Big change ahead for China and our export challenge

You don't need me to tell you we lucked out when we sited our island continent not too far from China. But will our luck hold?

Or, more pointedly, what do we have to do to ensure we stay lucky?

A major report, released this week, Partnership for Change, seeks to answer that question. It was prepared jointly by Professor Peter Drysdale, of the East Asian Bureau of Economic Research at the Australian National University, and Zhang Xiaoqiang, of the China Centre for International Economic Exchanges, with strong support from both governments.

Actually, our location on the edge of Asia is only half our good luck. The other half was discovering our island is rich in high quality, easily-won minerals and energy.

As a result, our economy has proved a fabulous fit with the re-emerging China. As the report explains, "Australia and China are deeply complementary trading partners".

Our "comparative advantage" is opposite to China's. A country has a comparative advantage in producing a particular item if it can do so at lower opportunity cost than other countries face.

"Australia has a large natural resource base relative to its population [so it] therefore specialises in the production of primary goods for export, and uses the proceeds to purchase labour-intensive and other manufactured goods," the report says.

"Conversely, China has a large labour supply, but relative to its population has smaller endowments of natural resources and accumulated capital. For this reason, China's industrial development was built on labour-intensive production, which it exchanges with Australia for imports of scarce resources."

And what a successful partnership it's been. In the space of not much more than a decade, China has become our biggest trading partner. It takes about 35 per cent of our exports of goods and services, and supplies almost 20 per cent of our imports of goods and services.

China is so big - its population is 56 times ours - and has been so successful in pursuing this growth strategy it's now the second biggest economy in the world (the biggest, if you allow for differences in purchasing power), the biggest trading nation and the world's biggest producer of manufactured goods.

But nothing stays the same. The resources boom that saw our trade with China grow so dramatically has reached its final stage. Prices for coal and iron ore have now fallen back.

The period of massive investment in new mines and natural gas facilities is ending, with construction spending falling sharply. The last stage is big growth in the quantity of our mining exports, with large increases in natural gas exports (mainly to China) still to come.

The boom was ended by big increases in the supply of commodities (from our competitors as well as us), but also by a slowing in China's demand as its need for more steel peaked.

So, after a period of huge expansion in our mining sector, our economy is making the adjustment back to normal, where most growth in production and employment comes from the ever-expanding services sector.

This is happening, with a few bumps. But, as part of its progress to full economic development, China is going through a much more dramatic "transition".

The report says China is "shifting its growth drivers from investment, exports and heavy industry to consumption, innovation and services".

"Chinese production is shifting from a model based on adaptation and imitation of goods, services and technologies developed elsewhere, to a model based on domestic innovation", it continues.

Part of this involves a shift from labour-intensive, low-tech, low-value manufacturing to more advanced, high-tech, high-value manufacturing.

This has already started.  Over the 20 years to 2015, low-tech manufacturing's share of China's total exports of goods has shrunk from almost half to less than 30 per cent.

So the big question is whether, now China is changing direction, it will still be the gold mine it's been for us so far.

China will still need to import a lot of our natural resources, even if its demand for those resources won't be growing as fast.

The report notes that, with prices so far down, our share of China's import market has increased markedly. Huh? It's because, compared with our competitors (including local Chinese mines), we're such an efficient, low-cost producer.

The report has modelled three scenarios for our trade with China over the next 10 years. Drysdale stresses the results aren't exact, but give us an idea.

The "baseline" scenario, where existing trends continue without much change, would see our exports to China grow by 72 per cent, while China's exports to us grew by 41 per cent. (All these figures are in real terms.)

The pessimistic scenario sees China's annual growth falling below 5 per cent during the decade. Even so, our exports to China would grow by 28 per cent, while their exports to us grew by 20 per cent.

The optimistic scenario, however, would see our exports to China grow by 120 per cent, while their exports to us grew by 44 per cent.

And the catch? Both countries would need to engage in supply-side (production) reforms to make it happen.

For China, this would involve reforming its banks and financial system, reforming its state-owned enterprises, and liberalising the capital account of its balance of payments by lifting restrictions on money flows and allowing a freer-floating exchange rate.

For us, it would involve increasing competition in sheltered industries, openness to foreign investment and skills, and facilitating investment in social and physical infrastructure.

These are what we'd have to do to make real our dream of getting our share of all the extra demand for fancy food and services coming from China's by-then massive middle class.

Here we'd be battling against a different and much bigger range of competitors than we face in the commodities market. You wonder if our spoilt business people are up to it.

Read more >>

China plans big expansion of trade - without us

You've heard of belt and braces. You may even have heard of one country, two systems. But have you heard of One Belt, One Road? No, I thought not. Rest assured, you will.

It's a topic much discussed in business and economic circles in China, as I learnt on a visit there sponsored by the Australia-China Relations Institute at the University of Technology, Sydney.

It's a plan for the establishment of a new Silk Road between Europe and China, to increase trade and cultural exchange between all the countries along the route.

It's an initiative of the Chinese government, first announced by President Xi Jinping​ in 2013, and much elaborated since then.

The belt refers a land-based Silk Road Economic Belt running through China to Central Asia to Russia and Europe.

The road refers to a sea-based Maritime Silk Road taking in the countries of south-east Asia and running through the Indian Ocean to the countries of South Asia, then through the Suez Canal to the Mediterranean.

To keep muddling metaphors, the maritime "road" may even have a spur line to Africa. In principle, more than 60 countries could be involved.

It may sound like a politicians' grand vision that won't get far. That's certainly the way some American critics have reacted to it. There could be much suspicion, resentment and resistance to China's expansion plans from countries and their citizens, they say.

But while pollies talk big in Western countries, in China they tend to act big. Making the initiative a reality would involve much spending on infrastructure such as sea ports, airports, railways, highways, oil and gas pipelines, power stations and special economic zones.

China has much to gain from all this, of course. Its existing development activity in certain African countries suggests it would supply much of the materials and labour for infrastructure projects.

Should the oft-predicted economic "hard landing" eventuate and lead to rapidly rising unemployment at home, its desire to get on with foreign construction projects might be heightened.

Establishing a new Silk Road means China, already the world's largest trading nation, would greatly expand its export opportunities.

But trade between a willing buyer and willing seller is mutually beneficial. And increased trade could do much to hasten the economic development of the "stans" of Central Asia - such as Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan.

Already there is much interest and activity in Pakistan.

Geoff Raby, a former Australian ambassador to China, has observed that the initiative is "of great strategic significance for Beijing, as it is also intended to reduce China's major strategic vulnerability caused by so much of its seaborne trade, especially crude oil, having to go through the Strait of Malacca".

As an aside, this vulnerability also helps explain China's sensitivity over the South China Sea.

Full implementation of the initiative could take decades, of course. But a solid start has already been made. For instance, a freight rail link between the south-western China province of Sichuan (the one with the spicy food) and Lodz in Poland is now running three trains a week.

This fits also with the Chinese government's earlier - and continuing - Go West campaign to move economic activity - particularly labour-intensive manufacturing - inland from the richer coastal provinces, where labour is getting ever-more expensive.

But have you noticed something? The many countries that could get involved with the initiative include Indonesia, but not us.

At least, not directly. There is scope, however, for Australian banks and other financial institutions help facilitate the funding of infrastructure projects.

Much of the construction of projects will be done by big Chinese state-owned enterprises. We could, of course, sit back and hope this leads to restored demand for our coal and iron ore.

But the SOEs will often need to partner with foreign firms able to provide the specialist expertise they lack in in such things as engineering and major construction.

Many Australian companies are well-equipped to supply such consulting services, but to-date our firms have shown limited appetite for the higher risks involved in developing country projects.

Much safer to limit your innovation and agility to pressing the government for "reforms" that cut the tax you pay or allow you to drive harder bargains with your employees.

But not to worry. There are Japanese and South Korean firms who'll be happy to eat the Chinese lunch we don't fancy.

Read more >>

Don't imagine China's troubles to be bigger than they are

Is the Chinese economy slowing down or melting down? You don't have to go far to find someone purporting to know a lot more about China than you do, who's making the most apocalyptic predictions.

And who knows? Maybe one day they'll be right. But I'll wait for it to happen before I start worrying.

By the same token, to say China is "slowing" seems a bit euphemistic. Being a developing country you can't say it's in recession the way you might say it of an advanced economy, because developing economies rarely experience an actual contraction in real gross domestic product.

