KGB interview: RBA's John Edwards

Reserve Bank board member and Lowy Institute non-resident fellow John Edwards tells Business Spectator's Alan Kohler and Stephen Bartholomeusz:

- The conventional wisdom that suggests the mining boom has been transformative for the economy is wrong
- The transition away from mining investment is taking place, with housing construction starting to pick up in response to lower interest rates and years of unmet demand
- How the high Australian minimum wage has minimised certain kinds of labour and has shaped Australia's society
- Joe Hockey's budget over the full distance will be brought back into surplus almost entirely by revenue increases
- The public's preference for health spending over other types of spending must be recognised and supported by the government
- The discourse around economic reform must become more credible and focus on perpetuating success instead of imminent catastrophes

Alan Kohler: Well John Edwards, it seems to me there’s kind of a bit of a contradiction in your proposition. The book’s called Beyond the Boom, but you also say in the book that there wasn’t any boom. So, which is it? Was there a boom or no boom?

John Edwards: Well, I don’t think that’s quite fair, truthfully, Alan. You know, there was a boom. In fact I think the boom has continued. But what I do think is that the boom has been very much less influential on the Australian economy than we usually suppose and my numbers suggest that if you put everything together -- all of the mining productions, all of the mining investments, everything that went into mining and metal processing -- then if you compare 2012 to 2002, that sector was about 3 per cent of GDP, bigger than it had been before the boom began. So, it’s important, but it’s not quite as important as it’s widely supposed.

AK: I suppose your central proposition in a way is that there was a mining boom, but as you say, it wasn’t as influential on the economy, so looking at the economy as a whole -- income, GDP and all, a whole wide range of measures -- the previous 10 years to 2002 were higher growth, better than the following 10 years.

JE: Yes, it’s quite extraordinary, isn’t it -- and unexpected -- that actually in the 10 years before the boom began we grew better than the 10 years after it began. And it makes the point I guess that we’ve had what’s nearly 23 years of pretty good expansion in the Australian economy and the mining boom’s been an important episode in that, but it’s certainly not the end of the story.

AK: And the other point you make of course is that we’re beating ourselves up about it all the time, which is interesting.

JE: I just think we’re very much more pessimistic than we need to be. One reason is that we magnify the impact of the boom and consequently if we think it’s being withdrawn, we imagine a great calamity follows. But the mining boom wasn’t quite as big as we think. For example, another calculation that the total income gained in, say, 2012 compared with 2002 was about 3 per cent of GDP also. Useful, but not transformative. Then our essential issue as the boom begins to fade, and it’s by no means over, is replacing, over time -- we’ve got five, maybe 10 years -- 3 per cent of GDP. Well we can do that.

Stephen Bartholomeusz: John, during that boom period that you talk about -- so 2002 to 2003 onwards -- we had record terms of trade, record levels of investment, strong GDP growth and very low unemployment levels. Are you arguing that had the boom never occurred, we would have sailed through the global financial crisis and the post crisis period unaffected?

JE: I think we probably would and the reason is that our banks were not strong because of the mining boom, they were strong because they were more prudent, because we had the financial system that at that point took less risk than the US or the UK financial systems, and of course because we had our financial collapse at the end of the ‘80s/beginning of the ‘90s from which we learned quite a lot. So no, I don’t think we would have been affected by the global financial crisis in the way other countries were even if we didn’t have a mining boom.

SB: In his book Dog Days, Ross Garnaut says -- as you do -- that the impact of the resources boom was about 3 per cent of GDP over the period, but he also said that it peaked at 10 per cent of GDP. That’s slightly more significant, isn’t it?

JE: Well, on the latest numbers actually mining started to go up as a share of GDP. If you just look at the quarterly numbers, it’s gone to about 11 per cent of GDP, from 9 per cent in 2002-03. I’m talking volumes. So this makes two points, I think. One is that actually the mining boom is by no means over. We’re seeing decent volume increases in iron ore and coal in particular and we will of course see LNG in big quantities a little further down the track. But I’ll also make the point that in 2012, which is what a lot of people think to be the peak of the mining boom, actually mining was the same share of GDP in volume terms as it had been before the boom began and, as a matter of fact, as it had been 20 years before.

SB: Isn’t one of the complicating issues here though, John, that when we talk about the mining boom we talk about the investment phase for that boom and, as you say, we’re now moving into that production phase where we will see volumes go up dramatically over the next few years, particularly as the LNG projects kick in. Will the volume effects be sufficient to offset the very significant price decline we’re seeing in all the hard commodities?

JE: Well, it’s a big hill. So far we’re in front. As I recall the numbers, we’re not quite at the level of mining export revenues that we were in 2011, which was the peak, but we’re not very far off it and we will probably soone exceed it. In other words, despite the fall in prices the increase in volumes has been sufficient to almost offset it and in a year or two likely completely offset it.

