The Lucky Country's Luck About to Run Out?
"The poor white trash of Asia." It is some 30 years since a typically arrogant Lee Kuan Yew wrote off Australians with these derisory words.
It has been nearly three decades of developments which have seen Australia confound such critics: The major economic reforms of the 1980s that opened up the economy and undermined old businesses and union power centers; a high level of immigration from all corners of the world, particularly middle-class Asia (not least large numbers from Singapore), which spurred the economy and enabled Australia live down a racist past. Most recently, Australia has enjoyed a seven-year economic boom, barely touched by the global financial crisis, outstripping almost all OECD countries as capital flowed in and the nation hitched its export wagon to China's growth.
But the end of these 30 years of Australian rise may be at hand. Amid all the bullish statistics about growth, commodity prices and the exchange there is one which is extremely disturbing for the long-run health of the nation. That is the level of productivity, the only sure way for raising income levels over time.
According to a recent report by the independent and respected Grattan Institute. over the past decade more than half – 1.8 percent out of 3.1 percent of annual average gross domestic product growth has been provided by population growth, only 1.4 percent by productivity. The situation has deteriorated further over the past four years with almost zero growth in overall (manpower and capital) productivity growth and even a negative performance if tracked by the less common Gross Domestic Income (GDI) measure. The latter takes account of the huge gains in Australia's terms of trade which have enabled real incomes to rise without requiring any additional inputs. Since 2002 the Reserve Bank of Australia's index of commodity prices has risen from 40 to 130, a gain almost unprecedented even in an Australia, which has always known huge swings in its terms of trade.
The robustness of the economy in the face of the dismal productivity performance can thus be largely attributed to the rising prices and volumes of mineral exports. The commodity price index has risen from its nadir and is now back above the 2008 peak before the global crisis sent it into a sharp but short-lived correction. The resources boom is having a huge knock-on effect which has short term benefits but is setting up longer term big risks.
At first the increase in demand from China and elsewhere was met by spare capacity. But now massive new investments are in progress to meet what is supposed to be a continuing rise in demand for iron ore, coal, etc. In turn that has created demand for labor, boosting immigration and demand for housing. And it has attracted huge capital inflow, mostly through the banking system.
The only obvious short-term downside of all this has been a rising gap between resource producers, contractors and some consumer sectors and parts of the economy – manufacturing in particular – undermined by a very strong currency.
However, look a little closer and there is a clear link between weak productivity and the mining boom. The productivity of capital has been falling sharply partly because of the high capital cost of many new mining ventures, particularly in infrastructure, to provide the means to export very abundant deposits. Secondly, the open economy and low international interest rates in conjunction with the labor inflow have fuelled both housing construction and very high property prices.
Labor productivity has done better but Australia's openness to temporary as well as permanent migration, which accounts for the population growth, also reduces incentives to make workers more efficient. As a result too, real incomes of workers have barely, if at all kept up with price increases with most of the mining book benefit accruing to corporate profits, much of which is foreign owned. With household debt – mostly for housing – now 160 percent of annual incomes, consumers are in a weak position to cope with any significant rise in real interest rates.
And that, one way or another, they must expect, almost regardless of Reserve Bank policy. The household debt level has been financed primarily through increases in bank borrowing offshore. Net national liabilities now stand at A$771 billion and net debt at A$666 billion. Net foreign liabilities of the financial system now total A$380 billion compared with just A$173 billion five years ago. There are thus two major dangers arising.
The ending of the era of excess intentional liquidity and the rise in global interest rates.
The ending, whether it comes slowly or suddenly, of the China commodity import boom with its consequent impact both on real demand and the perceptions of financial markets.
Either of these will result in a decline of the Australian dollar, possibly slowly, possibly very sharply which in turn will tend to push up inflation and erode real household incomes.
Overconfidence in the continuation of the minerals price boom is astonishing to those with experience of Australia over the past 40 years, let alone readers of 150 years of Australian history. But Treasury and unofficial commentators appear to view this as a "super-cycle" with another decade to run. They seem not to have noticed not only some fundamental changes which China has to face – a fast declining rate of urbanization and workforce growth – but the massive investments in minerals now in progress thanks to today's prices. Few minerals are genuinely scarce. They just take time and money to exploit. Mine and energy development booms are underway not just in Australia itself but in Indonesia, Brazil, Canada, Russia, Africa and elsewhere. The price cycle is remorseless.
The end of the commodity price boom could well prove ugly for the short-term economy and the financial sector in particular. Even now Australia's is running a current account deficit of 2-3 percent of GDP and it could easily spike to 5-6 percent should export prices slip far adding to the cost of servicing existing debt and pressuring banks which have more than 50 percent of their loans to property. The Reserve Bank will do its utmost to prevent a US-style property crash so the prospect is easy money and a very weak currency.
The floating Australian dollar is a safety valve to some extent, as almost half of foreign debt is in that currency. In many ways the dollar has been too high for too long and a fall will ease the pain of falling terms of trade and higher global real interest rates. But do not be surprised is the Aussie dollar is back to 70 US cents before the year is out and tests 50 cents within a dozen years of last hitting that mark in 2001.
But coming off this commodity high is only Australia's first problem in maintaining its high growth status. The end of the boom will vastly reduce demand for labor and hence the inflow which has provided such a GDP boost. More than that, the overall productivity of the economy will be hurt by the rising percentage of old people either outside the workforce or with diminishing contributions.
Just possibly those developments, plus the impact of a weak dollar, will spur productivity and demand for domestic manufactures. Possibly. But if they do not and productivity levels remain so flat one can expect that within a decade a Chinese reincarnation of Lee Kwan Yew will be talking about the "poor white trash of Asia" – even if many of their own citizens would rather be "poor yellow trash" in an easy-going Australia than be patriots to their own goose-stepping regimes.