Give and take: a prosperous Australia for a declining manufacturing industry?

Australia is now being presented with a historic opportunity to tackle some of the problems which have beset this nation for many years.

I am referring, of course, to the fact that Australia is now experiencing what may well turn out to be the largest and most prolonged commodities boom in our history, driven largely by our capacity to meet many of the resource requirements associated with the industrialization and urbanization of the two most populous nations on the planet, China and India.

Hence we are experiencing the most sustained upswing in our 'terms of trade' (the ratio of export to import prices) in at least 140 years, and the biggest expansion in resources sector capital investment in at least 160 years.

This has the potential to create enormous wealth and prosperity for the people of Australia – if we manage it wisely.

Unfortunately, the experience of previous 'commodities booms' in Australia does not inspire a great deal of confidence that we will manage it wisely.

Each of our last three 'commodities booms' – the Korean War wool boom of 1951, the mining boom of the late 1960s and early 1970s and the rather briefer resources boom of the early 1980s ended in a burst of double-digit inflation, followed (inevitably) by recession.

Although the circumstances of each of these three episodes were different in many respects, one of the features common to each of them was an inability or unwillingness on the part of both the Australian people and their governments to accept that making the most of the opportunities presented by these surges in commodity prices entailed a significant degree of structural change.

In particular, the Australian people and their governments have always had trouble accepting that the sum of the various sectors of the economy – primary industries, mining, manufacturing, construction and services – can't add up to more than 100% of gross domestic product; and hence that if commodity-producing sectors are to expand as a proportion of GDP then other sectors have to shrink.

When the Australian people and governments are unable to accept that simple arithmetic principle, the result has been, unavoidably, higher inflation as the commodity-producing sectors compete with other sectors of the economy for increasingly scarce labour, materials, capital and other factors of production.

Australia is always going to have a larger mining sector than most other 'advanced' economies, because of the bounty of natural resources with which the continent we occupy has been endowed.

And it is also more or less inevitable that the services sector will account for a similar proportion of the Australian economy as it does of other 'advanced' economies with similar standards of living, because people with standards of living similar to ours typically choose to spend a similar proportion (around 70%) of their incomes on services, and because most services are inherently not tradeable.

Indeed, the main reason for the decline since the mid-1970s in manufacturing as a share of GDP or of employment is not, as is commonly claimed, the dismantling of the tariff barriers but rather the fact that, as Australians' incomes have risen, the share of those incomes which they have chosen to spend on goods has fallen from almost 40% to less than 25%, while the share which they spend on services has risen from just over 60% to more than 75%.