AK: John, every second day I get something from an economist from a bank or an investment bank where you used to work yourself talking about the transition of the Australian economy and on the whole the commentary is along the lines that the transition so far is on track. Are you arguing that there isn’t really a transition taking place or that it’s on track?

JE: Oh, I think we are. The main transition we need to make of course is from the investment boom, as Stephen suggested earlier, to seeing that investment boom peak as it has and begin to come down probably quite rapidly two or three years in. It started off as 2 per cent of GDP, got to 7 per cent I think and it’ll go back to, say, 2 or 3 per cent. So we’re not actually at this point making the transition that we’ll need to make, but I think we’ve begun; that is, we can already see evidence that housing construction is beginning to pick up in response to lower interest rates and unmet demand over the years. And of course there’s evidence, as we mentioned before, that mining hedge books are picking up in a big way and that will be helpful also. I think we’d all agree that to affect the transition satisfactorily we need to see a pickup in non-mining investment. We’ll see soon if we’re beginning to see that in infrastructure, but we need it more widely and it’s not there yet.

AK: If one was looking for a reason to be anxious, isn’t the issue in terms of this transition from mining investment that the employment in mining investment and resources investment is about five to eight times the employment in resources operation?

JE: I haven’t heard the number five to eight times. Resources operations, it’s not trivial, it’s about 2 per cent of GDP.

AK: It’s really just the outsized employment in those versus the operational thing, leaving aside what the exact number is.

JE: Yeah. Sorry, I meant 2 per cent of employment in mining itself.

AK: Oh, I see. Right.

JE: Well, fortunately if we can make a sharper shift towards infrastructure, then the kind of skills that are now being deployed in mining investment -- that is, heavy engineering construction skills -- will work well in that new space, as they will be if we see some kind of upturn which eventually we’re going to see in office construction. It’s true, as I guess you’re implying, that it’s not an easy transition between the skills that you use in mining investment and the skills you use in residential construction.

SB: John, conventional wisdom has it that the mining investment boom has contributed to us becoming a high-cost country. All the comparisons we see with other developed economies -- their wages, their costs of developing new mines, buildings, LNG projects, whatever, producing cars or manufactured food -- would suggest that we are high-cost. Yet you don’t agree with that, do you?

JE: I do think that far and away the largest element of what is supposed to be part of our costs is in our exchange rate. I hope we will see a lower exchange rate in the coming years, because we’ll need that to be competitive in a broader range of industries.

It’s true that we have higher minimum wages than other countries on however they’re measured. But I don’t think that case has been demonstrated, other than we know we’ve got a high exchange rate that is not competitive in terms of other exchange rates. We come out looking quite expensive.

SB: On wage rates, the comparison is that our minimum wage is twice that of the States and about one and a half times that of Europe. If those relativities are maintained, does that mean we have to vacate certain types of activity?

JE: It does. I think we’ve made a deliberate decision in this country to minimise certain kinds of activity. For example, private people don’t have drivers by and large, they don’t have cooks. If they have house cleaners, they’re occasional. They don’t have full-time gardeners. We don’t have a huge sector of people doing menial tasks for very low wages. That was the decision we made many, many years ago and it characterises us as a society.

AK: John, one of the more pointed things you talk about and say is that the federal budget deficit is not due to increased spending but to lower revenue, and that more than half of the problem is caused by the personal income tax cuts delivered by the John Howard-Peter Costello government. I’m just wondering how kind of reckless that was under the circumstances. Just as the Labor Party tends to bask in the glories of its reform era, should the Coalition should apologise for what it did in those years?

JE: Alan, the truth is it would have been very, very difficult for Peter Costello to have handled it in a different way. He was running very large surpluses and the demand that he should have run even bigger surpluses and have allowed tax to rise even more substantially than it did and the share of GDP is beyond political possibility.

What was a mistake at the time was that the income tax cuts were given in a way that allowed such a big space between the rates and such low rates that when the whole thing turned down, as it did in 2008-09, it turned down very abruptly. Income tax didn’t come back, or at least it hadn’t come back until very recently. 

Normally, in the Australian economy, income tax bounces back. On this occasion, it didn’t happen. 

The interesting thing is that despite all the very sharp debate about Joe Hockey’s budget, the truth is Joe Hockey’s budget over the full distance is brought back nearly into surplus almost entirely by revenue increases.

Eighty per cent of the change in the fiscal balance between this financial year just ending and 2017-18 -- if we exclude the impact of the $9bn support for the RBA -- then of the change in the fiscal balance over that period that Hockey has rejected, 80 per cent of that is increased revenue. And of that increased revenue, two thirds is increased income tax. That’s all in the budget.

AK: Most of the complaints are about the period beyond the forward estimates and the big cuts that will kick in after that time. You make a reference in the book to fiscal drag or bracket creep, and that used to be in the Treasury’s forecasts for revenue over the next ten years. Would you say that what’s occurred beyond the forward estimates -- the second six years of the ten-year forecast -- that what Hockey has done is in a sense replaced bracket creep with spending cuts over that period?

