Glenn Stevens: Cross-currents in the global economy
Speech by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, at the Australian
Industry Group's Annual National Forum, Canberra, 25 October 2010.
* * *
Introduction
The topic the AIG had proposed for this session was "The Australian Economy to 2020". That
would of course involve forecasting up to 10 years ahead. That's a rather risky proposition
because forecasts are very hard to make. It might be safer, especially for a central banker,
not to look forward at all!
The way I want to start is by looking back 10 years. This may serve as something of an
admonition to be circumspect in making forecasts. But identifying some big trends in the
Australian economy over the intervening period - one or two of which were quite unexpected
a decade ago - may contain some indications of issues for us to be aware of in the next
decade. A couple of the trends that are readily observable also point to some current
challenges in global economics and finance, and it is these to which I shall turn in the second
part of these remarks.
2000 - the year that was ...
A decade ago, Sydney had just hosted the 2000 Olympic Games. The city of Melbourne had
hosted a meeting of the World Economic Forum. There were some wonderful sporting
moments for Australians in the Games, though the Games are perhaps remembered for their
logistical success as much as for the medal tally. The WEF meeting is perhaps most
remembered for the protests, which turned ugly.1
But these events should also be remembered as occurring at the height of the dot-com
mania and its obsession with the "new economy". Australians were told by more than one
prominent visitor that year that we lived in an "old economy", with the implication that we
needed to shift towards the production of IT goods. Blue-sky valuations were being applied to
companies that had not, at that point, earned a single dollar of profit (and many never would).
The Australian dollar was slumping.
The Economist magazine remarked that:
"... As Sydney was presenting the new face of modern Australia to the world, the
currency markets were giving a different verdict. At the end of the games' first
week, the Australian dollar fell to a record low of 53.63 cents against its American
namesake. ... The Australian dollar's fall is partly explained by the greenback's
remarkable strength ... But it also reflects a continuing belief among financiers
and potential investors that Australia has yet to complete the transition from being
an old economy, based on natural resources, to a new economy fired by
information and other technology."2
Other examples could be given.
As we now know, the dot-com bubble had actually started to deflate by the time those words
were printed. The NASDAQ share index had already fallen by about 25 per cent from its
early 2000 peak. By early in 2001 the US Federal Reserve would be cutting interest rates as
the US economy went into recession. The new economy - the latest (but not the last) in a
long line of new paradigms - still had a business cycle after all. The Australian dollar would
fall further in 2001, reaching a low point of about US48 cents in early April. Some felt that it
might fall as far as US30 cents. More than any other single economic indicator, this particular
price was often taken as a summary statistic for economic health.
In 2000, some people were making the point that, in the old versus new economy stakes, it
was probably in the use of information technology, rather than in the production of IT goods,
that the gains would be greatest. On that score Australia ranked highly.3 Or they made the
point that Australia would probably do best, in its production structure, to stick to its
comparative advantages in minerals or agriculture or various services.4 But it was hard going
trying to make sensible points against the barrage of market and media commentary.
Ten years on, though, it does not seem to have been to Australia's disadvantage not to have
built a massive IT production sector. On the contrary, the terms of trade are at a 60-year
high, the currency just about equals its American counterpart in value and we face an
investment build-up in the resources sector that is already larger than that seen in the late
1960s and that will very likely get larger yet. In the area of information technology,
meanwhile, the pace of change continues to be rapid: prices continue to fall, profits have
proved very hard to come by and a number of prominent names from 2000 have
disappeared. It is still better, it seems, to be a user than a producer of IT.
The point of saying all this is not to poke fun at those whose prognostications a decade ago
turned out to be wide of the mark. Anyone who has to forecast for a living has, from me, a
degree of sympathy. The point is simply that forecasting is very hard and that the latest
conventional wisdom often turns out to be just a passing fashion. We might add that market
pricing, at some points in time, may not be much better than that, even though markets tend
to get it roughly right on average.
Long-term trends
Having given that caution, it is worth recounting just a few of the trends we can observe over
the past decade or longer. The increased borrowing of the household sector was one such
notable trend. It had already been under way for nearly a decade by 2000, but kept going for
the best part of another decade after then. I have said before that this probably won't be a
feature of the next decade. We are seeing more caution in borrowing, and the rate of
household saving from current income, while still low, has risen over recent years. It follows
that some personal and business strategies that did well in the earlier period of households
gearing up probably won't do as well in the future.
Other trends have been a continuation of developments that had already been under way for
a long time. For example, as a share of the economy, services have continued to rise, while
manufacturing and agriculture have declined. Those sorts of trends, in broad terms, are
pretty common to advanced economies.
Mining's share of output had changed little since the mid 1980s, but has picked up noticeably
over recent years. This seems likely to continue in the near term at least, so we are seeing a
faster pace of change in the relative sizes of industries than we had seen for a number of
years. Formal metrics of the extent of structural change in the industry composition of GDP
have increased but do not, at this point, show it to be outside the range of previous
experience.5 That could well change, though, given the size of the resources sector build-up
that appears to be under way.