At their worst they just grow at rates that, by their standards, are pretty bad, but by ours we'd be very pleased to have. In that sense it seems likely China is in or entering its own version of a recession.

Its rate of growth has been slowing for more than a year, it probably has more slowing to do, and with a bit of bad luck it could slow a lot more. At worst we're talking about growth in GDP slowing to maybe 4 per cent a year.

The biggest problem – as the doomsayers have long been saying – is the "overhang" from China's long-running real estate boom, in which far more apartments were built than there were people wanting to buy them.

Now housing construction has come to a halt in various parts of China, and it won't resume until the existing stock of empty homes is finally sold off. That could take at least a year, probably two. So the economy won't start to pick up anytime soon.

Limited housing construction means weak or declining growth in the manufacture of housing materials such as crude steel, cement and plate glass.

That's not the whole story, but it does mean the weakness is concentrated in construction and manufacturing, which just happen to be the main components of "industrial production" – an economic indicator the world's financial markets pay great attention to, not least because it's published monthly.

Trouble is, industrial production ain't easy to measure. It's particularly hard to do in developing countries, which don't have the bureaucratic infrastructure we have and where the shape of the economy keeps changing, not to mention the extra problems in measuring it monthly rather than quarterly.

This has prompted some in the markets to suspect a conspiracy rather than a stuff-up, and allege the Chinese authorities are making the numbers up. They may not be as reliable as we'd like, but don't believe that.

Another thing to remember – as people in the market tend to forget – is that industrial production accounts for only about 45 per cent of Chinese GDP. The remaining 55 per cent is in a lot better shape, as a Reserve Bank assistant governor, Dr Christopher Kent, argued in a speech this week.

By the way, if you're looking for someone to trust on China you could do worse than our central bank. It's well aware of the importance of China to our international prospects and so puts a lot more personpower than most into studying it: six or seven economists in Sydney, plus another two attached to our embassy in Beijing.

Kent says that although the weakness in China's property and manufacturing sectors is clearly of concern to commodity exporters like Australia, there are a number of countervailing forces supporting broader activity in China.

"First, growth in the services sector [worth about 45 per cent of GDP] has been resilient, and should continue to be assisted by a shift in demand towards services as incomes rise," he says.

"Second, growth in household consumption has also been stable in recent quarters, aided by the growth in new jobs. Of course, such outcomes cannot be taken for granted; if the industrial weakness is sustained, it might eventually affect household incomes and spending.

"Third, Chinese policymakers have responded to lower growth by easing monetary policy [access to loans] and approving additional infrastructure investment projects.

"They have scope to provide further support if needed, although they may be reticent to do too much if that compromises longer-term goals, such as placing the financial system on a more sustainable footing."

So what does this mean for us? The substantial slowing in industrial production has contributed to the further decline this year in the prices we get for our exports of coal and iron ore. (Of course, the bigger reason for the lower prices we're getting is the substantial increase in the supply of these commodities from places such as Australia.)

Kent says that what transpires with China's industrial production, and in Asia more broadly, will have a big influence on how much further commodity prices fall.

And the changing nature of China's development – a higher proportion of services and lower proportion of goods – limits the potential for commodity prices to go back up.

But here's the good news: Kent reminds us that the shift in demand towards services and Western agricultural products in China and Asia more broadly presents new opportunities for Australian exporters.

As recently as the mid-noughties, China's GDP was growing at the rate of 10 per cent. This is why money-market types are shocked to hear it's now growing by only 6.5 per cent, let alone 4 per cent.

But this just shows that even money-market types can be innumerate. As the distinguished former economic journalist Anatole Kaletsky has reminded us, China's GDP today is $US10.3 trillion ($14.5 trillion).

In 2005 it was $US2.3 trillion. So even just 4 per cent of $US10.3 billion is much more than 10 per cent of $US2.3 trillion.

To the Chinese, what matters most is the rate at which GDP is growing. To the rest of us, however, what matters is the size of the absolute addition the Chinese are contributing to gross world product.

Read more >>

Moratorium on new coal mines makes economic sense

What are we meant to do about coal? For some time now it's looked like Australians face a painful choice between doing the right, moral thing by the rest of the world and continuing to make a living from our rich endowment of natural resources.

The burning of coal is by far the biggest source of the greenhouse gas emissions that are causing climate change. Australia is one of the world's biggest producers of coal.

Greenies have been arguing for years that, although it's too much to ask that we just stop exporting the stuff, we should at least get in no deeper by ceasing to build any new mines or expand existing mines.

In August, Anote Tong, President of the Republic of Kiribati, called for an international moratorium on new coal mines as a way of underpinning the efforts to get increased commitment to reduce emissions at the Paris summit in December.

Not surprisingly, Tong's call for a moratorium has been supported by 11 other Pacific island nations worried about rising sea levels. But he's also winning support from such influential figures as the Nobel Prize-winning scientist Peter Doherty and the British economist Lord Nicholas Stern.

For such an international moratorium to be effective, we'd have to be part of it. At present, we have 52 proposals to build new coals mines or expand existing ones.

But isn't it too much to ask us to leave all that black gold in the ground? Mining and exporting coal is an important way this economy makes its living.

The developing countries – including China and India – have a lot more developing to do, meaning they'll need a lot more energy, much of which will be coal. What's so bad about them trying to get rich like us? And why shouldn't it be we who supply that coal?

We need more jobs, and think of all the jobs building more big mines would create.

So what's it to be? Conscience or self-interest? Well, how about both?

The Australia Institute think-tank has begun campaigning hard for a moratorium, and a forthcoming paper by its chief economist, Richard Denniss, argues that economic and political considerations actually say we should be joining the moratorium.

Why? In a nutshell, because coal's days are numbered. The rapidly falling price of renewable energy such as wind and solar, combined with the growing resolve of China, the US and others to reduce their emissions, put a dark cloud over the future of coal.

Coal mines are intended to have lives of 50 to 90 years. Will coal prices be high enough in 30 or 40 years to make continued production profitable? If not, investors in new coal mines won't get their money back, but will be lumbered with "stranded assets" – assets that no longer earn much of a return.

Denniss says it's now widely accepted by international agencies that meeting the goal of limiting global warming to 2 degrees requires keeping most fossil fuels unburnt and in the ground.

All this helps explain why the world's big banks, including our own, have become markedly less enthusiastic about financing new coal mines. That – plus the present flat state of the world coal market.

According to the BP company's energy outlook, global coal consumption grew by just 0.4 per cent last year, well below its 10-year average growth rate of 2.9 per cent.

Within that, China's consumption grew by just 0.1 per cent. And Professor Ross Garnaut, of the University of Melbourne, is predicting a significant decline in China's demand for coal for the foreseeable future.

Were we to build all our proposed new mines, we'd double our annual exports. According to Denniss, just proceeding with the five biggest projects in Queensland's Galilee Basin would increase the world's seaborne coal trade by 18 per cent.

What do you reckon that would do to world coal prices at a time when coal demand is weak?

See the point? In such circumstances, preventing further coal development – including by governments declining to subsidise new mine railways and ports – wouldn't just reduce future greenhouse gas emissions.

By avoiding causing further decline in coal prices, it would also benefit the owners of existing mines, the banks that have lent to them and those who work for them, as well as the owners of present and future renewable energy projects. Not to mention the governments dependent on revenue from price-based mining royalties and company tax collections.

On its face, by causing coal prices to be higher than otherwise, it would harm the users of coal and coal-fired electricity. But when you remember that, without something like a carbon tax, the price of coal fails to include the cost to the community of the environmental damage that coal-burning does (including the death and ill health caused by the particulate air pollution from power stations), that's not anything to feel bad about.

But what about all the jobs that building new mines would have created? They're temporary and often exaggerated by the projects' proponents. Once they're built, open-cut coal mines employ surprisingly few workers.

The construction workers not employed to build more mines than are good for us could be better employed building more useful infrastructure.

When you think it through, the case for a moratorium on new coal mines has a lot going for it.

Read more >>

Why the Trans-Pacific Partnership is no game-changer

Think you know a bit about economics? Try this quick quiz: what's your impression of the Trans-Pacific Partnership Agreement reached between the United States and 11 other Pacific Rim countries, including Australia, this week?

Would you say it is: a) a gigantic foundation stone for our future prosperity that will boost growth, create jobs, raise living standards and increase productivity; b) a terrible deal that advantages big American multinationals at our expense, or c) not a big deal either way?

