Our dealings with the world have reversed, for good or ill

One of the most remarkable developments in our economy in recent times is also the most unremarked: after endless decades of running a deficit on the current account of our balance of payments, for the past two years we’ve been running a surplus. Which looks likely to continue.

Because a “deficit” sounds like it’s a bad thing, and the media know their audience finds bad news much more interesting than good news, I guess it’s not so surprising this seemingly good news hasn’t attracted much attention.

But one thing economics teaches is that, contrary to popular impression, not all deficits are bad and not all surpluses are good. It depends on the circumstances. But regardless of whether they regard a current account surplus as a good sign or a bad one, I suspect most economists think there are more important issues to worry about.

This week the Australian Bureau of Statistics revealed a record trade surplus of $10.5 billion in just the month of June.

We recorded a current account surplus of $17.6 billion during the March quarter this year. That compares with a peak deficit of $23.5 billion in September quarter, 2015.

Since the bureau started publishing the figures in 1959, we’ve run 221 quarterly deficits, but just 26 surpluses. Eight of those have come over the past two years.

But let’s start at the beginning. A country’s “balance of payments” is a summary record of all the transactions during a period of time between, in our case, an Australian on one side and a foreigner on the other. Those on either side could be businesses, governments or individuals. Mainly they’re businesses.

Conceptually, the balance of payments is recorded using double-entry bookkeeping, where one side of the transaction is recorded as a debit and the other as a credit. So, when you add up all the debits and add up all the credits, the two amounts should be equal. Thus the balance of payments is in balance at all times.

This matters because the balance of payments is divided into two main accounts, the “current account” and the “capital and financial account”. The value of transactions involving exports or imports of goods and services goes in the current account, as do payments – in or out - of income such as interest and dividends.

But the other side of each of those transactions involving exports, imports or income payments, the amount someone has to pay – the financial side of the transaction – goes in the capital account, as do purely financial transactions, such as when one of our banks borrows from or lends to some overseas bank, or when one of our superannuation funds buys or sells shares in a foreign company.

Bear with me. The income we earn from foreigners who buy our exports or pay us dividends or interest is recorded as a credit, whereas the money we pay to foreigners for our imports or as dividends on the Australian shares they own or interest on the money they’ve lent us is recorded as a debit.

When we sell them shares in an Aussie business, borrow from them or sell them some real estate, that’s a credit in the capital account. When they sell us shares or land or lend us money, that’s recorded as a debit.

An account where the debits exceed the credits is in deficit. When the credits exceed the debits it’s in surplus.

There had to be a reason for explaining all this, and we’ve reached it. Historically, we almost always imported more than we exported, running a deficit on trade in goods and services. Likewise, we always had to pay more in dividends and interest to foreign owners and lenders than they had to pay us on our foreign shareholdings and loans to them, thus causing us to run a “net income deficit”.

Put the trade deficit and the net income deficit together and you get the balance on the current account, which was always in deficit. Oh no!

But here’s the trick. Since the double-entry system means the debits always equal the credits, if we always ran a deficit on the current account of the balance of payments, that means we always ran an equal and opposite surplus on the capital account. Yippee!

So if you think it’s good news that our current account is now in surplus, what do you think of the news that our capital account is now in deficit? Time to stop assuming all deficits are bad and all surpluses good.

In all the decades that our current account was in deficit, economists never thought that a bad thing. They knew Australia was – and should be – a “capital-importing country”. We always had a lot more investment opportunities than we could finance with our own saving, so we invited foreigners to bring their savings to Oz to participate in our economic development.

This continuous inflow of foreign capital gave us a continuous surplus on the capital account and thus allowed us to import more than we exported. Naturally, we had to pay big dividends and interest to those foreign investors.

So, why has all that reversed? Well, the reversal began in about 2015, long before the pandemic. Its first main cause is the rapid industrialisation of China, which has greatly increased our exports of minerals and energy and, until the pandemic, education and tourism.

But a second, less-favourable development has been our part in the rich economies’ slowdown in economic growth since the global financial crisis in 2008. This has involved increased saving and reduced investment spending – both of which have helped move our current account towards surplus and our capital account towards deficit.

Economists at the ANZ Bank predict the current account will fall back towards balance over the next few years. But we won’t return to our accustomed capital-importing status until we and the rest of the rich world escape the present low-growth trap.

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Memo generals: China is our inescapable economic destiny

There must be times in Australia’s history when people look at the nation’s economic experts and wonder if they have any idea what they’re doing. Today, the boot’s on the other foot: people who care about our economic future are wondering what game the nation’s defence and foreign affairs experts think they’re playing.

The concern of many business people and others has been most eloquently expressed by Dr John Edwards, former Reserve Bank board member, in a paper for the Lowy Institute. He’s in complete agreement with Scott Morrison’s assertion last year that “even during an era of great-power competition, Australia does not have to choose between the United States and China”.

Edwards says Australia made its choices long ago, and is now locked into them. “It chose its region, including its largest member, China, as the economic community to which it inescapably belongs. It also long ago chose the US as a defence ally to support Australia’s territorial independence and freedom of action.”

There is a good deal of tension between these two choices, but no possibility that either will change, he says. “Like many other enduring foreign policy problems, it cannot be resolved. It must instead be managed.

“However, it can only be managed if the Australian government has a clear and united understanding of Australia’s interests, and competent people to execute policies consistent with that understanding.”

Australia’s trade with East Asia has been growing faster than its gross domestic product and its trade overall for many decades. Our exports to East Asia now account for more than a sixth of our total GDP. Half of these exports go to China, and now amount to 10 times those going to the US.

Australia is meshed with China’s economy not only because China is such a big market for our exports, but also because China is the major trading partner of our other major markets in East Asia: Japan, South Korea, Taiwan and the ASEAN countries.

Today, East Asia and the Pacific form a regional economic community that, in terms of trade and investment between its members, is only a little less integrated than the European Union, and very much more integrated than the North American region.

“Already selling all it can to Japan and Korea, Australia would not find new markets for iron ore and coal to replace even a part of what it now sells to China. Nor could it easily replace exports of wine, meat, dairy products and manufactures to China. The largest share of foreign tourists is from China, as is the largest share of foreign students,” Edwards says.

“Without trade with China, Australia’s living standards would be lower, its economy smaller and its capacity to pay for military defence reduced.” (Generals – armchair and otherwise – please note.)

“It is difficult to imagine plausible circumstances in which an Australian government would voluntarily cut exports to China. Australia cannot and will not decouple from China’s economy any more than Japan, Korea, Taiwan or Southeast Asia can, wish to, or will,” he says.

Australia’s stance towards the US-China competition must therefore be informed by a recognition that what injures China’s prosperity also injures Australia’s prosperity. Economic "decoupling" of China from North America or Europe is not in Australia’s interests.

But “nor will Australia decouple from its security arrangements with America. The US will remain the primary source of advanced military technology for Australia. It will also remain the primary source of security intelligence.

“And no hostile power can entirely discount that possibility that the US would come to Australia’s military assistance if required. The security arrangements Australia has with America are therefore sufficiently valuable that no Australian government would voluntarily depreciate them, let alone relinquish them.”

The tension between these two pillars of Australia’s engagement with the world will continue for decades to come. The centrality of these relationships makes it all the more important for Australia to conduct them carefully and cleverly, always guided by a notion of Australia’s long-term interests, we’re told.

“China’s growing role on the world stage, its authoritarian government, its suppression of internal dissent, its territorial claims and defence build-up in the South China Sea, together with the deterioration of the relationship between the US and China, make this tension increasingly difficult to manage.

“Thus far, the cleverness Australia increasingly needs is not evident in its handling of relations with China . . . Refusing to take sides in the trade and technology competition between China and the US is Australia’s declared policy. It was wisely adopted – but not deftly implemented,” Edwards concludes, with admirable restraint.

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Too soon to say how hard virus will hit economy

To judge by the gyrations of the world’s sharemarkets, the coronavirus has us either off to hell in a handcart or the markets are panicking about something bad that’s happening, but they’re not sure what’s happening, how long it will last or how bad it will end up being. I’d go with the latter.

So would Reserve Bank deputy governor Dr Guy Debelle. He said in a speech this week that there’s been a large increase in the financial markets’ "risk aversion and uncertainty".

"The virus is going to have a material economic impact but it is not clear how large that will be. That makes it difficult for the market to reprice financial assets," he said.

That’s central-bankerspeak for "they’ve got no idea what will happen". Which is hardly surprising, since no one else has, either. More from Debelle’s speech as we go.

But understand this. Farr’s law of epidemics, developed in the mid-19th century, says that the number of cases of a new disease rises and then falls in a roughly symmetrical pattern, approximating a bell-shaped curve.

Depending on how quickly the disease spreads, the bell can have a steep rise and fall or a shallow one. Epidemiologists seek to make the bell as shallow as possible by slowing the disease’s spread. This allows the health system to avoid being overwhelmed – reducing the likelihood of panic and chaos, and making it more likely those who most need medical attention get it.

In theory, it allows more time for the development of a vaccine or useful drugs, but the World Health Organisation has said it will take about 18 months for a coronavirus vaccine to be widely available.

At this stage, the main way of slowing the spread is "social distancing" – reducing the contact between people by cancelling sporting events, closing schools or workplaces or ordering people to work at home. Of course, many people are doing their own social distancing by staying away from restaurants and bars.

