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The Mineral Resource Boom and the Economy of South West Queensland

National Economic Review
National Institute of Economic and Industry Research
No. 68   October 2013

The National Economic Review is published four times each year under the auspices of the Institute’s Academic Board. The Review contains articles on economic and social issues relevant to Australia. While the Institute endeavours to provide reliable forecasts and believes material published in the Review is accurate it will not be liable for any claim by any party acting on such information.

Editor: Kylie Moreland

This journal is subject to copyright. Apart from such purposes as study, research, criticism or review as provided by the Copyright Act no part may be reproduced without the consent in writing of the relevant Institute.

ISSN 0813-9474

The mineral resource boom and the economy of South West Queensland
Dr Ian Manning, Deputy Executive Director, NIEIR

Abstract
As outlined in the State of the Regions report for 2012–2013, the current national resource boom is patchily distributed, with some regions reporting frenetic activity and others depressed as a side-effect of the boom. South West Queensland lies on the margins of the boom: it is not involved in the booming iron ore and coal export industries but parts of it produce petroleum, natural gas and coal seam methane. To ensure that benefits continue, it is necessary to plan for what will happen after the boom has run its course. There are two main concerns. First, infrastructure should not be allowed to deteriorate as a result of boom usage or the diversion of resources to the boom. Second, the boom should not be allowed to detract from the productive capacity of the pastoral, tourism and other non-mineral resource industries in which the region has expertise. The present paper investigates several policy measures to optimise the benefits from the mining boom. Such measures include: ensuring that the mineral resources industry makes appropriate contributions to local infrastructure through a rural equivalent of the urban developer charge system; ensuring that the industry makes appropriate direct contributions to local government; increasing state royalties to fund a regional development trust, as pioneered in Western Australia; financial regulation to require appropriate financial intermediaries to insure housing values in the towns of the region; and investment to improve the quality of transportable homes. A further measure, a review of income tax zone rebates, is canvassed in a complementary paper.

This paper was prepared for the Shires of Bulloo, Murweh, Paroo and Quilpie, the Maranoa Regional Council and Regional Development Australia, Darling Downs South West region. It is printed with permission.

National resources and the economy
Geoffrey Blainey’s popular history of Australian mining is entitled The Rush That Never Ended. Despite this title, it is actually the history of a sequence of rushes, some small and local in their effects but a few of them major to the extent that they changed the course of national economic history. These major rushes (mining booms) were separated by decades when other industries took the lead in Australian economic development. Over much of the nineteenth century, before Australia became an integrated economy, the pastoral industry was in the lead in all six colonies, while farming provided a solid basis for development in most colonies in the late nineteenth and into the twentieth century. The prosperity of the post-war period in the mid-twentieth century was based on manufacturing. However, the late twentieth century saw a revival in the exploitation of mineral resources (mining is now something of a misnomer: underground mining has declined in favour of quarrying and oil and gas wells). The Poseidon boom was preceded by the first Pilbara boom, after which there was a lull followed by the present resources boom.

The national resources boom
The current Australian resources boom is a response to an unexpected increase in the international prices of three minerals. First, The US dollar price of iron ore rose more or less continuously from 2004 to peak in 2011 at nearly thirteen times its level in 2003, although it has since fallen to eight times its 2003 level. Second, the US dollar price of thermal coal rose from 2004, spiked in 2008 then fell, before recovering to four times its level in 2003. Finally, the US dollar price of liquefied natural gas (LNG) rose from 2004, spiked in 2008, fell, and then recovered to four times its level in 2003, although falls are expected given declining gas prices in the United States.

Although part of each of these increases reflects the fall in the value of the US dollar, the increases have been substantial whatever the currency used to measure them. Australia has resources of all three minerals and, once it was realised that prices were going up despite the Great Financial Crisis, investment boomed in increasing Australian production capacity. The reason for the high prices lies primarily in demand from China arising from rapid economic growth.

In describing the effects of a resources boom, it is important to keep an eye on the future. The very word ‘boom’ implies subsequent bust. There are some who believe that the current level of activity in the mineral resource industries is not a boom but can go on forever. However, the historical record is that peaks in mineral prices have been followed by periods of lower prices as international supply has caught up with demand. There is every reason to expect that this will occur in the present case, if only because the Chinese are investing heavily in expanding supply, partly in Australia but also in other mineral-rich countries. When prices fall the industry responds by reducing investment in capacity expansion and the boom ends. Regions which prospered during the boom are thrown back on other sources of employment.

The rush of the current resources boom is well measured by gross operating profits in the ‘mining’ industry, which, as defined by the Australian Bureau of Statistics, includes all mineral resource exploitation. In 2011 profits in the industry were running at the rate of approximately $A94 billion a year: nearly four times their level a decade previously. In 2011 profits in the mineral resource sector accounted for 32 per cent of all business operating profits (excluding the agricultural sector and most of the finance sector), a significant increase from their share of 19 per cent in 2001. This increase in profit share was largely at the expense of manufacturing, which had approximately the same share of non-agricultural, non-financial profits as mineral exploitation in 2001 but declined to 11 per cent in 2011 (ABS, 2012). There was a causal relationship at work here:

  • The Reserve Bank of Australia responded to the resources boom by raising interest rates. The currency market responded to this and to the increase in foreign investment in Australia by raising the Australian exchange rate, which reduced the Australian dollar prices of imported manufactured goods. The Australian manufacturing industry found itself unable to compete.
  • The rise in resource exploitation profits generated a boom in resource-related investment and, hence, in the demand for construction labour. Although there has been no general wage breakout during the boom, there has been competition for skilled labour, to the detriment of manufacturing.

Although the primary victim of the resource boom has been manufacturing, the high exchange rate has penalised export industries across the board, including resource exploitation itself. However, the penalty is of little concern to the mineral resource industry because it has been counterbalanced by booming prices. In addition, the industry is largely overseas-owned and thinks in terms of the US dollar, the euro, the yen or the yuan. The penalty has been severe for tourism and export education but because of the hazy definition of these industries in official statistics is not well documented.

The farming and pastoral industries are also trade-exposed, but have been relatively well placed to survive the high exchange rate, for three main reasons. First, the agricultural and pastoral industries have a long history of exposure to fluctuating world prices, including (since 1983) fluctuations due to the floating exchange rate. Through long and sometimes bitter experience they are better prepared to deal with fluctuating prices than manufacturing and service industries. Second, the agricultural and pastoral industries likewise have a long history of exposure to good and bad seasons, which has again forced resilience upon them. It has helped that in much of Australia seasonal conditions have been reasonably good in recent years so that increases in quantity sold have helped to counteract price reductions due to the spike in the exchange rate. Finally, international prices for a number of key pastoral and agricultural commodities have been reasonably favourable over the past few years. Thus, in 2011 the US dollar prices of beef and fine wool were sufficiently high to offset the exchange rate so that Australian dollar prices were comfortably above the low levels suffered in the 1990s and up to 2005. These factors have so far sheltered many agricultural and pastoral businesses from the adverse effects of the resources boom expressed in the high exchange rate and competition for labour.

A further potential adverse effect of resource exploitation, its environmental impact, can be important for the agricultural and pastoral industries, as well as for tourism, although it is not important for manufacturing or export education. For example, several decades ago the mining of beach sand in Queensland was curtailed because of its serious environmental effects, including the impact on tourism. More generally, resource exploitation can directly disrupt rural production. Mineral exploration can involve entry to farm properties, which affects the use of the properties, while mining and quarrying can debilitate farmland, pre-empt water supplies and pollute creeks and ground water. The various state mining acts provide for compensation but farm organisations argue that the compensation is insufficient. More fundamentally, they claim that it is not right that mining should have the automatic precedence over agriculture as a land use granted to it by the current state mining acts.

The rapid changes in relative industry competitiveness that have resulted from the resources boom have had pronounced regional effects. Activity has boomed in the mineral resource regions and slumped in regions based on manufacturing and tourism. The effects in the agricultural and pastoral regions are more complex, partly because the high exchange rate has been partially offset by increased international prices and partly because several agricultural and pastoral regions also host mineral resources.

The prospect of an end to the boom is of great importance in assessing its effects. If the increase in the profitability of mineral resource exploitation is permanent, it is rational to divert resources from less-profitable industries to the new high-profit industry. However, if the high profits are temporary, the diversion of resources may come to be regretted once the boom ends and the country has to depend on its established industries. Thus, a boom that weakens other industries, for example by raising wage costs so that routine maintenance is postponed, may turn out to be costly in the long term, because it will be difficult for the established regional industries to take up the slack when the boom ends. In contrast, it is possible for boom investment to strengthen the other industries, for instance, by improving general transport infrastructure. If this happens its long-term effect is likely to be positive.

