16/11/2011 - 10:19

Opportunities to emerge from the chaos

16/11/2011 - 10:19

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Volatility has become the norm in the world’s economies as a ‘once-in-a-century’ global economic transformation unfolds.

CHANGE: We are in the midst of a once-in-a-century global economic transformation, and it is occurring right on Australia's doorstep.

Volatility has become the norm in the world’s economies as a ‘once-in-a-century’ global economic transformation unfolds.

THE global economy is heading down a windy road, with twists and turns ahead that we can’t predict.  

Post-GFC, it was expected that the global economy would recover at a modest pace as the financial excesses were worked out of national, business and household balance sheets.

However, we have seen events occur that threaten to derail this recovery.

Events in the unfolding saga of the European sovereign debt crisis are changing on a daily (if not hourly) basis. It’s not just events in Europe either, with the unprecedented downgrade by Standard & Poor’s of its US sovereign credit rating in August providing yet another twist.

Uncertainty and risk aversion associated with global growth concerns and the European sovereign debt crisis have gripped financial markets. Volatility has become the new norm.

The rise of Asia

With economic commentary focused on the short term and the North Atlantic, it can be easy to overlook the bigger picture. We are in the midst of a once-in-a-century global economic transformation, and it is occurring right on Australia’s doorstep.  

The most obvious manifestation is the rapid growth of China and India, but also increasingly of Indonesia and Vietnam.

This transformation does not end at Asia’s edge, however.  We see a similar story developing in other emerging economies. For example, a young population and improvements in human capital will likely contribute to an expected doubling in South Africa’s GDP in the next 20 years, and Nigeria is expected to increase three-fold to displace South Africa as the continent’s largest economy by the late 2020s. 

Latin America also continues to surge forward with Brazil and Chile leading the way, with both expected to double in size by 2030.

Returning to Asia, despite rapid growth in living standards, China and India remain at the early stages of their economic development. Even today,

China’s GDP per capita is only around that experienced by Japan in the early 1960s and by Australia prior to the 1950s.

Future economic success is not pre-ordained. But assuming broad trends continue, a major socioeconomic implication of this growth is that an increasingly wealthy and mobile middle class will populate China and India’s cities in the decades ahead.

On some projections, there will be 1.7 billion middle class consumers in the Asia Pacific region by 2020 – more than the rest of the world combined.

At that time (2020) China will be the single-largest middle-class market in the world in dollar terms.

Rising incomes will lead to changing food consumption patterns, and increased demand for luxury and durable consumer goods, and services such as international travel and tertiary education – features of consumption patterns in developed economies. This opens new opportunities for Australia.

Structural change

With significant changes in the makeup of the global economy come significant pressures on the structure of the Australian economy. This is not entirely surprising for a relatively small open economy. And while adjustment is challenging, some of the changes should be considered more an acceleration of ongoing trends than a new phenomenon.

The first wave of impacts from the ‘Asian century’ is a familiar story now – a once-in-a-generation demand for our mineral and energy resources has manifested in a historically high level for the terms of trade.

While the terms of trade are likely to remain well above historical averages, as the supply of resources catches up with demand, we expect the terms of trade to gradually decline.

Reflecting the terms of trade surge, though, our exchange rate both in nominal and real terms is setting new post-float records and, in turn, having a profound impact on our traded-goods sector.

While businesses have developed experience in managing short-term fluctuations in the exchange rate, we have seen evidence recently that existing business models can be easily threatened when the exchange rate remains persistently high – a situation we are likely to confront for a long time yet.

The shift in economic activity towards mining and mining-related sectors, and the service sectors more generally, is part of a longer-term trend away from parts of traditional manufacturing which began in the middle of the 20th century. 

This structural evolution of the Australian economy reflects a prolonged shift in our comparative advantage, but is not just something endemic to Australia. Our evolution towards a more service-oriented economy is common to the economic development of all advanced economies, including those in Asia.

Where Australia is different is the growth in the size of our mining sector, not in the decline in our manufacturing sector.

Though it may be a surprise to some, employment in manufacturing in Australia has generally fared better than in the major advanced economies during the past decade or so.

Relative to the start of the last decade, Australia has recorded a smaller decline than the G7 average and the change is roughly similar to that seen in German manufacturing employment.

The US is contending with its own problems in this area, as emerging markets shift into higher value manufacturing such as IT and telecommunications, placing pressure on a long-held comparative advantage by the US.

Overall, this highlights that in a changing world other advanced economies are experiencing similar adjustments to the structure of their economies, part of which is explained by the long-term trend towards services as they mature but also the impact large emerging economies are having on global supply chains.

It also highlights that comparative advantage is not a static concept.

Rather comparative advantage shifts, and those countries that are flexible and responsive to change will be those best placed to maximise the resulting opportunities.

While the structural adjustment story tends to focus on the adverse impacts, it is also important for policymakers to highlight the benefits from a changing economy.  

The high exchange rate, while affecting our non-resource traded sectors, is boosting living standards through cheaper imported consumer goods and assists in placing downward pressure on inflation with obvious benefits for interest rates. 

The flexible exchange rate, therefore, is one way the benefits of the resource boom are spread across the economy.

• This is an edited version of an address by Dr Martin Parkinson, Secretary to the Treasury, titled Policy Challenges In A Changing World, to the American Chamber of Commerce in Australia on November 9.


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