Looking at the trade accounts, we can see that the share of resources in exports has risen
very significantly over the past decade while those of the manufacturing, agricultural and
services components have declined. This is not to say that the absolute values of exports
for the latter sectors have fallen since 2000 - indeed services exports have grown quite
strongly - but the rise in resource exports has well and truly outpaced everything else, as a
result of both volume and price rises.
It is in the destinations of exports, however, that we see perhaps the most striking changes
over the space of a decade. As it happens, the weights in the Reserve Bank's trade-weighted
measure of the value of the Australian dollar were updated just a few weeks ago. In the most
recent year, the overall weight on the Chinese currency rose by 4 percentage points. That
was quite a large movement in a single year but it is just the latest manifestation of a
profound trend. Stepping back, it is apparent that there has been a striking further orientation
in trade towards the Asian region since 2000.6 The table below tells the story.
Australia's merchandise exports by destination
Per cent share of total, financial years
A decade ago, Japan was far and away the largest export destination for Australian goods.
The United States was second, South Korea and Europe tied for third and China came sixth
after New Zealand. Today, Australia's top goods export destinations are, in order, China,
Japan, Korea and India - accounting for some 58 per cent - followed at some distance by
the United States, New Zealand and the euro area, all closely bunched, accounting for a
further 13 per cent or so between them.
Given the ongoing shift in the world economy's centre of gravity towards Asia, the direction of
this change is not at all surprising. Many countries would be seeing the weight of their trade
shifting in the same direction as ours. One of the reasons for the strong performance of the
German economy this year, for example, has been the strength of demand for high-end
manufactured products in Asia. For Australia, though, it is a powerful phenomenon.
Now this is just the exports side. When we consider both imports and exports - and indeed
when we include trade in services - the United States and Europe remain important for
Australia (though less so than China these days).
The United States and Europe - along with New Zealand - also continue to account for a
large proportion of Australian investment abroad and are the source of the vast bulk of
foreign investment into Australia. In fact, the share of outward Australian investment going to
Asia has actually fallen slightly since 2000. Moreover, financial developments in the major
economies, and especially the United States, are still very important drivers of capital flows,
and of shifts in financial and business sentiment.
So there are still important links to the major economies. I am not arguing for "de-coupling", if
by that idea is meant that somehow the north Atlantic countries have ceased to have a
significant impact on the global economy, or no longer matter to us. Everything is connected,
and economic events in the north Atlantic countries still matter greatly.
But trends in those countries are leavened to no small degree by developments in the
AsiaPacific region, which is progressively becoming both larger and more capable of exerting a
degree of independent influence over its own economic performance. It used to be said that
when the United States sneezed, Asia caught a cold. Recently it seems that the United
States has contracted pneumonia, while Asia sneezed and caught a bad cold, but then
recovered pretty quickly. Even in the financial field, the size of offshore investments by Asian
official holders has become quite important, including for the Australian dollar. And while the
stock of cross border investment between Asia and Australia remains small compared with
that between Australia and the United States or Europe, that is surely in the process of
changing.
The point of all this is not to say that somehow Australia has been, or will be, "saved" by
China or Asia. The emergence of Asia is to our advantage, if we respond to it correctly. But
there is no free ride from the global or regional economy and there never will be. Nor is it to
deny that a country's own policies, for better or worse, and followed over a long period, also
make a significant difference to its economic outcomes. There is no escaping responsibility
to keep our own house in order.
The point, rather, is that we ought to take more than a passing interest in events in our
region, and in the conduct of economic policies in our region, and not just those in the
countries that once completely dominated the global economy, but no longer do.
This brings me to the issue foreshadowed in my title.
Cross-currents in the global economy
At the risk of over-using a clichéd term, the global recovery has been very much a two-speed
one. The United States, the United Kingdom, Japan and some continental European
economies saw deep downturns in output, and have to date experienced only weak
recoveries that have left the level of output well below its previous trend and unemployment
much higher than normal (Graph 1). In the United States in particular there is a very troubling
increase in the duration of unemployment, which, with its likely atrophy of skills, does not
bode well for future growth.
In Asia outside of Japan and in Latin America, economies have traced out the more classic
"v-shaped" path. In east Asia excluding Japan, the level of real GDP is well above its
previous peak. It follows that most of these economies are likely to experience some
moderation in the pace of growth, from something well above trend, to something more like
trend. This is normal after a rapid recovery.
Graph 1
This difference in performance between large parts of the emerging world and the core of
what we could call the "established" world of industrialised economies leaves the global
economy poised at a critical juncture. In Asia, capacity utilisation has more or less recovered
and growth will moderate. Many of the old industrial countries, in contrast, still have large
increase
volumes of idle capacity and are searching, with increasing urgency, for ways to
their growth. But they are having trouble increasing their own demand. So we face a
slowdown of some degree in global growth at a time when substantial spare capacity
remains in the global economy. The "global imbalances", so called, have persisted, and have
a new dimension: there is an imbalance in the location of spare capacity in the world.