South West Queensland: Geography and population
As an example of the effects of the resources boom in a largely pastoral region, part of which has been directly affected by the boom, we take South West Queensland, here defined as five local government areas (LGAs): Bulloo, Maranoa, Murweh, Paroo and Quilpie. This region lies north of the New South Wales border and forms a strip approximately 350 km wide, stretching roughly 800 km east from the South Australian border. Four of these LGAs are legally shires, while Maranoa is legally a regional council, but, with apologies to Maranoa, in this article we will use the term ‘shire’ to refer to each of them. Each shire is geographically large, typically 200 km east to west and 200 km north to south. At the 2011 Census the resident population of the region was 20,931. More than half these people (13,100) live in Maranoa. The largest town in Maranoa, and, indeed, in the region, is Roma, with a population of approximately 6,000. The next most populous shire is Murweh, which accounts for nearly one-quarter of the population of the region and has the second-largest town, Charleville, with a population of around 3,200. Paroo follows, with a shire population of 1,900, including the region’s third largest town, Cunnamulla (population 1,200). Quilpie Shire has a population of a little fewer than 1,000 and Bulloo Shire a resident population of 400. The region has one other town of around 1,000 population: Mitchell, in Maranoa shire. The largest town in Quilpie Shire is Quilpie, with the population around 560, while the largest (some would say only) town in Bulloo Shire is Thargomindah, with a population of 200.

Over the past two decades the population of the region has increased gently, although it is best described as stable.

The economy of South West Queensland
The market value of output produced in the region, excluding corporate profits, is estimated at $A918 million, of which roughly 60 per cent originates in Maranoa, 19 per cent in Murweh, 8 per cent each in Quilpie and Paroo, and 4 per cent in Bulloo. The value of output per person employed is highest in Paroo and Quilpie (approximately $A108,000 per worker). This is something of a statistical artefact, because output in these shires is dominated by the pastoral industry, much of which is run by family businesses whose profits are included in the value of production. The value of output per person is somewhat lower in Bulloo and Maranoa: between $A80,000 and $A90,000 per person employed. The gas industry is important in these shires, but its corporate profits are not included in the value of production because they are difficult to allocate geographically and do not generate incomes available for local distribution. Finally, Murweh has the lowest value of output per person employed, a little under $A70,000, due to its hosting low value-added industries, such as the abattoirs and various service industries.

Across the region as a whole, approximately 7 per cent of the value of production is not available for distribution within the region because it is claimed by workers who live elsewhere. The remaining income generated within the region is split more or less equally between wages/salaries and business income. In 2010– 2011 residents of the region paid approximately $A160 million in income tax but received approximately $A180 million in social security payments. The balance differed between the shires. Income tax payments by Murweh residents comfortably exceeded their social security receipts but it was the other way round in Paroo, with the position in the remaining shires being more or less balanced. Residents of the region also paid indirect taxes but benefited from the provision of government services that generated employment in public administration and police, education and health services. This employment accounted for nearly one-quarter of total jobs, and its location was determined largely by government policy on service provision and, in turn, by the location of people who required services. The underlying reason why people live in the region is the incomes generated by its economic base.

The economic base of South West Queensland
Residents of the region earn incomes from the export of the products and services of three main industries to people outside the region. These economic base industries account for approximately one-third of total employment in the region, with other support and service industries accounting for the remaining two-thirds. In what follows, the long-term economic mainstay of the region, the pastoral industry, is first considered. Tourism and support services are then discussed before turning to mineral resource exploitation.

The pastoral industry
The resident employed workforce comprises a little over 10,000 workers, of whom one-quarter are employed in agriculture and forestry: primarily in pastoral production, although dry-land crops are grown in favoured parts of Maranoa. There is also a small irrigation area based on the Warrego River at Cunnamulla. In addition, the wild honey of the bush is harvested by beekeepers and the forestry industry feeds several small sawmills. The principal export products are beef cattle, wool and sheep for meat. Producing all three requires careful management to ensure that the fluctuating carrying capacity of the country is utilised without overgrazing. Management techniques include rotation between paddocks, browsing, agistment and judicious timing of animal turn-off.

Several challenges face the pastoral industry. One such challenge is maintaining detailed local knowledge to underpin property management. This knowledge is not easily acquired because it takes decades to experience the full range of seasonal conditions. Another is developing pastoral products that meet specific market requirements and, hence, command premium prices. Controlling costs, particularly labour costs but also transport costs, is another issue. It is here that there is potential for conflict with the mining industry. Another issue is the control of pests, especially wild dogs and cats.

Two other meat animals, goats and kangaroos, offer potential for expanded production, but both are difficult to manage because neither species respects fences. So far, goats have been herded and then processed as for other meat animals while kangaroos have been culled in the field: a process that has led to problems of quality management. The future of these products depends on improvements in animal management.

For the region as a whole, employment in the pastoral industry declined by 20 per cent from 1991 to 2011. The decline was most severe in Quilpie and Bulloo and had two major causes. The first was the prolonged slump in wool prices during the 1990s and early 2000s, which generated a move out of wool. There was a magnified effect on regional employment, because wool production is more labour-intensive than beef cattle or meat sheep production, and even itinerant workers (such as shearers) tend to live locally. The second major cause was an unusually long drought, particularly in the western part of the region. Both the drought and the wool slump have ended, and over the past few years employment in the pastoral industry has been recovering. It should also be remembered that other elements in regional employment are directly linked to the industry. Roma has the largest cattle sale yard in Australia and Charleville has one of the few remaining inland abattoirs.

Pastoral production is an extensive land use that is not seriously disturbed by mineral exploration nor seriously compromised by oil or gas wells or pipelines. The main potential for environmental conflict concerns ground water, with potential for competition for ground water flows and potential for the mineral resource industry to pollute ground water flows as well as creeks and waterholes.

Tourism
Compared to the agricultural and mineral resource sectors, tourism is a relatively minor export industry for the region. Accommodation and food services account for less than 6 per cent of the resident workforce and many of these workers are employed to provide services for local people or for the mineral resource exploitation industry. However, the region has capitalised on its position astride the grey nomad route through inland Australia, an imaginative example being its investment in the Cosmos Centre at Charleville. The region does not attract many international visitors except for the backpackers who provide much of the hotel workforce in Roma. The mining boom has resulted in a shortage of tourist accommodation in Maranoa but not in the other shires.

Support industries
Apart from the export-oriented elements in its economic base, the region provides employment in necessary commercial support services in transport, construction and trade. These services account for approximately 40 per cent of total employment in the region.

Mineral resource industries
The region’s second most important export industry, measured by employment, is the exploitation of mineral resources, which employs a little over 5 per cent of the resident workforce. Because of the importance of fly-in fly-out in this industry, its contribution to total jobs located in the region is somewhat greater, at 8 per cent, and because it pays relatively high wages its contribution to wage incomes would be somewhat greater again, but still way short of the pastoral industry.

This industry comprises three distinct segments. First, in Quilpie and Bulloo Shires, opals are mined by fossickers and other small businessmen. These enterprises have none of the characteristics of the big mining companies and can be treated as an adjunct to the tourism industry.

Second, the western parts of Quilpie and Bulloo Shires lie within the Cooper Eromanga basin and have proved prospective for hydrocarbons. Local crude oil production supports the Eromanga oil refinery: a small but significant enterprise that supplies diesel, kerosene and specialist mining fuels to a large area of outback Australia. The Jackson oilfields in Bulloo shire have been producing since 1981, with crude oil piped out via Adelaide and Brisbane. More recently, the area has been developed for natural gas. Santos operates a processing facility at Ballera, from where gas can be piped west to the Moomba hub, north to Mount Isa or east to the hub at Wallumbilla. Exploration is under way to potentially extend gas production to Paroo and Murweh Shires, but these at present have no mineral production.

Finally, energy resources available in Maranoa include coal, oil, natural gas and coal seam gas. Coal was mined at Injune until the dieselisation of the Queensland Railways in the early 1960s. The oil and natural gas fields have a century-old history, much of it a history of disappointment. The natural gas hub at Wallumbilla, east of Roma, was not sited to serve local production but lies at the point where the natural gas pipeline from Ballera bifurcates to serve Brisbane and Gladstone. However, over the past decade, coal seam gas production has increased considerably in Maranoa and across the borders in Western Downs and Banana. These increases have generated investment in gas processing plants and an increase in the importance of Wallumbilla. Coal production has yet to resume in the shire but seems likely to do so as soon as the present limits on transport capacity to the coast can be overcome.

Resources boom in South West Queensland
The national resources boom has been based on iron ore, coal and gas. South West Queensland cannot produce iron ore and does not currently produce coal but has been well placed to participate in the gas boom. The pace of development in the gas industry in South West Queensland picked up in the early 2000s, well before the national resources boom was triggered in 2004 by the rise in world prices of iron ore and energy minerals. At the time there was no question of export markets and, indeed, there was a strong possibility that Queensland would be supplied with natural gas from Papua New Guinea. Three factors served to increase interest in local gas production. First, in 2000, the Queensland Government announced a cleaner air policy, which, with a long lead time, guaranteed a market for gas in electricity generation in Queensland. Second, at approximately the same time, investors were showing considerable interest in alumina production at Gladstone, again with potential to increase the demand for gas. Finally, developments in the technology of coal seam gas production lowered costs.

In response to these signals, investment in coal seam gas began in earnest in Maranoa and adjacent LGAs. The contribution of the national resources boom has been to confirm demand, including introducing the prospect of export demand by construction of LNG export terminals at Gladstone. Investment has continued, now mainly focused on export demand. Employment in the mining sector in Maranoa continues to increase but not at the rapid rate experienced in the first 5 years of the present century.

