Transcript
CHAIR
We move to a, we've got a bifurcated section this time, so we move out of international space, really, to Australian adjustments here and Bob and Peter's paper on policy issues in the long run, looking forward beyond the resources boom. Bob?
PROFESSOR BOB GREGORY
So I'm just going to warm up for a few minutes and then get on to the paper. The Reserve Bank and the Treasury and I think very similar about these things, so the question arises, why am I talking about this now, and I'm talking about this because A, I will be much clearer and more dogmatic than either the Bank or the Treasury, and that's a very valuable thing to have; secondly, I will lay out policy which the Reserve Bank and Treasury may not be able to say and thirdly, you may say, and this is important, is what are all these I's when the first name on the paper is Peter Sheehan's? And for those of you who don't know Peter and I, I feel, before I go on and on about the I's, that I should tell you, is the Bank knows all those things about me, but there are three other residual problems; first of all, who's going to do the work, and that overwhelmingly is Peter, and then secondly, who's going to get Bob off his old ideas onto new ideas, and Peter is a part of that, and thirdly, who can put up with this preposterous behaviour of me trying to steal all the limelight, and in the words of Facebook, he is my best friend and he forgives me, at least he used to.
So, let me tell you what we're going to do. You will have seen all this implicit in Chris Kent's paper, but it's like his comment when he said the exchange rate was too high, their paper inevitably is not as clear as I will be. The mineral boom has to be thought of as three phases, and Chris does that, and the point about the phases is that each one of the phases is very, very different, and so let me try and nail down, in a very graphic way, why they're different. And I want to talk, all through this talk, in a very, very, stylised, simplified way to bring out the essence. I want you to think of yourself as being an Australian worker in some sense, okay? And I want you to think of the mining boom as being a thing which foreigners do to us, okay? Which is no doubt an exaggeration, but just think of it like this, and here's the essence of the three phases; the first phase is that the foreigner, and the foreigners shift throughout the talk, the first phase is the foreigner says to the Australian worker, how would you like ten percent more income? And the Australian worker says, great, what do I have to do? Answer: nothing. Just take the money. Well, how do I turn this into real goods and services? Well, when we give you the money, the exchange rate's going to change, it'll appreciate, and all those things that you buy through imports are going to be very much cheaper, and all workers will get this. And basically that's what's happened, and I'll show you. That is a big deal.
The second phase, which is a different foreigner, in this case it's the mining company, is, they say to the Australian worker, how would you like to help us build mines? What do I have to do? Well, you're going to have to move a little bit and you're going to have to go to the desert a little bit, and you've got to work for it, but we will pay you well. That's the second phase, and that' basically what we're going through now.
The third phase is the really interesting one, which I think is very hard to think about; and then the foreigner says, well, now that we've given you the money free at the beginning, we then take it away from you, although not by choice, but the terms of trade will take it away. Secondly, now that you've built the factory, we don't want you to build the factory anymore, or the mine, it's done, but what we're going to do is we're going to increase export as a fraction of the Australian GDP, dramatically. Oh, but by the way, you're not going to produce them. What's going to essentially produce them is foreign capital, because all these mines are so capital intensive; to take the extreme case of that, I was talking about the Pluto yesterday, the Pluto project, I can't remember the numbers, 14 billion, 34 billion, something like that, six hundred workers now that it's completed, on the site. So, the essence of this story is, you can see quite clearly Australians have, as it turned out, gained enormously from stage one, dramatically, everybody, and roughly speaking, about half of our income gains over the last decade have been this, what I call a free gift. The second stage is, the main gainers, in fact, are people who are doing the construction, except that the construction flows are everywhere, you know, as Chris said this morning, there are lawyers and there are accountants and all sorts of things. And the third stage is really the interesting one, because in the third stage, we're going to be in the situation where we're going to be exporting a lot, getting foreign currency, then the foreigner is going to be wanting to take his foreign capital back, to a large degree, large capital outflows, nobody's going to be producing much of these exports, how will the economy adjust? So the point of that story is just to show you these three distinct phases.
