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The Dutch disease down under

High resource prices worked out quite well for Australia, says Stephen Gordon


 

The U.S. is a natural point of comparison for the Canadian economy for many obvious reasons. But Australia is an even better point of reference when is comes to certain aspects of our economy, especially in the last decade. Both countries are a major exporters of  natural resources and have undergone significant transformation over the last decade.

The surge in commodity prices increased the terms of trade — the ratio of the price of exported goods to the price of imported goods — in both economies, but the effect in Australia was far stronger than what we saw:

So it is perhaps appropriate that the most intuitive explanation for the effects of an improvement in terms of trade on economic welfare that I’ve seen came from Governor or the Reserve Bank of Australia Glenn Stevens:

“When the terms of trade are high, the international purchasing power of our exports is high. To put it in very (over-) simplified terms, five years ago, a ship load of iron ore was worth about the same as about 2,200 flat screen television sets. Today it is worth about 22,000 flat-screen TV sets – partly due to TV prices falling but more due to the price of iron ore rising by a factor of six. This is of course a trivialised example – we do not want to use the proceeds of exports entirely to purchase TV sets. But the general point is that high terms of trade, all other things equal, will raise living standards, while low terms of trade will reduce them.”

(Regular readers will recognize this passage from here.)

We all know that the Canadian dollar appreciated as resource prices rose. The Australian dollar appreciated even faster:

And it’s worth noting that the Australian experience of the last recession was “Recession? What recession?”

I suspect the reasons why Australia sailed through the downturn unscathed is that it is less integrated than Canada with the U.S. and European economies (which tanked) and more integrated with China (which didn’t). The swift recovery in resource prices was a significant factor in explaining why Canada recovered more quickly than other G7 countries, and probably explains why Australia only saw a short-lived reduction in the rate of growth of GDP during 2008-09.

For some reason, the term “Dutch disease” seems to be uniquely associated with fossil fuels, so the phrase doesn’t dominate the public debate in Australia the the extent it does here. But the same mechanisms are at work: a shift toward resources and away from other export sectors. My own take is that these transitions have been a net benefit to the Canadian economy, and that the transition costs have been surprisingly low. A recent RBA report uses much the same approach and reaches essentially the same conclusion for Australia: 

“Strong growth in Asia, particularly in China, has had a profound impact on the Australian economy over the past decade. Most notable so far has been the boom in the resource sector, with commodity prices and hence Australia’s terms of trade rising to historically high levels over a number of years. This has been accompanied by a sizeable appreciation of the exchange rate. While the terms of trade have passed their peak, the substantial investment in productive capacity of the resource sector in recent years is expected to provide a large boost to the production and exports of resources in coming years.

… relative wages and prices adjusted in a way that facilitated the reallocation of factors of production towards the resource sector.”

The RBA study pays special attention to the exchange rate appreciation, noting that the stronger Australian dollar had the effect of moderating the effects of resource price increases: higher exchange rates make all exports — including resource exports — less competitive on world markets. It also emphasizes the role a stronger currency has in increasing real incomes.

As Mark Carney noted in his Dutch disease speech,

“In a world of elevated commodity prices, it is better to have them.”

Indeed it is. Just ask the Australians.


 

The Dutch disease down under

  1. Pct of Australian economy that is resource based compared to Canada? A less diversified economy will show higher sensitivity to higher commodity prices, which may be why the divergence in 2005 +.

    • I’m pretty sure that resources constitute a much larger part of Australia’s economy than it does in Canada. Though I could be wrong.

      • And maybe resources fully controlled by the Feds. With easy deepwater access.

        SG: and that the transition costs have been surprisingly low.

        Assuming the resource sector stays strong over the long term. counterfactual Alberta 1986-1996-ish

  2. It’s true. Australia is an even bigger freeloader off of resource welfare checks than Canada, having fallen further down the value-added chain. But if history is any indication, all resource booms must come to a bust.

    That doesn’t mean we should follow their lead and become a nation of open-pit miners. Most Canadians want a stable, sustainable economy that is environmentally responsible and good-quality 21st-century jobs and business opportunities across the country.

    That is certainly too much to ask from neo-conservatives who believe big corporate profits trickle down to the little people and “create jobs.” Let’s see what options we have in 2015.

    • Yes, trickle up economics has worked amazingly well everywhere it’s been tried.

      • Centrist, demand-side, “trickle up” economics created modern living standards in the post-war era. Progressive taxation put more money in people’s pockets, not the reckless tax cuts of the past 30 years that only benefited the rich while helping to destroy post-war living standards.

        BTW, in the post-war era we paid our bills. The US paid down its debt from 135% debt/GDP to 35% (now 103%.) Canada from 100% to 17% (now 85%.)

        • Wow, shocking that countries that were going into massive debt to fight a world war would start paying off that debt once the war was over!! You can try chalking up higher living standards to higher taxes, but you completely ignore the fact that there was a massive influx of workers after the war, and then women started entering the workforce.

          If you actually believed that paying more taxes would put more money in your pocket, why don’t you voluntarily pay the maximum amount of taxes that you can? Because you believe that higher taxes would put more of other people’s money in your pocket. Your not looking out for the best interests of the nation or economy as a whole, you’re simply selfish and trying to get more for yourself from others.

