have wasted the golden years, spending on McMansions, overseas vacations, gold-plated barbeque grilles and BMWs. Bradley Jones, an Australian economics whiz at the IMF, penned a harsh internal note called Australia's Brewing Crisis of Complacency, invoking Lee Kwan Yew's warning about becoming 'the poor white trash of Asia.' When boom turns to bust, Jones asks, 'will the ruling political class rise to the occasion?'

John Edwards has penned a nifty little book for the Lowy Institute's Penguin Specials series tackling these fears head-on. In Beyond the Boom, Professor Edwards acknowledges the long history of 'the black armband view' of Australian economics.

'Australia's economic problem is a ninety-year-old problem…a legacy of relative economic decline throughout the century' wrote Paul Kelly in 1992, just as Australia's present mining boom started roaring into life. Admittedly with the benefit of a quarter-century's prosperity behind him, Edwards thinks such pessimism was, and still is, way overdone. It turned out that Australia was not Argentina, which seems the more apt target of Kelly's appraisal. But was Australia really just lucky because it happened to be a dominant and proximate supplier to the needs of China's own voracious expansion? Or was there more to Australia's success, qualities that will support the nation well after the current economic cycle subsides? [fold]

Edwards argues that Australia made its own luck. It has undertaken extensive reforms, notably in federal and state financing and promoting pension investment. It has solid government, healthcare, and education. Some of its companies are world-class. Australia performed the amazing feat of settling two million long-term immigrants, adding 10% to its population, in the last decade, a testament to the quality of its institutions and its infrastructure. Defying the caricature of beaching slackers, Australians work hard and save even harder (at least by Anglo-Saxon standards). Australians are not feckless or profligate, but 'even frugal.' That they have socked away private savings during the boom years suggests commonsense and (something which I think is overlooked) a deep unease about the future. Far from being complacent, they realise their good fortune (and the price of their houses) may one day come crashing down.

They are right to be worried. By Edwards' calculation, the total resource economy (including all related activities) is 18% of GDP, large indeed. As for the incremental contribution of mining to GDP, Edwards calculates three percentage points over eight years; consistent with most estimates of about 0.5% annually. However, gross mining investment alone (ie. capital expenditure in new mining assets) is a whopping 7% of GDP (historically it has been 1-2% at most) and now is set to plunge. Mining companies are slashing capital expenditure and that will hurt.

But Edwards notes something very odd about the Australian mining industry. The boom, as he says, has been a quiet one, confined mainly to Western Australia. Mining employs relatively few workers. Much of the capital equipment is imported — not a 'good' thing, but it does mean that the capital expenditure downswing will mainly be borne by foreigners. And foreigners own fully 80% of the major mining companies. Edwards calculates that for every $100 in mining value added, fully 48c end up in the pockets of overseas shareholders. Edwards also reckons much of the long boom in mining income has been because of commodity price rises rather than volume increases. Australia's export prices have risen as the 'China price' for imported goods has kept deflating. Although such 'terms of trade' gains are debatable and difficult to calculate, they imply the real economy should be buffered in a mining downturn.

 Still, there's no denying 'the crucial requirement for sustained prosperity will be higher exports of non-mining goods and services.' The mining boom could evaporate much faster than expected. China may hit peak steel soon, just as Australian miners ramp up massive new iron ore capacity, forcing prices down. The global price of coal has almost halved since 2011. Even LNG, touted as Australia's next big resource export category, looks vulnerable to piped gas competition from Russia, Central Asia and possibly North American LNG. Worse, Australian costs have spiraled out of control by project over-runs, outrageous wages and cushy labour practices.

That, in my opinion, is the killer argument for why the boom will end and, indeed, why it must end: quite simply Western Australia has become hopelessly uncompetitive. Fortunately, the rest of the country is much better placed to serve the world with education, financial and healthcare services, agriculture, specialty manufacturing and tourism. Resources have been and will continue to be highly lucrative, and Australia has the institutions to spread the wealth widely. The nation pocketed the mining boom, but it must again be ready to adapt when it ends.

Photo by Flickr user Eugene Regis.

COMMENTS

4 Jul 2014 09:37

Reading John Edwards Beyond the Boom, I am struck by how easy it is to take the same facts, and treat them as good or bad news. The factual core of Edwards' argument is that the importance of the mining boom to the living standards of ordinary Australians has been greatly exaggerated. 

I entirely agree. To quote my own evidence to a Senate Committee inquiry the Minerals Resource Rent Tax in 2013:

The mining boom has already reached or passed its peak, and most Australians have seen little or no benefit as a result. Employment in the mining sector peaked in 2012 at a little over 2 per cent of the workforce. Mining-related activities, particularly construction, have generated more jobs, but are also at or near their peak. Employment gains in mining have been offset by the adverse effects on other industries of the sustained overvaluation of the Australian dollar. 

