Not Just Lucky, Good: The Australian Economy in 2012

Prime Minister Julia Gillard is keen to make the point that Australia is not just lucky, it's good and it's good because of good policy.  At the Prime Minister's economic Forum in Brisbane (I'm still waiting for my invitation) she said:

It probably wasn't Gary Player who first said "the harder I work, the luckier I get" but he certainly made that quote his own. He could have been talking about Australia. If we ever were just a lucky country, we're certainly not now.

It's not luck that makes this a top-10 country on low trade barriers, openness to international ideas, sophisticated and independent economic institutions, a list that goes on.

Luck didn't give us the three triple-A ratings which only seven other economies can claim – which no previous Australian government can claim either.

Luck didn't make us a top-two country on the measures that are most important to us: political stability, social mobility, ease of starting a business.

Luck didn't keep us out of the worst global recession in 80 years. 

And luck won't build us a new economy for the future. We have to make it.

The Gary Player quote is of course an old chestnut that John Howard used when people argued that the good economic outcomes were mainly to do with luck, rather than good policy. 

There’s nothing fortuitous or guaranteed about economic prosperity. That old saying of, was it, Arnold Palmer or Gary Player that … the more I practice the luckier I get … what it really means is that the harder you work at good policy, the better the outcome … economic management is not some kind of automatic autopilot thing.

During the 2007 election campaign, Paul Keating argued that John Howard was the beneficiary of both a booming global economy and Labor’s transformational policy reforms of the 1980s and 1990s.

I think the public are quite wise about the economy and governments now and they know that the structural changes of the ‘80s and ‘90s are working. The real question today with the economy growing so rapidly and unemployment so low is why doesn't the tinder box go off? That is, why don't we get the big bang? The big bang in inflation and in wages back into the old dismal cycle? The answer is because of the structural changes. Nothing to do with Mr Costello's economic management … and everything to do with Labor’s structural changes from the ‘80s.

If it were true that public were wise about the economy, then I imagine that the government would be doing better in the polls.

The determination of whether Australia's current favourable predicament is due to luck or skill is only half the problem for analysts of Australia's political economy. Right now the real problem is that most Australians don't seem to be aware of how well things are going for Australia. Part of this has to do with the fact that some people aren't actually doing that well, particularly in relation to others. The aggregate concepts of GDP, terms of trade and so forth are exactly that: aggregate. 

But many Australians are doing well. And in particular more people (per capita) in Australia are doing well than in other countries. Basically Australia is the best country in the world to be living in right now (that is beyond the non-economic reasons as to why living in Australia is so excellent like Australian rules football) 

So why do we have such a negative view of our economic success. A read of Glenn Stevens latest speech provides some of the answers and I've written previously on why I think there are negative perceptions about Australia's economic predicament. To argue that the mining boom is the major problem is just plain wrong. Without the mining boom we'd be doing a lot worse. But, the mining boom has had a negative impact on other tradable sectors of the economy (that is those parts of the economy that export or compete against imports).

The real problem for the government lies with a series of structural changes that are negatively affecting collective perceptions of future prospects.

The first is the long-running shift away from manufacturing towards services and the more recent revitalisation of the mining sector. This has come, to some extent, at the expense of manufacturing and important service industries such as tourism and international education. The following graphs come from a presentation made by the RBA governor to the PM's economic forum. 

The two sectors that have been in major decline are agriculture and manufacturing. For good or bad these are two sectors of the economy that are seen as 'special' and so when they are doing it tough their problems are amplified through the public sphere. 

The second structural change is the shift away from debt-financed consumption and rising housing prices to a higher rate of saving – generally considered under the description deleveraging or simply the paying off or consolidation of debt. The NSW government in its Budget has tried to boost the housing market once again by giving large sums of money to property sellers.

We should really call this second structural change the end of an earlier structural change towards higher debt that’s been going on since the liberalisation of the financial sector. The inability to continue to grow debt even further undermines an important source of growth over the past 20 years

The problem is that household debt remains at historically high levels. 

The third structural change is the tentative shift towards a less pollution-intensive economy through the establishment of a carbon price and support for renewable energy through a variety of schemes and policies.

The first two structural changes are long-running and largely unavoidable without significant and perhaps costly policy interventions, which could cause more problems than they fix. 

The third involves a greater level of immediate political choice. But it has the ability to encourage a shift towards a more diversified, future oriented economic structure. 

And though the introduction of a carbon 'tax' is only likely to have a minor impact in the short-term, the way that debate has polarised the community has added to negative perceptions of the Gillard government. Despite the government's major efforts to redistribute wealth to compensate voters for the price rises associated with the carbon 'tax', it seems that those same voters focus only on increasing costs, particularly the cost of electricity.