The virus has now arrived in most countries. Its spread is well advanced in China, Iran, Italy and South Korea, but much less so in Singapore and Hong Kong, where the authorities got in earlier with their social distancing measures.

Such measures, however, cause considerable inconvenience, especially to parents, and disruption to the economy – both to the production of goods and, more particularly, services, and to their purchase and consumption. Not to mention the associated loss of income.

Some of this economic activity may merely be postponed – so that there’s a big catch-up once the epidemic subsides. But much of it – particularly the performance of services (if you miss a restaurant meal or a haircut you don’t catch up by having two) – will be lost forever.

Obviously, China is central to the story for both the world economy and ours. China’s economy was hit hard by the virus and the drastic but belated measures to slow its spread, though the number of cases does seem to have passed its peak and rapidly declined. Debelle said "the Chinese economy is now only gradually returning to normal. Even as this occurs, it is very uncertain how long it will take to repair the severe disruption to supply chains."

The globalisation of the world economy in recent decades is a major part of the story of this virus. It means people in any part of the world are almost instantly informed about unusual things happening anywhere else in the world. It’s good to be better informed, but sometimes it can be frightening.

For another thing, globalisation has greatly increased the trade between countries, particularly trade in services, such as tourism and education. Trade in services has been greatly facilitated by the emergence of cheap air travel.

It’s all the overseas air travel everyone does these days that has caused epidemics that break out in one part of the world to spread around the world within a few weeks. More pandemics has become one of the big downsides of globalisation.

And when governments try to limit the spread of a virus by banning the entry of people from countries where the virus is known to have spread widely, this disrupts and damages those of that country’s industries who sell their services to foreign visitors.

(When the government stops you supplying a service to willing buyers, economists classify this as a shock to the "supply side" of the economy. When your sales fall because customers become more reluctant to buy whatever you’re selling, that’s a "demand-side shock" to the economy.)

Our imposition of a ban on non-residents entering Australia from China has hit our tourism industry and our universities. Debelle said that, since January, inbound airline capacity from China has fallen by 90 per cent. Until recently, he said, tourist arrivals from other countries had held up reasonably well, "but that may no longer be true".

The Reserve estimates that Australia’s services exports will decline by at least 10 per cent in the March quarter, roughly evenly split between tourism and education. Since services exports account for 5 per cent of gross domestic product, this suggests the travel ban will subtract 0.5 percentage points from whatever growth comes from other parts of the economy during the quarter.

Another consequence of growing globalisation is the emergence of "global supply chains" – the practice of multinational companies manufacturing the components of their products in different countries, before assembling them in one developing country and exporting them around the world.

China is at the heart of the supply chains for many products. So Debelle’s remark about the delay in repairing "the severe disruption to supply chains" is ominous. The Reserve’s business contacts tell it supply chain disruptions are already affecting the construction and retail industries – but there’s sure to be more of this "supply-side shock" to come.

And the shock to demand as - whether through virus-avoidance, necessity or uncertainty - consumers avoid spending money, has a long way to run. But, Debelle said, it’s "just too uncertain to assess the impact of the virus beyond the March quarter".

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Trump's mad trade war has a hidden logic

Simple economics tells us Donald Trump’s stated reasons for starting a trade war with China make no sense. But more advanced economics tells us it’s no surprise he’s 'P’d off' over China’s economic rise.

Trump complains that the United States buys more from China than China buys from the US, meaning his country runs a trade deficit with China. He sees this as an obvious injustice and a sign China is cheating.

But economics teaches that bilateral trade imbalances are natural and normal, the inevitable consequence of countries’ differing “comparative advantage”. (Australia’s strength is rural and mineral commodities, for instance, whereas China’s is manufacturing.)

What matters is a country’s trade with all its trading partners. But, even here, economics teaches it’s not necessarily bad for a country to run an overall trade (or, strictly, current account) deficit.

Why not? Because a country runs a current account deficit when its investment in new homes, business equipment and public infrastructure exceeds its ability to fund this investment with its own saving by households, companies and governments, thus requiring it to call on the saving of foreigners.

Conversely, a country runs a current account surplus when it saves more each year than it needs to fund that year’s investment spending, thus allowing it to lend some of its saving to foreigners.

Because some countries (such as China, Germany) save more than their profitable investment opportunities can take up, they run current account surpluses most years.

On the other side of the coin are countries (the US, Australia) that have more profitable investment opportunities than their savings can cover, so they run current account deficits most years.

Put the two groups together and – at least in theory – the world’s annual saving flows to the most profitable investment opportunities to be found on the planet, thus leaving everyone in the world better off.

But a deputy secretary of the Department of Prime Minister and Cabinet, Dr David Gruen, noted in a recent speech that, at a more advanced level of analysis, some of the recent tension over trade is a consequence of the strong and sustained growth of Asian economies, including China.

“As economies in our region have grown and moved up the value-added chain, they have increasingly competed with more entrenched, influential and valuable industries in advanced countries [such as the US],” Gruen says.

When rapidly developing countries embrace some new technology, the consequent increase in their productivity constitutes an increase in their real income (because they’re producing more output per unit of input).

This should also help raise the income of the developed countries with which they trade, since the rich guys are usually getting access to imports that are cheaper than they can produce themselves.

“While some advanced-country industries [and their workers] have undoubtedly been harmed by a rising Asia-Pacific, a rising Asia-Pacific has also meant more demand for other goods and services from advanced countries [as the developing countries spend some of their higher income on imports from the rich world],” Gruen says.

So better technology and increased trade between the rich and poor countries don’t reduce the real incomes of the advanced countries, but they are likely to change the distribution of income.

More income is likely to flow to the owners of capital and to highly skilled workers, while some lower skilled workers’ real incomes stagnate or fall.

“Such disruption is likely to continue as technology makes it easier to trade services across borders, and economies in the Asia-Pacific become increasingly sophisticated. Some of these newly threatened advanced-economy jobs rely on intellectual property or skills premiums, providing an economic rent worth protecting.

“It is no surprise that the generally open-trade stance of those in places like Silicon Valley sits alongside [Trump’s] demand for strong enforcement of intellectual property rights,” Gruen says.

And, although the rich world is better off with free trade, as technology continues to bring down natural barriers to trade in sectors previously considered “non-tradeable” – particularly services – politically influential opposition to free and open trade is likely to continue, he says.

But there’s a second implication of the economic rise of Asia I bet you haven’t thought of. “It makes less sense for the largest economy in the world to bear the costs of maintaining an open trading system as its economy becomes a relatively smaller share of global output.

“Free trade is a 'public good' – we all benefit from it, but each country has an incentive to shift the cost of maintaining it to others.

“The United States shouldered that burden when it was the world’s largest economy. When you are half the global economy you tend to benefit wherever in the world trade is occurring.

“The logic of [it] continuing to do so is now less compelling. The rules-based [trading] system, including the World Trade Organisation, emerged at a time when the US was the dominant global superpower."

Small or medium-sized economies with limited bargaining power in global markets (such as us) are better off with free trade – even when other countries are being protectionist. Why? Because protecting a few of your industries against imports hurts the rest of your industries more than it hurts the countries whose imports you don’t take.

But that’s not always true for large economies with significant market power, such as the US. They can sometimes use tariffs to drive down the prices other countries charge them for imports.

How? Their market is so lucrative the country supplying the imports absorbs some of the cost of the tariff to keep its retail prices competitive. The lower price of imports across the docks improves the big country’s terms of trade, increasing its real income.

Get it? The US has less to lose from an outbreak of protectionism than do smaller countries like us. That’s why the rest of us have to put more effort into preserving and abiding by the WTO’s “rules-based system” and Trump isn’t quite the madman he seems.

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Little right, much wrong with Trumponomics

For years I've wondered how America's business elite could grab almost all the proceeds of the country's growth, leaving real wages permanently stagnant, without having ordinary workers rioting in the streets.

Now I know. The anger kept building until a political huckster called Trump found the way to exploit it for personal advancement.

The bitter joke is that the populist promises he made to keep out Muslims, Mexicans and Chinese imports would do little to make the mug punters better off, whereas many of his more conventional economic policies will do much to further fatten the pockets of the 1 per cent the punters so resent.

While we wait to see which promises he acts on, the best guess is he'll implement those of his policies that fit with Republican orthodoxy.

After all, he'll be relying on the usual Republican suspects to make up his cabinet and relying on Republican majorities in Congress to put his policies into law.

This suggests he'll be quick to start phasing corporation tax down from 35 per cent to 15 per cent, and lowering all rates of personal income tax (though not necessarily in a way that favours low and middle earners).

He's likely to increase defence spending and maybe even keep his promise to fund a much-needed urban infrastructure renewal program.

But surely this would cause a huge expansion of the still-excessive federal budget deficit, wouldn't it?

Yes, but that's unlikely to stop it happening. It is, after all, similar to what Ronald Reagan did on coming to office in 1981.

We're about to see confirmation of an eternal truth of American politics: the Republicans care hugely about the evils of debt and deficit – it keeps them awake worrying about what we're leaving for our children and grandchildren – but only when there's a Democrat in the White House.

For the most part it will be a giant exercise in trickle-down economics – even though many of the people who fell for Trump's crude charms now rightly see it for the voodoo economics it mainly is.

Protectionism may be the new saviour – in Nick Xenophon's Oz as well as Trump's Rust Belt states – but it's still the delusion it always was. It seems "only common sense", but that doesn't mean it works.