Income flows from mining have been dominated by profits, mostly accruing to overseas corporations, and to a handful of wealthy Australians, whose gains have primarily been the result of successful speculation, rather than any contribution to the discovery of mineral resources or their efficient extraction.

Edwards gives the numbers on this: for every $100 in value added by the mining industry, state governments get $6 and employees get $20. This leaves a profit of $74. Of that amount, the federal government gets $14, foreign shareholders get $48, and Australian resident shareholders get $12.

From one viewpoint, this is a bad news story. By virtue of the failure to secure an adequate return from our publicly-owned minerals, Australia missed the benefits of the boom. And, given the near-certainty that the (already heavily compromised) Minerals Resource Rent Tax will be repealed in the near future, it seems likely that this experience will be repeated.

Fortunately, the one element of the Rudd Government's response to the boom that seems certain to be retained is the extension of the Petroleum Resource Rent Tax which will apply to the LNG projects that look set to be the primary source of future growth in the resources sector.

On the other hand, the fact that we derived little benefit from the boom can be seen as a good news story. [fold]

As Edwards points out, most of those who suggest that we squandered the boom take this to mean that we dissipated the benefits of the boom on wasteful private and public consumption, or by relaxing the pressure for unremitting economic reform that is taken to be the essence of good public policy. 

It follows, in this view, that the end of the boom will produce a painful readjustment to reality. The usual end of such an analysis is a sermon on the need for a renewed round of micro-economic reform, essentially consisting of 'the list' of proposals remaining from the agenda of the 1980s.

But this analysis makes sense only if we (Australian governments and ordinary households) received the benefits of the boom in the first place. In reality as Edwards points out, households in particular have seen hardly any benefit from the boom. Ever since the 'wake-up call' of the global financial crisis, Australians have been busy tightening their belts and paying down household debt.

Edwards is similarly effective in his critique of the ritualistic calls for more reform, criticising the 'black armband' view of Australian economic history and noting that such rhetoric 'very often disguises as imperative reforms in the general interest proposals that in reality merely benefit one group of Australians over another.'

The kinds of reforms we really need are those that enhance human capital and encourage innovation. These reforms have been almost entirely neglected by the advocates of 'the list', who have maintained their focus on the issues of last century, and their focus on reducing public expenditure. Again, as Edwards observes, the real problem with fiscal policy in Australia has been the damage to revenue caused by the tax cuts of the Howard Government.

If I have one major point of disagreement with Edwards, it is his failure to discuss macroeconomic policy. Australia has experienced more than two decades of steady growth since the recession of the early 1990s. This is not, as is commonly claimed, the result of microeconomic reform. New Zealand implemented much the same reform agenda, and its economic performance has been miserable. Rather, it is because Australia's macroeconomic policymakers have made the right calls when it mattered most.

In the Asian crisis of 1997, the Reserve Bank kept interest rates low and allowed our currency to depreciate against the US dollar, in line with those of our Asian trading partners. And, when we were threatened by the GFC, Australia undertook more substantial and effective stimulus than the US or Europe.

Unfortunately, there is no guarantee that such good sense will prevail in the event of a future crisis. The rhetoric of the Abbott Government has been based on demonisation of the stimulus that saved us from the GFC, and on absurd alarmism about public debt. Fortunately, its actual fiscal policy has been far less contractionary than its rhetoric would suggest. Still, it is easy to imagine that a future macroeconomic shock would be met with policies of austerity, with predictably disastrous results.

But this is a minor issue. Edwards offers a welcome critique of the dominant rhetoric of the Australian public policy debate, which echoes the apocalyptic tones of those who warned, a generation ago, that we would by now be the 'poor white trash of Asia'. We are, as Edwards says, well placed to prosper in a future where the mining sector has returned to more its more normal role as a substantial, but still relatively minor, driver of economic activity.

COMMENTS

7 Jul 2014 08:14

Judith Sloan sums up my Beyond the Boom paper in two propositions: 'what mining boom?', and 'she'll be right, mate'.

Those who have read the paper will recognise these propositions as gross caricatures. For those who haven't got round to reading the piece, I should explain that I argue that the mining boom is by no means over and in some respects has barely begun, and that it has had substantial effects on both output and income. I also point out, however, that in the ten years before the boom Australia had higher real income and output growth than it has had since, and that the income and output gains from the boom have been more modest than widely believed.

It follows that, while it will be challenging, we can adjust to the decline of the investment phase of the boom and also the decline in metals and minerals prices without a sharp decline in output or income. I certainly don't think 'she'll be right' and that we need do nothing more to secure Australian prosperity in coming decades. But I do think the big contribution government can make is in the development of the human capital of Australians.

I'm pretty sure progress does not lie in big changes in the industrial relations framework, or in returning to the Workchoices regime that Judith prefers. The industrial relations framework is serving us pretty well, and we should focus our attention on policy areas that we know can make a difference. These certainly include, for example, early childhood education and more learning support for the quarter of our school kids who perform poorly.

