A couple of years ago, I gave a speech in which I responded to Professor Ross Garnaut’s 2013 claim that, with the end of the mining investment boom, the Australian economy faced a hard landing (or ‘dog days’ in Ross’s parlance) in the absence of bold productivity-enhancing reform, because the unprecedented size of the downswing in mining investment would prove too disruptive for the domestic real economy and the labour market to absorb.^[1]

At the time of my speech (mid 2014), my view of the transition was cautiously optimistic, or as I put it: ‘so far, so good’. But that was early in the mining investment downswing, and it is of interest to re-visit that conclusion with the benefit of a further two-and-a-half years of lived experience, which has put us in sight of the end of the investment downswing.

So as not to keep you in suspense, my punchline is that this further two-and-a-half years has been kind to the cautiously optimistic view. While it is always possible to find ways in which economic outcomes could have been more favourable, in aggregate the Australian economy has adjusted remarkably well to what has been an extremely large shock – certainly the Australian economy has suffered substantially less disruption than the economies of the other major commodity exporting countries.  

My presentation today involves running through a series of charts which puts the boom in context, and provides a sense of how the economy has coped with the biggest shock of its kind in Australia’s economic history.

Let me begin by reminding you how big this boom has been. The first two charts continue to amaze me, even though I have watched as they have evolved over the past several years.

The terms of trade boom we have just lived through is easily the biggest sustained boom in our history, as the 5-year centred moving average in Chart 1 makes abundantly clear. It has now been five-and-a-half years since its peak in the September quarter 2011, with the terms of trade having fallen by over 30 per cent since then.

As is widely understood, the boom was largely a consequence of big rises in the prices Australia received for many of its mineral commodity exports. What is less frequently commented upon, but was also a feature of the boom, was the significant rise in the price of a range of rural commodities. Both these developments owe a lot to rising demand from China and, to an increasing extent, India and Indonesia, as they continue their development, urbanisation, and strong growth of their middle classes, with rising disposable incomes to match.

Resources investment increased from less than 2 per cent of GDP before the boom to around 9 per cent in 2012-13. This resulted in something like a quadrupling in the capital stock in the resource sector, and a tripling in the sector’s productive capacity in the space of a decade. The largest investment was in LNG production capacity, with Australia on track to overtake Qatar as the world’s largest sea-based exporter of LNG. The economic activity and employment that accompanied the investment boom drove a significant reallocation of labour across industries that is now being unwound as investment projects reach completion.

Developments in per capita incomes have been almost as striking as those in the terms of trade and resources investment. The terms of trade boom provided a sizable boost to income growth in the 2000s, sustaining strong growth in per capita incomes. This was in the context of weaker labour productivity growth than we achieved in the 1990s and a weaker contribution from rising labour utilisation than we achieved in the 1980s.

In the years since its peak in 2011, the terms of trade have detracted from income growth by so much that, even with reasonable labour productivity growth, gross national income (GNI) per capita has been falling. This has also been reflected in gradually falling real average earnings per hour across the economy over the past four years, for the first time in living memory.

It is as well to recognise that this anomalous behaviour of income and earnings growth is overwhelmingly driven by the rapid decline in the terms of trade Australia experienced over this time. With an end to the trend decline in the terms of trade now in prospect, positive real income growth should return – with its rate of growth again strongly influenced by the rate of labour productivity growth.

The adjustment of real wages across industries has supported the economic adjustment. Relative wages adjusted more freely over this boom than was possible in earlier decades, resulting in less disruption to the real economy and, importantly, the labour market.

As the resources boom gathered strength from around 2004, strong demand for labour in the resources, construction and professional services sectors saw wages strengthen relative to those in other sectors. And then, as the boom receded after 2011, wage growth in these sectors slowed to less than the average, enabling the wages in other sectors to catch up somewhat. This pattern seems likely to continue as the resources investment downswing continues to run its course.

As the boom has receded, overall wage moderation (with gradually falling real earnings as shown in Chart 4) has provided strong support for employment, and helped translate the sizable nominal depreciation of the exchange rate into a real depreciation, which has been crucial for the rebalancing of the economy.

The sort of relative wage adjustment shown in Chart 5 didn’t occur in the 1970s or early 1980s, and the result was significant increases in unemployment – an outcome we’ve succeeded in avoiding during the latest episode.

Patterns of employment growth across sectors have mirrored changes in the economy. It is revealing to split the past decade into the five years leading up to the terms of trade peak, 2006-11, and the five years since, 2011-16.

Service sectors (health care, professional services and education) have seen strong employment growth over both five-year periods. Unsurprisingly, employment in the resources sector expanded strongly in the first five-year period, but not subsequently. Manufacturing saw a fall in employment over the first five-year period (small in percentage terms), a result of both strong productivity growth reducing the need for labour inputs to produce a given amount of manufacturing output, and the strong real exchange rate reducing competitiveness. By contrast, since 2011, employment in manufacturing has risen slightly.

The change in the destination of Australia’s exports over the past decade has also been striking. A decade ago, 11 per cent of Australian goods and services exports went to China; now it’s around 27 per cent, with the higher share predominantly coming at the expense of Japan and the European Union. The share of exports to many other countries in our region has remained broadly stable, as those countries provide some of the primary markets for our coal and LNG exports.

The huge rise in exports to China was initially dominated by iron ore and coal. Since 2013, however, the value of iron ore and coal exports to China has fallen significantly, with big falls in prices dominating significant rises in volumes. At the same time, the fall in the exchange rate has facilitated a significant diversification of Australia’s exports to China, with big rises in the value of rural exports, as well as tourism and education exports.

Let me now conclude with some reflections on the future.

In common with most advanced economies, we are faced with a period of relatively weak labour productivity growth outside the resources sector, and the ageing of the population is gradually reducing labour participation rates. At a fundamental level, the continued shift in economic weight towards Asia, the disruptive effect of new technology, ageing populations, mass people movements across borders, overlayed with the pressures of sustainability are reshaping the global environment and complicating the strategic challenges facing policy makers.

With Asia moving up the value-added chain, there is competition for more service jobs in the global market. Slow global growth and elevated levels of uncertainty have contributed to more moderate economic growth and job creation in Australia.

Forecasts for global growth, like those produced by the IMF, continue to imply a delayed timetable for global economic recovery. The latest forecasts for 2017 and 2018 show a gradual global recovery, though with growth remaining somewhat below trend. It is worth noting, however, that the growth rate of global potential output appears to be markedly lower that before the financial crisis, so that global trend growth is also lower.

In the United States, labour market indicators – in particular, wages growth and the behaviour of quits – suggest an economy now close to full employment, and certainly closer than at any time since the onset of the financial crisis nearly a decade ago. With the US macro-economy therefore in a stronger cyclical position than the Australian economy, it seems likely that US monetary policy will be tightened several times before the Australian monetary authorities see the need to respond similarly.

If that analysis is correct, it seems likely to be accompanied at some point by further significant weakening of the Australian dollar, which should help support the continued rebalancing of the Australian economy.

^[1] I am grateful to Tobias Beckmann and Dan Smith for enthusiastic assistance preparing these remarks, and to Jason McDonald and Nigel Ray for helpful comments.