Glenn Stevens: Economic conditions and prospects
Address by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the Economic
Society of Australia (Queensland) 2011 Business Luncheon, Brisbane, 15 June 2011.
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Thank you for the invitation to visit Brisbane today and to join with the Economic Society here
in Queensland to talk about our economic situation.
It is barely five months since the flooding that inundated parts of Brisbane and had such a
tragic impact only a couple of hours west of here in Toowoomba and the Lockyer Valley. It is
only four months since Cyclone Yasi wrought havoc on some northern coastal communities
and flattened key crops. The people of Brisbane, and of Queensland, have shown their
resilience and adaptability in the face of these disasters.
The economic effects of those events, and of the Western Australian cyclones over the
summer, have been seen at the national level. Falls in coal and iron ore production more
than fully explained the decline in measured economic output in the March quarter, which
occurred not because demand slumped but because the economy's capacity to supply
output was temporarily curtailed. There was also a sharp rise in some prices, which tends to
happen when supply is suddenly disrupted. Bananas are the most celebrated manifestation
of this. With 75 per cent of the crop more or less destroyed, and few sources of alternative
supply available, prices to the consumer have quadrupled.
The effects of these natural disasters are now gradually abating. Information on coal mining
suggests that it is gradually recovering, though more slowly than had been expected initially
owing to the difficulties of getting water out of the pits. Iron ore production has fully
recovered. The banana plants are re-generating. Most other crops are also getting back to
normal supply levels. As this occurs, we should see the impact of these events on prices
start to reverse. For Queensland, the scars from last summer's events remain - and always
will. The destruction of capital stock is a loss of wealth, but capital can ultimately be rebuilt;
lives lost cannot.
But despite the tragedy, Queenslanders are getting on with things.
The broader context in which these events have occurred is well known. The proverbial
pet-shop galah can by now recite the facts on Australia's trade with China and our terms of
trade, which are at a level not seen in over a century. It was already clear by about 2006 that
something quite profound was happening in the continuing rapid growth of China, India and
other emerging countries.1 This upward trajectory continued, and even accelerated in some
cases, in the subsequent period. Then the crisis occurred, and the Chinese economy slowed
abruptly. But the authorities responded forcefully and China's economy returned to very
strong growth quite quickly. And so the trends in place up to the middle of 2008 had resumed
within a year.
The rapid growth in Chinese, Indian and other emerging world demand has been stimulating
demand in the global economy, despite the weakness in demand from the "north Atlantic"
group of countries. This gives a boost to a country like Australia: our economy's increased
exposure to Asia - the part of the world where much of the growth is occurring - plus the
high terms of trade make for an expansionary macroeconomic event. At present Australia's
terms of trade are about 85 per cent above their 20th century average. The amount of
additional income accruing to production in Australia from that is 15 per cent or more of
annual GDP. Even allowing for the fact that a substantial fraction of this income accrues to
foreign investors that own large stakes in many of Australia's resources companies, this
represents a very large boost to national income.
These expansionary forces are at work on an Australian economy that was widely regarded
as very fully employed by early 2008, and that experienced only a fairly mild and short
downturn thereafter. As of today, measures of capacity utilisation are not as high as at the
end of 2007, and unemployment is not as low as it was then. Nonetheless, the degree of
slack in the economy overall does not seem large in comparison with the apparent size of the
expansion in resources sector income and investment now under way.
With that general outlook, it follows that macroeconomic policies must be configured in the
expectation that there will need to be some degree of restraint. Monetary policy has already
been exerting some restraint for a while. Looking ahead, our most recent analysis (as
published in early May) concluded that the underlying rate of inflation is more likely to rise
than fall over the next couple of years. This central expectation - subject to all the usual
uncertainties inherent in forecasting - suggests, as we said at the time, that "further
tightening of monetary policy is likely to be required at some point for inflation to remain
consistent with the 2-3 per cent medium-term target". It remains, though, a matter for
judgement by the Board as to whether that point has been reached. At its most recent
meeting, the Board's view was that it had not been. New information will, as always, be
important in our monthly assessments of what monetary policy needs to do. As far as prices
are concerned, we will get another comprehensive round of data in late July.
