The 'dutch disease'

One of the Budget statements which has failed to capture media attention is the analytical document "Opportunities and Challenges of an Economy in Transition" – a chapter within the major Budget Strategy and Outlook document (Budget Paper No 1).

It lacks the immediate political impact of a cut in family allowances or a change in single mothers' benefits, but it is probably the most important document in the set of budget papers, because it outlines looming economic challenges – challenges which could be very costly and disruptive if not handled with sound policies.

It confronts us with the economic environment Australia will be face in coming years and the adjustments we will have to make in our economic structure, if we are to survive as a prosperous nation.

Unsurprisingly, its focus is on the rising economic strength of India and China. It is a story of exponential growth; for example it cites a projection indicating that by 2020 Asia will have more middle class consumers than the rest of the world combined, and most of these will be in India and China.

Its analysis of the Australian economy is mainly about the mining boom, which will support that Asian growth. Here, too, the figures are extraordinary. Mining investment in the coming year will be about $76 billion, and their analysis of mining investments indicates that there are projects to the value of $380 billion already in the pipeline.

These are difficult figures to grasp. We're talking about $40 000 a household, eight National Broadband Networks or ten Melbourne-Sydney very fast trains.

The document's message is that while there will be strains on the Australian economy, some of which we are currently experiencing – a high exchange rate and labour shortages in particular – we should have no difficulty in coping with the transition.

We have coped with big transformations before, first in our agricultural sector and more recently in our manufacturing sector. Although these changes have been disruptive, each time we have come through them with a stronger and more competitive economy.

In other words, we do structural change well, and we should have no difficulty in coping with the demands of a mining boom and the need to place a price on carbon.

Critics of such a Panglossian scenario will point to the downsides. Commodity prices are volatile. Prices of iron ore and coal are more volatile than prices of steel, which, in turn, are more volatile than prices of motor cars; it's a wild ride at the start of the supply chain.

Another problem is what is called the "Dutch disease", a term describing the impact of the North Sea gas boom of the 1970s and 1980s on the Netherlands economy.

Inflows of investment capital, and subsequent commodity exports, drive up the exchange rate, to the detriment of other trade-exposed sectors, and because these trade-exposed sectors contract, the economy becomes even more dependent on commodity exports. When, in time, the commodity cycle ends and the currency returns to pre-boom levels, the economy faces a difficult task because it has lost so many of its trade-exposed industries.