Mining makes us 6th richest

THE resources boom has given Australia the sixth highest GDP per head in the Western world but most of that comes from temporary causes that will reverse, making high productivity growth imperative for our future, a new report warns.

Global consultants McKinsey points to the resources industry as the main culprit for Australia's poor productivity growth in recent years, saying it is wasting capital by overambitious planning and poor project control.

In a new perspective on Australia's productivity debate, a McKinsey report shifts the spotlight from labour productivity to capital productivity. It says the efficiency with which we use capital has fallen in recent years, putting a brake on growth at a time when mining investment has dominated the economy.

"Capital productivity in mining is the major issue", McKinsey partner Chris Bradley told The Age. "Australia's productivity challenge is to do the major projects better. We're not even halfway through this resources boom. The amount of investment ahead is bigger that what we've seen so far. We have the opportunity now to leverage the experience we've gained in this area to make the second half much better.

"Prices are not going to stay high, in all likelihood, and we're not the only resources player."

The report, Beyond the boom: Australia's productivity imperative, was written by a team headed by McKinsey senior public sector partner in Sydney, Charlie Taylor. It says Australia is one of the "fortunate few" rich countries with good income growth but its causes are transient, and productivity growth must drive the economy in future. The report estimates that most of Australia's income growth between 2005 and 2011 came from one-off factors: mostly rising export prices (the terms of trade) and the boom in capital inputs (mining investment).

While most of the fall in capital productivity had sound reasons the long gestation period of new mines, and miners digging up lower-value seams while prices are high it says capital productivity in new mines could be improved 30 per cent by better timing of projects, using simpler solutions, and making the design fit the budget rather than vice versa.

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Going down. Non-mining investment plummets

BUSINESS investment in the non-mining economy has shrunk to its lowest share of gross domestic product for almost 40 years, as a result of the high dollar and appears set to fall lower still.

The Bureau of Statistics estimates that in the nine months to March, business investment in manufacturing and services such as finance, retailing and IT fell to 4.95 per cent of GDP, its lowest level since 1972-73.

The bureau's quarterly survey, taken in April and May, found companies plan to invest even less in 2012-13. Manufacturers' investment plans were 11 per cent lower than at the same stage last year, while service companies' plans were down 4 per cent.

Even if these plans are upgraded as usual over the year ahead, the survey implied that non-mining business investment would shrink, to about 4.5 per cent of GDP.

That would take it back to levels last seen 60 years ago, in the savage bust that followed the Korean War boom.

The bureau figures were published weeks ago, but escaped attention, as analysts focused on the mining industry's record investment plans. At face value, two-thirds of all business investment in Australia this financial year will be in mining, and just a third in all other industries combined.

The Reserve Bank reported last week that in 2011, more than half of Australia's growth in GDP came from mining investment. Since the entire economy grew just 2.1 per cent, that implies growth in the rest of the economy was barely 1 per cent.

The Reserve voiced concern that the high dollar is doing more damage to the economy than it anticipated. While mining is booming, the Reserve reported that activity in the rest of the economy is subdued.

"In liaison, many firms indicate that they are slowing their investment spending in line with weaker cash flows, and are becoming more selective about which projects to pursue," it said. "Many companies [are] prepared to spend on machinery and equipment investment [only] to the extent necessary to offset depreciation."

The bureau figures show investment by non-mining companies has now slid well below its worst levels in the 1990-01 recession.

Non-mining investment between 1987 and 2000 averaged 6.6 per cent of GDP, as companies built new offices, hotels, retail complexes, or re-equipped factories, truck and car fleets or equipment hire centres.

But since 2010 it has ebbed as mining investment has boomed. Manufacturing investment, which averaged 3.4 per cent of Australia's GDP in the 1960s, has now slumped to less than 1 per cent, with much of that invested to process minerals before export.

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Why BHP wants to be free of unions

BHP Billiton has one key goal in demanding reform of industrial relations law: it wants its managers to be free to manage the business as they see fit.

The issue is not primarily about wages, or productivity, but power. BHP wants to get the unions out of its decision making.

In the wake of BHP chairman Jac Nasser's broadside on Wednesday against the Fair Work Act, the mining tax and Australia's high-cost economy, Employment Minister Bill Shorten hit back, blaming BHP itself for its problems.

"If a company is struggling to persuade its long-standing workforce of the case for change, then perhaps the problem isn't just the law, maybe it's the way the case is being put, and the engagement of the workforce," Mr Shorten said.

The ACTU Congress condemned "BHP's pursuit of safety deregulation, that would transfer vital safety roles from qualified workers on the job to management". It declared support for the 3500 coalmine workers in Queensland's Bowen Basin in their 18-month campaign of industrial action against the BHP Billiton Mitsubishi Alliance (BMA).

BHP sees it differently. The list of complaints in its submission to the review of the Fair Work Act is mind-numbing in detail. Most relate to just one of its five key principles of industrial relations: "management's retention of the ultimate responsibility and right to run the business with employee consultation not elevated to a right of veto over operational decision making".

"BHP Billiton contends that the legitimate sphere of enterprise agreements is entitlements for employees in respect of their wages and conditions of employment," it says. The Fair Work Act, it argues, goes beyond that, to allow "interference with managerial decision making".

The submission was lodged in February, two months before BMA took the drastic step of closing its Norwich Park coalmine, in part due to industrial action led by the Construction, Forestry and Mining Employees Union over a proposed enterprise bargaining agreement.

The agreement, which would cover the mines operated by the BMA in central Queensland, offers annual wage rises of 5 per cent for the next three years, plus a production bonus of $15,000 a year. It was rejected overwhelmingly by workers at meetings last October. But a postal ballot approved by Fair Work Australia is now under way to seek a second opinion from workers.

In its submission, BHP lists 18 union claims in the dispute that it calls "beyond what is reasonable or necessary for the protection of employees".

They include union demands that:

Delegates be paid for time off to deal with member issues, attend union meetings, including preparation time for meeting conveners.

Delegates be able to use mobile phones at all times, regardless of safety rules.

Employees not be suspended during investigations into their conduct, or disciplined for breaching BHP's code of conduct.

Contractors and labour hire workers now most of BHP's workforce be paid the same as the minority of employees.

The submission goes well beyond that. BHP wants to be free to conclude individual agreements with high-income employees (such as miners). It wants to tighten the rules on pattern bargaining, union officials' right of entry, union representation and a dozen other issues.

The review, headed by Reserve Bank board member John Edwards who 20 years ago was point man for then prime minister Paul Keating in the reforms to introduce enterprise bargaining will hand its report to Mr Shorten by May 31.

Its terms of reference, however, aim to limit it to reporting whether the act is working as intended.

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Commodities outlook bleak - IMF

THE International Monetary Fund has forecast a significant fall in commodity prices over 2012-13, with a risk that an unstable global economy could drag them down even further.

Releasing two chapters from next week's World Economic Outlook, which will publish its new forecasts for global economic growth, the IMF warns that in the near term, and perhaps the long term, commodity prices are likely to slump rather than to hold to present levels.

It also dismisses the case for sovereign wealth funds to invest revenues from commodity exports, saying the money would deliver a bigger return if it were invested in physical and social infrastructure to lift future productivity.

"The weak global economic outlook suggests that commodity prices are unlikely to increase at the pace of the past decade," the IMF says. "In fact, under the baseline World Economic Outlook projections, commodity prices are forecast to decline somewhat during 2012-13. Sizeable downside risks to global growth also pose risks of further downward adjustment in commodity prices."

The IMF's January update cut its forecast of global growth in 2012 from 4 per cent to 3.3 per cent, and in 2013 from 4.5 per cent to 3.9 per cent. Its latest comments suggest next week's revised forecasts will be similar.

They come as China yesterday reported a return to trade surplus in March, largely because its annual import growth fell to just 5.3 per cent. Imports of iron ore, for which Australia is its largest supplier, fell 9.1 per cent from a year ago.

The Bureau of Statistics reported last week that Australia's earnings from mineral exports had fallen by 17.5 per cent in the past six months, from $17.3 billion in August to $14.3 billion in February.

The Reserve Bank's commodity price index also peaked in August, and was down by almost 10 per cent in March.