Fiscal policy is also playing a significant role. The "fiscal impact", calculated as the shift in the
Federal budget position from one year to the next, is forecast to be minus 2 per cent of GDP
in the 2011/12 fiscal year. A further, though slightly smaller, effect is forecast by the Treasury
in the following year.
There remain, of course, differences in economic performance around the country. Given
movements in commodity prices over the past year and the stated investment intentions of
major resources companies, these differences are more likely to increase than decrease
over the coming period. More generally, while everyone understands that there is a "mining
boom", many people would say that they themselves cannot directly feel the effects. We
have seen widespread re-emergence of talk of "two speed" or "multi speed" economies.
Within the state of Queensland itself there were differences in performance, even before the
floods, let alone after them.
How then do we make sense of these phenomena?
It is a complex story, and I do not wish to make light of any of the legitimate concerns that
people have about the differing economic conditions - actual and potential - across regions
or industries. But there are three observations worth making.
The first is that the impact of the resources sector expansion does get spread around, in
more ways than might immediately be apparent. Obviously mining employs only a small
share of the workforce directly - less than 2 per cent. But to produce a dollar of revenue,
companies spend about 40 cents on acquiring non labour intermediate inputs, primarily from
the domestic sector. Apart from the direct physical inputs, there are effects on utilities,
transport, business services such as engineering, accounting, legal, exploration and other
industries. It is noteworthy that a number of these areas are growing quickly at present.
Once the costs of producing the output and other factors - such as taxes - are taken into
account, the remaining revenue is distributed to shareholders or retained. While a significant
proportion of the earnings distributed goes offshore, local shareholders also benefit. In fact,
most of us are shareholders in the mining industry through our superannuation
schemes.2 We don't get this income directly to spend now - it is in our superannuation.
Nonetheless, it is genuine income and a genuine increase in wealth.
A good proportion of the earnings retained by companies is used to fund a further build up of
physical investment, which imparts demand to construction and manufacturing. Based on the
industry liaison the Bank has done, around half - give or take - of the demand generated by
these projects is typically filled locally, though, of course, this amount varies with the nature
and details of any specific project.
So there are effects that spill over, even though it is not always easy to spot them. In the end
the combination of the resources sector strength and all the other factors at work in the
economy has, to date, produced a national rate of unemployment of around 5 per cent, and
in Queensland only a bit over 5 per cent. There are regional variations in unemployment
rates, but at this point these look comparable to what has been seen at most times in the
past 10 years - a period that has seen both lower average unemployment rates and lower
variation in unemployment rates than the preceding decade.
Secondly, some of the undoubted differences in performance observable at present look like
the inverse of earlier differences. Take housing prices and population growth, which are of
course quite closely related. It surely is no coincidence that the two state capitals that have
had the clearest evidence of declining house prices over the past couple of years - Brisbane
and Perth - are the two that previously had the highest rate of population growth and that
have since had the biggest decline in population growth. Moreover, it is hard to avoid the
conclusion that changes in relative housing costs between states, while certainly not the only
factor at work, have played an important role. Relative costs are affected by interstate
population flows, but those costs then in turn have a feed-back effect on population flows.
This is particularly so for Queensland.
Historically, Queensland has had faster population growth than the southern states, as it has
seen a slightly higher natural increase, a rate of net international migration on par with other
states and a very substantial net positive flow of interstate migrants. Net interstate migration
to Queensland peaked around 2003 - not long after Sydney dwelling prices had reached a
new high relative to other cities. Interstate migration at that time was contributing a full
percentage point a year to Queensland's population growth. By 2008 this flow had slowed a
bit, but international migration had picked up and Queensland's population growth increased,
peaking at nearly 3 per cent. Western Australia's population growth was even higher,
peaking at almost 31⁄2 per cent.