Now, if you think about it from the worker's perspective, period one is this gift, there's great expansion, everybody runs around spending money, but then the foreigner starts taking it back, and when I say the foreigner, I mean people out there, it's the mine for the minerals and the supply of minerals, which we're a part of as well, they start taking it back, and if they take it back, that reduces our income level, and our income level will fall, roughly speaking, in proportion to the terms of trade fall. Nobody knows about that, but it could be 100%; nobody's thought of that recently, but everybody's estimated out where the terms of trade is going; it's coming down fast.
Secondly, in the construction phase, there are a lot more jobs going and we can see that whenever we go to WA and Queensland, and that in some sense is replacing this loss of income of the free gift for the terms of trade. But when that turns around, that's going to be a deflationary force, so we've got two deflationary forces, and if the increased exports are like I've roughly described to you, mainly things which are not by and large using Australian labour and things which are, to a significant degree, being matched by capital outflows, then that'll not be a positive force, which offsets the previous two positive forces; it won't be strong enough. So if that occurs, that suggests that the Reserve Bank and the Treasury have really had it easy in many ways, to this point. As Chris said this morning, the reason why the economy has done so well is because of everything that was done before the crisis began. Remember, he mentioned floating exchange rates, that was done beforehand, industrial relations labour markets, that was done beforehand. The Treasury has had it fairly easy, they're marked up the tax policy, by and large, but by and large they've had it easy. That's going to be really quite difficult, because if there was a major downturn, that we're going into that downturn when the fiscal policy hands are tied because of the fear of deficits. When we go into the downturn, if it's there, monetary policy hands will be tied, because by then interest rates will be very low, and we all know, looking around the world, that banks find it hard to stimulate economies when interest rates are so low.
So, what are we going to do? So we suggest the following, in broad terms. When we look at Australian cities and Australia generally, and when we go back to the rhetoric of more or less the last decade, up until the last couple of years, everybody was s
ort of convinced that Australia had an infrastructure backlog. For those of you who live in Melbourne and Sydney, you know that, right, you can't get around. For those who live in WA and Queensland, you know there's pressure. So we would like to put in place an infrastructure boom, as it were, to replace what we think is the end of the mineral boom. But how do you do an infrastructure boom given that infrastructure booms are predominantly under State control and given that the feds have got their hands tied basically with the fiscal policy and the worry about deficits.
So we are suggesting something which is, and this is all Peter, I might add, so blame him, we're suggesting something which is not on the macro agenda, basically, and that is, Australia has to look more closely at federal state financial relations. It's pretty obvious when you think about it, right? The first thing that happens is that they are the people who do the infrastructure expenditure, secondly the fed are the ones with the great credit ratings, not the states, so if we can somehow or other get the federal credit ratings into the state borrowing patterns, that'd really help. Thirdly, the income distribution across the states is changing dramatically, so that WA and Queensland are getting royalties, the way things work in Australia, if you've got a time lag, the other states get their hands on that and we redistribute. WA and Queensland haven't minded this system, by and large, because they were the ones who usually got the redistributions, so the state royalties and the rising of state taxes has got to destabilise the federal state relationship system, so that's another reason. And thirdly, partly because the only area where I can see clearly where we've failed over the last decade is in the tax side, it looks now as though we're getting hardly any federal taxes out of mining, it looks now, in retrospect, that we may have given away too many tax cuts and concessions in the past, so given that that is the situation, I really do think, looking ahead, that we do have to have a GST increase. I just think it's inevitable. And who is it that's going to likely lobby the most hardest for that? Well, it's already started: the states. So when you look at the federal state financial relations, I think you can see lots of opportunities there for moving around, to try and move the discussion forward, but we know, from mining projects, and infrastructure's not that different, they take a long time to get started, so we have to start thinking about that now. We know, from the rent resource tax on mining, that you can't spring these things on, they take a long time to get people used to the idea, so I think we've got to get used to this idea of revisiting the federal state financial relationship system.
