QUARTERLY ESSAY 54 Dragon's Tail



John Edwards

There is much to reflect upon in Andrew Charlton’s wide-ranging and beguilingly written essay. He argues that China’s demand for resources has been very important to Australia’s prosperity in recent years, and that the growth in China’s demand for resources is likely to be weaker in coming years. No disagreement there. He also argues that Australia needs to have a flexible economy, attend to the education and training of its workforce, expand its services exports and encourage innovation. Again, no disagreement. I do disagree with him, however, on how Australia has responded to the mining boom, and therefore on where we are now and where we go next. In Beyond the Boom, published around the same time as Charlton’s essay, I come to quite different conclusions.

For example, a central point of Charlton’s essay is that “Australians did not save much of the proceeds of the mining boom over the past decade.” This is an important argument, and much leads from it. But as I show in Beyond the Boom, there is another way to think about our experience. Since the boom in resource prices got going at the end of 2003, Australia’s national savings have increased by 3 per cent of GDP, to one quarter of GDP. Almost all of the increase has been in household savings. About half of the increase occurred before the global financial crisis, and half afterwards. The significance of this 3 per cent is that it is equal to the Australian resident share of the increase in mining export revenues over the same period. Far from wasting the boom revenues, Australians saved them. It is certainly true that a big share of increased company tax (mostly not from mining) was handed back as personal income tax cuts, but those cuts were saved by households. 

Consistent with the rising savings rate, household consumption growth during the boom has been quite restrained, particularly when compared to the previous ten years. During the boom, Australians have not only saved more and consumed less than in the decade before the boom, but also worked harder and studied more. Australia’s capital stock during the boom has risen by nearly two-thirds (excluding housing), and its human capital has also increased, with more education and training. This frugal, restrained behaviour was plainly evident during and after the global financial crisis, but began earlier. One result is that Australia has financed what is probably the biggest investment boom in its history without a blowout in its current account deficit. Another is that a very big investment boom is slowing without a bust – a sharp contrast to our earlier experiences of investment booms. 

In thinking about where we are and where we go next, a key issue is how big the boom has been, and whether it is over. Charlton doesn’t put a number on it, but my impression is that he thinks the mining boom is very big indeed. I agree that it is big – the issue is how big. In my analysis, I show that output rose considerably faster in the ten years before the boom began than it has since, and that real incomes rose just as fast. The “boom” years have not been as good as the preceding years. Drawing on published RBA research, I estimate that the whole of the resource economy – mining, mining investment, metals processing and all the Australian inputs for these activities – rose by 3 per cent of real GDP, comparing 2012 with 2002. That is a pretty big increase, but not quite as big as commonly supposed. From 2003 to 2010, the output of mines grew as a share of GDP by the same amount as the health care and social assistance sector (both by 1 per cent of GDP). In 2010, mining was still the same share of GDP as in 1992. 

More happens with Australian income, since iron ore and coal prices rose dramatically. In tracing the income gains, it’s relevant that four-fifths of the mining sector is owned overseas, and half of the income from mining is attributable to overseas shareholders. The increase in Australian income due to the mining boom appears to be around 3 per cent of GDP – in this case nominal GDP and calculating the gain as the increase in the value of mining exports (or alternatively, of nominal gross value added in mining) between 2002 and 2012. Again, big – but not all that big.

So I would argue that while the boom has been extremely useful, it has not been as big as sometimes suggested, and Australia has handled it quite well. Nor is the boom by any means over – mining output has only accelerated markedly faster than GDP over the past few years. There is plenty more to come in increased iron ore output, and the big increase in LNG exports hasn’t yet begun. 

What is passing is the crest of the mining investment boom. In 2003, mining investment was around 2 per cent of GDP and today it is around 8 per cent. We might expect mining investment to get back to 2 or 3 per cent of GDP in the next three or four years. But half of the goods and services in mining investment are imported, so the drag on Australian GDP or the amount we need to replace is around 3 per cent of GDP. That will be difficult, but by no means impossible. Increased mining output will help, as will increased home construction – and there is plenty of evidence both are occurring. There is also room for increased household consumption and increased infrastructure investment. Business investment outside mining has been weak since the global financial crisis. At some point it will pick up. 

Charlton argues that Australia has been afflicted with the “Dutch Disease,” by which increased resource exports come at the expense of the rest of the economy. This is certainly widely believed, and often repeated. The Dutch Disease mechanism depends on a limited supply of capital and labour, which is then allocated away from activities such as services or manufacturing, and towards mining. But in a relatively small open economy without capital controls there is no constraint on capital, other than the rate of return. The capital invested in mining is not capital that might otherwise be profitably invested in manufacturing or farming or finance. At least half of the inputs into mining investment and mining are imported. Nor is labour closely constrained. In the first ten years of the boom, Australia added a net two million migrants to its population – a high proportion of them workers. The mining and construction workforces have increased during the boom, but even so the whole of the increase in both sectors is no more than one-fifth of the increase in the total number of employees in Australia from the beginning of the boom until now. Evidently, we can run a mining boom without shutting down the rest of the place. 