In any case, were Trump to impose a huge tariff on Chinese imports, do you imagine that would re-open the ghostly steel mills in Gary, Indiana, or the rusting automobile plants down the road from Michael Moore's place in Flint, Michigan?

Turning back globalisation is no easier than turning back time. The main thing you'd do is rob working people (and the rest of us) of access to the one aspect of globalisation they've clearly benefited from: imported goods much cheaper than the locally made goods they replaced.

Don't kid yourself: some lost their jobs in factories, but all workers – most of whom never worked in manufacturing – benefited from lower prices.

That's why there's no free lunch in protection: it's a scheme where the fortunate few are subsidised by the less-favoured multitude. It's not foreigners who lose out, it's other locals.

And don't kid yourself on this: far from all the jobs lost from manufacturing were lost through import competition.

Far more than many oldies realise were lost through computerisation. That's a big part of the reason reimposing high tariffs would do surprisingly little to restore manufacturing employment.

It's a convenient delusion that globalisation is solely the product of "neo-liberal" deregulation. Its other, bigger driver is technological advance and the digital revolution. Think any pollie can stop that?

This isn't to say scuttling the Trans-Pacific Partnership free-trade agreement would be any loss. It offered trivial benefits to us, in return for giving foreign multinationals power to push our government around.

Just because preferential trade deals are called "free-trade agreements" doesn't make them a good thing. The US's primary goal in its many agreements is to advance the interests of its exporters of intellectual property, while continuing to protect its farmers.

Its trans-Pacific deal was intended as cover for the bilateral deal with Japan hidden within it, as well as strengthening America's trading links with all the main Asian economies that weren't China.

The Yanks may be paranoid about the rise of China, but the joke is there never were two big economies – the two biggest – more interdependent. The US is China's largest trading partner, while China is the US's second-biggest – and its biggest creditor.

The Yanks are really stoopid​ enough to take a crack at Chinese imports? Trump is a cunning con man, not an idiot.

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Banning new coal mines wouldn't cost the earth

If you want to shock and appal a politician, just suggest Australia join the United States and China in limiting the building of new coal mines.

Think of all the growth we'd be giving up, they protest. All the jobs that wouldn't be created. Some even argue we have a moral duty to sell more coal to the world. How else will the poor countries be able to develop their economies so they become as rich as we are?

Short answer: by relying more on other, less carbon-emitting forms of energy.

Surely the sooner we arrest global warming the better off we'll all be, rich and poor.

The goal of the moratorium on new mines is to hasten the process of decarbonising economic activity.

It's clear the world's growing commitment to action against climate change will see a decline in the demand for coal - the most emissions-intensive way to make electricity - so that much of our huge deposits of coal will stay in the ground.

It's true there's a lot more coal to be burnt before world demand dries up, but total consumption actually fell in 2014-15. Within that, China's consumption fell by 3.7 per cent.

The big fall in coal prices in recent years tells us the supply of coal now exceeds demand. With Australia accounting for 27 per cent of seaborne trade in coal, what happens if we expand our production capacity and start exporting more?

We push the world price down even further. Since the average cost of electricity from renewable sources is, as yet, higher than for coal-based power, this would worsen the comparison further, slowing the shift away from fossil-based electricity.

It would also lower the prices being received by our existing coal exporters, threatening employment in their mines. So a moratorium would benefit our pockets as well as the environment.

But how much would we lose by not building any more coal mines nor extending existing ones?

The Australia Institute set out to answer this question with help from modelling by Professor Philip Adams, of the Centre of Policy Studies at Victoria University, Melbourne.

The study found that, even with a ban on new mines, Australia's coal production would decline only gradually as existing mines reached the end of their economic lives. Existing mines and those already approved could still produce tens of millions of tonnes of coal into the 2040s, assuming other countries still wanted to buy them.

The modelling suggests the nation's economic growth would be barely affected, with the level of gross domestic product being just 0.6 per cent less than otherwise by 2040. Whether we did or we didn't, nominal GDP would roughly have doubled to $3 trillion by then.

Because coal mining is so capital intensive, the effect on national employment would be even smaller. By 2030, the level of employment would be 0.04 per cent lower than otherwise, but by 2040 this difference would have gone away.

Similarly, the value of our total exports of goods and services is projected to be only 1 per cent lower than otherwise by the final years of the period.

But our coal production is concentrated in NSW and Queensland, so the adverse effect on those state economies would be greater. By 2040, the level of gross state product would be, respectively, 1.3 per cent and 3.8 per cent less than otherwise, while the other states' GSP would be a little higher than otherwise.

Now, I trust that by now you've learnt to be cautious about accepting the results of modelling exercises, especially when they've been sponsored by outfits using the results to advance their cause, as is the case here.

The simple truth is that no-one knows what the future holds, and that's just as true for the econometric models economists construct.

Their models of the economy are more comprehensive and logically consistent than the model we hold in our heads. But relative to the intricacy and complexity of the actual economy, models are still quite primitive (this one doesn't have the official data to let it distinguish between steaming coal and coking coal, for instance).

Models are built on a host of assumptions, some based on economic theories about how the economy works and some about what will happen in the future.

The strength of this particular modelling exercise is that it's a lot franker about the model's limitations and about the specific assumptions.

It uses a dynamic "computable general equilibrium" model designed to capture the interrelationships between 79 industries, divided into states and regions.

The model takes account of "resource constraints" - it acknowledges that land, labour and capital are scarce; that everything you do has an opportunity cost.

This means that, unlike much "modelling" produced for the mining lobby, it doesn't assume that the skilled workers needed for a new mine just appear from nowhere rather than having to be attracted from jobs elsewhere, nor that when a new mine isn't built, all the labour and materials that could have been used sit around idle.

As is normal, the modelling starts by establishing a business-as-usual "baseline" projection out to 2040. For instance, real GDP is assumed to grow at an average annual rate of 3 per cent for the first five years, then 2.6 per cent for the remaining 20 years.

Once this baseline or "reference case" is established, the modellers impose the policy change (no new coal mines) and run the model again to see how this changes the baseline results.

That is, it's not a forecast, just an attempt to get an idea of the consequences of banning new coal mines.

The model's modest results make sense. The effects would be small because the coal industry is just a small part of the economy, because the phase-out would be gradual, and because other industries would expand to fill the vacuum it left.

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Big change ahead for China and our export challenge

You don't need me to tell you we lucked out when we sited our island continent not too far from China. But will our luck hold?

Or, more pointedly, what do we have to do to ensure we stay lucky?

A major report, released this week, Partnership for Change, seeks to answer that question. It was prepared jointly by Professor Peter Drysdale, of the East Asian Bureau of Economic Research at the Australian National University, and Zhang Xiaoqiang, of the China Centre for International Economic Exchanges, with strong support from both governments.

Actually, our location on the edge of Asia is only half our good luck. The other half was discovering our island is rich in high quality, easily-won minerals and energy.

As a result, our economy has proved a fabulous fit with the re-emerging China. As the report explains, "Australia and China are deeply complementary trading partners".

Our "comparative advantage" is opposite to China's. A country has a comparative advantage in producing a particular item if it can do so at lower opportunity cost than other countries face.

"Australia has a large natural resource base relative to its population [so it] therefore specialises in the production of primary goods for export, and uses the proceeds to purchase labour-intensive and other manufactured goods," the report says.

"Conversely, China has a large labour supply, but relative to its population has smaller endowments of natural resources and accumulated capital. For this reason, China's industrial development was built on labour-intensive production, which it exchanges with Australia for imports of scarce resources."

And what a successful partnership it's been. In the space of not much more than a decade, China has become our biggest trading partner. It takes about 35 per cent of our exports of goods and services, and supplies almost 20 per cent of our imports of goods and services.

China is so big - its population is 56 times ours - and has been so successful in pursuing this growth strategy it's now the second biggest economy in the world (the biggest, if you allow for differences in purchasing power), the biggest trading nation and the world's biggest producer of manufactured goods.

But nothing stays the same. The resources boom that saw our trade with China grow so dramatically has reached its final stage. Prices for coal and iron ore have now fallen back.

The period of massive investment in new mines and natural gas facilities is ending, with construction spending falling sharply. The last stage is big growth in the quantity of our mining exports, with large increases in natural gas exports (mainly to China) still to come.

The boom was ended by big increases in the supply of commodities (from our competitors as well as us), but also by a slowing in China's demand as its need for more steel peaked.

So, after a period of huge expansion in our mining sector, our economy is making the adjustment back to normal, where most growth in production and employment comes from the ever-expanding services sector.

This is happening, with a few bumps. But, as part of its progress to full economic development, China is going through a much more dramatic "transition".

The report says China is "shifting its growth drivers from investment, exports and heavy industry to consumption, innovation and services".

"Chinese production is shifting from a model based on adaptation and imitation of goods, services and technologies developed elsewhere, to a model based on domestic innovation", it continues.

Part of this involves a shift from labour-intensive, low-tech, low-value manufacturing to more advanced, high-tech, high-value manufacturing.

This has already started.  Over the 20 years to 2015, low-tech manufacturing's share of China's total exports of goods has shrunk from almost half to less than 30 per cent.

So the big question is whether, now China is changing direction, it will still be the gold mine it's been for us so far.

China will still need to import a lot of our natural resources, even if its demand for those resources won't be growing as fast.

