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Growth, investment, and trade

Doug McTaggartSeptember 2010

2

Agenda

- US

• Recession and recovery

- Why Australia did well

- Openness and the Australian economy

- The commodities boom and Australia

• Sustainability

• Dutch disease

- Global structural imbalances

- Concerns

• Data requirements

3

GFC and the real economy – a recap

- Collapse of financial sector leverage led to a collapse of world growth in the fourth quarter 2008

- Order of proceedings was• Household confidence folded September 2008• Retail sales and broader consumption fell• Inventories/sales ratio soared• Business confidence collapsed• Manufacturing collapsed• Business investment contracted• Unemployment up

- End result• Collapse in inventories and world trade• Slowest global growth in over 50 years

4

A recession in US and Euro manufacturing

Because discretionary consumer spending collapsed, inventories accumulated in a totally unexpected way. This led to a collapse in manufacturing

Industrial production fell at the rate of 12 per cent per year in the US, 20 per year on Europe, and 40 per cent per year in Japan

-25

-20

-15

-10

-5

0

5

10

15

per

cen

t p

er

year

Annual growth in industrial production

Eurozone

United States

1.2

1.3

1.4

1.5

1.6

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

per

cen

tInventory to sales ratio -- US

5

World trade collapsed as in Great Depression

The decline in world trade was the largest seen in many decades, largely the result of contracting household consumption of discretionary consumer goods, compounded by the freeze in credit

What the world trades most are:

• Bulk commodities

• Discretionary consumer product

What the world stopped buying was discretionary consumer product

-40

-30

-20

-10

0

10

20

30

40

50

60

Jan-

80

Jan-

82

Jan-

84

Jan-

86

Jan-

88

Jan-

90

Jan-

92

Jan-

94

Jan-

96

Jan-

98

Jan-

00

Jan-

02

Jan-

04

Jan-

06

Jan-

08

Jan-

10

Jan-

12

per

cent

per

yea

r

Developing economies

Developed economies

Growth in world trade

6

The V-shaped global recession

Measured real GDP growth fell in nearly all economies

September 2007 shaped as the trough in a “normal” business cycle, until the GFC hit

A V-shaped deep trough occurred

Australia fared better than most, though now the pack is catching up

-6

-4

-2

0

2

4

6

8

10

Mar

-80

Mar

-82

Mar

-84

Mar

-86

Mar

-88

Mar

-90

Mar

-92

Mar

-94

Mar

-96

Mar

-98

Mar

-00

Mar

-02

Mar

-04

Mar

-06

Mar

-08

Mar

-10

Mar

-12

% p

er y

ear

.

US UK Canada Australia

Real GDP growth per year

7

This US recovery is par for the course

99

100

101

102

103

104

105

106

107

-4 -3 -2 -1 0 1 2 3 4 5 6 7 8

US Real GDP (NBER trough = 100)

Quarters around NBER trough

Nov 2001

Mar 1991June 2009*

* QIC assumed trough. NBER is yet toreport a trough date.

98

99

100

101

102

103

104

105

106

107

-12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24

US private non-farm payroll employment (NBER trough = 100)

Months around NBER trough

Nov 2001

Mar 1991

June 2009*

* QIC assumed trough. NBER is yet toreport a trough date.

The US economy has recovered from the deep recession about as fast as it could have, and at least as fast as in past recessions

Why the current paranoia regarding double dips and so?

Because attitudes to risk have changed dramatically over the last two years

8

The US economy reinvents itself …. again

By allowing the unemployment rate to reach double figures the US economy again goes through a process of “creative destruction”

The process of reinventing itself every decade or so ensures that the US remains the most efficient economy on the globe, with the best prospects for future growth

To paraphrase George Friedman: “This is the beginning of the American Century”

change in output per hour

-2

-1

0

1

2

3

4

5

6

7

% p

er

year

Change in unit labour costs

-6

-4

-2

0

2

4

6

8

10

12

14

Ma

r-8

0

Ma

r-8

2

Ma

r-8

4

Ma

r-8

6

Ma

r-8

8

Ma

r-9

0

Ma

r-9

2

Ma

r-9

4

Ma

r-9

6

Ma

r-9

8

Ma

r-0

0

Ma

r-0

2

Ma

r-0

4

Ma

r-0

6

Ma

r-0

8

Ma

r-1

0

Ma

r-1

2

% p

er

ye

ar

9

Why the US is so important

0

5

10

15

20

25

SSA ARG AUS BRA CHI FRA GER IND JAP RUS UK US

per

cent

PPP Constant (2000) US$

Consumption shares of global output2007

World Bank data for 2007 show why the US is so important for all in the global economy.

