The Paradox of Plenty

Will the Resource Boom bust us?

Since the onset of the global financial crisis, the Australian economy has remained resilient in marked contrast to the downturn experienced by other advanced economies (Department of Treasury, 2009-2010; Department of Foreign Affairs and Trade, 2010). Primarily, the moderate growth rates recorded during this period have been influenced by increasing Asian demand for our resources combined with high commodity prices (Reserve Bank of Australia, 2009, p.8 & p.40; DFAT, 2009-10; DFAT, 2010; Australian Bureau of Agricultural and Resource Economics, 2010). However, the changing composition and direction of Australias international trade has raised concern amongst some analysts who believe that whilst the shift towards a heavily commodity-focused export base has contributed positively to our economic performance, the implications for Australias economic vulnerability and long-term prosperity must be also be considered. It will be argued in this article, the broadening of our export base would help to minimise the risk of future economic shock and the resultant threat to our long term prosperity. The influence of changing trade patterns Firstly, in determining whether Australias changing export base will expose the economy to future shocks and threaten its long-term prosperity, the trends relating to the composition and direction of international trade will need to be identified. Data released by the Australian Bureau of Statistics shows that over the last decade there has been an increase in trade between Australia and developing economies such as China and the ASEAN countries. Interestingly, the US and the EU remain important but only as a source of imports. Figure 1 provides a snapshot of these changing trade patterns. Additionally,

Figure 2 illustrates that whilst the composition of trade imports has been relatively stable, Australia has experienced a narrowing in the composition of its export base (Figure 3).

Australian Bureau of Statistics. (2010). Clearly, international demand for primary resources has changed the composition of Australias export base and heavily weighted it towards the resource sector. Whilst there is no doubt that the resultant boom has positively contributed to the Australian economy through wealth creation and an increase in tax revenues, the heavy reliance on such a narrow base has left the economy vulnerable to future shocks. On the positive side, its multiplier effects have generated increased activity elsewhere in the economy providing a broad stimulus in areas such as fuels, transport, chemicals, construction, and construction materials, and business services (Price Waterhouse Coopers, 2010; Australian Bureau of Statistics, 2010c; Australian Bureau of Statistics, 2010b). Consequently, there are many Australians who are dependent upon the resources sector directly or indirectly for their employment as well as to fund their superannuation and share portfolios. Furthermore, the increase in demand for commodities combined with the rise in 1

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commodity prices has also been credited as a reason for an extraordinary stimulus to domestic incomes since 2002 (Department of Treasury, 2008). The Australian Treasury estimated in 2008 that the terms of trade boom had increased national income by 13 % since 2002 (Garton, 2008). Thus the Australian economy is in a position of vulnerability due to the effect of the resources boom in stimulating employment, increasing export revenue and providing greater revenue to the government, as any change will negatively affect these areas. However, the economy is also in a position of vulnerability due to what is referred to as the Gregory effect or resource curse. As a result of the boom, there has been a reduction of activity in other export industries including manufacturing and tourism (Office of Economic and Statistical Research, 2010). One of the corollaries of the present resources boom is the strong exchange rate which has further squeezed the profitability of these sectors and diminished their viability. Should the resource boom end, there is concern that there will be very few remaining internationally competitive export industries able to provide employment opportunities. Additionally, Australias narrow export base has contributed to the volatility of the Current Account Deficit (CAD). In fact, Australias exports fell sharply in 2009 as a response to the global recession, which brought a reduction in demand and prices, significantly reducing the growth in export revenues and contributing to the current account deficit blowout of 23 % or $17.459 billion (ABS, 2009, 2009a). The volatility of the CAD illustrates the Australian economys vulnerability to changes in external demand and/or prices and the need to broaden the composition of international trade for long term stability and prosperity. Furthermore, Australias changing trade patterns has seen considerable reliance on specific trading partners such as China, Japan, Korea and India (DFAT, 2009).

Any change to one or more of these economies will have an impact on our balance of trade and long term profitability. In particular, there is growing concern about whether China will be able to maintain its high level of demand for Australian resources during its current period of economic transformation and reform. It is argued that Chinas inability to make effective use of monetary policy renders the Chinese economy vulnerable to shocks (Bartholomeusz, 2010). Additionally, current high levels of growth have been caused by unsustainable stimulus spending (Bartholomeusz, 2010 ). Any slight change will cause a downturn in demand and impact significantly on the Australian economy (Messenger, 2010). According to the Reserve Bank of Australia, a material slowdown in steelmaking and the construction sector in China may lead to a significant fall in commodity prices and potentially delay investment by resource companies in Australia (RBA, May 2010, p.58). In fact, the Chinese steel industry saw a brief slowdown in late 2008 which impacted negatively on Australias trade figures (DFAT, ). This indicated the vulnerability of the Australian economy to external shocks threatening long term profitability. Additionally, it can be argued the Australian economy is also vulnerable because the current situation of high demand for Australian resources will be impacted in the future by global environmental policy. In particular, the implementation of climate change response policies will challenge the growth in coal consumption by increasing the cost of using coal compared with alternative energies containing lesser amounts of greenhouse gas. Australian coal is a major component of our export base; however demand for this commodity will be affected should more environmentally sustainable resources be sought by our trading partners. The current demand for our coal supplies may also be challenged over the next decade by competition from emerging producers. Notwithstanding this threat, there will be significant opportunities for competitive Australian coal producers to 2

