The Two-Speed Economy: Policy Suggestions for a Balanced Economic Growth - Literature review Example

Running Head: INTERNATIONAL TRADE AND PAYMENT The Two-Speed Economy: Policy Suggestions for a Balanced Economic Growth Word count: 2024 The Two-Speed Economy: Policy Suggestions for a Balanced Economic Growth Australia’s two-speed economy Two-speed economy is a concept used to describe economies whose industries show different growth rates. Manufacturing may, for example, outpace agriculture, or as the case has been in Australia in the past few years, the mining sector may outpace the manufacturing sector. Commentaries about the two-speed economy in Australia intimate that the country is divided into two separate economic zones (Mitchell & Bill, 2006; “Two-speed economy”, 2012). It is indicated that resource-rich states are in one set of the economic zone, which is booming due to the associated wealth, while non-mining states are hypothesised as belonging to a different economic zone, which is struggling economically. The economic differences between the two zones is attributed to a boom in resources, with Western Australia and Queensland belonging to the booming resource-rich states, while the remaining states are grouped into the languishing resource-poor states. While two-speed economies are not necessarily a bad thing, they are not necessarily a good thing either. According to Garlton (2008), the interdependence between industries within the same economy means that the two-speed economy brings about complex challenges to a country. Specifically, a country with a two-speed economy has to manage its monetary flows, trade, and currency policies well in order to enhance its relative economic wellbeing on the international front. However, the country must also manage its internal economic policies well in order to balance the development needs of underperforming industries while reaping maximum benefits from the well performing industries (Pritchard, 2011). Whether the two-speed economy is real or just a fragment of the imagination of overzealous economic analysts has been discussed at length. Supporters of the concept argue that resource-rich states enjoy large returns especially from the mining boom (Garlton, 2008). It is also indicated that in addition to the high returns, resource-rich states enjoy regionalised labour benefits (Gillies, 2010). The labour benefits emerge because as a result of improved economic welfare, labourers in the resource-rich states earn more than their counterparts in non-mining states. Moreover, the resource-rich states register lower levels of unemployment when compared to non-mining states. Additionally, it has been noted that there are limited labour benefit leakages to other state economies (Gillies, 2010). Analysts who contest the reality of the two-speed economy concept argue that the benefits of the mining boom (or any other resource boom) are dispersed to the larger Australian economy through commonwealth taxes, capital returns, and the greater purchasing power that the Australian dollar has as a result of increased exports (Gillies, 2010). On their part, Bjornland and Thorsrud (2013) indicate that there is bound to be substantial productivity spillover from the dominant industry, whose effect will be felt in the industries that lag behind. The spillover effect leads to enhanced production, investment, wages and employment in the non-performing industries (Bjornland & Thorsrud, 2013). There is some consensus among proponents and opponents of the concept that the mining boom negatively affects trade exposed sectors such as tourism, hence meaning that the economies of states that are reliant on tourism slow down whenever the Australian dollar strengthens as a result of a mining boom (Davidson, 2011). While both the proponents and opponents of the two-speed economy proposition make sound economic arguments, a critical analysis would reveal that the mining boom does indeed have some negative implications on the manufacturing sector. Incidentally, the non-mining states mainly rely on the manufacturing sector for economic development and growth. In an attempt to explain the implications of the mining boom in Australia, Davidson (2011) makes reference to the Dutch disease. The Dutch disease concept suggests that “a boom in the natural resource sector shrinks the manufacturing sector through crowding out and an appreciation of the real exchange rate” (Smith, 2014, p. 1). Applied in Australia’s context, one could argue that when there is a mining boom in one of the states, the focus shifts from manufacturing to mining. As Davidson (2011) notes, even the factors of production are re-directed to mining, hence meaning that less attention is given to the manufacturing sector. Since most of the mining resources are sold outside Australia, the Australian dollar gains ground against other world currencies, and as would be expected, a stronger Australian dollar makes Australian manufactured goods more expensive in the world market. Consequently, Australian goods, especially those that compete on price, become uncompetitive. Australian products that compete on quality, good distribution and placement, and even good marketing strategies may however not be significantly influenced by changes in the country’s exchange rate. One point that is worth analysing is whether the Dutch disease is present in the Australian economy. Several writers (Davidson, 2011; Downes, Hanslow & Tulip, 2014) do not