Growth, investment, and trade Doug McTaggart September 2010 QIC ABN 95 942 373 762 is a statutory government owned corporation regulated by State Government legislation pertaining to government owned corporations. The Corporations Act 2001 does not apply to QIC and, therefore, QIC does not hold an Australian financial services licence and the financial product disclosure provisions in the Corporations Act 2001 do not apply to QIC. However, the Corporations Act 2001 does apply to QIC’s wholly-owned subsidiaries. Where required, QIC’s subsidiaries have obtained an Australian financial services licence. QIC and its subsidiaries and associated entities, and their directors, employees and representatives (“the QIC Parties”) do not warrant the accuracy or completeness of the information contained in this document (“the Information”). 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Agenda - US • Recession and recovery - Why Australia did well - Openness and the Australian economy - The commodities boom and Australia • Sustainability • Dutch disease - Global structural imbalances - Concerns • Data requirements 2 GFC and the real economy – a recap - Collapse of financial sector leverage led to a collapse of world growth in the fourth quarter 2008 - Order of proceedings was • Household confidence folded September 2008 • Retail sales and broader consumption fell • Inventories/sales ratio soared • Business confidence collapsed • Manufacturing collapsed • Business investment contracted • Unemployment up - End result • Collapse in inventories and world trade • Slowest global growth in over 50 years 3 A recession in US and Euro manufacturing 15 Annual growth in industrial production 10 5 per cent per year Because discretionary consumer spending collapsed, inventories accumulated in a totally unexpected way. This led to a collapse in manufacturing 0 -5 United States -10 -15 Eurozone -20 Industrial production fell at the rate of 12 per cent per year in the US, 20 per year on Europe, and 40 per cent per year in Japan -25 1.6 Inventory to sales ratio -- US per cent 1.5 1.4 1.3 Jan-12 Jan-11 Jan-10 Jan-09 Jan-08 Jan-07 Jan-06 Jan-05 Jan-04 Jan-03 Jan-02 Jan-01 Jan-00 Jan-99 Jan-98 Jan-97 Jan-96 Jan-95 Jan-94 Jan-93 1.2 Jan-92 4 World trade collapsed as in Great Depression 40 30 20 10 0 -10 Developing economies -30 5 Jan-12 Jan-10 Jan-08 Jan-06 Jan-04 Jan-02 Jan-00 Jan-98 Jan-96 Jan-94 Jan-92 Jan-90 Jan-82 -40 Jan-80 What the world stopped buying was discretionary consumer product Developed economies -20 Jan-88 • Discretionary consumer product 50 Jan-86 • Bulk commodities Growth in world trade Jan-84 What the world trades most are: 60 per cent per year The decline in world trade was the largest seen in many decades, largely the result of contracting household consumption of discretionary consumer goods, compounded by the freeze in credit The V-shaped global recession Measured real GDP growth fell in nearly all economies 2 0 -2 -4 US 6 UK Canada Australia Mar-12 Mar-10 Mar-08 Mar-06 Mar-04 Mar-02 Mar-00 Mar-98 Mar-96 Mar-94 Mar-92 Mar-90 Mar-88 Mar-86 -6 Mar-84 . 4 Mar-82 Australia fared better than most, though now the pack is catching up 6 Mar-80 A V-shaped deep trough occurred Real GDP growth per year 8 % per year September 2007 shaped as the trough in a “normal” business cycle, until the GFC hit 10 This US recovery is par for the course 107 The US economy has recovered from the deep recession about as fast as it could have, and at least as fast as in past recessions US Real GDP (NBER trough = 100) 106 Mar 1991 105 June 2009* 104 103 102 Nov 2001 101 100 Why the current paranoia regarding double dips and so? Because attitudes to risk have changed dramatically over the last two years 99 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 Quarters around NBER trough * QIC assumed trough. NBER is yet to report a trough date. 107 US private non-farm payroll employment (NBER trough = 100) 106 105 June 2009* 104 103 102 Mar 1991 101 100 99 Nov 2001 98 7 -12 -10 -8 -6 -4 -2 0 2 4 6 8 10 12 14 16 18 20 22 24 Months around NBER trough * QIC assumed trough. NBER is yet to report a trough date. The US economy reinvents itself …. again change in output per hour 7 5 4 % per year By allowing the unemployment rate to reach double figures the US economy again goes through a process of “creative destruction” 6 3 2 1 0 The process of reinventing itself every decade or so ensures that the US