The last 48 hours have illustrated what Karl Marx might call the internal contradictions of Australia’s 22 years of recessionless prosperity. On the one hand, the country’s massive resource wealth is a magnet for capital and a source of income for labour, capital, and government. On the other hand, when the world is in the grip of a general deflation for the price of labour, it’s hard for a developed country to retain high-wage skilled manufacturing.
That leaves the country with an unappealing proposition: export minerals and energy with no value added because you have them…and give up on the idea of value-added manufacturing, for good. I’ll come back to this in a moment. It has implications for investors and the economy in 2014. But first the facts.
Holden will shed 2,900 jobs in Australia. It will stop making cars by 2017. It joins Ford in blaming the strong Aussie dollar, a competitive car market, and high labour costs as the main reasons for throwing in the towel. After $19 billion in government handouts over the last twenty years, only Toyota will be left making cars in Australia. And who knows how long that will last?
According to GM CEO Dan Akerson, ‘The decision to end manufacturing in Australia reflects the perfect storm of negative influences the automotive industry faces in the country, including the sustained strength of the Australian dollar, high cost of production, small domestic market and arguably the most competitive and fragmented auto market in the world.‘
You could argue that a healthy, profitable car industry is the sign of a productive and dynamic economy. But the truth is, there are plenty of productive, dynamic economies where they don’t make cars at all. They don’t make cars in Singapore, for example. Or Norway.
Those are small countries that choose to pursue their comparative advantage on the world stage. Singapore – with no natural resources to speak of – has made itself a magnet for capital by having low taxes and relatively few obstacles to starting and running a business. The Norwegians plough their oil money into a Sovereign Wealth Fund to manage their smallish Welfare State (small in that Norway has a population of just five million people).
Australia doesn’t have to make cars to be prosperous. But there is something sad and vaguely unsettling about losing generations of skill at building vehicles. Perhaps that’s nostalgia for the past. But it raises a legitimate question: are there some industries that it’s in ‘the national interest’ to subsidise?
If you ask that question to the industries receiving the subsidies, they’re always going to say yes. Yet the price of those subsidies is always born by consumers in the form of higher prices. If you pay more for cars than you have to (let’s just add that $19 billion to the price of every car sold in Australia for the last 20 years) it means you have less money to spend on other things.
That’s the pernicious aspect of handouts to industry. You always hear about who benefits. You always hear about the jobs saved. And of course, around Christmas, you’re going to hear about the people who are out of work with families. It is not great.
But you never see the stories of the people who lose their jobs because the government kept one industry in business and diverted money away from other businesses. The person who loses from the handout is ‘what is unseen’ in the words of economist Frederic Bastiat. Let’s not forget that.
Australia may turn out to be better off not making cars at all and leaving that to factories in Thailand or Japan. That will be cold comfort to the 52,000 people involved in car making in some capacity. If you had an economy creating new jobs in new industries, it would be less of a worry. But it is a worry.
Dutch, debt, and coal
It’s a worry because of the dollar. With bigger government deficits, a lower terms of trade, and smaller interest rate differentials relative to other countries, the Aussie dollar ought to be lower than it is. But its strength persists. Why?
Money continues to flow into Australia to develop resource projects. This is the whole ‘comparative advantage’ story again. For example, earlier this week Treasurer Joe Hockey made it easier for a Chinese coal company to take 100% ownership in its Australian venture. Previously Yanzhou Coal Mining Company’s ownership stake in Yancoal Australia was restricted to 70%.
Hockey lifted that restriction earlier this week for a simple reason: the project needs Chinese money to continue. The Treasurer said, ‘Since those conditions were imposed, significant challenges have emerged for the Australian coal industry, including slowing demand, declining coal prices and a number of mine closures.’ If Australia wants to keep the coal jobs created by Yancoal, it needs Yanzhou’s money.
You could repeat this scenario all across the resource sector. With the banking industry completely obsessed with the housing market, the resource industry has just three sources of funding for new projects: cash generated by existing production, funds raised in the equity market, or foreign capital.
There’s no reason to be afraid of foreign capital, mind you. It’s just a tough position for the country to be in after 22 years of growth. Value-added industries can’t survive with a high dollar and globalised labour. But the dollar is kept high by the attractiveness of the country’s mineral wealth and the fact that the banks choose to invest in housing over resources.
Is it the worst of all worlds if you end up with low-value added resource extraction industries and a higher percentage of foreign ownership of your resource assets? Well, that’s not entirely fair. You can move an Australian car factory to China. But you can’t move a coal mine there. Resource projects will always require capital, labour, and investment. They create real wealth. But this whole business about Australia being ‘Asia’s quarry’ is starting to sound accurate.
Maybe Joe Hockey holds the key. The Treasurer is set to release the mid-year economic and fiscal outlook next week. The papers report that the government now estimates its debt will peak at $500 billion, $50 billion higher than the last estimate and exactly at the debt ceiling that was conveniently abolished last week.
A blow-out number like that should weaken the dollar. Australia’s relatively small government-debt-to-GDP ratio was one of the pillars of the Aussie dollar’s strength in the last five years. That pillar is looking awfully crumbly these days. Can the dollar hold up?
I don’t know. The dollar has defied everyone, thanks to capital flows. The worsening fiscal picture might slow speculative capital flows to Australia. But the weaker dollar may lead to more foreign investment in resources. Stay tuned.
By the way, you can’t really blame the current government for that number. But it doesn’t matter anyway. Governments of both parties now face the same problem in Australia: a two-speed economy that relies on credit expansion to drive up house prices and China to hold up resources.
By Dan Denning
