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Australia's two-speed economy will have to adapt to meet shifting demands from China and India in the 21st century, the Secretary to the Treasury has told a packed audience at The University of Western Australia.

Dr Martin Parkinson PSM was speaking at the Shann Memorial Lecture, an annual event held in honour of the late Professor Edward Shann and supported by The University of Western Australia Business School and the Economic Society of Australia (WA).

During the lecture, Dr Parkinson identified four long-term trends facing the Australian economy: continued globalisation, rapid technological innovation, demographic change, and environmental pressures.

The first of these trends - globalisation and the development of emerging market economies - will mean that the Asia-Pacific region will no longer be solely driven by its quest for minerals and resources, but will also boast the largest middle-class market in the world.

‘We need to take the decisions that will allow us to succeed in this new world,' argued Dr Parkinson. ‘By 2020, the Asia-Pacific region could have more people in their middle class than the rest of the world combined.'

Using estimates from Treasury and the International Monetary Fund (IMF), Dr Parkinson predicted that China's share of world domestic product would overtake the United States' share by the end of the decade, and that India would overtake the United States by 2050.

This will provide opportunities for Australia in areas such as education, tourism, and high-end consumer goods.

The boom that wasn't

While the mining boom has increased Australia's real gross national income (GNI), the two-speed economy has meant that the benefits have not been evenly felt by all households.

‘With the rise of China and India, the global demand for resources and energy has outstripped the rise in global supply, resulting in a sharp rise in global resource and energy prices,' explained Dr Parkinson.

Combined with the growth of Chinese low cost manufacturers, ‘this has resulted in Australia's terms of trade reaching their highest sustained level in 140 years,' Dr Parkinson said.

In practical terms, this means that due to supply and demand factors, Australia can now buy increased imports with the income it receives from exports.

Dr Parkinson predicted that over the next two years, the mining and related metals manufacturing sectors (which comprise 12% of the Australian economy) will grow by around 10% per annum. Mining-related construction, services, manufacturing and transport sectors (8-10% of the economy) will grow by around 30% in 2011-12, and then 20% in 2012-13. The remaining non-mining sectors will, he estimates, grow at around just 1% annually over the next two years.

The difference between sectors is stark. It can be accounted for by several factors, says Dr Parkinson: ‘the impact of the terms of trade on the exchange rate and competitiveness, the lingering effects of the global financial crisis including the cautious consumer, and Australia‘s decade-long productivity performance.

‘Since March 2003, real gross national income (GNI) has grown significantly faster than real gross domestic product (GDP), by around 14%. The improvement in the terms of trade has in fact accounted for around 40% of total real national income growth since early 2003.

‘Is this sustainable? Eventually no, but when this is likely to be the case remains unknown.'

Until then, higher mineral prices mean that real producer wages in the mining sector are decreasing, leading to increased employment and higher wages paid to employees in the sector. Unrelated sectors, however, are suffering. Real producer wages are going up, making employment growth subdued.

‘In this regard, real consumer wages (that is wages deflated by the CPI) in the mining and construction sectors have grown strongly, increasing by around 20% since the beginning of the boom,' explained Dr Parkinson. ‘On the other hand, real wages in the manufacturing sector have grown much slower since the beginning of the boom, and actually fell over the past year.'

Australia's higher terms of trade, brought about by the mining boom, should have resulted in higher purchasing power for households. Yet this has not happened.

Dr Parkinson argued that the manufacturing sector needs to invest in innovation to remain competitive and ensure wage growth.

‘Part of the challenge for us has to be to help manufacturing firms move up the value-add chain, and you don't do that by hand-outs,' he said.

‘You do that by investing in innovation, creating the sorts of flexible markets they need and ensuring that you bring the innovative edge, to the manufacturing community.'

Shaping the future

To ensure the wellbeing of Australia over the longer term, Dr Parkinson argued that policies must be developed now. ‘I believe the theme of sustainability will need to shape the approach to policy development of this generation,' he said.

Each generation, he argued, should bequeath to the next an equal or increased amount of stock capital, which includes physical and financial capital, human capital (productive skills, knowledge and health), environmental capital (natural resources and the eco-system) and social capital (individual rights, sense of community, networking within individuals and among communities, strong institutional structure and trust base - all concepts necessary for an open and competitive economy).

‘Running down the stock of capital in aggregate diminishes the opportunities for future generations. In one way or another, eroding the productive base will lead to lower future wellbeing,' said Dr Parkinson. He held that if one component of the capital stock is eroded it should be at least compensated by increasing the other capital components. That is, if natural resources are eroded to take advantage of the favourable terms of trade at present then the returns from trade should be invested in developing physical and financial assets and human and social capital so that at least current level of wellbeing can be sustained for future generations.

Far-reaching consequences

Dr Parkinson, who served for more than three years as inaugural Secretary to the Department of Climate Change and Energy Efficiency, said that Australia is not getting sufficient return on its environmental capital.

‘Water and carbon are not yet priced appropriately,' he argued. ‘In the case of minerals and energy, arguably society is not sharing sufficiently in the returns from their exploitation, with the vast bulk of the benefits accruing to the shareholders of the firms doing the mining. As such, society is not getting the resources it would need to build up other parts of its capital stock.

‘Unsustainable growth cannot continue indefinitely - if we reduce the aggregate capital stock in the long run future generations will be made worse off. The problem is that we can be on an unsustainable path for a long period - and by the time we recognise and change, it could be too late.

‘Climate change policy - both in relation to adaptation and mitigation - is not just an environmental issue; it is more fundamentally an economic and social challenge.

‘To an economist, climate change is fundamentally a risk management issue. Even if you do not accept all elements of the science, prudence suggests taking out some form of insurance.

‘We also need to remind ourselves, and others, that if no-one acts first we all lose. But more so - unless we all act, we all lose in the end... Moreover, to suggest Australia should do nothing because we are only 1.5% of emissions suggests that most countries should do nothing - not Indonesia, not the UK or France.'

Dr Parkinson reminded his audience that 89 countries have made pledges under the Cancun Agreements, and that these countries account for 83% of global carbon emissions.

An ageing population, a pressured economy

Economists can't afford to ignore Australia's ageing population.

‘The proportion of the population aged 65 and over has increased from just over 8% in 1969 to around 13% today,' said Dr Parkinson. ‘The 2010 Intergenerational Report (IGR) projected that by 2050 the proportion of the population aged 65 and over would rise to around 23%.'

Increased government spending - on healthcare, aged care, and pensions, is inevitable. ‘As a consequence, spending [is] projected to exceed revenue by 2.75% of GDP in 40 years' time,' said Dr Parkinson.

Older Australians choosing to stay in the workforce longer, said Dr Parkinson, could have a positive impact on the budget. ‘If our participation rate in 2049-50 turns out to be 57% rather than the 60.6% we are currently projecting, real average annual GDP growth will fall by a further 0.11 percentage points. This small change in the participation rate will also lead to increased spending in the order of 0.9% of GDP in 2049-50 (or around $33 billion in 2010-11 terms) on health care, aged care, pensions and education, putting further pressure on the budget,' he said.

With numbers this large, it is clear that something is changing. And with careful economic management, this could be a change for the better.

The full transcript of Dr Martin Parkinson's speech, ‘Sustainable wellbeing - An economic future for Australia' is available from: www.treasury.gov.au/contentitem.asp?NavId=008&ContentID=2134. An audio recording is available from: https://lectopia.uwa.edu.au/lectopia/lectopia.lasso?ut=2200&id=160264 .

Media references

Heather Merritt
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UWA Business School
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Verity Chia
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UWA Business School
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