Australia: Mine, all mine

Financial Times

Profiting from Asia’s rise and dependence on mineral exports is hurting competitiveness

Steve Sargent, the head of General Electric’s operations in Australia, says people are often surprised to learn that a nation of 22m is now one of GE’s biggest markets – bigger than China in fact. The secret lies in a resources boom that allows the conglomerate to sell locomotives, turbines and underwater technology for the massive mining and energy projects that abound across the island continent. But it is misleading to see this purely as an Australian success story.

“Remember it’s not Australians buying what we produce; ultimately it’s 3bn people north-west of here,” he says. “If developing Asia is the growth engine of the global economy then mineral-rich Australia provides the fuel.”

By hitching itself to Asia, and particularly China’s urbanisation, Australia has prospered to an extraordinary extent. The country is now entering its 21st year of consecutive growth with a triple A credit rating, an unemployment rate of a little more than 5 per cent and, unlike much of Europe, a strong banking sector.

As economic gravity shifts to Asia it is Australia – more than any other advanced nation – that has profited. Since 2007 the economy has expanded more than 10 per cent. “The days of us looking to the British and Americans for inspiration and comfort have passed. It’s our turn to tell them how it works,” says political journalist George Megalogenis in his latest book The Australian Moment.

But although the ties to Asia may initially appear to be a blessing, some people fear they could prove a curse as the two juggernauts of Asian growth – China and India – start to slow. By having too much of a good thing, the argument goes, Australia, or the “quarry in China’s backyard”, has become too dependent on commodity-led growth. That has made it lazy and complacent, and analysts fear it could be pumping up a credit bubble. As Australia’s wealth has increased, the willingness of business and government to make the difficult decisions needed to improve productivity growth – which economists say needs to return to about 1.5 per cent per annum from only 0.4 per cent between 2006 and 2011 – has diminished.

“If Chinese resource demand holds up, everything will probably be fine. But if it doesn’t, everything won’t be. In fact, there might be trouble anyway,” says Dylan Grice of Société Générale.

The resources boom has pushed the exchange rate to a level where many manufacturers cannot compete. Tourism, retail and education, which support more than 3m jobs, are also struggling. Both foreign holidaymakers and would-be students now find Australia extremely expensive to visit, unlike a decade ago. Meanwhile, wages in the resources industry have soared to levels that have left some non-mining parts of the economy unable to retain or attract staff.

A combination of factors has led some to ask whether parts of the economy suffer from Dutch disease, a phenomenon where income from natural resources distorts the rest of the economy. In order to succeed, some argue that Australia must redefine its global position more confidently.

“Australia’s greatest challenge is a psychological one more than it is an economic one. Australia must, psychologically, see itself as part of the region rather than as a white enclave who inherited a continent and struck it lucky,” says Paul Keating, the former prime minister.

“We have to open up socially and psychologically to nations that aren’t populated by people with a European history,” he says.

While recent statistics for the economy (which expanded at 4.3 per cent in the year to March) and employment (nearly 40,000 jobs were added in May) paint a happy picture, the reality is more complex. Many Australians far from the west coast mining boom, particularly those living in the east coast cities of Sydney and Melbourne, do not see the benefits of the resource boom.

“I’ve lost six experienced mechanics to the mines since October,” says Beric Lynton, who runs a car dealership on Queensland’s Gold Coast. “We can’t compete with the wages they offer,” he adds, explaining that a shortage of mechanics in Australia means he is now forced to look to Europe for replacements.

Some of the more negative sentiment can be explained by the strong currency. Businesses are struggling to compete while the Australian dollar remains around parity with its US counterpart. While the mining sector added almost 60,000 jobs in the past year, the retail and manufacturing sectors lost almost 50,000 jobs.

As money pours into new mining and gas projects, the Treasury estimates the resource-related sectors of the economy will grow by an average of 9 per cent a year over the next two years. In contrast, the non-resources part of the economy will grow at an annual average rate of 2 per cent over the same period. The two-speed economy is reflected in recent data, which show demand in resource-rich Western Australia rose 14.5 per cent in the year to March 2012 – almost three times the national average – but just 1.9 per cent in New South Wales.

We have a world-class industry … [we] should be proud of. But it is a global and competitive industry in a fragile time

Predictably, this split has political repercussions. Wayne Swan, Treasurer of the ruling Labor party, has attacked billionaire mining magnates such as Gina Rinehart, recently crowned the world’s richest woman by a local magazine. He said they were using their considerable wealth to oppose “good public policy” and economic reforms.

“A handful of vested interests that have pocketed a disproportionate share of the nation’s economic success now feel they have a right to shape Australia’s future to satisfy their own self-interest,’’ he said of Ms Rinehart’s investment in Fairfax Media, one of the country’s biggest media companies and owner of The Sydney Morning Herald.

The debate has continued with the unpopular minority Labor government, which faces a heavy defeat at the next election, using the budget to “spread the benefits of the mining boom” with A$5bn of new payments to low and middle-income families.

All this has sparked angry responses from the mining industry. “Attacking individuals and specific industries doesn’t build confidence in our country – nothing good comes from this. It is particularly troubling when these attacks are directed at the resources sector, a part of the economy that has the potential to continue growing, creating jobs for many more Australians,” Jac Nasser, the chairman of BHP Billiton, said recently.

