Commodity Prices and Commodity Exporters

Catching up on some reading on the weekend I came across these fabulous graphics that put recent commodity price increases into context.  They come from chapter four of the latest World Economic Outlook from the IMF.

Source: IMF staff calculations.
Note: The real price index for a commodity group is the trade-weighted average of the
global U.S. dollar prices of the commodities in the group deflated by the U.S. consumer
price index and normalized to be 100 in 2005. 

The blue vertical lines indicate long cycle
peaks, and the red vertical lines indicate long cycle troughs. 

The exact dates of these turning points are as follows (where M = month). 

Energy: 1981:M1, 1998:M12, 2008:M7.
Metals: 1974:M4, 2001:M12, 2008:M6. 

Food: 1977:M4, 2001:M11, 2011:M2. 

Raw materials: 1973:M9, 2002:M1, 2011:M2. 

While energy prices peaked at a level higher than the peak of 1981, the recent peaks for metals, food and raw materials have gotten nowhere near the peaks of the 1970s. The note above shows the month and year of the various peaks.

The second graphic to come from the report shows the percentage that commodity exports account for in total exports and in GDP. 

What the graphics show is that Australia has an export structure that is closer to developing countries than other developed economies, which was seen as a bad thing in the1980s and 1990s, but is now seen as a good thing. Australia must be very close to becoming a red country rather than a pink country in the top graphic. 

BUT it also shows that we are NOT as dependent on commodity exports as many of these developed countries primarily because exports are less important for the Australian economy than for most countries in the world apart from Japan and the United States (and Europe if considered as one country!). 

Our economy is overwhelmingly made up of services. In fact according to the ABS services account for 80 per cent of the economy (remember construction is a service!)  (Services were once defined by The Economist as things that you can buy or sell, but can't drop on your foot - I'm sure that doesn't apply to construction). See here for a breakdown of the Australian economy.

Still we have become increasingly dependent on resource exports and that may be a problem as the IMF makes clear in a world where demand and prices for commodities could be on the wane.

China and the Australian Dollar

The high Australian dollar is a source of joy for many Australians, especially those travelling overseas or buying goods overseas via the Internet. To be honest, I dig it in a big way. I get that lovely feeling of schadenfreude every time some British person complains about how expensive everything is here in Australia and I love buying books from the UK's Book Depository at reduced rates with no shipping costs and an inflated exchange rate.

(Nevertheless try as I might I couldn't buy the running shoes I wanted from the US either because the stores didn't ship to Australia or they did, but didn't have the size or style I wanted. I eventually found an Australian online store that sold shoes much cheaper [for Asic Kayano 18s about $70 cheaper than the retail outlets like Rebel and Super Amart]. For an analysis of the Internet and bricks and mortar retail see here)

But these pleasures just serve to highlight that a high dollar is a major problem for Australian (non-resource) exporting and import-competing businesses. Resource exporters aren't suffering yet, because demand remains high for the things that they export, especially coal, iron ore and gas.

As most educated Australians will understand, a high Australian dollar makes imports cheaper and exports dearer, which eventually causes many businesses, especially those with options to make things in other countries to reassess whether it is worthwhile continuing production in Australia. This is what has been happening in recent weeks with Toyota and Holden announcing job cuts and before that Bluescope Steel announcing that it was abandoning exports and cutting jobs.

Expect these announcements to become more frequent in coming months, especially given the fact that economic policy-makers in Australia seem to think that nothing can or should be done about the high dollar.

The exchange rate is a key enforcer of structural change in a resources boom. This phenomenon has been called variously 'Dutch disease", the two-, three- or multi-speed economy, and the patchwork economy.

Current concerns go beyond the banal fact that economies are always multi-speed. But right now the higher prices for Australian resources and the inflow of capital to fund investment and to take advantage of interest rate differentials between Australia and most countries with very low, zero, or effectively negative, interest rates is bolstering the Aussie. Borrowing at low interest rates and then investing in Australia with relatively high interest rates is rather attractive at the moment. Also a factor is growing foreign purchases of Australian bonds, especially by central banks and sovereign wealth funds.

According to another report in the FT, foreign ownership of Australian government securities has reached 80%.

While this makes some bond traders nervous, the real problem for Australian government bonds at the moment is a lack of supply. Still one trader argues:

this is worrying as heavy foreign ownership of government bonds can be very dangerous, particularly when this is combined with a country running a current account deficit (i.e. the country is reliant on capital inflows from abroad).

