Two other ways globalisation is changing things

We're still learning to cope with a globalised world. Things work a bit differently now, and we have to adjust our thinking accordingly.

Globalisation – the breaking down of barriers between countries – is leading to increased trade between economies and increased flows of financial capital around the world, not to mention greater flows of people.

Another dimension of globalisation that's having big effects without being widely noted is the globalisation of news.

News of important happenings somewhere around the world now reaches most people in the rest of the world with a delay of maybe only a few minutes.

Because humans have evolved to continuously monitor their environment in search of threats, the news that interests us most is bad news. The news media are only too happy to oblige. They ignore all the good things that are happening, and all the everyday things as well, to give us a concentrated dose of any highly unusual, bad thing that's happening anywhere in the world.

The question is whether we're capable of absorbing this quite unrepresentative picture of what's happening around us without unconsciously reaching the conclusion that the world is in much worse shape than it actually is.

One lesson we've learnt is that everything in different parts of the world is now much more interconnected. That's true – particularly in the global economy – but we can take it too far.

The classic example of the heightened economic effects of globalised news was the global financial crisis of 2008, when news of crashing sharemarkets and teetering banks in America and Europe was beamed into living rooms all around the world every night for a month.

Ordinary people in distant countries such as Australia had to judge how this absolutely frightening news might affect them. They assumed the worst. Business and consumer confidence plunged and households and businesses began battening down the hatches, moving money between banks and cutting their spending.

It turned out all our banks were safe. Thanks to our tight supervision of them, they had no "toxic debt". But the government did have to help them when the international financial markets in which they borrowed stopped operating briefly.

The point is, our consumers and businesses were so frightened by all they'd heard about troubles overseas that we could have had a local recession anyway, had the Rudd government – and the Reserve Bank – not acted so quickly and effectively to calm people down with "cash splashes" and news of its plans for stimulus spending.

Now the big news is Greece's financial troubles, about which the media assume our curiosity knows no bounds. The obvious question for news consumers to ask is, how will this affect me?

Short answer: probably it won't. We can feel sorry for the Greeks, or not, but we need to remember Greece is a country of just 11 million people, with an economy representing about 0.4 per cent of the world economy and the tiniest share of our exports.

It is true that, should Greece exit the eurozone, this would raise uncertainly about pressure on the other weak and heavily indebted member countries, and this could lead to the euro currency union coming to a messy end.

If that were to happen – which wouldn't be any time soon – it would have flow-on implications for every country. But you'd have to say that, just as living on a Greek island would be a good way to get as far away as possible from any problem in Australia you were trying to escape, the reverse also applies.

Another way we're still adjusting to how globalisation is changing things concerns the way we've always measured international trade. This story is told in the Productivity Commission's annual report on trade and assistance.

Every country has always measured the "gross" value of its trade. The full value of each exported good or service has been attributed to the last industry that handled the item and to the country it was sent to.

But the advent of "global value chains" – where the production of manufactured goods in particular is spread between countries, with parts coming from various countries to be finally assembled in another country – has made this gross value approach ever more misleading.

So the World Trade Organisation is now making more use of individual countries' "input-output tables" to measure exports on a "value-added" basis. That is, each industry sector that contributed to the production of an export item gets the credit for the value it contributed to the final price.

Doing the numbers on this more accurate basis makes a big difference. The final price of manufactured goods, for instance, includes the value of raw materials provided by agriculture or mining, plus the value provided by service industries such as transport and providers of professional and scientific services.

Looking globally, manufactured goods' share of total world exports drops from 67 per cent to 40 per cent, while services' share doubles to 40 per cent. The shares of agriculture and mining increase from 13 per cent to 20 per cent.

The new story for Australia is different because our exports are dominated by primary products. Using the most recent figures available, for 2008, the commission estimates that manufacturing's share of our total exports drops from 36 per cent to 14 per cent, while services' share jumps from 18 per cent to 42 per cent.

Agriculture's share is unchanged at about 4 per cent, while mining's share drops only a little to 40 per cent.

As for the destination of our exports, looking at the period from 2002 to 2011, North America and Europe's share rose from 23 per cent, measured on a gross basis, to 32 per cent on value-added. The shares of our Asian customers fell.

One lesson: we should worry less about the decline of manufacturing and think more about the rise of the services economy.

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A far from wonderful set of growth numbers

The economy may have grown faster last quarter than business economists were expecting, but that tells you more about their forecasting ability than the economy's strength. Despite what Joe Hockey says, the numbers weren't all that wonderful.

