Striking parallels: divergent paths

It has done so not only by raising the incomes of commodity producers themselves.

It has also done so by boosting the tax revenues of the Federal Government (which through the company income tax system takes 30 cents of every additional dollar that higher commodity prices adds to the profits of companies such as Rio Tinto or BHP Billiton), which in turn has handed almost over every additional dollar it has thereby reaped to households in the form of tax cuts or increased cash benefits.

And it has done so by exerting downward pressure on the prices of imported consumer goods, thereby helping to keep inflation and interest rates lower than might otherwise have been the case. And also by stimulating a significant increase in capital expenditure by the resources sector and in its associated infrastructure.

The only real downside from the “China effect” is that by keeping the exchange rate for the Australian dollar higher than it might otherwise have been, the international competitiveness of Australia’s trade-exposed manufacturing and services sector has been eroded. In effect, these sectors have been “squeezed” (pdf file 50KB) to make room for an expansion in Australia’s resources sector in the context of greatly diminished “spare capacity”.

Thus Australia, unlike the UK to some extent, finds itself at a very auspicious point in the business cycle with low unemployment by the standards of the preceding decade or so; rising real incomes; record corporate profits and share prices; and buoyant government revenues keeping budgets in surplus.

The only arguable “black spot” on our contemporary economic report card is that, despite the currently highly favourable conjuncture of export and import prices, Australia is still running a current account deficit in excess of 6 per cent of GDP - in large measure because buoyant domestic demand is spilling over into imports.

The striking thing about this is that we have been here before - in 1960, in 1973, in 1981 and in 1989. With the exception that inflation and interest rates are much lower than they were in 1981 and 1989, the description I’ve just given of the current state of the Australian economy also accurately summarises the condition of the Australian economy on each of those four previous occasions.

And yet within less than two years of each of those four occasions, Australia found itself in one of the four serious recessions we’ve experienced in the past 50 years.

That hasn’t happened by accident; it has happened because whenever the Australian economy has previously enjoyed such a felicitous combination of circumstances, governments and their agencies have made three fatal policy mistakes.

The first has been that of allowing wages growth significantly to exceed productivity growth as “bargaining power” in the labour market has swung from employers to unions.

That mistake seems unlikely to be made on this occasion - partly because of the government’s industrial relations reforms; and partly because structural changes in the labour market - highlighted by the fact that there are now more owners and managers of businesses than trade union members in the labour force - have helped to cement an understanding that pushing for wage increases which are not underpinned by productivity gains is a sure route to widespread job losses.

The second mistake which Australian governments have always made at this stage of the business cycle is that of failing to permit the Reserve Bank to raise interest rates “a little bit” in the early stages of a cyclical acceleration in inflation, and thus ultimately forcing the bank to raise interest rates to recession-inducing levels in order to get inflation down to tolerable levels once more.