Malcolm Turnbull and his ministers' exaggerated claims about the benefits likely to flow from the agreement rest on the expectation that it will allow our farmers to sell more sugar, beef, cheese, wool and rice to the other economies, at higher prices.

Since these gains have been achieved at little cost in terms of increased access to our market for the other countries' exports, we're surely well ahead on the deal.

Does that make sense? Only if you don't know much economics.

As for the claim that it's a terrible deal, it has some truth to it, but is itself exaggerated. It's true that part of the deal involves our acceptance of "investor-state dispute settlement" arrangements, which allow foreign companies – but not local businesses – to take actions for damages against governments that make decisions which adversely affect their profits.

This is an unwarranted imposition on democratic governments' sovereignty which, at best, will involve them in significant legal costs in fending off vexatious claims.

It's true, too, that trade deals with the US have involved attempts to advantage American companies holding intellectual property – patents, copyright and trademarks – at the expense of local consumers.

And the intense secrecy in which the TPPA has been negotiated – we still don't know the details of the agreement and won't for some months – raises justified suspicion in many people's minds. What is it that big companies and lobby groups may know, but the public may not?

Even so, it does seem that Trade Minister Andrew Robb has fended off American attempts to further advantage foreign pharmaceutical companies at the expense of Australian patients and taxpayers.

In the old days trade agreements were about increasing trade between countries. These days, they're at least as much about imposing restrictions on governments' freedom to legislate as they see fit.

But to assess the likely effects on the economy – on growth, incomes, jobs and productivity – we need to set this legislative aspect to one side and focus more directly on trade and investment.

Be clear on this: there's no doubt that reducing barriers to trade between countries increases the material prosperity of the countries involved. Reduced protection and increased trade have played a significant part in the greater prosperity enjoyed first by the developed economies and then the "emerging" economies since World War II.

Most of those gains were achieved by successive rounds of multilateral reductions in import tariffs and quotas. That is, the reductions applied to all of a country's trading partners, not just some.

But the World Trade Organisation has been trying unsuccessfully since 2000 to organise another multilateral agreement. In the meantime, countries have taken to making bilateral trade deals, where the concessions made to the other country aren't available to any other economy.

This makes them preferential trade agreements, not the free trade agreements they are known as.

They're greatly inferior to multilateral agreements because they tend to divert trade from more efficient to less efficient supplier countries, simply because the less efficient suppliers happen to be subject to lower import duties.

And the picking and choosing between which countries get preferential treatment and which don't creates a need for complex "country of origin" rules that add much red tape to international trade.

This week's regional preferential trade agreement between 12 countries representing 40 per cent of world gross domestic product will still be trade-diverting to some degree, particularly since it excludes such significant trading partners as China, India and Indonesia.

But it could lessen the burden of red tape if, as mooted, it involves uniform country-of-origin rules.

The other weakness of trade deals is their encouragement of mercantilist thinking – the notion that countries get rich by exporting as much as they can and importing as little as they can – a fallacy economists have been fighting since the days of Adam Smith.

The nature of bargaining is to gain as many concessions as you can while making as few of your own as you can. But this is the exact opposite of the way you maximise the economic gains from trade.

You gain most not by inducing trading partners to reduce their barriers to your exports, but by reducing your own barriers to their exports. You gain when you shift productive resources from things you aren't very good at doing to things you are.

That's the first reason for believing a modest increase in sales for our farmers and little change for our import-competing industries won't do much to increase growth, jobs and productivity.

The second reason – and another reason mercantilism is fallacious – is that if we did get a lot higher prices for our agricultural exports without much change in import prices, this improvement in our terms of trade could be expected to lead to a rise in the value of our dollar.

If so, our farmers might be better off but this would be at the expense of our manufacturers, tourist industry and other exporters of services.

As yet we've done no modelling of the likely economic benefits of the TPPA. But various American modelling exercises – and our officially commissioned modelling of our recent bilateral deals with South Korea, Japan and China – all suggest the gains will be small – say, a level of GDP that's just 0.5 per cent higher than otherwise after 10 years. No big deal.

Read more >>

Libs deserve share of reform credit

I am a career-long admirer of Paul Keating. He opened our economy to the world, dragging us into the era of globalisation. Of the 13 treasurers I've observed in my career, I judge him to be far and away the best – though he did have his failings.

But last week Keating came out fighting when John Howard argued that the Coalition opposition of the time also deserved praise "because it gave bipartisan support to so many of [Keating's] reforms".

Keating objected to "a creeping part of the orthodoxy of late that the reformation of Australia's financial, product and labour markets . . . was not executed by the Hawke and Keating governments but was some kind of project undertaken with the active co-operation of the then Liberal-National opposition".

"Nothing could be further from the truth."

Sorry, but Howard has a point.

It's true there was no overt co-operation between Labor and the Coalition, nor any atmosphere of sweetness and light. The Liberals never said anything good about Labor and always found plenty to criticise and oppose. To the casual observer, it was adversarial politics as usual.

In particular, the Libs vigorously opposed almost all of Labor's tax reforms, particularly the taxes on fringe benefits and capital gains, the compulsory superannuation levy and even the restoration of the assets test for the age pension.

They also vigorously opposed Medicare and Labor's Accord with the union movement.

Howard may be happy to praise the Hawke and Keating reforms at this late stage, but he didn't at the time, nor during the almost 12 years he was prime minister. This is an old trick: praising long departed opponents as a way of criticising the present incumbents.

I don't doubt that, had a Howard-led government been elected in 1983, it wouldn't have instigated all the reforms Keating made in the following 13 years. It would have lacked the vision, drive, courage and sense of urgency Keating had – not to mention the support of its Labor opposition.

Keating is no doubt right in saying his biggest problem in pushing reform was getting the Labor caucus and the unions lined up behind him. In this the Accord was a great help, meaning ACTU secretary Bill Kelty deserves his share of the reform credit.

The Labor faithful may regard Keating as a saint up there with Whitlam today, but at the time they thought of him as a turncoat.

But the fact is Howard is right in listing all the reforms the Coalition, under the influence particularly of him and his former adviser, Professor John Hewson, did not oppose: privatisation of Qantas and the Commonwealth Bank, deregulation of bank lending rates, floating the dollar, admitting foreign banks, ending import quotas and virtual phasing out of tariffs, and introducing the HECS scheme for university fees.

Urged on by Hewson, Howard instigated the whole financial deregulation project by commissioning the Campbell report. He implemented as many of its recommendations as Malcolm Fraser would let him, before the Fraser government was swept from office.

It's noteworthy that nothing Keating went on to do was mentioned in the 1983 election campaign. In opposition, Keating joined the rest of Labor in vigorously attacking financial deregulation.

In office, he changed his tune, used a quickie report by the banker Vic Martin to sanctify the Campbell proposals, and proceeded to implement them all.

Howard is right in saying the most politically courageous reform was ending the protection of manufacturing. Until then, protectionism had been a bipartisan policy for decades, strongly supported by business and the unions. It remains supported by the public to this day.

It was usual for protection to be stepped up during recessions. But in the depths of the recession of the early '90s – our worst since the Depression – Keating actually instigated the second stage of its removal.

Never was there a better opportunity for the Libs to rally the nation against this monstrous act of folly. By then they were being led by Hewson and his criticism remains burnt on my brain: Labor should have gone further.

Keating says he never worried about the Libs, never even spoke to them about things. I believe him. What I don't believe is his implication that, had they opposed his reforms, nothing would have been any different.

In the key areas Howard listed, Keating knew his opponents would not attempt to score points against him, that the interest groups and voters adversely affected would have no political flag to rally under. This hugely strengthened his hand.

It was a unique period in our economic history, for which the Libs deserve their share of credit.

Read more >>

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.

Read more >>

Resources boom not done yet

If you think the resources boom is all over bar the shouting, someone who ought to know begs to differ. He thinks the last phase of the boom is just getting started. But even he thinks the boom leaves us with stuff to worry about.

In a speech this week, Mark Cully, the chief economist of the federal Department of Industry and Science, says the resources boom actually consisted of three booms.

The price boom lasted for about eight years and peaked in 2011. The overlapping investment boom lasted for about six years, with $400 billion worth of resources projects. Overall, business investment spending peaked in the last quarter of 2012 at an astonishing 19 per cent of gross domestic product.

By now we're in the early stages of the production boom, making the whole thing more of a "super-cycle" than a common or garden boom.

