Saturday, August 24, 2013

Resurces boom now a growth negative but still going

Kevin Rudd keeps saying the China resources boom has ended, but Reserve Bank governor Glenn Stevens said recently the boom was merely "changing gear" and going through a "phase shift". So who should we believe?

The econocrat, of course. The politician is exaggerating. It's true, however, that we have reached a highly significant point in the boom: though it's far from ending, we've reached the point where it's gone from making a positive contribution to economic growth (real gross domestic product) to making a net negative contribution.

The resources boom we're living through is one of the most significant things ever to happen in the history of our economy. So it's worth getting a clear picture of it in your mind. It's not a simple story.

The boom began in 2003 and was divided into two parts by the global financial crisis of 2008-09. For a few months it looked as though it was over, but then it started up again to be bigger and better than before.

But here's the tricky bit: you can divide the life of the boom into three phases - hence Stevens' talk of a "phase shift".

The first phase was an almost unbelievable increase in the prices we received for our exports of coal and iron ore, prompted particularly by the rapid industrialisation and urbanisation of China and other developing countries. This greatly increased our export income and lifted our terms of trade - export prices received relative to import prices paid - to their most advantageous in about 150 years.

But minerals prices stopped rising and started falling a long time ago - the middle of 2011 - and since then our terms of trade have deteriorated by about 18 per cent.

It's clear prices have further to fall, but how far and how fast they fall we can only guess. Right now, our terms of trade are still very much better than they were in the decades before the boom.

And the econocrats are confident that, even when prices have fallen as far they're going to, our terms of trade will remain a lot better than they were. If so, this will be a lasting consequence - and benefit - of the boom.

The second phase of the boom followed from the higher prices: resource producers responded to the increased demand by greatly increasing their investment in new mines and facilities. That was particularly true for iron ore and natural gas, and to a lesser extent coal.

Stevens says annual new investment spending by the resources sector rose from an average of about 2 per cent of GDP, where it had spent most of the previous 50 years, to peak at about 8 per cent.

That's a phenomenal increase. And all that mining construction activity has been the main factor driving the growth in the economy for the past few years while the manufacturers and tourist operators have been hit by the high dollar, and home building and retailing have been hit by the end of the long credit boom and other problems.

But the construction phase seems now to have gone over the hill. Treasury observed in the economic statement that "with investment in iron ore and coal projects likely to have already peaked, future resources investment will be underpinned by liquefied natural gas projects already under construction".

So the big development is that the amount of mining investment spending seems to have stopped getting bigger from quarter to quarter - and thus contributing to the quarterly growth in real GDP - and will now get smaller each quarter, meaning it will now subtract from quarterly growth.

Note, however, that though the amount of construction activity will get smaller each quarter, more investment will still be happening each quarter. That is, the second, construction phase of the boom isn't over, it's just passed its peak.

Come back in five years time and we'll have a lot more mines and natural gas facilities than we have today. Don't let the economists' obsession with quarter-to-quarter growth mislead you.

The next thing to remember is that maybe 40 per cent of our total mining investment spending goes on the purchase of imported capital equipment.

And, obviously, money we spend on imports is a minus in the sum that gives us GDP, the value of domestic (local) production of goods and services. So a reduction in a minus helps with growth. Allow for the decline in imports and the reduction in mining investment spending doesn't subtract as much from the bottom line as first appears.

Which brings us to the boom's third phase, production and export, which is just getting going. As all the newly built mines and gas facilities come on line, we experience very strong growth in the volume (quantity) of mining production and exports of minerals and energy.

This, of course, makes a positive contribution to the growth of GDP - and it's the main reason for saying the boom is far from over. Stevens says volumes of iron ore are rising by about 15 per cent a year. Shipments of natural gas won't start increasing strongly until 2015, and will probably have several years of very strong growth then remain high for a few decades.

Treasury says the record surge in investment has more than doubled the resource capital stock (production capacity) over the past decade, and this will support strong growth in mining commodity exports for years to come.

Even so, when you put all the bits together - a negative contribution from slow mining investment spending, a positive contribution from fewer capital imports and a positive contribution from increased production of exports - you're still left with a net negative contribution to growth from here on.

Finally, don't forget this: we started with a mining sector that accounted for about 4 per cent of total national production. Now it's 10 per cent and counting - a lasting consequence of the boom.