All three structural changes have acted together with popular perceptions of government incompetence, profligacy and duplicity – well prosecuted by the opposition and sections of the media – to undermine optimism and support for the government in opinion polls.

I’m not suggesting that these three structural changes fully explain voter dissatisfaction, but they have made a substantial contribution to it. 

I want to finish with some other graphs that should at least allow us to agree that the Australian economy is doing better than most other countries. 

The first is GDP, which shows just how well we've done compared to other advanced economies.  

Another measure which shows the quality of the growth is GDP per capita, which also shows us leading the pack. The real basket case here is the UK economy, which is showing clearly how well austerity works as a solution to recession. The UK is still behind where it was in 2005. Fabulous performance! Take out the German economy and the Euro area would also be doing very poorly. 




 


The lucky dimension of Australia's success is explained by the terms of trade, which have sky-rocketed in recent years after being in long-term decline for the whole of the twentieth century (see the red line). The forecast is for a significant decline of the terms of trade in coming years - a prediction that makes more informed punters pessimistic. I must admit that I often find myself wondering just how many years can we go without a recession?

One of the major reasons for the high terms of trade is explained by this fabulous graph form the Governor, which shows the relative decline of the US and Europe and the rise of China and India. 

Relative economic decline has been going on since the end of World War II. See here for discussion.

A long-term look at unemployment, also shows how well we've been doing compared to the period before the last recession. In the early 1990s I thought there was a chance that unemployment would continue to trend upwards over economic cycles. I was certainly wrong about that, but those were days where pessimism was perhaps more justified. 

This improved employment outcome has occurred despite a growing percentage of workers since the 1950s as more women entered the labour market. In coming years, the definition of 'working age population' will change as workers stay in the labour market beyond 65, some by choice, others by necessity. It seems certain that as life expectancy increases that working life expectancy will increase. Indeed it will become a fiscal requirement for the state in all economies. 

So cheer up, things could be worse. We could not be having a mining boom and we could have really bad economic policy-makers like those in the UK and Europe who believe that austerity is the solution to economic stagnation.

China's Steel Industry

A Reserve Bank of Australia paper from 2010 by James Holloway, Ivan Roberts and Anthony Rush on China's steel industry makes interesting reading in the light of the problems of the Australian steel industry.

Some of the main points:

Growth has been rapid with the period from the mid-90s to the mid-2000s most significant. Growth fell during the financial crisis and recovered on the back of extensive fiscal stimulus by the Chinese government. My guess is that it will slow over the next few years.

Since the introduction of market-based economic reforms in 1978, the Chinese economy has grown strongly, recording an average annual growth rate of around 10 per cent. Over this period, Chinese steel production has also expanded rapidly, growing at an average annual rate of 7 per cent during the 1980s, 10 per cent during the 1990s and close to 20 per cent in the 2000s (Graph 1).

China's percentage of global production has increased rapidly.

China now accounts for around 45 per cent of global steel production, which is significantly higher than its share of 15 per cent at the start of the decade

The Chinese government has attempted to consolidate the industry increasing the percentage of production by the large state-owned firms.

In 2008, there were more than 660 companies producing crude steel, with thousands of other firms producing finished steel and steel-related products. The top 10 producers accounted for less than 50 per cent of crude steel output, with the next 75 companies accounting for an additional 30 per cent (State Council 2009, CISA 2009). Most of the larger Chinese steel producers are state-owned, while a significant proportion of the smaller producers are private companies. Geographically, the industry is widely dispersed. The coastal provinces account for around 65 per cent of crude steel production, with the concentration of steel production in the north-east of the country partly reflecting proximity to major iron ore mines, particularly in Hebei and Inner Mongolia ... 

In July 2005, the National Development and Reform Commission issued a formal policy on steel that sought to spur consolidation by increasing the concentration of steel production among large producers, and to protect the environment by reducing energy consumption and eliminating obsolete production capacity. Targets for industry consolidation through mergers and acquisitions or closures of small- to medium-sized firms were outlined. In June 2010, the State Council updated these targets, announcing that the production share of the 10 largest steelmakers was to rise from 44 per cent in 2009 to 60 per cent by 2015, with a goal of cultivating three to five very large, internationally competitive iron and steel conglomerates (State Council 2010). 

Steel can produced from iron ore and coking coal or from scrap. In Western countries a good deal - about a half to two-thirds - is produced from scrap. In China it is mostly produced from scratch.

