Australian Government, 2011‑12 Budget
Budget

Statement 4: Opportunities and Challenges of an
Economy in Transition (Continued)

Things to come: the mining boom and beyond

The next phase in Australia's economic evolution will be profoundly influenced by the continuing shift of global economic activity towards Asia. The rapid industrialisation and urbanisation of Asia have driven global demand for Australia's mineral and energy resources. Australia's natural advantages, relative proximity, and the skills and capabilities of the workforce, have given it a head start in capitalising on opportunities that will flow from this transition.

Yet the implications of the rise of Asia will not be limited to demand for Australia's resources. The mining boom is just the first manifestation for Australia of this change in the world's economic geography.

At some point in the coming decades, the majority of the global middle class will be living in the Asia‑Pacific region — especially in China and India. Their re‑emergence will have a major and lasting effect on how Australia does business in the 21st century — well beyond the current mining boom. As China and India continue to develop, the growing cities which are now driving high demand for Australia's mineral resources will be populated by an increasingly wealthy and upwardly mobile middle class. Like the mining boom, these developments will have a profound influence on the shape of the Australian economy into the future.

Mining boom mark II

The current phase of the mining boom shares many of the characteristics of mining boom mark I. However, there are a number of features which will set the next phase of the mining boom apart (Statement 2). These differences mean that some of the challenges associated with mining boom mark II will play out differently.

The terms of trade, and so mining activity, are expected to remain at historically high levels for an extended period. However, this time around, the magnitude of business investment is set to be even more impressive.

Driven by the mining sector, new business investment is expected to attain 50‑year highs as a share of GDP. This investment boom will be underpinned by a massive pipeline of resources projects planned for the next five years and beyond (Chart 13). The capital expenditure survey of the ABS suggests planned mining investment will reach a record $76 billion in 2011‑12 (ABS 2010e). ABARES estimates that this high level of investment is set to continue, with an estimated pipeline of resource investment of over $380 billion (ABARES 2010).

Chart 13: Indicative profile of mining projects (planned or under construction)

This chart shows that, based on the value of mining projects committed to, under construction or under consideration and an indicative profile of investment, mining investment is set to almost treble between 2009-10 and 2013-14.

Note: Value of projects and investment profiles are based on publicly available information and information received from mining companies through the Treasury's Business Liaison Program. Projects are classified as under construction/committed ($149 billion) and under consideration ($232 billion). Where no information is available on timing, the profile of a 'typical' resource project is assumed — beginning in 2011‑12, with 5 per cent of investment in the first year, followed by 15 per cent, 25 per cent, 35 per cent and 20 per cent in subsequent years. These estimates may fluctuate as profiles change, new projects come under consideration and/or existing projects are cancelled.

Source: ABS 5625.0, ABARES (2010) and Treasury.

Despite its capital intensity, labour and other inputs will continue to be drawn to the mining sector to support increasing levels of activity. Together with the long‑term expansion of the sizable labour‑intensive services industries, demand for large numbers of highly skilled workers is likely to strengthen.

As was the case at the start of mining boom mark I, there is some existing capacity to meet the growing labour market demands (Chart 14), albeit to a lesser extent given the lower rate of unemployment and the higher rates of participation in this phase of the boom.

Chart 14: Ratio of short‑term unemployment to total employment, by occupation

This chart shows that, in February 2011 (following the global financial crisis),  the ratio of the number of short-term unemployed and total number employed across most skills has reverted to levels broadly similar to February 2004.

Note: Excludes those unemployed for more than two years and those who have never worked for more than two weeks. 'Other white collar' includes workers in community and personal services, clerical and administration and sales. 'Other blue collar' includes machinery operators, drivers and labourers.

Source: ABS 6291.0.55.003 and Treasury.

While pressures associated with approaching capacity constraints are again expected to increase as unemployment continues to fall, another difference is the higher exchange rate. At the beginning of the first phase of the mining boom in 2003, the real exchange rate (in terms of the trade‑weighted index) was at a level comparable to its average since the floating of the Australian dollar. In contrast, it is now around 40 per cent above its post‑float average.