think that the Australian economy is affected by the Dutch disease. With the boom, Downes et al. (2014) found out that manufacturing output in Australia in 2013 was just 5 percent below what it normally would have been. The writers however found out that true to expectations, the mining boom had led to an appreciation of the Australian dollar, and this had an effect not only on manufacturing but also on other industries such as farming and tourism (Downes et al., 2014). Interestingly, a large proportion of Australia’s manufacturing sector serves the country’s domestic market, hence implying that the greatest impact of the mining boom was felt elsewhere in the services sector (e.g. tourism and agriculture), rather than in manufacturing (Downes et al., 2014). The tourism sector however has not had it all bad; according to Pham et al. (2013), there was increased discretionary spending by local leisure travellers during the mining boom, Moreover, there was increased business travel between different regions in Australia as well as increased yield in the aviation and accommodation sectors in the mining regions in the country. The negative economic impact of the mining boom was however evident in the reduced arrivals of international tourists (Pham et al., 2013). The author further notes that the strong Australian dollar gave Australians increased incentives to prefer out-of-country tourism as opposed to local tourism. Combined, the aforementioned points can be perceived to indicate that Australia’s economy does not suffer from the Dutch disease. The absence of the Dutch disease does not however indicate that all is well in the Australian economy. The two-speed economy is arguably a reality that Australia has to grapple with and find a solution to for as long as the country has resources that can be exploited and sold to the international market. As shown in Figure 1, New South Wales (NSW) is now ranked the best performing state economy, something that is buoyed by the real estate sector. Western Australia (WA) has on the other hand slumped to second place in economic performance, owing to the fading of the mining boom. Figure 1: Economic performance of the states in Australia Source: “NSW economy back on top” (2014) Possible policy interventions Australian policymakers certainly need to implement a number of measures in order to obtain a balanced economic growth despite the existence of a two-speed economy in Australia. To start with, Corden (2012) aptly notes that Australia has a floating exchange rate, and as such, the country’s policymakers cannot make any foreign exchange market interventions. A stricter tax regime is not however out of the question. Connolly and Orsmond (2011) note that although it is hard to determine the exact foreign ownership of Australia’ mining sector, estimates indicate that about four-fifths of the industry is owned by foreign investors. As such, if the foreigners were to repatriate their profits, Australia would not gain much from the profits. It is therefore argued that the booming sector should be made to pay significant taxes so that its gains can be spread in the larger economy. The high taxes would also arguably help compensate for the losses sustained in other sectors as a result of a strong currency. Notably, tax intervention is not an entirely new suggestion in Australia; the controversial Mineral Resource Rent Tax (MRRT) was based on the need to tax the excess profits earned by the mining firms. The MRRT has however been criticised for not being as rigorous a resource-rent tax as some analysts would have preferred it to be (Kong, 2012). Policy interventions could also include assisting the lagging industries or the states that are affected. For example, the government could adopt deliberate policy actions to improve the infrastructure of states whose economies are lagging behind (e.g. by helping the labour force improve its skills set and move to booming states). Admittedly, the intervention in the example does not offer long-term solutions. The RBA (Reserve Bank of Australia) can also choose to tighten the country’s monetary policy with an intention of attaining internal balance in the Australian economy. Theoretically, a tighter monetary policy constricts spending, hence curbing rising inflation and slowing down an economy that is bound to overheat (Kearns & Manners, 2006). A lower interest rate could also be combined with the fiscal surplus by the RBA in order to provide the economy with a macroeconomic policy intervention. Fiscal surplus occurs when a government’s income is higher than spending (Financial Times, n.d.). In Australia, assuming that a tax is imposed on the booming industry, a fiscal surplus would be generated. A fiscal surplus would also occur if government reduces spending. It can be said that combining the surplus with a monetary expansion policy through lower interest rates would lead to less appreciation of the Australian dollar since the RBA would have removed the incentive for capital inflows into the country. From the foregoing argument, it would appear that protecting the lagging industry would come at a cost, which seems to be in the form of discouraging capital inflows into the country. Whether that would be a sacrifice that the economy would be willing to pay is debatable. Enhancing national savings during the mining boom has also been identified as a possible policy intervention for Australia. Corden (2012) for example notes that national savings would