JE: Well, he has. It’s only now that we’ve got numbers that move out quite as far as this. It’s always been the case, of course. It’s certainly the case for many, many years that if you could check spending forward fast enough, then its paid for and that’s why every year, the expenditure review committee meets with the Treasurer and the Prime Minister and goes through the numbers and cuts down spending and readjusts it. 

What the government has done in these forecasts is to cap tax revenue at 23.9 per cent of GDP and you add 1.5 per cent of normal tax revenue. Let’s say you’ve got to 25.5 and you want a 1 per cent surplus, that’s taken you to cap spending at around 24.5. 

Now, I’ve probably got the arithmetic wrong, but I’ve got the kind of general direction. That’s what the government’s done. So, it’s said: we’re going to cap spending.They haven’t capped it at an acceptably low level. I mean where they capped it is where it’s been pretty much over the last 40 years. It does remind us that if you have a spending cap, health is going to be pushing against us, as it has for a decade. That’s where the price is going to be when we come around to the next election: how much health can we afford, how much education can we afford and what is the role of the federal government.

It would surprise me if in two years’ time, Tony Abbott and Joe Hockey are still saying that the federal government is going to get out of these areas.

SB: John, you were right about the long-run average for spending. It’s 24.6 over the last 20 years, 24.6 per cent. In that most recent budget, Commonwealth spending as a proportion of GDP or a percentage of GDP is 25.9 per cent, so it’s 130 basis points over the long-run average. Would that worry you? Do you think you have to get it back to the mid-24s?

JE: Oh, I’m quite happy. If we can get it down to 24.6, that’s good. I think that 25.9 number, Stephen, might include the $9bn for the RBA, which is more than half a per cent of GDP, so we’re really closer to 25. 

These numbers are very tedious, but if you took it for the year for which we have actual numbers, the prior year 2012-13, you would see that spending as a share of GDP is 24-point something. 

There was a big bounce in spending in 2013-14 for most of which Joe Hockey was the Treasurer. It may have somewhat artificially inflated the number. But I do think we should endeavour to constrain spending to somewhere between 24 and 25 as we have and that means in the long run, we’re going to have to be much more efficient in our health spending and remain careful in all other areas.

AK: Do you think in fact that it’s possible to hold spending under 25 per cent given the increase in life expectancy and health costs that flow from that?

SB: And NDIS and Gonski?

AK: And NDIS and Gonski? Is it feasible to do it?

JE: I’m not quite sure. It certainly would be a good aim for a Treasurer to see if they can get there. Health is not really driven by ageing; it’s driven by technology and by the availability of better medical procedures and people interested in prolonging a healthy heart.

Given that so much of spending is underpinned by government support, it may be that we’ve just got to recognise that there’s a public preference for health spending as opposed to other forms of spending and maybe we need to recognise that and continue to support it.

The numbers tell us where we’re failing in Australian education. We’re not failing in many areas, but we are failing in getting the best out of the bottom quarter of children, most of whom come from a low-income background. That’s where we need to do the work to get the average up and that’s what the Gonski money does.

AK: So John, why do you think there is all this despondency, given the obvious fact that Australia is doing fine? Is it simply, as you propose, that certain people are inclined to manufacture a crisis in order to push reform?

JE: It’s a very interesting question. You and Steve did say before the election that everybody’s feeling despondent because they’re despondent about the government. Then we changed the government, and they’re despondent again. So, it’s probably not the government. If you suggest that we don’t make enough of our achievements -- that we’re a little concerned that if we say we’re doing well -- it robs us of some impetus to do even better. But we’ve lost the policies. Discussion is losing credit in the community because it’s not recognised as a reality in people’s lives. 

We are in the 23rd year of uninterrupted expansion and we’ve got to change the discourse to recognise our success and to find a way of premising reform and improvement not on stress of imminent catastrophe, which is not credible, but a more sensible conversation about perpetuating our success.

AK: Perhaps it’s just that nobody likes a boaster.

SB: John, can you just explain to us what the motivation in writing this book was? You are looking backwards rather than forwards.

JE: Well, I don’t know whether I am. I didn’t intend to look backwards, but I do think we have to establish the base from what we’re discussing and what I wanted to investigate.

There are four propositions: that the mining boom is over; that the mining boom was huge and transformed us; that without the mining boom we’re in calamitous circumstances; and that we squandered the mining boom. 

All of those propositions then invite a view about where we should go next and what we must do, beginning with the idea that we’ve got to make huge changes in this country to all our institutions, but including our government and the way our government works. 

If, on the other hand, you take the view that actually we’ve been fairly successful, then you’re concerned to say, let’s make sure whatever else we do that we preserve the things that have been useful to us, that have been associated with that success. Let’s look to improvements that are consistent with the things that have made us successful.

AK: Thanks very much for joining us, John.

JE: Thank you, Alan. Thank you, Stephen.

SB: Thanks, John.