High dollar to hammer government budgets



The mining investment boom which has largely insulated us from the travails of the global economy is one chapter of that. But it would be a mistake to assume that the pressures of structural change will fade away because the investment boom has plateaued.

Emerging Asia’s growth already has weakened the connection between the Australian and the major developed economies.

In its new report on Australia, the Organisation for Economic Co-operation and Development argues that the pressure for structural adjustment is likely to increase. The centre of gravity of global activity, it says, is shifting east, from the mid-Atlantic in 1980 to Bucharest in 2008. By 2050 it will lie between India and China.

Specialisation, innovation, productivity and incomes generally increase the closer you get to the major economic markets, and the world’s major markets are coming closer to us.

However, not all industries will benefit equally.

The growth of Asia as the world’s centre of manufacturing already has seen the decline of production in the rich economies of standardised manufactured goods like steel, clothing, electronic goods, tools, and household appliances and, increasingly, cars.

These pressures have intensified in Australia as the mining boom and associated exchange rate appreciation have squeezed other trade-exposed industries.

The pattern of change will get more complicated as Asian economies become richer and Western economies develop new specialties and find new market niches among Asia’s consumers and industries.

The success stories are most likely to emerge from industries built on Australia’s highly skilled workers, and its natural resources and expertise in mining and agriculture. But there will be winners and losers in unexpected places.

But, the OECD warns, Asia’s rapid development, and the opportunities and pressures that creates, will mean continuing shifts of resources both between and within sectors.

The expansion of the mining sector also means the Australian economy will become more cyclical. Commodity prices are volatile because the supply is relatively unresponsive to changes in the economic cycle and demand. Prices of iron ore and coal boomed because miners could not expand supply quickly enough to keep pace with China’s demand growth. But any downturn in demand in the future will see prices fall very sharply. That’s because most of the cost of expanding supply is in building the new mine capacity. Operating costs are relatively low. For that reason, production won’t fall in line with demand. Miners will maintain their output so long as the price is high enough to cover their variable costs and make a contribution to their enormous fixed costs.

A more volatile economy will demand more flexibility in product and labour markets, in banking, and government finance.

The OECD also warns of the potential change in the role of the exchange rate. It talks of a “certain disconnection" between the dollar and the terms of trade which, if continued, could reduce the exchange rate’s stabilising effect on the economy.

A substantial weakening of the exchange rate’s shock-absorbing effect would impact on both major political parties.

Their simple commitment to budget surpluses makes them dependent on the stabilising effects of the dollar.

They might now have to re-educate voters on the role of budgets and their automatic stabilisers: the cyclical variations in revenue and spending that naturally pull the budget between surplus and deficit, and thereby helps stabilise the economy.

The Australian Financial Review