The timing of gas industry expansion was similar in Bulloo and Paroo, although to a considerable extent it reflected the completion of a pipeline investments committed in the late 1980s. The Ballera gas hub was constructed and connected by pipeline to the Moomba hub in 1994, which enabled wells in South West Queensland to supply the Adelaide market. The pipeline to Wallumbilla was added in 1997, providing access to markets in Brisbane and Gladstone, and the pipeline to Mount Isa was completed in 1998. These connections inaugurated a program of gas field development that peaked in the early 2000s but continues to this day, with the locus of activity moving northward into Quilpie Shire. As in Maranoa, the contribution of the natural resources boom has been indirect, by maintaining confidence that gas from the Cooper Eromanga basins will continue to find profitable markets.

Sequence of mineral resource development
The impact of mineral resource development on incomes and on other industries has to be understood in relation to the typical life of a gasfield. This has four phases: exploration, construction, production and remediation.

The exploration phase is carried out by a small mobile workforce spread over a large area. This workforce is highly skilled and depends on scientific support. It is inevitably based in major centres and its members frequently camp out when in the field. The chief limit to the duration of the exploration phase is the time limits that state governments impose on exploration licences to prevent ‘warehousing’. The exploration phase ends when sufficient reserves have been proved to justify the construction of processing and transport facilities.

During the construction phase the processing plant and transport pipelines are built and a relatively large workforce is brought in. Most of this labour requires general construction industry skills. Because serious capital expenditure is involved, it is in the investor’s interest that the construction phase should be as brief as possible, a few years at the most. The high wages paid in mineral resource sector construction are partly explained by the hurry.

For most minerals the production phase requires less labour than the construction phase. However, this is not necessarily true for onshore oil fields and gas fields where, as the field ages, exploration continues to pinpoint additional reserves and wells are drilled to exploit marginal reserves.

In the remediation phase the skills required revert to general construction industry skills. Revegetation can be quite labour-intensive, but the gas industry does not require the extensive surface earthworks typical of coal mining. The mining industry has a history of failure to provide for remediation but mine and petroleum tenements now require remediation and the major mining companies make reasonable provision, the costs being small relative to the damage to their reputations if remediation is not properly implemented.

The course of the resources boom in South West Queensland can be charted by its labour market effects.

The resources boom and the labour market
Between 2001 and 2011 employment in the mineral resource exploitation sector in Maranoa increased by 380 workers and in Bulloo/Quilpie by 220 workers. These increases followed a period of construction. Although its skill requirements are not outstanding compared with manufacturing or rural industries or, indeed, with local government services, the mineral resource sector is now renowned for the payment of high wages, at least during booms. It was not always thus: workers in the Maranoa colliery of the 1950s were paid much the same wages as other rural workers.

There are several reasons for the high wage rates currently paid. For example, the gas industry, like other major resource industries, is capital-intensive. Disruptions from labour shortages that involve leaving equipment idle are accordingly very costly and employers are willing to pay to avoid plant stoppages. The quid pro quo is that workers must submit to the discipline of working the required shifts. Another reason is that plant operators in the industry are frequently in charge of valuable equipment and mistakes in equipment operation can cost millions of dollars. High wages are, in part, compensation for being careful, the quid pro quo being that carelessness results in dismissal. High wages can also be seen as compensation for the personal disruptions that occur when people go to work in distant places in jobs that carry no guarantee of permanence.

Although not all firms in the industry follow this policy, the industry has a reputation for high labour turnover and low expenditure on training. The industry relies on two main sources of labour: local labour is recruited, either from those previously unemployed or underemployed or by recruiting from those previously employed by other local industries; and labour is recruited from outside the region.

Local labour
The advantage in recruiting local people is that they are already accommodated, acclimatised and incorporated into the local community. However, not all local people take up the opportunity to work in mining. For instance, many are not willing to submit to the industry’s work discipline. In addition, production sites are frequently located away from established homes and many are not willing to put up with the resulting travel requirements. Another issue is local workers not meeting the industry’s skill requirements. Thus, it is normal for mineral resource jobs to be on offer but not taken up by the local unemployed. In many remote areas governments and some mining companies provide training programs that attempt to upgrade the work and social skills of local unemployed people, particularly Aboriginal people, and these, coupled sometimes with job redesign, have been credited with increasing local participation in the industry.

Therefore, a mining boom is no guarantee for an end to local unemployment, although by all measures unemployment rates in South West Queensland have been below the national average and significantly below the average in other rural areas that lack resource sector employment. (The exception is Paroo, which of all the five shires has been least affected by the resources boom.)

Despite the reluctance of many local workers to accept mining sector employment, the sector has succeeded in attracting locally resident workers away from employers who are not able to match resource industry pay rates. The pressure was reported as least in Paroo, which is the furthest of the five shires from developments in the gas industry: 500 km away is too far for comfortable drive-in drive-out, let alone commuting, and the supply of housing in Cunnamulla is sufficient to keep housing costs low for purchasers if not for tenants. Home owners are understandably reluctant to trade their present comforts for high housing costs in the boom areas.

At the other extreme, high rents in Roma are reported to have forced local residents into the industry just to get enough cash to pay the rent. The following were reported:

  • pastoral workers and even owners were transferring to the resource industry, often part-year in the off-season for pastoral activity. The downside of this was that non-urgent maintenance tasks on the properties were being deferred, with eventual run-down in production capacity;
  • contractors, transport businesses and councils other than Paroo were finding it hard to keep drivers and plant operators; and
  • the Charleville abattoirs now rely on 457 visa workers.

Two dangers arise if labour cannot be found at costs similar to those prevailing in the regions without mineral resource developments: government (particularly local government) assets will be run down, particularly roads; and industries will be run down or even closed. As regards roads and other local government services, the resource exploitation companies can be required to pay rates that not only cover a fair share of road costs but allow councils to pay competitive wages, even though councils are reluctant to lock in high wage rates which will continue to apply after the need for them is over. However, this opportunity is not available in shires without mineral production. As regards the pastoral industry, the effect of the resources boom seems to have been marginal. Immediately essential production tasks are being carried out but there is a concern that a maintenance backlog is building up.

In industries characterised by large employers who offer permanent career employment, the established method of staffing unpopular posts is to make service in them a condition of career advancement. Recent management fashions have deemphasised permanent employment but outback experience can still be a valuable item on a professional CV. Career promotion continues to be an important element in staffing schools, hospitals, banks, police stations and the like: broadly, in providing professional personnel. The resource exploitation industry does not, in general, directly compete for the services of remote-area professional personnel but can make it difficult to recruit such people by raising housing costs. Housing would seem to be the key to maintaining the attractiveness of non-resource jobs in the region, whether or not the jobs require skills attractive to the resource exploitation sector. This will be discussed below.

Tax incentives and Higher Education Contribution Scheme repayment incentives may also be valuable, and are discussed in a separate article.

Labour recruited outside the region
When labour cannot be found locally, the mineral resource industry recruits elsewhere, not only within Australia but overseas. The industry uses permanent visas for skilled professionals and 457 visas for other workers. When employing labour from outside the region the resource industry has used two markedly different recruitment strategies:

  • In Bulloo and Quilpie almost 90 per cent of the industry workforce has been recruited from outside the region and continues to reside elsewhere (generally Adelaide, from where they fly in and fly out). Significant numbers of support personnel in accommodation and transport also fly in and fly out.
  • In Maranoa the number of resident mineral resource industry employees very nearly balances against the number of employment positions. However, this is believed to understate the importance of drive-in drive-out for the local economy, some of the drive-in drive-out activity being internal to the shire and some of it involving cross-border traffic to and from neighbouring shires.

The obvious reason for this difference is that Maranoa is less remote than Bulloo and Quilpie. The gas fields and processing facilities of the Cooper Eromanga basin are too far from either Thargomindah or Quilpie to support daily commuting from these established towns, although drive-in drive-out is a possibility. If these fields were to be served by resident labour, it would be necessary to build new townships: probably several of them, in view of the dispersion of the fields. There are numerous arguments in favour of fly-in fly-out:

  • Nobody wants to develop settlements that become ghost towns within a decade or two. Fly-in fly-out is appropriate when a workforce has to bivouac in a remote area for the limited duration of a project, especially a construction project. Accommodation needs can be met by temporary dongas without the need to provide more than basic facilities.
  • Recent experience at Ravensthorpe (Western Australia) highlights the perils of investing in mine-site townships.
  • In some remote areas, although not as far as is known in the Bulloo and Quilpie shires, the Aboriginal Traditional Owners prefer that outside workforces are employed on a fly-in fly-out basis.
  • There are employers in the mineral resource industries who believe that fly-in fly-out workforces are easier to manage. They are less likely to unionise strongly and there is a potentially wide field of recruitment when workers are sacked for failures of discipline.

Fly-in fly-out accords well with the industry’s tolerance for high labour turnover.

  • The Cooper/Eromanga gasfields are so spread out that townships to serve them would be very small and have limited facilities.