We're well aware that resource prices are still falling from their 2011 peak and that mining investment spending is rapidly coming to an end. But, according to Cully, the production boom is set to last far longer than the others did.

As always, it's a story of global prices being determined by the interaction of global demand with global supply. World prices shot up because demand grew faster than supply could keep up with.

Eventually, however, the world's producers of resources such as iron ore, coking and steaming coal, liquefied natural gas and petroleum responded to the high prices in textbook fashion, desperately expanding their production capacity so as to cash in on the bonanza.

It took a while for that extra capacity to come on line. But, as the textbook predicts, once supply started catching up with demand prices started falling back. And, adding to the pressure for lower prices, world demand started to fall off.

So, isn't that the same-old, same-old end to the story of the boom? And if we get to the point where world supply actually exceeds world demand, doesn't that mean prices could have a lot further to fall?

Not if it's turns out to be true – as I and others have believed – that this commodity cycle is being driven more by a longer-term change in the structure of the global economy than by the usual shorter-term cyclical mismatch between supply and demand.

Many people see the resources boom as caused by the rapid development of China, whose economy is now growing more slowly. But Cully sees China as just the first act, with other countries to follow.

"Economic growth in the highly populated emerging economies of Asia will continue to be a defining theme of this century," he says.

Per-person consumption of energy and materials in most countries in Asia lags the developed nations by a large margin and so is almost certain to grow. As incomes rise and they attract infrastructure and commercial investment, Asia's consumption of resources will grow by volumes that far outweigh whatever's happening in the rich countries.

Iron ore and coking coal are used to make steel, of course. Cully says China's steel production is estimated to have reached a record last year. He expects it to fall in the short term but, over the medium term, to reach a new peak almost 10 per cent higher by 2020.

"This will be required for China to continue expanding its infrastructure networks, especially rail, build more housing and grow its capital stock," he says.

Then there's India. Its Ministry of Steel wants present production to be four times higher by 2025. It may not achieve that target, but this still suggests rapid growth.

There've been highly publicised falls in the world price of iron ore in recent times, but Cully expects it to remain low this year and next before rebounding over the medium term as higher-cost producers exit the market and demand continues to grow. Australia has some high-cost producers, but most are in other countries, leaving Rio Tinto and BHP Billiton as the world's lowest-cost producers.

Turning to steaming coal, Cully questions the environmentalists' optimistic belief that world demand for it is on the way out. More than 300 gigawatt (one billion watts) of coal-fired electricity generation capacity is being constructed or has been approved in developing countries.

"Barring major policy adjustments," he expects coal-fired power to remain a primary source of generation in China and India. Japan, South Korea and Taiwan are increasing their use of steaming coal, while Indonesia, Malaysia, Vietnam and Thailand are increasing by even more.

Australia is likely to play an important role in meeting this increased demand because our coal's higher energy content makes it more suitable for use in advanced generators. Cully expects our exports to have increased by 15 per cent by 2020, making us the world's largest exporter of steaming coal.

Finally, natural gas. Cully's team projects that our exports of natural gas will increase more than threefold to about 75 million tonnes a year in 2019-20. By that time Australia would be the world's largest exporter of gas.

The increased volume of gas exports is likely to be the principal driver of growth in Australia's export revenue. Looking across all the mineral commodities, increases in the volume (quantity) of exports are expected to outweigh further decreases in prices, so that the value of these exports (price times quantity) increases by about a third through to 2019-20.

So what could there be to worry about? Well, it's worth remembering that, although we're exporting more thanks to the resources boom, our share of global exports is actually falling. Other countries' exports must be growing faster than ours.

More concerning, while we've been becoming global export leaders in iron ore, coal and natural gas, our range of exports has become even less diversified than it was before the boom.

Considering how dependent we are on exporting fossil fuels, that ought to worry us more than it does.

Read more >>

Economy: not good, but not disastrous

Don't drop your bundle. It's not clear the economy has slowed to the snail's pace a literal reading of the latest national accounts suggests. As for the talk of a "technical income recession", it's just silly.

What is clear is that, at best, the economy continues to grow at the sub-par rate of about 2.5 per cent a year, a rate insufficient to stop unemployment continuing to edge up. This has been true for more than two years.

A literal reading of last week's national accounts from the Bureau of Statistics says the economy - real gross domestic product - grew by a mere 0.3 per cent in the September quarter, down from growth of 0.5 per cent in the previous quarter and 1 per cent in the quarter before that.

But if we've learnt anything by now, it's that it's folly to take the quarterly national accounts too literally. They're just a first stab at the truth, based on incomplete and often inaccurate data.

The initial estimate for growth in any quarter will be revised - up and down - up to a dozen times before the bureau is satisfied it has got it pretty right. Reserve Bank governor Glenn Stevens referred recently to "the vagaries of quarterly national accounting".

Frankly, I don't believe the economy slowed markedly in the three months to September, or the six months, for that matter. If it were true, surely we wouldn't need to be told about it by the national accounts two months after the fact.

Since all individual economic indicators have their weaknesses and inaccuracies - meaning none should be taken too literally - the only adult way to proceed is to see if the signal coming from one key indicator fits with the overall message coming from the other indicators.

On the basis of what all the other indicators are saying, the forecasters - official and unofficial - expected growth in the September quarter of 0.6 per cent or 0.7 per cent, which would be consistent with the view we're still travelling at about 2.5 per cent a year.

When the published figures turn out to be half that, this suggests either that all the forecasters got something badly wrong, or that it's the published initial estimate that's wrong and likely to be revised up to something closer to what we expected.

The way we'll be able to tell whether the economy really has slowed to a crawl is by watching the rate at which unemployment rises in coming months. At the 2.5 per cent a year speed, it's worsening at a rate averaging 0.1 percentage points a quarter.

If that average rises, we'll know things are much worse than they were.

As for the "technical income recession", it proves little. Make a note that, in this context, the word "technical" is warning that what follows is based on an arbitrary rule with little sense to it.

"Technical" means two quarters of contraction in a row equal a recession. So one quarter of huge contraction isn't a recession, and two negative quarters separated by a zero quarter aren't a recession, but two consecutive negative quarters are a recession no matter how tiny the falls (or whether one is subsequently revised away).

"Real gross domestic income" is real gross domestic product adjusted for the change in our terms of trade during the quarter. Since, as we've seen, real GDP growth was weak in the past two quarters, the deterioration in our terms of trade in both quarters caused real income to decline by 0.3 per cent in the June quarter and by 0.4 per cent in the September quarter.

What happens to our terms of trade - and, hence, our aggregate income - is important. But, in this particular case, it's hard to get too excited.

As Dr Shane Oliver, of AMP Capital, has explained: "There is a danger in dwelling too much on the slump in real gross domestic income flowing from the falling terms of trade ... while swings in the mining and energy export prices are very important for resource companies, and hence for government revenues, their impact on the rest of the economy is far more modest."

In other words, the main impact is on mining company profits, and mining is about 80 per cent foreign owned. More their problem than ours.

If I thought the economy was sliding into genuine recession I'd say so. But I don't believe in exaggerating the bad news because it makes for more exciting betting on financial markets, makes a better story or because you've always hated whichever party happens to be in power at the time.

Read more >>

A good deal, but China wins on climate

At last, something to be positive about. Of all the Abbott government's efforts to improve our economic prospects over the year and a bit since its election, none compares with the benefits likely to flow from its remarkable trade agreement with China.

I'm not expecting to see any noticeable gains from the G20 leaders' pledge to increase economic growth by 2 per cent over the four or five years to 2018 - not directly as a result of our government's promised measures, nor indirectly as a result of the other governments' promises.

Those pledged actions don't seem to amount to much. And with Turkey taking over leadership of the G20 next year, it's possible this is the last we'll hear of them.

But the free trade agreement with China is of great substance, with phased reductions in China's tariffs (import duties) against many of our exports and, equally beneficial, in our tariffs against imports of certain manufactures from China.

It's likely to add significantly to our trade with China, increasing our ability to benefit from its growing middle class with ever more Western tastes, and giving us freer access to its ever more sophisticated manufactures. A coup for our tireless Trade Minister, Andrew Robb.

To be truthful, I've never been a great enthusiast for bilateral free trade agreements. They're greatly inferior to multilateral agreements, mainly because they're preferential agreements - you and I favour our mutual trade over trade with other people - contrary to what the term "free trade" implies.

