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What did I change my mind about in 2010? The mining boom and the deficit

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COMMENTS

4 January 2011 17:05

Is it too late to join those confessing to changing their minds over the past year' For me, the mind-shift is the belief (shared by mainstream economists) that it is OK for Australia to run a large current account deficit (4-5 per cent of GDP, sometimes even 6 per cent). This, we argued, is the natural working out of the nation's saving/investment balance. Provided it is the result of decisions by 'consenting adults' made without serious economic distortions, it would work out just fine in the long run.

Why have I changed my mind' Well, until the Global Financial Crisis, I thought Australia would always be able to fund this deficit comfortably: the New York money market was not going to dry up for good borrowers, was it' But we now have the answer to what we thought was a rhetorical question: yes, it could — and it did. We scraped through in 2008 by putting the Government's AAA rating on the line to keep our banks borrowing in New York.

In addition to losing faith in the financial market's ability to make sensible evaluation of risk (both before and after the GFC), I have also observed the Government's inability to implement necessary and sensible policies in response to a dramatic improvement in international prices for our commodity exports.

How should we handle this huge boost to our income' The first step is to recognise that the bonanza is probably temporary. Supply (in South America and Africa as well as Australia) will respond, and on past experience, resource producers will over-react and over-invest in the boom time. The sensible thing is to have policies in place which make use of some of the opportunities but don't assume that these commodity prices will last forever. Australia should invest more in resource production, but not re-jig the whole economy to make room for a wild-west resource stampede.

The best way of doing this would be to tax the windfall profits of the miners (it's not as if they worked to deserve the bounty; prices are high because the miners, worldwide, failed to foresee China's demand). This tax revenue should be put away into a sovereign wealth fund so that governments do not leave the cupboard bare when they lose office.

Instead, we see a passive policy response which aims to accommodate this mining investment boom, with substantial opportunity cost to the rest of the economy. This shift of resources occurs in three main ways.

  • First, the dramatically higher exchange rate frees resources by contracting other sectors which depend on international competitiveness; education and tourism are just two examples.
  • Second, inflationary pressures from the shift push up interest rates (already high by world standards), drawing resources away from interest-sensitive sectors such as housing construction, where we are currently not building enough to meet demographics, and thus ensuring sustained pressures on house prices.
  • Third, a higher resources tax could have funded a range of government services, such as public transport. This windfall revenue will now be left in the hands of the mining companies.

How was the compelling logic in favour of a substantial resources tax so easily over-turned' The miners won the argument by threatening a political campaign against the Government, and by threatening to take their investment elsewhere.

On the first issue, we need to be worried about our democratic future when threats of this kind are so effective. On the second, let's leave aside the question of whether the miners would really have put large investments in the cowboy world of Africa. Let's just say that if the miners scaled back their local investment plans, that would probably be a better outcome for Australia.

The miners have shown no capacity to pick global commodity cycles. In the 1980s they undertook minimal investment because they believed glass-fibre would make copper redundant and the downward trend in commodity prices would continue forever. More recently, one of our prominent miners demonstrated exquisite mis-timing by buying heavily into aluminium at the peak of the cycle. Why should we think that the mining sector has any capacity to get the current cycle right'

To accommodate the mining boom, we are encouraged to look with equanimity on a widening current account deficit. But there are consequences. It means selling off more of the farm: more foreign ownership. It means we will have a less diversified economy, making us more vulnerable the next time resource prices collapse. And it means increasing reliance on foreign funders to tide us over this adjustment.

We need to hope that, when the next crisis comes, our foreign financiers will be more helpful and understanding of our circumstances than they were in 2008.

Photo by Flickr user Georgie Sharp

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