'We'll all be rooned,' said Hanrahan, 'before the year is out.'
Pessimism is a key part of the great Australian tradition, reflecting a history of booms and busts. It has infected the debate on the mining boom of the past decade. But how does it make sense to treat a once-in-a-century windfall of astonishing export prices as if we would have been better off without it? John Edwards' Beyond the Boom provides a much-needed antidote to this pessimism.
It's one thing for business leaders and journalists to put forward attention-grabbing gloom. But the hand-wringing has been shared by high-profile economists with rigorous analysis to back their views. John Edwards addresses this group with a detailed deconstruction of what the minerals boom has brought.
The starting point is an increase in our terms of trade, which is unprecedented in size and longevity. This triggered a four-fold increase in mining investment. Remarkably, these extraordinary changes did not unbalance the macro-economy. The economy grew at around its usual pace, inflation remained low and stable, wages have been restrained, and the current account actually improved.
To make sense of this successful balancing act, Edwards takes us through each of the components of the national accounts: income, expenditure and production. Mining investment increased, taking an extra 5% of GDP. This didn't push production beyond the limits of capacity because about half of this extra expenditure was channeled into additional imports. For the rest, there was some reallocation from other possible uses, particularly through restraint of consumption. The income component of the national accounts shows the background to this restraint. In the decade before the mining boom, households had gone on a spending spree, encouraged by booming housing prices. During the mining boom, they repented and saved, making room for some resources to shift into mining investment.
Why were households so thrifty when the terms of trade delivered an enormous windfall to the economy?
There is no doubt that the improvement in the terms of trade gave a huge boost to income, but by and large it was not Australians who benefited. The largest part of the increase in income went as profits to the mining companies, which are four-fifths foreign owned. Of course some went to mine workers, but mining is capital intensive and in any case the workers were wage earners, not equity participants in the huge windfall. Federal company tax on mining companies was limited by the favourable depreciation allowances that the miners were receiving on their huge new investment expenditures. Glencore-Xstrata (our largest coal exporter) has gone further, arranging its affairs so it pays no company tax in Australia.
This skewed distribution of mining income may reconcile John Edwards' narrative with that of leading academic Bob Gregory. Professor Gregory calculates that the terms of trade increase boosted our income by a whopping 14%. He (and many of the rest of us) worried about what would happen when the terms of trade fell (as was inevitable). But if the greater part of the benefits have gone to the foreign miners, we won't miss what we never had.
In fact, the terms of trade haven't fallen much so far, so the point has not been tested. But we might take a kind of perverse comfort from this paradox: Australians may have avoided the problem of the well-known 'resource curse' by giving a large part of the windfall to foreigners.
How did we avoid a blow-out of the current account deficit, which usually accompanies a boom? Export prices saved us. We didn't produce much more or export substantially more in terms of volume, but with iron ore and coal both fetching seven times their pre-boom price, enough foreign currency was being earned to keep the deficit from growing. Why didn't the huge profits show up as capital outflow? They did show up in the detailed accounts, but were offset in the aggregate figures as the miners funded most of their new investment by ploughing back their profits.
Edwards is clearly right in saying that things have turned out well enough for Australia so far (what other advanced economy has maintained 22 years of sustained growth?). Looking ahead, our prospects are good. We have ended up with a lot more investment (albeit, still predominantly foreign owned), with much more to come in the LNG industry. Additional export volumes are starting to flow (again, with much more to come from LNG).
When the miners have used up their depreciation allowances, federal company tax will take around 14c in every dollar the miners produce and state royalties about six cents. Australian workers will receive nearly 20c. Australian shareholders own a fifth of the mining investment, and will get the benefits of this. In total, Australia will end up with around half of the long-term export income stream.
In addition, we're well placed to benefit from China's ongoing expansion, when exports of high-end food and services (tourism, education, technical expertise) will keep exports growing even when iron ore demand slows. If the terms of trade fall back further (which is quite likely), most of the impact will be felt by the mine owners — mainly foreigners. The exchange rate will depreciate, increasing the competitiveness of non-mining sectors.
That said, could we have done better? And did we make any obvious mistakes? With hindsight, the most serious error was the failure to put in place a resource-rent tax that would capture a large share of the mining boom, as we had done earlier with petroleum and gas.
The belated effort to do so, when the boom was well underway, was an abject political failure. The miners, despite having billionaires as their spokespersons, were able to convince the public that if they were asked to pay a resource-rent tax, they would shift their investment to rival resource-rich countries. Rio Tinto's painful experiences dealing with the governments of these countries (with Simandou iron ore in Guinea, Riversdale coal in Mozambique and Oyu Tolgoi copper in Mongolia) were ignored as the CEO warned us that Australia was his largest sovereign risk. The Rudd resource-rent tax was renegotiated by the former BHP chairman, with predictable outcomes for expected tax revenue. The current government is removing even this feeble tax. Mining royalties, a state government domain, fall victim to special relationships and inter-state competition to attract projects.
If government had been able to get hold of more of the mining revenue, this would have opened up opportunities to address the other sore point of the resources boom: its effect in pushing up the exchange rate to levels uncompetitive for traditional industries, particularly manufacturing. The awkward consequence of big cyclical swings on mining prices is correspondingly big swings in the exchange rate. The Australian dollar was worth much less than 50c in 2001 and well over parity ten years later. An effective resource-rent tax could have funded a sovereign wealth fund (as has been done by many other resource-rich countries), to be used to counter cyclical swings in commodities. Perhaps some could have been put aside to soften resource depletion. The result would have been a lower exchange rate and a more balanced economy; perhaps less investment in mining, and more in a variety of other industries.
In short, we had more than our share of the luck. We didn't blow the opportunity presented. We did well in macro-management of the boom. With better politics we could have done a lot better, but looking around the world, we've done better than most and we're well placed to keep up the good performance. John Edwards has set out this story with clarity and precision, providing the counter-case to the modern-day Hanrahans chanting 'we'll all be rooned'.
Photo by Flickr user josh.