The stronger starting point for the dollar may mean that the effect on other trade‑exposed sectors of the economy is more pronounced and may also affect the nature and pace of the rise in skills shortages in particular areas of the economy. In addition, with the terms of trade expected to remain at historically high levels for an extended period, these implications are likely to be played out well into the foreseeable future — reflecting a prolonged shift in Australia's comparative advantage.

Given the adverse effect a high exchange rate can have on other trade‑exposed sectors, there are understandable concerns about the possibility of the mining boom leading to long‑term economic underperformance — a phenomenon often called 'Dutch disease'.

If the high exchange rate proves to be long‑lived, there can be concerns over a loss to the economy of skills, value-adding and expertise that would otherwise have provided spillover benefits to other industries. Another concern associated with Dutch disease is that if a spike in the real exchange rate proves to be temporary, other tradable sectors that have suffered will not simply rebound to previous levels.

However, international evidence suggests that these concerns around Dutch disease are overstated and tend not to apply to advanced countries, which typically have policy and institutional settings conducive to the accumulation and development of investment, skills and expertise, and there is no evidence that Dutch disease reduces overall economic growth (see IMF 2010, Davis 1995, Larsen 2003 and 2006, Gylfason 2006, Statement 4 in Budget 2010‑11 and Box 4). These countries have capitalised on the expertise gained in their resources sectors and converted them into new economic opportunities.

Resource sectors in advanced economies tend to be highly skilled and generate their own spillovers — stimulating other industries as well as driving opportunities for long term economic growth.

In the case of Norway's oil boom, for example, Larsen (2006) finds little loss in spillovers since the 1970s, with any losses being substituted by gains in offshore oil extraction technologies. Norway has managed to maintain a well functioning non‑oil traded goods sector (Larsen 2006) and Norwegian manufacturing has benefited from the impact of higher oil revenues (Bjørnland 1998). For Finland, despite being a country rich in forestry resources, its share in forestry‑related machinery and equipment in world markets is larger than its share in wood, paper and pulp (Gylfason 1999).

For Australia, there is evidence of similar developments. Despite mining being 9 per cent of GDP in 2008‑09 (ABS 2010f), mining's share of total business expenditure on research and development (R&D) was at around 25 per cent (ABS 2010g) — suggesting that Australian mining is highly intensive in the development and use of knowledge, expertise and innovation.

Australia's mining technology services and equipment sector is also recognised as a leading supplier to miners globally (Tedesco and Haseltine 2010). In 2008‑09 it employed over 30,000 people and generated $8.7 billion (0.7 per cent of GDP) in revenue, with about 30 per cent of this coming from exports. These firms have a wide range of capabilities — many of which have applications beyond mining — including software design, technical consulting, equipment and machinery, automation systems, drilling, metallurgy, surveying, research and mining engineering services.

Box 4: Did the Dutch suffer from Dutch disease?

The potential for a commodity boom to have implications for other industries through the real exchange rate was first formalised and pointed out by Australian economist Bob Gregory in the 1970s (Gregory 1976 and Corden 2006). This effect was subsequently called 'Dutch disease'. While Australia's terms of trade can be expected to remain at historically high levels for some time, one concern around Dutch disease is that if a commodity boom proves to be temporary then those trade‑exposed sectors that have been negatively affected will not simply reappear or rebound, negatively affecting long‑term growth.

International evidence suggests that these concerns around Dutch disease tend not to apply to advanced countries. It is possible for these countries, with the right institutions and policy settings, experiencing a temporary surge in their resources sector to reverse boom induced structural adjustments.

This was the case even in the Netherlands (Chart 15). Dutch manufacturing declined during an intense period of energy resource extraction. This period of intense resource production ended in the early‑ to mid‑1980s, coinciding with an international economic downturn. Subsequently, Dutch manufacturing exports rebounded, both as a share of GDP and as a share of total exports. Manufacturing exports continued its resurgence in the 20 years following the Dutch disease period — reaching nearly 40 per cent of GDP and around 70 per cent of total exports in 1997. This period was also matched by solid long‑term per capita GDP growth — matching and, for long periods, exceeding average growth in the OECD.