This means they're capable of diverting and distorting trade, as well as generating red tape as rules are established to determine how much of an item that claims to be from China actually is.

But with efforts to achieve another round of multilateral trade improvements having been stalled since 2000, it seems we must accept that a spaghetti bowl of bilateral agreements is the best we're likely to get.

Australia has now negotiated quite a few of these deals, including John Howard's agreement with the United States in 2004 and Robb's agreements with South Korea and Japan earlier this year, but they amount to little compared with the China deal.

That's partly because China is fast becoming the world's biggest economy, partly because China is our largest trading partner - first on imports as well as exports - and partly because our economies are so complementary, but mainly because China is a still-developing country that joined the World Trade Organisation only in 2001 and so has many trade barriers still able to be reduced.

But it's a pity the government's ability to pull off such a good deal with the Chinese is not matched by a willingness to acknowledge the global good news embodied in last week's agreement between the US and China on measures to reduce greenhouse gas emissions after 2020.

This meeting of minds of the two most influential players in the world's efforts to contain global warming has boosted confidence that we may yet be able to limit the industrial-age increase in average temperatures to 2 degrees Celsius and that major progress is possible at the next meeting of countries in Paris next year.

To hear our leaders seeking to avoid short-term embarrassment by denigrating the agreement and misrepresenting China's efforts to limit its own emissions is terribly disappointing. Joe Hockey let himself down with his claim that China will continue increasing its emissions until 2030.

This suggests he's as well briefed on the subject as a radio shock-jock. Should he care to raise his understanding to the level we expect of a federal treasurer, he could read a speech that Professor Ross Garnaut, a noted expert on the topic, gave as long ago as August.

As such a vocal advocate of economic growth, you'd expect Hockey to understand that China is committed to raising its people's material standard of living to a greater fraction of that Australians and people in other rich countries have long enjoyed.

This has inevitably involved much increased use of fossil fuel, with China's rapid economic growth during the noughties meaning it has become the largest contributor to annual growth in the world's greenhouse gas emissions.

But at the meeting in Copenhagen in 2009, China committed itself to reducing the emissions intensity of its economic growth by 40 to 45 per cent between 2005 and 2020. That is, each extra yuan worth of production would involve the emission of less greenhouse gas.

Garnaut points out that, relative to what would otherwise have happened, this represented a larger reduction than any other nation promised. And his calculations imply that the Chinese will achieve their commitment.

They have moved to a new economic strategy in which less of their growth comes from investment in factories and infrastructure and more from consumer spending, especially on services. This should involve less use of energy, particularly from fossil fuels, and so fewer emissions.

Garnaut's projections of China's electricity generation to 2020 - which accounts for most but by no means all of its emissions - suggest that its burning of steaming coal will actually fall a fraction between 2013 and 2020.

So, far from China still increasing its emissions in 2030, Garnaut believes they are likely to have peaked by 2020. You should have known that, Joe.

Read more >>

At present GDP is more misleading that usual

I could attempt to explain to you why the Bureau of Statistics is having such embarrassing trouble with its monthly estimate of employment, but I won't bother. It's horribly complicated and at a level of statistical intricacy no normal person needs to worry about.

What this week's labour force figures now tell us is that, though the rate of unemployment has been slowly drifting up since mid-2011 - when it was 5 per cent - it seems to have steadied this year and, using the smoothed figures, has stayed stuck at 6 per cent for the past three months.

This is reasonably consistent with what we know about other labour-market indicators, such as job advertisements and vacancies, claims for unemployment benefits and employers' answers to questions about hiring in the National Australia Bank's survey of business confidence.

It also fits roughly with what the national accounts have been telling us about the strength of growth in the economy. We know that when the economy is growing at its trend rate of about 3 per cent a year, this should be sufficient to hold the rate of unemployment steady.

The accounts told us real gross domestic product grew by 3.4 per cent over the year to March, and by 3.1 per cent over the year to June.

But now let me tell you something that, while a bit technical, is much more worth knowing than the gruesome details of the bureau's problem with the labour force survey.

One of our smartest business economists, Saul Eslake, of Bank of America Merrill Lynch, has reminded us that GDP is only one of various summary indicators of overall economic activity provided by the national accounts. And the economy's peculiar circumstances over the past decade and for some years to come mean GDP is not the least misleading of the various measures.

Eslake says real GDP measures the volume (quantity) of goods and services produced within a country's borders during a particular period. (Actually, it doesn't include the many goods and services produced within households, which never change hands in a market.)

To estimate real GDP the bureau takes the nominal, dollar value of the goods and services produced, then "deflates" this figure by the prices of those goods and services relative to what those prices were in the base period.

We commonly take the value of the goods and services we produce during a period to be equivalent to the nation's income during that period. This easy assumption works for most developed economies most of the time.

But Eslake reminds us that "for an economy like Australia's, the prices of whose exports are much more volatile than those of other 'advanced' economies, abstracting from swings in the prices of exports (and imports) obscures a significant source of fluctuations in real incomes".

We've experienced a series of sharp swings in our "terms of trade" - export prices relative to import prices - over the past decade of the resources boom, which was interrupted by the global financial crisis in 2008-09. For the past three years, of course, mining commodity prices have been falling.

Trouble is, real GDP doesn't capture the effects of these swings. So the values of our production and our income have parted company, as they do every time our terms of trade change significantly. An improvement in our terms of trade causes our income to grow faster than our production, whereas a deterioration has the opposite effect.

This matters because of the chicken-and-egg relationship between production and income: we use the income we earn from our part in the production process to buy things and thus induce more production.

So if our real income slows or falls, soon enough this dampens our production.

However, the national accounts include a measure of overall economic activity that does capture the effects of movements in our terms of trade: real gross domestic income, GDI. It grew a lot faster than real GDP for most of the time between 2002 and 2011, but since then has grown much more slowly than real GDP (a big reason for our slowly rising unemployment).

Next Eslake says that as the resources boom moves into its third and final phase - with mining investment winding down and exports ramping up - real GDP growth will be an even less useful guide to what's happening to domestic income and employment.

This is because maybe 80 per cent of the income generated by resources exports will be paid to the foreigners who own most of our mining companies and who financed most of the new investment.

It's also because the depreciation of Australia's greatly enlarged stock of capital equipment and structures as a result of all the mining investment spending will now absorb a greater share of our gross income.

(A separate issue Eslake doesn't mention is that the highly capital-intensive nature of mining means the increased production of mineral exports will create far fewer jobs than you'd normally expect.)

If you've ever wondered about the difference between gross national product and gross domestic product it's that the former excludes all the income earned on Australian production that's owed to the foreign suppliers of our debt and equity financial capital, making it a more appropriate measure for us given our huge foreign debt and foreign investment in our companies.

If you've ever wondered what the "gross" in GDP, GNP, GNI etc means, it's short for "before allowing for the depreciation of our stock of physical capital".

So gross national income (GNI) is a better measure than gross domestic income (GDI), and net national disposable income (NNDI) is a better measure than GNI.

Which, by the way, explains why real NNDI is used as the base for all the further non-national-accounts-based modifications included in Fairfax Media's attempt to calculate a broader measure of economic welfare, the Fairfax-Lateral Economics wellbeing index, released each quarter soon after the publication of GDP.

Read more >>

Chinese economy overtaking US and getting more like it

It isn't so many years since I used to berate the denizens of the financial markets for their lack of interest in the economy that had so much influence on ours: China. How things have changed. So has China.

After averaging growth of 10 per cent a year for 30 years, China's economy is now struggling to achieve its reduced target of 7.5 per cent. The financial market participants' role has been to watch on with concern.

And this week comes news that, though the International Monetary Fund sees China coming close to target this year, it expects it to slow to 7.1 per cent growth in 2015 and slow further in following years.

More surprisingly, the fund says that China should slow down to give it a chance to work on its big problems, rapidly growing debt and a rapidly contracting real estate market. Fumble those and growth could be even lower.

But while so many of us have been so focused on China's difficulty maintaining its rate of growth, we've lost sight of how big it is and how fast it's still growing compared with the rest of us.

Compared, say, with the world's biggest economy, the United States. Except that, according to the calculations of Euromonitor International, China will overtake the US this year. That's when you compare the two economies using "purchasing-power parity", which makes allowance for the fact that one US dollar buys a lot more in China than it does in the land of the free.