The arguments against fly-in fly-out are as follows:

  • The fly-in fly-out lifestyle corrodes social and family life, although probably no more so than established ‘tour of duty’ occupations such as defence and seafaring.
  • Fly-in fly-out incurs high transport costs.
  • The pastoral and tourist industries in the same area rely on resident employment, so why not the resource exploitation industry?
  • Additional townships would help support the pastoral and tourist industries.
  • The Cooper/Eromanga oil and gas fields have turned yielded employment for two decades past and probably for two or three to come. Had townships been established when the fields were young they would have lasted long enough to be fully depreciated by the time their economic rationale disappears and they are abandoned and demolished.

Whatever the reasons for the long-term reliance on fly-in fly-out in the Cooper/Eromanga, the result has been that recruitment to the gas industry in Quilpie and Bulloo has placed very little pressure on local accommodation and has generated very little consumer expenditure in those shires: the fly-in fly-out workers do all their living and spending in their places of residence.

By contrast, many of the Maranoa gasfields are within daily commuting distance of Roma and other established towns and all are within drive-in drive-out distance. There has been strong pressure on all classes of accommodation in Maranoa, which, in turn, has fed back into the difficulty of recruiting employees for other industries. This applies not only to the pastoral and tourism industries (elements of the economic base) but to the service industries, which have opportunities to expand to service consumption expenditure given the increasing number of resident resource sector employees. We will return to the accommodation shortage when discussing housing.

The hospitality industry and agricultural enterprises with seasonal labour demands have made considerable use of backpackers while construction and manufacturing have made use of 457 visa workers. The question is why industries resort to immigrant labour when there are still large numbers of underemployed and unemployed Australians in other parts of the country and even within the region. One major reason is skill mismatches, many of which are as much social and behavioural as technical. More and better training and re-training are often recommended as answers. Another reason is the pressure on accommodation in the region coupled with the reluctance of Australian workers to leave their established houses in other regions and the metropolitan areas and the social networks that they have developed in those areas.

If immigrants are to be used to meet the local labour shortages created by the resource boom, there is something to be said for making work in the resource-booming areas a condition of their visas.

Transport effects
Gas and petroleum are most cheaply transported in bulk by pipeline. Once a pipeline is in place it makes no demands on the general transport system. However, the process of exploration, well drilling, processing plant construction and pipeline construction all require use of the general transport system, particularly roads, including many shire roads. The industry also uses road transport for product flows that are too small to justify pipeline construction.

Coal is a different matter. Export coal requires heavy haul transport as does domestic metallurgical coal and coal for electricity generation, except where the power station is located beside the mine. Although export coal is not, as yet, mined in the region, mines located in Western Downs and Toowoomba LGAs have contracted a high proportion of the limited rail capacity between Toowoomba and Brisbane and are also prominent generators of road traffic. The agricultural and pastoral industries complain that this is depriving them of high-capacity access to the abattoirs and Port of Brisbane: an especially serious matter for shippers who, for various reasons, do not have the alternative of export shipping through Newcastle via Moree. It is expected in the region that the construction of a rail connection to Gladstone and/or the bypassing of the Toowoomba Range by tunnel will allow a revival of low-cost bulk rail services. However, this is by no means certain, if only because the two main rail service companies active in Queensland have both decided to concentrate on bulk mineral and container traffic: there is no equivalent of the smaller operators who carry agricultural products from Moree to Newcastle. Under current prices and technologies it is arguable that the pastoral and farming industries can prosper without rail transport, but there is a strong argument for maintaining rail capacity against that day when the reduction of greenhouse gas emissions becomes a world and national priority.

Returning to roads, the Commonwealth remains the main source of roads funding for the South West, just as it is the main collector of road-related taxes. Its distributions are watched intently by local government and are more or less adequate: average road condition in the region is now substantially better than it was a couple of decades ago. The five shires also appear to have been reasonably satisfied with the distributions for flood damage repair made during 2011. However, resource-boom effects on local costs are not taken into account in the Commonwealth’s distributions. Again, some local roads bear mineral resource-related traffic, which is not taken into account in the Commonwealth’s distributions. However, the three shires directly affected (Bulloo, Quilpie and Maranoa) have moved to increase rates on the oil and gas industry to cover these costs. Shires have also negotiated with the gas companies to directly finance the construction of public roads required by the industry.

These arrangements do not cover road use during the exploration phase of mining development nor do they cover roads used in adjacent shires that have no mining tax base. However, apart from these deficiencies, the arrangements appear to be working.

Payments by resource extraction companies to governments
In addition to general taxes, such as corporation tax and payroll tax, there are two main classes of payment that governments may require from companies that extract non-renewable resources. The first is compensation for costs imposed on the community, notably road costs but also other items such as the cost of site rectification and pollutant management when these are left to governments rather than done by the business itself. The second is compensation for the loss of non-renewable resources. In the Australian states, these resources are owned by the states and compensation is known as royalties. The resource exploitation industries like to refer to royalties as taxes, but this is not correct.

Royalties are the price that the resource industries pay to gain ownership of the minerals they extract.

Because subsoil minerals in the region are the property of the state, neither local government nor the Commonwealth have the right to levy royalties. Therefore, local government has concentrated on cost recovery.

Payments to local government
The principal source of local government revenue, other than grants, is the rate on land. As landowners and lessees the mineral resource industries are liable to pay rates.

Queensland legislation requires rating to be on unimproved values, which have considerable merit as means of spreading the rate burden across ratepayers. However, a strict unimproved value rate generates notoriously small revenue from town allotments in rural shires. The legislation allows differential rating and it has become customary to impose a higher rate in the dollar for urban allotments than for rural allotments, the differential being determined by an estimate of the value of services provided to town ratepayers as compared to rural ratepayers. Rating on strict unimproved values also yields very low revenue from mineral resource exploitation properties: the unimproved values of these properties are low because the state-owned mineral resources lying under the property are not taken into account in valuing them. Local government has accordingly extended the established practice of differential rates for urban properties to impose differential rates on the mineral resource industry.

We may take the example of Bulloo Council, which has defined four areas occupied by mineral extractive businesses, each of which, ‘by virtue of its operation impacts significantly on the economic, environmental and social welfare aspects of the local community’.

Two of these areas are large consumers of council services, particularly roads. Land in these four areas attracts a considerably higher rate in the dollar unimproved capital value than rural land. These rates were determined by negotiation between council and the industry, and reflect estimates of: road maintenance costs occasioned by resource industry traffic; depreciation of relevant roads, which is fully funded; waste management; a contribution towards other shire services; compensation for the increase in wage costs due to the local presence of the mineral extraction industry; and a contribution towards the sustainability reserve which is being accumulated with an eye to maintaining services (particularly roads) when direct contributions from the resource industry cease due to the exhaustion of non-renewable resources.

By means of differential rating, Bulloo Shire Council raises nearly three-quarters of its total rate revenue from the oil and gas industry, but because grants and recoverable works are major sources of council funds this represents only 16 per cent of operating revenue. (Recoverable works are mainly road works at the behest of the state and Commonwealth governments but can include works negotiated with the resource companies to further their operations.) At less than $A3 million, the rate payment is also a minor expense in the books of the oil and gas companies.

Quilpie follows similar differential rating policies, and in 2011–2012 expects to raise nearly half its rate revenue from the oil and gas industry. After imposing differential rates on the industry it has abandoned a former road maintenance contribution levied on oil haulage. In rating the oil and gas industry Quilpie keeps an eye on the value of mineral production in the shire as reported by the Department of Mines and Energy.

Maranoa has likewise defined six resource-related areas on which it imposes differential rates: four areas of extractive industry plus petroleum leases and land ‘that is identified as having a gas refinery established on it’.

Although all shires host pipelines these are not rated. This policy concords with the general rate exemption for transport facilities. Mineral exploration licences are similarly rate exempt, presumably because they do not grant ownership or leasehold of land for which an unimproved value can be assessed. However, given their legal status as tenements they are potentially rateable, particularly if a fair value could be determined vis-à-vis other land titles.

The differential rating approach appears, so far, to have yielded revenue reasonably proportional to the increase in operational costs occasioned by resource extraction.

Two approaches have been noted: the ‘Bulloo’ approach, based on a broad assessment of the costs occasioned by resource extraction, including contributions to a sustainability fund; and the ‘Quilpie’ approach, based on the value of production. These two approaches frequently occur in public finance, the former reflecting the benefit principle and the latter the ability-to-pay principle. In the local government context the cost-based approach is on firm ground, but the negotiated nature of the settlements could prove a weakness in the case of councils that underestimate costs or that encounter resource extraction companies that are determined to strike a hard bargain, irrespective of the costs they impose. There may also be potential for dispute as the profitability of mineral extraction declines. If arguments develop, the parties are likely to appeal to costs, and councils should be prepared to provide a careful and accurate account of the costs occasioned for them by resource exploitation. The ability-to-pay approach is riskier for the council: it avoids the difficulty of trying to recover costs from unprofitable mineral extraction ventures and is likely to raise greater revenue from bonanzas. It is open to the objection that it is effectively a royalty and, hence, open only to the state (see below), but there are precedents in indigenous mining agreements and in the conditions under which mining leases are bought and sold. Given that state royalty rates on gas are 10 per cent of wellhead value, a local government addition of approximately 2 per cent would not be an excessive burden on the producers.