Chart 15: The Netherlands, real GDP, manufacturing and fuel exports

Manufacturing and fuel exports

This chart shows that, for the Netherlands, manufacturing exports as a share of GDP rebounded in the 20 year period after a intense period of natural resource extraction. Manufacturing exports as a share of GDP rose to close to 40 per cent in the late 1990s.

Real GDP per capita(a)

This chart shows that real GDP per capita rose in line with, and often faster than, the OECD-24 average in the 1980s and 1990s.

  1. Purchasing power parity adjusted GDP.

Source: World Bank World Tables, Conference Board Total Economy Database and Treasury.

The burgeoning global middle class

The mining boom is an early manifestation for Australia of the shift in the world's economic geography from west to east. As China and India continue to develop, the growing cities now driving demand for Australia's mineral resources will be populated by an increasingly wealthy and upwardly mobile middle class, with incomes and tastes to match. Increasing consumer purchasing power and changing spending patterns will open up new, often unforeseen, opportunities for Australia — well beyond those flowing from the current mining boom. However, this will also bring a new set of challenges.

While recent studies differ on exactly how to define, measure and forecast the global middle class, the common thread is the sheer magnitude of the income shifts in Asia which have occurred and will continue to occur.

Using the average poverty line in Portugal and Italy as the lower bound for its measure of the global middle class, one prominent study (Kharas and Gertz 2010) estimated that the number of middle class consumers in Asia could increase by more than 1.2 billion people by 2020. If borne out, these projections would mean that by the end of this decade Asia would have more middle class consumers than the rest of the world combined (Chart 16), with China surpassing the US as the world's single largest middle class market in dollar terms. By 2030, with India following China's lead, the world could have gone from mostly poor to mostly middle class, with two‑thirds of the world's middle class consumers living in the Asia‑Pacific region.

Chart 16: Projection of the global middle class by region, persons

This chart shows that the number of middle class consumers in the Asia Pacific region could increase by more than 1.2 billion people by 2020. By 2030, with India following China’s lead, two thirds of the world’s middle class consumers living in the Asia Pacific region.

Source: Kharas and Gertz (2010).

These projections inevitably rest on assumptions about future productivity and population growth, and the trends they suggest are not assured. In China and other emerging economies, the process of structural reform to facilitate progress will not be easy. Change will take place over decades rather than years, and there will be setbacks along the way. However, near‑term growth paths suggest that the continued sharp rise in the Asian middle class is the most likely scenario.

Consumption patterns change as incomes rise

Looking at the ratio of consumption to GDP over time can provide insights into how consumer spending patterns evolve as an economy develops (Chart 17).

In poorer countries, spending on basic goods typically accounts for a higher share of income, with household incomes barely covering spending on the necessities of life. However, in the early stages of development and incomes growth, the ratio of consumption to GDP can fall quite sharply, especially if there is a surge in investment.

In time, with continued income growth, a larger middle class devotes more money to purchasing luxury goods and services, both in absolute terms and as a share of their total spending. As a result, the ratio of consumption to GDP typically tends to increase as economies reach, and surpass, middle income status.

This process has been evident in the recent experience of Japan, Korea and other major Asian economic success stories of the past half century. The ratio of consumption to GDP declined as incomes grew at lower levels before picking up again as these economies grew towards high income status.

In contrast, China's consumption to GDP ratio has declined markedly over recent decades during the early, investment‑led stages of its economic re‑emergence, reaching a low of only 35 per cent of GDP in 2009. However, China is fast approaching income levels where consumption often turns, and the Chinese government is focused on reforms to foster higher incomes growth and rebalance the economy towards domestic demand. There is considerable scope for a strong rise in the ratio of consumption to GDP in the medium term.

