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Structural Changes in the Australian Economy: Part 2 – The Two Speed Economy (Q&A special)


Sharon Lai

By

August 5th, 2012


An introduction into what a ‘two-speed economy’ means, and some consequences and implications thereof.


Many of you would be aware that ESSA is hosting a Q&A event on the evening of Thursday August 16th, where our brilliant panel will be answering questions on immigration and the two-speed economy. In honour of Q&A, I have decided to continue my series on structural changes (read the first installment here) with an analysis of the two-speed economy. This article attempts to provide a snapshot of the key issues surrounding our two-speed economy and the main policy implications. I also consider some of the potential questions that our panel may be forced to contend with on the night!

The big picture

The two-speed economy refers to the resource-rich states of Western Australia and Queensland experiencing significantly stronger growth than other states, particularly the non commodity-exporting south eastern states. This has been borne through the increase in demand for our resources from the emerging economies of China and India, who are transitioning into construction-intensive stages of development.

The remainder of this relationship is relatively easy to infer with a simple exercise of comparative statics: greater demand for our commodities is leading to higher commodity prices, which in turn is evoking greater levels of mining investment.  In an address to the American Chamber of Commerce, RBA Governor Glenn Stevens noted the extraordinary speed with which mining investment has been rising over the past few years. By mid 2014, the RBA expects mining investment to reach at least 9 per cent of GDP, a proportion equal to business investment in the rest of the private economy combined (Stevens, 2012).

As such, Australia finds itself in the midst of a prolonged and sustained mining boom; a key consequence being that growth is currently concentrated within particular states and industries. The mining boom is evoking structural change in our economy, with labour and capital being diverted to these resource-rich states. Moreover, we are experiencing the largest sustained increase in the terms of trade (ratio of export to import prices) in history, which is having a profound upwards effect on our exchange rate.

 (Largely negative) impacts of the mining boom…

The real appreciation of the Australian dollar has been the primary instigator of our two-speed economy. In particular, whilst our resource-rich states have been booming as a result of their mining sectors, other states traditionally reliant on non-commodity producing, trade-exposed industries have felt immense pressure. The phenomenon by which a resources boom can have adverse effects on other trade-exposed sectors via real exchange rate appreciation is called “Dutch Disease”, a concept explored extensively by one of our panellists, W. Max Corden (see Corden, 2012).

In Victoria and other south-eastern states, manufacturing has historically been a significant contributor to both employment and output. Export-competing sectors such as manufacturing, tourism, and international education, are facing competitive pressures as the high dollar makes exports relatively more expensive for foreign consumers. Import-competing sectors, of which manufacturing is also one, also face greater competition as domestic suppliers struggle to compete with relatively cheaper imports. We are currently seeing low levels of capacity utilisation in key industries such as manufacturing, retail trade, and construction. Moreover, the strength of mining investment may be crowding out opportunities for investment in other areas, including in states such as Victoria, as labour and capital are diverted to mining-sector states to exploit the potential for higher profits.

The latest national accounts figures for the March quarter confirmed the unbalanced growth in the Australian economy. Whilst the seasonally adjusted percentage change in state final demand for the year was 14.5% in Western Australia, New South Wales recorded a comparatively meagre 1.9%, and Victoria recorded 2.7%. The past few years have been marred by job cuts in non-mining related sectors, many of which are manufacturing-related here in Victoria.

...But it’s not all bad news

As The Economist magazine stated rather eloquently, “to refer to a vast, valuable energy resource as the source of a ‘disease’ sounds rather ungrateful” (quoted in Banks, 2011). Perhaps most obviously, employees, executives, and shareholders in the mining sector reap the benefits of higher incomes and profits.  More generally, the mining boom has allowed incomes to grow over the past several years without generating inflationary pressures. The economy also benefits from the increase in tax revenue emanating from the booming mining sector. Finally, consumers have been able to benefit from cheaper imports borne through the real appreciation of the Australian dollar.