In passing, Judith ticks me off for not realising that the industrial relations system became national with Workchoices, rather than in the Keating reforms of 1993 and 1994. I think she will find that I nowhere attribute the national system to the Keating period, and I specifically include it in major reforms of the last 15 years. This emergence of the national system was covered in perhaps tedious detail in the 2012 Fair Work Act review, of which I was one of three panel members. I think the emergence of the national system is a great reform – Judith, I see, now wants to go back to state-based systems.

Thanks to Julian Snelder for a great phrase I wish I had hit upon myself: Australians 'pocketed the mining boom'. [fold]

This nicely captures the idea that Australians have by and large taken the mining boom in their stride. National savings have increased by about the same amount the mining boom has added to national income. Consumption, housing investment, and wages growth have all been reasonably restrained. Inflation has been within the target band. These are pretty big achievements, given the experience of past resource booms. I am not sure I agree with Julian that Western Australia is 'uncompetitive'. It shares with the rest of the country the problem of a high Australian dollar. As the investment boom declines and with it major construction projects, Western Australia is likely to find itself much less strained.

Its wonderful to find economists abroad giving a different perspective on Australian economic issues. I found Alex Tabarrok's take stimulating – particularly his view that if productivity growth does indeed hit a wall in the US and Europe, it must necessarily also hit a wall in Australia. Perhaps so, but it surely depends on the sectors where the slowdown in technology occurs. Australia is so small in comparison to the US and Europe, and its industry composition and economic circumstances so distinctive, that a global slowdown in the expansion of the productivity frontier might matter less to us than specific industry innovation.

For example, Australian average productivity would probably not be much hurt by a general slowdown in manufacturing productivity growth, and would be much advantaged if there is continued innovation in transport, logistics, health care, education, agriculture, and mining. The mix matters more than the average outcome.

Steve Grenville's take on the boom and his amplification of some of the key issues was, as ever with his writing, thoughtful and pertinent. I disagree with it so little I can only respond by commending the post to any reader who missed it.

COMMENTS

11 Jul 2014 10:05

John Edwards' Beyond the Boom is a welcome follow-up to his 2006 Quiet Boom, which I reviewed at the time in conjunction with Ian Macfarlane's Boyer Lectures.

I agree with the argument that economic reform should not be sold on the basis of a faux crisis or economic failure narrative. If proposed reforms are worth doing they are worth doing regardless of where we sit in relation to the business cycle or the budget outlook.

John notes that households saved the Howard Government's tax cuts and that household saving would have been lower in their absence. This is an important observation, because it demonstrates the private saving offset to changes in public saving. Possibly to spare his readers the jargon, John didn't mention this as an example of Ricardian equivalence, but it is clearly relevant here. I made much the same argument at the time.

It is perhaps worth noting that John was rather more sympathetic to tax cuts in Quiet Boom, where he says that:

It may well be worthwhile to reduce the top marginal income tax rate, or to encourage more workforce participation by older Australians or to increase the incentives to move from social security support to paid employment.

Those arguments remain valid, regardless of the state of the budget. While balancing the budget over time is important, this should not come at the cost of reducing incentives for labour market participation.

John also notes that during the financial crisis, the increase in private sector saving more than offset the decrease in public sector saving from the fiscal stimulus. He doesn't mention that this is at odds with the dominant narrative around the stimulus, which is that it worked because we 'went early, went large and went households.' If the stimulus worked, John's analysis implies that it was not through household consumption spending. I would like to have seen John spell out these implications in more detail (my take is here). [fold]

John maintains we should limit the current account deficit to 3.3% of GDP to contain growth in external liabilities. This is close to the average since 1960 and so is certainly achievable based on historical experience. However, in Quiet Boom John shows how conditioning macro policy on a view about the appropriate size of the current account deficit got us into a lot of trouble. Tim Geithner's attempt to get the G20 to sign up to a 4% of GDP limit on current account imbalances was similarly mistaken in my view. We cannot know in advance the appropriate rates of saving and investment, from which it follows that the appropriate current account deficit is also unknown.

John maintains that the government has a revenue rather than a spending problem, but this is necessarily a joint problem. The normative issue is to define what government should be doing and raise revenue accordingly. In that sense, the expenditure side is analytically prior to the revenue side, regardless of what is driving changes in the budget balance over any given period. The test both revenue and expenditure measures need to pass is whether they improve incentives to work, save and invest. Higher average tax rates do not pass that test and would be at odds with the aims of the tax reform process and raising labour force participation. Balancing the budget is important, but should not come at the expense of microeconomic incentives. Balancing the budget and stabilising net debt as a share of GDP will be a somewhat hollow achievement if it comes at the expense of a smaller economy that yields less revenue for government in absolute terms.