With China biggest and the US second, then come India, Japan, Germany, Russia and Brazil. We come in at 17th, not far behind Indonesia. The world certainly is changing.

Of course, the Chinese and American economies remain very different. China is big because of its much bigger population - 1.4 billion versus 300 million. Its income per person remains a fraction of America's. A not unrelated fact is that the US's productivity (measured as gross domestic product per worker) is more than nine times higher than China's.

And the two countries' industry structure is also very different. Agriculture contributes 10 per cent to GDP in China but just 1 per cent in the US. But get this: it accounts for almost a third of the workforce, compared with just 1.4 per cent in the US.

Manufacturing makes up 30 per cent of China's GDP, but only 13 per cent of America's. That tells us a lot about why China's rise, and the growth in its exports of manufactures, has affected so many other countries as well as maintaining downward pressure on world prices.

But the biggest difference between the two economies is their relative emphases on consumption and investment. Euromonitor International estimates that this year private consumption will account for 68 per cent of GDP in the US, compared with 37 per cent in China.

Here, however, we get to the really important news: the Chinese authorities have embarked on a process of "rebalancing" the economy, increasing consumer spending and domestic demand and reducing the roles of exports and investment in heavy industry.

The Economist notes that consumer spending has already begun its expansion, with its share of GDP rising from less than 35 per cent in 2010 to more than 36 per cent last year. And this year it has accounted for more than half the growth in GDP.

A big reason for stronger consumer spending is rapid growth in wages. Get this one: over the five years to 2013, real wages in manufacturing rose by about 2 per cent in the US, but by 45 per cent in China. As always happens, the benefits of economic development do flow eventually to ordinary workers.

This strong growth in consumption involves faster growth in the services sector, with manufacturing's share of GDP having peaked at almost a third in 2007.

This structural change means people following the ups and downs of the Chinese economy ought to be following a different set of indicators, as Peter Cai of China Spectator noted last week with help from Guan Qingyou, an economist at Minsheng Securities.

Cai says the main reason Chinese policymakers care so much about the rate of growth in GDP is their belief that the economy needs to grow by at least 7.2 per cent to absorb 10 million new entrants to the labour market each year.

But this correlation has been breaking down since 2010. Slower growth in GDP has not led to weaker job creation. Gaun suggests this is because the expanding services sector has a greater capacity to absorb new job seekers.


More fundamentally, China seems to be approaching its "Lewis turning-point", where a developing country runs out of its supply of surplus rural labour. This would also help explain the rising real wages.

Financial market participants focus on the growth in "industrial production" (manufacturing, mining and utilities) as a predictor of GDP growth, and on the manufacturing PMI (purchasing managers' index) as a predictor of industrial production.

But Cai says the strong correlation between industrial production and GDP is breaking down because the services sector is growing a lot faster than the industrial sector. Last year, for instance, the services sector contributed 47 per cent of the annual growth in GDP, whereas the industrial sector contributed less than 40 per cent. So, it's better to focus on the services sector PMI.

A big problem for China-watchers is that you don't know how much faith to put in official statistics. Earlier in his career, Premier Li Keqiang let it be known that he, too, had his doubts. So he focused on railway freight volumes, electricity consumption and bank lending as offering a better guide.

Now others have developed a "Li Keqiang index". But here, too, Guan argues that its reliability has declined, because of changes in the structure of industrial electricity use and changes in financing. China is changing.

Read more >>

Treasury's opportunities and threats facing our economy

It shouldn't surprise you that when the secretary to the Treasury, Dr Martin Parkinson, devoted half his major speech this week to "fiscal sustainability" - the tax increases and spending cuts needed to get the budget back on track - the media virtually ignored the other half.

But the budget isn't the economy. And in that other half Parkinson offered a revealing SWOT analysis of the economy, outlining its Strengths and Weaknesses, Opportunities and Threats. So let me tell you what he said (and leave my critique for later).

For people worried about what we do for an encore after the resources boom - about where the jobs will come from - Parko points to three big "waves of opportunity".

The first wave is the mining investment boom, which is ending but not leaving us high and dry. "With the capital stock in the mining and energy sectors now triple what it was a decade ago, additional productive capacity will drive strong growth in resources exports for several years to come," he says, although this will involve employing fewer workers than in the investment phase.

The second opportunity wave flowing from the vast economic shifts in Asia is rising global demand for agricultural produce. The Australian Bureau of Agricultural and Resource Economics and Sciences estimates that China's imports of fruit will treble by 2050. Imports of beef will grow by a factor of 10 while imports of sheep and goat meat increase by a factor of 19. Dairy will increase by a mere 165 per cent.

Asia already takes more than 40 per cent of our food exports. Parko warns, however, that our ability to gain a slice of its rising demand rests on continued productivity gains in our rural sector, supported by the right policy settings.

"Our handling of the concerns raised by foreign ownership of Australian agricultural land (and food manufacturing) in some parts of our community is one dimension of the agricultural policy challenge, along with our approach to trade policy, stimulating investment in on- and off-farm infrastructure and supporting research and development."

The third wave is the opportunities in the services and high-value manufacturing sectors brought about by the steadily increasing growth of the Asian middle class. It's estimated that, by 2030, just under two-thirds of spending by the world's middle class will come from the Asia Pacific region, compared with about a quarter today.

"To capture the benefits of the third wave, we will need to compete on the global stage for Asian demand for services and high-end manufactures on the basis of both cost and quality," he says. "We will also need to compete for foreign direct investment to help put the right export-related infrastructure in the right places."

But get this declaration from the economic rationalist-in-chief: "Contrary to how it is sometimes portrayed in the media, competing on the global stage does not mean driving down wages or trading off our standard of living. Far from it."

Parko says improving Australia's competitiveness in global markets means investing in the skills of our workforce so Australians have the opportunity to move into sustainably higher paid jobs, and investing in infrastructure that has a high economic return.

It means ensuring firms and their employees are freed from unnecessary regulatory burdens, and establishing the right incentives to encourage innovation and competition. "In other words, it means raising Australia's productivity performance," he says.

Which brings us to Parkinson's three big threats to our further economic success. The first is productivity improvement. He says that, even after you allow for temporary factors, there's been a slowdown in "multi-factor" productivity improvement that's broad-based across industries, suggesting that deeper, economy-wide factors are at play.

The second threat arises because, until mid-2011, the effect of this productivity slowdown on the rise in our living standards was masked by the rise in the prices we were receiving for mineral exports. But now the likelihood that these prices will continue falling means a "significant drag on Australia's national income growth" over the rest of this decade.

The third threat to continued strong economic growth comes from the turnaround in the "demographic dividend" delivered by the baby boomers. For about 40 years until 2010, the proportion of the population of working age (here defined as 15 to 64) grew a lot faster than the overall population because of the postwar baby boom, followed by a dramatic fall in the birth rate in the 1960s and '70s. This boosted economic growth.

"Over the next few years, this demographic dividend, which has been fading for some time, will actually reverse. The proportion of the population aged 65 and over is expected to increase to nearly 20 per cent in 2030, from 13.5 per cent in 2010."

As the population ages, the total participation rate - the proportion of people 15 and over participating in the labour market - will fall, despite the increase in the participation rate among older Australians. "This expected decline has already begun and will become more pronounced by the end of the decade," he says.

Productivity is the key long-run driver of income growth, but declining export prices and labour-force participation are expected to subtract from national income growth in future.

If we assume the productivity of labour grows at its long-term average, then income per person would grow over the coming decade by about 0.7 per cent a year, about a third of the rate to which we've become accustomed, he says. To avoid that, we'd need to sustain labour productivity growth of about 3 per cent a year, about double the rate we've achieved so far this century.

If we fail to make the reforms needed to achieve that rate of productivity improvement, by 2024 our income per person will have risen only to $69,000 a year, not $82,000. We'll each be $13,000 a year less affluent than we could have been.

Read more >>

We own as much of their farm as they own of ours

Did you know that, at the end of last year, the value of Australians' equity investments abroad exceeded the value of foreigners' equity investments in Australia by more than $23 billion?

It's the first time we've owned more of their businesses, shares and real estate ($891 billion worth) than they've owned of ours ($868 billion).

These days in economics there's an easy way to an exclusive: write about something no one else thinks is worth mentioning, the balance of payments. We'll start at the beginning and get to equity investment at the end.