These concerns seem to be overdone - Australia's CAD is as low as it has been for some time, but I suppose things could change if China fell in a hole.

Right now, the worry is the high exchange rate's negative impact on key sectors of the economy, particularly those that employ large numbers of people and help to create a more diverse economic structure for Australia.

As I have noted many times before on this blog and elsewhere, exchange rate-induced structural economic change has a lot to do with whether the high Australian dollar is sustained over the medium term or whether it falls against our major trading partners and, especially, the US Dollar.

According to Hume in the FT, most economists expect a fall in the Aussie, but not back to its long term post float average of around 75 US cents. Instead the consensus view is that it will be supported at about the mid 90s. But at the moment Australians going overseas are doing pretty well compared to the early 2000s:

Australians planning to visit London for this summer’s Olympic Games will get bang for their buck. The Aussie, which recently hit a 27-year high of 67.96p against sterling, has appreciated by more than 80 per cent since Sydney hosted the Olympics in 2000.

Given that he is a long-term bear about China's medium-term economic prospects (increasingly becoming more short-term) Michael Pettis questions whether the Aussie should be currently so strong:

I am actually much more pessimistic about Chinese growth prospects, commodity prices, and the pace of European recovery ... but even so we would have expected that the obvious prospective problems in Europe and China should have made themselves felt in the Australian dollar. So why has it remained so strong?

The answer he suggests might have something to do with the amount of capital flowing out of China as cashed up Chinese worry about the potential for wealth destruction in China in coming years.

I just had coffee earlier in the week with one of my PKU students. He told me that he and his business-owning father are trying to take money out of the country as quickly as possible. He says it has become harder recently (I don't know why) but everyone they know is setting up businesses abroad and trying to do the same, in part, he said, so that they can get foreign passports if they ever need it. On that topic there was an interesting article last week in the New York Times:

A recent survey of 980 Chinese millionaires found that 46 percent of them were considering leaving China and another 14 percent had already emigrated or were completing the paperwork for relocating. The survey by the Bank of China and the Hurun Report said 40 percent of the would-be émigrés — they’re known as “migratory birds” in China — would aim for the United States, followed by Canada (37 percent), Singapore (14 percent), Europe (11 percent), Hong Kong (5 percent) and Britain (2 percent). 

The leading reasons for taking flight: better educational opportunities for their children, advanced medical treatment, worsening pollution back home (especially urban air quality) and food safety concerns. But many potential émigrés, not surprisingly, are working on a Plan B in case China’s economic growth begins to slow, widespread social unrest takes hold or the political winds begin to blow against them.

We are seeing this process most vividly in Hong Kong. In spite of a recent video showing a fight between Hong Kongers and mainlanders in the Hong Kong subway, which went viral and inspired real anger and mutual recriminations among even some of my most laidback Beijing and Hong Kong friends, mainlanders are scooping up apartments in Hong Kong. This is from an article in Saturday’s South China Morning Post:

Data compiled by Midland Realty shows individual mainlanders spent HK$62.3 billion on residential properties in Hong Kong last year, or about 20 per cent of the value of all sales excluding those involving corporate buyers. That was almost double the 10.8 per cent in 2010. The agency expects the figure to jump to about 25 per cent this year.

Rich mainlanders are clearly eager to take money out of the country. And what is just as clear, the debate on the limits of state capitalism we have been hearing and reading about a lot recently is not just of academic interest to them. According to my student, it is becoming harder and harder for non-SOEs [state-owned enterprises] to do business in China, and more necessary than ever to have friends in high places.

As an aside, for those watching the real estate market, my student also mentioned that two very large real estate projects that his father runs are having trouble selling units. He said his father has decided to sell as quickly as he can, even at very low prices, rather than wait for prices to recover.

One of the places that Chinese capital could go is, of course, Australia. which may account for the continuing strength of the Aussie:

a lot of Chinese capital is flowing into Australia. He, for example, has traveled to Australia nine times in the past year, mainly looking after business for his father, who has also been to Australia many times. The family has large investments in food, real estate and construction, and my student tells me he often arranges to meet in Sydney or Melbourne school friends of his who also happen to be in Australia for similar purposes. My guess is that at least part of the reason for a strong dollar, in spite of weakening growth expectations, may be that a lot of Chinese capital is flowing into Australia.