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expand their output and exports, provided that investment in production, transport, and port capacities is maintained (ABARE, 2010). However, it is clear that the current situation of high demand for Australian resources may not continue due to these factors and we need to expand our export base as a contingency. Cyclical factors, such as changes in demand for commodities from other trading partners will also leave Australia vulnerable. The slowing of the Japanese economy in the late 1980s and the resultant decrease in demand for commodities (DFAT, 2008) clearly demonstrated this. Other potential threats to the demand for Australian resources include competition from alternative suppliers such as India, China and Indonesia (ABARE, 2010, p.8; DAFT, 2009, p33.). Given that India has vast coal reserves, the projected growth in Indian coal demand, according to some analysts, is expected to be met principally by domestic production (Melanie & Schneider, 2010). This would have an effect on Australias balance of trade figures as India is currently Australias third largest trading partner. Following the sharp increase in thermal coal exports in recent years, the prospects for coal producers in China to capitalise further on their vast coal reserves and proximity to the Asian market are significant. Small changes at the domestic level in China can generate significant ripples in the Asian coal market and significant implications for the Australian market (ABARE, 2010, p. 9). The impact will negatively affect our long term prosperity. However, an alternative view can be advanced using data which indicates the key trends over the next five years show Australias projected imports to India expected to double (ABARE, 2010b). Even though Indian coal production is rapidly expanding ABARE noted that most of the deposits are "distant from the coastal sites of a number of the planned power stations. This could result in high transport costs and potentially unreliable deliveries. ABARE estimates that Australian resource exports will jump from 141 million tonnes in 2009-

2010 to 200 million tonnes in 2014-2015. This future view is a positive which asserts that should China choke economically other countries such as India would fill the void (Callick, 2010). As demonstrated, Australias dependency on the current demand for our commodities and the corresponding high prices for these resources has major implications for our economy. This has already attracted considerable attention particularly as the net income deficit widens ( ). Australias accumulation of substantial foreign debt could be problematic and could imply some degree of vulnerability for a small open economy subject to large external shocks, including swings in investor sentiment (RBA, 2007). If international investors believe that the Australian economys external position is not sustainable then the value of the dollar will fall. The result may be a severe economic downturn. Alternatively it can be argued that in Australias case a high level of debt may not suggest vulnerability, but merely demonstrates resilience which serves to attract foreign capital (RBA, 2007).Although large current account deficits do expose us to risks in the event of a reversal in capital inflows, these risks are mitigated by a range of factors (IMF 2006b), including the fact that our deficits are investment-driven, our healthy fiscal position and flexible exchange rate, extensive hedging of foreign exchange exposures and a robust financial system. However, the potential for external financing to create macroeconomic vulnerability requires ongoing management. In view of the implications that our economys dependency has on our exchange rate and other export sectors, it can be argued that the broadening of our export base would help to minimise the risk of future economic shock and the resultant threat to our long term prosperity

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Conclusion The global resources boom has seen Australia shift back to a heavily commodity-focused export base (ABS, 2010); however, booms do not solve the fundamental recurring problem of Australian economic history: vulnerability to changes in international demand and international financial sentiment (Conley, 2009). While few commentators argue that Australias mineral boom is likely to end in the near future, the economic viability of

the industry will continue to be challenged by external vulnerabilities of trading partners and increased environmental costs. A failure to anticipate and plan for these eventualities may result in a resource curse or worse still this country will be left with a narrow based and weak economy. An over-reliance on resource wealth is still a precarious path for Australias future, just as it has been throughout Australian economic history.

Nathan Crome, formerly with the International Monetary Fund, has since 1999 been associated with the Department of Economics of the University of Oslo.

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References Australian Bureau of Statistics. (2007). Manufacturing Indicators Australia (No. 8229.0), Canberra: ABS. Australian Economic Indicators, Australia December 2005 (No. 1350.0) Canberra: ABS. Australian Educational International Export Income to Australia from Education Services in 2009 May 2010 Retrieved August 4, 2010 from http://www.aei.gov.au/AEI/PublicationsAndResearch/Snapshots/2010052810pdf

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