John is spot on in arguing that Australia's economic future lies in integration with Asia through trade in services. I would add that there are even larger gains to be had through increased trade in capital and labour. Regional free trade agreements will be important in defining the parameters of our engagement and deserve close attention from policymakers. The G20 would do well to focus on the successful conclusion of regional and multilateral trade deals.

Alex Tabarrok says the Reserve Bank deserves a lot of credit, but I do not think we can attribute Australia's relative economic outperformance to the conduct of monetary policy. Australia adopted inflation targeting along with the rest of the world. Australia's senior central bankers largely trained in North America and think much like Ben Bernanke. It cannot be said Australia followed a different intellectual approach or that we know something foreign central bankers do not.

At the onset of the crisis, CPI inflation was running at an annual rate of 5%, nominal GDP at 11% and inflation expectations were coming unhinged. In the absence of a global downturn, the RBA would probably have needed to engineer a severe domestic slowdown to bring inflation back to target. In that sense, the downturn in the world economy did the RBA a favour. Monetary policy is neutral in the long-run, so I don't think we can give the central bank too much credit for a 23-year expansion.

Photo by Flickr user Mario Bollini.

COMMENTS

14 Jul 2014 10:07

Growth in HALE index, Intangible GDP, net national income and GDP, 2005-2014.

John Edwards' Beyond the Boom tilts effectively against Australia's congenital Hanrahanism. It points out the extent to which we managed to finance the wild ride of the boom (the massive surge in mining investment, from 2% to 7% of GDP) without blowing out our current account deficit and foreign debt or setting off an inflationary spiral as we've done in the past. 

We did it with a floating exchange rate, superior macro-economic policy and higher savings. How many people are aware of these facts as recited by Edwards?

By 2013, Australia's rate of workforce participation was higher than the US, once cited as a country far ahead of Australia in respect of that indicator. Australia's rate of investment was far higher than Japan or Germany, to which Australia had usually been unfavourably compared in this respect. Its rate of saving was also far higher than Japan or Germany, recognised as saving paragons.

Edwards is strangely muted on the role of compulsory superannuation in lifting savings, perhaps because he's aware of its huge and inequitable cost to the budget. (Naïve question: If we want to lift household savings, we can use compulsion or incentives. Why do we use both?)

What's more, as Edwards points out, much of our investment occurred not in physical structures — buildings, plant and equipment — but in human capital, in the skills of our people. The Herald/Age Lateral Economics (HALE) index of well-being takes GDP and adjusts it for some of the major inadequacies of GDP in measuring well-being. And our measure (see graph above) corroborates Edwards' story, with human capital rising faster than GDP. [fold]

For instance, consistent with the figures Edwards cites, the proportion of the workforce with Certificate III qualifications or above has risen from 40.7% in 2003 to 52.3% in 2013. These changes scored a squillionth of the column inches devoted to the mining boom, but they matter more. From mid-2005 to the latest quarter reported, real GDP has grown by 28%. Net national income (NNI) captures the rise in the terms of trade and so lifts our measured economic growth to 33%. The HALE index takes NNI as a better starting point for measuring welfare than GDP and, even with rising obesity and mental illness weighing it down, human capital increases our measured increase in well-being another ten percentage points to 43%.

Does this mean we're out of the woods? Well, yes and no!

I'm broadly in agreement with Edwards that we've handled the boom relatively well (and brilliantly when compared with our former booms). Still, just as Adam Smith asserted, it was ongoing production that mattered more than accumulated treasure. We will (or won't) adjust to what the future throws at us not because of the accuracy of our pundits' predictions today, but rather as a function of the quality of leadership as the future unfolds.

The upside here is that, as Edwards points out, labour productivity can be expected to grow at 1.5% per annum. Even if it grew at 1%, this would generate around four times the annual growth cost that aging will impose upon our economy in the coming decades. And fiscal drag exerts a powerful budgetary counterweight against the depredations of rising dependency ratios.

None of this is to endorse the complacency produced by our increasingly dysfunctional political-infotainment complex. Each major party campaigns by gravely warning of impending crisis while promising not to hurt a fly. 

The world is a dangerous place, and pessimists like Ross Garnaut may be right that real income falls are in store for us. If he is right, then he's right also that bringing such a transition off fairly and efficiently (which is largely a function of how strongly unemployment figures in the transition) is a difficult business. 

There's another kind of complacency that Edwards' helps illustrate. There's an unfortunate presumption among our policy elite that productivity-enhancing reform is conceptually straightforward and only requires the stiffening our political resolve. In this scenario the role of the pundit is as a kind of motivational spur. In politics as in sport, it's a case of 'no pain, no gain'. 

Gary Banks' 'to do list' illustrates the problem. Edwards' claim that the adoption of any of the items on the list 'or for that matter the whole lot, would probably not make a measurable difference to GDP growth' is exaggerated. But his point, that the items on this list pale into insignificance against the reform strides from 1983 to 2000, is hard to dispute. Gary's list is mostly the unfinished business of those glory days of reform.

