Glenn Stevens: Australia and Canada - comparing notes on recent
experiences1
Remarks by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the Canadian
Australian Chamber of Commerce, Canada-Australia Breakfast, Sydney, 19 May 2009.
* * *
Thank you for the invitation to be here. As a one-time temporary resident of Canada and
graduate of a Canadian university, it is pleasing for me to see the Canadian Australian
Chamber of Commerce contributing to economic interaction between the two countries.
It is surprising that Australians and Canadians do not spend more time comparing notes,
given the things we have in common. Apart from a shared heritage as members of the British
Commonwealth (though Canada, of course, has the French-speaking heritage as well),2 we
are both federal states and constitutional monarchies. Both nations have relatively small
populations that occupy physically large continents. We are both commodities producers.
Our economies are open, and free flows of trade and capital are very important to us.
There are some interesting similarities, and the occasional informative difference, in
experiences, and examining these is helpful for Australians to understand better the way the
past six or seven years have evolved. I propose to look at some of those today.
Looking to the future, both our countries have reason to believe that we will come through
this episode in reasonable shape. We also have important shared interests in the way the
international economic and financial system evolves over the years ahead. In canvassing
some of these issues, I am mindful that David Dodge, the former Governor of the Bank of
Canada, spoke to this group only a few years ago, concerning many of the same questions.3
I find myself agreeing with the sentiments he expressed then, and repeating many of them
today.
Similarities, differences and recent developments
Australia and Canada have similar levels of GDP per capita (based on purchasing power
parity, nominal GDP per capita was around US$37 000 for Australia and US$39 000 for
Canada in 2008). Since 1990, Australia's growth in real GDP per capita has been a little
higher than Canada's.
In terms of economic structure, the primary production sectors, combined, are of similar size
in the two countries (Table 1). Australia has less manufacturing, but more mining than
Canada. There are also some notable differences in the composition of our mining sectors.
Both these turn out to have been of some importance over recent years, as I shall point out
shortly. But, overall, the economic structures of the two countries at a very broad level are
reasonably similar and, beyond the resource sector concentration, not all that different from
the "norm" among industrialised economies.
Trade and financial flows between Australia and Canada are small - Canada accounted for
around 1 per cent of Australia's merchandise exports and imports in 2008, and around 1 per
cent of foreign investment received by Australia.
But trade overall is very important to Australia, and even more so to Canada. Exports of
goods and services amounted to just under a quarter of Australian GDP in 2008 and more
than a third of Canadian GDP. Commodities make up a significant share of the value of
merchandise exports in both countries, although they are rather more important to Australia,
as Canada also has sizeable exports of machinery, equipment and cars (Table 2). The
composition of the two countries' commodity exports differs somewhat - Canada's exports
include a larger share of crude oil, natural gas and forestry products, while Australia has a
larger share of exports in coal, iron ore and many metals.
Commodity prices tend to vary quite a bit, of course, driven largely by the ebb and flow of the
world business cycle. This means that fluctuations in the terms of trade have long been an
important feature of both countries' economic experiences. For many years, the movements
seemed to be quite similar - at least until the international downturn of 2001 (Graph 1).
Graph 1
In the subsequent global upswing, while both countries saw their terms of trade increase,
Australia's terms of trade began to pull ahead of Canada's. Between the beginning of 2002
and the middle of last year, the Canadian terms of trade had risen by more than 30 per cent.
But over the same period, the Australian terms of trade rose by over 60 per cent.
Why the difference? The answer is that the more rapid rise for Australia reflected the fact that
our exports have a higher share of commodities, and within that, a higher weighting towards
the commodities that had experienced the largest price increases (Table 3). That said, since
Canada's trade share of the economy is considerably larger than Australia's, the smaller size
of the terms of trade rise in Canada still imparted a pretty significant boost to national
income.
Income gains driven by the terms of trade are generally expansionary. The boost would be
expected, other things equal, to result in stronger growth in demand and output relative to
capacity, more risk of inflation, higher interest rates and a rise in the exchange rate, relative
to countries that did not share the shock.
So it seemed to turn out. In the phase of the terms of trade upswing, both our countries saw
growth above average, interest and exchange rates rising and some upward pressure on
inflation. There were, nonetheless, some differences. The Australian dollar did not rise as
much as the Canadian dollar, which is a bit surprising given Australia's greater rise in the
terms of trade. Australia also saw somewhat higher growth in demand on average during the
2002 to 2008 period than Canada. Associated with those trends was a more pronounced rise
in inflation at the end of the upswing, which saw us deviate further from our inflation target
than Canada (Graph 2).