So that's the story. Now let me sort of illustrate it fairly quickly with the key slides that we want to demonstrate our major proposition about the three stages and how they're going to change and how we think, at the end, we're talking about two years, three years hence, we think that the major forces in this country are going to be going on the downward direction rather than the upward direction. You'll see some interesting slides by the way, which I've cut out, but in many ways these are very interesting because they go to deep psychological things, but let's not worry about that. This is what we do, I've already told you about that, okay? But I want to emphasise that the words stylised characterisations, that's coming from me, as an academic who's trying to make everything simple so you can see it, and I think I've laid it out. So what I don't want you to do is play around by saying, oh, what if the terms of trade went up by 10%, or what if this happened tomorrow? I want you to focus on the big story and see whether you think the big story is roughly right and if so, whether you can think of any other way out, if there is going to be a major deflationary outcome in three or four years. So we sort of think that, but we're not prepared to go to court and swear that this will happen, but that's more or less what we think.
This is a major picture which I want to spend some time on, because I think this is really important, and you've seen it already, but I think Chris presented it, but he gave so many pictures you might have missed it. See the line that's second from the top? That's our GDP growth, forget about the fact that these aren't in log terms; the main thing about our GDP growth is nothing's changed in Australia. If I show you that picture, we're just moving along the same way as we have always done. So if we're moving along at the same way as we've always done, why this suggestion that things are about to fall apart and these three phases are so important? Well, the reason is twofold; the first one is, the bunch of countries on the bottom, they're the US, Europe, put down whichever country you want, basically, and see, life hasn't been the same for them, and we're now roughly speaking, about 10 percentage points above the US, for example. That's all because of stage one, right? That's all because the terms of trade increased so much, and as the foreigners gave us this money, it flowed into GDP.
Those of you who know a little bit about national accounts know that GDP is the production of goods and services in volume terms and it does not include directly the fact that the price of exports rise, in fact the National Council was put together in real terms to take out the effect of the price increases. So the line on the top is Australia GDP plus stage one terms of trade gift. Now, here's the scary part, which is what I used yesterday which I'm now rather fond of, do you know the gap between the top line and the United States is 25% relative to a decade ago? Relative to a decade ago, our income levels have risen 25% in real terms compared to the US. I've never seen anything like this before in my life, in fact, you can't even see it, I don't think, in the last century, unless you play around a little bit with data at the very beginning. Now the other essence of this picture, by the way, is, the gap between the Australian GDP and the other line is the free gift that can be taken away as terms of trade fall. So that really shows you the size of the problem.
So what we do is, Peter and I, this is stage one, on this axis here is the fraction of GDP, and we measure the trading gains. The trading gains are our fancy words for the gains in our income that have come about because our terms of trade have increased. If you go to the peak, it looks like the terms of trade increase has delivered about 10% to Australians. 10% of my salary, which is about 100 00, I guess it's 10 grand, 10 percent or Chris's salary which is 400 000, it's about, what, what's 10% of 400 000? 40 000? Big bikkies, right? So, after that, we've now mapped in what we think the terms of trade will do over the new future, we have been falling quite sharply. Now, the important point here is, while we will have gained at the end compared to the front, the terms of trade will still be above what they were, if you want to measure the effect on incomes, you've got to look at the changes, that is because the terms of trade are falling, it is withdrawing income stimulus from us, and that shows you the size of the change. We think the size of the change will probably be about 6 or 7% of GDP. That, by the way, is bigger, by and large, than GDP falls in a real recession.
This is the second picture. I won't talk about the red things because the red things are puzzles which we just won't have time to get into. The second picture is stage two. The interesting thing is, if you go back to the beginning of the graph, which is about 2003, you can see from this graph how long it takes for mining investment to come about. So, most of this, go back to the global financial crisis, for example, mining investment itself made very little contribution to avoiding the financial crisis here, it was all the terms of trade effect I showed you on the previous picture. But you can see where we've got th
is vertical line, that the mining boom is building up, so we're quite optimistic about next year, and maybe even a little bit of the year after, because we think the investment boom's going to replace what we lose from the terms of trade, so we're not too worried about that. But notice, because the terms of trade are coming down sharply, and this starts coming down sharply, once we get two or three years hence, we've got two things coming down.
And this, lastly, is what we think about exports. The most extraordinarily thing about this picture is, this is total exports, resource exports, in real terms, as a share of GDP, and you can see here that, to the left of the line, exports of mining products have really played a very small role in the increase in income in this country, it's all been, in the first instance, the terms of trade, step one, in the second instance, mainly construction, and now, the export volumes start increasing.