Unlike Australia's Treasury and the Reserve Bank, the IMF is not convinced that commodity prices will stay high. It warns that long-term prices are "even more unpredictable", and their future direction has "unusually high uncertainty". It urges governments to take "a cautious approach ... building buffers to address cyclical volatility".

Governments earning revenue windfalls from commodity exports, it says, should adopt counter-cyclical policies: stash away windfalls and increase taxes in boom years to keep the economy on an even keel, then spend the windfalls and cut taxes when the boom goes bust.

It is unimpressed by the case for sovereign wealth funds, particularly those (such as China's) that invest in foreign government bonds offering low returns. It urges governments instead to direct the revenues from commodity booms into investment at home to lift productivity.

"Changes in public investment expenditures give the strongest output effect, by raising private sector productivity (for instance, via improvements in education, health and infrastructure), and subsequently by increasing private capital, labour and corporate incomes and consumption," it says.

Another essay from the Outlook, on household debt, says that when highly-geared housing booms go bust, falling house prices explain only about 25 per cent of the consequent slump in consumer spending.

The bigger impact, the IMF says, comes from going from a period of rapidly growing household debt to one of stable or declining leverage. That is why housing busts after years of rising debt are the most severe.

Its insight helps explain why the growth in consumer spending in Australia has slowed far more than was expected.

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Irish nightmare: Prepare

MARIAN Wilkinson's absorbing Four Corners report this month on the collapse of the Irish economy was a powerful reminder of two fundamental truths. Booms tend to end in busts. And the busts do more harm than the boom does good.

It could be a valuable lesson for the Gillard government - which desperately needs to reconnect with the voters and economic reality - for its advisers, for the Reserve Bank, for the federal opposition, now in effect a government-in-waiting, and for all of us.

A day after Queensland's electoral massacre, Treasurer Wayne Swan began his weekly note with another enthused spiel on how good things are - ''an economy that is growing solidly, low unemployment, very low debt, sturdy public finances, and contained inflation'' - and above all, '' a resources sector that is going from strength to strength''.

''New (resources) investment has risen from $47 billion in 2010-11 to $95 billion this year, and will rise again to an expected $120 billion in 2012-13'', he said, momentarily confusing facts and forecasts. ''The boom in investment isn't surprising given the boom in exports ? (which) are likely to reach nearly $200 billion this financial year, and climb to around $258 billion in five years.''

And all this is good for us? Remember the property boom in Ireland, and how rich it made the Irish feel - until it bust?

Our boom, too, is likely to bust: most booms do. The bigger the boom, the bigger the bust.

Don't worry about it, officials say. This time is different. This boom will last for years, maybe decades. The growth of China and India will see to that.

Uh-huh. Take a look at the graph, produced by the Reserve Bank. The terms of trade is a measure of export prices, expressed as a ratio to import prices. As you see, this is not the first big boom in our export prices. There was one in the 1920s, which ended in the Great Depression. There was one in the Korean War, which ended with 20 per cent inflation and recession in 1952-53.

As the graph shows, those booms ended with a hard fall, and prices then resumed their long-term trend decline (the blue line slanting downwards). This is our third export price boom: how will it end?

Frank Gelber, director of Sydney economic consultants BIS Shrapnel, has been thinking about that. BIS Shrapnel has had an outstanding forecasting record, winning the Palme d'Or as the best tipster in The Age midyear survey seven times since 1993.

Gelber has looked on with alarm as mining investment has risen from 1 per cent of GDP to 4.4 per cent last year, and perhaps 7 per cent by 2012-13. He sees at least five years of strong mining investment ahead. He has seen the Reserve Bank jack up interest rates in response, to rein in the economy so that this boom doesn't lead to an inflationary breakout. And he's seen the dollar soar to its new peaks in response to the mining investment, the high interest rates and the uncertainty over the big Western economies.

But if mining investment is booming by 50 per cent a year, and the economy's growth is held to slightly above trend, that means other sectors of the economy have to shrink to make way for it. Long-established businesses are dying, factories closing, jobs going overseas - all to accommodate a boom that is only temporary and will give way to a bust.

''The boom will end when the supply of minerals catches up with the demand,'' Gelber says. ''I don't know when that is. We've now locked in projects that will underpin investment activity for the next five years, so the question is: what are the probabilities that it will proceed beyond that?

Gelber and BIS Shrapnel estimate a 25 per cent probability that the boom won't continue once these projects are built. They estimate an almost two-in-three probability that the boom will end within 10 years, and 90 per cent that it will be over within 15 years. Whenever it ends, he warns, Australia faces a major recession.

Why? Because the real boom is not in mining, a capital-intensive sector, but in mining investment, which reaches out far more into the economy. Treasury deputy secretary David Gruen estimates that while mining is only about 10 per cent of GDP, the ''mining-related'' economy is now about 20 per cent of GDP. That puts far more jobs at risk when the boom goes bust.

''Half of all the office space in Perth is now tied up with people servicing mining investment,'' Gelber says. ''The same is true for a quarter of the office space in Brisbane. Think of all the jobs in the construction sector, the back-line employment. The fall in investment will see a major decline in growth.''

But can't we then just bring back the industries now shrinking because of the high dollar? No, says Gelber. ''We're burning our bridges. We are losing the skills, the equipment and the markets. When the Australian dollar collapses, we won't have the industries any more. We will have to go through a total reversal of the process of structural change we are seeing now. We will see a big drop in our standard of living.''

What can we do to avert it? Gelber is pessimistic. The mining tax has been neutered. He sees value in governments investing in ''productivity-enhancing infrastructure'', such as the NBN, and in ''soft infrastructure'' such as research and development, and skills training.

But he warns: ''This is a long war of attrition.'' Firms in trade-exposed industries will be fighting for survival. Gelber wants policy makers to grasp that this boom, too, will end, and Australia will need a very different economy then. ''We've got to have an eye to what will happen after the mining boom. I'm aghast at how we are walking over the cliff, like lemmings.''

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Our facts have changed. Baillieu needs a narative.

When the facts change, I change my mind. What, sir, do you do?"

- attributed to JOHN MAYNARD KEYNES

WHETHER Keynes ever voiced these exact words is a matter of dispute. What is beyond doubt is that he expressed such thoughts and we remember them because they embody a profound truth. When we find ourselves in a new situation, our ideas must be flexible to respond to it.

Australia is now in a new situation, one unlike anything we have seen before. In the year to December 2011, investment in mining grew by more than GDP did. Mining investment grew by $8.24 billion; the volume of GDP grew by only $7.7 billion.

One industry located mostly in the outback is growing very fast. Most of the rest of the economy, located in the south-eastern cities, where the bulk of Australians live, is growing slowly or not at all.

The main reason our economy has hit a wall is that the Australian dollar has risen to hover around $US1.05 50 per cent above its long-term average of US70?. This has made a wide range of economic activity uncompetitive, forced firms to close and sent tens of thousands of jobs overseas.

Second, the Reserve Bank has set interest rates at levels appropriate for mining, not for the mainstream of the economy. Lending rates for home buyers are now at 2005-06 levels. Lending rates for small business are at late 2007 levels. The economy needs stimulus, yet interest rates are contractionary.

Third, governments are cutting spending to get back to surplus, and cutting hard because revenues have been clobbered by tax losses run up in the global financial crisis, by consumers' caution and by the lack of growth.

Our facts have changed. But our governments, the Reserve Bank and the federal opposition have not changed their minds. What is happening to Australia does not fit the stories each wants to tell us. So for different reasons their policy is to ignore it, and hope that it goes away.

One luminary tells of a recent conversation with a Chinese banker, who gave him an earful of his amazement at Australia's complacency at this threat to our industries. "What is your policy to deal with the dollar at this level?" the man from the world's most successful economy asked with vehemence.

In fact, the banker knew the answer: our policy is to allow Australian manufacturing and service industries to wither, hoping this will "free up" workers to take jobs in mining without causing inflation.

This is not good enough. Our manufacturers are constantly berated with advice that they must be flexible and nimble in responding to challenges. So they do; but it is ludicrous when the advice comes from those who are inflexible in their own job: policy.