Graph 2
That said, Australia coped with the terms of trade upswing better this time than in some past
episodes. An inflation peak at around 5 per cent in 2008 compares to around 25 per cent in
the commodities boom of the early 1950s and 18 per cent during the boom in the mid 1970s
(Graph 3). Several economic reforms contributed to this improvement - including the floating
exchange rate, more flexible labour market and stronger monetary policy framework.
Graph 3
More recently, the impetus from the global economy has reversed direction for both countries
as a result of the global recession. Canadians would have sensed the change first, reflecting
Canada's very close ties with the United States - which absorbs around three-quarters of
Canada's merchandise exports, equivalent to around a quarter of its GDP. The economic
weakness in the United States began to take root as problems in its housing sector and
financial system emerged in 2007, reducing demand for Canadian exports and weighing on
growth, even with the booming terms of trade.
In Australia's case, exports are not as large a share of the economy, as noted, and the
destinations are both more diverse and more oriented to Asia (China and Korea account for
more than a fifth of the value of Australian merchandise exports, and Japan accounts for
another fifth). Overall, Asia was initially relatively little affected by the problems in the major
economies. It was really only in the second half of 2008, as the financial turmoil led to a
sharp drop in confidence among households and firms around the world, that a
reassessment about Asia's prospects began.
Even then, Australia's export volumes have not weakened to date as much as those of many
other countries (Table 4).
One reason is that the slump in global trade was initially concentrated heavily in
manufactures, which is a smaller share of exports for Australia than others. Another is the
stronger linkage of key commodity exports to China, which appears to have seen a pick-up in
growth this year. Chinese industrial output fell for four months between July and November,
but has since recovered all those losses. A similar pattern has been seen in Korea, where
industrial output suffered a sharp decline around year end but apparently made up about half
of that over February and March.
Looking ahead, with commodity prices at present levels, Canada's terms of trade look like
they are still somewhat above the average for the preceding couple of decades. Australian
resource producers have accepted lower prices for the year ahead, and this is likely to
contribute to a decline in the terms of trade by the end of 2009 of about 25 per cent from the
peak, as shown in the chart. Yet even with that, at this stage Australia's terms of trade over
the coming year look like they will still be around 40 per cent above the two-decade average
up to 2000.
So in some important respects, not only did the economic upswing that ended during 2008
provide a bit more impetus to Australia than Canada, but the ensuing global economic
downturn has not, to date at least, hit Australia as hard as it has Canada. On a comparison
of these two countries, the effects of export volume losses in slowing overall demand in the
economy have been less important in Australia.
As for inflation, it has moderated. The headline figures overstate the fall in inflation in both
countries because of the decline in petrol prices, but measures of core or underlying inflation
are trending lower. Of course in Australia, inflation has further to fall than in Canada, since it
reached a higher peak.
Key strengths
One important feature that our two countries share at present is the relative resilience of our
banking sectors.4 Notwithstanding the global credit crisis, Canadian and Australian banks
continue to be profitable and are well capitalised by private investors - something that many
advanced countries cannot claim. For the 2008 reporting period, the return on equity for the
five largest Australian banks was 17 per cent, and it was 141⁄2 per cent for Canada's major
banks. This was lower than in the preceding few years, which had been ones of exceptional
profits for banks around the world - and years during which, in retrospect, risk was
increasing - but still very solid. It is noteworthy that equity market valuations of the two
banking systems display more confidence in asset quality and potential future earnings than
for US, European or UK banks, as judged by the market premium over book value (Graph 4).
Graph 4
The solid performance of these banks reflects a number of factors. Firstly, holdings of the
complex securities at the centre of the crisis were modest by international standards.
Secondly, banks in Australia and Canada had more conservative lending practices in their
home markets than their counterparts in the United States and the United Kingdom. While
sub-prime mortgages accounted for around 13 per cent of the US mortgage market in mid
2007, the closest equivalents in Australia and Canada accounted for around 1 per cent and
less than 5 per cent of their mortgage markets, respectively.
