Twelfth or Eighteenth? Measuring Australia's Economic Weight

No one could accuse Australia's politicians and economic bureaucrats of being shy or inscrutable when it comes to analysing the Australian economy. Treasury and the Reserve Bank provide regular commentary on the current state and future prospects of the Australian economy and make a wealth of statistical information freely available.

Some commentators argue that Treasury and the Reserve Bank of Australia are too optimistic about Australia's economic prospects, but having read most of the commentary that has been produced in recent years by economic policy-makers I think that there is a certain amount of hedging going on. The RBA Governor says that "Australia's glass is at least half full".

At the most basic level, policy-makers are optimistic because they believe that current shift of economic weight to China and emerging economies generally will continue indefinitely into the future. In other words, the belief is that future performance will be consistent with past performance.

Members of the Gillard government, as you would expect, are also regular contributors to economic debate hoping that advertising the success of the Australian economy will reverse the government's poor showing in opinion polls.

Treasurer Wayne Swan recently noted that Australia was now the world's twelfth largest economy and that during Labor's period of office it had moved up 3 places, whilst during the Howard government's tenure it lost 3 places.

In the past five years Australia’s economy has surpassed the economies of South Korea, Mexico and now Spain. Our economy has grown around 11 per cent since the end of 2007 while the US has grown only around 1¾ per cent and many European countries are still substantially smaller due to the massive recessions they have suffered. Inhabiting a place among the top dozen largest economies on the planet is particularly impressive when you consider that we have only the 51st biggest population.

This is a truly impressive performance, but one of the reasons we've improved our ranking is because of the appreciation of the Australian dollar against the US dollar. In 2007, the Australian dollar averaged 83.89 US cents compared to an average of 103.43 cents in 2012 up to the 12th October.

If economies are measured on a USD exchange basis, then if a country's currency appreciates against the USD then the economy 'increases' in size as well. 

If the Australian dollar were to fall substantially over coming years, other things being equal, the 'size' of our economy would also decrease.

This US dollar exchange measurement, therefore, is clearly only a partial way to measure the real size of economies, let alone wealth or development.

Swan bases his projections on the IMF's World Economic Outlook Database, the latest of which has just been released. The figures for 2012 are estimates, obviously, and the IMF provides further estimates out to 2017.

An alternative way of measuring the size of economies is by purchasing power parity (PPP). According to Vogel:

A purchasing power parity (PPP) is a price index very similar in content and estimation to the consumer price index, or CPI. Whereas the CPI shows price changes over time, a PPP provides a measure of price level differences across countries. A PPP could also be thought of as an alternative currency exchange rate, but based on actual prices.

A PPP index provides a way to convert national accounts to a common currency - called Geary-Khamis or international dollars - based on purchasing power. GDP is adjusted to reflect different costs of living and production within different economies. As most travellers and international investors know, goods and services and production costs are considerably lower in some countries than they are in others. The most widely known index is The Economist's Big Mac Index and there is an iPod Index as well. Both are gross oversimplifications of PPP.  

If we consider the top 20 countries on PPP and USD terms we get vastly different results.

The IMF calculates the GDP share of the total for every economy on a PPP basis, but the USD figures have to be constructed. For both tables I have ranked countries on the basis of their 2012 'results'.

China is half the size of the United States on a USD basis compared to a little over three-quarters on a PPP basis. Measured by PPP, China is estimated to overtake the United States by 2017, but on a USD exchange basis it would still remain substantially smaller (21.3 per cent of the total for the US and 14.3 per cent of the total for China in 2017).

The IMF only makes estimates out to 2017, but the general impression is that China is inevitably destined to overtake and then leave the United States in its wake.

According to the latest PPP estimates for 2012, India has passed Japan as the world's third largest economy, although in terms of the USD measurement its economy remains less than half the size of the Japanese economy and only 10th overall only 2 places above Australia (2.7 per cent compared to 2.2 per cent of the total).

In 2017 (PPP), India is projected to leave Japan behind, although it will still only be a third of the economic weight of China. Australia falls slightly to 1.1 per cent of the total.

In 2017(USD), India will be 6th, just behind Brazil. Australia will move to 13th one place behind Indonesia.