Take the dollar. There has long been a consensus in Australia that floating the dollar was a good thing; I too was part of it. The dollar rose and fell over that time, usually between US60? and US80?, sometimes higher or lower. But firms facing trouble could tighten their belts and wait for it to change.

The situation firms face now is very different. Even well-run companies that took tough decisions to adapt to the crisis are now struggling. The dollar has made imports 33 per cent cheaper on the domestic market, and exports 50 per cent more expensive overseas. That is a huge blow to our competitiveness. China would not allow it to happen to its producers, nor would Singapore, South Korea, Taiwan or any other economic success story.

The Bank of Switzerland has drawn a line in the sand; it has intervened in the market to force the franc back below 1.20 to the euro, and keep it there. Central banks can do this because they can create currency. The downside is that increasing the money supply adds to inflation. But the risk of inflation getting out of control in a flat economy is remote.

We need to talk about this. We need to talk too about why Canberra is pledging a budget surplus that will impose a contractionary budget on an already weak economy.

In effect, Wayne Swan is promising us that he will bring down a bad budget that will be the opposite of what Australia needs. And Tony Abbott and his team are attacking him for not promising to make things even worse.

The Baillieu government is in a trickier position. The states have few sources of revenue, and ours is drying up. The Victorian Treasury and its Vertigan review have told ministers they should invest more, but pay for more of it from revenue. And in a normal world, that's the right advice. Victorians need to know that when the state runs a surplus today, it is to invest it in building new infrastructure, not to lock money away in the bank.

Victoria's economic slump into near-recession has been sudden, and due to reasons beyond any state government's control. The government has taken a long time to make decisions, but it is more important that it makes the right decisions rather than fast ones. The Baillieu team has been in power just 15 months. It did not expect to win government, and it came in with a lot of baggage from opposition, most of which it has slowly cast off. It now supports myki, the regional rail link and the desalination plant. Eventually it will abandon its silly policy to put armed guards on every railway station.

Its real problem is that it has yet to decide why it's there. It needs to have a credible central policy that tackles the real problems Victoria faces. It needs to have a story to tell, and be willing to go out, meet people and tell it.

Why was it elected? Primarily because transport infrastructure had not kept up with the demand for services. Building that infrastructure should be its policy. That would lift productivity, growth and jobs. The facts have changed, but that policy would fit them.

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Two Australias: Reserve should admit it got it wrong

AUSTRALIA'S economy is not doing as well as our ministers and senior officials like to boast. They keep telling us it is ''in a sweet spot'', displaying strong fundamentals, outperforming the world, we've heard it all. But the statistics show the real Australian economy is very different.

This time last year the Reserve Bank forecast that Australia's GDP would grow by 4.25 per cent over 2011. Even after the Queensland floods it still forecast this, implying a growth rate of 6 per cent over the second half of the year. In the May budget, Treasury raised its growth forecast for the 2011-12 financial year to 4 per cent.

Last week the Bureau of Statistics reported that the economy actually grew 2.3 per cent in 2011. In the second half of 2011 it grew at 2.5 per cent. It has added just 10,000 jobs in a year. And, above all, a sharp divide has opened up between the mining states of the north and west and the everything-else economy of the south-east, where two-thirds of Australians live.

What went wrong?

Quite a few things. First, officials underestimated the strength of the headwinds created by the combination of a dollar at record highs and interest rates at relative highs. Outside mining-related areas, growth in 2011 was minimal, yet home mortgage rates are still at 2005-06 levels. Small business overdraft rates are at the levels of late 2007, when the Reserve was trying to slow down an overheated economy.

Isn't that the fault of the banks? No. The Reserve's chiefs tell us that had the banks not raised their margins, they themselves would have lifted the cash rate to force retail rates to these levels. They think interest rates are where they should be.

Second, market fears over Europe have been a factor, exacerbating the rise in the dollar. But it would be ludicrous to pretend that Europe made more than a minor contribution to our two-speed economy.

The government and the Reserve also made two policy errors. Their goal was to ''make room'' for the mining boom by slowing down the rest of the economy. This would ''free up resources'' so that the mining boom could go ahead without sending inflation out of the Reserve's comfort zone, as it had in 2007-08.

Their goal was to slow down activity in the labour-intensive sections of the economy - manufacturing, retailing, tourism and all manner of services - to allow a boom in mining, which is highly capital-intensive. Clearly, that would hurt jobs.

Mining produces about 10 per cent of Australia's GDP, but employs only 2 per cent of its workers. Much of the activity now is in mining construction, but that is capital-intensive too.

In the year to November, when annual job growth was 63,000, the 50,500 jobs gained in mining and construction employment were outweighed by 51,500 lost in manufacturing alone. Three months later, the bureau estimates that in the year to February Australia added just 10,000 jobs. Updated figures on Thursday could show most of the economy shedding jobs.

This should have been predictable. If you shut down activity that employs a lot of people to ''make room'' for activity that employs few people, jobs growth will suffer. If you do enough of it, it will go backwards, as it is now.

Aren't there flow-ons from mining to the rest of the economy? Yes. Treasury deputy secretary David Gruen estimates ''the mining-related economy'' - ''those parts of the domestic manufacturing, construction and service industries that directly contribute to mining production and investment'' - has swollen from producing 4 per cent of GDP to 9 per cent.

Some of that is in the south-east. But the data is clear: the ''trickle down'' to south-eastern Australia from the mining boom is a trickle. What the high dollar and high rates are doing is not.

But aren't mining profits spent in Australia? When they fund more mining investment, yes. But there is less flow-on from mining dividends: 80 per cent of our mining shares are owned overseas, and most of the Australian shares are held by super funds whose job is to save, not spend.

That leads to the second policy error: the failure to realise that a mining boom with high interest rates would divide Australia into two economies.

The Reserve Bank has been preoccupied with ensuring that it does not let this mining boom unleash inflation as it did in 2007-08. In effect, it has set monetary policy to meet the needs of that industry, and not the mainstream of the economy, as it is meant to do.

Julia Gillard and Wayne Swan locked themselves in to delivering a budget surplus for political reasons. That will give Australia a contractionary budget when we need an expansionary one. The Coalition is not even at the game; they're out at some other field promising big spending cuts and job cuts, which would put the south-east in deeper trouble.

The Reserve needs to show the humility, and integrity, to admit that it got it wrong. Interest rates are far too high for the mainstream of Australia's economy. Swan and Gillard should find the courage to also change course and produce a budget that meets Australia's economic needs, not their political ones.

To err is human. But not to correct one's errors, when one can, is perverse.

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Recession a risk in slow lane of two-speed economy

TEN years ago, mining investment in Australia began rising sharply. By 2005-06 it had trebled in just five years. Over the next five years it doubled again. On current plans, it will double again in just two years to mid-2013.

It is being driven by what Treasury deputy secretary David Gruen calls ''a once-in-a-lifetime boom'' in commodity prices and Australia's terms of trade: the ratio of the prices of the things we sell overseas to the prices of the things we buy overseas. We all know the story, but even so, the numbers are staggering.

The terms of trade index has almost doubled, from 66.2 in June 2003 to 131.5 in September 2011. In other words, the same volume of exports today buys us twice as many imports as in 2003.

The Reserve Bank's index of commodity prices in $US has shot up from 34.2 in June 2003 to 157.0, last August, before ebbing back to 142.0. That means that a typical tonne of coal or iron ore exports today earns its owners four times as much as in 2003.

And where commodity prices go, the $A follows. Between 1985 and 2005 it averaged 70 US cents. In the past year, it has averaged $US1.05. That's made local production 50 per cent more expensive in $US, and imports 33 per cent cheaper in $A. So firms are shutting down and jobs are going overseas.

The scale of this shift is colossal. And it is a tribute to our policymakers, and the policy framework they inherited, that Australia has kept on the rails. Past resources booms always ended in tears, because inflation got out of control. This time the Reserve has focused on keeping inflation down and, apart from a flare-up in 2007-09, has succeeded.

There has been a price for this. The economy is growing more slowly; Australia's average growth since 2004 has been 2.75 per cent, or just over 1 per cent per capita. We're still stuck in third gear. Unemployment is back over 5 per cent, low in our terms, but well above the 2 and 3 per cent of success stories such as Singapore, Korea and Norway.