US household consumption accounts for one third of total global consumption and about one fifth of world output (slightly lower with PPP estimates)

China and other emerging economies have a long way to go be dominant forces in the global economy

10

Conclusions on the US

- The recent recession was one delivered by rational consumer behaviour as they took steps to guard against a financial market melt-down – the recession we chose to have

- Even as global financial markets are de-leveraging by about 50%, there is no evidence that households (US and other) are de-leveraging or are having to de-leverage going forward

- US economic growth will quickly return to trend

- The US economy again reinvents itself

- The US economy, led by the US consumer, is and will remain the engine of world growth. Other economies are largely dependent on the US and the broader Anglo-world

11

How has Australia done through the GFC?

The Australian business cycle is still highly correlated with the US business cycle, albeit we have done somewhat better in recent times

It is clear the US drives the Australian business cycle

And note that average GDP growth was higher before the commodities boom than it was after:

3.3% 1990-2004

3.0% 2004-10

Real GDP growth

-6

-4

-2

0

2

4

6

8

10

Mar

-80

Mar

-82

Mar

-84

Mar

-86

Mar

-88

Mar

-90

Mar

-92

Mar

-94

Mar

-96

Mar

-98

Mar

-00

Mar

-02

Mar

-04

Mar

-06

Mar

-08

Mar

-10

Mar

-12

per

cent

per

yea

r

US Australia

12

Why Australia did relatively well

- Robust financial sector – even though relatively large

- National, uniform prudential legislation

- High immigration rates

- High initial interest rates

- Variable rate mortgages and consequent large fall

- Falling oil/petrol prices

- Recent experience with skilled labour shortages, labour hoarding

- Relatively small manufacturing sector

- Predominance of bulk commodity exports

- Stimulus packages

13

How open is the Australian economy?

0

30

60

90

120

150

per c

ent

1970 2008

Imports + exports as a share of GDP1970 and 2008

211 / 361Not very, relatively speaking!

So the question is, just how much did Australia’s success through the GFC revolve around our trade links with Asia, in general, and China, in particular, via commodity exports?

Note that Australia always was and still remains a relatively closed economy. We sit alongside the US and Japan – very large internal markets – and also Brazil, Argentina and India

14

The commodity price boom

50

60

70

80

90

100

110

120

130

Sep

-59

Sep

-62

Sep

-65

Sep

-68

Sep

-71

Sep

-74

Sep

-77

Sep

-80

Sep

-83

Sep

-86

Sep

-89

Sep

-92

Sep

-95

Sep

-98

Sep

-01

Sep

-04

Sep

-07

Sep

-10

2007-0

8 =

100

The terms of trade

0

40

80

120

160

200

240

280

320

Apr-02 Apr-04 Apr-06 Apr-08 Apr-10

Coking coal

Iron ore

Thermal coal

Benchmark commodity prices (US$/t)

The commodities boom, beginning in the early 2000s, but accelerating in 2004, has been very much a price boom.

It has both supply and demand elements.

Global stocks of commodities, especially base metals, reached record lows in 2004, fuelling price rises

This coincided with increasing demand for Australian coal and iron ore from China, which between 2004 and 2008 went from being the world’s largest importer of steel to the world’s largest exporter

15

The booming commodities sector

0

10

20

30

40

50

60

70

80

90

Ju

n-8

7

Ju

n-8

9

Ju

n-9

1

Ju

n-9

3

Ju

n-9

5

Ju

n-9

7

Ju

n-9

9

Ju

n-0

1

Ju

n-0

3

Ju

n-0

5

Ju

n-0

7

Ju

n-0

9

Ju

n-1

1

per

cen

t

Plant and equipment

Buildings and structures

Type of capex

0

10

20

30

40

50

60

70

per

cen

t

Other selected industries

Mining

Manufacturing

Industry share of capex

The re-direction of resource utilisation in Australia has been dramatic as seen in business investment outcomes:

• Mining has squeezed out capex spending in manufacturing

• Capex spending in buildings and structures has squeezed out capex in plant and equipment

16

Uneven state impacts

The impacts have not been uniformly positive across Australia

• WA has dramatically increased its capex share, largely at the expense of NSW, with less significant impacts on VIC and SA

• QLD has done moderately well

0

5

10

15

20

25

30

35

40

45

Jun

-89

Jun

-91

Jun

-93

Jun

-95

Jun

-97

Jun

-99

Jun

-01

Jun

-03

Jun

-05

Jun

-07

Jun

-09

Jun

-11

Jun

-13

per

cen

t

WA

NSW

QLDVIC

SA

State share of capex

17

And trade impacts?