Since 1990, Japan has fallen rapidly down the league table of economies as more than 20 years of slow growth and recession have taken their toll. The World Bank online databases only go back to 1999 and projections were only made at this time for one additional year, but we can be reasonably sure that projections based on past performance would have had Japan challenging the United States for supremacy in the 1990s based on 1980s performance.

Paul Krugman, writing in 1994, noted that: “at the growth rate of 1963-73, Japan would overtake the United States in real per capita income by 1985, and total Japanese output would exceed that of the United States by 1998!”.

While China and Japan have profoundly different political economies, assertions about inevitability and irreversibility seem to have a horrible habit of coming unstuck.

Australia is twelfth, as Swan suggests, in terms of the USD measurement, but 18th on PPP terms, just behind Iran. With the recent collapse of the Iranian currency, it is unlikely that Iran will score so well on a USD basis in coming measures.

Recently, Secretary to the Treasury Martin Parkinson argued that Australia now has a smaller economy than Indonesia's, but this is only true if measured via PPP. In terms of USD it still has a smaller economy than Australia's (2.2 per cent of the total compared to Indonesia's 1.3.

Based on current projections Indonesia will have a slighter larger economy than Australia's in terms of US dollar exchange in 2017. Of course this might well change if the Australian dollar falls relative to the US dollar in coming years, as it probably will. This relativity will depend as well on what the Indonesia rupiah does against the US dollar in the next few years.

Over time, of course, PPP indexes must also be recalculated and these undertaken by the International Comparison Program of the World Bank. As economies develop, the costs of living and production increase, making even PPP comparisons problematic at best and inaccurate at worst.

It suits Wayne Swan to use the USD exchange measurement - twelfth sounds much better than eighteenth - and it suits Parkinson to use PPP to make his points that emerging economies are now a much more important part of the global economy, and that Indonesia might leave us behind if we don't improve our productivity and tax system.

What this all means is that measures of economic weight should be taken as indicative rather than absolute and that future projections should carry the same warning as investment products that "past performance is no guarantee of future results".

Economic 'progress' is another thing entirely and we need to consider measures such as GDP per capita, human development and environmental sustainability to get a more accurate picture of the state of play.

For GDP per capita, the distinction between the two methodologies is significant with Australia ranking 6th on a USD exchange basis and 15th on a PPP basis in 2011.

On the Human Development Index, which includes a range of including life expectancy, literacy, education and GDP per capita, Australia ranks second behind Norway. In the 2011 HDI rankings, China came 101st, Indonesia 124th and India 134th.

Improvements in productivity - the efficiency of labour and capital - and an egalitarian distribution of the fruits of that productivity are what matters for the long-term. Getting our policy-makers and the wider population to realise that the two are not contradictory is the short-term challenge.

Queensland Employment Compared

If you thought things felt a little crappy in Queensland on the jobs front you'd be right. This from MacroBusiness's Leith van Onselen. Western Australia powering ahead.

Maybe cutting so hard, so quickly on public sector jobs wasn't the right thing to do right now.

Still they'll need to re-employ all those people reasonably soon either back as public servants or as consultants.  

Should be good for those graduating in 2-3 years time.

Net Interstate Migration

A graph from a recent speech by Philip Lowe Deputy Governor of the Reserve Bank entitled "The Labour Market, Structural Change and Recent Economic Developments" provided an interesting graph of interstate migration over the past years.

As Lowe points out:

the rate of net interstate migration to Western Australia over the past year is the highest for around 25 years. It is also worth noting that interstate migration has played an important role in the Tasmanian economy, with the situation switching from sizable net inflows to net outflows and back again over the course of just a few years. For a period in the 2000s, internal migration was adding around ½ per cent to Tasmania's population annually. Today, it is subtracting almost this amount.

The rate of net migration to Queensland has slowed considerably over the past few years, while NSW is the only state to suffer from net losses over the entire 20 or so year period.

Impolitic Cartoons

 

Comparing China with Japan and Other Stories

Is it possible or relevant to compare China with Japan and if so which Japan? Should it be 1970s Japan or late 1980s Japan? While many commentators argue that China is better compared to 1970s Japan, Michael Pettis argues that China resembles 1980s Japan because of the unbalanced nature of its economy.