create some sort of financial ‘back up’ that would cater for future adverse events in the economy. The Organisation for Economic Co-operation and Development (OECD) (2010) lauds such an approach noting that savings have the capacity to enhance long-term capital gains, especially if the savings are invested well. According to Corden (2012), savings can be used for future investments or for purposes of enhancing production and employment in an economy, and combined, such activities help enhance the economic growth of a country. Funding infrastructure development using proceeds attained through taxes from the booming sector is also another possible policy intervention that can be used to equalise the economic development in states whose economies are lagging (OECD, 2010). Stevens (2011) further suggests that investing the savings in infrastructure or in the education sector of the states that are lagging behind could greatly enhance the performance of their respective economies. Lessons from Norway as documented by Larsen (2004) actually show that channelling resources into the education sector really works since a country would be boosting its human capital, who would then be able to engage in research and development for purposes of enhancing the economic well-being of the country in the future. Conclusion Overall, this essay will conclude by noting that there are several policy issues that the Australian economy can employ in order to attain more balance between states that have resource booms and those that are not as resource-rich. None of the policy interventions discussed in the essay is foolproof. However, the government and the policymakers who assist government in decision-making can weigh the merits and demerits of each policy intervention, and based on the effect that each will have on balancing the booming states and the lagging states, choose which ones to apply. As is evident from the MRRT, correctly framing the policy intervention and correctly implementing it also affects its success or failure in attaining the desired economic balance among states. Consequently, the policy actions that will be decided upon will need some careful thought, which may require input from different stakeholders interested in the economic prosperity of all states within the larger Australia. References Bjornland, H.C., & Thorsrud, L.A. (2014). Boom or gloom? Examining the Dutch disease in two-speed economies. CAMP Working Paper Series, 6, 1-47. Connolly, E., & Orsmond, D. (2011). The mining industry: the bust to boom. In H. Gerard & J. Kearns (Eds.), The Australian economy in the 2000s (pp. 111-156). Sydney: Reserve Bank of Australia. Corden, W.M. (2012). Dutch disease in Australia: Policy options for a three speed economy. Australian Economic Review, 45(3), 290-304. Davidson, S. (2011). Trade in a two-speed economy: Should Australia protect its industries? RMIT University Lecture Notes. Retrieved from http://www.apec.org.au/docs/2011_lecture/4.2%20Sinclair%20Davidson.pdf Downes, P., Hanslow, K., & Tulip, P. (2014). The effect of the mining boom on the Australian economy. Reserve Bank of Australia – Research Discussion Paper, Retrieved from http://www.rba.gov.au/publications/rdp/2014/pdf/rdp2014-08.pdf Financial Times. (n.d.). Definition of fiscal deficit/surplus. Retrieved from http://lexicon.ft.com/Term?term=fiscal-deficit%2Fsurplus. Garlton, P. (2008). The resources boom and the two-speed economy. Economic Roundup, 3, Retrieved from http://archive.treasury.gov.au/documents/1421/HTML/docshell.asp?URL=02+The+resources+boom+and+the+two+speed+economy.htm Gillies, A. (2010). Giving money away? The politics of direct distribution in resource-rich states. Center for Global Development – Working Paper 231, 1-21. Kearns, J., & Manners, P. (2006). The impact of the monetary policy on the exchange rate: a study using intraday data. International Journal of Central Banking, 2(4), 158-184. Kong, H.S.C. (2012). Laying 22 economists end to end. The Economist. Retrieved from http://www.economist.com/blogs/freeexchange/2012/07/australias-new-mining-tax Larsen, E.R. (2004). Escaping the resource curse and the Dutch disease? When and why Norway caught up with and forged ahead of its neighbours. Statistics Norway- Discussion Papers, 377, 1-34. Mitchell, W., & Bill, A. (2006). The two-speed Australian economy. Centre of Full Employment and Equity Working Paper, 06-07, 1-14. NSW economy back on top as mining boom wanes (2014, October 20). The Australian. Retrieved from http://www.theaustralian.com.au/subscribe/news/1/index.html?sourceCode=TAWEB_WRE170_a&mode=premium&dest=http://www.theaustralian.com.au/business/economics/nsw-economy-back-on-top-as-mining-boom-wanes/story-e6frg926-1227095484505&memtype=anonymous OECD. (2010). OECD economic surveys: Australia 2010. OECD Publishing. Pham, T., Bailey, G., Marshall, J., Spurr, R., & Dwyer, L. (2013). The economic impact of the current mining boom on the Australian tourism industry. Tourism Research Australia, Canberra. Smith, B. (2014). Dutch disease and the oil and boom and bust. OxCarre Research Paper. 133, 1-28. Stevens, P. (2011). Is Australia just a “two-speed economy” or is it about to suffer from an attack of the “resource curse”. UCL School of Energy and Resource, 1-16. Two-speed economy requires policy action (2012, July 30). The Sydney Morning Herald. Retrieved from http://www.smh.com.au/federal-politics/editorial/twospeed-economy-requires-policy-action-20120729-236ef.html Read More