Monday, 5 August 2013

What happens when commodity prices relapse?

All the talk in Australia at the moment is of 'transition' - GDP growth had been sustained by a huge boom in investment to bring new resource projects on stream, but this has now peaked, and the transition challenge is that the drop in investment spending need to be made up by stronger growth in other components of GDP. There'll obviously be a pickup in export income as the new resource projects go into production, so that's a plus, but there's still an open question whether the increased resource export revenues, and a pickup in the currently rather downbeat domestic economy, will be enough to sustain overall GDP growth at the rates of recent years.
The Rudd government's recent pre-election Economic Statement reckons that any slowdown will be very modest - 2.75% in 2012-13, slowing very marginally to 2.5% in 2013-14, and picking up again to 3% in 2014-15 - but that may well be wishful thinking. It's not currently consistent with, for example, the very soggy July readings from the AIG Performance of Manufacturing and Performance of Services Indices.
The impact of the Australian resources boom on the Aussie economy thus far, and how it will play out next, is in sum a grunty issue, and not just for Australia - we've been partial beneficiaries of an important export market that has grown uninterruptedly since 1991. The issue has been tackled very thoroughly in a new report, 'The mining boom: impacts and prospects', from the independent Grattan Institute think tank.
The main points are: the boom had substantial positive benefits for Australia as a whole, and not just in the mining states (contrary to the Australian 'man in the street' wisdom); while Australia got the 'Dutch disease' symptom of a high currency, it's likely that tradable sectors squeezed by the high dollar (manufacturing, tourism) can bounce back as the dollar returns to more normal levels; much slower post-boom economic growth, or even recession, might happen, but it's equally plausible that Australia will have a soft landing; and, finally - and this was the surprise to me, as I had a mental image of Aussie governments by and large running a responsible fiscal ship - Aussie governments have let the mining largesse somewhat go to their heads, and need to do some fiscal repair work.
I'll mostly let you read the thing for yourself, but here are a couple of the more interesting findings.
Here's a chart showing how previous international episodes of commodity boom and bust have played out (New Zealand's there with an early-1970s cycle), suggesting that countries don't necessarily slump when commodity prices relapse, especially if they are running generally responsible macroeconomic policy.

And here's the chart showing how a A$190 billion windfall to the Aussie fiscal books over the decade to 2012-13 financed a A$182 billion deterioration in the underlying structural balance. As the report says (p45), "Successive Commonwealth governments appear to have treated the terms of trade windfall largely as if it were recurrent income", and it advises (p47) that "The Commonwealth’s fiscal strategy should be amended to set spending targets so that a windfall from the terms of trade does not result in unsustainable spending increases or tax cuts".

There are obvious parallels for us. We all know that the Aussie have been shipping out their ores at very fancy prices to the booming industrial markets of North Asia, and we all know that we've been having a decent run with our own prices, too. I'm not sure, though, that it's generally appreciated that our price boom is at least as big as theirs. I didn't realise it till I did the calculations. Here's a chart comparing our commodity prices (from the ANZ's Commodity Price Index) with theirs (from the Reserve Bank of Australia's Index of Commodity Prices), both expressed in SDRs, and with the RBA series rebased to the ANZ's Jan 1986 = 100.

And our fiscal balance has also had an adventitious boost from high commodity prices. In Table 17 of the Budget Update 2013 - Additional Information, Treasury estimated that our underlying (cyclically adjusted) fiscal deficit was running at 1.8% of GDP in the year to June 2013: without the boost to the government tax take from unusually high commodity prices, the deficit would be more like 3.0% of GDP (the exact number depends on how high you think our commodity prices are, relative to their longer term trend). 
More generally, we're currently relying on the Canterbury rebuild, and both us and Australia are relying on high commodity prices and the associated investment, to put good GDP numbers in the window. Those stimuli aren't going to last forever: as the Grattan Institute reminds us, what are we going to do for an encore?

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