Crude (or unprocessed) steel can be produced either directly from iron ore and coking coal using the blast furnace/basic oxygen converter method, or from scrap steel (and other inputs) using the electric arc furnace method. In the United States and Europe, where the electric arc furnace technology is commonly used, between one-half and two-thirds of steel is produced using scrap. In contrast, in China more than 90 per cent of crude steel is produced by steelworks using blast furnaces and basic oxygen converters (World Steel Association 2010). This reflects difficulties with the supply of electricity in some parts of China and low domestic availability of ferrous scrap, due to relatively low household consumption of steel-intensive manufactures and limited scrap collection and processing systems. The prevalence of the converter method has important implications for resource demand: on average, each tonne of Chinese steel requires around 1.7 tonnes of iron ore and more than half a tonne of coking coal as inputs. This helps explain the significant increase in China's demand for these resources over the past decade.

China has significant iron ore reserves but they have lower iron content than ore from Australia (62 per cent), Brazil and India (both 65 per cent). Not only is Chinese ore more expensive to process, but much of it is located "inland in the north and west of China. While steel mills in the north-east are close to major iron ore mining precincts, it is costly to transport ore to steel mills located elsewhere in the country."

Increased iron ore shipments have benefited Australian iron ore producers enormously

Strong demand for steel has seen the imported share of iron ore supply increase from around 10 per cent in the late 1980s to more than 50 per cent currently, although over the past five years China's iron ore output has generally kept pace with growth in steel production. This reflects a number of factors, including the high price of imported iron ore and the temporary downturn in steel demand associated with the global financial crisis. More recently, iron ore imports have remained at a high level, having picked up sharply as the Chinese economy recovered from the downturn in late 2008 and early 2009 aided by the substantial fiscal stimulus, although domestic production has also been strong.

 

In recent years, more than 80 per cent of China's iron ore imports have come from Australia, Brazil and India. In an effort to diversify supply, Chinese policymakers have encouraged direct investment by Chinese companies in iron ore exploration and iron ore mines abroad. To date, numerous investments have been made in West Africa, South America, Central Asia, Russia, Australia and Canada, many of which are large in scale. While efforts to diversify supply may have implications for the Chinese steel industry's sourcing of raw materials in the future, the likelihood of continued high rates of economic growth suggests that China's imports of raw materials will remain high.

China has also become more dependent on coking coal imports.

[I]n the first half of 2009, coking coal imports surged, with a pronounced effect on Australian coking coal exports to China. This surge reflected a combination of factors, including a strong rise in steel production, a significant decline in international freight rates, and lower Chinese production of coal owing to efforts to consolidate the coal sector and mine closures or renovations for safety reasons. While China has extensive reserves of coking coal, many of its existing deposits are relatively inaccessible and therefore costly to mine. Many of these deposits are also far from major steel-producing areas.

Steel is mainly used in the development of buildings, structures and machinery, with the construction industry accounting for "more than one-half of steel consumption".

Worryingly for steel exporters, China's steel exports have increased since 2006, although they have varied.

Since 2006, China has been a net exporter of steel products. The early 2000s saw a large increase in steelmaking capacity, partly reflecting an increase in the number of small- and medium-sized firms; this growth in capacity translated into higher production, some of which flowed onto the international market. Since China's accession to the World Trade Organization in 2001, the volume of steel exports has increased noticeably; however, steel exports have not recorded sustained growth, and over the past few years have been declining as a share of total domestic production. At times when steel production has risen faster than domestic demand for steel, such as during the 2008 slowdown, China's steel exports have surged, only to decline again when domestic demand for steel has recovered, as was the case during 2009.

Note that these are net exports, China still imports higher quality steel from abroad.

There may be continuing opportunities for developed countries to push their credentials for higher quality steel products.  The Australian government could assist the industry especially for steel use within Australia by insisting on rigorous quality testing for imported steel and for restricting contracts that lock out Australian producers. But protecting the industry by tariffs or insisting that projects must use a quota of Australian steel would be a backward step for the Australian economy.

Zealous economic liberals pronounce any suggestion that governments should assist industries as closet protectionism and ironically put their faith in the Chinese Communist Party to keep  the Chinese economy growing at 10 per cent or so until the 2030s, I have less faith.

The CCP will need to rebalance the Chinese economy away from excessive investment and when the inevitable adjustment occurs the Australian resource sector will be negatively affected.

Australia needs to debate continuing economic vulnerabilities and consider the potential problems of a less diverse, resource dependent economy.

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.

Structural Change in the Australian Economy

While this might seem like a boring topic, it's probably one of the most important medium to long term economic issues facing us as Australians. 

I have recently written a piece for APO, called Structural Shenanigans in the Australian Economy. The APO  is the best source of information on Australian policy issues. It is run by Peter Browne from Swinburne, who given the amount of work he does must never sleep!

Click on the link above if you want a read or paste this into your browser http://www.apo.org.au/commentary/structural-shenanigans-australian-economy ...