For the entire period of the commodities boom, Australia’s trade balance has deteriorated, except when imports crashed during the GFC as households curtailed consumption

But isn’t the commodities boom, for Australia, an export led boom?

What has happened?

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

Mar-

80

Mar-

82

Mar-

84

Mar-

86

Mar-

88

Mar-

90

Mar-

92

Mar-

94

Mar-

96

Mar-

98

Mar-

00

Mar-

02

Mar-

04

Mar-

06

Mar-

08

Mar-

10

Mar-

12

perc

en

tag

e p

oin

ts

Net exports contribution to GDP growth

GFC

Commodities boom

-4

-2

0

2

4

6

8

10

per

cen

t

Real trade balance as a share of GDP

18

Currency valuation effects

As the AUD appreciated, tourism changed from a large export industry to a large import industry

This is a dramatic example of the Dutch Disease (Gregory Thesis), and it applies across the board to all Australia export sectors outside of the resources sector

We haven’t managed this very well.

-200000

-150000

-100000

-50000

0

50000

100000

150000

Jan-0

0

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1

Jan-1

2

nu

mb

er p

er q

uar

ter

0.4000

0.5000

0.6000

0.7000

0.8000

0.9000

1.0000

1.1000

US

D/A

UD

Net outbound departures

USD/AUD

Tourism as an import industry

Tourism as an export industry

The Dutch disease

19

The states and the Dutch disease

The net effect of the Dutch disease was very positive for WA, good for QLD and very bad for the other states, leading to the two speed economy

The GFC brought a temporary end to this disparity but it looks likely to emerge again, when spending stabilises

-6

-4

-2

0

2

4

6

8

10

12

14

16

18

Mar

-00

Sep

-00

Mar

-01

Sep

-01

Mar

-02

Sep

-02

Mar

-03

Sep

-03

Mar

-04

Sep

-04

Mar

-05

Sep

-05

Mar

-06

Sep

-06

Mar

-07

Sep

-07

Mar

-08

Sep

-08

Mar

-09

Sep

-09

Mar

-10

Sep

-10

Mar

-11

per

cen

t p

er y

ear

QLD WA

NSW SA

VIC

20

Are structural imbalances an impediment?

-1000

-800

-600

-400

-200

0

200

400

600

US

$ B

illio

n

China

GermanyJapan

Saudi

AustUK

USA

Current account deficits

Are they structural imbalances at all?

Those countries with (relatively) large and persistent CA deficits are Anglo, rapidly growing and demographically young.

These are good environments for foreign investment

• Good governance

• Transparent

• High yielding

And are likely to continue to attract foreign investment flows for a long time to come

21

Productivity growth also dissappointing

Productivity growth through the commodities boom has also been disappointingly low.

There are a number of possible explanations for this:

• Capacity limitations

• Lower R&D

• A 3-sector problem – agriculture, mining and utilities

• Slower micro-reformFred Hilmer: “What’s wrong with microeconomic reform today?”, UNSW, 31 August 2010

22

What are the concerns?

- Is Australia putting all its eggs in the China basket and ignoring more traditional sources of growth?

- Is the commodities price boom sustainable? The supply effect.

- Will the China effect persist?

- If so, how do we deal with structural re-alignment of Australian industry that is required?

• Stolper-Samuelson: return to capital intensive factors (physical and human capital -- skilled labour) goes up, return to other factors goes down (less skilled labour)

• Capital-labour ratios rise

- What are the cross-jurisdictional implications?

23

Data issues

- To understand the impact on the structure of the Australian economy, we require an integrated database by industry and region that is:• Consistent with the national accounts• At the same level of disaggregation as the input/output data• Includes estimates of:

Capital formation;

Capital stock; and

Return to capital.

- Problems with what we have:• Annual national accounts lack sufficient industry disaggregation and a

return on capital measure;• Quarterly business indicators definition may differ from national accounts

and lacks sufficient industry disaggregation • Input/output data lacks timeliness, a measure of the industry capital stock

and return to capital.