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By Warwick McKibbin*
Many policymakers fail to realise that a long-term transformation of the global economy is under way and the upheaval in established industries, reflected also in Australia, is not just a result of the mining boom or the Dutch Disease that commodity booms can spawn.
The implications of the global transformation are important for us as it will affect the rates at which our multi-speed economy adjusts, as well as the terms of trade and the capacity of the federal budget to respond.
The emergence of China and India has caused a growing structural shock for Western economies, as there has been a big change in production and consumption that has changed global relative prices and comparative advantage.
In addition, shifts in savings and investment have altered global trading patterns, and the resulting shifts in capital flows have altered interest rates around the world.
The global financial crisis was in part the outcome of these pressures, combined with a long period of inappropriate macro-economic policy responses and institutional flaws in major economies, particularly in banking and other regulation.
Countries affected by the crisis have made the mistake of not adjusting their economies to this long-term structural shift, mistaking structural shocks for inadequate demand.
The 2001 recession in the US was met with loose monetary policy that led to further misallocation of global capital, setting the scene for the crisis in 2008, which was met again with demand management policy when the major problem was structural change and capital misallocation.
The fortunes of the global economy will continue to be determined by these long-term trends for decades.
These include not only the increasing dominance of large emerging economies in the global economy but also large demographic changes, productivity and technical innovation and the impact of, and the policy response to, environmental problems.
This major transformation of the global economy is affecting Australia and it is not just because we sell mining output to China.
If policy is based solely on forecasts about whether China will keep buying our minerals, then Australia is making a big mistake.
Australia is lucky that we are selling mining output to China so we have funding now to pay for structural adjustment over time.
The question is how we should be responding to the mining boom when considered as part of this larger story.
The traditional Dutch Disease model of increased demand for commodity exports driving expansion of one sector and contraction in others assumes fixed national capital and labour supply.
If labour and capital is allowed to flow into Australia, the mining and non-mining parts of the economy can expand, but at different rates. However it is not just the mining boom that is changing our economic structure, so policy should encourage structural adjustment and flexibility as Australia is subject to the forces of the global economic transformation.
It is bad policy to keep subsidising declining industries and redistributing temporary revenue for consumption – it should be invested in transformation including increasing flexibility in the economy. Governments shouldn’t be picking winners but should be creating a flexible environment for industries and individuals to adapt.
Commodity prices are rising because of real growth in emerging economies and loose monetary policies that are increasing nominal demand (and nominal debt) globally.
The relative price of commodities is likely to fall when global supply increases and growth in China slows, or a global recession emerges from Europe or from a reversal of the liquidity bubble.
In Australia, the 2012 budget was framed against a backdrop of major structural adjustment from a changing global economy, a collapse in productivity and major risks from Europe. Yet the budget focused on income redistribution and rapid fiscal consolidation with the goal of reaching a surplus in 2012-13. The context and the delivery of the budget do not align.
It is a mistake to think our multi-speed economy is only the result of the mining boom – it is a global relative price shock reflecting a major global transformation. Over coming years volatility will be high as policy errors in major economies continue.
Australia faces major economic challenges and to date has been lucky to have additional resources to finance the economic reforms that are needed to meet these challenges.
However, instead of investments in labour market flexibility, significant tax reform and removing impediments to incentives to innovate, this government has chosen to use the proceeds to consume the boom.
*Warwick McKibbin is a former Reserve Bank board member and is director of the ANU Research School of Economics. This article, also published in the Australian Financial Review, is based on the speech he gave at a Deakin Policy Forum in June hosted by Professor Michael Porter from the Alfred Deakin Research Institute.