Dragon’s Tail: The Lucky Country After the China Boom
By Andrew Charlton | Quarterly Essay | $19.99
Beyond the Boom
By John Edwards | Penguin Special | $9.99
In June 1853, Karl Marx wrote a dispatch for the New York Daily Tribune under the title “Revolution in China and Europe.” Written in the teeth of recent defeats – Marx had described the Parisian uprising in the summer of 1848 as “the greatest revolution that has ever taken place” only to find himself composing its unhappy obituary a year or so later in his Eighteenth Brumaire – this may have seemed, even from the point of view of a professional revolutionist, rather optimistic.
But the spirit of insurrection, extinguished in Europe, had already set the Celestial Empire alight. Marx predicted that the Taiping Rebellion would prompt the nervous Chinese to begin holding on to their cash, with the result being a slackening in demand for items that the British had customarily exported to China – mainly textiles, that is to say, and Indian narcotics (although here the demand was, shall we say, more inelastic). This, combined with a diminished supply of “so indispensable an article as tea,” would lead ineluctably to “the explosion of the long-prepared general crisis” in Europe.
The equivalence between the position Australia now finds itself in and the one Marx forecast for Britain is not exact (all things being equal, we would prefer the Chinese people to keep saving) but it would be interesting to know if Xi Jinping remembers the importance that the father of scientific socialism placed on the state of Chinese domestic conditions for the economic stability of the West. China’s need for steel – or, to be precise, the iron ore and coking coal needed to produce it – has dragged Australia along for a very enjoyable ride. But the next stage of Chinese development will likely see its citizens spending more on consumer goods and a reduced, though still significant, demand for the raw minerals that Australia has been shipping off in bulk.
Andrew Charlton’s Dragon’s Tail is an impressionistic account of recent Chinese economic history and its impact on Australia, as well as a survey of the possible consequences of an end to its quicksilver growth. Charlton traces the contours of the “investment-led growth model” that has, as his overworn but unarguable phrase has it, “lifted tens of millions of people out of grinding poverty.”
The model has three essential parts: “low currency, low wages, low interest rates.” An undervalued currency encourages exports and discourages imports; miserly wages make Chinese businesses competitive; low interest rates make it easier for businesses to finance investment with borrowing. But each of these policies has a less happy concomitant: all of them work to repress the amount of money at the disposal of Chinese families. Worse, by arrogating so much of the fruits from growth in order to fund further investment, the Chinese government has placed bets on a great many projects, not all of which can pay off.
Charlton’s forecast for the Chinese economy is unpropitious, to say the least. He raises the prospect of a debt crisis, noting that if the money owed by state-owned enterprises and municipal authorities is included then the ratio of debt to annual income is about 200 per cent. The other possibility is more benign. “We will strictly ban approvals for new projects in industries experiencing overcapacity,” Charlton quotes vice-premier Zhang Gaoli as saying. The Chinese government will have to convince its people to accept a slower rate of economic growth as the weight of economic activity shifts to domestic consumption.
What does this portend for Australia? The two problems – that China will no longer want as much of what we produce, nor will it be willing to pay the pretty prices it has – may uncover a deeper Australian malaise that extends further than the mines. The challenge, as Charlton outlines it, is known as “Dutch Disease.” When an industry grows in the way the mining sector has done, it begins to suck workers and money away from other industries, leaving them to wither. Meanwhile, as the exchange rate rises, Australian exports become more expensive. Whether this is bearable in the long run depends on the duration and extent of the boom. It is not much good telling a manufacturer who has filed for bankruptcy that the exchange rate will eventually fall. Unless we are willing to accept lower living standards, other industries will have to grow faster, or become much more productive.
Set against this pessimistic forecast is John Edwards’s extended essay, Beyond the Boom. This lively little philippic is directed against what he terms the “black armband” school of Australian economic history (a slightly unfortunate term to resuscitate), which seems to include Ross Garnaut and Bob Gregory, and to an extent Charlton.
For Garnaut, at least, these circumstances will require a substantial depreciation of the exchange rate. A drop in the nominal rate of exchange can come about in several ways. One of them will be surprisingly easy. The US Federal Reserve is gingerly winding down its policy of vacuuming up financial assets, a program that, to cut a dull story short, has kept our own currency artificially buoyant. This will provide some relief on the exchange rate, but not enough, according to Garnaut, who advocates lower interest rates to drag down the value of the dollar. This would need to be offset by reduced government spending.
