Dog Days: Australia After the Boom (Redback) by Ross Garnaut

BOOM: THREE PHASES
    As discussed in the Introduction, it is useful to think of three overlapping phases of the resources boom: the terms of trade phase, the investment phase and the export expansion phase. The terms of trade phase began in 2002 and affected the Australian economy from 2003. Apart from a break in the year following the Great Crash of 2008, our terms of trade rose rapidly and consistently to a peak in September 2011. The downward slide since then has been as rapid as the rise, and more likely than not in 2014 or 2015 we will see much lower levels still.
    The investment phase got underway in 2006, but increased gradually until 2010 and also with a break after the Crash. Resources investment as a share of the economy looks set to reach a peak late in 2013. It will then decline until it is not far above the historical average in about 2017. The effect of this investment on the Australian economy in any year is a mixture of the positive, from the capital expenditure, and the negative, from the corporate tax deductions it allows. The net positive effect of resources investment was probably greatest in 2012 and will become a net negative for a number of years after 2017.
    The third phase, the expansion in export volumes, began in 2012 and will continue for a year or so after the end of the investment phase, to about 2017.
    If we put these three overlapping phases together, and since we spent most of the increased income from higher export prices as it arrived, we can see the expansionary effect of China’s demand on the Australian economy commencing in 2003 and growing steadily stronger (with the break after the Great Crash) until 2011. The positive impact of the China resources boom on the overall Australian economy ended in late 2011. Since then, the overall impact of the resources sector has been contractive and is likely to remain so for a number of years.
    The three phases contribute to the Australian economy in different ways. It is worth looking at each of them in more detail, so as to understand the underlying forces driving big changes in our economy.
    THE BIGGEST PHASE: TERMS OF TRADE
    Strong terms of trade contribute mainly to government revenue, but they also raise the income of Australians who own shares in resource companies. At their peak in September 2011, the terms of trade were more than double the average of the first twenty years of the floating currency (1983–2002). This added almost 24 per cent to nominal gross domestic product.
    Yet much of this increase did not directly affect the Australian economy because about three-quarters of the equity in resource companies is owned overseas. The main effect of the higher terms of trade was to raise potential government revenue by around 10–11 per cent of GDP, with about 1 percentage point accruing to the states as royalties and the rest to the commonwealth as corporate income tax, capital gains tax, resource rent tax on offshore petroleum, income tax and withholding taxes on dividends from resource companies. (I say potential, because if the increased revenue is spent, as it was, it raises the cost level of the economy and the real exchange rate, which in turn reduces resource-sector profits and government revenue.)
    Separately, the terms of trade raised potential Australian incomes by about 2.5–3 per cent of GDP through increased dividends or increases in the retained earnings of companies whose shares were held by Australians directly or within superannuation funds. There was an additional wealth effect as the price of resource company shares rose in anticipation of higher future earnings. So the total effect of the terms of trade boom from the average of 1983–2002 to the peak in late 2011 was to raise potential average incomes of Australians by more than one-eighth.
    Since late 2011 there has been a steady decline in the resources sector’s contribution to Australian incomes. How low will the terms of trade go and for how long? That depends