But there's been a bigger cost that policymakers are reluctant to admit, or tackle. Australia has fractured into two economies.

The growth is overwhelmingly in minerals development, in Western Australia, Queensland and the Northern Territory. The south-eastern states - Victoria, New South Wales, South Australia, Tasmania and the ACT - are now going backwards on some indicators, growing slowly on others. Australia has been a two-speed economy since 2005, but now the two speeds are 100km/h on one side of the country, and 10km/h on the other.

Treasury anticipated this. In a recent speech, Gruen said its budget forecast of 4 per cent growth in 2011-12 assumed the non-mining economy would grow just 1 per cent. The first forecast was way out. Economic growth is now likely to be between 2.5 and 3 per cent, which implies the non-mining economy is virtually flat.

The pain is being felt where the non-mining economy is concentrated: in the south-east, where two-thirds of Australians live and work. The risk of recession in south-eastern Australia is now real. In the past year, that two-thirds of the country has seen falls in jobs, job vacancies, newspaper job ads, construction activity, home building approvals, retail sales volumes, and now, a sizeable drop in business investment plans. Growth is almost at a standstill. What should the government do? The word from Treasury and the Reserve is: do nothing. High mineral prices are here to stay, maybe for a decade, maybe for many decades.

That implies that the high dollar is also here to stay. It may not stay quite as high as it is now, but their message to business is: if you can't find a way to compete with the dollar at something like parity (with the $US), you'd better find another life.

(To be fair, Treasury secretary Martin Parkinson told a Senate committee last month the best way to help manufacturers is to improve education, workplace relations, management skills and infrastructure. But all of them are things we want to do whether manufacturing is in boom or bust. For manufacturing, Treasury's advice is: do nothing.)

If Treasury and the RBA are right in assuming that mineral prices and the dollar will stay high, then their advice makes sense. Australia's car industry cannot compete globally with the dollar at parity. To try to keep it going would be expensive, and probably futile. Better to cut it off now and retrain its workers for jobs elsewhere.

But there are two problems. First, this advice is based on forecasts, not facts. Treasury and the RBA have not covered themselves in glory in recent forecasting; it's a long time since either has got a call right. They're human like the rest of us.

Chris Richardson of Deloitte Access Economics once called it ''a pure punt that China and India will keep growing faster than the world's miners can keep digging deeper''. It is a gamble that the global supply of minerals will never catch up with the growth in demand. And that's a big gamble.

If it's right, then you save money you might have spent trying to salvage industries that are beyond saving. But if it's wrong, the manufacturing firms you shut down will not come back. We would permanently lose economic capacity that we will need when mineral prices subside.

The second problem is that by doing nothing, you risk sending Melbourne, Sydney and two-thirds of Australia into recession or near-recession, so that the Pilbara and Bowen Basin can be developed at top speed. That is not just bad economics. It is bad politics.

Let me try a forecast: if that's Labor's policy, it will end 2013 back in opposition.

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A crisis looms in south-eastern Australia

LAST week the Bureau of Statistics revealed that more business investment in Australia now goes into mining than in all the rest of the economy put together. In 2012-13, on companies' present plans, investment in the rest of the economy would shrink while mining's share would swell to 70 per cent. Investment in the south-east, where two-thirds of Australians live, would shrink, and three-quarters of all business investment would be in WA, Queensland and the Northern Territory. Treasurer Wayne Swan hailed the figures as ''a resounding vote of confidence in our economy''.

We believe it is quite the opposite. The investment figures and other data suggest the south-eastern states - Victoria, NSW, South Australia, Tasmania and the ACT - are heading towards recession. In the past year their full-time jobs have shrunk by 38,000, and total employment by 26,000. Their newspaper job ads have shrunk by 21 per cent. Their job vacancies have shrunk by 15 per cent. Their construction activity has shrunk by 1 per cent. Their home building approvals have shrunk by 20 per cent; their retail sales volumes by 0.2 per cent. Their trend level of business investment was still rising, but December's slump and the sharp fall in investment plans suggest that too is turning. All these indicators tell only part of the story. But to see all of them heading down together is ominous. We are now two economies, and one of them is in deep trouble.

The mining economy of the north and west is running red-hot. The everything-else economy of south-eastern Australia has gone cold. The government's economic advisers meant it to be that way, although they have clearly overdone it. They believe Australia is going through a ''structural transformation'' from a diverse economy to one dominated by mining. A global shortfall of minerals has driven up commodity prices, and where commodity prices go, the Australian dollar follows. The dollar is now 50 per cent above its long-term average, making much of the economy of south-eastern Australia globally uncompetitive - in manufacturing, tourism, international education, areas of agriculture and office work that can be done more cheaply overseas. Treasury says we are still only in the early stages of this transformation.

Yet what are the government and the Reserve Bank doing? They are set on slowing the economy further. Federal and state governments are giving the budget surplus priority over jobs and growth. Treasury estimates that federal and state budget cuts will reduce Australia's growth in the two years to mid-2013 by 4.25 percentage points. The Reserve Bank cash rate is at a neutral 4.25 per cent, but governor Glenn Stevens says that is only because the banks are doing its work for it. Had bank margins remained unchanged since 2007, the cash rate would now be at least 5.5 per cent. The bank, the Treasury and the Treasurer believe that if the mining economy is running red-hot, then the rest of the economy has to run cold to prevent things overheating. They did not want it to run as cold as this, but there is no sign yet of any policy shift.

There should be. The floating dollar served Australia well for decades, but it is not serving it well now. When good businesses built up on sound plans are sacrificed because currency dealers make them uncompetitive, then policies must change. In the successful economies of Asia, governments intervene in currency markets to shield local producers. They set budget policies to moderate booms and busts, not to deepen them. They build diverse economies, not bet everything on one industry.

Our policymakers should focus on bringing the dollar down, and bridging the divide between the Pilbara and the rest of Australia. There are ways to do it: lower interest rates, intervention in currency markets, a deeper and wider mining tax and slower budget cuts. Australians will not forgive them if they just stand back and watch us hit the wall.

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COLUMN: Mining states bake while the rest shiver

YOU know the old joke about statisticians. If you've got one foot in boiling water and the other in a bucket of ice, they will tell you that, on average, your temperature is normal.

It's a bit worrying when any economist takes that approach in the real world. It's seriously worrying when the economist is someone as bright and as influential as Treasury secretary Martin Parkinson, for whom I have a very high regard.

It makes you worry that, after their growth forecasts have repeatedly overshot the mark, Treasury and the Reserve Bank still do not understand the strength of the headwinds the economy faces from the combination of high debt, high interest rates, and a dollar at record highs.

I hope they're right. But in three of the past four years they've been proved way too optimistic. If they've got it wrong again, then it's game over for Labor, whoever leads it.

Last Friday, Parkinson told the Senate economics committee the economy was growing at about trend pace and underlying inflation was in the middle of the Reserve's target zone.

''If you look at those two macro aggregates, you would think things are tracking along in a fairly sweet spot,'' he said.

''[Yet] there is an overwhelming negative sense about much of the national discussion and debate. I do think the whole mindset is a bit overdone … [we are] in the grip of unjustified economic gloom. Yes, there are challenges but the opportunities ahead of us are the sort we've never seen before.

''It's almost as if most Australians tend to think we live in Greece. We don't. We actually have an incredibly bright future in front of us.''

Hold on: let's test that against reality. Two days earlier, the Westpac-Melbourne Institute index of consumer sentiment, on which 100 means optimists and pessimists are evenly balanced, came in at 101.1.

I suspect that is far, far higher than it is in Greece.

A day earlier, the National Australia Bank's business survey reported a similar finding.

Business confidence and actual business conditions were both in positive territory in January, if only marginally.

Small business is pessimistic. The Australian Chamber of Commerce and Industry reports its confidence is now at the lowest point since March 2009.

But then so are its business conditions and, more or less, its profitability. Debt tracker Dun & Bradstreet reports small business failures in the December quarter jumped 48 per cent year on year and 128,000 firms are likely to experience ''financial distress'' in 2012. Does small business know something Treasury doesn't?