Meanwhile, at least up to 2007, people were confident and finance was readily available.
Brisbane housing prices, which had been a bit over half of the average level of Sydney and
Melbourne prices in 2002, had risen to be almost the same by 2008, which was unusually
high.
The rate of interstate migration to Queensland then slowed further, to be at its lowest in at
least a decade. The effects of that on state population growth were compounded by a decline
in international migration, something seen in all states. At the same time, finance became
more difficult to obtain and lenders and borrowers alike became more risk averse. This
happened everywhere, but its effects in Queensland seem to have been more pronounced.
Since then, Brisbane housing prices have been declining relative to those in the southern
capitals and the construction sector here has found it tough going.
So a complex interaction of forces - the commodity price cycle, the financial cycle,
population flows, endogenous responses of housing prices that then feed back to population
flows and so on - has been occurring. The ebb and flow of these forces has made for
differences in performance, first in one direction, then the other.
Thirdly, the industry make-up of our economy is continually changing. While this is often a
slow process - almost imperceptible in most years - these shifts have been significant over
time. There is little doubt that trade-exposed manufacturing firms not linked to the resources
sector are facing tough conditions at present. But many people might be surprised to learn
that the peak in manufacturing's share of Australia's GDP was in the late 1950s - more than
five decades ago. Its fastest rate of relative decline, so far, was probably in the second half of
the 1970s. On the other hand "business services" - including things such as accountancy,
legal and numerous other services - have grown fairly steadily and now are credited with
more than twice the share of GDP of manufacturing.3 Several of these sectors are being
boosted by the flow-on effects of the resources boom at present.
As for the mining sector itself, its share of GDP has tended to rise since the late 1960s,
having been quite low in the mid 20th century. But in 2010, the mining sector's share of GDP
was still only about the same as it was in 1910. It will surely increase noticeably over the next
five years, though will remain much smaller than it was in the gold rush era.
Again, none of this is to deny that there are differences in performance by industry and
region. It is simply to give some perspective on what we see.
The point about long term shifts reminds us to look beyond the immediate conjuncture, and
to think about the magnitude of the event through which we are living. For a good part of the
change in our terms of trade is a manifestation of a large and persistent change in global
relative prices. Let me be clear here: there is a cyclical dimension to the China story, and it is
important that we remember that. But there is also a structural dimension. And the
associated change in relative prices constitutes a force for significant structural change in the
economy. I think we have all only begun to grasp its implications relatively recently.
For a long time, the world price of foodstuffs and raw materials tended to decline relative to
the prices of manufactures, services and assets. But for some years now the prices of things
that are grown, dug up or otherwise extracted have been rising relative to those other prices.
This is mainly due to trends in global demand. At any point in time for a particular product we
can appeal to supply-side issues - a drought, a flood or a mine or well closure, or some geo
political event that is seen as pushing up prices. But stepping back, the main supply problem
is really that there has simply been more demand than suppliers were prepared or able to
meet at the old prices.
We do not have to look far for the cause: hundreds of millions of people in the emerging
world have seen growth in their incomes and associated changes in their living standards,
and they want to live much more like we have been living for decades. This means they are
moving towards a more energy- and steel-intensive way of life and a more protein-rich diet.
That fact is fundamentally changing the shape of the world economy. Even if China's growth
rate moderates this year, as it seems to be doing, these structural forces almost certainly will
continue.
It is worth noting in this connection that many commentators have for years been calling on
policymakers in the emerging world to adopt growth strategies that rely more on domestic
demand and less on exports to major countries. This is happening. It carries the implication
though that, first, more of the marginal global spending dollar is going to products that are
steel-, energy- and protein-intensive for the emerging world's consumers and less on other
things like, say, luxury property in western countries.
