Learning to love the Boom

For now, other factors contribute more than productivty (MFP) to our wealth

Sensation sells, of course (“Salut DSK!“). Today’s Australian carries a gloom-laden account of Treasury Secretary Martin Parkinson’s address to the Melbourne Institute’s Economic and Social Outlook conference about structural challenges posed by the minerals boom.

But newspapers have been slower to pick up on two other talks at the same conference that I found still more valuable. One was by Tony Abbott, who lucidly explained why the Gillard/Brown carbon tax is an expensive, insufficiently-evaluated, deceptive policy that is inappropriate for its stated objective (no remarks at all about climate change, incidentally).

The most interesting paper I have seen, however, was a timely, typically-enlightening presentation by Gary Banks (Productivity Commission Chairman) entitled Australia’s Mining Boom: What’s the Problem?. It is on the same topic as Parkinson’s talk but based on a longer view and—while not apparently inconsistent with the Treasury view—much more sanguine about the strength of the economy and the manageable size of future challenges.

The problems posed for Australia by the mining boom are not the associated structural changes. To the extent that we have a two (or more) speed economy, that should be welcomed as the mechanism by which we are capitalising on our external good fortune, yielding higher living standards for Australians. The real challenge confronting policy makers is to ensure that the adjustments can proceed smoothly. This also means holding the line on past reforms that have enhanced our economys flexibility and avoiding introducing new rigidities.

Banks practices what he recommends: sifting the evidence before deciding that a problem exists and well before leaping to a “solution”. In the course of a short paper and presentation Banks describes an economy that has changed, dramatically, for the better since our last minerals-led boom in the 1970s thanks to a long—and incomplete—series of structural reforms based on evidence and consultation not ideology and leadership “elites”. He reviews the options for savings, investments, “rescuing” industries suffering the appreciation of the dollar and for recovering fiscal balance after the “stimulus” (suggesting we put the cleaners through one troubling trough of government excess)…

Manufacturing share of output has fallen steadily for decades as our wealth has tripled

Banks begins by looking at the wood, rather than the trees. The “two speed” minerals boom economy is in fact a wonderful source of national luck and riches; the supposed “hollowing out” of the manufacturing sector and the rapid growth in service sector employment is an acceleration of a long-established trend (and anyway, manufacturing output continues to grow); inflation is well-controlled thanks to a floating exchange rate that allows the real-rate of exchange to rise as necessary, keeping prices under control, and; wage settlements have been unexceptional during this boom, thanks to the dismantling of the old centralised wage-fixing structures.

He sees no benefit in a “sovereign wealth fund” to sterilise foreign income flows (which as Ken Henry has observed can also be achieved by retiring government debt) and he notes that, in view of our exposure to uncertain events (Chinese growth rates, sovereign defaults in Greece etc) individuals seem to be managing their own income volatility risks without the use of less efficient wealth funds.

Banks acknowledges that labor productivity has fallen but points out that the weakening of the output/input ratio is due to the massive increase in labor and capital inputs into minerals (and other) sectors; we are enjoying unprecedented wealth as a result, so there is hardly any call for concern about a short term decline in productivity (of course, productivity must rise again in future to sustain growth once the boom dissipates). Only in the long run is productivity (as Krugman’s dictum has it) “nearly everything” about the sources of wealth. In the short-term—where we live and make public policy—there are other factors that may predominate (see the graph at the top of this post).

Banks has recommendations to make on the topic of “fiscal consolidation” to restore the balances that we had achieved prior to the GFC stimuli. On the income side, Banks declines to offer a view about the appropriate level of a minerals resource tax, except to note that it is a subject of keen interest to the owners of competitive resources in Latin America, implying that there is a big penalty for squeezing too hard. On the expenditure side, he notes that a number of programs for which there was little evidence of net benefit before their adoption (“Cash for Clunkers”, the “green” car initiative) have been withdrawn. He says nothing of the NBN—although it too is un-evaluated, an extraordinary technological risk (locked-in to fibre) and a retrograde monopoly—possibly because the Commission has already criticised the absence of a cost-benefit analysis and the NBN is now settled policy of the Labor/Green/Independent alliance.

Instead—reprising a theme he developed last year— Banks launches into defence procurement:

…no doubt there is more low-hanging fruit waiting to be picked. For example, the case for Australia spending $36 billion or so on another dozen homemade submarines, when imported alternatives could be purchased for a fraction of the cost (and risk) has never been adequately explained publicly notwithstanding the generally acknowledged failure of the Collins Class precedent. The whole area of defence procurement seems ripe for a thorough independent review

Although his speech reprises (and extends) remarks he made last year on fiscal policy and the structural challenges of the minerals boom, Gary Banks has again done us great service in this talk. The Commission demonstrates, fortunately, that good public policy practice can moderate and make sense of what is otherwise a confused and sensationalised battle between interested agendas.

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