Edwards disputes both the diagnosis and the cure. He argues not only that the economic benefits of mining investment have been exaggerated, but also that the response of governments and households to the rise in mineral exports was much less exuberant than Garnaut would have us believe. While, as Charlton correctly points out, governments have disbursed a great deal of the increased company tax receipts from the boom in the form of income tax cuts, Edwards argues that households saved a great deal of this increased income. Furthermore, the Australian mining industry is “roughly four-fifths foreign owned,” and therefore a significant share of both the benefits of its rise and the burden of its decline will fall on foreigners. Once state and federal governments have taken a slice, about half of the economic product of the mining industry in Australia goes overseas.
And the duller the party, the more bearable the hangover. “The increase in living standards,” according to Edwards, “is a statistical illusion” that derives from measuring hypothetical rather than real increases in income. Sure, says Edwards, higher prices for our exports would have allowed us to buy more imports – but we didn’t spend all of the hypothetical increase in income that way. And some of the actual gain accrued to foreigners. There is something to this argument, although Edwards exaggerates the extent to which the black-armband school has ignored the issues of foreign ownership (Gregory even wrote a paper on it), and he underplays the benefits of a higher exchange rate that lowered the price of our imports.
The best part of Beyond the Boom is Edwards’s dismissal of the operatic declamation that manages to pass itself off as policy debate in Australia. Edwards characterises – you might say satirises – this view with brio: “Feckless and complacent, Australians would regret their heedless neglect of bracing reforms that, though uncomfortable today, would to some extent mitigate the slump tomorrow.” Moralists make lousy macroeconomists. It does not follow, as a matter of either logic or algebra, that a period of opulence must be atoned for by a period of austerity.
So what can we do if we wish to proceed without “bluster”? It isn’t easy to say. We are in some senses facing a similar dilemma to the Chinese, who, as Charlton argues, have exhausted all of the obvious investment opportunities. In Australia, we have run out of obvious setpiece reforms. Floating the dollar was admirable, but it’s difficult to do again. Which is not to say that we ought to sit on our hands – just that the path from here on in is much less easy to discern. We may need to accept that some of the policies we try may not yield miraculous results, or even discernible benefits at all.
Both Charlton and Edwards emphasise the need to develop human capital (the infelicitous term economists use to describe what you get when you educate somebody) and infrastructure. We also need to muscle our way into Asian supply chains that handball products from country to country at each stage of the production process – although, as Edwards says, it’s not easy to discern a distinct role in this for government policy. Edwards says both that the task facing Australia will not be “easy” and that the list of reforms he has assembled is a “modest enough agenda”; on the whole, I agree with the first statement more than the second.
He also makes the nontrivial point that it will be important to “retain and cultivate” the macroeconomic settings that have tempered the current boom, while distinguishing between “those policies that benefit most Australians” and those designed for or by sectional interests. He identifies successful policies such as the floating exchange rate and the independence of the Reserve Bank.
Another success he might have mentioned is the Australian welfare state. Usually, when the market for our exports turns favourable, the rich tend to profit from it more than the poor, as the economists Sambit Bhattacharyya and Jeffrey Williamson found in a paper last year. The Korean war wool boom – another season of prosperity we owe, in a roundabout sort of way, to communism – furnishes an example of this. When the US army found itself fighting above the 38th parallel, demand for Australian wool to clothe its soldiers spiked, with an attendant increase in the share of national income in Australia accruing to the top income earners.
This time, the increase in inequality has been much more muted. Why? Well, there are several reasons, but one is that Australia has evolved a system of support for the poor that is highly efficient. Without it, it is unlikely that reforms designed to make us more productive would be politically possible. An unapologetically generous system of income redistribution is not luxury cargo that weighs us down on the high seas of international commerce: it is the ballast that will prevent the ship from tipping over.
Edwards also evinces a remarkable sanguinity on the question of Australian political culture and the likelihood that it will prove capable of managing the twilight of the boom. Recent events make me more sceptical. The Senate, for example, has just euthanised an eminently reasonable scheme to reduce emissions of greenhouse gases. Yet the policy’s macroeconomic impact had been almost undetectable: proof that there are occasionally, if not free lunches, then at least lunches that are very reasonably priced. The law was dispatched with the aid of a party that is actually named after its founder and spiritual leader, a phenomenon I had thought the prerogative of banana republics. Worse, this party founder, having administered the needle of mercy, finds himself quite unexpectedly named in the will: the net present value of the repeal of the carbon tax to Clive Palmer would almost certainly be denominated in millions. You can perhaps see why, though I share Edwards’s assessment of our macroeconomic management thus far, I am unconvinced that we are likely to be so fortunate in the future.
China’s industrial adolescence has been enriching, in both senses of the word, for our own country. What comes next is much harder to guess, although those wishing to divine how Australia ought to prepare itself would do well to read both of these interesting and well-argued essays. •