Before our economists decided the current account deficit, the foreign debt and our overall foreign liability weren't worth worrying about, we established that, when measured as a percentage of national income (gross domestic product), the current account deficit moved through a cycle with a peak of about 6 per cent, a trough of about 3 per cent and a long-term average of about 4.5 per cent.

Those dimensions were a lot higher in the global era of floating exchange rates than they'd been in the era of fixed exchange rates (which ended by the early '80s). This worried a lot of people, until eventually economists decided the new currency regime meant there was less reason to worry.

This explains why economists haven't bothered to note that for four of the past five financial years, the figure for the current account deficit as a percentage of GDP has started with a 3. And, as we learnt earlier this month, the figure for the year to December was 2.9 per cent.

So it seems clear that recent years have seen a significant change in Australia's financial dealings with the rest of the world. And the consequence has been to lower the average level of the current account deficit.

The conventional way to account for this shift is to look for changes in exports, imports and the "net income deficit" - the amount by which our payments of interest and dividends to foreigners exceed their payments of interest and dividends to us.

The first part of the explanation is obvious: over the past decade, the world's been paying much higher prices for our exports of minerals and energy. This remains true even though those prices reached a peak in 2011 and have fallen since then.

On the other hand, the prices we've been paying for our imports have changed little over the period. So, taken in isolation, this improvement in our "terms of trade" is working to lower our trade deficit and, hence, the deficit on the current account.

Next, however, come changes in the quantity (volume) of our exports and imports. Here, over the full decade, the volume of imports has grown roughly twice as fast as growth in the volume of exports. Until the global financial crisis, we were living it up and buying lots of imported stuff. And maybe as much as half of all the money spent on expanding our mines and gas facilities went on imported equipment.

The more recent development, however, is that the completion of mines and gas facilities means enormous growth in the volume of our mineral exports - with a lot more to come. At the same time, as projects reach completion there's a big fall in imports of mining equipment. That's a double benefit to the trade balance and the current account deficit.

Turning to the net income deficit, it's been increased by the huge rise in mining companies' after-tax profits, about 80 per cent of which are owned by foreigners. Going the other way, world interest rates are now very low and likely to stay low.

Put all that together and it's not hard to see why current account deficits have been lower in the years since the financial crisis, nor hard to see they're likely to stay low and maybe go lower in the years ahead.

The current account deficit has to be funded either by net borrowing from foreigners or by net foreign "equity" investment in Australian businesses, shares or real estate. This means the current account deficit is the main contributor to growth in the levels of the national economy's net foreign debt, net foreign equity investment and their sum, our net foreign liabilities.

Historically, our high annual current account deficits worried people because they were leading to rapid growth in the levels of our net foreign debt and net total liabilities.

But looking back over the past decade, and measuring these two levels relative to the growing size of our economy (nominal GDP), there's no longer a clear upward trajectory. Indeed, it's possible to say our net foreign debt seems to have stabilised at about 50 per cent of GDP, with net total liabilities stabilising a little higher.

Over the decades, the level of net foreign equity investment in Australia has tended to fall as big Aussie firms become multinational by buying businesses abroad and Aussie super funds buy shares in foreign companies, thus helping to offset two centuries of mainly British, American, Japanese and now Chinese investment in Aussie businesses.

But the net total of such equity investment is surprisingly volatile from one quarter to the next, being affected not just by new equity investments in each direction, but also by "valuation effects" - the ups and downs of various sharemarkets around the world as well as the ups and downs in the Aussie dollar.

Between the end of September and the end of December, net foreign equity investment swung from a net liability of $27 billion to a net asset of $23 billion. This was mainly because of valuation effects rather than transactions, so I wouldn't get too excited.

What it proves is that, these days, the value our equity investments in the rest of the world isn't very different from the value of their equity investments in Oz.

Read more >>

Why the success of the G20 matters

It's easy to be cynical about the G20. Will the meeting of finance ministers and central bank governors in Sydney this weekend, and the leaders' summit in Brisbane in November, amount to anything more than talkfests?

People say the Brisbane summit will be the largest and most important economic meeting ever held in Australia. That's true, but it just means it will be bigger than the Sydney APEC leaders' summit in 2007 - which is remembered mainly for The Chaser boys' Bin Laden stunt.

But though it's easy to be cynical, it's a mistake. It's possible the two meetings this year will prove no more than talkshops, but that would be a great pity. And, since Australia is this year's chair of the group, it's up to Joe Hockey and Tony Abbott to make sure they're worth more than that.

The G20 began in 1999 as a group for finance ministers and central bankers, in the aftermath of the Asian financial crisis, which revealed the need for greater co-operation and co-ordination between governments in responding to crises in the global financial system and, better, making changes to the global financial "architecture" (rules and institutions) that reduced the frequency and severity of financial crises.

The formation of the G20 was a recognition that the G7 (compromising only Europe, North America and Japan) wasn't truly global, particularly because it excluded the emerging BRICS economies - Brazil, Russia, India, China and South Africa.

For a decade or two most of the growth in the global economy has come from the BRICS, and the developing economies now account for more than half gross world product. For a better global spread, the G20 also adds Argentina, Indonesia, Mexico, Saudi Arabia, South Korea, Turkey, the European Union and, of course, Oz. With just these 20, it accounts for 85 per cent of gross world product.

In 2009, in the aftermath of the global financial crisis, the G20 was upgraded from just finance ministers to include summits of presidents and prime ministers, an acknowledgment of the way economic power had spread beyond the North Atlantic. But why do we need these get-togethers?

Because, as Christine Lagarde, boss of the International Monetary Fund, said recently: "The breakneck pattern of integration and interconnectedness defines our times."

It has become unfashionable for the media to talk about globalisation, but it's continuing apace. As Mike Callaghan of the Lowy Institute said last week: "If there is one lesson from the [global financial] crisis, it is the interconnectedness between financial markets. Events in US financial markets had worldwide consequences. We need co-operation to deal with globally operating financial institutions."

These days, global integration is being driven less by deregulation and more by advances in technology, particularly the information and communications revolution. One part of this is the way the internet has globalised the media.

News of an economic calamity in one country is now conveyed to the rest of the world almost instantly. Financial traders in New York or other centres can start moving money out of the affected country in no time. They can then take a set against neighbouring countries they merely fear may have a similar problem, giving rise to a big problem called "contagion", where trouble spreads like a communicable disease.

And TV news that a few banks are tottering in Europe can scare the pants off consumers and business people in countries around the world, prompting them to stop spending until their confidence returns.

But it's not just crises. As Callaghan reminds us, more and more businesses now operate globally. Goods are more likely to be "made in the world", with inputs from many countries rather than just one. So the trade policies agreed by the international community have to adapt to the new reality that such "value chains" are increasingly driving world trade.

Then there's tax. The more businesses that operate globally, the more businesses that are able to exploit loopholes between different countries' tax laws, shifting their profits to countries with low tax rates. This is eroding the tax base of many countries - including ours - so their taxes aren't raising as much revenue as they should be.

In other words, technology-driven globalisation - the ever-reducing barriers separating particular economies - is throwing up problems that can't be solved by individual countries acting individually.

So we need greater communication, co-operation and co-ordination between countries, first, to discourage countries from pursuing "beggar-thy-neighbour" policies - I attempt to fix my problems at your expense, which usually provokes retaliation, so we all suffer - and, second, to find group solutions to the various problems.

The first couple of G20 leaders' summits in 2009 were quite effective in ensuring the Great Recession wasn't as bad as it could have been. But the truth is the G20 has been running out of momentum, resorting to high-sounding rhetoric while getting bogged down in excessive detail.

Considering how crisis-prone the global economy has become, it's important merely for world leaders, treasurers and central bankers to know each other, have face-to-face meetings and phone each other.

But we also need more joint action, and if the G20 doesn't lift its game the big boys will stop coming to meetings and eventually shift their interest to a smaller, more cohesive group which includes China and a few others, but excludes Australia.

Clearly, it wouldn't be in our interests to lose our seat at the top table. That's why it's so important we use our position as this year's chair to get the G20 back on the rails. Many pre-meeting phone calls need to be made by Hockey and Abbott to their counterparts, to gather support on the directions to be taken.

Then they need to chair the meetings effectively, discouraging set-piece speeches and encouraging interchange that improves mutual understanding and makes progress on a limited range of key issues.

We have a lot to gain or lose.

