In a paper published recently on the Minerals Council of Australia website, Adelaide-based economist Jonathan Pincus takes issue with some of the calculations I make in my Lowy Institute Paper Beyond the Boom. He makes a number of criticisms, but the big one is of my estimate of the income gain from the first decade of the mining boom. I put this gain at 3% of nominal GDP, comparing 2002 to 2012.
Essentially, Pincus claims that the gains from Australian mining exports should be calculated in US dollar prices rather than Australian dollars. If they are calculated in this way, the gains are bigger because over this period the Australian dollar appreciated. He then 'corrects' my estimates with his.
There are lots of problems with Pincus' material, one of which is that his numbers are wrong. Pincus claims the exchange rate of the Australian dollar against the US dollar doubled in the period 2003-4 to 2011-12. It didn't. When taking the overall average of the monthly averages for each of those fiscal years, the gain of the Australian dollar was a little less than half. Measured using the trade weighted index (TWI), which is relevant to his argument, the gain was less than a quarter.
I don't know, but my guess is that Pincus has confused the change in the period 2003-04 to 2011-12 with the change over the whole period starting from 2001 (well before the mining boom began) to 2012. This mistake is itself instructive, and points to a big problem with his methodology. Pincus implicitly assumes all of the gain in the exchange rate is due to the rise in mining exports and can be attributed to the boom.
But we know that is not so.
A large part of the appreciation of the Australian dollar against the US dollar over the period of interest to Pincus reflected a broader trend of depreciation that had nothing in particular to do with Australia. From 2002 through to 2008, the US dollar was declining against most other currencies, including the Australian dollar. We know that is so because it is shown in the US Federal Reserve Board's nominal and real trade-weighted US dollar series. Unless we suppose that Europe, the UK and China, for example, were also experiencing mining booms, this substantial element of USD depreciation and reciprocal AUD appreciation cannot be attributed to the peculiar circumstance of Australia's mining boom.
Another large element of Australian dollar appreciation was its recovery from the post-Asian financial crisis lows, when it fell below US $0.50. Much of that recovery occurred before the mining boom began. Of the increase in the exchange rate claimed by Pincus, one third of the appreciation against the USD and nearly half of the appreciation measured by the TWI occurred before the boom began.
Finally, higher commodity prices no doubt had an influence, but higher interest rates also drove up the currency – especially after 2008, when the US, UK and Europe moved towards zero rates while Australia raised its own from GFC emergency settings. The fact that Australia had markedly higher rates than the US, Europe, the UK or Japan could be said to be distantly connected to the mining boom, but it is as much a story about zero rates elsewhere as high rates (actually, by our standards, low rates) here. Zero or near-zero policy rates in the US, Europe, the UK and Japan have nothing to do with the Australian mining boom.
There is no way of sorting out how much of the exchange rate gain is due to the boom, and how much to these other influences. It's not a problem Pincus recognises – he claims 100%, no discussion.
There is another conceptual problem with his method. If the gains from higher mining prices are bigger when presented in changing US dollar equivalents over the period, so is Australian GDP when treated the same way. If we blow up mining revenue by presenting the gain in US dollars equivalents, we should do the same to the denominator, which is nominal GDP. Otherwise we are dividing apples by oranges. If we do treat GDP the same way, it increases in the same proportion as export returns and we arrive back with my number, not his. In adopting the method Pincus uses, any export over a period of Australian dollar appreciation is blown up compared to GDP – education services sold to foreigners, for example, or inbound tourism or farm exports. The elements of GDP would add up to more than total GDP, which is surely not a good idea.
Even measured Pincus' way, the gain is certainly less than he supposes, because he wrongly claims the exchange rate doubled in the relevant period.
In Beyond the Boom I canvased the notion of adding to the gain from the boom the lower price of imports, which might be the result of a higher exchange rate. One problem with that notion is explained above – we don't know how much, if any, of the exchange rate change is due to the boom.