What would happen if growth in China slows significantly? This would probably result in a sharp drop in non-food commodity prices, which should cause much slower growth in Australia. But if a Chinese slowdown coincided with an increase in private Chinese capital outflows, it might be difficult for the Australian dollar to adjust downward sufficiently to help absorb some of the cost of the slowdown. In that case Australia might suffer low growth and an expensive currency – not a very good combination.

Let's hope that this doesn't eventuate!

Let me finish this already long post by noting that this is not an argument against the floating exchange rate, which has been overwhelmingly beneficial for Australia since the early 1980s and has helped Australia to adjust to international shocks and keep inflation in check during the boom. But let's not pretend that it doesn't have some costs that the government and the RBA will need to manage.

The Internet and the Death of Retail?

[O]ne of the most harmful habits in contemporary thought, in modern thought even; at any rate, in post-Hegelian thought: the analysis of the present as being precisely, in history, a present of rupture, or of high point, or of completion, or of a returning dawn ... I think we should have the modesty to say to ourselves that, on the one hand, the time we live in is not the unique or fundamental or irruptive point in history where everything is completed and begun again.  We must also have the modesty to say, on the other hand, that . . . the time we live in is very interesting; it needs to be analysed and broken down, and that we would do well to ask ourselves, ‘What is the nature of our present?’ ...  With the proviso that we do not allow ourselves the facile, rather theatrical declaration that this moment in which we exist is one of total perdition, in the abyss of darkness, or a triumphant daybreak, etc.  It is a time like any other, or rather, a time which is never quite like any other.
Michel Foucault 1983

The end of everything we call life is close at hand and cannot be evaded.
H.G Wells 1946

Is the Internet killing traditional bricks and mortar retail? There's no doubt that retailers are doing it tough at the moment, but the Internet is only one of a series of problems facing the sector. The major concern about the Internet for the retail sector is prospective, rather than current, loss of sales.

The major short- to medium-term problem for retailers is the paying down of debt by Australian households and the end of debt-fuelled consumption. This is reflected in increased saving by Australians. Together these pressures are damaging confidence about future possibilities for retailers to make money with their traditional model.

While many in the industry want the government to 'do something' to fix things, it's clear that adaptation to changing consumption habits and technologies will be essential for medium to longer-term retail survival. In this post I consider a variety of statistics and measures about the impact of the Internet on the retail sector and outline some of my own experiences. I conclude that the future has not yet arrived and that retail sector still has time to adapt to change that is happening more slowly than many imagine. 

According to the Productivity Commission (PC) there are "140 000 retail businesses in Australia, accounting for 4.2 per cent of GDP and 10.7 per cent of employment". This makes it one of the most important sectors for employment after "health care and social assistance", at 11.4 per cent of employment. (For a detailed account of the structure of the Australian economy see here)

Let's begin by something close to my heart - books. I buy a lot more books from overseas suppliers than I used to because they simply are much cheaper. Books from the Book Depository (no postage) and Amazon are generally less expensive than bookshops or online suppliers in Australia, although not always, especially for Australian books (Fetch, for example, provides an online comparison service for online book purchases).

The longer-term worry for book sellers might be from eBooks rather than overseas suppliers of paper copies, but currently it's online sales that are the major threat. So what are the numbers? Luckily the Department of Innovation, Industry, Science and Research has just produced a report on the Book Industry. Its market analysis estimated that "the total value of books sold in Australia during 2010 was $2.3 billion", with "online book sales worth $280 million in 2010, or 12 per cent of the total book market."

In a survey of "1,000 Australians, 53 per cent of books purchased online in 2010 were bought from overseas online booksellers". If we tie these two figures (improperly) together we get a figure of about 6 per cent of total sales bought from overseas book sellers.

The analysis also reported that:

Adjusted for inflation, the total value of books sold in Australia increased by an annual average of 1.1 per cent from 2001 to 2010. Relative to other retail industries, the Australian book industry underperformed over the past decade. It performed more favourably, however, when compared against other creative industries in Australia and overseas book industries.

So what about eBooks?

Australians purchased approximately $35 million worth of eBooks in 2010, which is equal to 1.5 per cent of the total value of book sales for that year. The eBook market in Australia is projected to reach between $150 million and $700 million in 2014, representing between 6 per cent and 24 per cent of total estimated book sales.

Between $150 million and $700 million? That's a fairly big grey area of $550 million. In other words, they have no idea.