Since then we've failed to replenish the intellectual larder. Australia, a standard bearer for neo-liberal reform and the only one with a focus on equity, has been reticent to build on that legacy by moving beyond it.

Recently we at Lateral Economics were commissioned to estimate the benefits of more vigorous policies to embrace open-source data in the age of the internet. Despite high-level government commitment to the agenda, and the fact that the US and the UK are racing ahead of us, Australia is taking its time. Treasury and the Reserve Bank don't even have real-time tax data from GST returns to help them take the economy's pulse. We surprised ourselves to find that such an agenda could add around 1% to economic growth without generating any substantial losers. But it's not on Gary's list. 

That's just one example. I could offer many more, having worked on my own list for some time. But none conform to the ideological formulas of the 1980s and 1990s, when the dominant criterion by which reforms were judged was as crude as asking whether they were more or less 'pro-market'. 

Chest-beating endurance of electoral pain won't deliver reforms like this if there isn't the intellectual curiosity and courage to imagine them and get them on the list.

COMMENTS

14 Nov 2014 13:40

In a paper published recently on the Minerals Council of Australia website, Adelaide-based economist Jonathan Pincus takes issue with some of the calculations I make in my Lowy Institute Paper Beyond the Boom. He makes a number of criticisms, but the big one is of my estimate of the income gain from the first decade of the mining boom. I put this gain at 3% of nominal GDP, comparing 2002 to 2012.

Essentially, Pincus claims that the gains from Australian mining exports should be calculated in US dollar prices rather than Australian dollars. If they are calculated in this way, the gains are bigger because over this period the Australian dollar appreciated. He then 'corrects' my estimates with his.

There are lots of problems with Pincus' material, one of which is that his numbers are wrong. Pincus claims the exchange rate of the Australian dollar against the US dollar doubled in the period 2003-4 to 2011-12. It didn't. When taking the overall average of the monthly averages for each of those fiscal years, the gain of the Australian dollar was a little less than half. Measured using the trade weighted index (TWI), which is relevant to his argument, the gain was less than a quarter.

I don't know, but my guess is that Pincus has confused the change in the period 2003-04 to 2011-12 with the change over the whole period starting from 2001 (well before the mining boom began) to 2012. This mistake is itself instructive, and points to a big problem with his methodology. Pincus implicitly assumes all of the gain in the exchange rate is due to the rise in mining exports and can be attributed to the boom.

But we know that is not so. [fold]

A large part of the appreciation of the Australian dollar against the US dollar over the period of interest to Pincus reflected a broader trend of depreciation that had nothing in particular to do with Australia. From 2002 through to 2008, the US dollar was declining against most other currencies, including the Australian dollar. We know that is so because it is shown in the US Federal Reserve Board's nominal and real trade-weighted US dollar series. Unless we suppose that Europe, the UK and China, for example, were also experiencing mining booms, this substantial element of USD depreciation and reciprocal AUD appreciation cannot be attributed to the peculiar circumstance of Australia's mining boom.

Another large element of Australian dollar appreciation was its recovery from the post-Asian financial crisis lows, when it fell below US $0.50. Much of that recovery occurred before the mining boom began. Of the increase in the exchange rate claimed by Pincus, one third of the appreciation against the USD and nearly half of the appreciation measured by the TWI occurred before the boom began.

Finally, higher commodity prices no doubt had an influence, but higher interest rates also drove up the currency – especially after 2008, when the US, UK and Europe moved towards zero rates while Australia raised its own from GFC emergency settings. The fact that Australia had markedly higher rates than the US, Europe, the UK or Japan could be said to be distantly connected to the mining boom, but it is as much a story about zero rates elsewhere as high rates (actually, by our standards, low rates) here. Zero or near-zero policy rates in the US, Europe, the UK and Japan have nothing to do with the Australian mining boom. 

There is no way of sorting out how much of the exchange rate gain is due to the boom, and how much to these other influences. It's not a problem Pincus recognises – he claims 100%, no discussion. 

There is another conceptual problem with his method. If the gains from higher mining prices are bigger when presented in changing US dollar equivalents over the period, so is Australian GDP when treated the same way. If we blow up mining revenue by presenting the gain in US dollars equivalents, we should do the same to the denominator, which is nominal GDP. Otherwise we are dividing apples by oranges. If we do treat GDP the same way, it increases in the same proportion as export returns and we arrive back with my number, not his. In adopting the method Pincus uses, any export over a period of Australian dollar appreciation is blown up compared to GDP – education services sold to foreigners, for example, or inbound tourism or farm exports. The elements of GDP would add up to more than total GDP, which is surely not a good idea.

Even measured Pincus' way, the gain is certainly less than he supposes, because he wrongly claims the exchange rate doubled in the relevant period. 

