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.