So people are still buying hard copy books, just not from Borders anymore. Borders might have been a great store to visit, but you would have to be making a last minute purchase, uninformed or insane to buy books there. The mark up on books (and CDs) at Borders was ridiculous when compared to the Book Depository or even other bricks and mortar book stores. I can remember trying to buy my son a copy of the yearly AFL Record at Borders and finding out that their price was about $8 dearer than the recommended retail price.

Still my son and I used to love going to Borders at the mall to browse and we miss it now that it's gone. I hope that bookshops survive, but generally I only buy books from book stores when I want the book for someone else as a last minute gift or for my son when he's finished his last one and doesn't want to wait the 4-5 working days the Book Depository takes to deliver.

It's not all bad news for bookshops. Recently I visited Avid Reader in West End, Brisbane, on a Saturday morning. My son bought some books and I bought a coffee. The shop was packed with browsers and, it seemed, buyers. If there's a future model for bookshop, Avid certainly looks like it. If Avid or Riverbend Books in Bulimba can't survive I'd be extremely worried for all book shops.

But it's not just books of course that are facing growing competition from the Internet, StrawberryNet is considerably cheaper for skincare, cosmetics and perfume and less trying on the olfactory system than than those huge, smelly sections of department stores. Buying a pair of ASICS Gel Kayanos will set you back $250 at Rebel Sports, but I've seen them online (from the US) for just over $100.

The higher Australian dollar and the GST exemption on purchases under $1000 are also factors in the appeal of overseas Internet purchases, but the major factor in the excessive price differential appears to be high mark ups by retailers to cover employees, rent and profits (obviously).

I know that my friends increasingly look to the Internet for many different types of goods, but as someone once said "the plural of anecdote is not data" so it's important to try to get some indication about the total level of Internet purchases. (Apparently the original quote was "the plural of anecdote is data", but I much prefer the later more cynical version!)

According to the best estimate of the PC, "online retailing represents 6 per cent of total Australian retail sales - made up of 4 per cent domestic online ($8.4 billion) and 2 per cent from overseas ($4.2 billion)". The Reserve Bank of Australia reports that there are "no official data on the total value of online purchases, although a range of industry estimates suggest that these purchases are equivalent to around 3 per cent of household consumption".

Note that total retail sales and household consumption are different measures. Nevertheless it is clear that both the PC and the RBA acknowledge that sales have grown rapidly in recent years from albeit low bases.

While there are some structural breaks in the data due to changes in reporting over time, the data on domestic spending show rapid growth in online purchases over recent years. Since 2005, the value of online spending on debit and credit cards has grown at an average annual rate of more than 15 per cent, although over the past year there has been little change in this type of spending. In contrast, traditional card spending has increased at a slower average rate of around 9 per cent since 2005. It is important to note that despite the stronger growth in online spending, online payments account for only around 10 per cent of total domestic payments on credit and debit cards.

According to the RBA:

The data on payments made on Australian cards at overseas merchants include payments made when Australians travel overseas, as well as payments made by Australians for online purchases from overseas merchants. In total, the value of international electronic purchases has grown at an average rate of 15½ per cent since 2005, which is faster than the growth in electronic domestic purchases of 10 per cent.



To buy online obviously requires access to the Internet and that has grown rapidly as well. The Australian Bureau of Statistics (ABS) reports that "at the end of June 2011, there were 10.9 million Internet subscribers in Australia" a figure which excludes "Internet connections through mobile handsets".

Internet usage increased at an annual rate of nearly 15 per cent and increased by 4.4% since the end of 2010. Significantly 95 per cent of connections are now broad-band and 87 per cent of Australian Internet users are accessing download speeds of 1.5Mbps or greater. All of this adds up to greater Internet penetration and the potential for further inroads into traditional retail.

International purchases have not just been spurred by the Internet, but by the massive increase in the number of Australians travelling overseas. As the RBA reports:

It is likely that much of this growth in international purchases reflects the significant increase in the number of Australians travelling overseas. In 2010, Australians made around 6¼ million trips overseas, excluding business-related trips. This has increased by 55 per cent since 2005, with this growth in travel leading to increased spending overseas. In addition, the appreciation of the exchange rate has made foreign goods and services cheaper. While this has reduced the value of a given quantity of foreign goods and services in Australian dollar terms, it is also likely to have led households to increase the quantity of purchases abroad. Although it is not possible to specifically identify online offshore purchases, the data suggest that the share of this type of purchase in total spending remains relatively low. In aggregate, total spending at foreign merchants – including spending by Australians travelling abroad – is less than 4 per cent of total payments.

