It seems like an impossible vision, but I’ve often wondered if Australia will ever strive to be an economy beyond exporting basic resources like coal, iron and agriculture and joint at the hip with the United States. To answer this question, I had to develop a better understanding of the industries that form Australia’s economic engine, productivity, international trade, geopolitics, national politics, societal pressures and, of course, our home turf of research & development.
The Australian Economy
The Australian dollar is one of the seven most traded currencies globally and that is pretty interesting for a country that started floating its dollar in the 1980s. Today, it is well known as a ‘commodities’ currency, with our currency strength drawing a solid correlation to iron ore prices. So it is no surprise that our most significant exports are primarily from mining followed by agriculture (beef) and higher education.
Below is a table of Australia’s top 20 exports and it does take much to realise there is plenty of mining-related activities in both materials and energy. The outliers in the top 10 are beef and education and tourism. Nothing seems strange until we start comparing the differences with Australia’s contemporaries.
Let’s compare countries similar to Australia based on the average wealth of a person. In this case, let’s say any countries with a GDP per capita that falls within the 10th percentile of Australia’s: Denmark, Greenland, Netherlands, Sweden and Austria. Now depending on which source you use, you may find more European countries to list and the occasional appearance of a country like Singapore or the United States.
Note: It is interesting to note that the usual suspects, Canada, UK and US are not that prominently featured in this list. Though both Canada and the UK fund research around 1.7% as well and both are popular destinations for international education.
How is Australia economy unique from most countries?
- Australia has the least amount of sector diversity for top 10 exports
- Australia has nothing from the manufacturing sector within the top 10 exports.
- Australia has the lowest annual expenditure on R&D by percentage of GDP of these countries at ~1.79%.
- Australia is uniquely one of the only countries that has education as a top 5 exports.
This discussion draws upon R&D, exports and currency strength to raise a particular point. Australia relies primarily on exporting commodities that could be sourced from another country selling similar items for cheaper. If Australia’s currency becomes too strong, the iron ore, natural gas or coal might be sourced from a country selling for less. This however is some room to remain competitive in some commodities markets by formalising trade deals, developing a reputation for high-quality commodities (i.e. mad-cow free Australian beef) or improving the efficiency of logistics (transport, wastage minimization). The last two points are where R&D can play a tremendous role in productivity and will be covered in a later section.
To no surprise, Australia’s International trade partners are some of the biggest and developed economies in the indo-pacific region and longtime allies like the U.K. and U.S. On the top end of this list are notable for large manufacturing industries and/or have quite sophisticated advanced manufacturing capabilities. The exports are primarily ores and energy (coal or liquid natural gas).
As a general rule though, economies primarily driven by commodities exports often prefer to hover at lower exchange rates to maintain a competitive price for their goods. Consequently, the cost of importing items becomes more expensive and this contributes to price inflation. Interestingly Australia’s currency is anything but weak, it’s actually still the 15th strongest currency in the world. This is likely contributed to the long economic stability we’ve seen over the last 30 years and includes the mining boom.
So this all sounds great, except all this wealth that is measured as GDP per capita also means that the population will expect a better standard of living through higher wages. This is where the Labor party has a bone to pick over the low wage growth especially in the last decade.
Is it as simple as raising wages?
It’s an obvious solution but critics would suggest increasing wages would also slow business growth, hire less staff, move their operations overseas or close down altogether. Basically, all the things that increase unemployment and lead to a recession. This is broadly the rationale of supply-side economics that is often adopted by recent Coalition governments. The principle here is to restrain from big wage increases by offering tax deductions to keep inflation low and interest rates low.
Wage increases are seen to drive up inflation to the point of ‘overheating’ the economy. The end result would be a recession (oversimplification I know). The way the Australian reserve bank typical controls inflation by influencing consumer behaviour by:
- Increasing interest rates – to discourage spending, taking new loans and makes the dollar more attractive to invest in
- Monetary contraction – the reverse of what we have been doing through this pandemic of buying up bonds (simple terms: printing more money).
These cascading effects here include strengthening of the dollar which will reduce the cost of imports but reduce the competitiveness of our exports and slow economic growth (because businesses will borrow less) thereby making taking a loan less feasible. This also hurts anyone with a pre-existing mortgage floating interest rate and there will be a lot of Australians affected through negative gearing. This can also lead to a self-perpetuating cycle to increase wages again. Note that any policies that ultimately make homeownership unattainable are a sure-fire way of losing a Federal election.
So does increasing wages inevitably lead to a recession?
My view is yes if increasing wages is the only policy implemented. No, if a government can stomach transformative change to the Australian economy.
In this part series, I’ve taken a Keynesian economic approach and oversimplified the Australian economy. The effect of increasing wages, inflation, interest rates and recessions. The consecutive parts will discuss further on transforming the Australian economy.