In Brisbane today, in the theatre of Morgans Financial Limited, along with Griffith’s Tony Makin and Morgans’ Michael Knox, I spoke on “The end of the mining boom”, at an event organised by Griffith’s APEC Study Centre. My slides are available for download (After the mining boom 4 May 15), and the speech notes I prepared, which I loosely stuck to, are reproduced below. Note that my speech was given prior to the RBA’s interest rate decision being announced.
After the mining boom
Some of you may recall the economy as “rocking horse” analogy made by Swedish economist Knut Wicksell, referred to in Nobel Laureate Ragnar Frisch’s classic 1933 paper on the business cycle [SLIDE 2]. Say a rocking horse is constantly being hit by a club, at irregular times and with varying forces; it nonetheless exhibits a rocking motion although the amplitude and frequency of the rocking may change.
The shock or impulse needs to be distinguished from its propagation through the economy. The end of the mining boom is certainly a large shock to the Australian economy—and the Queensland economy, in particular—but the economy has endured other shocks before and may not result in a recession, as there are factors that tend to smooth out the impacts of shocks. For example, at the Treasury, one of Australia’s great economic achievements was seen as riding out the Asian financial crisis due to the depreciation of the Australian dollar. I’ll refrain from commenting on the 2008 financial crisis, due to the large debate on the efficacy of the fiscal policy response.
Further, there are a number of positive macroeconomic developments occurring at the same time. For example, the large level of investment in property by Chinese investors. Also, the US recovery is very positive news, and should eventually help drive global growth and compensate for slower growth in China.
It’s obvious there is a lot going on. Wicksell and Frisch have given us a useful framework to think about the end of the mining boom and the huge shock it is imparting to the economy, but it is now our challenging task to understand how that shock is propagating through the economy.
The commodity price drop is a large one, as shown in the chart Tony put up earlier. This has had a flow-on impact to the viability of some current mines and future projects. It has resulted in mine closures and job losses and reductions in planned investment (and in exploration). At the same time, there is the natural transition from the construction to the operational phase for mines and the LNG plants that would have occurred anyway.
The reductions in mining-related construction work and capital expenditure have had a large impact on Queensland’s economy [SLIDE 3]. In Queensland, this has occurred at the same time as a reduction in capital expenditure by the State and local governments [SLIDE 4].
Partly as a result, we have seen unemployment rise across Australia and especially in Queensland, and notably in areas heavily dependent on mining, such as the Rockhampton and Mackay regions [SLIDE 5]. Queensland’s unemployment rate is now above the national average, although much lower than historical highs [SLIDE 6].
While the job losses in the mining sector itself are apparent [SLIDE 7], the indirect impacts as the shock propagates through the economy are less obvious. An input-output analysis funded by the Queensland Resources Council suggests these indirect impacts may be large, due to the linkages mining has with other sectors. According to this analysis, the resources sector accounts for one in every four dollars of economic activity in Queensland, and supports one in five jobs in the economy.
However, there is a large debate about the robustness of estimated multipliers. Further, while mining employment has grown strongly in recent years in Queensland, the flow-on impacts on employment in other sectors aren’t necessarily clear. The mining boom has undoubtedly increased employment in professional services, particularly engineering, due to downstream impacts. However, it’s difficult to see a large contribution, and professional employment appears to have mainly grown according to the steady upward trend we’d expect given higher levels of education and growing demand for services domestically and internationally. And construction employment has been flat since the financial crisis [SLIDE 8].
Clearly mining is of importance to the economy, but the importance of the sector has waxed and waned over time. With a big surge in exports expected due to the new LNG terminals and the boost in coal exports that occurred during the mining boom, mining’s contribution to the Queensland economy is likely to settle at a higher level than previously, but lower than the peak in 2008-09 associated with a very high coal price [SLIDE 9].
The Australian and Queensland economies have survived and grown in the past with much smaller mining sectors, but nonetheless there will be significant changes as we adapt to the end of the mining boom.
Let’s think about what has changed by considering how we benefited from the boom. Important channels by which Australians benefited from the mining boom included:
- high incomes earned as mining employees or as suppliers of goods and services to the sector;
- the benefit of our increased purchasing power regarding overseas goods through a higher exchange rate (although offset partly by the adverse impact the exchange rate has on local industries); and
- very importantly, greater taxation revenue for governments, including notably higher company tax receipts for the Commonwealth and greater resource royalties to State Governments, particularly Queensland and WA.
Some commentators have noted that Australia has been experiencing an “income recession.” This will flow through to consumption spending which will have additional flow-on impacts in the short-term. Of course, the income effect from a lower terms-of-trade on the real economy may not be as great as feared because a lot of the profits of the resources sector flow overseas any way. Around three-quarters of equity in resources company is held overseas according to one estimate cited by Ross Garnaut in his book Dog Days.
Further, recent Wesfarmers results suggest that, at least on a national basis, there hasn’t been a large hit to consumption spending [SLIDE 10]. In part, this is due to the wealth effect of buoyant property markets in our capital cities.
Expansionary monetary policy will play an important role in facilitating the adjustment to the mining boom—does anyone here doubt the RBA will today cut the cash rate to a record low of 2 per cent? Of course, the expansionary monetary policy might have some undesirable consequences eventually, if it adds further froth to the property market by encouraging borrowing by an already heavily indebted household sector.
As noted above, at an international level, I expect the US recovery will help support global growth and, very crucially, growth in China.
Whatever happens in the short-term, I expect the economy will adjust over the long-term, and unemployment will stabilise around its natural rate, although our national income may be lower than it otherwise would be if commodity prices stayed much higher. Of course, we live in the short-term so it’s important to consider these impacts. To understand what is happening as the mining boom unwinds, let’s consider what happened during the boom.