The report notes that, with prices so far down, our share of China's import market has increased markedly. Huh? It's because, compared with our competitors (including local Chinese mines), we're such an efficient, low-cost producer.

The report has modelled three scenarios for our trade with China over the next 10 years. Drysdale stresses the results aren't exact, but give us an idea.

The "baseline" scenario, where existing trends continue without much change, would see our exports to China grow by 72 per cent, while China's exports to us grew by 41 per cent. (All these figures are in real terms.)

The pessimistic scenario sees China's annual growth falling below 5 per cent during the decade. Even so, our exports to China would grow by 28 per cent, while their exports to us grew by 20 per cent.

The optimistic scenario, however, would see our exports to China grow by 120 per cent, while their exports to us grew by 44 per cent.

And the catch? Both countries would need to engage in supply-side (production) reforms to make it happen.

For China, this would involve reforming its banks and financial system, reforming its state-owned enterprises, and liberalising the capital account of its balance of payments by lifting restrictions on money flows and allowing a freer-floating exchange rate.

For us, it would involve increasing competition in sheltered industries, openness to foreign investment and skills, and facilitating investment in social and physical infrastructure.

These are what we'd have to do to make real our dream of getting our share of all the extra demand for fancy food and services coming from China's by-then massive middle class.

Here we'd be battling against a different and much bigger range of competitors than we face in the commodities market. You wonder if our spoilt business people are up to it.

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Fast-moving China is big and bold; we think small and fearful

Sorry if I sound wide-eyed, but I was mightily impressed when I visited China as a guest of the Australia-China Relations Institute. Obviously, we were directed to the best rather than the worst but, even allowing for that, it was still impressive. Those guys are going places.

In a hurry. I was struck by how fast-moving the place is – in several senses. We argue interminably about getting a high-speed rail link, while the Chinese just get on with it.

We took the bullet train from Beijing to its nearest port, Tianjin, 140 kilometres away. So smooth you didn't really notice how fast it was going.

The government-run China Daily announced while we were there the plan to have 30,000 kilometres of high-speed track built by 2020. You could be sceptical – except they already have 19,000 kilometres installed.

Tianjin, admittedly a city of 11 million, has the newest, fanciest, most cavernous cultural centre and municipal buildings I've seen. I tried not to wonder how much it all cost and where the money had come from.

So many of us have outdated perceptions about China. It's a poor country producing cheap clothes and toys and knick-knacks in sweat shops.

That used to be true, and in parts of the country still is. But these days China is a middle-income country anxious to get rich gloriously.

In the Tianjin free trade zone is a factory for the European-owned Airbus. All the jetliners it produces are sold in China.

Of course, we tell ourselves, any technology they use has come from foreigners, sometimes without proper recompense.

Don't be so sure. We visited Shenzhen which, until 36 years ago, was a fishing village just across the water from Hong Kong, before someone made it a special economic zone.

I remember visiting it in January 1984 on a tourists' day-trip from Hong Kong. It was a dusty country town with a big new hotel for foreign visitors and a few factories, plus stalls selling stuff to tourists. I bought a Chairman Mao cap with a red metal star.

Today it's a city of 10 million, with income per person of about $29,000 a year. It has maintained 45 per cent of its area as parks and forest by the simple expedient of having housing go up rather than out.

It still has some low-end manufacturers, but they're being encouraged to move inland or to some south-east Asian country, such as Vietnam.

Land and wages in Shenzhen are too expensive for low-value production. Last year in China consumer prices rose by 2 per cent, while the average wage rose by 8 per cent.

So manufacturing in Shenzhen is moving to the high-tech end and the services sector now accounts for 60 per cent of its economy.

Its businesses put huge sums into research and development. In 2014 R&D spending accounted for 4 per cent of Shenzhen's gross domestic product. In Oz it's about half that.

BYD – standing for Build Your Dreams – is a private company founded in the city in 1995. It started out making batteries for mobile phones, but is now well advanced with the research and development needed to fulfil its "three green dreams" of making solar farms, travelling renewable energy storage stations, and electric vehicles.

It still makes and sells conventional cars, but is more interested in its range of hybrid and pure electric cars and buses. It's best known in Australia for its electric forklifts.

Many Chinese cities seek to reduce pollution by capping the number of new cars they'll register each year. Buy a hybrid or electric car, however, and you avoid the lottery.

Buy an electric SUV and the government gives you a subsidy of about $27,000, reducing the price of BYD's model to $47,000. The subsidy will be phased out as the company gains economies of scale.

Before moving to Shenzhen, BGI began life in 1999 as the Beijing Genomics Institute. It's now one of the world's largest genomic institutes, using gene sequencing to develop antenatal tests for genetic abnormalities and to detect diseases earlier.

In agriculture it's using genetic assisted breeding (not genetic modification) to develop better strains of fish and millet – a grain widely consumed in China.

It has more than 800 scientists working for it, and a wall showing the many covers of the journals Science and Nature celebrating its notable discoveries.

Huawei was founded in Shenzhen in 1987 by Ren Zhengfei, a former engineer in the People's Liberation Army. It started as a manufacturer of office PABX phone systems, but is now the largest telecommunications equipment manufacturer in the world.

It ploughs a minimum of 10 per cent of its revenue back into research and development, spending about $12 billion last year. The company is staff owned, with Ren's share down to 1.4 per cent.

It has installed Australia's largest private 4G communications network for Santos' mining operations.

In China it helped the Shenhua coal company raise the capacity of its Shuo Huang railway to 200 million tonnes a year. Its 4G system permitting synchronous control of multiple locos allows single train lengths up to 3000 metres long, carrying up to 20,000 tonnes.

China is big; we think of ourselves as small. China is confident, impatiently pushing towards a better future; we are fearful, waiting for more luck to turn up.

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China plans big expansion of trade - without us

You've heard of belt and braces. You may even have heard of one country, two systems. But have you heard of One Belt, One Road? No, I thought not. Rest assured, you will.

It's a topic much discussed in business and economic circles in China, as I learnt on a visit there sponsored by the Australia-China Relations Institute at the University of Technology, Sydney.

It's a plan for the establishment of a new Silk Road between Europe and China, to increase trade and cultural exchange between all the countries along the route.

It's an initiative of the Chinese government, first announced by President Xi Jinping​ in 2013, and much elaborated since then.

The belt refers a land-based Silk Road Economic Belt running through China to Central Asia to Russia and Europe.

The road refers to a sea-based Maritime Silk Road taking in the countries of south-east Asia and running through the Indian Ocean to the countries of South Asia, then through the Suez Canal to the Mediterranean.

To keep muddling metaphors, the maritime "road" may even have a spur line to Africa. In principle, more than 60 countries could be involved.

It may sound like a politicians' grand vision that won't get far. That's certainly the way some American critics have reacted to it. There could be much suspicion, resentment and resistance to China's expansion plans from countries and their citizens, they say.

But while pollies talk big in Western countries, in China they tend to act big. Making the initiative a reality would involve much spending on infrastructure such as sea ports, airports, railways, highways, oil and gas pipelines, power stations and special economic zones.

China has much to gain from all this, of course. Its existing development activity in certain African countries suggests it would supply much of the materials and labour for infrastructure projects.

Should the oft-predicted economic "hard landing" eventuate and lead to rapidly rising unemployment at home, its desire to get on with foreign construction projects might be heightened.

Establishing a new Silk Road means China, already the world's largest trading nation, would greatly expand its export opportunities.

But trade between a willing buyer and willing seller is mutually beneficial. And increased trade could do much to hasten the economic development of the "stans" of Central Asia - such as Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan.

Already there is much interest and activity in Pakistan.

Geoff Raby, a former Australian ambassador to China, has observed that the initiative is "of great strategic significance for Beijing, as it is also intended to reduce China's major strategic vulnerability caused by so much of its seaborne trade, especially crude oil, having to go through the Strait of Malacca".

As an aside, this vulnerability also helps explain China's sensitivity over the South China Sea.

Full implementation of the initiative could take decades, of course. But a solid start has already been made. For instance, a freight rail link between the south-western China province of Sichuan (the one with the spicy food) and Lodz in Poland is now running three trains a week.

This fits also with the Chinese government's earlier - and continuing - Go West campaign to move economic activity - particularly labour-intensive manufacturing - inland from the richer coastal provinces, where labour is getting ever-more expensive.

But have you noticed something? The many countries that could get involved with the initiative include Indonesia, but not us.

At least, not directly. There is scope, however, for Australian banks and other financial institutions help facilitate the funding of infrastructure projects.

Much of the construction of projects will be done by big Chinese state-owned enterprises. We could, of course, sit back and hope this leads to restored demand for our coal and iron ore.

But the SOEs will often need to partner with foreign firms able to provide the specialist expertise they lack in in such things as engineering and major construction.

Many Australian companies are well-equipped to supply such consulting services, but to-date our firms have shown limited appetite for the higher risks involved in developing country projects.

Much safer to limit your innovation and agility to pressing the government for "reforms" that cut the tax you pay or allow you to drive harder bargains with your employees.

But not to worry. There are Japanese and South Korean firms who'll be happy to eat the Chinese lunch we don't fancy.

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China does its own thing in its own way

On the prospects for China's economy, it's easy to be wrong. We analyse unfamiliar things by comparing them with things we understand, but in its massive size and economic history, China is one of a kind.