This shift in consumption patterns also manifests in the composition of household consumption. For the earlier industrialisers like Japan and Korea, the composition of consumer spending has evolved in tandem with its increasing size, with consumers devoting relatively more of their growing incomes towards services and consumer durables in recent decades.

Chart 17: Private consumption as a share of GDP

Selected Asian economies

This chart shows that, for a number of advanced Asian economies, consumption as a share of GDP fell in the early stages of their economic development (that is when their real GDP per capita was low). As real GDP per capita rose further and approached middle income status, consumption to GDP would pick up. The consumption to GDP ratio of China and India are still falling given the early stage of their economic development.

China and India(a)

This chart shows that, for a number of advanced Asian economies, consumption as a share of GDP fell in the early stages of their economic development (that is when their real GDP per capita was low). As real GDP per capita rose further and approached middle income status, consumption to GDP would pick up. The consumption to GDP ratio of China and India are still falling given the early stage of their economic development.

  1. Data for India is for financial years.

Note: Purchasing power parity adjusted GDP.

Source: National statistical agencies, World Bank, Conference Board Total Economy Database and Treasury.

More recently, the early stages of a similar shift in the pattern of consumer spending are already evident in China (Chart 18). Since the early 1990s, growing incomes and overall consumption across each of the urban income groupings have been accompanied by shifts away from basic goods and towards the goods and services associated with higher income levels.

In the poorest urban households in China, between 1994 and 2009, the portion of per capita spending devoted to food fell from 61 per cent to 47 per cent. For the wealthiest households, the share of spending on food fell from 42 to 31 per cent. Similar falls were evident across the middle income groupings. The share of spending for clothing, like food, also fell across the board.

Correspondingly, across each group, China's urban consumers have generally dedicated a greater share of total spending over time to residences, medical services, transport and communication, and educational, recreational and cultural services. The largest shifts towards the latter two categories have occurred in the higher income groups.

Chart 18: China's urban consumption structure by income groupings

Food

This chart shows that, as incomes have risen in China over time, urban households across income groups have generally shifted more of their consumption away from more basic goods like food towards higher order goods and services like health, education, travel and recreation.

Medical services

This chart shows that, as incomes have risen in China over time, urban households across income groups have generally shifted more of their consumption away from more basic goods like food towards higher order goods and services like health, education, travel and recreation.

Transport and communication

This chart shows that, as incomes have risen in China over time, urban households across income groups have generally shifted more of their consumption away from more basic goods like food towards higher order goods and services like health, education, travel and recreation.

Education, recreation and culture

This chart shows that, as incomes have risen in China over time, urban households across income groups have generally shifted more of their consumption away from more basic goods like food towards higher order goods and services like health, education, travel and recreation.

Note: Figures based on per capita consumption expenditure data for eight urban household income groupings.

Source: CEIC China database and Treasury.

Asia's rise will generate opportunities as well as challenges

The path of development taken by Japan, Korea and a number of other Asian economies has already had a distinct impact on Australia's pattern of trade. A key difference which sets the current and future phases of the rise of the Asian middle class apart is the size of the Chinese and Indian populations. The growth in China's middle class is still in its early stages and India remains some way behind China by almost all indicators. Yet as these giants continue to grow and as the preferences of their people change — in favour of goods and services associated with higher income levels like consumer durables, culture, tourism and advanced education — the potential size and depth of global consumer markets is vast.

An appreciation of the potential scale of these emerging consumer markets can be gained from the rapid rise in the ownership of consumer durable goods in Chinese urban households — a sizable and growing proportion of the 400 million households in China (Chart 19). Between 2000 and 2010, the number of automobiles per 100 urban households in China is estimated to have risen from less than one to more than 12; the number of mobile phones from 16 to 188; computers from eight to 70 and the number of microwave ovens from 16 to 58. While rates of growth between different consumer durables vary, similar patterns are evident across a whole range of goods — with growth especially strong for 'new technology' goods.