As my old boss Ken Henry emphasised in several speeches, the mining boom was associated with a movement of resources across sectors that is pejoratively labelled “Dutch Disease” but which is perfectly natural according to international trade theory. Resources appear to have flowed from manufacturing and residential construction, for example, to the resources sector. In Queensland, manufacturing employed around 190,000 people in the late 2000s but now employs around 165,000.
To some extent, the increased demand for different skills across the economy was met by higher labour force participation, a reduction in unemployment—recall Queensland’s unemployment rate fell below 4 percent—and increases in hours worked. Resources were attracted to the resources sector by higher factor prices, with reports such as those of truck drivers earning $150,000 per year. So, after the mining boom, we may expect an unwinding of some of these things, and indeed that’s what we’re seeing [SLIDE 11].
It is likely that further job losses in many related industries to mining will occur in the short-term, but there are some bright spots in the economy due to lower interest rates and fuel prices, which no doubt contributed to the positive Wesfarmers result. Also the exchange rate has to an extent performed its usual role as an economic “shock absorber”, and the depreciation of the exchange rate has helped our tourism sector and international student attraction [SLIDE 12]. The boost to tourism is possibly what’s behind the surge in hospitality employment in Queensland over the last year or so [SLIDE 13].
While growth over the rest of the year at least will remain below trend, I expect the Australian and Queensland economies will muddle through the end of the mining boom, and over the medium to long-term a large number of jobs will be generated by the health, disability and aged care sectors, particularly taking into account the ageing of the population and introduction of the National Disability Insurance Scheme, the NDIS.
Health spending, of course, will continue its inexorable rise. For example, consider how it has overtaken education as the Queensland Government’s major expenditure item [SLIDE 14].
Deloitte Access Economics has forecast that, of the roughly 310,000 jobs that will be created in Queensland over the five years to 2018-19, around 55,000, or nearly one-in-five, will be in health care and social assistance. Other services industries such as retail trade, education, and professional services are important contributors to employment growth, as is construction.
Also, employment in other sectors should, to differing extents, grow as the economy as a whole grows. In Queensland, I expect construction employment to rebound strongly given recent strong levels of building approvals [SLIDE 15]. The sustainability of this recent trend, given the potential for over-supply, will depend on population growth, and crucially on whether there is a pickup in interstate migration [SLIDE 16].
Future employment levels in different industries will depend on a myriad of factors and hence forecasting is no more than crystal ball gazing. Future employment growth will occur mainly in the private sector, and it is important to continue with economic reform to promote future growth opportunities. Obvious candidates for reform include penalty rates—very important for a hospitality sector we’re very reliant on to provide jobs, especially for young people—planning regulations, and restrictions on taxis and pharmacies. The implementation of the Harper Review recommendations would provide important growth opportunities.
Impacts on government
Revenue streams to Government (via company tax and royalties, for example) from the resources sector are now falling short of expectations, compounding the budgetary woes of Commonwealth and State governments. We’ll find out next week what the revenue write-down from the lower iron ore price will be, but reports are it could be over $5 billion per annum.
The revenue situation is also problematic for the Queensland Government, which set itself an immense fiscal challenge to pay down debt without leasing out assets. Unfortunately the Queensland Government has become much more dependent on volatile and uncertain royalty payments in recent years [SLIDE 17].
Even over six months, Treasury’s estimates of royalties can change by hundreds of millions of dollars. Indeed, between June and December last year, the previous Government revised the royalties estimate for 2014-15 from $2.85 billion to $2.51 billion, a downward revision of $340 million. Given the downturn in the resources sector, it is possible the 2014-15 estimate could be revised down further at Budget time later this year. And the Treasury must certainly be starting to worry about how robust those forecasts of $3-4 billion per annum in royalties from 2015-16 onward are now.
Because it was anticipating $8 billion to spend on new infrastructure from asset leases, the previous Government had, in my view, under-provisioned for new infrastructure in the Budget forward estimates [SLIDE 18]. As the new Government will not be leasing out assets, it is difficult to see how it can provide the level of new infrastructure that the community—and work-starved engineering and civil construction firms—demand without compromising its objective to start paying down debt. It is lucky residential construction is picking up, because civil construction will likely remain sluggish.
For all practical purposes, the so-called mining boom has ended although its legacy will be a larger mining sector than for most of our history and much higher exports, but with many of the benefits going overseas. As we’d experienced high levels of capital expenditure and mining-related employment, the end of the mining boom is a major shock hitting the economy. However, signs are good that we’ll get through it without a recession at this stage.
That said, we won’t be as wealthy as we would have been if it had continued, and our governments will find it harder to pay for the ever-increasing expenditures of government with lower revenue growth, partly a result of income tax cuts enacted during the mining boom in the late 2000s. To an extent, the mining boom may have contributed to a desire for even greater expenditure—such as on the NDIS—when it appeared the good times might last forever. Some of you may have heard Chris Richardson on 7.30 Report last night describing the source of Australia’s current budgetary challenge in four words: “temporary boom, permanent promises.”
The end of the mining boom reminds us of that powerful phenomenon in life: regression to the mean, or proverbially “what goes up must come down.” Arguably, we should have seen the income gains from the resources boom as temporary, and saved them rather than boosting expenditures or giving permanent tax cuts. Never again should we talk about commodity price super cycles (similar to how we talked about the “great moderation” prior to the financial crisis). Unfortunately, we often have the foolish idea that this time is different, when it almost never is. Thank you.