Striking parallels: divergent paths

So what is the reason for this difference in the recent economic experience and the economic prospects for two economies whose experience over the previous two decades or so had been so uncannily similar?

The answer is geography and resource endowment.

Britain’s economic fortunes have, over the past 30 years or so, become increasingly intertwined with those of its fellow members of the European Union. The problem this poses for Britain is that the European Union has become increasingly sclerotic, unable to contemplate let alone undertake the reforms required to address deep-rooted structural problems which have undermined its long-term economic performance and prospects.

By contrast, Australia’s geographical location and its bounteous endowment of natural resources have made it almost uniquely well placed to benefit from the rapid growth and industrialisation of China.

Although China’s economy will almost certainly experience cyclical fluctuations in its growth rate (in my view China may well experience a downturn after the Beijing Olympics), there is no reason why it cannot achieve economic growth averaging somewhere in the range 6 to 9 per cent a year over the next decade and possibly the decade after that as well.

As a result, China will almost certainly move past the United States to become the world’s largest economy sometime between 2013 and 2018.

China is for the most part a net importer of commodities and a net exporter of (a growing range of) manufactured goods. And it is now large enough a participant in global markets for the things that it exports and imports to be exerting significant upward pressure on the prices of the former and downward pressure on the prices of the latter.

Australia, by contrast, and somewhat unusually for a “First World” economy, is the exact opposite - a net exporter of commodities and a net importer of manufactured goods (and services). Nature has richly endowed this country with many of the things China needs and cannot produce for itself; while we have relatively fewer of the industries which are increasingly vulnerable to competition from China than the United States or Europe (or, for that matter, other Asian economies).

China has therefore, almost single-handedly, reversed one of the most relentless and detrimental long-term trends in Australia’s economic experience - namely, the persistent tendency for the prices of Australia’s exports to decline, either in absolute terms or relative to the prices of our imports (which economists refer to as the “terms of trade”).

By the end of last year Australia’s “terms of trade” were more favourable (ie, the prices we were receiving, on average, for our exports were higher relative to the prices we were paying, on average, for our imports) than at any point since the March quarter of 1974.

The improvement in Australia’s terms of trade so far this decade has lifted Australian real per capita gross disposable income by over $2,600 per head.

The “China effect” has therefore helped to sustain growth in the Australian economy beyond the end of the residential property boom - in contrast to the experience in the UK; and in contrast to what I expect will be the experience in the United States when its housing boom comes to an end, as I suspect it will later this year.