The mining boom is making Australia potentially wealthier, but also creating problems because of the high exchange rate. What should government policies be?
There are two issues, and it is very important that they are distinguished. One concerns taxes and the other concerns the exchange rate.
The aim of taxation is that some of the benefits of the boom go to the Australian community as a whole and not just to Australian shareholders and employees, and certainly not mainly to foreign owners. Taxation is probably the main channel (though not the only one) through which Australia benefits from the boom.
There are the normal company and income taxes, revenue from which will be increased by the boom. Additionally, when there are exceptionally high profits – as there have been - they should, in my view, be taxed through something like a super-profits tax.
All these extra taxes would be borne both by the foreign owners of the mining companies and associated firms, and by owners who are Australian residents. Indirectly, executives and other employees and suppliers of the mining firms would also be affected.
Such a tax can be too high. It may discourage foreign capital inflow into Australian mining and also reduce the incentive to fully exploit opportunities. Indeed, very high taxes may end up leading to less total revenue from taxes. If the tax discourages capital inflow and new investment, it will reduce future profits and thus total revenue from taxation in the future. But so far, as the various mining industries develop, especially liquefied natural gas (LNG), there is no sign of such discouragement.
Such a tax can also be too low. The main reason would be the political power exercised in various well-known ways by wealthy companies and interested individuals. Two ways are through influencing public opinion with advertising and influencing policy through lobbying. This sort of thing is very open in the United States. I think it is a danger in Australia.
I now come to the second policy issue. This concerns the exchange rate. Australia’s exchange rate has greatly appreciated since the mining boom began, and this has certainly been a problem for other actual and potential export industries, as well as for import-competing industries. Appreciation is caused both by the huge rise in mining incomes owing to higher prices of iron ore and coal, and to the massive inflow of foreign capital into the sector, leading to an investment boom. Of course, there are other factors - notably the low interest rates abroad.
Obvious victims of appreciation are some parts of manufacturing, domestic tourism, and the export-of-education industry. Also included should be potential exporting firms that would have developed if the exchange rate had been lower. This is called the “Dutch Disease problem” because the Netherlands was believed to have once gone through that experience.
Does the Dutch Disease require policy action by the government designed to moderate the appreciation – and thus to depreciate the exchange rate somewhat? This is a big issue and a difficult question to answer.
Firstly, it must be remembered that there are also gainers from the appreciation, as Australians travelling overseas certainly recognise. Cheaper imports, owing to appreciation of the exchange rate, have reduced the cost of living and brought benefits to wage-earners and the general community, as well as firms that use imported inputs.
Secondly, measures to depreciate the exchange rate all have problems. One way would be for the Reserve Bank (our central bank) to lower interest rates. That would reduce capital inflow and increase outflow, and would indeed lead to some depreciation. But, unless there is slack in the economy the effect would be inflationary. To offset that, fiscal policy would have to be tightened, perhaps leading to a substantial surplus. Such a sustained fiscal surplus policy would be politically difficult.
I have discussed various possible policies to deal with Dutch Disease in Australia in a recent working paper for the Melbourne Institute of Applied Economic and Social Research.
In particular, I discuss the possible role of a sovereign wealth fund that invests the fruits of a fiscal surplus abroad, and thus is a form of government savings that gives the government a useful nest egg in case the boom comes to an end – as it surely might.
In this working paper, I point out something that may be surprising. When the government taxes the mining sector and the effect is mainly felt by foreign owners who would have spent their receipts abroad, and the government then puts the proceeds into a sovereign wealth fund that invests abroad on behalf of the government, there will be little or no effect on the exchange rate. Foreign spending by the taxed owners is reduced, and foreign spending by the Australian government is increased. Thus these taxes that bear on foreigners will not reduce the Dutch Disease.
It is easy to misunderstand this result. In the working paper I go on to say “the taxation and the use of the sovereign wealth fund may well be justified: Australians get a bigger share of the benefits of the boom, and, prudently, their government saves it and invests it abroad”.
In other words, as I pointed out at the beginning, taxation of the mining sector is desirable because it gives the Australian community some of the benefits of the boom. Some of these benefits will be felt when the fruits of the sovereign wealth fund accumulation come back to Australia, perhaps once the boom has declined or come to an end.
In the Australian Financial Review on March 13, an article by Laura Tingle summarised some of the results of my working paper, and did so very accurately. But the headings on the article conveyed a false impression. The first heading was “Don’t rely on mining tax, Labor told” (I never referred to Labor), and the second heading was “Resource tax case flawed: expert”. In Business Day of The Age, March 14, another article has a brief paragraph which refers to “criticism of Labor’s mining tax from economist Max Corden”.
I want to tell the readers of The Conversation that I favour a mining tax, but don’t expect one that only affects foreign owners of the mining industry to reduce the Dutch Disease.
I should add that if the tax were so high that it reduced capital inflow into mining substantially then it would indeed moderate the Dutch Disease effect. But that is not the sort of tax that either the Government or I favour. It would be more than just a super profits tax.
The subject is complicated – but important. Please read my Working Paper!