Wednesday, September 17, 2014

China's Proposed Import Bans on Thermal Coal: Not the Real Problem Facing Australia

The Chinese government has announced that it is going to limit certain coal imports from next year. The Sydney Morning Herald reports:
The Chinese government is to limit the use of imported coal with more than 16 per cent ash and 3 per cent sulphur from January 1, 2015 in a bid to improve air quality, especially in cities such as Beijing and around Shanghai.
According to one analyst: ''[Australian coal exports are] typically around 5500 kilocalories and 24-25 per cent ash. So we've got big problems.''

However, others are less concerned by the changes arguing that the impact on other coal exporters will be even greater.
The restrictions applied vary in stringency depending on geography ... The least stringent [restrictions] apply across the entire country and would not affect a single major Australian thermal coal exporter, all of whom would comfortably comply. However it is the most stringent which apply to the major economic zones of Beijing, Hubei, Tianjin, the Yangtze River Delta and the Pearl River Delta which are of the greatest relevance. These areas are on or close to the coast and therefore are the most prospective for Australian seaborne exported coal ... only 10% of Australian coal exports go to China, and the highly restricted region represents 42% of Chinese thermal coal imports further softening the blow. This means the amount of production likely to be affected is low.
What is clear is that we need some context to assess the impact of China's proposed restrictions and any potential damage to the Australian economy.

According to the Department of Foreign Affairs and Trade's Composition of Trade, in 2013, China was Australia’s largest export market, accounting for 31.9 per cent ($101.6 billion) of total exports of goods and services (an increase of 28.2 per cent on 2012); Japan was Australia’s second largest export market ($49.5 billion); the Republic of Korea was third largest market ($21.3 billion).

Major goods and services export markets

Coal is Australia's second biggest export, behind iron ore and in front of education related travel services.

According to another DFAT publication, from 2001 to 2011, "the value of coal exports rose from $12.5 billion in 2001 to $46.8 billion in 2011, a rise of almost 300 per cent."

Traditionally our biggest market for coal has been Japan, with China a much less significant market until recently. Between 2001 and 2011 Coal exports increased their share of exports to China but were still dwarfed by iron ore exports.

Since 2011, Chinese coal exports have more than doubled from $4.5 billion to $9.1 billion in 2013.

Australian Coal Exports 2013 

The point to note here is that China has traditionally mined a lot of coal itself, but in recent years Chinese production has been in decline with significant producers struggling.  An integral component of the restrictions, therefore, will be to encourage more Chinese coal production.

The most important point to note, however, is that there are two major forms of coal exports – thermal and metallurgical. Thermal coal is used mainly for electricity generation, whilst metallurgical coal is used in steel manufacture.

Metallurgical coal exports in 2012-13 were $22.4 billion and thermal coal exports were $16.2 billion. It is thermal coal exports that could be affected by China's bans.

Principal markets for resources and energy exports
in 2012–13 dollars

Source: BREE

The above graphs clearly show the rise in both metallurgical and thermal coal exports to China since the early 2000s, but China remains a significantly less important market than Japan for both.

A problem with the focus on the potential damage to Australian thermal coal exports from the Chinese bans is that it may miss the real problem for Australian exports over coming years. The coal sector in Australia has been in trouble for quite some time, with coal miners slashing their work forces in recent times.

One of the major vulnerabilities for Australia moving forward is the increase in the share of unprocessed raw materials exports, which have substantially increased their share of total exports since 2008 and even more so since the late 1990s.

The real danger for Australian coal exports would be similar restrictions on exports of thermal coal to Japan and South Korea. Let's face it if you want to do something about climate change and levels of pollution then restricting the growth of coal burning will be essential.

Despite the moves by the Chinese authorities, coal remains the second most important source of energy. Renewables have been growing rapidly in recent years, but their share is still depressingly low.

While coal consumption is declining in Europe and North America it is increasing markedly in the Asia-Pacific.

Source: Vox

Thermal coal burning is going to continue for quite some time yet and the Chinese restrictions will have considerably less impact than the growth slowdown in China and the decline in house building and infrastructure development.