Now, I will talk a little bit about this red line, because this red line or this red shaded area is not a part of the discussion, very much. What we predict basically is that resource exports as a share of GDP will probably increase eight percentage points, say, that's big. It's a big, big increase. But the question is that most of this increase is owned by, these exports are coming out of foreign mining companies and it's the foreign mining companies that came into this deal with us, in the second stage, to build all the construction, so the foreign mining companies at some stage are going to want to start repatriating their profits, capital outflow. We never think about that, at least, I haven't thought much about that. So, when we think about it, we get roughly that red shaded area; so it's not as though all these exports belong to us, in any sense; they go in our national as Australian exports, but they're produced... Well, just take Pluto, for example, if it cost 34 billion or whatever the number is, somebody's got to pay for that, and the way we pay for it essentially is when we export all this LNG, most of the revenue will go towards paying for the capital cost, it won't go towards paying the 600 or so workers on the sites. So that split between the foreign and the domestic is really quite important, and you'll see this split between foreign and domestic... Actually, I will tell you about this, each one of these red balloons are our split between domestic and foreign, and in each case we don't really understand them well, so, for example, when the terms of trade go up, the mining companies initially get all the benefit, but then the exchange rate essentially taxes the mining companies and then redistributes it throughout Australia, because the exchange rate goes down, takes money away from mining companies, gives it to us, we buy cheap imports. We think that's big, we think it's big, but the ABS think it's small, and the reds are the ABS numbers.
When we do the construction, I talked about the Australian worker working for the foreign company to build the mine, a lot of the mines are imported in same way or another, of which Pluto would be a good example, right? You make most of the stuff in Korea and bring it over; it depends on which product you're looking at, and that's the split, and then this is our split, and I think these splits are an important way that we have to think about the economy now which we didn't do in the past.
We add the three stimuli together and this is what we get. So essentially, we get, after a year, maybe, a deflationary force going out through Australia, so the mining boom switches from this free gift which we all enjoyed immensely, they start to withdraw it as the terms of trade falls, which means, by the way, if the terms of trade disappear, we all have to give up 10% of our income in a simple model; it's an awful lot to give up. Then you see the investment starts to fall and then lastly you see, not fully replaced by export. So down this slope is a major deflationary force and I think that's the key issue; A, when you really think this is reasonable, and B, what you're going to do about it. You don't wave your hands and say we're forming industrial relations without actually saying what you're going to do, and besides, I don't think it'll matter much. And that's the issue, and that's why we want to put in place this commonwealth federal state relationships.
So here it is. We think that when we go into this slide, you may as well stop reading about what the central bank is up to, unless you're interested in speculating in the short term, because their hands will basically be tied, as they are in most countries. You go to the US now, interest rates are so low they can't do much, unless you're a great believer in quantitative easing, which most people aren't, and we're not. We're not against it, we just don't think it can be big enough to offset this, like it's not big enough to turn the United States' economy around and back to where it was, or big enough to whatever's going on in the UK, to turn the economy around. Fiscal policy we are pessimistic about because we believe that there's already a structural deficit in place and we think it's going to get worse, and then when we overlay that with the political attitudes about fiscal deficit... We don't see Tony Abbott, and I'm sorry I have to single him out, as saying, my major job when I get in is to have expansion in fiscal policy. He certainly will not cut taxes in the way he wants to cut them, I assume, but he won't be an expansionary person, and even if the other mob are in power, they will find their hands tied too.
So that's why we've got to think of a way of getting this infrastructure boom in, which can be acceptable, and I think by putting together these various elements of the states that I'm talking about, the fact that the real income distribution across the states has changed, the tax income has changed through royalties, the fact that the credit ratings are a problem, the fact that the GST which they receive is shrinking, all those things ought to make the states want to come to the table, and I think when they want to come to the table, the feds should go there and use it as a big package; increase the GST, change the federal state financial relations, get the new innovations we've made institutionally on infrastructure, get that into place so we can move ahead; start early. If you don't start early, the situation will bypass us.
So, I think I should not get into these other points, but there are many other things one could have talked about. I think we'll leave it at that and we'll them up in the discussion. Thank you.