The two principles are not mutually exclusive, and it could be appropriate to combine them, with a basic rate related to direct costs occasioned by resource exploitation and a value-related addition, which would come into play only when the basic rate yielded less than (say) 2 per cent of wellhead value. The additional revenue could then be credited to a sustainability reserve.

A second area where there may be scope for formalisation of current practice is the once-only capital contributions made by resource extraction companies as part of bringing resources into production. An analogy may be made with the contributions made by developers of urban housing estates. Contributions by resource companies may appropriately include capital roadworks, water supply, sewerage, water pollution control and drainage works required for the project to proceed.

An important aspect of urban developer contributions is compliance with town planning. This cannot so easily be imposed on mineral resource developments, because the resource determines the location of the development. However, there is scope for negotiation over the location of supporting developments: roads, pipelines, processing facilities, campsites and townships. It makes sense to locate these so that, as far as possible, they will be generally useful both during and after resource extraction. For example, some of the remote area roads in Bulloo Shire have been routed to be useful to grey nomads as well as to the gas industry. Maranoa is seeking to ensure that facilities are subsequently useful for rural residential areas.

A more contentious matter is the question of industry contributions to housing and urban development. It is accepted practice that where the mineral resource industry (or the pastoral industry for that matter) employs people in remote areas it should provide accommodation. Such accommodation is either exempt from fringe benefits tax (FBT) or is assessed for FBT at

50 per cent of ‘market rates’. In towns where there are dwellings for private rental, FBT becomes unavoidable. There is a case for review of the incidence of FBT to ensure that it does not constitute a subtle incentive favouring fly-in fly-out.

A question of incentives also arises where councils require that resource companies should pay developer charges towards the provision of housing in existing towns which are to be extended to accommodate resource industry workers. The companies may then calculate that it is cheaper for them to use drive-in drive-out or fly-in fly-out. Despite the possible adverse incentives, there is a case that developments other than short-term construction should include a contribution to local government urban infrastructure. There may also be scope for measures to assist in the provision of actual housing, for example a requirement that resource exploitation companies, as part of the price of their permission to exploit, should provide bank guarantees for mortgages raised on new owner-occupied or rental housing owned by third parties in urban areas expected to house personnel employed at the resource development, with the number of dwellings covered depending on the size of the resource development.

Payments to the state government: Royalties
The administration of mineral wealth would be a relatively simple matter if all resources were known, complete with the cost of extraction. The fundamental problem of resource management would then be seen as one of resource allocation between the current and future generations. Having made a decision about this, the state could call tenders for the extraction of particular resources. It would receive, as sales revenue, the difference between the tender price and the resource sale price. However, neither the true extent of resources nor the cost of their extraction are known. Weighing up the risks and incentives, the state may be expected to maximise the return from its resources if it exacts a price that rises as the final sale price of the mineral goes up but falls as extraction costs increase. A price so determined becomes a form of profit sharing and can easily be mistaken for a tax: an emotive misidentification which the mining industry played for all it was worth in opposing recent Commonwealth mining tax proposals. In fairness to the industry, the Commonwealth proposal was, indeed, a tax, because the Commonwealth has no right to levy royalties (if a state had required a similar payment, it would have been a royalty). The Commonwealth saw an opportunity to raise revenue because the states had failed to raise their royalties in line with the resources boom. The upshot is that the right of the states to levy royalties has been vindicated and they have the opportunity to raise their mineral prices to claim a larger share of the current boom.

The history of royalty payments in Australia begins with the nineteenth century gold rushes, during which the colonial governments were reluctant to levy royalties because the diggers were numerous, vociferous and had many ways to evade payment. To this day, fossicking minerals are largely exempt from royalties, in Queensland and elsewhere. However, most of the mineral extraction industry is now large-scale and capital-intensive and there are no technical problems in the calculation of royalties provided the formula is clear. In Queensland royalties are mostly charged ad valorem, varying by mineral, as follows: gemstones are free of royalty up to $A100,000 sale value, after which the state claims 2.5 per cent of their sale price; petroleum (including natural gas and coal seam gas) is sold for 10 per cent of its wellhead value; and coal is sold for 7 per cent of its value up to $A100 a tonne and 10 per cent thereafter, with the calculation performed separately for domestic and export sales.

Because this revenue is derived from the sale of non-renewable assets, there are strong arguments for hypothecation of the revenue to investment in replacement assets. Western Australia has set a precedent with its Royalties for Regions fund, which feeds the Western Australian Regional Development Trust. Queensland faces many of the same problems of development of remote regions as Western Australia, so the Western precedent is especially relevant and should be investigated.

One of the hopes of the Western Australian government is that it will be able to develop industries to process its resources before they are exported. People in South West Queensland also wonder whether manufacturing industries can be built on the basis of its gas and coal supplies. The present oil refinery at Eromanga provides a small-scale precedent, but it is sheltered by transport costs from world competition in a way that a larger-scale industry would not be. Even so, the region should be alert to opportunities, which could arise in conjunction with that other energy resource which the region has in abundance: sunlight.

Housing
At the 2006 Census, approximately one-third of the occupied dwellings in the region were rented with the remaining two-thirds occupied by owners or purchasers. The individual shires varied from the overall pattern as follows:

  • In Bulloo, the proportion renting was relatively high, due largely to state-owned houses, many of which were presumably occupied by personnel providing state services. In addition, the council was an important landlord. Few houses were being purchased but a substantial proportion was wholly-owned. Very few new dwellings were being built.
  • The pattern in Paroo and Quilpie was broadly similar, although with a little less emphasis on state ownership and a few more home buyers. New dwellings were under construction despite the gradual fall in population in Paroo.
  • In Maranoa and Murweh, approximately one-quarter of dwellings were being purchased, balanced by a smaller proportion of outright ownership. New dwellings were under construction but not at a particularly rapid rate and in Maranoa a shortage of accommodation was developing.

All shires reported that they were trying to promote low accommodation costs as a way of retaining workers for industries that could not afford to pay resource industry wage rates. A primary element in the strategy was low land costs, well below metropolitan levels. However, both lot servicing costs and dwelling construction costs were higher than in the metropolitan areas for three reasons: the transport costs for materials; the need to accommodate out-of-town skilled labour; and the lack of economies of scale in construction.

In Thargomindah the impact on costs was estimated at between 25 and 30 per cent over costs in Toowoomba, raising the cost of a $A300,000 dwelling to $A380,000. The impact in Charleville would be less because of the availability of local tradespeople, but in Roma would reflect direct competition from resource-related construction for the services of local tradespeople.

In Australia the preferred low-cost tenure is home ownership. The low costs derive in part from tax favours, particularly the lack of taxation of capital gains made on owner-occupied dwellings. However, the benefits of owner-occupancy can be offset by the costs of buying and selling houses. For people who are obliged to change residence in the course of their careers, home ownership is not necessarily the lowest-cost housing option, particularly when they live in regions where capital gains are far from guaranteed. In South West Queensland towns home ownership is likely to be the lowest-cost housing option for people who stay put for at least a decade, perhaps less, but there is likely to be a healthy demand for rental accommodation not only from people who cannot surmount the financial barriers to home ownership but from people who expect to be stationed in the town for less than a decade.

Two particular barriers to entry into home ownership were reported in the towns of South West Queensland: bank requirements for relatively high down payments, reported to be due to an assessment that employment continuity is risky in towns with a narrow economic base; and fear on the part of potential buyers that they might be landed with capital losses, again reflecting an estimate that the economic base is narrow and the risk of downturns is serious. These two barriers also affected investment by private landlords: hence the heavy reliance on employer-provided housing, including housing provided by the shires. Several of the shires have become active traders on the housing market in the attempt to keep house prices down in their towns.

The two barriers have a common cause: the risks that derive from a narrow economic base. However, pool together all the remote towns of Australia and one no longer has a narrow economic base. This is the classic basis for insurance. It is surprising that the finance sector, which so prides itself on its capacity to innovate, has not offered insurance against the risk of falling dwelling values in defined locations. Essentially the risk concerned is that of falling unimproved values, although it could also be based on average improved values for the town concerned. There is a case for Commonwealth government action to ensure that the finance sector provides such insurance, at least in remote areas (but possibly generally) at a reasonable price. If this risk can be specified and insured against, it should become easier to gain funds for investment in housing in remote areas. (A similar proposal is developed in R. Shiller, 2004, p. 118.)

Another suggestion is to invest in the upgrading of removable homes. Historically, a high proportion of the dwellings in South West Queensland have been wooden, designed so that, if they are no longer needed on a particular site, they can be uplifted from their stumps and re-erected elsewhere. In view of the uncertain prospects for employment based on mineral resources, there is a case for a continuation of this tradition, with opportunities to use prefabrication and modern materials. Such techniques are already in general use for temporary camp dongas and the challenge is to move them upmarket. There is also a challenge to local government to ensure provision of adequate sites for such homes, not in caravan parks but urban lots so that the resident families can integrate into the town population without stigma. Such land developments should include plans for re-use of the sites should this become necessary.

As noted above, the only industry in the region with the capacity to pay developer charges to councils to assist with new housing construction is the resource exploitation industry, where such charges may be required as part of the price of the resource. Many factors enter into the decision as to whether a given mining licensee should be required to contribute to housing development, particularly the permanence of the development and its location vis-à-vis employee source towns. However, councils should not be shy of arguing for such contributions.