“We have a world-class industry that all Australians should be proud of. But it is a global and very competitive industry in a fragile time.”

As Chinese economic growth slows, things could get very bumpy for Australia’s resource sector. “Even if Chinese policy makers don’t drop the ball, it could mean that their demand for commodities is much less over the next five years than we currently think,” says Brian Redican of Macquarie Securities.

The world’s biggest mining companies understand the risks. Over the past months, they have been making cautious comments on expansion plans because of a softening outlook for commodity prices.

BHP Billiton recently backed away from a five-year target to spend A$80bn on “growth projects”. Its chief executive, Marius Kloppers, says he will not approve any major projects in the near future. “The economics of some of these projects is changed. I think for the next two years, 18 months perhaps, we will just wait and see how things develop.”

The government counters that more than half the projects pending in Australia’s A$500bn resources investment pipeline have already been approved and that the next phase of growth will come from huge natural gas projects, targeting sales in Japan and South Korea. The Treasury expects businesses to invest a record A$120bn in resources over the next 12 months.

But a rapid escalation in construction and labour costs means analysts reckon a significant number of projects may not proceed. A recent report commissioned by the Minerals Council of Australia showed iron ore projects are up to 75 per cent more expensive to build in Australia than west Africa and the cost of installing a tonne of new capacity at a thermal coal mine has risen three fold in five years, threatening projects such as Rio Tinto’s A$2bn Mount Pleasant pit.

Uncertainty about the fiscal regime following decisions by the Labor government to introduce new carbon and mining taxes also looms large.

“Does Australia have its risks? Yes.” Ivan Glasenberg, chief executive of Glencore, said recently. “It’s a first-world country but it’s doing things that are making people cautious in investing. So Australia is becoming another country where you’ve got to make sure the rules aren’t going to change on you.”

Beyond the resources sector, there are other issues that present threats to the Australian economy. One is high property prices. Another is an overextended consumer. Like their Anglo-Saxon cousins in the northern hemisphere, Australians spent more than they earned over the past two decades (debt to disposable income exceeded 160 per cent) and they are now trying to pay it back.

“When you scratch the surface of the Australian ‘miracle’ you don’t just find a miraculous commodity supercycle; you also find an equally miraculous credit supercycle as well. A credit bubble built on a commodity market built on an even bigger Chinese credit bubble – Australia looks like leveraged leverage, a Collateralised Debt Obligation squared,” says Mr Grice.

Glenn Stevens, governor of the Reserve Bank of Australia, says “household deleveraging” explains a lot of the unevenness in the economy. “It’s not just about the mining sector squeezing other sectors by drawing away labour and capital and pushing up the exchange rate. It is doing that, but slower growth in sectors that had earlier done well from unusually strong gains in household spending would have been occurring anyway, even if the mining boom had never come along,” he says.

or all its vulnerabilities there is little doubt Australia is uniquely positioned among advanced economies to ride the shift of economic power to Asia. This does not hinge simply on China, which probably has decades of healthy growth ahead. It also depends on a broader rise of a middle class across Asia that will require infrastructure built from Australian raw materials.

“I have no doubt that we are on the threshold of our greatest ever era and the challenge will be managing prosperity,” says Joe Hockey, shadow treasurer and a Sydney lawmaker.

But to seize this historic opportunity Australians must tackle issues created by the country’s two-speed economy and also, says Mr Megalogenis, start taking their “backyard more seriously”.

“Sitting back and allowing the mining sector to dictate the relationship will deny the other 90 per cent of the economy a productive engagement with the region and condemn Australia to a new form of insularity. The alternative to greatness is to become the rich white trash of Asia.”

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Property market: ‘The mining boom isn’t helping us here’

With its pristine beaches and balmy climate, Queensland’s Gold Coast is one of Australia’s leading tourist destinations – and one of its toughest housing markets. A pre-financial crisis housing boom has left a glut of high-end properties which, based on current sale rates, estate agents estimate will take up to five years to clear.

“The mining boom isn’t helping us here,” says Dom Machado, a consultant at the A$650m Salacia Waters development. Although prices have been slashed by 40 per cent, South Korea’s Lotte Engineering & Construction has sold only about 40 flats. It is a similar story at developments along the 40km coastline.

Property is often cited by analysts and groups such as the OECD as one of the biggest threats to the Australian economy. “In some countries, such as Canada, Belgium, France, Australia, Norway and Sweden, house prices are very high relative to rents and incomes, pointing to … further corrections in those in which real house prices are already in decline,” the Paris-based body said in its most recent economic outlook.

Australia has one of the world’s highest ownership rates according to research company RP Data. It also has some of the least affordable property. The Demographia International Housing Survey says five of the world’s most expensive cities are Australian.

Professor Steven Keen of the University of Western Sydney estimates nominal house prices in Australia have risen by a factor of six since 1986 – eclipsing the US, where house prices rose 3.5 times before the bubble burst in 2006. He forecasts that the market will be undone by its own success.

“Having successfully driven house prices skywards, the cost of entry is now prohibitive so that the flow of new entrants is drying up,” he says.

Other economists point out that leading cities, while expensive, do not suffer from oversupply.

In its most recent report, the National Housing Supply Council says demand across Australia rose by an average of 153,000 homes a year between 2001 and 2010; supply (completions net of demolitions) rose by an average of 132,500 per annum in the same period.

 

 

 

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