Structural Changes in the Australian Economy: Part 1

Part 1 – The Modernisation of China, Our Commodities Boom, and Structural Adjustment. 

 

This article is the first of a series of macroeconomic analyses which I’ll be conducting on the changing structure of the Australian economy. In recent years, economic commentators and policymakers alike have been uttering the words “structural change” faster and more often than the RBA can say: “At its meeting today, the Board decided to…” As this term is likely to remain on everyone’s lips in the foreseeable future, it’s high time to make sense of it. We’ve all heard statements being thrown around like “once-in-a century terms of trade”, “two-speed economy”, and even “Dutch Disease”. What are the linkages between these concepts? Are union heavyweights and other interest groups justified in lambasting the RBA’s reluctance to cut the cash rate this year? Closely related to this, is the question of whether policy has a role to play in assisting with the process of structural adjustment. Moreover, is the manufacturing industry really dying, and where does productivity fit into all of this? This series will examine all of these questions and more, beginning with an overview of the commodities boom, moving into a manufacturing-related, sector-specific analysis of trends, and concluding with some opinion pieces on the appropriate role of policy.

To the average individual, “structural change” is becoming an all-encompassing and generic term, used almost catatonically by policymakers to explain differences in growth between our mining and non-mining states and industries, and quite abrasively by interest groups to force said policymakers into action. However structural change is of course, always occurring, and indeed, is always necessary. It is a crucial accompaniment to any country’s advancement through the stages of economic development and growth – a booming economy that experiences a shift in industry structure from agriculture to manufacturing reaps the benefits of higher growth and improved living standards. This exact transition has been occurring in China and India for the past decade. Put another way, structural change is a consequence of China being well on its way to becoming the world’s largest economy. However the necessity and benefits of structural change do not detract from the potential for adjustment to be painful and drawn out, as lobbyists for government assistance to manufacturing will no doubt agree.

Although the commodities boom will be the focus of this article, a brief digression is warranted to consider other causes of structural change. In particular, the past 50 years has seen the services sector expand its share of output and employment whilst witnessing the decline of manufacturing and agriculture. Structural changes in consumption behaviour have supported this trend, with the demand for services increasing faster than the demand for goods following rising incomes. The increasing prominence of the services sector can also be attributed to services being non-tradeable and produced domestically. These trends, which are underpinned by Australia’s transition into a knowledge-based and service-oriented economy, have also been observed in all high income countries.

Notwithstanding that growth in the services sector is an important part of Australia’s structural change story, the main point of interest in this article is that we are currently in the midst of a significant and prolonged commodities boom. This boom has been driven by the exact modernisation and industrialisation of China and India described above. As these economies move into more advanced stages of economic development, their demands for steel and energy have inevitably skyrocketed. Australia is well endowed with natural resources and is already the world’s largest exporter of iron ore and coking coal. As a consequence of the greater demand for our resources, we are currently experiencing what’s likely to be the largest sustained increase in our terms of trade in history. Closely aligned with this trend has been the spike in the Australian dollar. The high dollar is the key instigator of what we now refer to as “structural change”, as non-commodity producing, trade-exposed sectors are faced with heightened competitive pressures.

A crucial point to note is that the GDP in specific sectors cannot sum up to be more than 100% of overall GDP. Therefore, the expansion of commodity-producing sectors as a proportion of GDP implies that other sectors have to shrink as a proportion of GDP. A high exchange rate implies that exports are less internationally competitive whilst imports are relatively cheaper. As such, the sectors likely to be in decline are those facing competition from lower prices of imported goods and services. In the current environment, manufacturing and tourism have been hit the hardest. Combined with the high resource prices currently inflicted by the terms of trade, labour and capital are being driven out of non-resource sectors and into mining. This is where the “two-speed economy” argument emerges, whereby the resource-rich states of Western Australia and Queensland have been experiencing relatively stronger growth than the rest of the country. The issues surrounding the two-speed economy and the manufacturing industry will be examined more closely in forthcoming articles.

The fact that structural adjustment is occurring is indisputable. The fact that it is inducing clear ‘losers’ is also evident. The question that remains is what role policy should play in assisting the structural adjustment, and indeed whether structural change should be occurring at all. Although potential policy responses will be discussed in future articles, I will conclude now with some brief comments. The only logical reason why structural change should be prevented is if policymakers believe that the mining boom is the corollary of a temporary demand-side shock. The RBA’s reluctance to cut the cash rate this year despite some soft data releases suggests confidence in the continued demand for our resources from China. When considering our rich reserves of natural resources and the benefits of the mining boom to date, structural change should not be prevented. Yet as discussed, the process of structural adjustment can leave some industries and states struggling to catch up. Therefore although the exact role of policy remains quite ambiguous and widely debated, there may be a case for assistance in some form.