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Rudderless Australia Drifts On

Australia, Business, China, Company Strategy, Environment, Sustainability, Technology
By John Richardson on 21-May-2015


By John Richardson

THERE used to be two certainties in life that everyone in Australia could depend on. We all know that the first certainty was, and sadly still is, death. But the second certainty was China acting as the “bankroller” of the Australian economy. This has all but vanished since late 2013.

The second certainty rested on the well-placed confidence that China would buy just about every tonne of iron ore and coal etc. that Australia produced. But then the The Great Unwinding began.

It didn’t really matter to most people in Australia why China bought all these resources before this turning point was reached. So what if  iron ore went into inventories for a short while? Underlying demand growth was so strong that high stockpiles would always quickly vanish. And so what if the iron ore and coal was wrecking the environment? Beijing didn’t seem to care and so the good times felt as if they would last forever.

But it should have mattered to one group of people – the country’s politicians. It was supposed to be within their pay grade to see around the corner, to warn Australia, my adopted country, about the risks ahead and plan for those risks.

The former Labor government instead behaved like a rabbit caught in the proverbial headlines when, in August 2013, it was forced to write down its estimate of tax receipts by no less than Aus$33 billion in the space of just ten weeks.

Tony Abbot’s Liberal Coalition benefited hugely from being able to spin this, and other economic problems, as a sign of Labor mismanagement that would be put right if they won the next Federal Election. This spin was one of the main reasons that the Coalition did, indeed, triumph in the November 2013 poll.

The trouble is that whilst the Liberal Party-led Coalition talked about Labor economic mismanagement, none of its criticisms related to how Labor had failed to see events coming in China. China didn’t seem to figure in the election campaign hardly at all, in fact.

And so, as I feared would happen, the Coalition has recently been forced to concede that it has also got its sums very badly wrong. As The Economist reported:

joe-heroOn May 12th Mr Hockey [Joe Hockey, Treasurer of Australia – see picture on the left) delivered the government’s second budget—and second deficit. It has soared to Aus$41 billion ($32 billion) for the current fiscal year, from a projected A$30 billion a year ago. It has been estimated at Aus$35 billion for the coming fiscal year.

Budget papers reveal that iron-ore prices have almost halved since last year, cutting about Aus$90 billion from forecast export-revenue. The government has also written off Aus$52 billion in tax revenue since last year, more than a third of that due to the collapsing price of iron ore.

And, coincidentally, on the very day that the Federal Budget was delivered, iron-ore prices entered a new losing streak. They are down by 10% over recent trading days.

The great news, though, is that Joe Hockey has admitted that the iron-ore market is oversupplied and that the Coalition has a Plan B for Australia’s, which can be summarised in one word: Services:

Whilst services accounted for around 70% of Australia’s GDP they were responsible  for only 17% of its exports, he added in a speech to business leaders earlier this week in New South Wales. This compared with iron ore, which took up 55% if exports, but only accounted for 10% of the Australian  economy, he said.

Fantastic. So far so good

He went on to say that small businesses, which, of course, provide many services, are the key to Australia’s future. To this end, the latest budget includes tax breaks for small businesses. Terrific.

Sadly, though, he then said that the future for Australia was inevitably bright because of the rise of the Asian middle class.

There would be more members of the Asian middle class by the end of this decade as there already are in Europe and North America combined, he told his audience.

By 2030, China and India alone would be home to over 2 billion middle class consumers, with another 220 million in Indonesia, he continued.

And whilst he accepted that China was slowing down, lower percentage GDP growth was off a much bigger base than a decade again, said the Treasurer.

So if China from now on only grew at, say, 6.5% per year, this would mean the same increase in the volume demand for Australian exports as when it was growing at 13% per year, he claimed.

I worry that Mr Hockey was missing all the complexity here and so the risks.

To start with, we know that what it means to be middle class in developing Asia is vastly different from what it means to be middle class in the West.

To use China as an example, what Mr Hockey should have also told his audience was this:

  • High Income groups in China’s urban areas had $9,000 of income in 2013, versus $4,000 in 2007, according to China’s National Bureau of Statistics. Great progress, but a long, long way from being middle class by Western standards.
  • The Middle Income group in urban areas had $4,000 in 2013 versus $1,600 in 2007, and the Low Income group had $,1,900 versus $700.
  • And the High Income group in rural areas had just $3,500 income in 2013 versus $1,300 in 2007.

Even China’s High Income group would be below the poverty line in the West, Mr  Hockey should  have told his audience.

He also should have said this:

Now that the credit “wealth effect” is over China for good, these real income levels tell us that our exports must be very, very competitively priced in the future. 

This is a huge challenge for Australia because of our often ridiculously-high cost base. We can hardly export plumbing services when one-man trader plumbers earn as much as Aus$1,500 a day compared with a pittance in China.

So we need to make some hard decisions, we must drastically reduce our cost base, if we are going to export more services and goods to China.

Further, it was the kind of services that he identified that worried me. He talked of how people in China, and the developing world in general, would want bigger and bigger houses, and so more architectural services that Australia could provide.

But he made no mention of the environment, which was a critical mistake.

Tony Abbott doubts climate-change science. But this is not the point. I am not going to enter into a debate about climate-change science and I don’t think Abbott’s other critics should only focus on this issue.

What we should also focus on is what we do know, definitely, without any shade of scientific doubt: China’s air, soil and water pollution has created nothing short of an existential crisis. Beijing knows this because China’s politicians are far from stupid. So China will need a lot of help in cleaning-up its environment.

Hence, after recognising all the above, Mr Hockey should have added:

We, as a government should do everything in our power to encourage the innovation in Australia in the products and services China will need to tackle this crisis. This means, for example, more Australian-owned research into new water-treatment chemicals, new solar and wind power systems and air-filter technologies.

We then also need to recognise that this simply has to mean that growth of Chinese demand for our coal will be less than we had thought.  We need to prepare for this.

Finally, Mr Hockey oversimplified things when talked about the kind of economic growth that China has enjoyed over the last few days inevitably spreading to the rest of the developing world.

What he needed to tell his audience was that Australia had to prepare for what happened in China being an historical “one off”.

He then should have explained why, as follows:

•The West has lost the “wealth effect” of the Babyboomers because a critical mass of those born between 1946 and 1964 have retired, with many more due to retire in the coming decades.

•Official data shows that there are now more households in the West headed by over-50s than those headed by younger people.

•As a result, average household spending is now in steady decline in inflation-adjusted terms. This really matters because 60% of GDP in most economies is accounted for by consumer spending.

•So China and other emerging markets cannot depend on the West to easily soak-up their manufactured goods.

•China’s post-2008 effort to boost the local economy was a failure. It has left China with debts that quadrupled from $7 trillion in 2007 to $28 trillion by mid-2014, huge manufacturing and real estate overcapacity and terrible, terrible pollution. This means that it is simply impossible for any other emerging market to walk in China’s stimulus, or manufacturing, footsteps.

If Mr Hockey had even hinted at getting most  of the above, I would have cheered him to the rafters, and he might well have won my vote, once I become an Australian citizen.