Secondly, more of the marginal production of the world economy has to be in those raw
material intensive products - and in the raw materials themselves - and less in the
production of the other things. Ultimately there will be enough steel, energy, food and so on
to meet demand - supply is responding. But considerable adjustment is needed to get there
(and Australia is a very prominent part of that adjustment).
The average consumer in an advanced economy is effectively experiencing a decline in
purchasing power over food, energy, and raw material-intensive manufactures. Australian
consumers face this to some extent as well. Were Australia not a producer of raw materials,
we would be experiencing a good deal more of it. In such a world, there would be no
resources sector build up. Our currency would be much lower. We would be paying much
more for petrol at the pump, for our daily coffee and for a wide range of other consumer
products. We would not be holidaying overseas in our current numbers.
We would have more of some other forms of economic activity that we currently have less of
- we would, perhaps, be less of a "multi speed" economy. But it's unlikely our economy
overall would be stronger. As it is, the rate of unemployment has seldom, in the past few
decades, been much lower than it has been recently. Moreover, in that alternative world the
real income of Australians in aggregate would be a good deal smaller.
But Australia is a resource producer, so we have the advantage of being able to take part in
the additional supply of things that are in strong demand. This helps our incomes. Mining
companies are doing their best to capitalise on the increase in demand, and the effects of
this will flow through the economy, but other producers are also enjoying a boost to their
income. Rises in the global prices of rural commodities over the past couple of years have
been sufficient to deliver higher prices to most farmers despite the appreciation of the
Australian dollar.
As consumers, the rise in our currency means that we take some of that higher income in the
form of greater command over tradeable goods and services. The foreign exchange market
being what it is - namely an asset market - it has looked a long way forward into the
resources boom and pushed up the currency quite quickly. This is having significant effects.
While consumers do seem to be continuing their more cautious mindset overall, many seem
over the past year to have had the confidence to leave the country to experience foreign
travel at prices more attractive than any seen for a long time. Australia's tourism sector is
feeling the resultant loss of business, particularly in Queensland where the floods also had a
separate impact on confidence. That latter effect will pass - Queensland's set of natural
endowments that attract tourists remains in place. But the need to adapt to the high
exchange rate may continue.
For as well as conveying a rise in purchasing power to consumers, the high exchange rate is
exerting a powerful force for structural change. I think we are seeing this in the retail sector.
The rapid growth of internet commerce - from a very small base - has been the topic of
considerable discussion. This was bound to happen anyway with technology. But with the
higher Australian dollar, the component of the retail "product" that is added in Australia - the
local distribution and retailing overheads that are required to provide the
retail "experience" - has become both much more visible, and much higher relative to the
production cost of the good itself. So the incentive for the consumer to avoid those overhead
costs has increased quite noticeably. The retail sector is therefore under pressure to reduce
those costs.
These are just some of the structural adjustment forces at work. Of course it is easy to talk
about structural change in the abstract. It is another thing to cope with it in practice. There
are no magic-pill solutions, nor are there any real alternatives to adjustment. What solutions
there are, though, are likely to involve a re-focusing on productivity performance after a
period in which, at least at a national level, our productivity growth has been disappointing.
Yet, as I have said before, this is a much better problem to have than those we see in many
advanced countries. The event to which we have to adjust is inherently income-increasing for
Australia. Moreover, we do not carry the legacies of the past several years in our banks' or
public sector balance sheets that are such an impediment in other places.
Conclusion
Queenslanders have shown their resilience and adaptability this year in the face of
extraordinary events. People from elsewhere in Australia have nothing but admiration for
you.
Resilience and adaptability are among the characteristics we will all need in order to cope
with a global environment that is growing more complex rather than less, and that presents
both economic challenges and opportunities greater than those we have seen for many
years.
The task for the economics profession - all of us here today and in like gatherings and
institutions around the country - is to do our part in trying to understand these challenges
and opportunities, to explain them to our communities, and to articulate the responses that
are most likely to see our country prosper.