Australia's prosperity illusion

The results of the CEDA / Business Spectator survey hold, in some ways, a cautionary tale. To wit: there is "almost universal acceptance that Australia's prosperity for at least the next decade is reliant on trade and investment links to China.”

There is, of course, no question that China has played an important role in Australia's very strong economic performance over the past decade. And it goes without saying that China, as the world's second largest economy and Australia's largest trade partner, will play a part in our future.

But for the business community to believe that Australia's prosperity is reliant upon the giant to our north is concerning, for two reasons.

First, how comfortable is the Australian community in putting all of its eggs, as it were, in the China basket?

Second, and more importantly, have we forgotten where the answer to prosperity really lies – namely, in lifting Australian productivity through education, innovation and drive?

As the inhabitants of a small, open economy, Australians are always mindful of being the small fish in a very big pond. Events overseas can have massive impact at home, as the past few years will attest. On the one hand, the explosion of demand for commodities out of China has generated a once-in-a-generation terms of trade boom for Australia for the past decade. On the other hand, the collapse of the US housing market nearly brought down the entire global financial system. No wonder Australians now cast a wary eye offshore, waiting for the next shoe to drop.

But the reality is that we are masters of our own fate. Australia by and large emerged unscathed from the GFC not because China put a floor under commodity prices, but because Australian policymakers put a floor under the economy with a set of proactive, meaningful adjustment policies.

The RBA slashed rates aggressively, and allowed the currency to plummet. The government undertook significant fiscal stimulus, and numerous measures were put into place to ensure the smooth functioning of the domestic banking system during a time of great stress. Importantly, Australia's public finances had virtually been bullet-proofed, providing enough pocket money to get through the long rainy day that was 2009. That, too, was our public policy choice – one that governments throughout the G20 are now wishing they had also made.

The global economy is slowly recovering from the GFC, but our future is still in our own hands. Yes, the terms of trade boom is significant, and appears to be ongoing. At the current rate of expansion – with the terms of trade having risen by nearly 30 per cent over the past year – we are looking at an impact not felt in Australia since the global rebuild that followed World War II. No wonder that business sentiment in Australia now rises and falls with copper prices.


Australia's terms of trade, 1870 - present


The question for our prosperity, though, is not really the strength of the global recovery, or the growth rate of China, or its demand for iron ore. The question is our reaction. And there, the signs are that even continued rises in commodity prices may not drive the prosperity that so many seem to assume is around the corner.

How can this be? Simply put, the commodity boom in and of itself does not generate prosperity for Australian households. Mining itself as an industry is only 9.5 per cent of GDP, as against 10 per cent for financial services and 18 per cent for professional, health, education and administration services. What generates the wealth from mining is the contribution to gross domestic income (GDI), and the redistribution of that income via tax.

What partly drove perceptions of "prosperity” in Australia from the start of the commodity price boom in 2000 was a rise in the GDI that – redistributed through tax – pushed up household income. In early 1999, household disposable income growth was running at around 3 per cent per annum, and the savings rate and GDI were both rising at about 2 per cent per year. By 2002, both GDI and household disposable income were rising toward a rate of 5 per cent per annum, and Australia's savings rate went negative for the first time in modern economic history.

Consumers cottoned on to expectations that their incomes would continue to rise in the future. And they were right. By the time the GFC hit, in mid-2007, household disposable income was rising at an annual rate in excess of 10 per cent. It goes without saying that when households earn more and save less, they consume more. These were the boom times.



But something big happened to Australians in the GFC. The threat of a drop in income – even if never realised – seems to have shifted perceptions about what constitutes a "safe” level of personal debt. Economists call this a "behavioural change,” and in this case, the change seems to be in favour of more precautionary savings, less debt and less consumption. Evidencing this, though household income has risen at a faster rate over the past year, savings rates remains well above 5 per cent. The household debt service ratio actually decreased in the September quarter, after rising somewhat from its low in June 2009. The household debt service ratio is still a full 2 percentage points below its peak of 12.5 per cent in late 2008. All of this with a 30 per cent rise in the terms of trade over the past 12 months.

If this change is permanent, the post-GFC world will not see the terms of trade boom generating the same sort of household behaviour as in the naughties. What felt like prosperity, in fact, is not. Note the desire in this survey and others for the government to avoid further fiscal stimulus – to save windfall mining revenues, for example.

What will deliver prosperity? When it comes to Australia's place in the global economy, the answer is still Asia. But rather than thinking of the stuff we can dig out of the ground, we need to focus on the stuff we can dig out of our minds. The answer to Australia's future prosperity lies in its ability to continually increase its productivity – especially in the services sectors that now dominate the economy and employment – and to expand our trade in services with our large trading partners to the north. That is the exciting new frontier. A future of large Australian services conglomerates, exporting their services to China, India, Korea, Indonesia and Vietnam – that is the stuff prosperity is made of.

China is still a developing country with an evolving political system and numerous economic policy challenges to face in its future. It could be the case that China's demand for our iron ore and coal will expand for evermore, until the last generation. Then again, it might not.

Yet, we put ourselves in the hands of China's continued expansion – and not just expansion, but very specifically an ever-rising demand for iron ore and coal. The trusting handover of Australia's economic future is evidenced not only by this survey, but by the fact that business sentiment now rises and falls with copper prices. And the majority may indeed prove correct. But as Jim Rogers says, "It's a basic fact of life that many things 'everybody knows' turn out to be wrong.”

Amy Auster has served as Head of International Strategy at ANZ Group, a CEDA national member. These are her personal views.