What could be done to foster a better outcome for everyone?
There has been an increasing focus on exchange rates of late, with talk of "currency wars"
and so on. My view is that more flexibility of exchange rates in key emerging countries in
Asia - including China, but not only China - would be part of a more balanced outcome.
But exchange rate flexibility alone isn't enough. Changes in exchange rates don't themselves
create global growth, they only re-distribute it. Unless the exchange rate changes were
accompanied by more expansion in demand globally, we would not have solved the problem
of excess capacity, we would only have relocated it. The additional step needed is stronger
domestic demand, compared with what would otherwise have occurred, in the countries
whose currencies would appreciate in such circumstances.
Of course there should be room for this given that the higher exchange rate would, other
things equal, help to dampen inflation. In principle, at least, this looks like a potential
"winwin" outcome. The appreciating countries could enjoy faster growth in living standards than
otherwise, while the weaker countries whose currencies were moving lower would get some
stimulus to aid their recovery.
There are, however, some complications. A number of Asian countries have been
experiencing worrying increases in property prices. Low interest rates and easy financial
conditions have contributed to this. Arguably domestic financial conditions in these cases
need to be tighter, not looser. So it is not clear that monetary policy would be the best option
to boost domestic demand. That said, allowing exchange rates to appreciate more quickly
would probably help to dampen increases in asset prices.
What about more expansionary fiscal policies as the way of increasing domestic demand?
Many, though not all, Asian countries would have some scope for that, given the long record
of fiscal prudence and low public debt levels. But these countries are very unlikely to do
things that would seriously impair their fiscal position in the long run. Hence my suspicion is
that fiscal action, if it came, would be only modest.
Some argue that structural changes are needed to lower national saving rates in countries
like China. Such changes could involve a shift in the distribution of national income away
from state enterprises to households, who are thought more likely to spend it, a better
developed social safety net, and so on. In all likelihood these sorts of changes will occur over
time. But structural change is rarely a rapid process.
So I think we should be realistic about how much difference exchange rate flexibility would
make to the unbalanced nature of growth in the global economy, at least over a time horizon
of just a few years. It is definitely part of the answer (and it is surely in the interests of the
countries with closely managed rates to accept more flexibility), but it is no panacea.
A full resolution of the imbalances will take time. It will involve more far-reaching changes to
very deep-seated attitudes to saving, which remain very different across the regions of the
world. As incomes in Asia continue to rise, saving rates will probably decline over time, but
only gradually. Meanwhile, aggregate saving rates in America and Europe will have to rise
over time, given the extent to which financial obligations have grown relative to likely future
income, particularly on the public side. The key question is whether these two trends, in
opposite directions, will occur at the same pace, or not.
Good policies can certainly help the world get to a better solution than might otherwise occur.
But even with good policies, it is likely to be a slow grind out of the current difficulties for
some countries. We probably have to accept that global growth was unsustainably fast in the
few years prior to the crisis, that too much capacity of certain types was built up in the wrong
places, that spending in some countries ran too far ahead of permanent income and that a
period of adjustment and structural change cannot be avoided, even under ideal policy
settings. If that is so, then, in all countries, an emphasis on accepting the need for
adjustment generally - not just in exchange rates but in economic policies and structures
across the board - is key.
Conclusion
Economies are not static machines. They are a complex and dynamic combination of actors,
all continually seeking to adapt to changing conditions. That is one reason that economic
outcomes are very hard to predict, and why I am circumspect about predicting "Australia to
2020".
Looking to the long run, we probably can make a few very general observations, but not
much more. Real income per head has generally been on an upward trend in industrial
economies for the past 250 years, with occasional setbacks. Most likely that will continue
(albeit that some major countries will take some time to recover their income levels of three
years ago). As a broad observation, and definitely not as a precise forecast, we might expect
that a decade from now Australia's per capita GDP will probably be roughly 15 per cent
higher in real terms than it is now, give or take a few percentage points. The economic policy
arguments, by the way, will all be about what policies might gain or lose those few
percentage points.
In 2020, there will probably be, at a rough guess, an extra couple of million people working,
compared with today's 11.3 million. But exactly how all those people working will earn their
living and go about their work is considerably less predictable. A good proportion of those
13 million-plus jobs will be in firms that don't yet exist. Some will be in industries or
occupations that barely exist as yet. And no one can give you a blueprint for which areas will
succeed and which will not, any more than the pundits a decade ago, at the height of the
"new economy" fad, could foresee the shape of Australia's economy today.
Succeeding in the future won't ultimately be a result of forecasting. It will be a result of
adapting to the way the world is changing and giving constant attention to the fundamentals
of improving productivity. That adaptability is as important as ever, in the uncertain times that
we face.