That's one conclusion I've drawn from a visit to China as a guest of the Australia-China Relations Institute, at the University of Technology, Sydney, and the All-China Journalists Association.

In recent years people in the world's financial markets have gone from ignoring the Chinese economy to assuming it works the same way a developed economy does.

Hence the consternation in global share markets last year and again early this year when China's share market took a sharp dive. Surely this meant its economy was in big trouble.

Well, maybe, but not for that reason. China is still a developing, middle-income economy and its share market is a relatively recent creation of its government, lacking the strong links with the real economy we're used to in the West.

As Professor Peter Drysdale, of the East Asian Bureau of Economic Research at the Australian National University, has explained, the worth of China's share market is equivalent to about a third of its gross domestic product, compared with more than 100 per cent in developed economies.

It accounts for less than 15 per cent of the financial assets of China's households, which is why formerly booming share prices did little to boost consumer spending and why falling prices will do little to hurt consumption, he says.

The market is dominated by individual investors rather than financial institutions, as in the rich world, and Chinese companies don't rely on it for capital-raising.

Much of the angst in the West over China's slowing rate of growth – from 10 per cent a year for many years to 6.7 per cent over the year to June – reveals an ignorance of how developing countries develop.

Provided they're well managed, it's easy for underdeveloped economies to grow rapidly as workers move from the farm to a city factory and as existing Western technology is taken off the shelf and applied.

But as the economy expands it becomes harder and then impossible to maintain such high rates of expansion.

China's less dramatic growth rate of six point something is now "the new normal", as its government says. Further slowing is possible in the next few years.

We in the developed world – where growth rarely gets much higher than 2 or 3 per cent a year – are so unfamiliar with such rapid growth rates that we forget the basic arithmetic involved.

At a constant growth rate of 10 per cent, an economy doubles in about seven years. At a constant rate of 6.7 per cent, it doubles in about 10.

Consider this: China's growth in 2005 of 11.3 per cent added $US338 billion to its size, whereas growth of 7.4 per cent in 2014 added $US708 billion. It's the absolute size of China's growth – its addition to gross world product – that matters most to the rest of the world.

Another trap for foreign observers is to assume China has a market economy like ours, or that the Chinese government is busy turning its economy into a market economy.

That's easy to believe when you're told that, in 2014, China's private sector produced at least two-thirds of its GDP, with the private sector creating more than 90 per cent of the additional jobs and with the public sector accounting for just 11 per cent of China's workforce (compared with 14 per cent in Oz).

But China's economy is still far from being a market economy like ours, and it's not clear the Chinese government wants to make it one.

Remember China's history. In the 1950s, following the Communist revolution of 1949, private property was expropriated and a planned economy established.

All that began changing after 1979, when Deng Xiaoping initiated the far-reaching market-oriented reforms that have brought China's economy to where it is today.

China's many remaining state-owned enterprises may not be as dynamic and fast-growing as its private sector, but they remain an important part of the economy. Indeed, they're a drag on the economy, often badly run with problems of overcapacity and overproduction.

Many foreign economists are urging China to simply close or privatise its remaining SOEs. And it's true that reforming them would be an important part of raising China's productivity performance.

But it's not clear this is the intention of China's President (and general secretary of the Communist Party), Xi Jinping. Some degree of reform may come, but it may involve adopting market mechanisms where thought appropriate rather than eliminating the government-owned business sector.

Making China's economy the same as any Western developed economy is unlikely to be Xi's objective, even if the pressure of events causes it to continue drifting in that direction.

China remains a one-party state, and the objective of that party is to remain in power. That may mean reforming rather than eliminating SOEs, which are run by party officials.

Within the Chinese government, power is shared between the central, provincial and municipal governments, all of them run by party officials. Beijing's power is constrained.

Xi is unlikely to initiate any big changes before the Communist Party's 19th national congress late next year, when he will be able to increase his grip on power.

Economic reform and year-to-year economic management is guided by the 13th five-year plan. Growth in GDP is not just a measure of economic success, it's a political target.

Most Westerners believe continuing economic development and rising living standards lead inevitably to democratic governance, and the cases of Taiwan and South Korea add support to this idea.

But whether that applies to China remains to be seen. Certainly, it's a long way off. The safest prediction is that China will do its own thing in its own way.

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China still our advantage in a dismal world

We are living in an era of exceptionally weak growth in the world economy. We can now look back and see that era began after the global financial crisis in 2008. We can look forward and not see when the era will end. It could be years, for all we know.

Naturally, this continuing global weakness has its effect on us. So we shouldn't blame ourselves for our own weaker growth relative to our earlier performance. Rather, we should recognise that, relative to the other developed economies, we've been doing pretty well.

But we do need to remember that, compared with the others, we have a secret weapon: our strong economic links with China.

Nigel Ray, a deputy secretary of Treasury, spelt out the unusual features of the world we've entered in a speech this week. He notes that "global growth has struggled to regain sustained momentum post-global financial crisis, and global aggregate demand remains weak".

This is despite monetary policy (interest rate) settings in nearly all the major economies remaining "extraordinarily accommodative", and global public debt increasing since the crisis.

Official forecasters have continued to downgrade prospects for global growth, he says. The International Monetary Fund downgraded its forecast in its January update - the 17th downgrade in five years.

Now get this. Slower world growth has been accompanied by a number of trends that can be seen across the global economy: slower growth in international trade, weak business investment, slower productivity growth, slower population growth in the advanced economies, low inflation, and lower expectations about future inflation.

Wow. That's the sort of poor performance you expect to see briefly at the bottom of a world recession, not as a semi-permanent state.

We knew that slower growth in the working-age population as a result of population ageing would mean slower economic growth, but now official forecasters in other countries are also reconsidering their view of long-run "potential" growth in gross domestic product (just as we've done recently, cutting it from 3 per cent to 2.75 per cent).

For the other countries, "this partly reflects the ongoing legacy of the global financial crisis - such crises have long-lived effects on investment in productive capital and on labour markets, increasing structural unemployment and lowering labour force participation rates".

In other words, if business goes for some years under-investing in new and improved capital equipment, this diminishes the economy's production capacity. And when some workers go for years unable to find another job, they tend to lose their skills and the self-discipline that goes with having to turn up to work on time every day and do as you're told.

But it's not only the after effects of a protracted recession. Ray says recent estimates by IMF economists suggest that productivity growth was slowing in the advanced economies even before the GFC.

More recently, we've noticed that the "convergence" between the emerging and the advanced economies (as the emerging economies catch up by growing at a much faster rate than the advanced countries) that we've seen since the turn of the century is showing signs of stalling.

If that happens, it means slower global economic growth and could have other undesirable consequences.

It happened that Reserve Bank deputy governor Dr Philip Lowe gave a speech in Adelaide on the same day, adding to Ray's description of the strange state the world economy finds itself in.

Lowe noted that, although the official interest rate in the United States has been increased for the first time in nine years, the Bank of Japan has unexpectedly moved its rate into negative territory.

In doing so it joined the European Central Bank, the Swiss National Bank, the Swedish Riksbank and the Danish central bank with negative interest rates. And there's an expectation in various countries that yet further monetary easing will take place.

Lowe says that, in earlier decades, it was very rare for central banks to worry that inflation and inflation expectations were too low.

"Yet today we hear this concern quite often, and the 'unconventional' has almost become the conventional," he says.

But back to China and the special advantage it gives us in a dismal world. Ray says we have a higher proportion of our exports - about 32 per cent of our exports of goods - going to China than any other advanced economy does.

Twenty years ago, China's economy was less than a third of the size of America's. Today it's the largest economy in the world when you measure it according to "purchasing power parity" (as you should).

China's rate of growth may be slowing, but it remains one of the fastest growing economies in the world.

What many foreign observers don't seem to understand is that, just as we are "rebalancing" our economy from mining-driven to other sources of growth, so the Chinese are doing something similar, shifting from growth based on heavy industry, investment and exports, to growth based on service industries, consumer spending and imports.

It's possible the Chinese economy could falter as it makes this transition, but they'll get there in the end and this is why it's possible for us to shift from selling them mainly minerals to selling them the goods (fancy Western foodstuffs) and, particularly, the services their growing middle class demands.

We've been talking about this for years, but now it's actually happening. Ray says China is already our largest destination for services exports, taking about 14 per cent of them last financial year.

China is now our second largest source of overseas visitors, and their visitors spend far more than average. More than a million Chinese tourists arrived in 2015.

But get this: those million visits represented only about 1 per cent of China's overseas tourism market. They are so big relative to us that just a tiny share of their market is a big deal in helping us keep growing.

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Don't imagine China's troubles to be bigger than they are

Is the Chinese economy slowing down or melting down? You don't have to go far to find someone purporting to know a lot more about China than you do, who's making the most apocalyptic predictions.

And who knows? Maybe one day they'll be right. But I'll wait for it to happen before I start worrying.

By the same token, to say China is "slowing" seems a bit euphemistic. Being a developing country you can't say it's in recession the way you might say it of an advanced economy, because developing economies rarely experience an actual contraction in real gross domestic product.

At their worst they just grow at rates that, by their standards, are pretty bad, but by ours we'd be very pleased to have. In that sense it seems likely China is in or entering its own version of a recession.

Its rate of growth has been slowing for more than a year, it probably has more slowing to do, and with a bit of bad luck it could slow a lot more. At worst we're talking about growth in GDP slowing to maybe 4 per cent a year.