It’s true that the relatively high dollar has lowered returns in export industries from what they might otherwise be (including, of course, returns from mining exports). The issue is how big the effect has been. What we can say with certainty is that in December last year the number of short-term visitor arrivals (mostly tourists) to Australia reached a new peak of well over three-quarters of a million, and that in seasonally adjusted terms tourist arrivals are running this year at a record level that is one-third higher than it was before the mining boom began. That should cheer Charlton’s gloomy Cairns café owner, Darren. Farm exports in the year to May were more than two-thirds up compared to the first year or so of the boom. Education exports have rebounded to a new high that is more than double the level at the beginning of the boom. Service exports overall are now running at a level more than two-thirds higher than before the boom. These are all current dollar increases, which is a relevant measure if we are thinking about the impact of a higher exchange rate. Exports of manufactures (excluding metals) haven’t done so well, but they are up by over a third in Australian dollars, and in volume terms are up by one quarter compared to their level when the boom began. All up, the dollar value of exports, excluding all mining and metals exports, is up by half as much again compared to the beginning of the boom in 2003. So if we have Dutch Disease, it’s a pretty mild case. (The same goes for imports. In theory we should have vastly increased consumer imports; in practice we haven’t.) 

Charlton raises some dire predictions on the outlook for China, and then qualifies them. As he writes, the Chinese leadership is well aware of the issues and is addressing them through faster wage increases, some financial liberalisation, and so forth. China has, he rightly says, a considerable buffer in the form of vast currency reserves and, one might add, in a savings rate that could be a lot lower without damage to the China economy. And, as he also writes, there are instances of interminable crises in recent history, but there are also plenty of instances of managed transitions. On this issue, I am with Charlton the optimist rather than Charlton the pessimist. We should also bear in mind that urbanisation in China has a very long way to go, and to the extent that Chinese policies favour households and consumption they will also favour home construction, since they all go together. New towns and cities, with new apartment blocks, use a lot of steel. 

Finally, it is not at all central to Charlton’s argument, but I often wonder whether his interpretation of the global financial crisis – which is the same as that of Ben Bernanke, Joe Stiglitz and plenty of others – is completely convincing. Basically, in this interpretation China is to blame by causing a “savings glut.” This reasoning implies that intended global saving in the years preceding the financial crisis was higher than intended global investment. If that was the case, and the United States was a preferred destination for this excess, one would expect to see US interest rates falling and the US dollar rising as savers compete to buy US dollar assets. But when one looks at the numbers, it is not so. In the five years before the global financial crisis, US interest rates were rising – both short term and long term. At the same time the US dollar was falling. Against the Chinese yuan, for example, it fell by more than a tenth. These price movements are in quite the wrong direction for the “savings glut” story. Furthermore, US household consumption rose no faster than GDP in the years of the global financial crisis, while exports and business investment grew very much faster. Those facts do not fit the “savings glut” story either. The glut explanation has the happy property of finding China at fault for exporting cheap manufactures and buying US treasury bonds. US investment banks were thus unwitting victims of this macroeconomic mystery. There is of course much more in this debate, but I am unconvinced by Charlton’s presentation of what I readily concede is a widely respected view.

Charlton’s interpretation of the boom years is of a piece with his interpretation of Australian economic history. Here he retells the familiar story of a “Federation Settlement” of high wages, high tariffs and restricted immigration to make a case that Australia’s comparative performance declined from around 1890 to the early 1980s, when it was reformed by the Hawke and Keating governments. This is a big issue, but any reader who has got this far deserves a break. Those interested in a different and I think more plausible view of Australia’s economic history might profitably read Ian McLean’s wonderful book Why Australia Prospered, which I draw on in Beyond the Boom. McLean’s title suggests the difference between his interpretation of Australian economic history and the black armband story recounted by Charlton.

I have disagreements, but I should also say that I think Charlton has made a valuable contribution to the Australian economic debate by tackling some big themes in a thoughtful way. There is much in his Quarterly Essay that I found stimulating. 


John Edwards is a member of the Board of the Reserve Bank of Australia, and CEDA. He is a visiting fellow at the Lowy Institute, and an adjunct professor with the University of Sydney Business School and the John Curtin Institute of Public Policy. His most recent publication is Beyond the Boom. From 1997 to 2009, Dr Edwards was chief economist for Australia and New Zealand for HSBC. From 1991 to 1994, he was principal economic adviser to Treasurer and Prime Minister Paul Keating.


This correspondence discusses Quarterly Essay 54, Dragon's Tail. To read the full essay, subscribe or buy the book.

This correspondence featured in Quarterly Essay 55, A Rightful Place.


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