According to the national accounts released by Bureau of Statistics this week, real gross domestic product grew by 0.9 per cent in the March quarter and by 2.3 per cent over the year to March.

This, of course, is well below the economy's "trend" (long-term average) rate of growth of 3 per cent a year, the rate needed just to hold unemployment steady in an economy with a growing number of people wanting to work.

But that's just the first reason the figures aren't as good as they initially appear. Another - one economists perpetually forget to remind us about - is that we have a population growing at the rapid rate of about 1.5 per cent a year, thanks to high immigration.

So we need quite a bit of growth just to stop average income per person falling. Turns out real GDP per person grew by just 0.8 per cent over the year to March.

Another thing to remember is that the growth in real GDP - the quantity of goods and services produced in Australia - is just one way, the most common way, of measuring economic activity.

It's usually assumed that the growth in the nation's production is the same as the growth in its income. But, first, the assumption breaks down if there's a significant change in Australia's terms of trade - in the prices we're getting for our exports relative to those we're paying for our imports.

That's because changes in our terms of trade affect the international purchasing power of the nation's income. When our terms of trade improve, the goods and services we produce are worth more when we buy goods and services overseas; when our terms of trade deteriorate, the stuff we produce is worth less when we're paying for imports.

With the prices we received for our mineral and energy exports rising greatly in the years before their peak in 2011, our "real gross domestic income" grew a lot faster than our production, real GDP.

Now, however, with coal and iron ore prices falling sharply, our real gross domestic income is growing much more slowly than our production, even falling. In the March quarter, real GDP grew by 0.9 per cent, while real GDI grew by only 0.2 per cent.

Over the year to March, real GDP grew by 2.3 per cent, but real GDI fell by 0.2 per cent. This matters because the real value of our income has an indirect effect on future real GDP, which is what drives growth in employment.

But a second assumption implicit in our almost exclusive focus on real GDP is that all the goods and services produced in Oz belong to Australians. They don't. In particular, maybe as much as 80 per cent of the value of the minerals and energy we produce and export is essentially the property of the foreign owners of our mining companies.

The Bureau of Stats highlights gross domestic product in conformity with international convention. But the fact is we'd be better off using gross national product, which measures how much of GDP actually stays with us rather than going to foreigners in interest and dividend payments.

And, because the deterioration in our terms of trade arises mainly because of the fall in prices of mineral exports, real GDI overstates the fall in our income. Real gross national income grew by 0.4 per cent in the quarter, and by 0.6 per cent over the year to March.

But, turning back to real GDP and its components, another reason the figures aren't as good as they appear is their heavy reliance on growth in exports. The volume (quantity) of our exports grew by 5 per cent in the quarter and by 8.1 per cent over the year to March.

This means exports contributed 1.7 percentage points to our overall growth of 2.3 per cent for the year. That's almost three-quarters of it.

Normally, this wouldn't be a worry. But when you remember that most of the export growth came from mining, and that mining is highly capital-intensive, you see there is a worry. It means that real GDP growth of 2.3 per cent isn't contributing as much to employment growth as we usually assume.

The figures show that the Reserve Bank's efforts to stimulate growth in the "non-mining" economy are having mixed success. They're working well with investment in new housing, which grew by 4.7 per cent in the quarter and 9.2 per cent over the year.

But they're getting nowhere with encouraging non-mining business investment to offset the sharp fall in mining investment. Overall, business investment fell by 2.7 per cent in the quarter and by 5.4 per cent over the year.

And get this: fiscal policy (including the budgets of the state governments) is hindering, not helping. Public investment in infrastructure fell by 2.4 per cent, its fifth successive quarterly decline, to be down by 9.1 per cent over the year, which subtracted 0.4 percentage points from overall growth over the year.

Consumer spending grew by an improved, but still below-trend, 2.6 per cent over the year, despite weak growth in wages and employment, and a rising tax bite from household disposable income.

What's keeping consumption reasonably strong is a falling rate of household saving. It fell from 8.8 per cent of household disposable income to 8.3 per cent in the quarter, down from 9.6 per cent a year ago.

It's normal and rational for households to adjust their saving to smooth their consumption spending as the economy moves through the ups and downs of the business cycle.

Even so, it's yet another respect in which the numbers weren't all that wonderful.