Australians don't think we live in Greece. But nor do we think we live in a ''sweet spot'' where all the economic fundamentals are going well.

And when Treasurer Wayne Swan, the Treasury and the Reserve Bank try to tell us how good things are, we sense that their whole mindset is, indeed, a bit overdone.

And since they make the big policy decisions, that is cause for concern - except for the Liberal Party, which has reaped the benefit of past policy errors.

First, let's check those fundamentals. In the year to September, seasonally adjusted GDP grew by 2.5 per cent, or roughly 1 per cent per head; that's a bit below trend. Job growth, which was fundamental when I was a kid, has slumped from 344,000 a year ago to just 22,000. Unemployment is still just 5.1 per cent because, for reasons that are unclear, people without jobs have left the workforce rather than look for work.

None of those figures are world-beaters. Of the 34 advanced economies, Australia ranks just 14th on growth in GDP. It is in the bottom half on growth in GDP per head. It has only the equal 10th-lowest unemployment rate.

But there is a more serious problem, which Parkinson freely concedes. If GDP growth is close to trend, it is because one part of the economy is really hot - mining investment - while the rest is becoming colder.

The geographical divide is stunning. In the year to September, domestic demand (that is, spending) grew by 4.2 per cent, much faster than GDP, because so much of the new spending was on imports. But that was an average of two very hot states and four cold ones.

The trend measure shows demand grew by 13 per cent in Western Australia and 8.2 per cent in Queensland. But in all other states, it grew by between 0.1 and 1.7 per cent. Outside the mining states, spending per head was virtually flat.

The bottom line is that 77 per cent of the trend growth in spending over the year was in WA and Queensland, which have 30 per cent of the population. Only 23 per cent was in the rest of Australia, which has 70 per cent of the population.

Since the start of the GFC, Australia has added 92,000 jobs in mining and 62,500 in construction. But by November it had lost 127,000 jobs in manufacturing, almost as many as in the entire 1990-91 recession.

On current trends, there will be a lot more jobs lost in the cities where Australians live, where their partners work, their kids go to school, where they have their homes, their families and friends.

As Liberal senator Arthur Sinodinos and Labor's Doug Cameron emphasised to Parkinson, the ''structural adjustment'' that costs them their jobs has to generate new jobs where they live, not on the other side of the continent.

I think that's why most Australians are wary of Treasury's optimism.

They live in the real Australia, not in a statistical average.

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Do we need industry when we have a mining boom?

THE drastic cuts at BlueScope Steel raise two key questions. Does it matter to Australia if we have a steel industry or not? And if it does, is it worth trying to keep it?

We could ask the same questions about whether Australia should keep making cars. We could ask the same questions about whether we should keep manufacturing anything.

The record dollar is slowly driving Australian manufacturers out of business. With each cent the dollar rises, their import competitors become cheaper and their exports more expensive.

From 1985 to 2005, the Australian dollar averaged US75¢. It has now risen 40 per cent above that to around $US1.05.

That shift has made imported goods 30 per cent cheaper - and our exports 40 per cent more expensive. Australian manufacturing is slowly being crushed. Why has the Australian dollar risen so much? Firstly, because our mineral export prices have risen to record levels and the Australian dollar tends to rise and fall with them.

Secondly, our interest rates are now far higher than in other AAA-rated countries, offering investors juicy returns. Also, the Reserve Bank keeps hinting that it will raise rates higher still.

Thirdly, while most Asian countries (such as China) keep their currencies low to boost local output, ours floats freely. The Reserve at times has intervened to stop the dollar falling, but never to stop it rising.

Nor would it. The Reserve is obsessed with the mining boom and thinks the big threat to Australia is inflation. To contain prices, it is reining back the other 90 per cent of the economy. Its hints of more interest rate rises keep pushing the dollar higher.
Does it matter if Australia becomes, in Kevin Rudd's words, ''a country where we don't make things any more''?

Treasury and the Reserve say it doesn't. They think mineral prices will stay high for decades, keeping the dollar too high for manufacturing to survive. They say we will ship out so many minerals, we won't need it.

Others see that as reckless. Mineral prices could fall sharply. But when factories close, they don't reopen.

To avert that would require big policy shifts, not Band-Aids. The risk is that we will lose manufacturing permanently for a mining boom that turns out to be only temporary.

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Age Economic Survey: What we should do

AUSTRALIA'S market economists believe we have entered a long boom in minerals prices, which will keep the dollar high and make it futile to try to shield sectors such as manufacturing, agriculture and tourism from the ongoing damage this will create.

The panel of economists in The Age's half-yearly conomic survey endorses the Treasury/Reserve Bank view that surging demand from China, India and other developing countries will keep commodity prices relatively high for years and perhaps decades.

They agree this will keep the dollar high, and that in turn will drive a long decline in prospects for other trade-exposed sectors of the economy. But they argue against government support to shield these industries, other than retraining retrenched workers.

Two policy proposals won widespread support. Some in the panel urged the government to make a third try at the mining tax, to extend it across other minerals sectors and raise its rate to something closer to the original plan. Many called for the proceeds to be put into a sovereign wealth fund.

The Gillard government opposes both options. Its minerals resource rent tax, to start in mid-2012, would apply only to coal and iron ore mines, and at a rate of 22.5 per cent of profits above a generous threshold. On Treasury's estimates, most of the proceeds would be spent immediately, while others warn that the spending could outweigh the revenue.

AMP Capital chief economist Shane Oliver said: ''Industrialisation in China, India and elsewhere has a lot further to go, resulting in supply continuing to struggle to keep up with demand.

''Apart from broadening the mining resource rent tax to include all mineral commodities, the best thing governments can do is to help to make sure that the whole economy is acting as efficiently as possible by boosting infrastructure, removing impediments on the supply side of the economy, and [addressing] labour shortages by training and immigration policies.

''Artificially propping up adversely affected industries would be futile and ultimately against the national interest.''

HSBC's Paul Bloxham agreed but urged the government ''to get back to fiscal surplus more quickly'' by imposing ''a larger mining tax'', the revenues of which would be put in a sovereign wealth fund and ''put aside for a rainy day''.

Richard Robinson of BIS Shrapnel urged the mining tax be extended to gold and base metals and levied at a higher rate, although he urged that part of its revenue be used to reduce company tax rates to benefit the rest of the economy.

But Paul Brennan of Citigroup said that opportunity was lost by the mishandling of the mining tax and forecast ''it won't be revisited, at least in the next few years''. He said ''the best policy response is to support retraining of workers affected by the two-speed economy''.

ACCI's Greg Evans emphasised the need for the government to run ''structurally tighter fiscal policy'' to reduce pressure on interest rates. NAB's Alan Oster added that ''the RBA will also have to take into account the effect of interest rate hikes on the less robust enclaves of the economy''.

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Reserve Bank risks a bust to stop boom

THE markets think there is only a 16 per cent chance that the board of the Reserve Bank will lift interest rates today. You hope they're right - but it's far from certain.

Our central bank is on a mission. It believes Australia is springing into a new boom that threatens to lift inflation. Its job is to stop inflation getting out of hand, and its one real weapon is interest rates.

And the boom it foresees is not ''five minutes of sunlight'', as John Howard memorably called the post-recession growth bounce in 1994 (of which, more later). The bank believes we have entered a new era in which global supply of minerals will be unable to meet the booming growth in demand, driven by China and India. And that will entrench high minerals prices for years, and possibly decades.

How does that change life for you and me? Well, high minerals prices over time will mean we also get full employment, and more: a high Australian dollar over a long period, making many producers uncompetitive, and the perennial risk of high inflation - which the Reserve will shield us from by high interest rates.

And if you're in debt (as most households are), that could make life uncomfortable. If the minerals boom unfolds on the scale its advocates envisage, life could become very uncomfortable.

Essentially, the Reserve and Treasury believe the other 90 per cent of the economy will have to shrink - in relative terms, and in some parts, in absolute terms - to free up the resources for the minerals sector to fulfil its destiny to dig up Australia's rocks and sell them to the world.

We are not talking about small tweaks here. The Reserve's most uncritical fans among market economists predict that in the next 15 months, it will deliver at least four interest rate rises, and possibly five. If they are right, that would wreak big changes in the Australian economy.