According to the ABS, the real change is in the number of Australians going overseas with the number of foreign visitors remaining relatively static. Increases in overseas travel means less domestic travel and less domestic spending.

Visitor Arrivals, short term 

Resident Departures, short term

So Internet and international purchases are growing rapidly, but with a long way to go until we can definitively announce the death of traditional retail.

Another way the RBA considers the growth of Internet purchases is by considering "the number of inbound postal items delivered through the Australia Post network". While it doesn't seem that long ago that pundits were arguing that email would kill traditional postal services since 2005, "the total number of items delivered has increased at an average annual rate of around 10 per cent, in contrast to an average annual decline of 1 per cent in the total number of domestic and outbound postage flows."

Another measure is the "steady increase over a number of years in the number of Google searches for ‘Amazon’ and ‘eBay US’". As the Australian dollar appreciated from mid-2010 these searches increased significantly.

Another thing close to my heart are movies and television. I wonder how long video stores will survive? Will they also find  new ways to stay profitable like Australia Post and other parcel deliverers? Or will they gradually fade away as more and more people connect their televisions to the Internet?

People have long been predicting the death of the video store, but they continue to survive and appear to be doing reasonable business, at least whenever I visit. Still it's not really a business with great growth prospects. I certainly wouldn't be encouraging anyone to invest in a video store right now. Perhaps technologically adept Internet store employees will create businesses to help people like me set up their television and Internet combinations! 

The reasonably tech savvy, especially 'the downloaders', probably still account for only a minor percentage of DVD watchers. Nevertheless Torrent Freak reports that 15 per cent of all torrent downloads of the final episode of Lost "originated from Australia, despite the country representing only 0.3% of the world’s population", proving that Australians are both reasonably technologically competent and frustrated by the lack of immediate access to popular shows. 

Another report estimated that one million Australians accessed illegal downloads via BitTorrent sites in April 2009, a figure that no doubt would have increased since then. Rolling Stone reveals that most illegal downloading (as a percentage of total downloads) occurs outside of the US and Europe, but "fewer than 20 percent of Internet users worldwide pay for downloads of individual songs, and even fewer pay for downloads of full albums".

The difference between the US and Europe and the rest of the world is borne out by a mid-2010 survey of 7000 illegal downloaders who reported that they "would pay for them if there was a cheap and legal service as convenient as file-sharing tools like BitTorrent".

Such findings tie in with my personal conversations with friends and students, many of whom tell me that they would be happy to pay for legal downloads as long as the costs are not too great and they could get immediate access. A friend recently laughed at me when I told them I still occasionally bought CDs i.e. the physical item in a plastic case. Students are always amused when I show a video (as in VHS) in class. Video, of course, was once the wonder technology: "You mean I can record a television program?". I wonder what young people think of those who still buy vinyl, let alone those who continue to use reel-to-reel players.

***

Like so many things in the world today, we tend to imagine a possible future and then 'teleport' it back into the present as though it were already the current reality. This has probably always been true as Dan Gardner outlines in Future Babble: "Excited predictions of the amazing technologies to come — Driverless cars! Robot maids! Jet packs! — have been dazzling the public since the late nineteenth century." Gardner outlines how Herman Kahn published  a book in 1967 called The Year 2000. In it he wrote that "by the end of the century nuclear explosives would be used for excavation and mining, 'artificial moons' would be used to illuminate large areas at night, and there would be permanent undersea colonies." As you might realise, he was wrong about this and he was also wrong when he argued that the Soviet Union would be "one of the world’s fastest-growing economies at the turn of the millennium".
I also vaguely remember visions of future technology in the 1980s, such as the hopes for full immersion virtual reality. If I remember correctly it was almost certain that by 2011 we'd be able to lose ourselves completely in virtual worlds and not just by looking at computer screens. But perhaps I was just watching too many 'futuristic' movies.

As Ferdinand Mount wrote quite some time ago, apocalyptic visions are more interesting than the idea that things will gradually change.
 

