Australia's "Dutch Disease"?

The outback economy of the world, Australia, has been one of the strongest performing economies in the developed world for nearly three decades now, even managing the buck the Great Recession. But the strength conceals some areas of concern, which have been amplified by economic trends of the past decade. The biggest concern, as a recent FT op-ed suggested, may be the possibility of an affliction of the Dutch disease, driven by its recent commodities export boom.

The Dutch disease refers to the phenomenon, which has origins in Holland following the discovery of natural gas in the North Sea in the 1960s, wherein the domestic currency appreciated dramatically in response to a surge in exports of gas, thereby making the other exports extremely uncompetitive and adversely affecting the long-term health of the country's economy.

The FT has an excellent analysis which writes that Australia may be facing much the same situation, on the back of a commodities export boom driven by China's insatiable appetite. The share of commodities in merchandise exports have ballooned since the middle of the last decade, with the source of this demand being East Asia, mainly China (it takes up 26% of Australian exports).





It does not require much analysis to detect signs of concern from this trend, especially for a less diverse economy like Australia. There are several signatures of imbalances creeping in. It is estimated that though the natural resources sector only represents 10% of the economy, it sucks up 70% of capital expenditure. Mining projects worth A$ 832bn, or 60% of GDP are currently under execution or consideration. The structural impact of these investments could be staggering. And finally, there is the big external risk that such dependence, especially to one country, poses to the Australian economy. The FT writes,

"Booming sales of iron ore and coal have meant the country has hitched its fortunes to China like no other developed nation. That intimacy exposes it to the whims of a communist Asian power that could readily dump Australia if cheaper commodities were to be sourced elsewhere.

In the immediate future, the China-fuelled boom and the growing might of the mining industry are destabilising Australia’s economy by propelling the currency upward, squeezing trade-exposed industries ranging from manufacturing to tourism and boosting inflation. A shortage of workers for big resources projects has led to wage spikes that threaten to spill over into less buoyant industries.

Just ask manufacturers trying to export and those industries trying to compete with imports made cheap by the local dollar, which – long weaker than the greenback but this year bouncing either side of parity – reached a nearly three-decade high last month of US $1.10."

The graphic below shows that Australian dollar has been appreciating steadily against the US dollar since the turn of the millennium, coinciding with the spectacular growth of demand for commodities from China. After the recession indiced blip in 2007-08, it has been rising again since January 2009.



The rising Australian dollar is starting to impact manufacturing and agriculture, apart from the country's other major source of revenues, tourism. Recently, BluScope Steel, the nation's largest steel manufacturer, closed down "one of only three of the nation’s blast furnaces as part of an overhaul to cope with a surging local currency". Interestingly, for a country which is among the largest iron ore exporters, Australia does not have a strong steel industry.

Another area of concern is the apparent lack of plan to take a share in the windfall profits that are coming out of this boom and filling the coffers of mining giants like BHP and Rio TInto. Unlike the example of Norway and many Middle Eastern economies which have established rainy day funds or sovereign Wealth Funds financed out of resource booms, Australia does not have any and proposals to impose some windfall taxes on the minerals extracted have fallen by the wayside. In fact, and in a testament to the power wielded by the increasingly dominant mining lobby, a proposal to introduce a mining super tax was among one of the reasons for the exit of the previous government of Kevin Rudd. The watered down version proposed by the Gillard government is still awaiting Parliamentary nod.

Update 1 (18/6/2012)

FT reports of the possible emergence of a two-speed Australia revolving around commodities,

The Treasury estimates the resource-related sectors of the economy will grow by an average of 9 per cent a year over the next two years. In contrast, the non-resources part of the economy will grow at an annual average rate of 2 per cent over the same period. The two-speed economy is reflected in recent data, which show demand in resource-rich Western Australia rose 14.5 per cent in the year to March 2012 – almost three times the national average – but just 1.9 per cent in New South Wales.

The spectacular growth of commodity resource extraction has had the predictable effect of crowding out resources from all other sectors and eroding their relative competitiveness.