Many companies would shut down, especially in trade-exposed areas such as manufacturing, tourism and higher education. Many workers would lose their jobs. That would not be accidental ''collateral damage''. It is how the policy works.

The Reserve and Treasury believe (in my view, wrongly) that we are close to full employment. The mining companies say they plan to double their investment in 2011-12 from current levels. Even if that is exaggerated, the Reserve sees its role as ensuring that the companies do not bid up wages so high they create a wages breakout that would spread across the nation, and create the inflation it is there to stop.

To be blunt, it sees its role as to create unemployment - or at least, slow employment - in the rest of the economy, so that more of our scarce skilled workers go to build and operate the mines, where their work will bring the greatest return.

As Treasury secretary Martin Parkinson argued last month in a speech in Sydney, this is structural change. The factories and tourist ventures they close will not come back. In their view, the long boom in mineral prices means Australia will not need them. Others are less sure.

These rate rises would have damaging consequences for many, in a wide range of areas. Melbourne, and south-eastern Australia, would take the brunt of the damage, if firms here are shut down by high interest rates and an ever-higher dollar. Ross Garnaut is right: if the Reserve follows this course, then the carbon tax is a minor issue. Firms will be shut down anyway.

We need to talk about this - and before the Reserve jumps the gun by lifting interest rates for the eighth time in less than two years. Is there a better way to handle the problem? If so, what?

The first step for the Reserve is to guard against hubris. It is not enough to convince itself that it knows what lies ahead. It was right in 2009 when it said the recession would be short and shallow. But forecasting the future is fraught with danger and, recently, the Reserve has got more calls wrong than right.

A year ago, its forecasts significantly overestimated both non-farm growth in 2010 (by a full percentage point) and underlying inflation (by half a percentage point). I don't blame the Reserve for not foreseeing things that few if any saw coming, but look back at its forecasts at this time in 2009, or 2008, or 2007, and you can see its crystal ball is all too fallible. It needs to tread warily. In 1994, it ended that ''five minutes of sunshine'' with three big interest rate rises. Some of us warned this was overkill, and we were right. Unemployment stopped falling, and remained stuck around 8.5 per cent until late 1997, after the Reserve had relented. Let's not repeat that mistake.

As Oliver Cromwell put it: ''I beseech you, in the bowels of Christ, think it possible you may be mistaken.''

There are alternatives. If our choice is between giving mining companies a free hand to import the skilled labour they need, or shutting down growth in the rest of the economy in the hope that some of the displaced workers will migrate to the Pilbara, the first is obviously a better solution. With the Immigration Department predicting net overseas migration to be just 170,000 to 180,000 a year from now to 2014, there is room for more.

We seem to have lost the best option: a comprehensive, well-designed tax on mining profits that would keep the mining boom in check. A golden opportunity to do that was blown away: first, by the Henry review, which proposed an excessive, impractical tax that required taxpayers to pay for mining companies' losses - and then by the Gillard government, which backed down so far that it stripped the tax of any bite or universal coverage.

But the Reserve should try a strategy that parents use (within limits): let nature take its course. If mining companies and contractors get into a bidding war over wages, fewer mines will be built. The risk of a wages breakout in the Pilbara triggering breakouts in Melbourne or Sydney is remote. Let them solve their own problems. Don't shut down the rest of the economy to try to solve their problems for them.

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Not when but if China slows down

THE International Monetary Fund projects that within five years, China will overtake the United States to become the world's biggest economy. Yet investors are nervous that long before then the world's most astonishing growth engine might run off the rails.

In consecutive falls since the middle of last week the Shanghai Composite Index shrank by 4.75 per cent in six days, amid fears that the People's Bank of China might overreach in its campaign to rein in inflation.

The index is now more than 10 per cent below its peak, mainly because China's inflation rate climbed to 5.4 per cent in March (BHP and Rio, take a bow) and in just seven months, the central bank has tightened quantitative controls eight times and raised interest rates four times.

So it should be no surprise that recent figures have shown growth in manufacturing output slowing, or that analysts such as Goldman Sachs are edging down their forecasts of China's 2011 growth (in Goldman's case, just from 10 per cent to 9.4 per cent), or that Standard & Poor's should highlight the possibility that in a worst case scenario, 10 per cent of loans by Chinese banks could be non-performing within three years.

Does that mean China's extraordinary run is ending? And what are the risks for us if our main customer should stumble? Like most of us, I'm no China expert. But over the years, we've all seen warning after warning that China's record growth is about to end. So far it hasn't, and the institutional wisdom is that it won't.

This year the IMF estimates China's GDP will be 20 times what it was in 1980. That's right: twenty times. Australians think we've done pretty well, yet our GDP is only 2.7 times the size it was then.

On the IMF's figures, China has gone in just 30 years from being one of the world's poorest countries to being its biggest middle-income country. For 30 years it has averaged growth of 10 per cent a year. Not even Japan or South Korea have matched that.

Nonetheless, China has got there with an economic model that owes far more to its Asian neighbours than to standard Western economics. In Western economics, the consumer is king, and the goal of economic policy is to maximise consumer welfare. In Chinese economics, the producer is king, and the goal of economic policy is to make Chinese producers the most competitive in the world.

Its policy mix is quite different from that used by Japan and Korea in their rise. They relied essentially on protecting their domestic market by shutting out foreign investment and imports alike, and developing a highly effective culture of innovation by imitation and kaizen (continuous improvement) to develop world-class industries behind their protective walls. The walls came down only when they were already globally competitive.

By contrast, in the 1990s, the West forced China to lower its protection dramatically as its entry fee for joining the World Trade Organisation. That forced China to rely on weapons the WTO could not control: a heavily undervalued currency that makes its exports more competitive, and imports into China less competitive; a host of behind-the-border controls; and a culture of ruthless piracy of Western innovations.

Many argue that this cannot last. To keep its exchange rate low despite its explosive growth, for instance, China acquired more than $1 trillion of US Treasury bonds exposing itself to the risk of huge losses if its de facto currency peg collapses. But as the US dollar has slid since 2009, the People's Bank has managed to juggle its conflicting goals: at first going down with the US, then allowing the yuan to creep up by 5 per cent against the $US, but continuing to slide against other currencies.

It is gradually moving out of US Treasuries, instead using its huge current account surpluses to buy up companies and resources in direct investments around the globe. Federal Reserve data suggests China bought just $51 billion of Treasury bonds in 2010, and has been a net seller this year.

The fears of investors are not shared by the international financial authorities. The IMF's latest Outlook last month projected that China's growth would slow only marginally, from an average of 10 per cent a year since 1980 to 9.5 per cent over the coming decade. Here in Australia, Treasury's forecasts are broadly similar.

If it is wrong, the consequences for Australia could be dramatic although more for individual companies than for the economy overall. Australia's currency has soared largely because of the high commodity prices created by China's booming demand for iron ore and coal. If China stumbles, the first casualties here would be high commodity prices and the high dollar.

The effects of that could be complex. Mining companies gain from high prices, but lose from the high dollar. The new mines opening up are cost efficient and a lower dollar could see them offset lost sales in China by gaining new markets elsewhere. But the dislocation would be severe.

Mining investment would slow sharply. But other globally exposed industries such as manufacturing, tourism and agriculture would benefit if the high dollar disappeared.

The Reserve Bank too would face conflicting pressures. The high dollar has helped it by lowering import prices and slowing the rest of the economy: the transition to a low dollar would imply higher import prices, pushing up inflation. But the Reserve's prime fear is that the resources boom could lead to a wage-price spiral. If China stumbled, that boom would deflate, and the fear with it.

But will China stumble? Before you join the bears, remember: China is a country that lives well within its means. The IMF estimates its savings rate at an astonishing 54.3 per cent of GDP. And its current account is running a surplus of 5.7 per cent of GDP. Just as Australia is bound by its low savings rate and current account deficit, China's high savings rate and surplus gives it the freedom to flick the switch to consuming whenever it needs to.

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Miners talk big but don't deliver

MINING companies are planning an investment boom to make all other booms look flat. But can they deliver?