Another is that when we look at what happened to import prices as opposed to the exchange rate we discover that, as a matter of fact, import prices did not fall. The Australian dollar import price index is the same now as it was in 1994, 20 years ago. The growing volume of cheap manufactures from China and variations in importers' margins have mostly overwhelmed exchange rate changes.
It is also true and I think relevant that the rate of growth of the volume of consumer goods imports did not much change in the ten years to 2012 compared to the ten years to 2002, which was before the boom began. One might argue that prices overall rose, while import prices did not. Even so, since consumer price inflation was much the same before and after the boom, one would have to say consumers benefited from zero change in import prices just as much before the boom as during it. The boom made no great difference.
Almost all of the gain in the terms of trade was in higher export prices, as Pincus concedes. That is the gain I calculate.
Pincus likes the 'trading gain' concept as a measure of the boom's benefits. This argument was covered in Beyond the Boom and Pincus has nothing new to add to arguments made with greater force and clarity (and much earlier) by Bob Gregory. This 'trading gain' is the difference between GDP deflated in the usual way and GDP with exports deflated by the import deflator instead of the export deflator. That is the only difference between the measures. It is designed so that if there is a change in the terms of trade, the growth rate of these measures will differ from each other. Gregory calls the difference the 'trading gain'. As I point out, the difference in the relevant period is 14%. But 14% of what? Pincus tumbles in to that hole (as he did into the exchange rate hole) and declares it to be 14% 'of GDP'.
But they are different concepts, measured in different ways. The most one can say is that income measured one way was 14% bigger than income measured another. And as I point out, the trading-gain difference is true only if the additional export income is spent on imports. It is evident in the arithmetic. Nor does the trading-gain measure specify whether the gain is attributable to foreigners or Australians, especially in a period in which large investments are financed by retained profits. In an earlier paper Pincus uses the estimate that four-fifths of Australian mining equity is foreign owned, a number I also use.
In Beyond the Boom I make much of the fact that the Australian dollar income gain from the increased value of mining exports was saved. Pincus writes about this as if he has discovered something I overlooked. It is in fact a central point in my argument. He also gets caught up in another conceptual mess, ascribing the increase in savings to what he thinks is the income gain from exchange rate appreciation and/or the terms of trade gain (it's not clear which). The problem here is that savings is measured as nominal Australian dollars as a share of nominal Australian GDP. It is not measured in US dollars or in real dollars, whether terms-of-trade-adjusted or not. The additional savings comes from actual Australian dollar income, not a conceptual terms-of-trade-adjusted real income.
The most mysterious aspect of the Pincus piece is that it was published by the Minerals Council of Australia, as if countering an anti-mining view. Beyond the Boom is not anti-mining in any respect. Mining executives to whom I have presented the results have not found it so, as far as I know. Nor is there any reason why they should.
A final point is a larger one. The point of Beyond the Boom is that the decline of the investment phase of the mining boom, the decline in mining output prices and the decline in our terms of trade do not necessarily mean we are heading into recession or depression as some have warned. Here we are, well into the inevitable decline in the terms of trade and well past the peak in mining investment, yet despite grim predictions, we are getting by. Growth has slowed and no doubt will remain less than its potential until non-mining investment and household consumption strengthen. Even so, real output growth is around 2.5% or a bit better, unemployment is stabilising and we are creating jobs. For three years now labour productivity growth has been well above the average of the last few decades, and in the most recent numbers multifactor productivity has turned the corner and is now again increasing. Wages growth has slowed more than expected and the exchange rate has usefully depreciated.
All these are good and hopeful signs. There is no economic crisis, no collapse. We do not have, as Maurice Newman, the chairman of the Prime Minister's Council of Business Advisers predicted, zero growth. We have not, as economist Ross Garnaut predicted, fallen into the worst recession since World War II. So far, so good. Things are turning out pretty much the way expected in Beyond the Boom, and not least because the boom was not as big as widely supposed – and in many respects is not yet over.