Gender balance in employment
It is now accepted Australian practice that both men and women wish to be in paid employment while they are of workforce age. Therefore, if families are to be attracted to live in country towns suitable paid work must be available for both husbands and wives. Second-earner work does not necessarily have to be full-time (many second-earners prefer part-time work), but it does have to be available, along with complementary services, particularly child care.

The labour market in the towns of South West Queensland has proved reasonably accommodating in supplying work for married couples. The service industries are adept at creating part-time positions, the gender stereotyping of jobs has broken down and the TAFE network assists in providing necessary skills. However, there is still a responsibility for councils and other public institutions, in their role as employers, to watch the local labour market and endeavour in their employment policies to ensure that couples can find satisfactory work for both partners.

Tax concessions and government services in remote areas
In this article the consequences of the resources boom for South West Queensland have been reviewed. The region has participated in the boom, although not fully: mineral resource exploitation has not become its dominant economic activity. On the assumption that booms do not last forever, we have considered ways in which the pastoral, tourism and other industries can be sustained, not only for the sake of their current economic contribution but even more in anticipation of their continued contribution once the resources boom has subsided.

The discussion has not been exhaustive and, in particular, two groups of policies have not been mentioned. First, the Commonwealth offers tax incentives to work in remote areas. These can be helpful in recruitment and payment of personnel. Second, both the Commonwealth and state governments pursue policies on service provision which can be helpful in recruiting personnel to work in South West Queensland. These topics (which are related) are discussed in a companion article.

Conclusion
On balance, South West Queensland is benefiting from the mineral resources boom: some shires more than others. However, to ensure that benefits continue, it is necessary to plan for what will happen after the boom has run its course. There are two main concerns. First, infrastructure should not be allowed to deteriorate as a result of boom usage. Similarly, infrastructure put in place as a result of the boom (including transport, water management and urban development) should be designed for maximum value after as well as during the boom. Second, the boom should not be allowed to detract from the productive capacity of the pastoral, tourism and other non-mineral resource industries in which the region has expertise. Even during the boom these industries continue to dominate the region’s economic and employment base, and the region will once again turn to them when the resource boom subsides.

Numerous measures have been canvassed in this paper. One such measure is ensuring that the mineral resources industry makes appropriate contributions to local infrastructure through a rural equivalent of the urban developer charge system. (The local governments of the region are already doing this but there may be room for systematisation.) Another is ensuring that the mineral resources industry makes appropriate direct contributions to local government. (The local governments of the region are already doing this through differential rating but there may be room for underpinning what are essentially now negotiated contributions.) In addition, state royalties could be increased to fund a regional development trust, as pioneered in Western Australia. Financial regulations should require appropriate financial intermediaries to insure housing values in the towns of the region. Finally, investment is necessary to improve the quality of transportable homes.

References

Australian Bureau of Statistics, 2012, ‘Business Indicators, Australia, Mar 2012’, cat. no. 5676.0, ABS, Canberra.

Shiller, R., 2004, The New Financial Order, Scribe, Melbourne.

Blainey, G., The Rush That Never Ended, Melbourne University Press, Melbourne.

 

 

 

 

 

 

 

 

Net Benefits of Mining Expansion

National Economic Review
National Institute of Economic and Industry Research
No. 68   October 2013

The National Economic Review is published four times each year under the auspices of the Institute’s Academic Board. The Review contains articles on economic and social issues relevant to Australia. While the Institute endeavours to provide reliable forecasts and believes material published in the Review is accurate it will not be liable for any claim by any party acting on such information.

Editor: Kylie Moreland

©National Institute of Economic and Industry Research

This journal is subject to copyright. Apart from such purposes as study, research, criticism or review as provided by the Copyright Act no part may be reproduced without the consent in writing of the relevant Institute.
ISSN 0813-9474

Net benefits of mining expansion
Dr Peter Brain, Executive Director, NIEIR

Abstract
The present study examines the net benefits to the Australian economy of a mining boom. In light of the changed circumstances that are likely to prevail over the coming years, extrapolation of past responses to mining expansion into the future suggests that there may be little headline net per capita additional benefit. The resource claims to meet the infrastructure and service demands of the increased population induced by the current episode of mining expansion will be presented in full, creating very difficult political and economic constraints, adding to those from climate change. The situation will be compounded by the national productivity growth tending to remain below historical trend levels. However, the resource expansion could be managed differently, to maximise its net additionality. Such management would include increased harvesting of resource rents and measures to increase the domestic content of mining investment.

Introduction
In a previous article we argued that, because the mining industry produces standardised commodity products, the drivers of expansion in the industry are very different from those in industries which develop and market differentiated and branded products (Brain, 2012). The commodity-production nature of the industry means that bursts of expansion generally occur as a response to unexpectedly high mineral prices, although they can also take place as a response to the discovery of new low-cost resources.

The current Australian episode of high investment in additional capacity to produce iron ore and energy minerals was generated by a burst of high prices. Past experience is that such episodes induce sufficient capacity expansion to increase world supply and so bring prices back towards costs of production, ending the investment boom. An episode of mining expansion thus has several phases: an initial phase of normal production; a phase of investment and high construction activity induced by high prices; a phase of increasing output as additional capacity comes on stream; and, finally, the stabilisation of production, generally at a higher level of output but not necessarily at higher prices than during the first phase.

During the construction phase the mining industry makes major demands on the construction industry in the country where the investment takes place. In particular, the demand for labour is high during the construction phase but falls during the enhanced output phase, a characteristic which is generally true of investment–output sequences. This demand for skilled construction workers can be met in four ways:

  • the existing workforce could be used more intensively, so that other construction activity is unaffected;
  • labour could be diverted from other construction to mining investment;
  • guest workers could be used from overseas, with workers obliged to return home after completion of the investment campaign; and
  • immigration of workers with the appropriate skills could be increased.

Each method has its disadvantages.

  • If mining investment is limited to that which can be undertaken by available labour, even working intensively, the amount of investment will be limited, perhaps to less than that desired by investors.
  • If labour is diverted, other construction programs will have to be curtailed. The question is then whether the mining investment has higher priority than the curtailed investment.
  • Guest workers have a habit of becoming permanent migrants, in which case the disadvantages of the immigration solution become relevant.
  • Increased immigration raises the question of how to find work for the immigrants (or for the established residents they have displaced) once the construction boom is over and the demand for labour has subsided.

The demand for construction materials also rises during periods of enhanced mining investment, but this demand can readily be met from imports if for any reason there is a shortage of local supply. Indeed, the global strategies of mining investors often favour overseas sourcing, because this adds to demand in their home countries. It is mainly in regard to labour that an important analytical question arises. From a country’s point of view, who are to be regarded as the potential beneficiaries of a period of mining expansion: the population of the country as at the beginning of the expansion plus its descendants or the population as augmented by any induced migration?

Not only is it important to be clear as to the population relevant to assessment of the benefits of mining investment, it is important to be clear as to the metric of assessment.

Indicators of national economic welfare
National economic benefit or welfare can be measured by a variety of indicators. The most often used indicators are employment, preferably full-time equivalent employment, and gross domestic product (GDP). The two are used together because there will be times when employment will increase but productivity measured by GDP per person employed will fall. An unambiguous increase in national economic welfare will only occur if GDP and employment both increase and productivity does not fall.

The use of the GDP measure, especially in the case of mining expansion, is open to the criticism that it does not distinguish between foreign-owned product and product owned by domestic residents. The important consideration here is the distribution of gross product generated by overseas-owned enterprises. If 90 per cent of the gross product is distributed to domestic employees and in tax payments, foreign ownership is of little relevance. However, in mining approximately 60 per cent of value added accrues to foreigners in the form of interest payments, depreciation cash flow, dividends and retained earnings in the enterprise. These do not add to domestic incomes. An indicator which excludes foreign payments for interest, dividends and retained earnings is gross national product (GNP).

The other distinguishing feature of mining is its high level of capital intensity. Relatively large increments in investment are required to increase output. In turn, this means that there will need to be large deductions from GDP in the form of replacement investment appropriately financed from depreciation, if the output is to be sustained. A measure which deducts depreciation, or at least depreciation undertaken on behalf of domestic residents and foreign distributions out of value added, is net national product (NNP). This concept is akin to the concept of national net disposable income in the Australian National Accounts and measures the benefits to domestic residents in terms of household consumption expenditures and government finances.

Finally, it is argued that the prime measure of welfare is consumption expenditure. Hence, the relevant welfare indicator is the flow-on implications for household consumption expenditure plus net additional taxation receipts. Tax receipts are included because they determine further potential flow-on benefits for household consumption expenditure (tax rate reductions) or public consumption expenditure increases.

Gross benefits of the construction phase
The extent to which an episode of mining expansion benefits the prior-resident population of the country in which it takes place is strongly influenced by two factors:

  1. the extent to which mining investment in the construction phase increases demand and so increases employment; and
  2. the extent to which labour demands during the construction phase are met by immigration.