In Beyond the Boom I canvased the notion of adding to the gain from the boom the lower price of imports, which might be the result of a higher exchange rate. One problem with that notion is explained above – we don't know how much, if any, of the exchange rate change is due to the boom. 

Another is that when we look at what happened to import prices as opposed to the exchange rate we discover that, as a matter of fact, import prices did not fall. The Australian dollar import price index is the same now as it was in 1994, 20 years ago. The growing volume of cheap manufactures from China and variations in importers' margins have mostly overwhelmed exchange rate changes.

It is also true and I think relevant that the rate of growth of the volume of consumer goods imports did not much change in the ten years to 2012 compared to the ten years to 2002, which was before the boom began. One might argue that prices overall rose, while import prices did not. Even so, since consumer price inflation was much the same before and after the boom, one would have to say consumers benefited from zero change in import prices just as much before the boom as during it. The boom made no great difference. 

Almost all of the gain in the terms of trade was in higher export prices, as Pincus concedes. That is the gain I calculate.

Pincus likes the 'trading gain' concept as a measure of the boom's benefits. This argument was covered in Beyond the Boom and Pincus has nothing new to add to arguments made with greater force and clarity (and much earlier) by Bob Gregory. This 'trading gain' is the difference between GDP deflated in the usual way and GDP with exports deflated by the import deflator instead of the export deflator. That is the only difference between the measures. It is designed so that if there is a change in the terms of trade, the growth rate of these measures will differ from each other. Gregory calls the difference the 'trading gain'. As I point out, the difference in the relevant period is 14%. But 14% of what? Pincus tumbles in to that hole (as he did into the exchange rate hole) and declares it to be 14% 'of GDP'.

But they are different concepts, measured in different ways. The most one can say is that income measured one way was 14% bigger than income measured another. And as I point out, the trading-gain difference is true only if the additional export income is spent on imports. It is evident in the arithmetic. Nor does the trading-gain measure specify whether the gain is attributable to foreigners or Australians, especially in a period in which large investments are financed by retained profits. In an earlier paper Pincus uses the estimate that four-fifths of Australian mining equity is foreign owned, a number I also use. 

In Beyond the Boom I make much of the fact that the Australian dollar income gain from the increased value of mining exports was saved. Pincus writes about this as if he has discovered something I overlooked. It is in fact a central point in my argument. He also gets caught up in another conceptual mess, ascribing the increase in savings to what he thinks is the income gain from exchange rate appreciation and/or the terms of trade gain (it's not clear which). The problem here is that savings is measured as nominal Australian dollars as a share of nominal Australian GDP. It is not measured in US dollars or in real dollars, whether terms-of-trade-adjusted or not. The additional savings comes from actual Australian dollar income, not a conceptual terms-of-trade-adjusted real income.

The most mysterious aspect of the Pincus piece is that it was published by the Minerals Council of Australia, as if countering an anti-mining view. Beyond the Boom is not anti-mining in any respect. Mining executives to whom I have presented the results have not found it so, as far as I know. Nor is there any reason why they should.

A final point is a larger one. The point of Beyond the Boom is that the decline of the investment phase of the mining boom, the decline in mining output prices and the decline in our terms of trade do not necessarily mean we are heading into recession or depression as some have warned. Here we are, well into the inevitable decline in the terms of trade and well past the peak in mining investment, yet despite grim predictions, we are getting by. Growth has slowed and no doubt will remain less than its potential until non-mining investment and household consumption strengthen. Even so, real output growth is around 2.5% or a bit better, unemployment is stabilising and we are creating jobs. For three years now labour productivity growth has been well above the average of the last few decades, and in the most recent numbers multifactor productivity has turned the corner and is now again increasing. Wages growth has slowed more than expected and the exchange rate has usefully depreciated.

All these are good and hopeful signs. There is no economic crisis, no collapse. We do not have, as Maurice Newman, the chairman of the Prime Minister's Council of Business Advisers predicted, zero growth. We have not, as economist Ross Garnaut predicted, fallen into the worst recession since World War II. So far, so good. Things are turning out pretty much the way expected in Beyond the Boom, and not least because the boom was not as big as widely supposed – and in many respects is not yet over. 

COMMENTS

27 Nov 2014 17:12

Senior economic policy makers, economic analysts, academics and commentators have been concerned about the daunting challenge of structural and budget adjustment facing Australia due to the decline in mineral prices from the levels reached in the boom period of 2003-04 to 2011-12.

In Beyond the Boom, John Edwards estimates that the mining boom contributed 3% to GDP: 'Three per cent of real GDP is big, but as a change over eight years it is not that big'. This estimate of 3% is central to Edwards' strong dissent from the widespread belief that Australia is facing a formidable challenge. Because of Edwards' profile and appointments, including on the Board of the Reserve Bank of Australia (RBA), his assessment carries weight in the policy debate.