If they can, then the hawks have a case for lifting interest rates now, despite almost all the arguments against it. If they can't, then let's preserve our options as the future grows murkier.

Yesterday's Bureau of Statistics survey of business investment reveals a widening gulf between what mining companies say they will invest and what they actually invest. Three months ago, they said they had invested $22 billion in the six months to December 2010. But they told the ABS they would invest $35 billion in the six months to June.

Uh-huh. Well, three months later, we find they invested only $10 billion in the March quarter.

Sure, there was a cyclone and floods, and yesterday's figures are only preliminary. But 2010-11 will be the fifth consecutive year in which mining investment will stop well short of the forecast.

It matters because the miners forecast $83 billion of investment in 2011-12 twice what they're investing now. If they achieve that, it would be by sucking resources from other parts of the economy to clear shortages that limit investment now.

The main story of 2010-11 was that Australia sank back into below-trend growth as interest rate rises forced consumers to tighten their belts. Fitch Ratings reported yesterday that mortgage delinquencies soared in March to 1.8 per cent. Take care.

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National tax pain set to be Victoria's gain

WHO wins, who loses from the West Australian government's decision to end a $2 billion loophole in its iron-ore royalties? WA wins in the short term probably. Victoria and other states stand to win big in the medium term. The miners will get off scot-free, thanks to Canberra's pledge to pay their royalties.

And that means the Commonwealth will be the loser but an angry loser, with many ways to get even.

The WA royalties won't kill off Wayne Swan's budget surplus. On Treasury estimates, there would still be surpluses of $3 billion to $5 billion each year from 2012-13 to $2014-15. And Labor will find ways to get back its losses.

The key result will be to heighten WA's bitter complaints over the split up of Commonwealth grants by pushing the system to breaking point.

WA Treasurer Christian Porter says that under current rules, the Commonwealth Grants Commission eventually will take the new revenue off WA so that by 2014-15 it would receive just 33 cents in every $1 that WA taxpayers pay in GST.

For decades, Victoria and NSW have subsidised other states (including WA), but never on that scale.

We now face a new reality. One state can raise far more revenue than the rest. WA estimates its iron-ore royalties will grow from $305 million in 2003-04 to $4.75 billion in 2013-14. It's a colossal windfall. It would be like Victoria seeing an extra $10 billion fall from the sky.

But WA has one problem: the Grants Commission. Its job is to distribute GST money to even out the differences in state revenue capacities. That means, over time, it takes all that extra money off WA to give to other states including Victoria.

It's happening now. Before the resources boom, WA was always subsidised by NSW and Victoria. But next year the Commission will give $1.5 billion of WA's GST revenue to poorer states and territories. WA projects that by 2014-15, it stands to lose $4 billion almost all the money it raises in iron-ore royalties.

There is not space to explain the technicalities. But Swan is right: over time, WA stands to lose all its new royalties, and more. It could even lose them next year, although it is likely to keep them for a few years before the commission's formulas claw them back.

Resources Minister Martin Ferguson says the Commonwealth will honour its pledge to pay the miners' royalties when it brings in its own mining tax. It will continue existing infrastructure projects in WA. But WA could lose the rest of the $2 billion of infrastructure projects promised with the mining tax.

So why did WA do it? I suspect it's a deliberate strategy to change the Grants Commission formulas, by raising the stakes so high that they become politically unworkable.

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Reserve rises may have missed the point

If yesterday’s GDP figures are right, then the Reserve Bank has misread the economy, and given us interest rate rises we don’t read.

If the figures are wrong — and their startling revisions to 2009-10 data don’t inspire confidence — then they are just a bit of static we can disregard. But don’t assume it.

For once, Wayne Swan did not come out yesterday with graphs showing how Australia is leaving the ‘‘major advanced economies’’ for dead. And no wonder. All except France and Italy are now growing faster than we are.

With growth of 2.7 per cent, we are now being left for dead by Germany (3.9 per cent), Japan (4.1) and Korea (4.5).

But The real bottom line is growth in GDP per head. The Bureau of Statistics estimates it rose just 0.8 per cent in the year to September. It is still below 2008 levels.

How can that be when we’ve seen so much growth in jobs, our mineral exports are booming, and even after yesterday’s revisions, the Bureau of Statistics estimates that real national income grew 7.2 per cent in the past year?

Surely that makes us richer? Which means we spend more?

Well, some of us. The key to the puzzle lies near the back of the book, where the Bureau examines the sources of household income.

Over the past two years of crisis and rebound, it estimates, total wage income grew by just 7 per cent - including inflation, including all those 400,000 extra jobs.

Average income per employee grew just 3.6 per cent. Inflation grew 4.1 per cent. That means that on average, households depending on wage income are now marginally worse off.

Household income is growing: but the part of it that is really growing is the income of households who invest. Our income from profits, dividends, rent and interest shot up 16 per cent in the same two years. So households with significant investment income are much better off.

But investor households are more likely to reinvest their windfalls than spend them. That’s reflected in the Bureau’s stunning revision of its story on what happened in the last year. It has cut its estimate of household spending in 2009-10 by a cool $27 billion, and trebled its estimate of household saving from $23 billion to $68 billion.

Its picture of Australia’s growth now is extremely patchy. In the past year, almost half of all non-farm growth was in mining, mineral processing and construction. Most of the rest was in the finance sector and professional services (lawyers, accountants etc). The other two-thirds of the economy is growing little, if at all.

Many economists, inside government and outside, don’t believe this. They point to the stunning jobs growth of the past year, to the Bureau’s record of revising up past data, and dismiss yesterday’s figures as at most a ‘‘speed bump’’ on our road to the boom the Reserve predicts.

They may be right. But in my mind, these figures add to concerns that, as in early 2008, the Reserve may have misread the game. It has focussed on the needs of one industry in one state — mining in WA — when its job is to set interest rates for the entire economy. There is a risk that it has done too much, too soon.

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Resources boom presents real challenge for government

THE OECD's question for Australia is simple: how do you manage a resources boom to maximise the gains and minimise its negative impacts on inflation, the budget, and other industries?

Its own answers are mostly good ones, even if they seem to have been written by Treasury, like a ventriloquist using the OECD as its dummy.

First, ensure taxpayers get the benefit of the boom by putting a comprehensive tax on mining profits, and not the three-legged dog Julia Gillard gave us. The mining tax should be redrawn to cover all minerals, all mining firms, and raised higher rate so taxpayers do not end up paying the miners.

Second, the government should not spend the money on routine services, but save it, or spend it only on infrastructure.

Third, keep open the doors to skilled migrants, to avoid labour shortages pushing wage rises out of control, and forcing the Reserve Bank to drive up interest rates.

Fourth, lift spending on infrastructure and regulate it better. Invest more in public transport, and make trucks pay the full cost of the wear and tear they impose on our roads. Slow the rollout of the NBN, to encourage competition between internet technologies.

Fifth, start a new wave of reform, mainly through comprehensive tax reform, but also by removing government support for the car industry. (Like Treasury, the OECD simply ignores the real-world impact of closing down our biggest manufacturing industry).

And last, set up a serious anti-poverty program, to bring more people into the workforce by tackling the underlying causes of their disadvantage: poor health, poor education, homelessness, welfare traps and dole benefits below the poverty line.

This is a real challenge for a government that has messed up the few bold decisions it has taken, and for an opposition that likes reforms only if they're popular. But if Treasury is right, this is the environment we are facing, so challenges can't be avoided.

It's a pity the OECD relied so heavily on Treasury's advice, and hence proposes to shut down the car industry. That would intensify the damage the resources boom will do to the south-east, where most Australians live. Learn to think outside the square, guys.

But the rest of its report raises many ideas our politicians should be thinking and talking about. Not that they will. Treasurer Wayne Swan yesterday ignored the 98 per cent of the report focused on reforms to highlight the few bits that let him pat himself on the back. How ungainly. How out of touch.

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Don't listen too closely to Treasury, PM

AUSTRALIA is catching up with New Zealand. After an election, NZ departments put on the web their briefings to incoming ministers. Last Friday, Treasury became the first Australian department to do the same and what a briefing it was.