Japan in the late 1960s and early 1970s may share many developmental characteristics with China today, but the Japanese economy in that earlier period never achieved, as far as I can see, the kinds of imbalances that it did much later in the 1980s, and so it is not really comparable to an extremely unbalanced China today.

These imbalances are well documented. The important characteristics of Japan in the late 1980s would almost certainly include the following:

• Japan in the late 1980s grew at extraordinary rates fueled by a credit-backed investment boom funded at artificially low interest rates.

• Although for many decades much of the investment may have been viable and necessary, by the 1980s investment was increasingly misallocated into expanding unnecessary manufacturing capacity, as well as fueling surges in real estate development and excess spending on infrastructure.

• Artificially low rates, set nominally by the central bank but in reality by the Ministry of Finance, and coming mainly at the expense of household savers also fueled a bubble in local assets.

• An artificially low currency fueled very rapid growth in the tradable goods sector while also constraining household income growth.

• Because the growth model constrained growth in household income and household consumption, it forced up the domestic savings rate to extraordinary levels.

• The combination of low consumption and excessive manufacturing capacity required a high trade surplus in order to balance production with demand.

• And finally, and most worryingly, debt levels across the economy began to soar as debt rose much faster than debt servicing capacity.

All of this is true of China today, and this is why it is much more important to understand how Japan rebalanced after 1990 if you want to understand the challenges and risks facing China today. China is not like Japan in the 1950s, 1960s or 1970s in any meaningful way even if its current development level is much closer to Japan during those decades. Because of the serious imbalances China is much more like Japan in the late 1980s, with the major difference being that Japan never took debt, investment, and consumption imbalances to anywhere near the levels that China has taken them.

Ouch ... How, then, will the imbalances be reversed.

For this reason what we really have to consider when thinking about China is how these imbalances tend to be reversed. Since they were reversed in Japan in the period following 1990, Japan provides at least one possible model for China’s rebalancing process and, perhaps much more importantly, it demonstrates the kinds of pressures that China will face as it is forced into rebalancing. ... 

What about Europe?

Economic growth in Europe over the next ten years ... will not be anything like economic growth in the last ten years adjusted for changes in demographics, taxes, or anything else. We will be dealing with a Europe in which the tremendous debt, currency, and labor cost imbalances of the past decade must be reversed, and since the most likely form of the reversal will entail the breaking up of the euro, any growth predictions that do not at least acknowledge this chaotic rebalancing process are likely to be flimsy at best.

Currently Paddy Power is offering odds for both the end of the Euro and for individual countries leaving the Euro. Interestingly Greece is not included. Too short or what? My prediction is for an exit during the Xmas-New Year period, if if indeed happens. It's possible of course that European policy-makers will do whatever it takes to keep the currency going. (In other words I'm not suggesting you take a bet!)

The problem for the world economy is that the credit-fuelled growth strategy prevalent in most of the world has to at best stabilise or keep reversing.

Likewise with predictions of US consumption growth, which will have to deal with reversals in the savings and consumer credit trends of the past decade, and with sharp change in two decades of housing behavior.

For Australia there is, at best, volatility ahead.

Predictions about the prices of hard commodities, which have to consider a major dislocation in the source of commodity demand since the early part of the last decade, are also likely to be highly unstable.

As Pettis points out economic predictions are very difficult.

If you want to make economic predictions, in other words, whereas a long historical view will be very useful because it allows you to consider the dislocations created by a reversal of unsustainable imbalances, recent economic data are largely useless, as are predictions based on linear adjustments of recent economic data. Instead of projecting from past data you must model the various paths by which rebalancing can occur, and your prediction must be limited to those paths.

Pettis gives relatively short shrift to the view that insights from neuroscience could make a difference in predicting economic events.