In a paper published by the Minerals Council, I argued that Edwards has greatly underestimated the economic benefits of the boom and, therefore, has vastly understated the adjustment challenge. Subsequently, in his post on The Interpreter, Edwards attempted to refute some of my arguments. [fold]

The crux of the matter lies in the distinction between production and income. Edwards' focus is on the production side, on the 'contribution to GDP from the mining boom to 2011-12'.

Almost all other commentators and modellers look beyond GDP, to the real income of Australians. Essentially, over and above GDP, during the boom a large boost was given to the income (or purchasing power) of Australians. Now that mineral prices have fallen, this will not recur, and it presents an adjustment challenge.

Economists have two standard methods to estimate the boost to economic income delivered by a boom in export prices: 

  1. The Australian Bureau of Statistics (ABS) way, using the System of National Accounts. This method yields a benefit equal to 14% of the GDP of 2011-12.
  2. The modelling way, using quantitative representations of the economy: this yields a benefit equal to 13% of the GDP of the year 2012-13 (argued in recent RBA Research Paper authored by Peter Downes et al. Although I discussed the paper in my Minerals Council critique of Beyond the Boom, it is not mentioned in Edwards' response as it was published after Edwards' book).

The ABS's national accounts tell us that over the decade to 2011-12, production as measured by real GDP grew more slowly than did the real purchasing power of GDP, as measured by national income. There was a 14% gain in income over and above the boost to GDP itself. This difference is usually called the 'trading gain', because it measures the benefit of a rise in the international terms of trade.

Before proceeding, here is a clarification to reassure Edwards: everybody has reported the size of the benefit of the boom as a ratio, equal to the benefit (however conceived) divided by some understandable denominator. Everyone, including Edwards, uses the GDP (or GNP) of the end year (2011-12 or 2012-13) as the denominator. Nobody who has contributed to the debate thinks that the ABS has estimated that the boom caused a 14% rise in GDP. Everybody knows that, because it takes GDP as given, the ABS method attributes no boost to GDP on account of the boom.

The Downes et al paper does, however, estimate that the boom did indeed boost the GDP of 2012-13 by 6%. National income was boosted by 13%, with the extra 7% mainly due to the trading gain.

Edwards steadfastly refuses to accept the standard interpretation of the trading gain as showing the rise in income, over and above the rise in GDP. His ground is that, for the 'trading gain' to become actual rather than merely hypothetical, the income boost must be spent on additional imports.

This assertion suggests a failure to understand national accounting. Edwards does not seem to appreciate that the ABS can estimate the size of the gain in income without having to show what uses were made of the income gain. Income can be used for saving, as well as for spending. Savings rose dramatically. Edwards amply documented the rise in saving, but he did not seem to understand that it refutes his argument that the ABS's 14% trading gain in income was merely hypothetical until it manifested as imports.

Moreover, Edwards has misinterpreted the facts about imports: 'Households, anyway, do not seem to have responded gladly to flat import prices. They have not very vigorously increased their purchases of imports compared with earlier trends.' But import prices were not flat. Instead, due to the rise in the exchange rate, they fell greatly, relative to Australian prices generally. That is what a sharp rise in the exchange rates does.

As to quantities, imports volumes rose about 70% faster than GDP in the boom (and the composition of imports did not change much). The additional imports were financed out of the higher national income and were stimulated by the large fall in the real price of imports.

The Downes et al paper confirms that the mineral boom caused a large rise in import volumes. The methodology used, a fully specified model of the economy, is far superior to Edwards' method, which estimated 'counterfactual' import volumes by simply comparing the decade before 2002-03 with the decade following.

Before going further, it is necessary to state that Edwards and all other commentators must realise that some benefits of the boom will last beyond its end. These lasting advantages are not captured in the production or income numbers discussed so far. They consist in huge rise in the capital stock, and a significant increase in private wealth, both of which will ease the adjustment to lower terms of trade.

There is a revealing lapse in Edwards' use of national accounts nomenclature. Although Edwards repeatedly states that his 3% is the mining boom's contribution to GDP, strictly his is an estimate of the mining boom's contribution to GNP, not GDP.

He first calculates the contribution as 6% of the GDP of 2011-12, but then discounts that by half because of foreign shareholdings in mining. But this is how the national accounts go from GDP to GNP, by deducting from GDP what is owned by foreigners on account of their productive and financial services (net of what is owing in the other direction). Thus, the ABS estimate of the trading gain takes account of foreign ownership of GDP and therefore, contrary to what Edwards asserts, should not be further discounted for foreign ownership.

Finally, there is something contingent in the way Edwards arrived at his 6% boost to GDP or 3% boost to GNP. If the rise of the exchange rate had been less, his estimate would have been more. Consequently, regardless of the cause of the rise in the exchange rate — and most observers say the mineral boom was a major, if not the prime factor — Edwards' method understates the national gain.