remains the most efficient economy on the globe, with the best prospects for future growth -1 Change in unit labour costs -2 14 12 10 To paraphrase George Friedman: “This is the beginning of the American Century” % per year 8 6 4 2 0 -2 -4 Mar-12 Mar-10 Mar-08 Mar-06 Mar-04 Mar-02 Mar-00 Mar-98 Mar-96 Mar-94 Mar-92 Mar-90 Mar-88 Mar-86 Mar-84 Mar-82 -6 Mar-80 8 Why the US is so important World Bank data for 2007 show why the US is so important for all in the global economy. China and other emerging economies have a long way to go be dominant forces in the global economy 9 20 15 per cent US household consumption accounts for one third of total global consumption and about one fifth of world output (slightly lower with PPP estimates) Consumption shares of global output 2007 25 10 PPP Constant (2000) US$ 5 0 SSA ARG AUS BRA CHI FRA GER IND JAP RUS UK US Conclusions on the US - The recent recession was one delivered by rational consumer behaviour as they took steps to guard against a financial market meltdown – the recession we chose to have - Even as global financial markets are de-leveraging by about 50%, there is no evidence that households (US and other) are deleveraging or are having to de-leverage going forward - US economic growth will quickly return to trend - The US economy again reinvents itself - The US economy, led by the US consumer, is and will remain the engine of world growth. Other economies are largely dependent on the US and the broader Anglo-world 10 How has Australia done through the GFC? The Australian business cycle is still highly correlated with the US business cycle, albeit we have done somewhat better in recent times 3.0% 2004-10 11 6 4 2 0 -2 -4 US Australia Mar-12 Mar-10 Mar-08 Mar-06 Mar-04 Mar-02 Mar-00 Mar-98 Mar-96 Mar-94 Mar-92 Mar-90 Mar-88 Mar-86 Mar-84 -6 Mar-82 3.3% 1990-2004 8 Mar-80 And note that average GDP growth was higher before the commodities boom than it was after: 10 per cent per year It is clear the US drives the Australian business cycle Real GDP growth Why Australia did relatively well - Robust financial sector – even though relatively large - National, uniform prudential legislation - High immigration rates - High initial interest rates - Variable rate mortgages and consequent large fall - Falling oil/petrol prices - Recent experience with skilled labour shortages, labour hoarding - Relatively small manufacturing sector - Predominance of bulk commodity exports - Stimulus packages 12 How open is the Australian economy? Not very, relatively speaking! 150 211 / 361 120 1970 90 2008 per cent So the question is, just how much did Australia’s success through the GFC revolve around our trade links with Asia, in general, and China, in particular, via commodity exports? Imports + exports as a share of GDP 1970 and 2008 60 13 30 Ko re a Si ng ap or e Ge rm an y Ch in a Ru ss ia In do ne si a UK In di a Ja pa n Au st ra l ia Ar ge nt in a US az il 0 Br Note that Australia always was and still remains a relatively closed economy. We sit alongside the US and Japan – very large internal markets – and also Brazil, Argentina and India The commodity price boom Benchm ark com m odity prices (US$/t) 320 The commodities boom, beginning in the early 2000s, but accelerating in 2004, has been very much a price boom. 280 240 200 160 Coking coal 120 It has both supply and demand elements. 80 40 Iron ore 0 Apr-02 Global stocks of commodities, especially base metals, reached record lows in 2004, fuelling price rises Apr-04 Apr-06 130 Apr-08 Apr-10 The terms of trade 120 110 100 90 80 70 60 Sep-10 Sep-07 Sep-04 Sep-01 Sep-98 Sep-95 Sep-92 Sep-89 Sep-86 Sep-83 Sep-80 Sep-77 Sep-74 Sep-71 Sep-68 Sep-65 Sep-62 50 Sep-59 2007-08 = 100 This coincided with increasing demand for Australian coal and iron ore from China, which between 2004 and 2008 went from being the world’s largest importer of steel to the world’s largest exporter 14 Therm al coal The booming commodities sector 70 Industry share of capex 60 Other selected industries 50 per cent The re-direction of resource utilisation in Australia has been dramatic as seen in business investment outcomes: • Mining has squeezed out capex spending in manufacturing 40 Mining 30 20 10 Manufacturing • Capex spending in buildings and structures has squeezed out capex in plant and equipment 0 Type of capex 90 80 70 Plant and equipment per cent 60 50 40 30 Buildings and structures 20 10 Jun-11 Jun-09 Jun-07 Jun-05 Jun-03 Jun-01 Jun-99 Jun-97 Jun-95 Jun-93 Jun-91 Jun-89 0 Jun-87 15 Uneven state impacts The impacts have not been uniformly positive across Australia • QLD has done moderately well 40 35 per cent • WA has dramatically increased its capex share, largely at the expense of NSW, with less significant impacts on VIC and SA State share of capex 45 30 WA 25 NSW QLD VIC 20 15 10 5 SA 16 Jun-13 Jun-11 Jun-09 Jun-07 Jun-05 Jun-03 Jun-01 Jun-99 Jun-97 Jun-95 Jun-93 Jun-91 Jun-89 0 And trade impacts? 