The first step in calculating the significance of the increase in demand is to assess the impact of mining investment under full additionality; that is, where the increase is met in a way which does not diminish other demands including other investment. This estimate can then be modified according to the extent to which the increase in mining investment reduces other investment.

The most practical and transparent analytical framework to estimate the demand effect under full additionality is to utilise a set of input–output tables that reflects the structure of the economy at the time the investment takes place. For this study, this was provided by a set of tables updated from the 2005– 2006 table to 2008–2009 with the distribution of value added reflecting the impact of foreign ownership. The algebra underlying the calculations is given at the end of the article.

From the 2008–2009 updated tables, the structure of the economy reflects the commodity price relativities which are likely to prevail, at least until 2014. Earlier input–output tables do not reflect current price relativities. If there are no capacity constraints on production, the increase in demand due to mining construction is measured by Type II multipliers; that is, the total of intermediate plus private consumption flow-on. These are given in Table 1, which is based on a flow of $A33 billion average annual net additional mining investment during the construction phase.

The modelling indicates that total imports grow by $A17 billion, which limits the increase in headline GDP to $A23.3 billion. If indirect taxes are added this gives a traditional multiplier of 0.74. If a Type III multiplier analysis had been employed, including induced non-mining investment flow-on, the multiplier would have been closer to unity.

A key variable of interest is the employment impact. The answer from Table 1 is that just under 200,000 additional workers will be required. The other key variable is the flow-on orders to manufacturing. From more detailed work, the total increase in gross output of the MM sector (from iron and steel to other machinery and equipment) comes to just under $A4 billion or a local content for the industry relative to total expenditure of 12 per cent.

Capture

These calculations provide an outside estimate of the value to the economy of the increase in demand due to mining expansion. The actual value is likely to be less, for two main reasons. First, the construction boom may directly attract labour and capital from other activities. Second, price effects associated with the boom may reduce the utilisation of both labour and capacity in other industries without transfer to the booming sector.

The first of these effects is expected and, indeed, welcomed by the neoclassical economists who dominate Australian policy formation; the latter, colloquially the ‘Dutch disease’ effect, they prefer to assume away.

Migration and mining expansion
Prima facie, there is little reason to expect major reductions in capacity utilisation in the non-resource industries as a result of the mining boom. On the capital side, much of the capital is supplied from overseas, both financially and physically. Indeed, the complaint is not that demand in the mining and construction industries is stretching capacity in the Australian capital goods industries but rather the reverse: that insufficient demand is flowing to these industries to offset the Dutch disease effect. On the labour side, the increase of less than 2 per cent in total labour demand is a lot less than the current unemployment rate, especially when Australia’s low labour-force participation rate (compared at least to some European countries) is taken into account.

However, it is no simple matter to shift underemployed labour into the jobs created by a mining boom. There are several reasons.

  • Many of the jobs call for specialised skills. Here there is something of an impasse: Australian governments (Commonwealth and state) expect either that private individuals will see the opportunities and acquire the necessary skills, or that the mining and construction industries will provide the necessary training. For their part, and with occasional exceptions, the mining and construction companies expect that individuals and/or governments will ensure that the necessary skills are available. The result is that skill-specific labour shortages can easily occur.
  • A significant minority of the jobs generated are located in remote areas where housing is poor but expensive and social opportunities are limited. Once again, there is an impasse: with honourable exceptions now mainly past, neither governments nor mining companies are willing to invest in remote mining towns which may lose their raison d’être within decades, and even when the physical infrastructure is provided the settlements often remain unattractive due to their isolation. The fly-in fly-out alternative gets round some of these difficulties at the cost of creating difficulties of its own, particularly for families.
  • Mining and construction involve the operation of valuable equipment. The companies accordingly impose tight labour discipline and are quick to sack workers who breach discipline. Poor labour relations do nothing to assist recruitment.

The mining and construction companies attempt to overcome these disadvantages with high pay. They also call for immigration as a way of meeting their recruitment problems. If recruitment were purely on a guest-worker basis, this would parallel their attitude to the supply of capital and ensure that the mining expansion was essentially an offshore matter. However, Australia has no tradition of guest-worker migration, preferring permanent migration. This may be a realistic attitude in view of experience elsewhere (that guest workers become permanent) but may also reflect folk memories of the high transport costs once associated with migration to Australia and the resulting difficulties in attracting migrants. The result is that considerable migration is required to satisfy the limited and specialised labour demands of the boom, given that only a small minority among migrants is directly suited to fulfilling these demands. Therefore, we take a macroeconomic approach to assessing the immigration requirements of a mining expansion.

Given the strong employment impact of the construction phase, the expectation would be for net Australian migration to be correlated with mining investment. From Figure 1, typically Australia has responded to each episode of elevated mining expansion with increases in net immigration. As Figure 1 indicates, for the years 1980 to 1989 the level of net immigration averaged 105,000 a year compared to 60,000 for the 4 years before 1980. At the end of the 1990s there was another spike in net immigration, partly as a lagged response to the second construction phase.

Before the third mining construction episode the average was 150,000. However, from 2006 to 2010 the average was 260,000 a year, or a total cumulative increase in population of 550,000 compared to trends before the current episode of mining expansion.

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If mi in the equation is set at zero and compared against the actual outcome, the estimate of the increase in population due to the mining boom falls to an additional 400,000 population between 2006 and 2010. This is lower than the 500,000 estimate given above from Figure 1 because of the influence of the trend term in the estimated equation.

If the average worker to immigrant population rate is between 0.3 and 0.4 (allowing for children and the basic male demands of the construction industry) immigration would have yielded approximately 150,000 workers towards the labour requirements of the construction phase. Therefore, between 60 and 80 per cent of the employment required by the current episode of mining expansion construction phase has been supplied by imported labour.

This dynamic is ignored in most assessments of the impact of elevated mining expansion. However, it is critical to the evaluation of economic benefits. The figure shows that a net 950,000 persons (rounded up to one million to allow for very modest net natural increase after migrant arrival) have been added to Australia because of the employment opportunities created by the three episodes of mining expansion since the late 1970s.

Significance of mining for the balance of payments
Where businesses are overseas-owned, employ little local labour and exist purely to supply overseas markets, a case can be made that they should be excluded from the national accounts of the host country and, instead, covered as offshore extensions of the owning economy. The case for this is particularly strong where labour is also supplied from overseas. Such enterprises were common in the 19th-century and early 20th-century empires and were often called enclave-export industries. Given that they frequently depended on franchises awarded by the colonial government, it is no surprise that with the end of colonialism they frequently found themselves nationalised.

The effect of excluding enclave-export enterprises from the national accounts of their host country would be to reduce the reported values for a number of variables, chiefly the following:

  • the inflow of overseas investment, particularly during the construction phase of the enterprise;
  • the stock of overseas investment;
  • the outflow of funds to service overseas investment, both profits and capital repatriation; and
  • the level of exports. (Sales by the excluded businesses would no longer be counted as export revenues of the host economy. Instead, resource rents collected by host-country resource owners (both governments and private owners) would be shown as exports, as well as labour supplied and any other sales by domestic businesses to the enclave-export industry.)

The net effect would be a major diminution in the importance of the excluded industries as measured by GDP or the national balance sheet, although as already remarked above there would be no effect in their importance as measured by NNP. The mining companies are strongly opposed to being defined as enclave-export industries, and equally to the use of measures such as NNP, because they wish to be regarded as pillars of the Australian economy. Their aversion to being regarded as overseas operators who just happen to be extracting resources in Australia is easy to understand given the history of nationalisation of mineral resources in countries where exploitation has been completely in overseas hands.

The decision to define mining operations as domestic rather than enclave-export industries has major effects on the headline economic indicators of host countries during periods of mining expansion. In particular:

  • commentators focus on the growth rate of GDP rather than the relatively low growth rate of NNP;
  • the growth rate of gross exports is emphasised at the expense of the lower growth rate of net export earnings after servicing overseas investment; and
  • the terms of trade are calculated on the basis of the price of exported products rather than the price of services to the enclave-export industry.

In a rational world these effects would not matter much, but in the harried world of finance it is likely that they contribute to the Dutch disease. In what follows, the indirect effects of periods of mining expansion on resource allocation are considered.

Dutch disease
As noted above, an episode of mining expansion requires a burst of capital investment. The benefit of the episode will be greatest if it uses otherwise unemployed resources, but it is more likely that resources will be transferred from less promising investments, or from less productive activities, into the construction effort required to expand mining. There is a double danger in this process.

  • The price mechanisms which assist this transfer may themselves create offsetting unemployment. This can happen when they dampen demand for non-mining products and services without affecting the transfer of resources into the expanding sector. Instead these resources become unemployed.
  • It produces a lingering shadow, in that investment foregone in the non-mining industries during the construction phase permanently affects their competitiveness. This mechanism was discussed in a previous article and its significance will be assessed below (Brain, 2012).

A particular case of these problems, referred to as the Dutch disease (because it was first recognised in the Netherlands during the North Sea oil boom) has two parts:

  • During the construction phase the exchange rate is overvalued, in the sense that it renders industries uncompetitive when they would be competitive at the exchange rates which obtain both before and after the period of mining expansion. This reduces non-mining exports, a matter of some concern when mining commodity prices fall back towards pre-boom levels. Because investment in product development has been curtailed, the reduction in non-mining investment during a period of resource expansion carries the risk that production in non-mining trade-exposed industries will be reduced more or less permanently.
  • The possibility of further episodes of overvaluation increases the riskiness of investment in non-commodity trade-exposed industries, so further reducing exports and import-competing capacity in these industries.