Read more >>

Trans-Pacific Partnership: we pay more for longer

According to someone called Oscar Ameringer, politics is the gentle art of getting votes from the poor and campaign funds from the rich, by promising to protect each from the other. However, when Tony Abbott spoke at the Business Council's 30th anniversary dinner last week, he was very much in protecting-big-business mode.

"On election night, not quite three months ago, I declared that Australia is under new management and once more open for business," he told the captains of industry. "My business - the business of government - should be making it easier for you to do your business because government doesn't create prosperity, business does.

"Governments' job is to make it easier for good businesses to do their best ... that's why almost everything we've done over the past three months has been to make it easier for Australians to do business."

It's possible, of course, that Abbott didn't really mean all that. Perhaps he was just greasing up business people because they were who he happened to be speaking to. Maybe next week he'll tell a bunch of consumers he's doing it all for them.

It's too early to tell just whose interests the Abbott government is seeking to advance. Maybe it doesn't yet know itself.

But I get a bit twitchy when I hear politicians running the line that what's good for General Motors is good for America.

I worry when I hear allegations that Australia bugged the cabinet room of a friendly nation not in the national interest but in the interest of a particular Australian company. Then that one of the politicians at the time has since become an adviser to the company.

I confess to being concerned about what deal Trade Minister Andrew Robb is doing in our name at the Trans-Pacific Partnership negotiations in Singapore this week.

The partnership is a trade treaty the US wants with 11 other Pacific rim countries: Canada and Mexico, Chile and Peru, Australia and New Zealand, Japan and Malaysia, Singapore, Brunei and Vietnam.

The US has been negotiating the treaty since 2006 in what it has insisted be complete secrecy. Although it has no doubt been consulting with its own big companies, and it's a safe bet our business lobby groups have been briefed about the contents of the treaty and have advised our government on their views and goals, the rest of us aren't meant to know what's going on.

Parliament will have to be told the content of the done deal before it votes to ratify any treaty the government has agreed to, but that's all. It's "need to know" and you, dear voter, don't need to know. Leave it to the adults.

Well, not quite. Last month one of the draft treaty's 29 chapters, on intellectual property, was published by WikiLeaks.

This week one country's detailed description of the state of negotiations was leaked. So we know a fair bit about what we're not supposed to know. And what we know isn't terribly reassuring.

What I know about the US government's approach to trade agreements - which doesn't seem to have changed since the deceptively named free-trade agreement we made with it in 2004 - is that its primary objective is to make the world a kinder, safer place for America's chief export, intellectual property: patents, copyright and trademarks - in the form of pharmaceuticals, films, books, software, music and much else.

To this end, the length of copyright would be extended beyond the 70 years to which it has already been extended, and copyright infringement would be made a criminal offence. It would be made easier for pharmaceutical companies to artificially extend the life of their patents and frustrate the activities of others wishing to produce generic versions.

It is clear this would greatly benefit America's big entertainment, software and drug companies.
What's equally clear is that it has no economic justification, being simple "rent-seeking"; government intervention in markets to enhance the profits of particular companies.Rupert Murdoch's 21st Century Fox would be a prime beneficiary.

Since Australia is a net importer of intellectual property, our government ought to be in no doubt the Americans' demands are contrary to our economic interests.

The leaks reveal many dubious demands by the US, but none more so than its promotion of "investor-state dispute settlement" provisions, which would allow foreign companies to pursue legal actions against our government in foreign tribunals if, for example, it were to introduce policies they considered contrary to their interests.

This would give foreign companies an advantage local companies didn't have. The Productivity Commission found such provisions offered few benefits, but considerable policy and financials risks. The former Labor government had a blanket ban on agreeing to such clauses, but Robb's approach is more flexible.

Why would any country agree to such unreasonable demands? Because, in exchange, the Americans are holding out the promise of greatly enhanced access to their markets - in our case, for sugar and beef.

So what we're not supposed to know is that, if the rest of us get sold out, it will all be in aid of Australian farmers. The trouble with running the economy to benefit business is you end up harming some to help others.

But not to worry. The leaks suggest agreement on the treaty is a long way off.

Read more >>

How what's hurting most is also what saved us

While many business people see the economy as badly performing and badly managed, our econocrats see it as having performed quite well and better than could have been expected. Why such radically different perspectives on the same economy?

Partly because business people - particularly those from small businesses - view the economy from their own circumstances out: If I'm doing it tough, the economy must be stuffed. By contrast, macro-economists are trained to ignore anecdotes and view the economy from a helicopter, so to speak, using economy-wide statistical indicators.

A bigger difference, however, is that business people are comparing what we've got with what we had, whereas the economic managers are comparing what we've got with what we might have got, which was a lot worse.

Business people know everything was going swimmingly in the years leading up to the global financial crisis of 2008-09, but in the years since many industries - manufacturing, tourism, overseas education, retailing, wholesaling - have been travelling through very rough waters.

The econocrats, however, have a quite different perspective: whereas the rest of us love a good boom, those responsible for managing the economy view them with trepidation. Why? Because they know they almost always end in tears and recriminations.

Particularly commodity booms. As a major exporter of rural and mineral commodities, we've had plenty of these in the past. They've invariably led to worsening inflation, a blowout in the trade deficit and ever-rising interest rates, followed by a recession and climbing unemployment. The latest resources boom was the biggest yet, involving the best terms of trade in 200 years, leading to a once-a-century mining investment boom. It could have - even should have - led to a disaster, but it didn't.

The macro managers' primary responsibility is to maintain "internal balance" - low inflation and low unemployment - which involves achieving a reasonably stable rate of economic growth. No wonder commodity booms make them nervous.

So how have they gone? As Dr Philip Lowe, deputy governor of the Reserve Bank, said in a speech this week, over the three years to March, economic output (real gross domestic product) has increased by 9 per cent, the number of people with jobs has risen by more than half a million and the unemployment rate today is 5.4 per cent, the same as it was three years ago.

Underlying inflation has averaged 2.5 per cent over the period, the midpoint of the medium-term inflation target. "So over these three years we have seen growth close to trend, a stable and relatively low unemployment rate and inflation at target," he says.

And that's not all. The investment boom hasn't led to a large increase in the current account deficit. There hasn't been an explosion in credit. Increases in asset prices have generally been contained. And the average level of interest rates has been below the long-term average, despite the huge additional demand generated by the record levels of investment and high commodity prices.

So "we have managed to maintain a fair degree of internal balance during a period in which there has been considerable structural change, a very large shift in world relative prices, a major boom in investment and a financial crisis in many of the North Atlantic economies", Lowe says.

So how was this surprisingly OK performance achieved? Well, that's the funny thing. The two factors that have done so much to make life a misery for so many businesses - the high dollar and increased household saving - are the very same factors that have been critical to our good macro-economic performance.

The high dollar brought about by the resources boom has reduced the ability of our export industries to compete in the international market and reduced the competitiveness of our import-competing industries in our domestic market, making life very tough for many of them.

For a while, many hoped the dollar's rise would be temporary, but now "there is a greater recognition that the high exchange rate is likely to be quite persistent and firms, including in the manufacturing sector, are adjusting to this", Lowe says.

"Many are looking to improve their internal processes and address inefficiencies. They are focusing on products where value-added is highest and where the quality of the workforce is a strategic advantage. We hear from businesses right across the country that they are looking for improvements and that many are finding them."

But here's the other side of the story. Had we not experienced the sizeable appreciation, he says, it's highly likely the economy would have overheated and we would have had substantially higher inflation and substantially higher interest rates.

"This would not have been in the interests of the community at large or ... in the interests of the sector currently being adversely affected by the high exchange rate." And it's unlikely we would have avoided a substantial real exchange-rate appreciation, with it coming through the more costly route of higher inflation. (The real exchange rate is the nominal exchange rate adjusted for our inflation rate relative to those of our trading partners.)

Next, the rise in the net household saving rate from about zero to 10 per cent of household disposable income since the mid-noughties represents about an extra $90 billion a year being saved rather than consumed by households.

This reversal of the long-running trend for consumption to grow faster than household income explains much of the pain retailers and wholesalers have been suffering. We've had more retail selling capacity than we've needed, forcing shops to fight for their share of business.

But had households spent that extra $90 billion a year on consumption, it's likely there would have been significant overheating. The exchange rate would have been pushed up, the trade balance would be worse and there would have been more borrowing from the rest of the world.

"And both inflation and interest rates would have been higher. I suggest that these are not developments that would have been warmly welcomed by most in the community," Lowe concludes.

Read more >>