AUSTRALIA´S SHAKY ECONOMY / THE NEW YORK TIMES OP EDITORIAL ( VERY HIGHLY RECOMMENDED READING )

July 12, 2010

Australia's Shaky Economy

By PHILIP BOWRING

HONG KONG — The sudden demise last month of Kevin Rudd as prime minister of Australia points to a fundamental issue for that nation: How dependent should it be on its vast mineral resources?

For sure, the underlying reason for Mr. Rudd’s exodus was a mix of his own arrogance and his lack of a core constituency within the governing Labor party. He was useful to the party only so long as he was popular in the country. The dramatic decline in his popularity as an election looms by year end was enough to seal his ouster.

The immediate cause of that decline was the plan for a so-called “super tax” of 40 percent on mining profits.

This was the subject of a barrage of attacks from mining companies that put projects on hold and accused the government of undermining Australia and its currency, driving investors to other mineral-rich nations. The plan was particularly unpopular in the mineral-rich states of Western Australia and Queensland and even met with little enthusiasm from many who believe that the miners could and should pay more tax on depleting natural resources.

The tax plan was simplistic and poorly presented and thus became an easy target for the mining lobby and its political allies. It did not help that it was announced at a time when mineral prices, though still high, were looking wobbly amid the uncertainty over growth prospects in China, the main driver of price rises of recent years.

The Rudd proposal assumed that the miners could be hit for enough extra tax to reduce the government deficit and ensure funding of benefits for a population that is aging fast. He may well have exaggerated the future profitability of a sector known for price spikes that are often followed by years of low prices (as long-gestation projects started during the spikes come into production).

But it could also be argued that the number of big projects now being developed, many with Chinese money, will themselves be a major contributor to future price declines. Indeed, China is hoping that its strategic investments will have just that result. It is a moot point whether a higher tax-rate would actually drive investment from politically stable Australia to Africa or Central Asia.

The ongoing minerals boom, characterized both by relatively high prices and a surge in investment in new mines and associated infrastructure, has resulted in an increasingly unbalanced Australian economy.

While employment and wages in the mining-related sector have surged, the major population centers have become over-reliant on government deficit financing and buoyancy in the housing market.

Perceptions of Australia’s mineral wealth have further exaggerated the divide by pushing the local currency to a recent average close to 85 U.S. cents compared with just 48 cents when mineral prices were at their nadir in late 2001. Yet despite the recent minerals boom, Australia still runs a large current account deficit and net foreign debt is now up to 50 percent of gross domestic product. In turn, this is heavily financed through wholesale borrowing offshore by local banks. Some of the debt is for new mines and other productive assets. But more finances the nation’s high household-debt.

The exchange rate has, many argue, been undermining manufacturing and skill-based services. In other words, it may be suffering from a serious case of the “Dutch disease” — the decline of other sectors caused by a sudden increase in mineral wealth, in the Dutch case natural gas in the 1960s.

Australia has had an enviable G.D.P. growth record in recent years. Its banks escaped the financial meltdown in the United States and Europe and it has been in the lead in pushing interest rates back to more normal levels. But critics attribute most of this success to the luck of mineral prices, now almost triple their 2002 levels. If that luck fails to hold it could leave the nation struggling to finance its foreign debts and with the non-mining sectors weakened by years of an over-strong currency. Agricultural exports endangered by water shortages.

Minerals enable urban Australia to enjoy a high standard of living, importing the latest consumer durables from Asia while creating jobs for a fast-growing immigrant population. It is hard to argue that new projects are undesirable given the wealth of resources Australia’s vast land mass contains. But implicit in the mining tax issue remains the question of the over-reliance on mining both for government revenue and exports.