Here’s why Australia’s reliance on commodities is unhealthy

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Of the four engines driving Australia’s post-pandemic recovery, all but commodity prices are spluttering. Government spending, which has more than offset the losses from the Covid-19 recession, is likely to be reined in to repair public finances. Consumption, which has been driven by a combination of pent-up demand and excess savings during lockdowns, is affected by inflation pressures and uncertainty.

Housing – both construction activity and the wealth effect of higher property prices encouraging spending – is now slowing because of the end of subsidies and higher interest rates.

This leaves Australia largely dependent on the remaining motor – commodity exports – for economic propulsion. Australia’s terms of trade (the ratio of export prices to import prices) reached record highs in the first quarter of 2022, benefiting from Chinese infrastructure spending and supply shortages created by the war in Ukraine.

But this reliance on commodities is unhealthy, for a number of reasons.

Commodity prices are volatile

Over recent years, iron ore prices have fluctuated between US$40 and US$210 a tonne; thermal coal prices between US$50 and US$410 a tonne; and natural gas prices between US$1.30 and US$14 per metric million British thermal units.

Overzealous demand projections, overinvestment, competition and politics create boom and bust cycles. Economy activity and government finances are vulnerable; for example, a US$10 a tonne fall in iron prices decreases Western Australia’s royalties by around A$800m per annum and Australian tax receipts by around A$3.7bn.

Commodities are finite and competition exists

Barring new discoveries, economic reserves at current production rates are about 55 years for iron ore, 120 years for coal and 44 years for liquefied natural gas. Given the energy transition and likely taxes or levies on carbon-intensive imports, Australia’s fossil fuel assets may never be fully exploitable.

Despite natural advantages, Australian exporters face competition from other producers. With no national allegiances, global resource companies source product from alternative operations with lower cost structures, weaker environmental protections and less onerous regulations. The reliance on commodity exports also makes Australia reliant on major purchasers such as China.

The economic benefits are overstated

Mining only directly accounts for about 250,000 jobs, or 2% of the total workforce. Most local jobs are during construction, although skill shortages and often remote locations mean that foreign workers are used. Operation requires few workers because of the high levels of mechanisation and automation.

Imported capital equipment is also required to develop and operate mines. For most of recent history, Australia’s external account has been in deficit requiring overseas money to finance the gap.

Australian resource companies are more than 80% foreign-owned and most of the earnings flow overseas. Large write-offs, depreciation, capital allowances and avenues for cross-border planning limit local tax receipts.

A dominant resources sector distorts the economy

This is known as the “Dutch disease”, when a focus on one sector leads to a decline in others. Mining monopolises capital and workers, pushing up costs and the currency and undermining a country’s competitive position. A high Australian dollar disadvantages agricultural and services exports, encourages imports, discourages foreign tourists, and makes it attractive for Australians to holiday abroad.

Resource dependency rarely features in policy discourse. Instead, the uncertain future of fossil fuels has generated enthusiasm for raw materials needed for low-emissions technologies, such as lithium, nickel and copper, as well as zero-carbon fuels such as green hydrogen.

The shift brings different problems.

Lithium production can be water-intensive placing pressure on Australia’s available supplies. The production of copper and nickel is energy intensive and environmentally damaging when the full production chain is considered. Direct exports of renewable electricity via underwater cables or green hydrogen fuel require technologies not yet economically viable.

Most importantly, the switch to new commodities, many of which are non-renewable, does not address the fundamental issues, exchanging one dependence for another.

Australia’s resource dependency is compounded by the fact Australia persistently misuses this income. It is channelled into consumption and tax cuts instead of savings, public goods, investments or a new industrial base.

The proceeds of booms could be saved to smooth out commodity price cycles or to invest for a post-mineral future. Options include a sovereign wealth fund or legislation, such as Chile’s fiscal responsibility law, which restricts governments from spending temporary mining revenue windfalls. Australia’s Future Fund does not perform these functions, being designed to fund public sector superannuation liabilities.

Such ideas are unpopular with shortsighted governments keen to control commodity windfalls to further political agendas, but future generations might curse their forebears for the repeated failure to use the bounty of mining booms to secure the country’s future.