Beyond The Boom – How Has The Mining Boom Changed Australia?

Australian economist Dr John Edwards is a member of the board of the Reserve Bank of Australia and Nonresident Fellow at the Lowy Institute.  In his Beyond The Boom, John Edwards challenges the prevailing pessimism. Cutting through the confusion, Edwards shows that the mining boom is far from over – and that it hasn’t been as important for Australian prosperity as widely believed. We have a bright future in the world, and the economy is well configured to get us there. To discuss all this – and more – Dr John Edwards addressed The Sydney Institute on Tuesday 26 August 2014

BEYOND THE BOOM – HOW HAS THE MINING BOOM CHANGED AUSTRALIA?

JOHN EDWARDS

It is a great pleasure to be back at The Sydney Institute.

This is a more than usually interesting time in the Australian economy. We’ve had more than a decade of extraordinarily high iron ore and metals prices, but those prices are now falling. We’ve had a huge investment boom in mining over the last decade, that took mining investment from just 2 per cent of GDP to 8 per cent of GDP. This is the biggest boom, probably, we’ve ever had in business investment. But that has now peaked and is coming off.

One of the first things Kevin Rudd did when he got back to the Prime Minister’s office last year was to declare that the “China resources boom” was over. Prominent economist Ross Garnaut has warned that, without major reforms, we are facing a very high risk of a major slump in the Australian economy. Bob Gregory, a brilliant economist, and former member of the Reserve Bank board, declared a few years a ago that the loss of income we would face as metal prices fell would be bigger than the income shock we experienced in Australia during the Great Depression. Overlaid on that, we’ve had the most recent concern that – partly as a result of these things, partly as a result of other things – we have a budget crisis. So we have both an economic challenge and a budget challenge.

Part of story about the boom which one often encounters is that not only is the boom over, not only do we now face a reckoning, but it’s largely our fault and it’s largely our fault because we wasted the opportunities that the boom offered to us.

These very widespread views and in my recent Penguin/Lowy essay Beyond the Boom I examine the evidence. Do they fit with the numbers – these concerns – and how much trouble are we in? So let me tell you some of the results of this little examination.

One thing I thought it would be useful to do would be to compare the ten years since the boom began – let’s say the end of 2002 to the end of 2012- to the prior ten years when we didn’t have a boom. What kind of difference is there in our experience over those twenty years?

The first thing we discover, rather to my surprise I have to say, was that actually we grew faster on average before the boom than we have since. We grew average output around 3.8 per cent annually in real terms in the years 1992 to 2002, and 3 per cent during the boom years from end 2002 to end 2012.

That might be true of output, but what about incomes? After all, we’ve had a huge increase in iron ore prices and other metals prices. So I had a look at that as well. There’s a measure economists use to try and capture the impact of the improvement in terms of trade. The terms of trade is basically the movement of export prices compared to input prices. The measure is called the real net national disposable income. You would think if we had a boom which doubled our terms of trade – export prices doubled while import prices stayed the same – if you had that kind of boom then you would expect incomes to be dramatically better in the last ten years than in the prior ten years measured in this way. Again, somewhat to my surprise, I discovered they’re not. This RNNDI measure increased one quarter in the years 2002 to 2012, which is pretty good. But it increased by a third in the years 1992 to 2002, which is even better.

This was all a bit perplexing to me. I continued the investigations. Surely since we’ve had a mining boom, mining output must have grown a lot faster than it did before the boom. And it’s true, it has. But actually not very much faster. It rose 50 per cent in the ten years to 2012 compared to 44 per cent over the previous ten years. Neither increase is at all impressive compared with what happened in the late 1970s, early 1980s when mining output grew by more than 100 per cent. We had bigger booms when we didn’t notice we were having a boom.

I thought at least – after all, the boom is about exports – it must be there in exports. Again, I discovered this is not so. It’s true if you just look at the dollar value of exports that in the ten years, after the boom began, the dollar value of exports increased about 100 per cent. This actually matched the increase in the ten years before the boom – 100 per cent. But when you look at volumes – that is, when you use a measure to get some sense of the actual quantities of exports – we did vastly better before the boom that we have in the boom. There’s not a single year, during this boom up to very recently, in which we even come close to matching the growth in the volume of our exports that we had in the ten years prior to the boom.

All of these results were quite interesting. They go to the question of what do we do without the boom. On the whole, we did at least as well if not better before the boom than during it.

Using some Reserve Bank work done last year, we can ask what has been the impact of the boom on the Australian economy over the last ten years.  What has happened with mining investment, to the output of the mining industry, the output of metals processing industry plus everything that goes into those industries? What effect has it had on enlarging the size of what we might call the resources sector? When you do the numbers on real output, as I do in the book, you discover – and here we’re comparing the resource sector share of GDP in 2012 to the share of GDP in 2002 – that this whole sector has increased (on the Reserve Bank numbers I was using) by about 3 per cent of GDP. It’s a big increase but it’s not actually as big as most people would have thought.

