EPO NSW: Dutch disease unlikely

It is unlikely that Dutch Disease is happening in Australia and structural adjustments in the economy must occur to ensure Australia gets the full benefits of the resources boom, Reserve Bank of Australia, Deputy Governor, Dr Philip Lowe, has told a CEDA audience

Speaking in Sydney on 16 February at the first CEDA Economic and Political Overview event for 2012, Dr Lowe provided a relatively positive outlook for the Australian economy.

While he said it was important that Australia keeps on developing human capital and ensuring policy flexibility in case the resources boom was not long lasting, he expected that it would last many decades.

"I think there are reasonable prospects that it will turn out to be long lasting and if that's right, then for the economy to get the benefits, for living standards to grow strongly, then we do need to make structural adjustments," he said.

"When people talk about the Dutch Disease they are talking about the problems the Netherlands faced when they had a resource discovery and that resource was going to be available for 10 or 20 years.

"The economy, the exchange rate, went up, and as a result of the higher exchange rate the manufacturing sector contracted and the concern was that once the resource base was used up they would have lost the skills base in the manufacturing sector.

"The issue here is, is the current good luck that we are having…just a transitory thing and will the resources we have be used up in 10 or 20 years?

"I think you can make a plausible case that this adjustment we are going through is really very long lasting.

"It is because of what is going on in Asia, that process of development of those very large and populous countries of Asia is going to take many many decades and Australia has the resources to supply the resource needs for Asia over many many decades.

"If that's the case the economy has to go through some structural adjustment and that structural adjustment is likely to be very long lasting."

Dr Lowe said the RBA expected low double digit increases in business investment in each of the next couple of years, in part as a result of the resources boom, which was having a spill-over effect for a number of industries, both direct and indirect.

"The indirect effects come through a variety of channels. Day to day, they can be hard to see but they do percolate through the economy," he said.

"In effect, there is a chain that links the investment boom in the Pilbara and in Queensland, to the increase in spending at cafes and restaurants in Melbourne and Sydney.

"The stable prices for many goods, combined with strong disposable income growth means there is more disposable income to be spent on services in the cities and towns far from where the resources boom is taking place."

Dr Lowe said Australia had started 2012 in relatively good shape, but a key global issue for 2012 and 2013 would be the impact of fiscal consolidation on economic growth, as Europe and the United States attempt to improve public finances.

"The aggregate fiscal contraction across the advanced economies is likely to be the largest seen for many decades," he said.

"This is not because the size of the fiscal consolidations in individual countries is unprecedented, but rather because the consolidations are occurring simultaneously in a large number of countries."

He warned that there was material risk that fiscal consolidation would weaken growth in the short run, leading to more fiscal consolidation, and in turn, even weaker growth.

"We are currently seeing this dynamic play out in a couple of the countries in southern Europe," he said.

"If it is not to be repeated on a wider scale, the fiscal consolidation in the North Atlantic economies will need to be accompanied by reforms on the supply side that lift the underlying rate of growth of these countries."

Dr Lowe also highlighted that while developments in Europe were interesting, it was important that we do not lose sight of what else is going on in the world.

He said recent US data had been better than was widely expected and, while the pace of growth has slowed in China, its economy was also continuing to grow solidly.

To read Dr Lowe's full speech, please click here.

NAB Chief Economist, Markets, Rob Henderson, providing  a financial markets perspective, agreed with Dr Lowe's comments regarding structural change occurring to Australia's economy.

He said while it was OK to ease the process, we shouldn't stop it from happening because that would inhibit Australia's  ability to take advantage of what's ahead.

"I think Australia is running an experiment here for the rest of the world," he said.

"What you do when you've got an economy that, rather than an unemployment rate that is too high, you've got an economy that has strong demand for its exports, that is running out of labour and capital, and yet tries to keep its inflation rate in that two to three per cent target band that the Reserve Bank has had now for a couple of decades.

"That's not a set of policy issues that is widely understood by economists around the world."

On the potential for further interest rate cuts, Mr Henderson said, provided there wasn't a blow-out in Europe, there was a 50/50 chance of one more rate cut, with one possible trigger being the Australian dollar continuing to rise.

On the introduction of the carbon price, Mr Henderson said he agreed with the RBA predictions that the carbon price would add about point seven percentage points to headline inflation.

"It makes very little difference to the outlook...so all the press you hear about the carbon price killing the economy, when you do the numbers, there isn't any way that's going to happen," he said.

To hear Rob Henderson's full speech click here.

The economic session was followed by a political outlook that included:

Former NSW Auditor-General and Former NSW Parliamentary Budget Officer, Tony Harris, highlighted some of the political issues in NSW, including the delays in privatisation of the NSW electricity network and integrating NSW into the seamless national economy.

He also pointed out that if NSW had grown as fast as Victoria had since 1999 to the September quarter last year, it would have $40 billion more in its coffers.

University of Sydney, Department of Government and International Relations, Emeritus Professor Rod Tiffen, provided analysis of the Federal political situation, including concerns over spin doctoring that was aimed at winning the day-to-day news cycle rather than looking at long term strategy.

Australian Financial Review, Political Editor, Laura Tingle, provided a race call on the current Federal leadership situation, highlighting that the Prime Minister, Julia Gillard, was under attack from three fronts - the Opposition, her own party and from her own mistakes due to a lack of political judgement.

She highlighted that normally the only way to break the poor polling deadlock Labor was currently experiencing, was to change political leaders or for "an act of God" event to occur, such as the Tampa incident was for John Howard. However, she said the issue for the Prime Minister was that a number of her colleagues now doubted she could capitalise on an act of God, if it were to occur.

Committee for Sydney, Deputy Chair, and COAG Reform Council Cities Expert panel member, Lucy Hughes Turnbull AO, discussed the importance of infrastructure delivery and some of the issues currently being examined relating to urban productivity, costs of obstruction and congestion charging, and the cooperation required between all three levels of government

The economic and political discussions were followed by a keynote address by The Airport Economist author and University of NSW, JW Nevile Fellow in Economics, Tim Harcourt. He provided a lighter take on the current economic climate and also provided insights into the impact of key international economies on the year ahead. An audio of his speech can be found here.

LINKS

Extract of Saul Eslake's contribution to CEDA's 2012 EPO publication as published in the Financial Review, 17 February 2012.
Media release
EPO publication summary
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