          • Nonsense. The purpose of economics is to put resources to their most effective use. Allowing a small minority of rich people to hog up all the resources is a pyramid scheme which produces an unstable and unsustainable economy. Not to mention it is a tyranny.

            A functioning economy requires the government to level the playing field and provide some degree of equality of opportunity to ensure people realize their full potential. In a functioning economy, all segments of society share in GDP and productivity growth. That’s what we had in the centrist post-war era. That’s what northern European countries have today.

            The last 30-year “age of greed” that put all the benefits into the hands of the rich, while living standards eroded for everyone else, not surprisingly, collapsed in a meltdown we have yet to recover from.

            Failure and tyranny is not justifiable, certainly not on the “principles” of unfettered greed, selfishness and an utter lack of accountability.

          • You say “equality of opportunity”, but what you really mean is that the government should choose who’s more equal than others. We live in a free society, there’s no institutionalized discrimination. Anybody can go to University, start a business. That’s equality of opportunity.

            As you stated, economics is about putting resources to their most effective use. But what you’re suggesting we need more of is confiscation of resources from those who’ve proven to manage them most effectively and transferring those resources to those who’ve proven most inept – or at least inexperienced – at managing them.

            But I find it awesome how you deride the “greed” in others to satisfy your own greed.

          • I don’t believe in greed. I believe in moderate levels of inequality and people getting fair wages and benefits. History has shown the free-market place does not deliver. It has also shown the rich are good at exploiting the masses and cheating them out of their fair share of the economic pie. That is not managing economic resources effectively. The centrist mixed-market system, however, has been proven to manage resources the most effectively, having created modern living standards in the post-war era.

          • “The centrist mixed-market system, however, has been proven to manage resources the most effectively, having created modern living standards in the post-war era”.
            You can repeat that as many times and in as many places as you want, it still doesn’t make it true.

    • Canada and Australia have been two of the most successful economies over the last ten years and all you want to do is whine. Europe is falling apart, the US debt is out of control, and Japan has been in a 20 year stagnation, and all you can do is complain about the successful countries. Grow up.

      • GDP growth over the last ten years has been the lowest since the Great Depression. Ask average Canadians how great they think the economy is actually doing. Look at “booming” Alberta. The price of oil slumps a little and their deficit triples (and this is after all their lecturing of ON, which still pays out $11B/yr despite being a “have not” province thanks to the hundreds of thousands of jobs destroyed by the Dutch Disease.)

        • GDP growth over the last ten years has been the lowest since the Great Depression

          False. I mean, that is so obviously false it’s hilarious. GDP growth from 1993 to 2003 was lower than from 2003 to 2013.

          The rest of your comment appears to be rambling non-sequiturs, you complain about GDP growth and then you complain about the one province that has had spectacular GDP growth. You’re a clown.

          • One can look at the GDP Growth graph on Google and see that the last ten years have been the worst for GDP growth in 50 years. Our recovery from the 2009 recession was also the weakest (add in GDP growth for 2012: 1.8%.)

            In the 1980s and 1990s we could expect recovery growth of around 5% real GDP. (Greater in the 50s, 60s and 70s.) Now Mark Carney says 2.5% GDP growth represents a full recovery. Of course, we aren’t even getting that. Carney’s original forecast for 2.5% growth for 2012-13 has been revised down to below 2%.

            http://www.google.ca/publicdata/explore?ds=d5bncppjof8f9_&met_y=ny_gdp_mktp_kd_zg&idim=country:CAN&dl=en&hl=en&q=gdp%20growth

          • You are a joke. You blather about economics but you don’t even understand the concept of GDP growth. Since growth is exponential it needs to be framed in a logarithmic scale to compare different periods (which converts a growth curve to a jagged sloping line.)

            Of course, the nominal GDP growth graph you refer to doesn’t factor in inflation. One needs to apply the GDP deflator for each year to calculate that year’s *real* GDP growth. A series can be converted to a base year’s constant dollars to get a real GDP growth curve. That curve would have to be converted to a logarithmic scale to see how each period’s growth compares to an average trend (a straight sloping line.)

            But one can compare real GDP growth for each decade. Acording to The Conference Board’s Total Economic Database, Canada’s real GDP (at 1990 dollars adjusted for PPP) was: 1991 $513.5B; 2001 $711.8B; 2011 $860.9B.

            That means the economy grew by 38.6% from 1991 to 2001 and 20.9% from 2001 to 2011. Real growth was 84.7% higher from 1991-2001 than 2001-2011.

            The Conference Board: Total Economy Database
            http://www.conference-board.org/data/economydatabase/

  3. The reason there is no case of Dutch Disease in Australia is because their manufacturing base has been on a steady decline since 1990. Canada, on the other hand, has shed about 500,000 manufacturing jobs from 2004 to 2009 as the dollar soared 60% in value from 2003 to 2008.

    The Dutch Disease premise is that a steep increase in resource development and exports causes the dollar to become overvalued which prices value-added exports out of the world market. According to the OECD (based on PPP,) Canada’s dollar is overvalued by 25%. Clearly that’s what’s happened here.

    Manufacturing Employment: Canada vs Australia
    http://www2.macleans.ca/wp-content/uploads/2013/02/mfg_employment_countries.png

  4. “In a world of elevated commodity prices, it is better to have them.”

    It’s amazing how this obvious fact eludes so many people.

    • Evidently the word “elevated” eluded you. Conventional wisdom suggests that what goes up must come down…

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