Treasury's red book, as it is known, tripped across almost every policy portfolio federal or state with criticisms, hints, warnings and reform plans. It was terse, just 80 pages of which 10 per cent was blacked out. But it was engrossing stuff: flawed but forceful, pointed and positive.

But pity the PM seeking guidance as to what should be her top priorities, when her government could be forced into a sudden-death election at any time. The red book is a great big Treasury wish-list, with no sense of priorities.

But some messages come through loud and clear: most of them important, a couple misguided.

As I read it, these are Treasury's priorities:

. To persuade the government to make room for the mother of all mining booms in WA by shepherding resources finance and workers there from other states and industries.

Treasury argues (ludicrously) that the economy is now close to full employment. To avoid inflation, manufacturing and tourism must shrink so mining can grow. It urges the government to speed this by scrapping support for "inefficient industries", apparently meaning cars and shipbuilding.

If adopted, this advice would shut down car manufacturing in Australia: the Ford plant at Broadmeadows, the Toyota plant at Altona and the Holden plant in Elizabeth, SA, where unemployment is already 19 per cent.

Treasury offers no proposals to address the devastation this would cause in Melbourne and Adelaide. It seems to assume that the unemployed workers would migrate to the WA mining towns.

. The projected budget surplus in 2012-13 is uncertain. If the world economy slows and mineral prices fall, it might not happen. Treasury wants the government to cut spending and resist pressure for tax cuts, both to secure the surplus and to generate savings to pay for difficult reforms.

As Access Economics director Chris Richardson puts it, the government's surplus forecast "is a pure punt that China and India will keep growing faster than the world's miners can keep digging deeper . . . If that punt is wrong, then Australia and its budget have big problems ahead."

. Australia needs to introduce emissions trading as soon as possible. It is clearly the cheapest way to reduce emissions. And without it, we will not reach the bipartisan target to reduce emissions to 5 per cent below 2000 levels by 2020.

. Tax reform must be tackled hard, with reform of state taxes, taxes on investment income, trusts, superannuation (especially tax dodges by self-managed super funds), welfare traps, and simplification as priorities.

. Welfare reform to increase workforce participation is a priority. But Treasury warns that this is likely to cost big money, which could rule it out until the budget is stronger.

. Co-operation between the Commonwealth and state governments is essential to reform. But Treasury's agenda is 100 per cent centralist. One thing it sees no need to reform is the mismatch of federal and state taxing powers, which has made the states beggars needing Canberra's money to do their job.

There are many vague hints and warnings: unstated fears about the national broadband network; patients should pay more of their own health bills; the navy should buy its ships overseas; and private investors should build more of our infrastructure.

These issues are important for Australia's future, especially tax, climate change and the budget. Between 2000 and 2008, governments cut income tax far more than we could afford, badly weakening the budget.

Chris Richardson points out that income tax as a share of wages and salaries has fallen 25 per cent since 1999-2000, to its lowest level in decades. He warns that global supply of minerals will catch up with demand in future, putting minerals prices back on their long-term declining trend.

That means we will not be able to rely on taxing mining profits to fund the long-term entitlements we have created. The budget will be in trouble.

But the implications of a future minerals bust go well beyond the budget. As Ross Garnaut put it two weeks ago: "The resources boom is not sustainable". Mining prices and investment will fall sharply at some point, putting pressure on the budget and on the economy. And industries being weakened by higher interest rates and the high dollar might not be there to rescue us.

"We've been pulling resources out of other sectors of the economy," Garnaut told a Melbourne Institute lunch. "Other trading sectors will have been very substantially weakened when they will be asked to make a bigger contribution".

Garnaut cited tourism and education, but the same is true for manufacturing and agriculture.

Treasury wants an economy where we put all our eggs in one basket: mining. That will be more volatile, more recession-prone, and massively disruptive.

Wrong way. Go back.

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Mining tax backflip to cost billions Price of Gillard's peace deal revealed

THE federal government has revealed that changes to the mining profits tax negotiated with the big resources companies will cost the budget billions of dollars more than initially acknowledged.

New figures released by Treasurer Wayne Swan show that in 2013-14, the second year of the tax, it is expected to raise only $6.5 billion compared with $13 billion in its initial form.

Over the first two years, the expected take would shrink from $18 billion under the old version to $10.5 billion under the new.

The expected losses to revenue are far greater than the $1.5 billion claimed by the government when it unveiled the revised tax on July 2.

Explaining the discrepancy yesterday, the government said that since the original version of the tax was announced, Treasury had upgraded its expectations for mineral prices and exports.

The government failed to disclose this when it announced the revised version of the tax.

As the real cost of the tax backdown was exposed, the government came under attack over the issue from former Treasury chief Bernie Fraser, who accused Prime Minister Julia Gillard of selling out to the mining giants.

Mr Fraser also criticised Opposition Leader Tony Abbott for wanting to rescind the tax, saying it was amazing that an alternative prime minister could "put the vested interests of big mining companies ahead of the national interests of this country".

The tax controversy overshadowed Mr Swan's news of further improvement in the budget forecasts a boost also driven by higher estimates of commodity prices.

The government released the budget forecasts and mining tax details to help set the framework for the election, expected to be called within days.

Ms Gillard will appear at the National Press Club today and give a speech flagged to be on economic issues.

The new budget forecasts improve the bottom line by $7 billion over five years to 2013-14, mostly through higher estimates of company tax. Treasury says the improvement would have been $12.5 billion but for policy changes essentially to the mining tax.

The forecast budget surplus in 2012-13 has more than trebled from $1 billion to $3.1 billion. In the same year, the forecast peak in the government's net debt has fallen from $94 billion to $90 billion.

"These figures show we are on track to put the budget back in surplus within three years," Mr Swan said. "We will be in surplus before every other major advanced economy."

He emphasised that the surplus did not depend on revenue from the mining tax. "Despite all the uncertainty in the global economy, we can be confident about our future," he said.

But shadow Treasurer Joe Hockey and Coalition finance spokesman Andrew Robb dismissed the statement as "dodgy figures, used to explain a dodgy tax, delivered via a dodgy deal".

"The massive debt and deficit remains largely unchanged, the reckless spending will continue unabated, and the forecast of a surplus is still simply not believable," they said.

The bad news is that Treasury marginally cut its forecast of growth in 2010-11, from 3.25 per cent in the May budget to 3 per cent. Slower growth in consumer spending and housing investment is expected to be offset slightly by growth in mining.

Unemployment is tipped to be 5 per cent in mid-2011, much the same as now, despite the addition of 250,000 jobs.

The improved forecasts came as Westpac and the Melbourne Institute reported a stunning 11 per cent jump in consumer confidence in July. Most of the increase came from Coalition voters, who had previously been pessimistic. Now it is the poor who are most pessimistic.

The losses revealed from the mining tax backdown tend to confirm criticisms by analysts that the changes will cost tens of billions of dollars over a decade.

If mineral prices in coming years fell below Treasury's buoyant expectations, there is a risk that revenue from the tax would be too small to finance initiatives dependent on it company tax cuts, tax breaks for small business and better superannuation benefits.

But Mr Swan said he was confident the revised figures would be proved right. "Prices will go up, they'll come down," he said.

"But everybody can be confident that they will be a higher level [than] the historical average was."

Mr Fraser, who was head of the Reserve Bank from 1989 to 1996 and a former Treasury boss, said Ken Henry's resources tax in its original form was too complicated. "It was over-engineered in a way," Mr Fraser told ABC television.

And the subsequent minerals tax brokered with the big miners was a sellout, he said.

On Mr Abbott's vow to rescind the tax, Mr Fraser said it "amazes me, frankly, how any alternative prime minister or alternative government can put the vested interests of big mining companies ahead of the national interests of this country . . . Whoever has sort of really devised that line really has rocks in his or her head."

Mr Hockey said Mr Fraser's view of the Coalition was dead wrong. "I have never seen a tax that receives so much remuneration and is yet expected to create investment and create more jobs," Mr Hockey said.

Mr Fraser said the government should have been able to win the day on its mining tax plans, as former prime minister John Howard did with the GST.

"If Howard can sell a GST . . . and the government can't sell an RSPT without a great hullabaloo, something is very wrong," Mr Fraser said.

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