Monday, April 4, 2011

Lucky Country is getting lazy By Michael Stutchbury

 Thank a productivity miracle for Australia's past decade of prosperity. It's just that the miracle has happened in China, rather than here. That has made Australia the luckiest country in the world.

 China's productivity gains have come from shifting hundreds of millions of rural peasants to coastal factories. There, Western technology has made Chinese labour much more productive and hence more profitable in a globalised economy. And that's driven the most powerful industrial revolution since Manchester's spinning machines grabbed 80 per cent of the world's cotton trade two centuries ago.
 Until recently, Chinese wages have lagged its productivity growth, in turn cutting labour costs, fattening corporate profits and driving its industrial expansion. This allowed China to remain competitive even while paying Australia four or five times more for steel-making raw materials.
 It has taken China a mere decade to advance from making less than one in 25 of the world's motor vehicles to more than one in five, turning it into the world's biggest auto producer as well as the biggest steel-maker. Much of the technology has been transferred by joint ventures with US, Japanese and German car companies.
 This dynamic has underwritten all Australia's income gains during the past decade even as our productivity has stalled. Led by China, emerging markets have driven global manufacturing output solidly above their pre-crisis highs, even as rich world economies have languished. As the chief supplier to the blast furnaces of the biggest industrial revolution, Australia instead is simply the world's luckiest country. Commonwealth Bank economist Michael Blythe estimates it boosted the real national pay cheque by $6000 a year for every man, woman and child.
 Yet Australia's national debate seems oblivious to how our fortunes - including our low jobless rate, healthy wage gains, strong dollar, cheap overseas holidays, high levels of government spending and elevated housing prices - are so dependent on this Chinese productivity story and our sky-high iron ore and coal export prices. Instead, it is more focused on the structural adjustment complaints, including population pressures and rising utilities prices, that come with our Chinese fortune cookie.
 There are good reasons to remain bullish on Australia's long-term China luck. But there is still a lot that can go wrong. Like many other resource-based economies, there's plenty of scope for us to blow it, including by inflating our expectations.
 A long-term observer of both the Australian and Chinese economies, Chicago-based economist David Hale points to the cyclical inflation pressures that forced China to lift official interest rates three times and to raise bank reserve requirements a half-dozen times in the past nine months.
 In Australia as the Commonwealth Bank's global economic adviser, Hale last week also pointed to separate "profound structural changes" that could weaken our China protection against foreign shocks.
 First is emerging labour shortages, particularly in southern and eastern China, that are driving 20 per cent plus annual wages gains. With wages no longer lagging productivity growth, Chinese corporate profits will be squeezed.
 The second is the gradual liberalisation of interest rate controls that, in the past, have captured Chinese household savings to provide a cheap source of capital for Chinese enterprises.
 Both are likely a necessary part of rebalancing growth drivers away from business investment and exports and more towards household consumption. But the profits and financing squeeze will show up in a lower investment rate that, in turn, will slow China's 11 per cent growth rates of the past five years to 7-8 per cent within the next five years.
 "China has had two major forces helping to drive the great boom of the last 15 to 20 years," Hale says. "One is cheap labour. The second is a very low cost of capital. Both of these factors are now in play."
 At the same time, Hale suggests the emerging iron ore province in west Africa could rival Australia's Pilbara and Brazil within a half decade. This is being driven partly by Australian mining exploration and development expertise and Chinese capital: a new side to the "complementary" Sino-Australian economic relationship.
 Hale suggests it also will break open the iron ore "cartel" run by BHP Billiton, Rio Tinto and Brazil's Vale and, in turn, partly reverse today's record high iron ore prices. These structural changes don't have to wreck our China luck so long as we manage it well. Commodity prices are still likely to remain well above pre-boom levels. The danger, Hale suggests, is complacency over the China shocks that could occur within a half decade or so.
 "People think they have been given a high standard of living just because of who they are and where they are so there is much less pressure for reform," Hale tells The Australian.
 "But the reality is that if all you do is dependent on your higher terms of trade then you will lose opportunities for growth because you won't be maximising your productivity and if there is a downturn at some point you suffer all the consequences."
 Hale notes that two decades of Australian economic reform has now "ground to a halt" because it is so difficult for a minority Labor government to provide decisive leadership.
 He nominates a budget surplus fund, infrastructure, a carbon price, a less regulated job market and a vigorous immigration program as the important big policy areas to get right.
 He finds Tony Abbott "frothy" but assumes that his team includes reform-minded types. In any case, he suggests, economic policy gains will remain stalled until an election installs a government with a clear majority and a mandate for reform.
 Boiled down like this, Australia's biggest risk now is that we don't know how lucky we really are.


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