China must lessen its investment share of GDP to rebalance its economy. It could do this in an orderly way over the next few years or it could resist the need to rebalance and face an eventual catastrophic rebalancing later in the decade. In other words, rebalancing away from investment towards consumption will occur, it just depends on when and how. Australia will be negatively affected either way.

What this means is that the decline in iron ore prices and export volumes will be way more important than a ban on thermal coal exports. Those concerned about this issue should be more worried by the general decline in commodity prices.

But it's not all gloom and doom for thermal coal. Given the Abbott government's hostility to developing solutions to climate change and to the advancement of the renewable energy sector, it's possible that coal miners may be able to expand their 75 per cent share of electricity production in Australia.  

Wednesday, September 3, 2014

She'll Be Right Mate? Australia's Economic Future

Real GDP per Capita is an important measure of real aggregate progress. While it doesn't tell us anything about the distribution of growth, it does tell us how much an economy is growing per person so that it removes the impact of population growth and immigration. Remember that in a country with a rapidly growing population, growth can be, at least in part, a consequence of that population growth.

The Reserve Bank Governor Glenn Stevens recently gave a speech highlighting Australia's relatively good performance in comparison with other developed countries.

In comparison to the US, UK, Euro area, Canada, Japan and New Zealand. The graph measures performance since 2005 by making all countries equal (100 on the Index) at this point.

As the Governor notes, these figures don't tell us what's coming but he outlines three possible sources of future growth.
Which sectors would be available to lead such an expansion? In the broad, there are three. There are households, governments and firms. Let's think about each briefly.
Households being willing to increase their debt and lower the share of current income being saved was a striking feature of Australia's economic landscape from the early 1990s until just prior to the financial crisis. Consumption spending consistently rose faster than income and the ratio of debt to income went from about 60 per cent in 1993 to 150 per cent by 2006. Households are servicing that higher debt quite well – mortgages make up most of their debt and arrears are running at about one half of 1 per cent, which is low by global standards. But as I have argued before, it seems unlikely that household debt can rise like that again. Nor would it be desirable. So while we can expect that household consumption spending can grow in line with income, or maybe a little faster given the rise in net worth over the past two years, the odds are against households being a driver of strong growth the way they were a decade ago.
What about the government sector? Most governments in Australia are trying to strengthen their own balance sheets by containing the build-up in debt that has been occurring. Public final spending is scheduled, according to the stated intentions of federal and state governments, to be subdued over the next couple of years. In fact, it is forecast to record the most subdued growth for a long time. By and large then, the public sector is not in the phase of using its balance sheet to expand demand faster than normal. 
That leaves the business sector. ...
My conclusion would be that many businesses are in a position to play their part in the growth dynamic over time. The fact that in some areas outside of mining the level of gross fixed capital spending is barely above depreciation rates suggests that, over time, capital spending in those areas will have to increase. The forward estimates of non-mining business capital spending released recently do show a further upgrading of intentions. That won't offset the impending fall in mining investment and it would be good to see further, and more substantial, upgrades over time. But the available data suggest that things are at least heading in the right direction.
Stevens canvasses the external environment in the first part of the speech and it appears that he is fairly sanguine about future possibilities.
Overall then, the global environment remains ‘interesting’, with significant challenges, uncertainties and puzzles. All that said, from Australia's point of view, the world economy continues to grow, inflation remains contained, our terms of trade though falling remain high, and financial conditions are remarkably accommodative.
Our external environment is heavily shaped by China. China is our biggest export partner and it is our other biggest export partners' biggest export partner, which means that any Chinese growth slowdown or rebalance towards consumption will have a negative effect on us and indeed all of Asia.