The biggest problem – as the doomsayers have long been saying – is the "overhang" from China's long-running real estate boom, in which far more apartments were built than there were people wanting to buy them.

Now housing construction has come to a halt in various parts of China, and it won't resume until the existing stock of empty homes is finally sold off. That could take at least a year, probably two. So the economy won't start to pick up anytime soon.

Limited housing construction means weak or declining growth in the manufacture of housing materials such as crude steel, cement and plate glass.

That's not the whole story, but it does mean the weakness is concentrated in construction and manufacturing, which just happen to be the main components of "industrial production" – an economic indicator the world's financial markets pay great attention to, not least because it's published monthly.

Trouble is, industrial production ain't easy to measure. It's particularly hard to do in developing countries, which don't have the bureaucratic infrastructure we have and where the shape of the economy keeps changing, not to mention the extra problems in measuring it monthly rather than quarterly.

This has prompted some in the markets to suspect a conspiracy rather than a stuff-up, and allege the Chinese authorities are making the numbers up. They may not be as reliable as we'd like, but don't believe that.

Another thing to remember – as people in the market tend to forget – is that industrial production accounts for only about 45 per cent of Chinese GDP. The remaining 55 per cent is in a lot better shape, as a Reserve Bank assistant governor, Dr Christopher Kent, argued in a speech this week.

By the way, if you're looking for someone to trust on China you could do worse than our central bank. It's well aware of the importance of China to our international prospects and so puts a lot more personpower than most into studying it: six or seven economists in Sydney, plus another two attached to our embassy in Beijing.

Kent says that although the weakness in China's property and manufacturing sectors is clearly of concern to commodity exporters like Australia, there are a number of countervailing forces supporting broader activity in China.

"First, growth in the services sector [worth about 45 per cent of GDP] has been resilient, and should continue to be assisted by a shift in demand towards services as incomes rise," he says.

"Second, growth in household consumption has also been stable in recent quarters, aided by the growth in new jobs. Of course, such outcomes cannot be taken for granted; if the industrial weakness is sustained, it might eventually affect household incomes and spending.

"Third, Chinese policymakers have responded to lower growth by easing monetary policy [access to loans] and approving additional infrastructure investment projects.

"They have scope to provide further support if needed, although they may be reticent to do too much if that compromises longer-term goals, such as placing the financial system on a more sustainable footing."

So what does this mean for us? The substantial slowing in industrial production has contributed to the further decline this year in the prices we get for our exports of coal and iron ore. (Of course, the bigger reason for the lower prices we're getting is the substantial increase in the supply of these commodities from places such as Australia.)

Kent says that what transpires with China's industrial production, and in Asia more broadly, will have a big influence on how much further commodity prices fall.

And the changing nature of China's development – a higher proportion of services and lower proportion of goods – limits the potential for commodity prices to go back up.

But here's the good news: Kent reminds us that the shift in demand towards services and Western agricultural products in China and Asia more broadly presents new opportunities for Australian exporters.

As recently as the mid-noughties, China's GDP was growing at the rate of 10 per cent. This is why money-market types are shocked to hear it's now growing by only 6.5 per cent, let alone 4 per cent.

But this just shows that even money-market types can be innumerate. As the distinguished former economic journalist Anatole Kaletsky has reminded us, China's GDP today is $US10.3 trillion ($14.5 trillion).

In 2005 it was $US2.3 trillion. So even just 4 per cent of $US10.3 billion is much more than 10 per cent of $US2.3 trillion.

To the Chinese, what matters most is the rate at which GDP is growing. To the rest of us, however, what matters is the size of the absolute addition the Chinese are contributing to gross world product.

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Moratorium on new coal mines makes economic sense

What are we meant to do about coal? For some time now it's looked like Australians face a painful choice between doing the right, moral thing by the rest of the world and continuing to make a living from our rich endowment of natural resources.

The burning of coal is by far the biggest source of the greenhouse gas emissions that are causing climate change. Australia is one of the world's biggest producers of coal.

Greenies have been arguing for years that, although it's too much to ask that we just stop exporting the stuff, we should at least get in no deeper by ceasing to build any new mines or expand existing mines.

In August, Anote Tong, President of the Republic of Kiribati, called for an international moratorium on new coal mines as a way of underpinning the efforts to get increased commitment to reduce emissions at the Paris summit in December.

Not surprisingly, Tong's call for a moratorium has been supported by 11 other Pacific island nations worried about rising sea levels. But he's also winning support from such influential figures as the Nobel Prize-winning scientist Peter Doherty and the British economist Lord Nicholas Stern.

For such an international moratorium to be effective, we'd have to be part of it. At present, we have 52 proposals to build new coals mines or expand existing ones.

But isn't it too much to ask us to leave all that black gold in the ground? Mining and exporting coal is an important way this economy makes its living.

The developing countries – including China and India – have a lot more developing to do, meaning they'll need a lot more energy, much of which will be coal. What's so bad about them trying to get rich like us? And why shouldn't it be we who supply that coal?

We need more jobs, and think of all the jobs building more big mines would create.

So what's it to be? Conscience or self-interest? Well, how about both?

The Australia Institute think-tank has begun campaigning hard for a moratorium, and a forthcoming paper by its chief economist, Richard Denniss, argues that economic and political considerations actually say we should be joining the moratorium.

Why? In a nutshell, because coal's days are numbered. The rapidly falling price of renewable energy such as wind and solar, combined with the growing resolve of China, the US and others to reduce their emissions, put a dark cloud over the future of coal.

Coal mines are intended to have lives of 50 to 90 years. Will coal prices be high enough in 30 or 40 years to make continued production profitable? If not, investors in new coal mines won't get their money back, but will be lumbered with "stranded assets" – assets that no longer earn much of a return.

Denniss says it's now widely accepted by international agencies that meeting the goal of limiting global warming to 2 degrees requires keeping most fossil fuels unburnt and in the ground.

All this helps explain why the world's big banks, including our own, have become markedly less enthusiastic about financing new coal mines. That – plus the present flat state of the world coal market.

According to the BP company's energy outlook, global coal consumption grew by just 0.4 per cent last year, well below its 10-year average growth rate of 2.9 per cent.

Within that, China's consumption grew by just 0.1 per cent. And Professor Ross Garnaut, of the University of Melbourne, is predicting a significant decline in China's demand for coal for the foreseeable future.

Were we to build all our proposed new mines, we'd double our annual exports. According to Denniss, just proceeding with the five biggest projects in Queensland's Galilee Basin would increase the world's seaborne coal trade by 18 per cent.

What do you reckon that would do to world coal prices at a time when coal demand is weak?

See the point? In such circumstances, preventing further coal development – including by governments declining to subsidise new mine railways and ports – wouldn't just reduce future greenhouse gas emissions.

By avoiding causing further decline in coal prices, it would also benefit the owners of existing mines, the banks that have lent to them and those who work for them, as well as the owners of present and future renewable energy projects. Not to mention the governments dependent on revenue from price-based mining royalties and company tax collections.

On its face, by causing coal prices to be higher than otherwise, it would harm the users of coal and coal-fired electricity. But when you remember that, without something like a carbon tax, the price of coal fails to include the cost to the community of the environmental damage that coal-burning does (including the death and ill health caused by the particulate air pollution from power stations), that's not anything to feel bad about.

But what about all the jobs that building new mines would have created? They're temporary and often exaggerated by the projects' proponents. Once they're built, open-cut coal mines employ surprisingly few workers.

The construction workers not employed to build more mines than are good for us could be better employed building more useful infrastructure.

When you think it through, the case for a moratorium on new coal mines has a lot going for it.

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Resources boom not done yet

If you think the resources boom is all over bar the shouting, someone who ought to know begs to differ. He thinks the last phase of the boom is just getting started. But even he thinks the boom leaves us with stuff to worry about.

In a speech this week, Mark Cully, the chief economist of the federal Department of Industry and Science, says the resources boom actually consisted of three booms.

The price boom lasted for about eight years and peaked in 2011. The overlapping investment boom lasted for about six years, with $400 billion worth of resources projects. Overall, business investment spending peaked in the last quarter of 2012 at an astonishing 19 per cent of gross domestic product.

By now we're in the early stages of the production boom, making the whole thing more of a "super-cycle" than a common or garden boom.

We're well aware that resource prices are still falling from their 2011 peak and that mining investment spending is rapidly coming to an end. But, according to Cully, the production boom is set to last far longer than the others did.

As always, it's a story of global prices being determined by the interaction of global demand with global supply. World prices shot up because demand grew faster than supply could keep up with.

Eventually, however, the world's producers of resources such as iron ore, coking and steaming coal, liquefied natural gas and petroleum responded to the high prices in textbook fashion, desperately expanding their production capacity so as to cash in on the bonanza.

It took a while for that extra capacity to come on line. But, as the textbook predicts, once supply started catching up with demand prices started falling back. And, adding to the pressure for lower prices, world demand started to fall off.

So, isn't that the same-old, same-old end to the story of the boom? And if we get to the point where world supply actually exceeds world demand, doesn't that mean prices could have a lot further to fall?

Not if it's turns out to be true – as I and others have believed – that this commodity cycle is being driven more by a longer-term change in the structure of the global economy than by the usual shorter-term cyclical mismatch between supply and demand.

Many people see the resources boom as caused by the rapid development of China, whose economy is now growing more slowly. But Cully sees China as just the first act, with other countries to follow.

