Time to bust out of the mining box

Productivity Spectator

Two reports yesterday spelled out quite clearly that it is time to stop blaming the government for all our woes and to get down to the hard task of running our businesses better.

And we need to act soon because our window to change is closing.

Everyone understands that the mining boom saved our bacon during the GFC, and continues to do so in the aftermath.

It has made us the envy of every developed nation.

But while everyone one else is effectively on belt-tightening austerity drives, Australia is still soft in the middle.

The report by global management consultant McKinsey has calculated just how dangerous our complacency has become.

In a study called "Beyond the boom: Australia's productivity imperative", the paper's authors warn that if we don't improve our productivity, income growth could effectively drop to zero. 

The huge capital investment in mining, and our ongoing mineral exports account for 90 per cent of the growth in our income.

The graph below highlights how unusual this growth is compared to trend levels.

Another graph, this one from Pimco's Raja Mukherji, suggests that the Chinese steel industry has been overcapitalising.

So it looks like there's about a 20 per cent oversupply. That will reduce demand for our iron ore.

It is natural that the huge increases in our terms of trade should fall back toward trend levels. That wouldn't be such a problem if Australia wasn't relying on the mining boom to offset our poor record on productivity growth.

As stated earlier, 90 per cent of the current growth in Australian incomes is coming from the mining boom. But McKinsey says that we are seeing an 11 per cent reduction in national income because of bad productivity. We are making up for 20 per cent shortfall by working longer hours.

That means we are vulnerable to a slowdown in resource consumption.

McKinsey takes a very conservative ‘worst case scenario' – one where our terms of trade falls back to trend levels, and two thirds of advanced resources projects and one third of less advanced projects go ahead. If we stick with our existing poor productivity, income falls to 0.5 per cent by 2017.

At that rate, sections of our two-speed economy hit a tree.

Now productivity is a concept that can be easily misunderstood. Two thirds of the fall in the nation's productivity is due to temporary factors related to the mining boom. The long lead-time for capital intensive projects means lots of cash goes in, without seeing an immediate return. With high commodity prices, miners are also increasingly tapping hard-to-find resources, digging deeper pits for less return. Those lower yields also push productivity down. Some will improve over time, and while commodity prices are high, it makes economic sense to find those low-yield mineral deposits.

But a third of the fall in Australian productivity is due to the failure to address costs and inefficiencies. This is the hard stuff that managers must do at the shop floor, and the big policy initiatives that governments need to take on microeconomic reform. If we return to the kinds of productivity levels that we enjoyed in the 90s, we would add another $90 billion in income by 2017. 

The huge investments into resources will continue to pay off, one hopes. China still has a lot of infrastructure left to build, with an estimated 300 million people still to leave rural plots for cities. The Middle Kingdom is also planning to connect its regions with better road and rail services.  

But trends always revert to the mean. This boom may last decades, but given we are at the middle point of massive investment into Australia, this is the windfall we must capture.

McKinsey says that outside the resources related sector, there have been some improvements in productivity but there is still a long way to go, particularly in our services economy (retail, telcos, banks etc) where the average Australian worker is $32 and hour less efficient than America workers.

Productivity wise, manufacturing is one of the better performing sectors of the economy. Those firms which have survived in the face of the high Australian dollar have been driven to improve efficiency.

But given we are already playing a part in the urbanisation and economic development of China, India and SE Asia, we should be planning for giving them advanced manufactured goods, as they become middle class consumers.

We should be using this boom to make sure that we set up winning industries for the future. In Europe and America everyone is talking about 'frugal innovation'. There is limited access to capital, and customers are favouring low-cost products, so manufacturers are creating products the hard way. 

With government budgets stretched, Americans and Europeans won't be able to finance big leaps in R&D.

We can.

The taskforce into smarter manufacturing is calling for a portion of the $9.4 billion the Commonwealth government invests in science and research into applied knowledge in manufacturing.

Wrong. We should be taking that windfall from mining revenues and not stealing from one sector's future to pay for another's. Australia has a competitive advantage in government receipts and should be using that income to grow a better future for the next generation.

We need to be making the most of our huge investment in mining machinery and become a world class supplier. Rio Tinto is currently importing a 75 metre long tunnelling machine to trial as an alternative to vast open cut mines. The drill is being imported from Germany.

The backbone of the German economy is the powerful Mittelstand engineering and manufacturing firms who do big, complicated projects like this. They succeeded because they were part of a scale economy – the mechanisation of Europe in the middle part of this century.

Australia has the biggest mining industry in the world. It is the scale economy that can create a generation of Mittelstand-type firms here.

Don't forget that we have a huge, untapped resource that can help us do this. Every year, tens of thousands of students from our neighbours, like China and India, come to Australia to learn at our universities. They are here to learn english, and to learn engineering, science, math and architecture from Australian professors. Not only are these students some of the best and brightest, but they understand our future customers.

The US has worked out the importance of retaining such people and hand out 140,000 high skilled visas per year. It's one of reasons that America is so far ahead in productivity, along with their investment in technology.

For the last 10 years, anyone with a penchant for math or science would have been scooped up by the finance sector. There is a lot more money to be made by creating high-frequency algorithms, and as we've seen, nowhere near as much of that pesky testing that engineers must do if they build a car, a plane, or a medical implant.

One can hope that stricter regulation of such activities will put a crimp on the incomes to be made by financial manipulation and smart people will be encouraged back into making things.

It is good we are thinking about our manufacturing future. The mining boom won't last forever, and the sooner we act, the greater the jump we can have on American and European firms.