Sizing up China's true influence on the economy

In the debate on the Australian economic outlook, one question looms large. What matters more for domestic growth prospects: the US economic boom or a Chinese slowdown?

At face value, the question is an easy one to answer. China takes just over 30 per cent of our exports, the US about 5 per cent. Consequently, China matters much more and its slowing heralds a new era of low growth for Australia -- and decades of deficits, of course.

But the actual dynamics are a little more complicated. China matters, of course. It matters a great deal, not only to the Australian economy but to global growth. Yet it's important not to overstate the fallout from a slip in China's growth rate to 7 per cent from 10 per cent or even 12 per cent.

The fact of the matter is, Australian exports to China are still booming -- they surged by just under 30 per cent in the fiscal year to 2014. Resource exports were obviously strong, particularly iron ore, which rose by over 20 per cent in value terms and nearly 15 per cent in volume terms. Recent data suggests that this strong growth has continued unabated, with ore exports up nearly 6 per cent in the September quarter to be about 20 per cent higher annually.

Yet even if exports weren't surging, it still wouldn't herald a period of low growth for Australia. Resource exports are less than 8 per cent of the Australian economy. Noting China's stake in those and exports elsewhere leaves about 6-7 per cent of the Australian economy exposed to a Chinese slowdown. That means 93-94 per cent of the economy isn't exposed.

That makes sense, as 92 per cent of the Australian economy (and 98 per cent of the labour market) is unrelated to mining. With that in mind, suggestions that the country's economic prospects rest on one small sector are clearly wrong. Statements that imply this reveal a very poor understanding of the Australian economy.

In any case, seeing Chinese economic growth of 7 per cent (or 6 per cent or even 5 per cent) is still very strong growth. No one should forget that while China's economy is ‘slowing', 2014 will likely see the country's largest expansion in history. That is, while China's economic growth rate is slowing, the magnitude of its expansion is likely going to be the largest on record. 

On current trends, something over $1.4 trillion (in nominal terms) should be expected, which is significantly above what we saw prior to the GFC with double-digit real growth rates. Mathematically it makes no sense for anyone to be concerned about a ‘Chinese slowing'. It is pure ignorance. This is why ‘slower' Chinese growth hasn't (and won't) lead to a noticeable fall in Australian export volumes.  

It's against that backdrop that the US boom assumes more importance. Not forgetting that the US, by itself, directly consumes about 12 per cent of global exports, and 17 per cent of China's and Japan's. 

The US is obviously a very important global market and an uplift there will buttress Chinese economic growth and growth elsewhere throughout the region. This will benefit Australia.

Less directly, the US economic boom will do much to lift non-mining investment in Australia. Australian business investment has a solid correlation to US economic growth prospects, as does consumer spending. Economists can debate the exact transmission mechanism, but the fact is it exists. Certainly the strong financial linkages are well known: The Aussie and US share markets usually enjoy a strong relationship, as do bond markets -- and indeed monetary policy.

With that in mind, the US economic boom matters much more for Australian economic prospects than China's ‘slowing'. It goes without saying that the net lift could end up being quite marked -- already there are signs aplenty that things are picking up. The small size of the resources sector and its relative unimportance to the jobs market means that an upswing in non-mining investment, housing and consumer spending would easily swamp the expected drop off in mining investment -- aided, of course, by continued strength in the export sector!