Australia in the world economy: shock-proof or just plain lucky?

November 17, 1993

Dick Nichols

The Australian economy has entered its 15th straight year of growth — its longest ever. It sailed through the 1997-98 Asian economic crisis and the 2001 global recession and now, with China sucking in enormous volumes of high-priced Australian iron ore, coal and gas, there's no sign of an end to the bonanza.

In 2005, the explosion in raw materials prices boosted Australia's terms of trade (prices of exports compared to prices of imports) by 13%, to a level not seen since the 1950s Korean War-driven wool boom.

Growth among Australia's other main trading partners is adding shine to the picture. In April, the International Monetary Fund (IMF) increased its forecast for world growth by 0.6 percentage points to 4.9%, the highest for 30 years. Financial markets, as tracked by the IMF's Global Financial Stability Report, show "unusually low risk premia and volatility".

The "average Australian" has certainly got wealthier since the last recession (1990-91). Real per capita income has grown by 40% and the net financial wealth of a working-age Australian has doubled in real terms.

Of course, this growing pie has been divvied up very unevenly, with Australia's top 200 corporations and their CEOs getting a whopping slice, the top 10-15% of wage and salary earners a decent chunk and the working majority some crumbs (usually just before PM John Howard faces an election).

And the price of this "Australian economic miracle"? People working harder, longer and under greater stress; ongoing pillage of the natural environment; a collapse in infrastructure spending and very little reduction in the numbers living below the poverty line.

But how shock-proof have 25 years of economic rationalist "reforms" made this grotesquely unjust model? Is the 15-year boom more the result of such policies or of good luck?

Profit bonanza

The economy's basic motor remains the strength of business investment, which has lifted total investment (including that in housing and by government) above its historic average of 24.5% of GDP. Since mid-2002 business investment has grown at an annual rate of 14%, replacing household consumption as the main driver of growth.

Short of a crisis elsewhere in the world economy, it is hard to see this investment cycle turning down soon. How could the "investment climate" for the boardrooms be better than the present combination of high profitability, rising share prices, oceans of retained earnings and low real interest rates?

Despite some recent nervous "corrections" provoked by fears of a crash in intensely speculative world commodities markets, the Australian share market is at a record level. And unlike the years before the 1987 share market crash, this increase so far corresponds to a real lift in profits — up 24% over the year to December 2005.

At the same time that other den of speculation, the housing market, has been temporarily brought in to the "soft landing" planned for it in 2003 by the Reserve Bank of Australia (RBA).

The rise in world oil prices is yet to spur the sort of inflation that would force sharp increases in interest rates — the RBA's recent 0.25 percentage point rise was a touch on the brakes done in the hope of avoiding a bigger rate hike later on. And while wage growth in 2005 averaged 4.2% and there are labour shortages across an increasing spread of skills and professions, business surveys still show expected inflation holding at just under 3% (the top of the RBA's target range).

Overseas corporations and financial institutions continue to show great belief in Australia as a profit opportunity. The current account deficit (CAD) — the difference between revenue from exports and Australian investments abroad as against spending on imports and revenue repatriated to foreigners investing in Australia — reached a record 7.2% of GDP in the December quarter of 2004.

Nonetheless, since mid-2004 the Australian dollar has slightly appreciated against the US dollar, the euro and the yen.

The real interest differential between Australian and US bonds — the risk premium demanded by overseas investors for lending to Australian governments and corporations — now hovers around zero (after being as high as 4% in 1993).

This confidence has largely been won through the continuing successes of Australian governments, Liberal and Labor, in implementing the capital-friendly recipes of economic rationalism.

Inflation? It was smashed by Paul Keating's 1990-91 "recession we had to have" and kept low ever since by RBA determination not to let it escape the 2-3% target range (and ACTU acceptance of this).

The federal budget deficit? This has been put into surplus such that federal government debt (still $96 billion in 1996) could be paid off.

Productivity? Its annual average growth rate reached 3.2% in the upturn after the 1990-91 recession (1% more than the historical trend), due overwhelmingly to Labor's introduction of enterprise bargaining and Howard's 1996 Workplace Relations Act.

Australia's secular terms of trade decline? Overturned, but here Canberra can claim only a part of the credit. Though partly due to increased exports of manufactures and services, this trend reversal has mainly been driven by the huge fall in the prices of imported manufactures from Asia, especially China.

CAD vulnerability?