This is because the rise in the exchange rate reduced his estimate of the benefits of the boom, but did not reduce the benefits to Australia as a whole. Edwards measured the AUD-denominated benefits that flowed to the Australian owners of mining shares to state governments as royalties and to the ATO as company tax payments from miners. The rise in the exchange rate reduced these AUD flows (regardless of the causes of the rise in the exchange rate). But the rise in the exchange rate did not reduce the national gain. It merely redistributed some of it away from the Australian owners of mining shares and towards other Australians, including those purchasing imports which were now much cheaper in AUD terms.

Edwards needs to understand that (to the first order of approximation) a rise or fall in the exchange rate redistributes income and wealth, rather than increases or decreases national income and wealth.

Unfortunately, in a table I misreported the dates for which I estimated the effect of the exchange rate on Edwards' calculation.

In conclusion,  Edwards seems to have had difficulty in applying the System of National Accounts to the issue, he confuses GDP, GNP and economic welfare and he does not understand the redistributive effect of a rise in the exchange rate. As a result, Edwards greatly understates both the benefit of the boom and the burden of adjustment caused by the fall in the international terms of trade.

 The lone dissenter is sometimes right, but not in this case.

Photo courtesy of Flickr user Robyn Jay.

COMMENTS

23 Dec 2014 12:00

In a post here a few weeks ago, Adelaide economist Jonathan Pincus claims that my Beyond the Boom book confuses output and income. Fair readers will find that Beyond the Boom is painstaking in making exactly this distinction. It is central to understanding the mining boom, which is why I wrote quite a lot about it.

In the book I calculate the effect of the mining boom on real GDP comparing the years 2012 to 2002, and quite separately – indeed, in another chapter, with the distinction and its importance explained – I calculate the income gains. In yet another chapter I discuss a different way of calculating the income gain.

In response to my earlier rebuttal Pincus concedes he was confused about (or 'misreported') exchange rates. I think his confusion is more widespread. The 3% contribution to GDP from the mining boom I infer from an excellent RBA paper, which uses a sectoral analysis approach. The 3% gain in nominal GDP from the boom (in the relevant years) is half of the 6% gain in nominal GDP from additional mining exports – a quite different calculation. All this will be clear to the reader, if not to Pincus. [fold]

Pincus likes the terms-of-trade-adjusted measure of real income. That is fine. I myself use it where appropriate. But it is important to understand what it is. In deflating nominal export revenue by the change in import prices, the measure expresses the change in export revenue in terms of the volume of imports that revenue can buy. Its limitation is that it is a conceptual measure. If for whatever reason people choose not to buy imports, the income gain remains possible, not actual.

As it happens, Australians did not markedly increase the volume of consumer imports during the boom. The big increase was in capital imports, much of it mining investment. In the ten years to the end of 2012 the volume of capital goods imports increased twice as fast as the volume of consumer goods imports. Indeed, in the ten years to the September quarter of 2011 (the peak), capital goods imports increased by just short of 400% – two and half times faster than consumer goods imports. The increase in the volume of consumer goods imports was somewhat faster in the ten years to the end of 2002 (before the mining boom began) than it was in the ten years to the end of 2012. This was part of the remarkable household restraint during the boom, which contributed to the rise in household savings that Pincus elsewhere acknowledges. Savings, incidentally, are calculated as a share of nominal GDP, not real output or income.

That is why I think it is useful to look directly at the actual gains from additional mining and metals exports, or from additional nominal output in metals and mining, again comparing 2012 to 2002. As to the impact of the exchange rate, I would refer back to my earlier reply to Pincus. He now blithely admits error on the exchange rate without addressing the consequence.

Pincus writes admiringly of yet another way of calculating the gains of the boom. This method compares the actual outcomes with those which might have occurred in a different world from ours. In this assumed world, global industrial production and global output were markedly less than in the actual world, and the effect on Australian output and income in this assumed world were then calculated using a model of the Australian economy. The difference between what actually happened and what might have happened in the hypothetical world is then construed as the difference made by the mining boom.

As a measure it is quite unlike either the usual terms-of-trade-adjusted trading gain measure, or the simple calculation of gain in nominal export income, or the sectoral analysis used elsewhere by the RBA. It is a useful and interesting exercise but the result depends entirely on the characteristics of the assumed alternative world economy and the characteristics of the model. It is a might-have-been, like wondering what might have happened if Colonel von Stauffenberg had succeeded in killing Hitler. With little trouble, anyone can think up an alternative world compared to which the mining boom would appear to be either a very big or a very small increase in Australian income and GDP.

I recognise the interest of the exercise but I prefer measures that look at the actual impact of higher prices over the period they occurred, compared to the starting point. I think my calculations will be closer to the actual experience of Australians. For policy purposes, for the question of how we adjust and what comes next, this is the important thing.

COMMENTS