RDP 2011-07: Australia's Prosperous 2000s: Housing and the Mining Boom 3. Development in Asia – Implications for Australia
December 2011
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Australia has greatly benefited from the rapid growth in Asia over the past decade, in particular in China and India. As Huang and Wang (2011) summarise, the development of Asia has been quite remarkable. Not only did Asian countries experience fast growth in the 2000s, but for China and India this growth was uninterrupted in contrast to the major developed economies. As a result, Asia's share (excluding Japan) of world GDP, at market exchange rates, has increased from around 10 per cent in 2000 to 17 per cent in 2010. Australia has prospered from this growth, both because of its endowment of natural resources and because growth in Asia means that there are now large economies closer to Australia than has previously been the case.
Industrialisation and urbanisation in China, and elsewhere in Asia, has greatly increased demand for resources, especially coal and iron ore for producing steel. China alone now accounts for almost half of global steel production. Australia is a major exporter of the key resources for steel production because it has large endowments of coal and iron ore, relative to a comparatively small population. In 2010, iron ore accounted for 17 per cent of the value of Australia's exports, while coal accounted for another 15 per cent. This represented incredible growth, rising from 3 and 7 per cent of export values, respectively, in 2003. Other exporters of these bulk commodities, such as Brazil for iron ore, have also benefited from this strong demand and the associated rising prices. However, being closer to China with direct shipping access has been an additional benefit for Australian producers as it lowers the cost of shipping. This boosts demand for Australian bulk commodities or increases the revenue of Australian producers, and so benefits Australian producers in the same way as having lower extraction costs.
The increase in commodity prices, and in particular coal and iron ore prices, has led to substantial efforts to increase commodity production. Since 2005, mining investment has increased from 12½ per cent of total private business investment to be around one-quarter. As a share of GDP, mining investment has increased from less than 2 per cent to around 4 per cent now, and with a significant contribution from liquefied natural gas (LNG) is forecast to increase to be above 6 per cent in coming years. Mining is more capital intensive than other industries and so, with a bigger mining sector, Australia's capital-output and investment-output ratios have increased and are likely to remain higher than they have been.
The increase in the size of the mining sector is likely to make the Australian economy, and its fiscal position, more cyclical. Commodity prices are inherently more volatile than prices of services or manufactured goods because supply is typically less elastic in the short run and demand more sensitive to economic cycles. In addition, historically, the difficulty in forecasting commodity demand and prices, particularly at the long horizons of resource investment projects, has often led to over-investment and ‘hog cycles’.
The mining boom has had other implications for the structure of the Australian economy. As well as mining investment and construction, it has increased the demand for labour, although overall mining-related employment remains a very small share of total employment. The flexibility of the Australian labour market has thus far enabled this greater demand to be accommodated without significant labour shortages or widespread increases in wages. The increase in commodity prices has also seen the Australian dollar appreciate significantly to 30-year highs in real terms, contributing to the reallocation of resources within the economy.
The growth of Asian economies has also lessened the isolation of Australia from major economic markets. Quah (2011) documents how the centre of global economic activity has shifted from being in the mid Atlantic in 1980, to be east of Bucharest in 2008, and is projected to be between China and India by 2050. Australia is still not close in absolute distance to large economies; for example, Beijing and Delhi are both closer to London than they are to Sydney. However, it certainly is the case that Australia is closer to Asia than it is to Europe or the United States. So the expansion of the Asian economies reduces Australia's relative economic isolation. This should work to increase Australia's trade, as distance is significant in explaining a country's trade; see, for example, Guttman and Richards (2006) and Disdier and Head (2008). Despite this, while the ratio of Australia's imports and exports to GDP increased in the 1990s following tariff reductions, it has been relatively stable through the 2000s despite the rapid growth of Asian economies.
The benefits of this relative proximity to large economies in Asia are likely to be more evident in some non-resource sectors, particularly services such as tourism and education. Education has been one of Australia's strongest growing export sectors; being relatively close, in a similar time zone with well-established English-language courses and generally favourable visa arrangements is an advantage. Australia is one of the five largest education exporters in the OECD and much of this demand has come from China and India. China and India together now account for just over 40 per cent of Australian education exports versus around 15 per cent at the start of the decade. But growth in education exports is likely to slow because of increased competition internationally, the appreciation of the Australian dollar, more restrictive visa requirements and some domestic capacity constraints (Hall and Hooper 2008).
Similarly, the share of tourism from China and Hong Kong is roughly double what it was in 2000; with a combined share of around 11 per cent they represent the second largest source of tourist arrivals. Nevertheless, this is still only half of the share coming from other countries in Asia, even after excluding Japan. But while rising incomes in Asia have increased tourist numbers, macroeconomic and other factors still have a dominant impact on tourism. The rising Australian dollar over the decade has depressed inbound international tourist numbers – as did the terrorist attacks in September 2001, the outbreak of SARS, and the financial crisis – so that overall growth in this sector has been weak.
The effects of developments in Asia flow through Australian imports as well as exports. Urbanisation and industrialisation has greatly expanded the production of manufactures in non-Japan Asia. As a result, the share of global manufactures trade coming from Asia, and China in particular, has greatly increased over the past decade. The heightened competition from Asian manufacturers exerted significant downward pressure on global manufactures prices. Consequently Australian import price growth was low over the decade, which also worked to boost the terms of trade. Overall, imports from Asia have increased from around 40 per cent of total imports at the start of the decade to around one-half.
There are some similarities in the impact on Australia from the development of China over the past decade and the growth of Japan in the mid 1960s to mid 1970s. Japan was already a significant trading partner accounting for 17 per cent of Australia's merchandise exports in 1965. With continued rapid growth over the following decade, Japan's demand for resources from Australia increased substantially. The share of Australian exports going to Japan doubled to 34 per cent and the resource share of Australian exports trebled to just under 40 per cent (Figure 5). This increase in Australia's resource exports and the importance of an individual trading partner looks remarkably similar to the 2000s. However, an important difference is that over the period from 1965 to 1975 Australia's terms of trade did not increase as they have recently (Figure 6).
The increase in Australia's resource exports to Japan resulted from rapid growth in the volume of resource exports, with resource prices moving broadly in line with import prices. In part, the rapid growth in volumes reflected the discovery and development of large iron ore deposits. In contrast, over the past decade the increase in the share of resource exports is attributable to a substantial increase in prices, not volumes.
The difference in the price response is not simply because China is a larger country; at market exchange rates China's share of global GDP now is broadly similar to Japan's share in the mid 1970s. One key difference in the current episode is that China is experiencing much more resource-intensive growth compared with Japan in the 1960s. Indeed, Eslake (2011a) shows that the share of global GDP produced by countries at a resource-intensive stage of development is currently much larger than at any time in the second half of the 1900s. China's share of global steel production has increased from 15 per cent at the start of the decade to around 45 per cent in 2010. In contrast, Japan's share of global steel production peaked at 17 per cent in 1973.[5] Similarly, at the end of the decade China accounted for close to half of global coal consumption, over 10 times Japan's share in the 1960s and 1970s.[6] Furthermore, Australia's resource export volumes also grew more rapidly in the 1960s and the first half of the 1970s, with annualised growth around 15 to 20 per cent, compared to 5 per cent over the past decade, seemingly reflecting the greater difficulties with expanding an already large and relatively mature mining industry.