Why Abbott and Gillard can’t forget the global economy: Kohler

“All politics are local”, said former US House of Representatives speaker Tip O’Neil, and the 2010 Australian election looks like conforming pretty closely to that aphorism, with two sets of strikingly similar, intensely local policies – so far at least.

But the big challenges for the incoming government will all be global, revolving round the response to some of the most powerful economic shifts in a century.

Specifically China is likely to keep growing at around 10% a year. It is undergoing a slowdown at the moment, but that is likely to be short-lived as the immense structural changes reassert themselves.

McKinsey & Co predicts that China will add 400 million to its urban population by 2025 and the number of ‘middle class’ households will quadruple to 280 million.

The challenges this will present for economic policy in this country are hard to overestimate.

Treasury Secretary Ken Henry has been warning for a while about the “two-speed economy” (booming resources, depressed manufacturing) and the bungled resource super profits tax was an attempt, in part, to deal with that by slowing down the fast one. The replacement, the minerals resource rent tax, will still have an impact, but it will be minor.

Last week researchers at ANU presented a paper to a conference on China in Canberra predicting that the intensity of China’s steel use would triple by the middle of next decade. Citigroup economist Paul Brennan says this implies a sustained commodity super-cycle that would “underpin a protracted increase in mining and related infrastructure investment in Australia”.

Before the GFC interrupted us in 2007-08, the commodity super-cycle produced a spike in our terms of trade that saw unemployment fall to 4%, inflation peak at 4.7%, the Australian dollar rise to near parity and the cash rate to 7.25%.

Of course in those days the local economy was also being super-charged by a credit-fuelled boom in the US and Europe, which has now collapsed – probably for a long time.

In fact, the US Federal Reserve let the cat out of the bag on that score last week in its minutes for the June meeting, with the statement that most members of the interest rate setting committee expected it take up to five or six years for the US economy to get back to normal. Europe will be lucky to do it that quickly.

The US has already escaped a double-dip recession (that is, two within 12 months), but all the data are pointing downwards. Housing is going backwards again, manufacturing orders have slumped, leading indicators are in reverse and employment is weakening. Going by last week’s minutes, the Fed is preparing to step in and print more money.

Two things might save the US from the two decades of deflation and depression that was Japan’s fate after the crash of 1990 – innovation and immigration. Japan had neither of these engines of renewal and growth, where American has them in spades.

As the US battles to stay out of the mire of deflation and China’s long march continues as the authorities there try to fight inflation without losing momentum, Australia is caught in the middle – head in the oven, feet in the freezer, so to speak.

The next few years will require some subtle, and potentially unpopular economic policy-making here to deal with this.

This article first appeared on Business Spectator.