As Stevens points out:
For Australia's particular group of trading partners, weighted by export shares, growth is running at about 4½ per cent, which is somewhat above the 30-year average. This strength reflects the continued increase in the weight of China as a destination for exports. Even though China is growing more slowly than it used to – at a mere 7½ per cent this year – the fact that its growth is so much stronger than most others combines with its increased weight to push up the weighted-average growth of our trading partner group. 
The determined pessimists among us [that's me!] will see the increased weight of China as a concern: what if something goes wrong and the Chinese economy experiences a sharp slowing in growth? In fact this is a question that could be put for most economies now – nearly 50 economies, including the United States, European Union, Japan, Russia and Canada, now have China as their number 1 or 2 trading partner. The full ramifications of the continuing rise in the weight of China's economy and, in time, its financial system in world affairs will be the topic for numerous lengthy books. But in short, the whole world is now more dependent on China than it was. 
For today, probably the most important point to note is that the near-term task of the Chinese authorities is to manage the desired slowing in credit growth and moderation in asset values. Housing prices are falling in many Chinese cities at present. This is not unprecedented – it is the third time in the past decade this has occurred. (Yes, house prices can fall, even in China.) This area – the asset price and credit nexus – is the one to watch, more than the monthly exports or PMIs and so on. 
Another pricing puzzle is exchange rates. Many in Australia have commented at length about the relatively high value of the Australian dollar against the US dollar. The Bank has made its views on this pretty clear and so I won't reiterate them today. But it's worth noting that many other countries have had a similar puzzle to ours – so the real question is why the US dollar has remained as low as it has.
Yes you read correctly. Nearly 50 countries have China as their number one or two trading partner.

What this means is that Australia is now more affected by Chinese conditions than ever before and what happens to the US dollar will affect the competitiveness of the tradable sector (exporters and import-competing firms).

We need China to keep growing strongly and for the US to increase growth so that the US dollar strengthens. The rest of the world economy also needs the US economy to increase its rate of growth.

Remember that measured by exchange rates the US is still the world's largest economy. The fact that about 70 per cent of the US economy is consumption means that the US remains the vital final destination of a whole lot of goods (and associated services) that have been initially traded between the countries of Asia (think the iPhone etc).

I have long thought that the decoupling of the overall Asian economy from Europe and North America could only be a temporary phenomena. China needs the developed world to keep buying Chinese goods (as does the rest of Asia) but, in turn, the developed world requires China to shift to higher levels of consumption.

In the absence of a shift towards higher consumption in China, it is doubtful whether Europe and North American economic policy-makers will be happy with enhanced export-led growth in China. A revitalised Chinese current account deficit will mean increased exports of Chinese capital and probably higher unemployment in the developed world.

Australians should hope that the world economy can rebalance and avoid the sort of recoupling of the Asian and developed world economies that would lead to an Asian growth slowdown.

Tuesday, August 26, 2014

Global Military Spending

There are several ways to consider and compare global military spending. The most obvious way is to calculate total military spending and convert to US Dollars. Another important measure is to consider the level of spending as a percentage of a country's GDP. We start with the second way first. (See the end of the post for a definition of military spending)

I constructed this from a World Bank database (based on SIPRI Stockholm International Peace Research Institute figures). Comparing military spending as a percentage of GDP allows us to consider how much of economic growth is taken up with military expenditures.

While the United States has the world's largest military by far it ranks only 13th on the level of spending as a percentage of GDP. Importantly SIPRI doesn't construct figures for North Korea. Estimates for North Korea range from 20-33 per cent of GDP.

