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%.

The same thing has happened in every other high-income country. It is only in those countries where manufacturers have been successful at exporting – such as Germany – has manufacturing shrunk as a share of GDP by less than the average for all industrialized countries.

Because Australia has a larger mining sector than other rich countries, it must have a smaller manufacturing sector than other rich countries. And it is similarly a matter of arithmetic that the manufacturing sector, and those parts of the services sector which are 'tradeable' (such as tourism, and – as a result of developments in information and communications technologies, retailing) will shrink further as a proportion of GDP if the mining sector is going to expand as a share of GDP.

Now if it were at all likely that the mining boom will turn out to be 'a flash in the pan', over and gone in a few short years, there might be a case to be made for 'holding back' the expansion in the mining sector in order to prevent what might then be wasteful investments and to preserve industries and jobs which might be needed again after a very short interval.

But I believe that, even on quite conservative assumptions China's demand for commodities will continue to grow strongly until at least 2019, and may not start to fall away until 2024; while in India, it is likely to continue well into the 2030s.

So for Australia to seek to restrain the expansion of the mining sector out of a desire to preserve jobs in other parts of the economy would be to forego an enormous boost to our national income over a long period of time. That income will instead go to other countries. We might as well regard it as an increase in our foreign aid budget.

In my view the only thing that governments can and should do by way of assisting industries which are under pressure as a result of some of the 'side-effects' of the mining boom, such as the strong A$, is to help them improve their productivity.

But governments should not seek to prevent structural change from occurring – for example, by trying to prevent the Australian dollar from rising, or by 'heavying' the Reserve Bank into setting interest rates at lower levels than the Bank's own judgements suggest are appropriate.

It should not try to force Australian consumers and businesses to pay higher prices for manufactured goods by denying them access to imports, which is no less a form of 'protectionism' than the more traditional versions such as tariffs and quotas.

Talk that the 'playing field' is not 'level' ignores the fact that countries which keep their exchange rates artificially low, or which impose high tariffs on imports, are actually imposing costs on their own people or businesses: and the fact that other governments are willing to disadvantage their own people in order to advantage selected industries or businesses isn't a good reason for us to do the same thing.

That's not to say that manufacturing isn't important: it is. It still accounts for about 9% of Australia's GDP and a similar proportion of total employment, and it creates additional income and employment both 'upstream' and 'downstream'. However I don't accept that there's anything intrinsically nobler about manufacturing than other forms of economic activity, including in particular, services.

Australia's long-term interests are not well-served by the deriding of services sector jobs as "taking in each other's washing". Indeed, it's highly likely that parts of the services sector – in particular, aged care – will play as important a role in providing employment opportunities for people with limited education or skills as manufacturing did in the now somewhat distant past.

Nor do I mean to suggest, when I say there is no point in seeking to restrain the expansion of the mining sector in order to preserve jobs, that we shouldn't be seeking to ensure that the Australian people derive an appropriate share of the income generated from the exploitation (by privately owned corporations) of finite natural resources of which they are the ultimate owners.

Although I believe that the 'Resources Super Profits Tax' as proposed by former Prime Minister Kevin Rudd was poorly conceived, and even less well 'sold' to the electorate, the principle underlying it – namely, that the return to the Australian people from the exploitation of mineral and energy resources should be based on the profits derived from the extraction and sale of those resources, rather than on the volume of resource production – is one that I strongly support. And I think it's regrettable that the Government has backed down.

The Australian Government will of course derive considerable amounts of additional revenue from ordinary company taxes paid by mining companies.

And since, according to research by Reserve Bank economists, 'a little over half the total receipts earned from mining operations' accrue to Australian residents (notwithstanding that foreigners may now own as much as 80% of current Australian mining operations), there will also be a significant indirect increase in tax revenues flowing to the Australian and State and Territory Governments.

A second key challenge arising out of the mining boom will thus be that of ensuring that this additional flow of revenue to government is not frittered away, but that it leaves a lasting legacy.

This is something which Australia failed to do during the first phase of the current mining boom. The Howard Government, in its last term of office, and the Rudd Government, in its first year of office, were unwilling to contemplate budget surpluses of more than 1% of GDP, so they 'gave away' the revenue that would otherwise have resulted in budget surpluses in the form of income tax cuts and cash handouts.

This mistake could have been avoided if Australia had been willing to establish some kind of 'stabilization fund' or 'sovereign wealth fund'.

An Australian 'sovereign fund' wouldn't be created out of the revenue from State-owned commodity businesses like Norway's Staatoil, or Chile's Codelco. Nor would it be funded solely by specific taxes levied on mining companies.

Rather, an Australian 'sovereign fund' should be created from the larger budget surpluses which Australia ought to be running once the mining boom gets into full swing.

An Australian sovereign fund would need to be governed by very tight rules, similar to those governing the Future Fund established by the Howard Government to prevent governments from touching the capital in the fund until the resources boom is 'over' according to some objective criterion.

Such a Fund would most sensibly be managed by the existing Future Fund Management Agency, who have done a pretty good job in managing the $75 billion which it now has under its control.

I've also long argued that such a Fund should be divided into separate accounts (probably though not necessarily of equal size), for some clearly designated purposes such as

• pre-funding some of the costs associated with population ageing;

• providing for the transport, health and education infrastructure of the future;

• drought-and disaster-proofing the nation (to the extent it's possible);

• assisting the transition to a 'low-carbon' economy; and

• making substantial and meaningful progress towards eliminating the extent of Indigenous disadvantage.

A sovereign wealth fund would, in effect, convert at least some of the revenue from what is a finite and depleting stock of natural resources into a potentially permanent stream of payments from a stable or even growing stock of financial capital. It would help to prevent a surge in domestic spending at a time when the economy is likely to be operating at 'full employment'.

It would also provide a means by which the present generation of Australians – those of us who, by coincidence rather than as a result of our own efforts, happen to have custodianship of the wealth which has been lying under, or around, this continent for millennia, at a time when the people of the two most populous nations on Earth are willing to pay very high prices in order to procure the resources on which that wealth is based – can discharge the moral responsibility I believe we have to future generations of Australians to leave to them a greater inheritance, rather than expropriating all of it for ourselves.