"Economic growth in the highly populated emerging economies of Asia will continue to be a defining theme of this century," he says.

Per-person consumption of energy and materials in most countries in Asia lags the developed nations by a large margin and so is almost certain to grow. As incomes rise and they attract infrastructure and commercial investment, Asia's consumption of resources will grow by volumes that far outweigh whatever's happening in the rich countries.

Iron ore and coking coal are used to make steel, of course. Cully says China's steel production is estimated to have reached a record last year. He expects it to fall in the short term but, over the medium term, to reach a new peak almost 10 per cent higher by 2020.

"This will be required for China to continue expanding its infrastructure networks, especially rail, build more housing and grow its capital stock," he says.

Then there's India. Its Ministry of Steel wants present production to be four times higher by 2025. It may not achieve that target, but this still suggests rapid growth.

There've been highly publicised falls in the world price of iron ore in recent times, but Cully expects it to remain low this year and next before rebounding over the medium term as higher-cost producers exit the market and demand continues to grow. Australia has some high-cost producers, but most are in other countries, leaving Rio Tinto and BHP Billiton as the world's lowest-cost producers.

Turning to steaming coal, Cully questions the environmentalists' optimistic belief that world demand for it is on the way out. More than 300 gigawatt (one billion watts) of coal-fired electricity generation capacity is being constructed or has been approved in developing countries.

"Barring major policy adjustments," he expects coal-fired power to remain a primary source of generation in China and India. Japan, South Korea and Taiwan are increasing their use of steaming coal, while Indonesia, Malaysia, Vietnam and Thailand are increasing by even more.

Australia is likely to play an important role in meeting this increased demand because our coal's higher energy content makes it more suitable for use in advanced generators. Cully expects our exports to have increased by 15 per cent by 2020, making us the world's largest exporter of steaming coal.

Finally, natural gas. Cully's team projects that our exports of natural gas will increase more than threefold to about 75 million tonnes a year in 2019-20. By that time Australia would be the world's largest exporter of gas.

The increased volume of gas exports is likely to be the principal driver of growth in Australia's export revenue. Looking across all the mineral commodities, increases in the volume (quantity) of exports are expected to outweigh further decreases in prices, so that the value of these exports (price times quantity) increases by about a third through to 2019-20.

So what could there be to worry about? Well, it's worth remembering that, although we're exporting more thanks to the resources boom, our share of global exports is actually falling. Other countries' exports must be growing faster than ours.

More concerning, while we've been becoming global export leaders in iron ore, coal and natural gas, our range of exports has become even less diversified than it was before the boom.

Considering how dependent we are on exporting fossil fuels, that ought to worry us more than it does.

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Materialist era a qualified success

Tired of obsessing over what happened in the economy yesterday? Let's go to the other extreme and look at what's been happening in the past 200 years, and broaden the focus from poor, ailing Australia to the world.

In October, the Organisation for Economic Co-operation and Development published a report, How Was Life? Global Well-Being Since 1820. It's an extension of the work of great economic historian Angus Maddison.

His life work was to piece together estimates of real gross domestic product for all the big countries and regions of the world between 1820, which he took to be the end of the (first) industrial revolution, and 2000.

This latest study has extended the GDP figures to 2010, but also tried to estimate measures of various other socio-economic indicators of well-being.

It paints a picture of the way economic development has spread throughout the world, raising living standards, widening but then narrowing the gap between incomes, fostering population growth and, when you combine the two, causing great damage to the globe's natural environment.

The world's population was about 1 billion at the start of the 19th century, but has grown to more than 7 billion today. That growth was both a cause and a consequence of economic development and the technological advance it promotes.

Advances in public health, particularly sewerage and clean water, led to falling death rates, which slowly encouraged people to have fewer children. Then advances in medical science took over, eventually including more effective means of contraception.

However, these improvements took a long time to spread from Western Europe and the "Western Offshoots" (Maddison's name for the United States, Canada, Australia and New Zealand) to the rest of the world.

This is the story of the huge challenge the world economy has faced in the past 200 years: how to feed, clothe and house this growing population. Overall, we've done it.

Between 1820 and 2010, the world's average real GDP per person increased by a factor of 10. Multiply that by the sevenfold increase in population and world real GDP rose by a factor of 70.

The first weakness in this materialist success story is obvious: this economic growth was spread very unevenly. In 1820, the richest country, Britain, was at most five times as wealthy as the poorest countries. By 1950, the richest countries were more than 30 times as well off.

Only recently has the spread of industrialisation to China and India, which between them contain about one-third of the world's population, caused global income inequality to begin to decline.

Another indicator the study examines is the movement in the real wages of unskilled labourers. They rise more or less in line with real GDP, suggesting that some income does indeed trickle down, even if it has to be helped along by government interventions such as minimum wages.

During the first half of the 19th century, unskilled wages were above subsistence level only in Europe and the Western Offshoots. Now, however, world unskilled real wages are about eight times what they were then.

They were always highest in the Western Offshoots, with Western Europe catching up only since World War II, and they are still low in south-east Asia and Africa.

Turning to education, in 1820 less than 20 per cent of the world's population was literate, and most of these were in Europe and its offshoots. Today, literacy is nearly 100 per cent almost everywhere, although in south-east Asia, the Middle East and North Africa, it's about 75 per cent, and in the rest of Africa it's only 64 per cent.

Much of the increase in literacy has been achieved since the war and decolonisation. It has been accompanied by rising average years of education in all parts of the world. Levels of global inequality are much lower for education than for income.

At the start of the industrial period, average life expectancy was about 40 years in Europe and its offshoots, and 25 to 30 in most of the rest of the world. Only after the late 1890s did life expectancy start to rise significantly. Now, it's about 80 in the rich countries. Elsewhere, the catch-up started after the war, with most of the other world regions now up to about 60 to 70, and only Africa lagging significantly behind.

Income inequality within particular European and offshoot countries has followed a U shape, declining between the end of the 19th century and about 1970, since when it has risen sharply. In other parts of the world, particularly in China, recent trends have led to greater income inequality.

However, when we look at global income inequality, it was driven largely by increasing inequality between countries, as opposed to within them. It worsened until the 1950s, but has since stabilised.

The other big weakness in the success story is, of course, what we have done to the quality of the environment. There has been a long-term decline in biodiversity worldwide. Emissions of carbon dioxide have been rising since the industrial revolution, with its shift to fossil fuels such as coal and oil.

Although almost all the greenhouse gases that have built up in the atmosphere since the early 19th century are the result of economic activity in the developed countries, China's huge population and remarkably rapid industrialisation mean that it has now taken over from the US as the world's largest emitter.

Something tells me that, from here on, climate change and other environmental damage will be the main factor limiting the spread of industrialisation and prosperity to the remaining less-developed parts of the world.

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A good deal, but China wins on climate

At last, something to be positive about. Of all the Abbott government's efforts to improve our economic prospects over the year and a bit since its election, none compares with the benefits likely to flow from its remarkable trade agreement with China.

I'm not expecting to see any noticeable gains from the G20 leaders' pledge to increase economic growth by 2 per cent over the four or five years to 2018 - not directly as a result of our government's promised measures, nor indirectly as a result of the other governments' promises.

Those pledged actions don't seem to amount to much. And with Turkey taking over leadership of the G20 next year, it's possible this is the last we'll hear of them.

But the free trade agreement with China is of great substance, with phased reductions in China's tariffs (import duties) against many of our exports and, equally beneficial, in our tariffs against imports of certain manufactures from China.

It's likely to add significantly to our trade with China, increasing our ability to benefit from its growing middle class with ever more Western tastes, and giving us freer access to its ever more sophisticated manufactures. A coup for our tireless Trade Minister, Andrew Robb.

To be truthful, I've never been a great enthusiast for bilateral free trade agreements. They're greatly inferior to multilateral agreements, mainly because they're preferential agreements - you and I favour our mutual trade over trade with other people - contrary to what the term "free trade" implies.

This means they're capable of diverting and distorting trade, as well as generating red tape as rules are established to determine how much of an item that claims to be from China actually is.

But with efforts to achieve another round of multilateral trade improvements having been stalled since 2000, it seems we must accept that a spaghetti bowl of bilateral agreements is the best we're likely to get.

Australia has now negotiated quite a few of these deals, including John Howard's agreement with the United States in 2004 and Robb's agreements with South Korea and Japan earlier this year, but they amount to little compared with the China deal.

That's partly because China is fast becoming the world's biggest economy, partly because China is our largest trading partner - first on imports as well as exports - and partly because our economies are so complementary, but mainly because China is a still-developing country that joined the World Trade Organisation only in 2001 and so has many trade barriers still able to be reduced.

But it's a pity the government's ability to pull off such a good deal with the Chinese is not matched by a willingness to acknowledge the global good news embodied in last week's agreement between the US and China on measures to reduce greenhouse gas emissions after 2020.

This meeting of minds of the two most influential players in the world's efforts to contain global warming has boosted confidence that we may yet be able to limit the industrial-age increase in average temperatures to 2 degrees Celsius and that major progress is possible at the next meeting of countries in Paris next year.

To hear our leaders seeking to avoid short-term embarrassment by denigrating the agreement and misrepresenting China's efforts to limit its own emissions is terribly disappointing. Joe Hockey let himself down with his claim that China will continue increasing its emissions until 2030.