What about Australia's chronic CAD and foreign debt burden, which caused so much angst in the 1980s, and which continues to average 4.5% of GDP, $56 billion for 2006? In the early 1990s economic commentators of all stripes (including this one) believed that the CAD set a "speed limit" for the Australian economy.

The conviction was that a growth rate much over 3.5% would suck in imports at such a pace that the CAD would rapidly widen and interest rates would have to rise to attract capital inflows. That would increase the risk of a downturn in investment and even recession. But growth averaging 3.9% in the 1990s disproved this theorem.

The key point to grasp here is that the CAD of any national economy also measures the degree to which domestic investors (corporate, government and household) draw on foreign savings to fund that part of their investment that is not funded by domestic savings.

Australia, like every other "frontier" capitalist economy, has traditionally been inserted into the world economy in this way, permanently drawing on the savings of older capitalist economies to help fund development. That is, in terms of its balance of payments, the Australian economy has nearly always run a surplus on its capital account, the mirror image of its CAD.

There is nothing wrong with running a CAD year after year, provided that foreign investors are happy enough with the deal they're getting and don't see any threats that would make them "head for the exits" — like a drastic Australian dollar depreciation devaluing their investments in terms of other currencies. And the greater their confidence, the lower will be the real interest rate needed to lure them into holding Australian debt, the more they'll invest in exploiting Australian labour, and the easier monetary policy, and the faster growth, can be.

This is what happened in the 1990s. Once the "investment community" became convinced that the RBA would lock in low inflation and the Howard government budget surpluses, the rate of investment in Australian assets accelerated and risk premia on Australian debt quickly shrank. As a result, net foreign private debt as a proportion of GDP has nearly doubled since 1995, from 26% to 48%.

Not that Australia's policymakers have become blase about the CAD and Australia's foreign liabilities — that's a big ongoing discussion. Rather, they have attacked the gap between investment and savings that it expresses directly by introducing forced savings (superannuation) schemes and the Future Fund, and by running government budget surpluses and paying off the government part of foreign debt. That this hasn't automatically reduced the CAD is due to the fact that any government penny-pinching can always be offset by increases in private investment and/or falls in private saving.

Nonetheless, the experience of the five "Anglo-Saxon" economies over this period — Australia, New Zealand, Canada, Britain and the US, all of which have experienced a big housing boom — shows that it has only been in those that have eliminated government budget deficits that the overall savings rate has been maintained (Australia, New Zealand) or increased (Canada) — even as the overall rate of investment has risen.

This result confirms research which has found that every dollar added to government budget surpluses increases total savings on average by 50 cents (see IMF World Economic Outlook, September 2005).

Brilliant or lucky?

Australia's economic policymakers would have us believe that the economic rationalist crusade is the main reason for Australia's 15-year growth phase. There is only a little truth to that claim — most developed capitalist countries enjoyed low inflation growth in the 1990s. And Australia has been ideally placed to feed off the ongoing Chinese boom, which would have sustained growth in almost any policy environment.

Australia's success in navigating the 1997-98 Asian econo0mic crisis was as much due to the extra influx of overseas funds seeking a "safe haven" than the cleverly depreciated Australian dollar. Or rather, this influx of capital fleeing the Asian mess freed the RBA to allow the cash rate to fall to 4.75% without having to worry about the impact on the CAD.

The RBA's acceptance of the depreciation of the Australian dollar by almost a quarter allowed boosted internal demand to sustain growth, despite the shrinkage of important Asian export markets.

By contrast New Zealand policymakers initially tried to defend their dollar by raising interest rates, producing a recession in 1998.

A similar tactic allowed the Australian economy to weather the 2000-01 global downturn, during which the RBA cut the cash rate from 6% to 4.25%. Then, when the speculative bubble in housing looked like getting out of control in 2002-03, rates were raised.

So, by reducing the need to worry about the CAD, the "reforms" have helped sustain the boom. But the Australian CAD, while not imposing any speed limit in the simple sense, still remains a critical point of vulnerability. Preventing foreign capital from exiting the economy means not upsetting corporate confidence — all policy must be directed to that end.

But is it all enough to guarantee that Australia will ride out the next financial tsunami or global recession as buoyantly as in 1997 and 2001?

[Dick Nichols is the managing editor of Seeing Red. For sources used in this article email <>.]

From Green Left Weekly, June 14, 2006.
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