Wrapping up: policy issues and Q&A

The main policy dilemma arising from this issue is whether there is a role for government in assisting with the process of structural adjustment. There have been calls for governments to support trade-exposed industries that are struggling as a result of the mining boom. Should declining industries be propped up? I’d say it would be very difficult to find credible support for outright interventionist policies, and many would agree that industry assistance can at best, influence the pattern of employment, and even then at the expense of some workers (see Banks, 2011). On the other hand, assistance in areas that may garner productive outcomes is often constrained by ambiguous policy tools and a paucity of evidence, such as innovation policies. I would argue that ultimately, efficiency measures, reducing regulatory burdens, and achieving greater investments in infrastructure are the most effective ways to support businesses and industries facing competitive pressures. However this issue remains a sore point for economic commentators and industry stakeholders – questions relating to government assistance are definitely ones to listen out for on Q&A!

The other key question pertains to how long we could realistically expect this mining boom to last. Commodity prices are largely regarded to have now passed their peak. Especially considering that continued strength in the terms of trade is by no means inevitable, are we prepared to face the risks of prolonged unbalanced growth? In order to ensure future rises in household incomes are not accompanied by inflationary pressures, the recent slump in productivity must be reversed. Perhaps we should be focusing not on the two-speed economy, but on boosting productivity levels instead! Nevertheless, the resources boom has undoubtedly presented a very interesting conundrum for policymakers and economists to address.  As Productivity Commission Chairman Gary Banks has stated, “How we now handle the structural tensions emanating from our present good fortune will determine whether we have learnt the lessons of our own history” (Banks, 2011).

 

Hopefully some of the issues I’ve highlighted throughout this article will be run past our panel on the night of Q&A – maybe you can ask some yourself! I hope to see many of you at ESSA’s biggest event of the year. If you would like to ask a question to our panel, please register your attendance here. Also, join our conversation on Twitter with the hashtag #essaqanda!

You can follow me on Twitter @SharonLai_

Further reading

Banks, G. (2011, November). Industry assistance in a ‘patchwork economy’. Speech presented at the Australian Chamber of Commerce and Industry (ACCI) Annual Dinner, Canberra, Australia.

Corden, W. M. (2012). The Dutch Disease in Australia: Policy options for a three-speed economy. (Melbourne Institute Working Paper 5/12).

Stevens, G. (2012, June). The glass half full. Address to the American Chamber of Commerce (SA) AMCHAM Internode Business Lunch, Adelaide, Australia.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

  • Deborah

    Regarding the Banks’ quote, what is an example of this same situation occurring in Australian history and how was it handled and what was the outcome?

    • Sharon Lai

      Hi Deborah,

      Thank you for your comment! In his speech, Gary Banks recognises that structural tensions have been emanating from the current mining boom. In particular, the manufacturing industry (which is both export-competing and import competing) has been adversely affected by the appreciation of the Australian dollar. This has instigated a call for governments to support this industry (as well as tourism and international education), e.g. through cash handouts/subsidies. However Banks argues that the ultimate long-run imperative of economic management should be productivity growth, which is the only way to maximise the benefits of the mining boom and improve living standards beyond it. He argues that these interventionist policies would be counterproductive to achieving this aim, drawing on historical examples. Basically in the 1980s, the Government implemented a round of market-liberalising policies, such as tariff reductions and deregulations. These pro-competition reforms increased the incentives for firms to be more competitive and responsive to pressures and opportunities, ultimately increasing productivity. During that time, firms were supported by reforms designed to enhance their flexibility and capacity to respond to the changing environment. Banks suggests that firms are facing a similar situation today, with the high dollar and factor demands of the mining sector creating competitive pressures. Therefore he argues that instead of merely intervening with subsidies for struggling industries, governments should be implementing reforms that promote the flexibility and adaptability of industries, firms, and employees. He cites several examples of such policies, such as labour market initiatives, reducing red tape, etc.

      All this leads me to answer your question about the specific quote I had in my article. At the beginning of the 20th century, Australia was extremely prosperous due to the value the world placed on our resources. In the period from the early part of the 20th century up to the 1980s (which if you recall, began the pro-competition reforms), Australia declined in “world rankings” of per capita GDP. However these reforms meant that we were able to reverse the decline and focus on boosting productivity. We are again facing heightened demand for our commodities, and governments now have the opportunity to demonstrate whether they understand the importance of productivity-enhancing reforms, and the potential detrimental impacts of interventionist policies in specific industries. That’s basically it in a nutshell! Sorry for the extremely long comment, and please do let me know if you have further questions.

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