This suggests he's as well briefed on the subject as a radio shock-jock. Should he care to raise his understanding to the level we expect of a federal treasurer, he could read a speech that Professor Ross Garnaut, a noted expert on the topic, gave as long ago as August.

As such a vocal advocate of economic growth, you'd expect Hockey to understand that China is committed to raising its people's material standard of living to a greater fraction of that Australians and people in other rich countries have long enjoyed.

This has inevitably involved much increased use of fossil fuel, with China's rapid economic growth during the noughties meaning it has become the largest contributor to annual growth in the world's greenhouse gas emissions.

But at the meeting in Copenhagen in 2009, China committed itself to reducing the emissions intensity of its economic growth by 40 to 45 per cent between 2005 and 2020. That is, each extra yuan worth of production would involve the emission of less greenhouse gas.

Garnaut points out that, relative to what would otherwise have happened, this represented a larger reduction than any other nation promised. And his calculations imply that the Chinese will achieve their commitment.

They have moved to a new economic strategy in which less of their growth comes from investment in factories and infrastructure and more from consumer spending, especially on services. This should involve less use of energy, particularly from fossil fuels, and so fewer emissions.

Garnaut's projections of China's electricity generation to 2020 - which accounts for most but by no means all of its emissions - suggest that its burning of steaming coal will actually fall a fraction between 2013 and 2020.

So, far from China still increasing its emissions in 2030, Garnaut believes they are likely to have peaked by 2020. You should have known that, Joe.

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Mining boom makes little sense

Conventional economic analysis assumes the behaviour of businesses is always rational but, in reality, the booms and busts that cause the ups and downs of the business cycle are driven by emotion more than rational calculation: unwarranted optimism, greed, impatience, short-sightedness and herd behaviour. Consider our resources boom.

The ideology of economic rationalism says private enterprise can do no wrong; ill-advised behaviour by business arises only through its rational response to distorted incentives created by the misguided interventions of governments.

This confers on the demands made by business a sanctity the captains of industry are quick to exploit. But their demands often aren't in the community's wider interest.

Now we're emerging from the decade-long resources boom it's easier to view the process with greater insight and make a more sober assessment of its costs and benefits.

What happened was a huge jump in the world prices of coal and iron ore as China's period of rapid economic development of heavy industry and infrastructure caused global demand to outstrip global supply.

The surge in China's demand caught the world's mining industry unprepared.

Like miners in other countries, our largely foreign-owned miners lapped up the huge increase in prices and profits.

But it didn't take long for greed ("the profit motive", if you prefer) and the irrational optimism that drives the world's entrepreneurs to take over, with companies seeking to exploit the high prices to the full by expanding their production capacity as much as possible as fast as possible.

What then kicked off was a multibillion-dollar race - between rival companies in a country, but also with the many companies in other countries, all expanding their capacity as fast as they could.

It takes a long time to build new mines and bring them into production. So the chances of your mine being completed in time to enjoy the super-high prices aren't great - the more so because it's essentially a self-defeating process: the more companies join the race and the harder they try to be among the first to complete, the sooner supply catches up with demand and prices start falling.

If mining companies were more rational, fewer would join the race. But companies are just as subject to herd behaviour as investors in a booming sharemarket. A mining chief who didn't join the comp would be subject to heavy criticism.

This is where the irrational optimism comes in. Each individual entrepreneur is in no doubt he'll be among the race's winners. We're gonna make a motza.

But while the miners are busy gearing up, their foreign customers are just as likely to be coming towards the end of their own boom in investment and construction. The inevitable result is that the global mining industry moves from a starting point of undercapacity to an end point of overcapacity.

This is the eternal story of mining. Only in passing is it ever in equilibrium; it's almost always in either under or oversupply - probably spending a lot more time over than under, the less profitable of the two conditions.

Now, this cycle isn't news to conventional economics, with its familiar "cobweb theorem" and "hog cycle" seeking to explain the phenomenon. But these models put too much of the blame on the unavoidable delays in increasing production, and too little on animal spirits.

And they don't prepare us for all the waste and inefficiency involved in a resources boom. In the miners' race to be first in and best dressed they compete furiously for resources, bidding up hugely the prices of labour, equipment and materials, and ending up with mines that cost them far too much to build.

They also develop lower-grade mineral deposits, the exploitation of which becomes uneconomic as soon as the world price drops back from its record heights.

In the aftermath of the boom, many acquisitions are written off, the chief executives who presided over these excesses get the chop and are replaced by bosses whose main skill is cost-cutting. They make speeches about how excessive Australian wages are.

Anyone who has followed the fortunes of our big three - BHP Billiton, Rio Tinto and Glencore Xstrata - will know just what I'm talking about.

In their race-driven frenzy to start new projects, the miners always portray themselves as impatient for God's will to prevail, with any politicians or community members who have doubts about allowing them to rip up the environment denounced as agents of the anti-progress devil.

In the aftermath of such booms we realise we should have refused to be rushed. Why does no economist ever warn us to be less short-sighted? Their faulty model.

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Chinese economy overtaking US and getting more like it

It isn't so many years since I used to berate the denizens of the financial markets for their lack of interest in the economy that had so much influence on ours: China. How things have changed. So has China.

After averaging growth of 10 per cent a year for 30 years, China's economy is now struggling to achieve its reduced target of 7.5 per cent. The financial market participants' role has been to watch on with concern.

And this week comes news that, though the International Monetary Fund sees China coming close to target this year, it expects it to slow to 7.1 per cent growth in 2015 and slow further in following years.

More surprisingly, the fund says that China should slow down to give it a chance to work on its big problems, rapidly growing debt and a rapidly contracting real estate market. Fumble those and growth could be even lower.

But while so many of us have been so focused on China's difficulty maintaining its rate of growth, we've lost sight of how big it is and how fast it's still growing compared with the rest of us.

Compared, say, with the world's biggest economy, the United States. Except that, according to the calculations of Euromonitor International, China will overtake the US this year. That's when you compare the two economies using "purchasing-power parity", which makes allowance for the fact that one US dollar buys a lot more in China than it does in the land of the free.

With China biggest and the US second, then come India, Japan, Germany, Russia and Brazil. We come in at 17th, not far behind Indonesia. The world certainly is changing.

Of course, the Chinese and American economies remain very different. China is big because of its much bigger population - 1.4 billion versus 300 million. Its income per person remains a fraction of America's. A not unrelated fact is that the US's productivity (measured as gross domestic product per worker) is more than nine times higher than China's.

And the two countries' industry structure is also very different. Agriculture contributes 10 per cent to GDP in China but just 1 per cent in the US. But get this: it accounts for almost a third of the workforce, compared with just 1.4 per cent in the US.

Manufacturing makes up 30 per cent of China's GDP, but only 13 per cent of America's. That tells us a lot about why China's rise, and the growth in its exports of manufactures, has affected so many other countries as well as maintaining downward pressure on world prices.

But the biggest difference between the two economies is their relative emphases on consumption and investment. Euromonitor International estimates that this year private consumption will account for 68 per cent of GDP in the US, compared with 37 per cent in China.

Here, however, we get to the really important news: the Chinese authorities have embarked on a process of "rebalancing" the economy, increasing consumer spending and domestic demand and reducing the roles of exports and investment in heavy industry.

The Economist notes that consumer spending has already begun its expansion, with its share of GDP rising from less than 35 per cent in 2010 to more than 36 per cent last year. And this year it has accounted for more than half the growth in GDP.

A big reason for stronger consumer spending is rapid growth in wages. Get this one: over the five years to 2013, real wages in manufacturing rose by about 2 per cent in the US, but by 45 per cent in China. As always happens, the benefits of economic development do flow eventually to ordinary workers.

This strong growth in consumption involves faster growth in the services sector, with manufacturing's share of GDP having peaked at almost a third in 2007.

This structural change means people following the ups and downs of the Chinese economy ought to be following a different set of indicators, as Peter Cai of China Spectator noted last week with help from Guan Qingyou, an economist at Minsheng Securities.

Cai says the main reason Chinese policymakers care so much about the rate of growth in GDP is their belief that the economy needs to grow by at least 7.2 per cent to absorb 10 million new entrants to the labour market each year.

But this correlation has been breaking down since 2010. Slower growth in GDP has not led to weaker job creation. Gaun suggests this is because the expanding services sector has a greater capacity to absorb new job seekers.


More fundamentally, China seems to be approaching its "Lewis turning-point", where a developing country runs out of its supply of surplus rural labour. This would also help explain the rising real wages.

Financial market participants focus on the growth in "industrial production" (manufacturing, mining and utilities) as a predictor of GDP growth, and on the manufacturing PMI (purchasing managers' index) as a predictor of industrial production.

But Cai says the strong correlation between industrial production and GDP is breaking down because the services sector is growing a lot faster than the industrial sector. Last year, for instance, the services sector contributed 47 per cent of the annual growth in GDP, whereas the industrial sector contributed less than 40 per cent. So, it's better to focus on the services sector PMI.

A big problem for China-watchers is that you don't know how much faith to put in official statistics. Earlier in his career, Premier Li Keqiang let it be known that he, too, had his doubts. So he focused on railway freight volumes, electricity consumption and bank lending as offering a better guide.

Now others have developed a "Li Keqiang index". But here, too, Guan argues that its reliability has declined, because of changes in the structure of industrial electricity use and changes in financing. China is changing.

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