Rank Country            2013
1 Oman 11.48
2 Saudi Arabia 8.99
3 Afghanistan 6.24
4 Israel 5.63
5 Angola 5.01
6 Algeria 4.95
7 Azerbaijan 4.68
8 Lebanon 4.36
9 Russian Federation 4.19
10 Armenia 4.10
11 Yemen, Rep. 3.93
12 Morocco 3.90
13 United States 3.81
14 Bahrain 3.77
15 Jordan 3.56
16 Mauritania 3.56
17 Iraq 3.54
18 Colombia 3.44
19 Pakistan 3.39
20 Singapore 3.27
21 Kyrgyz Republic 3.24
22 Namibia 3.15
23 Ecuador 3.11
24 Swaziland 2.96
25 Ukraine 2.93
26 Zimbabwe 2.78
27 Georgia 2.74
28 Sri Lanka 2.71
29 Korea, Rep. 2.60
30 Brunei Darussalam 2.56
31 Greece 2.46
32 India 2.45
33 Turkey 2.33
34 United Kingdom 2.30
35 France 2.24
36 Burundi 2.24
37 Vietnam 2.18
38 Portugal 2.17
39 Serbia 2.17
40 Uganda 2.16
41 Lesotho 2.15
42 China 2.05
43 Botswana 2.02
44 Tunisia 2.01
45 Chile 1.96
46 Estonia 1.96
47 Kenya 1.95
48 Uruguay 1.87
49 Timor-Leste 1.81
50 Poland 1.79
51 Zambia 1.69
52 Egypt, Arab Rep. 1.67
53 Croatia 1.66
54 Australia 1.63
55 Cambodia 1.60
56 Paraguay 1.60
57 Bulgaria 1.58
58 Italy 1.58
59 Montenegro 1.57
60 Malaysia 1.55
61 Thailand 1.52
62 Bolivia 1.45
63 Nepal 1.43
64 Peru 1.42
65 Norway 1.41
66 Burkina Faso 1.41
67 Mali 1.41
68 Brazil 1.40
69 Congo, Dem. Rep. 1.40
70 Denmark 1.38
71 Bangladesh 1.37
72 Malawi 1.36
73 Belarus 1.35
74 Fiji 1.34
75 Germany 1.34
76 Cameroon 1.34
77 Romania 1.33
78 Gabon 1.32
79 Albania 1.30
80 Netherlands 1.29
81 Philippines 1.28
82 Finland 1.27
83 Kazakhstan 1.25
84 Honduras 1.24
85 Macedonia, FYR 1.24
86 Venezuela, RB 1.21
87 South Africa 1.17
88 Sweden 1.17
89 Tanzania 1.15
90 Bosnia and Herzegovina 1.13
91 Rwanda 1.11
92 El Salvador 1.10
93 Czech Republic 1.08
94 Guyana 1.07
95 Belize 1.04
96 Belgium 1.04
97 Benin 1.04
98 Seychelles 1.03
99 Canada 1.01
100 New Zealand 1.00
101 Japan 0.99
102 Spain 0.94
103 Indonesia 0.90
104 Jamaica 0.85
105 Ethiopia 0.82
106 Switzerland 0.78
107 Austria 0.78
108 Nicaragua 0.76
109 Liberia 0.75
110 Argentina 0.74
111 Mexico 0.62
112 Dominican Republic 0.61
113 Papua New Guinea 0.57
114 Ireland 0.55
115 Ghana 0.53
116 Madagascar 0.51
117 Luxembourg 0.51
118 Cabo Verde 0.50
119 Guatemala 0.48
120 Nigeria 0.47

US military spending has declined over recent years, whilst China's has increased. Since 2004 Chinese military spending has increased by 170 per cent, whilst its GDP Has increased by 140 per cent. Still China only spends 2.05 per cent of its GDP while the US spends 3.81 per cent. Japan, due to its pacifist constitution still spends just under 1 per cent. 

The table below constructed from SIPRI databases shows basic measure alluded to above of total military spending converted to US Dollars. It shows the top 60 military spenders in the world (New Zealand comes in at 60). 

Figures are in US$m. at 2013 prices and exchange rates. 

RankCountry 2013 
1USA                           640221
2China, P. R.                  188460
4Saudi Arabia                  66996
5France                        61228
6UK                            57891
7Germany                       48790
8Japan                         48604
9India                         47398
10Korea, South                  33937
11Italy                         32657
12Brazil                        31456
13Australia                     23963
14Turkey                        19085
15Canada                        18460
16Israel                        16032
17Colombia                      13003
18Spain                         12765
19Taiwan                        10530
20Algeria                       10402
21Netherlands                   10328
22Singapore                     9759
23Poland                        9257
24Oman                          9246
25Iraq                          7896
26Indonesia                     7840
27Mexico                        7838
28Pakistan                      7641
29Norway                        7235
30Sweden                        6519
31Angola                        6095
32Greece                        5939
33Thailand                      5891
34Kuwait                        5815
35Chile                         5435
36Ukraine                       5338
37Venezuela                     5313
38Belgium                       5264
39Switzerland                   5053
40Malaysia                      4842
41Portugal                      4784
42Denmark                       4553
43Argentina                     4511
44Egypt                         4255
45South Africa                  4108
46Morocco                       4064
47Philippines                   3472
48Azerbaijan                    3440
49Viet Nam                      3387
50Finland                       3262
51Austria                       3230
52Peru                          2865
53Ecuador                       2803
54Kazakhstan                    2799
55Romania                       2521
56Nigeria                       2411
57Myanmar                       2211
58Czech Rep.                    2149
59Lebanon                       1936
60New Zealand                   1833

In terms of total military spending the US still dominates with 37 per cent of the total compared to China's 11 per cent. This means that China's spending is about 30 per cent of the US figure. 

