Economic Society Forum, Melbourne, Monday, August 20, 2012
Rather than plunging into a debate about whether policy makers should seek to influence our exchange rate and, if so, how they should go about it, I want to start by examining the reasons for people’s great concern about its present level. The high dollar is disadvantaging all our tradeables industries, but for the miners (and, to a lesser extent, the farmers) that’s being offset by the still exceptionally high prices they’re receiving, so we’re left with the manufacturers, tourism (which is both export and import-competing) and education of international students. But there’s been remarkably little public concern about the plight of the universities and the tourist operators. There’s been so little concern about tourism that the federal budget in May actually contained an increase in the special tax imposed on their industry, the departure tax, which went unremarked. So let’s not kid ourselves, we’re here tonight because of concern about the high dollar’s effect on manufacturing.
And I find this pretty puzzling. Why all this agonising about an industry that accounts for only about 8 per cent of the economy (and less of total employment), whose share of the economy has been declining for more than three decades? What’s so special about manufacturing? Why does news that a factory is closing and laying off 300 people cause far more consternation than news that a state government plans to lay off 10,000 people?
I can see why the punters imagine the economy to be built on the foundation of manufacturing, but I can’t see why anyone with any economic training would think it. I can see why the punters are susceptible to the physiocratic notion that goods matter but services don’t, but I can’t see why anyone with any economic training would think it. I can see why the punters are susceptible to the mercantilist notion that a country makes its living by trading with other countries, but I can’t see why anyone with any economic training would think it. So I can see why the punters imagine the economy to be composed of mining in the fast lane and manufacturing in the slow lane and not much else, but I can’t see why anyone with any economic training would think it. So I can see why the punters don’t realise that about three-quarters of the economy is the non-tradeables sector which, if anything, benefits from the high dollar via cheaper prices for imported materials and capital equipment, as well as from having customers who have higher disposable income thanks to lower prices for imported consumer goods and locally made import-competing goods.
I can see why the punters imagine we can assist manufacturing with protection, or by changing the value of the dollar, without that having any opportunity cost, but I can’t see why anyone with any economic training would think it. I can see why people who work in manufacturing are happy to advocate policies that favour manufacturing at the expense of the rest of the economy, but I can’t see why anyone with any economic training would be.
I can see why punters think retaining a large manufacturing sector is important to our self-sufficiency, but I can’t see why anyone with any economic training would think it. I can see why punters don’t understand that the way for an economy to get rich is to pursue its comparative advantage, but I can’t see why anyone with any economic training wouldn’t understand it. I can understand why the punters accept that structural change arising from technological advance can’t be argued with, but structural change arising from a change in our comparative advantage can be resisted, but I can’t understand why anyone with any economic training would think that way.
I can see why punters think mining is of little benefit to the economy because it’s so capital-intensive it employs very few workers, but I can’t see why anyone with any economic training would think that. I can see why punters imagine we live in six separate state economies that can grow at markedly different rates for years on end because they have no idea about the circular flow of income and how strong the linkages are between the states, through inter-state trade, the federal budget’s geographic redistribution of income, and the grants commission’s redistribution of state taxable capacity. I can see why punters don’t understand that one of the main means by which income is redistributed from the miners to the rest of us in the other states is, ironically, the high dollar. And why it would never occur to the punters that acting to lower the high dollar would reduce the extent to which the benefits of the resources boom were being redirected to the eastern states. But I can’t see why anyone with any economic training wouldn’t understand all that.
I can see why so many Victorians are convinced their state economy is heavily dependent on manufacturing. Victoria has a tradition of protectionism going back to the days of David Syme, there probably was a time when manufacturing accounted for a big share of the Victorian economy, Melbourne is the headquarters of the union movement and the manufacturing unions, and the Victorian media know stories about some threat to manufacturing strike a chord with their audience that stories about the problems of other industries don’t, so they happily reinforce the state’s perception of itself. But I can’t see why anyone who’s had a look at the figures lately would not have been disabused of this outdated notion.
Manufacturing’s share of national production is 8 per cent; its share of Victorian production is 9 per cent. In fact, manufacturing’s share is 8 or 9 per cent in all states bar WA, where it’s just 5 per cent. So if Victoria is just average on manufacturing, where does it stand out? Well, it has very little mining, but its great dependency is on - wait for it - business services, particularly financial services. Nationally, business services account for 23 per cent of production, but in Victoria their share is 28 per cent, which is almost as high as NSW’s 30 per cent. Business services are heavily concentrated in Victoria and NSW, where they account for at least 10 percentage points more than in the other states. The notion that Victoria and manufacturing go together is a myth.
When their attention is drawn to the difficulties facing manufacturing, the punters probably think the higher dollar is a bad thing. It wouldn’t occur to them that, apart from offering them cheap overseas holidays, the high dollar brings advantages as well as disadvantages. In particular, it represents the rest of the world volunteering to pay a premium for Australian assets. Why’s that a bad thing? And shouldn’t we think twice before doing what we can to stop them paying us so much? Taking measures to change the exchange rate involves changing the allocation of resources - probably in a less efficient direction. But it’s also, inescapably, redistributive. It involves governments deciding to take income from some people and give it to others. Let’s not kid ourselves it’s a free lunch.
I can understand why apologists for manufacturing bang on about Dutch disease. They want us to assume the resources boom will push the dollar sky-high, wipe out manufacturing, then disappear in a puff of smoke. But the analogy with the Dutch fails in two respects. First, their North Sea oil may have been used up in a few years, but our reserves of coal and iron ore won’t be. We’re going to be left with a much bigger mining sector to show for it. Second, I find it hard to see why the exchange rate isn’t going to stay uncomfortably high - well above its post-float average of about US75c - for at least the rest of the decade. It’s true commodity prices are coming down and that there’s a strong correlation between commodity prices and the Aussie dollar. But I doubt coal and iron ore prices are in the process of falling back anything like all the way to their pre-boom levels. And, in any case, the correlation has always been far from perfect. The dollar’s value is affected by an ever-changing range of factors we have no great handle on. Happy story-telling about how it’s all the fault of the Reserve Bank keeping the interest-rate differential too high, or wicked currency speculators, or wicked central banks buying Aussie bonds are delusional.
The key question is whether the uncomfortably high exchange rate is temporary or lasting. No one knows, but everything I see tells me it will stay up. If so, manufacturing - like all the rest of us - needs to get on with adapting to a changed world. The high dollar is not really bad for the economy, but it is really tough on much of the tradeables sector.