10 Real trade balance as a share of GDP 8 6 per cent For the entire period of the commodities boom, Australia’s trade balance has deteriorated, except when imports crashed during the GFC as households curtailed consumption 4 2 0 -2 -4 2.5 But isn’t the commodities boom, for Australia, an export led boom? Net exports contribution to GDP growth 2.0 GFC 1.5 What has happened? percentage points 1.0 0.5 0.0 -0.5 -1.0 -1.5 Commodities boom Mar-12 Mar-10 Mar-08 Mar-06 Mar-04 Mar-02 Mar-00 Mar-98 Mar-96 Mar-94 Mar-92 Mar-90 Mar-88 Mar-86 Mar-84 Mar-82 -2.0 Mar-80 17 Currency valuation effects As the AUD appreciated, tourism changed from a large export industry to a large import industry 150000 The Dutch disease 1.1000 100000 1.0000 50000 18 0.8000 -50000 0.7000 USD/AUD -100000 0.6000 Net outbound departures Ja n12 Ja n11 Ja n10 Ja n09 Ja n08 Ja n06 Ja n07 Ja n05 0.4000 Ja n04 -200000 Ja n03 0.5000 Ja n02 -150000 USD/AUD Tourism as an export industry Ja n01 We haven’t managed this very well. Tourism as an import industry 0 Ja n00 This is a dramatic example of the Dutch Disease (Gregory Thesis), and it applies across the board to all Australia export sectors outside of the resources sector number per quarter 0.9000 The states and the Dutch disease The GFC brought a temporary end to this disparity but it looks likely to emerge again, when spending stabilises 18 16 14 WA QLD 12 10 per cent per year The net effect of the Dutch disease was very positive for WA, good for QLD and very bad for the other states, leading to the two speed economy 8 6 4 2 VIC 0 -2 NSW SA -4 19 Mar-11 Sep-10 Mar-10 Sep-09 Mar-09 Sep-08 Mar-08 Sep-07 Mar-07 Sep-06 Mar-06 Sep-05 Mar-05 Sep-04 Mar-04 Sep-03 Mar-03 Sep-02 Mar-02 Sep-01 Mar-01 Sep-00 Mar-00 -6 Are structural imbalances an impediment? Are they structural imbalances at all? 600 Current account deficits Those countries with (relatively) large and persistent CA deficits are Anglo, rapidly growing and demographically young. China 200 Germany Japan Saudi 0 US $ Billion These are good environments for foreign investment 400 -200 • Good governance -400 • Transparent -600 • High yielding -800 20 USA -1000 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 And are likely to continue to attract foreign investment flows for a long time to come Aust UK Productivity growth also dissappointing Productivity growth through the commodities boom has also been disappointingly low. There are a number of possible explanations for this: • Capacity limitations • Lower R&D • A 3-sector problem – agriculture, mining and utilities • Slower micro-reform 21 Fred Hilmer: “What’s wrong with microeconomic reform today?”, UNSW, 31 August 2010 What are the concerns? - Is Australia putting all its eggs in the China basket and ignoring more traditional sources of growth? - Is the commodities price boom sustainable? The supply effect. - Will the China effect persist? - If so, how do we deal with structural re-alignment of Australian industry that is required? • Stolper-Samuelson: return to capital intensive factors (physical and human capital -- skilled labour) goes up, return to other factors goes down (less skilled labour) • Capital-labour ratios rise - What are the cross-jurisdictional implications? 22 Data issues - To understand the impact on the structure of the Australian economy, we require an integrated database by industry and region that is: • Consistent with the national accounts • At the same level of disaggregation as the input/output data • Includes estimates of: Capital formation; Capital stock; and Return to capital. - Problems with what we have: 23 • Annual national accounts lack sufficient industry disaggregation and a return on capital measure; • Quarterly business indicators definition may differ from national accounts and lacks sufficient industry disaggregation • Input/output data lacks timeliness, a measure of the industry capital stock and return to capital.