by: Paul Bloxham From: The Australian July 01, 2013 12:00AM
DOOMSAYERS predict that Australia's mining boom will be followed by a bust. Some have even suggested that the end of the boom could see Australia's overall living standards fall or cause a recession.
While a recession can never be ruled out, the end of the mining investment boom is unlikely to play out this way. Indeed, it seems rather perverse to think that, after investing in significant capacity to produce commodities in great demand by the rest of the world, such as iron ore, coal and liquefied natural gas, we would suffer a recession just as that capacity comes on line.
It is not as though Australia's growth in recent years has been driven by a binge of credit-fuelled consumer overindulgence or by firms hopped up on leverage. Indeed, there have been few signs of "irrational exuberance" in the broader economy. Activity in much of the economy has been crowded out by the mining expansion, and inflation and wage growth have been low outside the mining sector.
Growth has largely been driven by multinationals building capacity to produce iron ore, coal and LNG for emerging Asia. This is hardly the typical recipe for economic weakness - unless, of course, too much capacity has been built - but we are of the view that this also seems unlikely.
True, Asia's growth is slowing and so is China's. But these economies are still expected to grow at impressive rates compared with the West. These economies are also much larger than they used to be, so an increment of growth is a much bigger deal for the global economy than before.
More importantly, these economies are still at the commodity-intensive stage of their development. For every increment in new economic activity, the amount of commodities required to drive that growth will rise. Unlike in the West, where the services sectors dominate growth, these economies are still urbanising and industrialising and so need to keep building infrastructure. Our own estimates suggest that as a country moves from low income levels of about $US3000 a person to upper middle income levels of about $US20,000, its demand for commodities accelerates as more housing, buildings, bridges and subway systems are needed.
Back in the 1980s and 90s only 20 per cent of global output came from countries in this income range. Now, over 40 per cent of global output comes from countries that are at the commodity-intensive stage of their development. Indeed, global growth is dominated by these countries.
Even China still has a long way to go. Its urbanisation rate is still only 52 per cent, compared with about 75 per cent in the US.
In China, 18 million people move from rural areas to the cities every year and more infrastructure is needed to meet this demand. The Reserve Bank of Australia estimates that demand for iron ore will not peak until 2020 on the basis of the expected growth in China's housing demand alone.
The story extends beyond China to across the Asian region. Recent work by my HSBC colleague Ronald Man shows that $US11 trillion (70 per cent of the US economy) needs to be spent on urban infrastructure in Asia by 2030 as 650 million people are expected to move to the cities. Countries where a lot of building needs to be done include India, Indonesia and The Philippines. This is positive for Australia's medium-term prospects.
It is also important to keep in mind that three-quarters of the investment in Australia in recent years has been in capacity to produce LNG. The Australian government projects that LNG exports will rise about 400 per cent over the next five years. Quite simply, Australia's resources story is not just about Asia's roads, buildings and bridges, but also about how much people will use toasters, refrigerators and televisions. Australia is set to become a huge exporter of gas. Consumption patterns in Asia are already changing rapidly as the middle classes expand and as this happens energy demand will rise.
Another concern of the doomsayers is that the global supply of these commodities will increase so there could be a glut, which might force down global prices and reduce incomes in Australia. But we are also fairly well placed on this front. Australia is a low-cost producer of a range of commodities, which should ensure that even if commodity prices fall, export volumes will still rise strongly. Australian mining operations should continue to be profitable, even if less so than when commodity prices were higher. This is particularly the case for iron ore and also holds for the bulk of Australia's coalmines.
For LNG, the story is even more secure because the gas from the capacity expansion is largely forward sold on long-term contracts. This should mean that the next stage of Australia's mining story is more predictable.
While it seems fashionable to be pessimistic about Australia's growth prospects, we remain cautiously optimistic. Though Asia's growth is slowing, it is still expected to significantly outpace the western economies. Being strongly tied to Asia has helped Australia's economy in recent years and we see no reason why this should change.
Paul Bloxham is chief economist at HSBC Australia.