What you see is that in all the years from 2002 to 2012, as a share of GDP, mining didn’t actually increase at all. It was the same share of GDP as it had been 20 years earlier. It hadn’t changed. And metals processing hadn’t changed as a share of GDP. So the whole change in the size of this industry was actually in investment, which went from 2 to 8 per cent in GDP. Of that mining investment about half is imported machinery and so forth. All those huge trucks, we don’t make them here. Or LNG  platforms. They are made elsewhere. We import all that. About half of mining investment goes to imports. So if it’s gone up by 6 per cent of GDP it means the Australian GDP impact has gone up 3 per cent of GDP, which then corresponds to that other number. Again, quite a big number, but not as big as you might expect.

You might argue this is beside the point because the big thing is what happened with income. It’s true, if you double mine prices as we have, you do get a big increase in income. But mining is a bit peculiar as an industry in terms of income, for two reasons. The first is that in the Australian economy as a whole the value add of an industry is about 60 per cent wages and 40 per cent profits. In mining, it’s not like that at all. In mining, because it’s so hugely capital intensive and employs so few people, profit is 80 per cent of value added and wages are the remaining 20 per cent of value added. That’s one thing that influences the distribution of income.

Another thing is that according to Reserve Bank estimates, four fifths of the Australian mining sector is foreign owned. What that means is that four fifths of four fifths of the income generated by mining or the value added is in some sense attributable to foreigners. But taxes are an important exception. When you allow for taxes to the Commonwealth and royalties, the numbers work out that foreign shareholders should be attributed about half of the income from mining. And the rest – the other half of it – is split. Employees get 20 per cent of it, governments and Australian shareholders the remainder. Half of the increase in our mining revenues are not actually Australian. People offshore made the investments and they deserve a return on it.

So, how big was the income gain? There are a lot of ways of doing this and it is a controversial area but a simple way is just to look at the additional dollar value of mining exports over the period of the boom. It turns out the income gain, comparing 2012 to 2002, is about 6 per cent of nominal GDP. And half of that is attributable to foreigners. So, again, we get a number of 3 per cent. Three per cent of GDP is the whole of the income gain from additional mining exports, attributable to Australians, from the mining boom. Again, a pretty good number. Very welcome. But not transformative.

This has implications, for what we do next. But, before I get to there I want to think also about the frequent claim that Australians have been feckless and wasted the boom. The suggestion is that the mining boom has vanished and we’ve got nothing to show for it.

I’ll make a couple of points in relation to that which I think is quite significant. Over the whole period of the boom, household consumption as a share of GDP has been less than it was in the ten years before the boom began. The growth of household consumption has been slower. And that’s true even before the global financial crisis and truer after it. Home prices, particularly in real terms, rose less in the ten years of the boom than they had in the ten years prior to it. If consumption was rising more slowly and incomes were still increasing then savings were increasing. And this we find in the numbers. Comparing 2002 with 2012, savings in Australia rose by 3 per cent of GDP. What it means is that since the gain to Australian nominal incomes from the boom was around 3 per cent to the GDP and we saved an additional 3 per cent of GDP we in fact saved the boom. Far from being feckless, we saved it.

Not only that, at the same time we were saving it we find that Australia’s capital stock, as a result of all that investment, increased by nearly two thirds. That’s in real terms and excluded housing. Our participation rate in the workforce increased and the number of full time jobs compared to part time jobs increased and so forth. Basically, in the boom, Australians saved more and worked harder and invested more than they did before the boom.

That’s interesting. But there is a consideration that we do need to ponder. That is, the federal budget. What happened there? And there we’ve got a real issue. The Australian government budget deficit over the last five or six years has been extraordinary. We often don’t realise how amazing it is that if you take the deficits from 2008-9 to 2013-14 and you think about them as a share of GDP, they exceed those that followed the deep recession we had in 1983. And they match the deficits that we accumulated as a result of the recession from 1991-92.

As a share of GDP, our deficits – from 2008-9 – are already bigger than all of the deficits accumulated by all of Australian governments, state and federal, during the Great Depression. A quite incredible outcome. Yet in that whole period that I’m talking about – 2008-9, 2013-14 – we didn’t have a recession let alone a depression. Growth was quite good. In that whole period, just two quarters of contraction, and they were widely separated and quite mild. There doesn’t seem to be anything that could account for this vast fall into unprecedentedly large deficits. Just as a number, the accumulation of deficits since 2008-9 is already twice as big as the sum of all the deficits, of all the preceding deficits from 1971/72 to 2008/9, nearly 40 years.

This requires an explanation. How could that have happened? We didn’t have a recession. We were actually growing. Over that period in which we accumulated these huge deficits, we created 800,000 new jobs. The first thing, of course, we want to look at is spending. What happened with spending? There must have been a big blow out in spending. It’s true that in 2008/9, which was the year of the Global Financial Crisis, spending did increase quite a lot. It increased by nearly 13 per cent. That is a huge increase – the biggest increase for decades in a single year. But, in accordance with treasury advice and the government’s policy, those spending increases were wound back quite a lot the following four years. The increase in spending the last of those four years was 1.4 per cent, well below GDP growth.