Both countries have had regional booms in housing markets in the past few years,
associated with the run-up in commodity prices and the associated effects of the shift in
productive resources to those industries and regions that were enjoying the boom. Hence,
house prices in Alberta and in Western Australia had a large run-up compared with most
other regions in the respective countries (Graph 5). More recently, dwelling prices generally
have tended to soften. In Australia's case, the ratio of the median dwelling price to average
household income has declined quite noticeably since 2003, without a very large absolute
decline in housing prices (Graph 6). This is evidence for at least the possibility that these
adjustments can take place over reasonably lengthy periods and without being terribly
disruptive to the economy.
Graph 5
Graph 6
Of course, with the economy contracting at present, banks in both countries are seeing some
pick-up in mortgage arrears. Overall, though, Australian and Canadian households appear to
be having much less trouble servicing their debt than is the case in the United States and the
United Kingdom, as shown by their relatively low rates of non-performing housing loans
(Graph 7). This reflects the better lending decisions in earlier years.
Graph 7
Our common external interests
Of course, good domestic policies can do only so much to ameliorate the impacts of very
adverse international developments. Both economies have slipped into recession as
international forces have taken hold, albeit through differing chains of causation. But for the
reasons articulated above, there are good grounds to think that both countries should be in a
relatively good position and well placed to take part in a renewed international expansion. It
is too soon to say this is beginning yet, though developments over recent months are
certainly consistent with the view that a recovery will get under way towards the end of the
year. That said, most observers think that the early part of any new global expansion will be
characterised by pretty slow growth.
Even with the uncertainty over the near-term global outlook, however, it makes sense to look
forward. So in the final part of this address, I should like to talk about the common interests
we have at stake in the way the international community responds to the crisis and shapes
the next expansion.
First among these is the openness of trade and capital flows. The extent to which trade flows
slumped late last year perhaps gives a sense of what could happen were trade barriers to go
up. Everyone would suffer, and badly. This is fully understood at an intellectual level around
the world. Yet we know that in times of domestic economic difficulty, the pressures for
protectionism increase. Countries like ours need to keep making the point that trade is not a
zero-sum game; it is collectively a positive-sum process that stimulates innovation and
productivity, increases global growth and raises living standards.
Secondly, the continued development of many emerging economies will enrich the
opportunities for firms and individuals in economies like ours over time. But it will be sensible
for emerging countries to have strategies that rely less on the absorption of consumer
products by the developed world, at least for some years. That will involve, roughly speaking,
more consumption and investment at home, lower trade surpluses and a step back from very
large outflows of capital to the developed world. This is actually a rational choice for
emerging market countries. But a lesson many countries took from the Asian crisis was that
a strategy such as that was dangerous, because the rules of international engagement did
not provide adequate protection in times of difficulty. Their response was the build-up of
reserve assets in the period since 1998 - a costly form of international self-insurance,
involving sending hard-saved capital from developing economies to the rich world. It was
very much a second-best option but was pursued because first-best seemed unachievable.
So it is in the interests of many developing countries to alter their growth strategy, but to do
so they need confidence in the international system - its rules, governance, safety nets and
so on. At the same time, the countries that have dominated the governance arrangements
hitherto, and which will have to accommodate the emerging countries, will want to have
some confidence that we are all - emerging markets and developed countries alike - reading
from the same page about the role and responsibilities of the international financial
institutions and their member states. Australia and Canada have a shared interest in
fostering progress on these fronts, which will involve encouraging both emerging countries
and highly developed countries to move in ways that accommodate each other. I know my
Canadian counterparts have worked assiduously on these issues for many years. We
support those efforts.
Thirdly, much work is being done on the lessons we can learn from this episode for financial
regulation and structure. As countries whose financial and regulatory systems have
performed pretty well in this episode, and which are largely free of serious problems,
Australia and Canada are perhaps uniquely placed to contribute to the discussion. I think we
could hope to bring a sense of emotional detachment, balance and perspective to the
international discussions on regulatory reform, which can be quite heated at times.
Conclusion
The "great white north" and the "great south land" have much in common, as well as some
very informative differences. Sound policy frameworks and robust business sectors are being
tested at present, but they can meet the test.
We both certainly have, at this juncture, much at stake in the global economy recovering to a
path of balanced growth, with open markets and sustainable policy settings. There is plenty
we can do together to promote our common interests in the world, as well as our own
interaction. Part of this sharing of ideas and co-operation will be spurred on by forums such
as this one. I wish you every success.