Wednesday, June 15, 2011

The Economic Structure Debate

The RBA Governor Glenn Stevens made a speech in Brisbane today, basically arguing that virtually all of us benefit from the mining boom and that we better get ready for interest rate increases!

The first is that the impact of the resources sector expansion does get spread around, in more ways than might immediately be apparent. Obviously mining employs only a small share of the workforce directly – less than 2 per cent. But to produce a dollar of revenue, companies spend about 40 cents on acquiring non labour intermediate inputs, primarily from the domestic sector. Apart from the direct physical inputs, there are effects on utilities, transport, business services such as engineering, accounting, legal, exploration and other industries. It is noteworthy that a number of these areas are growing quickly at present.
Once the costs of producing the output and other factors – such as taxes – are taken into account, the remaining revenue is distributed to shareholders or retained. While a significant proportion of the earnings distributed goes offshore, local shareholders also benefit. In fact, most of us are shareholders in the mining industry through our superannuation schemes. We don't get this income directly to spend now – it is in our superannuation. Nonetheless, it is genuine income and a genuine increase in wealth.
A good proportion of the earnings retained by companies is used to fund a further build up of physical investment, which imparts demand to construction and manufacturing. Based on the industry liaison the Bank has done, around half – give or take – of the demand generated by these projects is typically filled locally, though, of course, this amount varies with the nature and details of any specific project.
So there are effects that spill over, even though it is not always easy to spot them. In the end the combination of the resources sector strength and all the other factors at work in the economy has, to date, produced a national rate of unemployment of around 5 per cent, and in Queensland only a bit over 5 per cent. There are regional variations in unemployment rates, but at this point these look comparable to what has been seen at most times in the past 10 years – a period that has seen both lower average unemployment rates and lower variation in unemployment rates than the preceding decade.
While it is this section of the speech that will attract attention, I'm more interested in his arguments about economic structure. Currently there is an important debate going on about the nature of the current boom and whether it will be sustained or not. In other words, will Australia's income continue to be boosted by Chinese (and general Asian) demand for our resources long into the future or will this boom like all others in Australian history be followed by a bust.

The most important statistical measure of this is the terms of trade discussed regularly on this blog. See Boom, Boom, Boom and Keep on Booming.

Right now Australia's terms of trade  is the highest it's been (on a 5 year average basis) since the Gold Rushes of the nineteenth century. So really it's at the highest level ever for Australia as a Federation. The purple trend line provides a good indicator for why many Australian policy-makers thought we were in deep trouble in the 1980s and 1990s because the things we were selling were declining in value and the things we were buying were increasing in value. Since then as the yellow line makes clear the opposite has occurred although most of the steep ascent is due to increasing prices for the things we sell, particularly iron ore and coal.
Stevens argues that there are two components to the China boom - cyclical and structural:
[T]he industry make-up of our economy is continually changing. While this is often a slow process – almost imperceptible in most years – these shifts have been significant over time. There is little doubt that trade-exposed manufacturing firms not linked to the resources sector are facing tough conditions at present. But many people might be surprised to learn that the peak in manufacturing's share of Australia's GDP was in the late 1950s – more than five decades ago. Its fastest rate of relative decline, so far, was probably in the second half of the 1970s. On the other hand ‘business services’ – including things such as accountancy, legal and numerous other services – have grown fairly steadily and now are credited with more than twice the share of GDP of manufacturing. Several of these sectors are being boosted by the flow-on effects of the resources boom at present.
As for the mining sector itself, its share of GDP has tended to rise since the late 1960s, having been quite low in the mid 20th century. But in 2010, the mining sector's share of GDP was still only about the same as it was in 1910. It will surely increase noticeably over the next five years, though will remain much smaller than it was in the gold rush era.
Again, none of this is to deny that there are differences in performance by industry and region. It is simply to give some perspective on what we see.
The point about long term shifts reminds us to look beyond the immediate conjuncture, and to think about the magnitude of the event through which we are living. For a good part of the change in our terms of trade is a manifestation of a large and persistent change in global relative prices. Let me be clear here: there is a cyclical dimension to the China story, and it is important that we remember that. But there is also a structural dimension. And the associated change in relative prices constitutes a force for significant structural change in the economy. I think we have all only begun to grasp its implications relatively recently.
One of the major ways that the mining boom affects economic structure is through the exchange rate. A higher dollar is great for travelling overseas, but not so great for Australian non-resource exporters (including the domestic tourism and education industries) or import competing industries.
For as well as conveying a rise in purchasing power to consumers, the high exchange rate is exerting a powerful force for structural change. I think we are seeing this in the retail sector. The rapid growth of internet commerce – from a very small base – has been the topic of considerable discussion. This was bound to happen anyway with technology. But with the higher Australian dollar, the component of the retail ‘product’ that is added in Australia – the local distribution and retailing overheads that are required to provide the retail ‘experience’ – has become both much more visible, and much higher relative to the production cost of the good itself. So the incentive for the consumer to avoid those overhead costs has increased quite noticeably. The retail sector is therefore under pressure to reduce those costs. 
Finally, Stevens correctly reminds us that the problems of structural change that we face are better than the problems of many other advanced economies where unemployment is high and growth anaemic. While we might complain about a 2 speed economy, it's much better than a no-speed economy!

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