Will Australia always be the lucky country?

Monday March 18, 2013

We were recently in Sydney for a conference and Mark Rider from UBS gave a thorough international comparison between Australia and the rest of the world. It was a very interesting presentation and stripped bare a lot of facts or perceived facts about Australia in an International context. To begin, we thought we would remind readers what GDP is – it stands for Gross Domestic Product and is the total market value of all final goods and services produced in a country in a given year. The larger your GDP the larger your economy is. Some of the facts presented are worth being summarised here:

GDP per capita – We have moved from the 23rd highest (in 2000) to the 5th highest (in 2011) in the world. Some of this can be attributed to the doubling of the dollar over this period, but we are now ahead of the US, Germany and Japan.

Median Income growth (2000-2011) – Ranked 2nd in the world behind Poland. Whilst it is always great to be paid more, the question we need to ask here is – is this growth justified or are we undermining our competitiveness? Greece was ranked 3rd in the world and it has recently become quite clear that this (combined with other bad decisions) very much undermined its competitiveness.

Nominal house price growth (2000-2010) – Ranked 1st . Anyone owning a house over this period would be pleased with this; however this is not so pleasing for those wanting to buy. Strong house price growth is generally good if it’s sustainable. The country that came second in this category was Spain – and clearly those rises were not sustainable.

House prices in Spain have collapsed – causing tremendous pain in their economy. It is generally accepted that sustainable house price growth should more or less equal income growth, but despite having the 2nd highest income growth in the world over this period, our house price growth exceeded this rate by some margin. Pleasingly income growth since 2011 has exceeded house price growth – we see this as a positive reversal of a dangerous trend.

Median Wealth per adult – Ranked 1st in the world – our median wealth is now $US221,704. About 80% of this wealth is in our houses.

Terms of trade growth (2000-2011) – Ranked 1st without a doubt this has been the key to Australia’s success over the last ten years. It has lifted GDP growth, incomes and wealth. Terms of trade is a measure of our export prices divided by import prices.

Terms of trade increases happen when the prices of things we sell go up and the prices of things we buy go down. To put it in simple terms, in 2005, a ship load of iron ore was worth about the same as about 2,200 flat screen television sets. In 2011 it was worth about 22,000 flat-screen TV sets. This was partly due to TV prices falling but more due to the price of iron ore rising by a factor of six.

It is important to point out that our terms of trade increases are not as a result of a policy decisions in Canberra.
Prices we receive and pay are determined by the world market and as such rises are the “free lunch” of economic growth and typically temporary. What is staggering is just is just how fortunate we have been, our increases were over 2.5 times second placed Norway and almost 5 times 3rd placed New Zealand.

Whilst it’s interesting to reflect where we have been, the question is where are we going? Unfortunately our terms of trade is now declining and this is expected to continue – the IMF believe that our rate will decline at 4.0%p.a. compared to the other advanced economies in the OECD in the next 3 years. Once again this is not political; it’s just that the price for iron ore and coal are retreating.

Productivity growth (2000-2011) – Ranked 20th

Manufacturing labour costs – Ranked 1st

Low growth and high costs. These last 2 factors are probably our greatest concerns for the Australian economy. Whilst some blame can be placed on our high Australian dollar, we are simply a very expensive place to conduct business and this has negative consequences for the competiveness of our economy.

Labour productivity is a measure of the amount of goods and services that the average worker produces in an hour of work. The level of productivity is the single most important determinant of a country’s standard of living, with faster productivity growth leading to an increasingly better standard of living.

Terms of trade increases also increase living standards, but as stated earlier we are now more likely to see declines in this measure. Further as a nation we can address and change productivity whereas terms of trade are largely out of our control.
It is worthwhile understanding why being uncompetitive is a problem.
Take 2 petrol stations “A” and “B”. Both sell identical levels of fuel, charge the same and make the same profits. However over time “A’s” costs increased at a rate greater than “B’s” and as a result “A” now charges 5c/litre more for fuel to cover the cost increases.

The market responds to the price change and many of “A’s” customers start buying fuel from “B”. This switch to “B” has meant that “A” sells less fuel and decides to make a 10c/litre increase to cover the shortfall. Unfortunately this drives even more customers to “B”. “A” is now seriously struggling and is forced to lay off staff. Customers recognise that not only is the price more expensive but the service is inferior, driving the last few faithful customers away and sending “A” out of business.

All the while “B’s” business has been booming on the back of the increased patronage from “A’s” former customers – as a result he expands and can employ more people.

When your terms of trade are booming, the need to stay competitive is less urgent as everyone can typically do well regardless. However as our terms of trade (i.e. commodity prices in Australia) fall, this all of a sudden makes things a lot more difficult. Ultimately if Australia does nothing to address our productivity and competitiveness we will end up like service station “A”.

We are encouraged to see more recent data shows that there are some very early signs that Australia’s productivity growth is starting to move in the right direction. However a lot of work needs to be done if we want to continue to increase our standard of living. Like the decision makers in Europe, this is an area where Canberra can help if it chooses to.

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