Note that these figures are measured in US dollars meaning they are subject to the same problems of measurement outlined in How Big, How Rich, How Developed. Constructed on a PPP basis, Chinese military expenditure would be more substantial as a percentage of the total.

The table from the PDA (Project on Defense Alternatives) below shows different measures for military spending from SIPRI and IISS (International Institute for Strategic Studies).

What this table makes clear is that how we measure military expenditure matters for our perceptions about China's rise and US relative decline. However, it also seems reasonably clear that the US retains an overwhelming military dominance regardless of the measure. 

Australia, despite significant declines in spending as a percentage of GDP ranks as the 13th largest military spender. 

Given the Abbott government's focus on the seriousness of the Islamic terrorist challenge and promises made, it seems clear that military spending will rise in coming years as will expenditure on domestic policing and surveillance. 

Military expenditures data from SIPRI are derived from the NATO definition, which includes all current and capital expenditures on the armed forces, including peacekeeping forces; defense ministries and other government agencies engaged in defense projects; paramilitary forces, if these are judged to be trained and equipped for military operations; and military space activities. Such expenditures include military and civil personnel, including retirement pensions of military personnel and social services for personnel; operation and maintenance; procurement; military research and development; and military aid (in the military expenditures of the donor country). Excluded are civil defense and current expenditures for previous military activities, such as for veterans' benefits, demobilization, conversion, and destruction of weapons. This definition cannot be applied for all countries, however, since that would require much more detailed information than is available about what is included in military budgets and off-budget military expenditure items. (For example, military budgets might or might not cover civil defense, reserves and auxiliary forces, police and paramilitary forces, dual-purpose forces such as military and civilian police, military grants in kind, pensions for military personnel, and social security contributions paid by one part of government to another.)
Stockholm International Peace Research Institute (SIPRI), Yearbook: Armaments, Disarmament and International Security.

Tuesday, August 19, 2014

European Dependence on Russian Energy

From: New York Times

Classic dilemma for IR and IPE students.

Who has the power in this situation?

In the short-term it seems clear that the Russians have power (no pun intended) given the dependence of many countries on Russian energy supplies. Over the longer-term, however, it seems likely that the switch away from Russian energy supplies could be disastrous for the energy export-dependent Russian economy.

The sanctions on Russia do not involve stopping the import of Russian energy, but other sanctions could lead to retaliation from the Russians in terms of energy exports or imports. Indeed the Russians have banned food imports from major Western countries. This will undoubtedly punish those exporters to Russia, but will also lead to food shortages in Russia itself. According to this report from the NYT, Russian bans on food  imports will advantage Chinese producers.

Thursday, August 14, 2014

Importing Chinese Tourists as Exports

Australia has been exporting large quantities of resources to China in recent years. I would like to say it has transformed our economy, but in reality it has accentuated pre-existing attributes of the Australian economy. Indeed, although the policy framework shaping Australia's economic interactions has been transformed, Australia remains reliant on resources to pay our way in the world.

In the 1980s, Japanese demand for resources was followed by a significant increase in Japanese investment and tourists. This is now happening with China and the prospects for further increases in Chinese tourism are high. 

Our importing of Chinese nationals to visit Australia is registered in the national accounts as an export as is the spending of Chinese students. 