By 2012/13, spending as a share of GDP was down the 24.1 per cent, which is a little bit below the average of the past decade. Even so, the deficit was $19 billion. So spending had gone back to its average but the deficit remained. If you have a look at the numbers, it turns out that of the whole deterioration between 2007/8 and 2012/13 in the budget balance, the fall in taxes as a share of GDP accounted for two thirds of the deterioration and the increase in spending a little over one third.

Fortunately, the parliamentary Budget office has done quite a lot of work on this issue and it solved some of the problems for us. It has a concept called a structural budget balance, which is basically the actual budget balance, a deficit or a surplus, minus temporary influences. What they show, quite directly, is that our structural surplus in the Commonwealth Budget began to decline from 2006/7 – two years before the Global Financial Crisis. We were already in deficit, in structural terms, by 2007/8 – that is, before the crisis – and we continued to accumulate deficits.

The Parliamentary Budget office concluded that from the structural budget balance peak of 2002/3 to its trough in 2011/12, the structural level of receipts – this excludes the GST, which is paid directly over to the states – fell by around 5 percentage points of GDP. And over that same period there was an increase in the structural level of payments of one per cent of GDP. The deterioration over that whole period in the structural balance was 6 per cent of GDP, which means, using this technique and the figures produced by the Parliamentary Budget Office, five sixths of the deterioration in our budget balance was a collapse in revenue. Five sixths of the problem we’re dealing with today is due to a collapse in revenue.

The reason we have a collapse in revenue, according to the Parliamentary Budget office and to the Treasury, is primarily because we gave ourselves huge personal income tax cuts and paid for them by company tax increases. Some of this came from the mining boom, but not all of it. At the same time we also paid for some of our personal income tax cuts with higher capital gains taxes, and so forth, in years before the Global Financial Crisis. When we were hit with the Global Financial Crisis a lot of this vanished and then more of it vanished when metals prices turned down and profits turned down in the Australian economy. What it did was expose a huge hole in our revenue, which is what we now are dealing with. At the same time, our personal income tax scales and levels have been adjusted so that they don’t pick up as quickly when incomes return as they once did.

Well, what do we do about it? What we have to do is what Joe Hockey proposes to do about it, but nobody seems to have noticed. If you look at the Treasurer’s numbers over the next five years, two thirds of the return to surplus that he projects, more if you project it forward, is increased tax revenue – mostly personal income tax. And that comes not from increasing taxes but from allowing them to recover.

Our Budget story is primarily a revenue story. That has all kinds of implications which I won’t go into now. I shall just conclude with a few thoughts.

It’s often been suggested that we have a thing here called Dutch disease – that is, we have a mining boom and the exchange rate goes up and this terminates our ability to compete with the rest of the world in other areas apart from mining. Actually, it doesn’t help mining very much if the dollar goes up, of course, but it doesn’t help manufacturing or agriculture, tourism so forth. The existence of this kind of effect is undeniable. It’s true that the Australian dollar rose above parity and we are used to it being around 70 or 65 US cents. It was a big difference. And it’s true our exports are affected by it. But if we do have Dutch disease, we have a very mild case. Let me give some evidence for that.

In December last year, we had three quarters of a million tourists in Australia. This is well over double the biggest number we’ve ever seen before the boom. Compared to before the boom, tourism is now running a third higher than it did. This is despite the Dutch disease. Our agricultural exports are at a new record high. They’re about two thirds higher than they were before the boom began. Our education exports dipped for a while and we changed the visa arrangements; they’ve now come back – it looks like our education exports are about double what they were when the boom began. Even in manufacturing, the value of our manufacturing exports (excluding metals, which went up anyway) is up by about a third. So, we could have done better but it’s not the most dismal set of circumstances. Certainly, it’s a pretty mild case of Dutch disease.

Can we adjust to the end of the mining boom? My main point is that it hasn’t been such a big boom – partly because mining is mostly foreign owned and partly because we’ve only just begun to increase iron ore and coal production in recent years. We haven’t begun, really, to export liquid natural gas in anything like the quantities that we’re going to in three or four year’s time. That will be huge, and we’re not even there yet. In many respects, the mining boom is not over. In some respects, it hasn’t yet begun. What is over is the investment phase. That means we need to replace around three per cent of GDP over three or four years. I think we can.

Certainly, we’re in a slow period at the moment. We’ve got a long way to go in home building which, in terms of housing starts, is not much bigger than it was about a decade ago. We’re seeing a huge rise in mining exports and that will continue for several years. We are doing okay in agriculture. There’s plenty of room at some point for household spending, consumption, to increase after the frugal years we’ve had. Finally, we should begin at some point to see action on non-mining business investment. It will certainly kick in at some point. When it does, it will surprise us by its figure. But it’s true that it’s not there yet.

To my mind, the most enduring point about our experience of the mining boom, or my interpretation of it, is that it’s another instance where we rather underestimate our achievement. There’s a wonderful book by an Adelaide economist, Ian McLean, called Why Australia Prospered and he shows that it is typical for Australians to underestimate their achievements, particularly in the economy. We all grow up with an idea that we’ve been feckless and complacent and the good times are just about to end. We’ve been in this state of mind for at least a century. Yet, over that whole period, we’ve done pretty well.