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The economy: old dog shows signs of life

With bad news this week from the March quarter survey of business capital expenditure, we need cheering up. Fortunately, budget statement No. 2 shows Treasury has been looking under every rock to find some good news.

It kicks off its annual assessment of the economic outlook by reminding all us worriers that the economy is entering its 25th consecutive year of growth, which is the second longest continuous period of growth of any advanced economy in the world.

And, we're reminded, though the economy has grown by less than its medium-term average ("trend") rate of 3 per cent-odd for five of the past six financial years, and is now forecast to grow by just 2.5 per cent in the financial year soon to end and 2.75 per cent in the coming year, this still leaves us as "one of the fastest growing economies in the advanced world".

Treasury gives us an update on the story we've become so familiar with in the past few years: the boom in investment in new mines and natural gas facilities is fast subsiding, leaving a big vacuum in economic activity that needs to be filled by faster growth in the rest of the economy.

To encourage such growth, the Reserve Bank has resumed cutting the official interest rate, such that it's now fallen 2.75 percentage points since its peak in late 2011, to a record low of 2 per cent. And, despite all the complaints about spending cuts, Joe Hockey has ensured his budget is only a minor drag on economic activity.

In response, we're now getting quite strong growth in new home building, and consumer spending is stronger than it was.

Fine. But that brings us to the crux of our continuing sub-par performance: business investment spending. Treasury expects mining investment to fall by more than 15 per cent this financial year, then by 25 per cent in the coming year and a further 30 per cent in 2016-17.

Yipes that's precipitous. And Treasury fears non-mining investment will show only modest growth until 2016-17 when it should increase by 7.5 per cent.

Put mining and non-mining together and you see business investment spending is the economy's continuing weak spot. After falling by 5 per cent last financial year, total business investment is expected to fall by another 5 per cent in the year just ending, then by 7 per cent in the coming year and even by a further 3.5 per cent in 2016-17.

Now you see why this week's figures for business "cap-ex" were such a downer. They really confirmed Treasury's dismal outlook. They showed a weak outcome for the March quarter and an unexpected deterioration in how much non-mining businesses expect they'll be spending in the coming financial year.

Moving right along, Treasury reminds us the economy does have a couple of things going for it apart from rock-bottom interest rates: one is lower petrol and oil prices and another is lower electricity prices (with more falls to come in some states).

And then, of course, there's the lower dollar, down mainly because the prices of our mineral exports are down, but perhaps also because our interest rates are lower than they were relative to those of other countries.

Our "real" exchange rate – that is, after adjusting the nominal exchange rate for our inflation rate relative to those of our trading partners – appreciated by about 30 per cent during the mining prices boom, but since September 2011 it has depreciated by about 13 per cent.

That's bad news for businesses and households buying imports, of course, but good news for Australian firms competing against imports in the domestic market. It's also good news for Australian exporters, who now get more Aussie cents for every US dollar they earn.

Treasury is forecasting strong growth of 5 or 6 per cent a year in the volume (quantity) of our exports over the next few years. Most of that is increased exports of minerals and energy as new mines come on line, but some of it comes from faster growth in non-mining exports.

On the other side, Treasury's expecting the volume of our imports to fall by 3 per cent in the year just ending and by a further 1.5 per cent in the coming year, before growing moderately by 2.5 per cent in 2016-17.

Why? Mainly because of fewer imports of heavy mining equipment, but also because the lower dollar will allow local firms to recapture market share from imports.

Such as? A classic exporting and import-competing industry is tourism. Real travel spending by international visitors to Oz has grown by 11 per cent since the start of 2012, whereas real travel spending by Aussies travelling abroad has decreased by 11 per cent.

The combined effect has been to turn our balance of trade in tourism services from a small deficit to a much bigger surplus. The increased inflow of tourists has been shared by all states.

Remember how much our leaders bang on about the big bucks to be made from China's rapidly growing middle class? Tourists from China accounted for more than a quarter of the growth in tourist spending in Oz last financial year.

The more than three-quarters of a million Chinese visitors that year spent an average of $8600 per person with our businesses.

Now get this: the volume of our exports of medium-skilled and technology-intensive manufactures has grown almost continuously over the past 30 years, as have our exports of high-skilled and technology-intensive manufactures, with the latter now bigger than the former.

It's really only the low-skilled and labour-intensive manufactures that have fallen back. The starring industries make goods such as pharmaceuticals, professional and scientific equipment, and machinery and transport equipment.

Strikes me we're not dead yet.

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