Chart 19: Number of consumer durable goods for urban households, China

This chart shows that, between 2000 and 2010, the number of automobiles per 100 urban households in China is estimated to have risen from less than one to more than 12; the number of mobile phones from 16 to 188; computers from eight to 70 and the number of microwave ovens from 16 to 58.

Source: CEIC China database.

This potential scale can also be seen in China's and India's sizable and increasing share of world outbound tourism over the past 15 years (Chart 20). While countries like the US, UK and Japan have been the more traditional sources for outbound tourism, the number of people departing from China and India for international travel and tourism has risen dramatically. In 1995, around 4.5 million residents from mainland China and 3 million from India travelled abroad for business and leisure. By 2009, outbound tourism from China had increased tenfold (to 48 million) and was close to catching up with the US and UK, while India had experienced a three‑ to four‑fold increase (to 11 million).

The emergence of a large global middle class will generate demand for a sizable array of goods and services. Nevertheless, it is not possible to forecast the exact mix of goods and services that will be demanded in the future, let alone the shape of the global economy that will best service these demands. Technological advances are also likely to lead to major, often unforeseeable, shifts in consumer spending — as seen in the rapid rise in spending on newer technologies.

Chart 20: Outbound tourism, resident departures by country of origin

Chart 20: Outbound tourism, resident departures by country of origin

Note: Figures for China include travel to Hong Kong, Macau and Taiwan.

Source: United Nations World Tourism Organisation.

Some non‑mining benefits are already evident

While not all opportunities from these emerging markets necessarily fall within areas of Australia's comparative advantage, some of the benefits from the rise in the Asian middle class are already evident.

Education is the largest of Australia's services exports. The number of international students studying in Australia from Asia, in particular from China, India and the ASEAN‑5, has grown strongly (Chart 21). As a result, education exports to China and India as a share of total education exports have risen sharply. A similar pattern can be seen for Australia's wine exports, where China's share is now five times larger than it was five years ago.

Chart 21: Australia's education exports

Student visa grants

Chart 21: Australia's education exports - Student visa grants

Share of total education exports(a)

Chart 21: Australia's education exports - Share of total education exports

  1. 'Education related travel services' by country (which include fees and other spending from international students studying onshore) as a share of total education related services exports.

Note: NIEs include Hong Kong, Korea, Singapore and Taiwan. ASEAN-5 consists of Indonesia, Malaysia, The Philippines, Thailand and Vietnam.

Source: DIAC, ABS 5368.0.55.003 and Treasury.

Additionally, China and India already make up an increasing share of international tourism in Australia (Chart 22).

Chart 22: International arrivals to Australia by country

Number of arrivals

Chart 22: International arrivals to Australia by country - Number of arrivals

Value of inbound leisure(a)

Chart 22: International arrivals to Australia by country - Value of inbound leisure

  1. June quarter 2010 dollars.

Source: Tourism Research Australia (2010).

While the number of tourists from traditional markets like Japan has declined substantially over the last decade, those from China and India have grown. Arrivals from China have more than trebled, overtaking Japan in 2008‑09 and are now close to catching up with those from the US. Despite the strong Australian dollar, growth in arrivals from China and India is likely to continue given the strong income growth in these emerging markets (Tourism Research Australia 2010).

To maximise the opportunities that will flow from the rise of the global middle class, Australia needs to continue to change and innovate in order to compete on the global stage. Notwithstanding the recent strong performance in education, tourism and a range of other exports to these emerging consumer markets, competition will be fierce. As China and India grow and develop, and as they catch up to the global technological frontier, the size and quality of their domestic education sectors is also likely to improve. Their reliance on foreign education providers may therefore ease, with a greater proportion of their education spending shifting to domestic sources.

Similarly, as emerging countries improve their tourism infrastructure, they will provide fierce competition for global tourism spending. Australia has a highly developed tourism sector characterised by rich natural endowments, excellent infrastructure and institutional stability. Yet other countries, often in addition to a rich natural and cultural heritage, are typically abundant in labour as well and are able to deliver high quality tourism services at relatively low cost.

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