Ashes to Economy?

Written by Chirag Shah on 27 August 2013

England has retained the Ashes this summer but is it just cricket that will be depressing the Australians over the next few weeks?

Australia was one of the few developed economies to emerge from the global recession largely unscathed.  Growth has been good for a quarter of a century, public debt is low, the banking system proved resilient during the financial crisis and is one of only a handful of countries that still retains a AAA credit rating. 

Success initially was based on some important structural reforms to labour markets and to welfare policy, coupled with macro-economic policies that used inflation targeting to keep increases in the cost of living in check. Australia's banks were better capitalised than those in Europe or the US when the crisis broke.  These reforms in the late 1980s and early 1990s coincided with China's emergence as a global economic superpower. China needed raw materials for its rapid industrial expansion and Australia had them in abundance.

In some ways, the Australian and Irish economies have followed very similar paths.  Both countries put in place supply-side reforms designed to boost growth and both had access to a huge market.  Ireland’s twenty years of expansion began with growth as a result of getting the fundamentals right at a time when multinationals were looking for a European base but ended with a bubble decade of wild property speculation and irresponsible lending.  So could Australia turn into the Ireland of the Antipodes?

In the days before the financial crisis, there were three groups of countries. In the first category were the workshop nations such as China.  The second held the debtor nations such as the UK and the US. These countries bought the goods churned out by the workshop nations, running up big current account deficits in the process.  Finally, there were the resource-rich countries. Some of these were the oil-rich nations of the Middle East; others included Russia and two important developed countries, Canada and Australia. All these countries did well out of a global economy in which China was growing at 10% a year and the US was acting as the spender of last resort.  Before the financial crisis, global growth averaged around 5% a year.  However, this model has now collapsed and 5% global growth looks like an aberration. 

With the US less willing to buy up everything Chinese factories produce, the new leadership in Beijing has worked out that it might not be sensible for investment to make up 50% of the nation's output. But the transition to an economy less dependent on investment and exports is likely to be slow and fitful.  All this has obvious implications for those countries heavily dependent on exports of energy and raw materials, such as Australia, where the mining industry has doubled its share of national output to 10% in less than a decade. Exports relating to exploitation of natural resources account for 60% of the total and while the mining sector has growth by 7.5% over the past decade the rest of the Australian economy has expanded by around 2.5%.

Australia now bears all the hallmarks of a country whose industrial base has hollowed out.  With the outlook for the global economy far less rosy than it was, the mining sector is also cutting back on investment. That has left the economy propped up by the one remaining source of growth – an overvalued real estate market.  Household debt in Australia rose sharply in the 1990s and 2000s and now stands at 150% of GDP.  The Reserve Bank of Australia is now cutting interest rates and talking down the currency in an attempt to rebalance the economy. 

The next 10 days will bring key indicators about the health of the Australian economy, including the official survey of business investment coming out this Thursday and the June-quarter national accounts next week.  Will the figures show an Australian economic collapse or must the Aussies wait patiently for the home Ashes series this winter before they see any improvement in performance.

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Chirag Shah
Trainee Corporate Accountant