Of making end-of books, there is no end. Whitaker’s Books in Print, 1994, lists 150 books entitled The End of ... Among those things designated for termination are Art Theory, Beauty, British Politics, Central Planning, Christendom (by Malcolm Muggeridge), Comedy, Conversation, Education, Elitism, Empire, Eternity, Gin-and-Tonic-Man (a book about public relations), Housework, Innocence, Insularity, Laissez Faire, Marriage, Modernity, Motherhood, Philosophy, Punishment, Science, the Cold War (six titles), the Family, the Novel, the World, Time and Zionism – not to mention the most celebrated post-war exercises in Endism, Ideology and History.

Things generally tend to fade away rather than end completely. But not always. I remember writing an essay in the course "Soviet foreign policy" in 1991, thinking that the Soviet Union would gradually change rather fall apart as it did. Wrong. Still, while Soviet-style central planning appears to have fallen off the back of the history bus, desires among authoritarian governments for more centralised control has not.

In various places in the back streets of Brisbane (and no doubt other cities) one can see the remnants of old delicatessens, butchers and the like, seemingly gone forever. But more recently, the corner shop appears to have made a bit of of a comeback, in parts of Brisbane at least. The New York Times recently had an article on how to order cuts of meat from butcher shops, which apparently are making a comeback in New York.

The world is changing rapidly and the Internet is playing a big role, but we're not as close to the future as we might think. More recent figures show that retail has not been doing as badly in recent months.

Recent figures show that retail as a whole is not in as bigger hole as the news stories seem to suggest. Turnover has increased over the past 3 months and the interest rate cut should make a difference as well, especially coming just before Christmas.

According to the ABS: "In trend terms, Australian turnover rose 2.4% in September 2011 compared with September 2010.

The following industries rose in trend terms in September 2011: Food retailing (0.5%), Other retailing (0.6%), Cafes, restaurants and takeaway food services (0.6%) and Household goods retailing (0.5%). Clothing, footwear and personal accessory retailing (-1.4%) and Department stores (-0.4%) fell in trend terms in September 2011.

All states and territories rose in trend terms in September 2011: New South Wales (0.4%), Western Australia (0.7%), Queensland (0.2%), South Australia (0.3%), Victoria (0.1%), Tasmania (0.7%), the Northern Territory (0.5%) and the Australian Capital Territory (0.3%).

Traditional retail will have to adapt, but it won't die. People will still want to walk around shops and buy things legally, but the days of soft profits and complacency seem to be numbered!

From 1956:



China, Mining and Manufacturing

Interesting allegations about Chinese contract stipulations about sourcing from China in a Wayne Swan interview with Fran Kelly on ABC Breakfast

KELLY: In terms of productivity, what about making the most of the manufacturing we do do? You did suggest yesterday the Government would announce more this week to follow up on union calls for a more effective local content policy. What are you talking about? Are you talking about direct incentives or tax incentives to encourage resource companies to buy Australian?

TREASURER: No, what we're talking about is that Australian firms should have the chance to pitch for business on a commercial basis. Now what I've heard from several businesses and from several sources is that some Australian businesses are not even getting the opportunity to pitch for the business on a commercial basis. I'm a bit disturbed by that so I'm going to examine those claims closely with the industry because I do think it is important that Australian business gets the opportunity to maximise the business that flows from these investments.

KELLY: Some of those claims - let me go to one of those claims because I've heard it too around places that some of the big miners signing contracts with China for instance over gas and other resources, within that contract it's mandated they buy Chinese equipment, not Australian.

TREASURER: Well, I'm a bit disturbed by that.

KELLY: Is there something you governments can do about that?

TREASURER: Well, I certainly intend to follow up that claim and ascertain whether it is true or not, and I would be very disturbed if that was the way it was going in some of the big projects. There are many people who are getting work out of these big projects. They are absolutely massive and there are lots of Australian businesses that are getting work and I'm aware of many of them. I've seen them in operation but if we are getting those sorts of practices creeping in that's not good and it's not good for the country. So I intend to look at those quite closely.

KELLY: And the report that suggests only 10 per cent of steel being used - massive amounts of steel - in projects like Gorgon and Olympic Dam, only 10 per cent of it is local. Are you critical of Australian resource companies for not buying locally made steel?

TREASURER: Well, certainly some of the steel will be imported and I don't think anyone would be surprised about that but if Australian manufacturers who are offering good product aren't getting the chance to get their head through the door then that's worth looking at very, very closely. 

While I'm against forcing companies to buy Australian., I'm also against companies being forced not to. If you're going to have a freer market-based economy, governments must be extremely vigilant against anti-competitive behaviour.

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 20^th 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!