This suggests that we don’t really need a radically new understanding of economics. To understand the global rebalancing, or the European debt crisis, or the upcoming Chinese economic adjustment, we need only to read the works of John Maynard Keynes, Hyman Minsky, Charles Kindelberger, Friedrich Hayek, or dozens of other economists of the 19th and 20th centuries. In every case they fully understood how economies can beetle along in one direction and then suddenly, as imbalances become unsustainable, reverse course and follow a dramatically different path.

This is simply a logical outcome of disequilibria, and doesn’t require anything quite so mysterious as brainwave patterns or irrational behavior mechanisms to explain the process. I think it was Herb Stein, President Nixon’s economic advisor, who reminded us that "If something cannot go on forever, it will stop."

In other words, as Keynes was reputed to have said: the unsustainable cannot be sustained.

It would have been much more powerful, I guess, if Stein had expressed this idea in a way somewhat more mathematical and abstruse, but anyway it seems like a pretty good explanation of what has happened in the US and in Europe in the past few years and what will happen in China in the next few. Just because many economists fail to see the point doesn’t require an overhaul of the discipline – perhaps it only requires an overhaul of the way the discipline is taught.

Pettis then goes on to quote a number of news sources outlining some very bad news for Australia.

From Bloomberg

Copper inventories at bonded warehouses in Shanghai probably climbed to a record as import premiums dropped to a four-month low, signaling demand in China may not be improving as much as expected after a summer lull.

Reserves were 650,000 metric tons, according to the median of nine estimates from traders, analysts and warehouse managers, compiled by Bloomberg. Five said that this was a record. The amount compared with an estimate of 550,000 tons by Macquarie Group Ltd. on Aug. 20. Fees paid by importers over the London Metal Exchange cash price are about $40 to $60 a ton on a cost, insurance and freight basis, the lowest since May.

Or this Financial Times article:

The southern Chinese province of Yunnan has launched a subsidy programme for metals producers, in a sign of the pain hitting the Chinese metals sector as demand growth remains low. Slowing economic growth in China, the world’s biggest consumer of commodities, has meant falling profits at Chinese raw materials producers, including copper smelters, steel mills and zinc smelters.

An official at the Yunnan Provincial Industry and Information Technology Commission confirmed that a small “stockpiling” programme, which has not been publicly announced yet, was launched in September and would continue until the end of the year. The programme targets copper, zinc, aluminium and other small metals, the official said.

Under the programme, which covers 300,000 tonnes of metals, producers will be able to draw subsidised loans from banks using their material as collateral. Banks will give the companies loans based on preset “purchase” prices for the commodity, and the Yunnan government will subsidise the process by paying for the interest on the bank loans. The system is designed to help smelters by providing them with more liquidity as financing gets more difficult. “The targets of this stockpiling system are the companies,” the government official explained.

But perhaps the inevitable pain could be delayed by more stimulus.

In Saturday’s South China Morning Post there was another article on roughly the same topic:

A group of state-owned Chinese shipping companies has placed a US$4.5 billion order for 50 supertankers, throwing a financial lifeline to struggling shipbuilders.

The order adds to a flurry of infrastructure investments by state companies in recent weeks - a key element in Beijing's effort to reverse a painful slowdown in economic growth. The government has approved a wave of spending on new steel mills, subway lines and other corporate and public works projects.

…Chinese shipbuilders, the world's biggest by tonnage, have been among the industries hit hardest in the slowdown. Orders have fallen by more than half, and shipyards are cutting jobs.

"Small and medium-size shipbuilding companies are either out of business or near bankruptcy," said Xia Xiaowen, an analyst for the China Shipbuilding Economy Research Centre, a think tank in Beijing. If the reports of new orders are accurate, "it will definitely be good news for those large manufacturers, and they don't need to worry about survival any more", Xia said.

But eventually, Pettis argues, rebalancing will have to occur.

no matter what analysts or policymakers may say, there is absolutely no way to resolve the problem of growing excess inventory except by abandoning the development model. Until China rebalances, in other words, it cannot resolve the problem of excess inventory because excess inventory is one of the inevitable consequences of the process that created the imbalances.

Hold onto your hats.

The Mismatch Between Solar Demand and Supply

From the NYT.

Might be an example of poor investment decisions. Just saying.

While I support solar, I get the feeling that the market's going to kick back hard in coming years.