Alan Kohler canvasses the potential numbers:
In June about five Boeing 747 loads of seasonally adjusted Chinese tourists arrived in Australia every day. For the year to June, the total was 769,000 -- a record number -- and second only to New Zealanders. More importantly, Chinese tourists stay the longest and spend by far the most: $5.1 billion in the year to March, according to Tourism Australia data, or $7,343 each -- double what the Kiwis spend. 
Apparently only 5 per cent of Chinese actually own a passport so there is a fair bit of upside potential there, although it's important to note that most Chinese are still poor. Despite China's rapidly growing economy over recent years, overall China is still a poor country, ranking 82nd in the world for Gross National Income per Capita (measured in US dollars) according to the World Bank. This puts it just above Namibia, but below Iraq and Turkmenistan. Australia ranks third.

In the case of tourism, purchasing power parity rankings of economic weight (see here for explanation) have less purchase than exchange rate measures (local currencies converted to US Dollars) because going overseas requires you to convert your money and pay higher prices. I'm not sure that poor Chinese will be visiting expensive rich countries any time soon.  Of course, with a population as large as China's, this is not really the point as long as the middle class keeps expanding and decides to spend some of its new found wealth on coming to Australia.

According to The Economist: 
Nearly one in ten international tourists worldwide is now Chinese, with 97.3m outward-bound journeys from the country last year, of which around half were for leisure. Chinese tourists spend most in total ($129 billion in 2013, followed by Americans at $86 billion) and per tax-free transaction ($1,130 compared with $494 by Russians). More than 80% say that shopping is vital to their plans, compared with 56% of Middle Eastern tourists and 48% of Russians. They are expected to buy more luxury goods next year while abroad than tourists from all other countries combined.
Supposedly, the number of Chinese tourists will double by 2010 and their spending will triple, although there is no indication how these numbers were arrived at. It's China so anything I suppose is possible.

Tourism Australia reports that there were "6.6 million visitor arrivals for year ending June 2014, an increase of 7.9 per cent relative to the previous year". China ranked second behind New Zealand with the UNited Kingdom third.

The Australian Bureau of Statistics compares 2013-14 with 2003-04 to see how short-term visitor arrivals have changed. Seemingly, the Japanese are less interested than they once were in Australia.

New Zealand numbers have increased by over 30 per cent, but the number of Japanese visits has fallen from 718,600 to 323,700, a fall of 55 per cent. Chinese visits have increased by nearly 230 per cent, while Indian visits have increased by nearly 250 per cent.

It is not just short-term visitor numbers that interest Australian authorities. In recent years, Australia has introduced 'significant investor visas', which enable people to buy their way into Australia. According to a recent report, the scheme "has reaped a total $1.7 billion to date", awarding 343 residency visas as at the end July 31. The Abbott government accelerated the scheme after concerns that the program begun in 2012 was not attracting investors. Accordingly "six hundred and two additional applications had been made at July 31, and $3.05 billion in investment pledged in return

Australia has been in a good location to take advantage of Asia's booming economy, although we should be careful about assuming that these numbers will continue to expand, just because Japan and China have large populations. Australia will continue to depend on the economic growth of East Asian countries with China increasingly important for all countries in the region. A slowing China will affect all other countries in Asia and in turn have a negative affect on Australia.   

Wednesday, July 30, 2014

Australia's Economic Vulnerabilities

Interesting comments from Australian OECD economist Adrian Blundell-Wignall.

He argues that the export-led model of many developing economies is not sustainable, especially over time as developing economies account for a greater share of global GDP (see here for analysis).

Not all countries can be exporters at any point in time exports must match imports so unless we start trading with another planet, not every country can have a trade surplus.

He then goes on to skewer the banks:
"If you go back to 1980 the earnings of the financial sector of the S&P 500 companies was less than 10 per cent."
He says the proportion of Wall Street earnings by finance stocks is now more than 30 per cent, having risen above its share when the GFC hit.
"The financial sector is supposed to be the sector that intermediates between real savers and real investors. That's what greases the wheels of capitalism," he said.
"Where do we get off thinking that the financial sector can just rip one third of the earnings for themselves?
"People want to understand why investment is a problem ... there's no inflation and the recovery is very problematic everywhere.
"Monetary policy can only do so much and you need an investment cycle to follow. And the investment cycle really isn't following."
He also warns of the danger of a slowing China for Australia and the potential for problems if the US dollar rises and has an impact on commodity prices.