But why should the exchange rate be overvalued during the construction phase? In neoclassical theory the exchange rate cannot be overvalued or undervalued, because the foreign exchange markets are believed to take into account all relevant factors, focusing on the balance of trade and, hence, the ability of each debtor country to service its debts. Sufficient to say that during the era of fluctuating exchange rates (broadly since the mid-1980s) the Australian exchange rate has failed to behave as theoretically predicted. Reasons for the current overvaluation of the Australian dollar which relate to the decision to treat enclave-export industries as integral parts of the Australian economy include the following:

  • an apparent high level of capital inflow;
  • an apparent prospect of high growth in export revenues; and
  • a high terms of trade.

In addition, other factors may be important, including the option exercised by a number of trade-surplus countries to maintain their exchange rates at ‘competitive’ levels by accumulating the financial assets of the indebted world (including Australia). It is also relevant that Australian real interest rates are higher than in the rest of the world, partly to restrain the level of economic activity (and, hence, assist in the transfer of resources to mining investment) but also because of the need to finance the high level of foreign debt.

For the purposes of the present study we now require a practical assessment of the severity of the Dutch disease as it currently affects Australia. The assessment requires comparison of a base case in which the mining industry continues its 1998–2005 growth rate through the period 2006 to 2012 and the actual case in which mining expansion occurred. The National Institute of Economic and Industry Review (NIEIR) has used its modelling system to make this comparison and published the results in the State of the Regions Report 2012–13 (Chapter 10). In brief, during the construction phase to date the mining expansion has, through mining investment and its multiplier effects, generated an increase of just under 7 per cent in Australian GDP. However, there have been offsetting reductions in activity in the non-mining industries which reduce the net benefit to date to approximately 3.1 per cent. This falls further, to 2.7 per cent, if the calculations are converted to a NNP basis. Taking into account the increase in population due to additional migration induced by the increase in mining activity, this further reduces to an increase of approximately 1 per cent in NNP per capita.

The State of the Regions Report further points out that all regions in Western Australia have unambiguously benefited from the mining boom. The regional pattern of benefit in the other states is patchy at best. The same goes for industry patterns, with strong increases of activity flowing from mining investment into construction while import-competing and non-mining export industries do less well than they would have in the absence of the boom. Among the industries which, on balance, do badly metal and machinery manufacturing is prominent. Given the importance of metal and machinery inputs to mining investment, this is an unexpected result, and raises the question as to why the linkage from mining investment to domestic demand for MM is so weak.

Local content of mining activity
Using NIEIR’s input–output table, the local content of mining activity for 2009 can be estimated. The direct demand from mining is defined as operational demands for goods and services plus investment requirements, including replacement investment. The operational demands are simply the intermediate industry demand column sums from the estimated input–output tables for all mining industries. This comes to a total demand for the mining sector of $A85.7 billion, of which $A75.8 billion is supplied by local industry. The bulk of the imports come from the metals and machinery (MM) sectors of overseas economies. Total MM demand for operations is $A11 billion, of which $A4.4 billion is supplied locally.

More importantly, from the investment data which is included in the totals in Table 2, it can be calculated that the investment component has a much higher import content. The import content is approximately half, with imports of $A26 billion. This includes replacement investment. Of the total imports, 60 per cent come in the form of products from the MM sector overseas.

These averages will change from year to year as the industry/project mix changes. For example, as the share of liquefied natural gas (LNG) projects in total mining investment increases over the next 2 years the MM sector’s share can be expected to increase.

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Effects beyond the construction phase
These calculations place us in the position to assess the impact, not only of the construction phase but of the production phase which follows. The more the increase in mining capacity is bought at the expense of capacity in other industries, the less these industries will be able to respond to increases in demand during the production phase. We investigate these possibilities on the basis of the two extreme sets of assumptions (full additionality and full displacement) and also consider the consequences of the resource requirements to support the induced population increase.

Mining expansion: Full additionality
Full additionality occurs when impact of both the construction and production phases on the economy is close to the Type II multiplier estimates from the latest input–output table. This calculation shows what would happen if no capacity is lost in the non-mining industries during the construction phase.

Given the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES’s) benchmark for forecast mining production over the next 5 years, Table 3 shows the impact of each annual increment in production. ABARE’s projection implies an annual average increase of $A12.6 billion in gross mining output, or $A63 billion between 2010 and 2015.

From Table 3, the increase in GDP is $A12 billion, of which $A6.8 billion is mining gross product. Thus, the total mining gross product multiplier would be 1.76 under full additionality. Much of this is overseas-owned, and GNP increases by $A7 billion. What is important, however, is the increase in real NNP, or what the Australian Bureau of Statistics now calls real net national disposable income. This increases by $A8 billion, or 1.18 times the increase in mining gross product. The increase in real net national disposable income is two thirds of the GDP increase because depreciation and foreign transfers from the mining industry (which include repayment of foreign loans, interest, dividends and retained earnings) reduce mining NNP to 53 per cent of mining gross product.

Government revenues increase by $A2.8 billion while total employment increases by 57,200. This means that over the next 5 years a total of 286,500 employment positions will be created by the projected mining output expansion. If full additionality applies there is every reason to welcome a mining expansion.

Mining expansion: Full displacement
Gross full displacement is defined as the Type II multiplier that results when the increase in mining exports is neutralised completely by an increase in imports and a reduction in non-mining exports. This adjustment is modelled by applying the same percentage adjustment to all import penetration ratios and non-mining exports. In this case GDP falls by $A8.8 billion and NNP by $A7.2 billion. Employment falls by 78,100, reflecting the relatively high labour intensity of the sectors displaced. This is further reflected in the near $A5 billion fall in wages and salaries.

Net full displacement can be estimated by subtracting the second from the first column in Tables 4 and 5. Compared to the full additionality case, displacement considerably reduces the benefits of a mining boom, but in Australia’s case does not completely take them away. The numbers indicate that, except for employment, policy-makers can be indifferent to a mining expansion which results in full net displacement because, on this basis, there would be a key benefit of an increase in national productivity. Government revenue is also positive with net full displacement.

The issue of government revenue
A first caveat to this reasonably positive result is that the tax revenue for new mining projects may take 5 to 10 years to peak because of the high write-offs in the early stage of production for, for example, preliminary expenses, depreciation and exploration expenditure. Second, for highly capital-intensive projects, resource rent tax may not be levied for 8 to 10 years from the commencement of production. The taxation results in the tables assume immediate payment of resource rent tax based on the industry averages. For the full additionality case, the increase in direct tax revenue from the mining sector equals $A1 billion. In the early years at least the estimate of nearly $A3 billion government revenue from mining should be reduced significantly.

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Costs of additional population
The second adjustment that must be made is that the gross and full displacement analysis indicates that 78,000 jobs are lost from industries that are, in the main, located in established regions with adequate infrastructure and community services.

The mining expansion case, in contrast, involves the necessity to increase national population in regions where, in the main, the infrastructure and resource requirements have not been provided. These costs need to be taken into account.

It is argued above that an additional 400,000 people will be induced to migrate into Australia to resource construction to allow mining production to increase as analysed in the tables. Given the rigours of life in many of the regions where mining investment is taking place, the workers imported to support the mining expansion will, by attrition, shift to industries and regions that are unrelated to the mining construction and production supply chain. If inflationary pressures are to be avoided, part of this attrition will have to be replaced by additional migration over the next few years. It will be assumed that the additional immigration will average out at 50,000 a year for the duration of the expansion, which is likely to continue to 2015 at least, and later for LNG if not for metallic minerals. Therefore, a notional 10 year construction phase will be assumed.

The annual and once-off expenditures that will be required over the next decade to support each 50,000 increment are given, by component, in Table 6 and come to a total of between $A5.0 billion and $A6.0 billion (to give a range rather than a point estimate). Given these resource claims from mining expansion either directly on government or in terms of resource claims on society as a whole (as is the case with housing), in order for Government and society to be indifferent between resource expansion and leaving the minerals in the ground the net Government revenue from resource expansion would have to be at least $A1.5 billion to $A2.0 billion greater on an annual basis than what is likely to be generated. If the balance is not to tip decisively away from net benefits to net costs there will have to be higher mining taxes, both in the short term and the long term and/or low levels of displacement of domestic non-mining production.

Three different tests can now be applied to assess the realism of these calculations. The first will examine the statistical relationship between real net national disposable income and mining product, the second will examine the relationship between state capacity and mining investment, and the third will examine the evidence of crowding out in the MM manufacturing sector. The three tests corroborate the reasoning in general, although they also suggest additional lines of investigation.

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Link between mining and net national income
One simple way to test for the link between mining gross product and net national product/net national income is to run a regression of real net national income (less mining and construction gross product) per capita against time and real mining gross product. To remove the terms of trade effect, nominal mining gross product is deflated by the Australian National Accounts’ gross national income implicit deflator rather than by mining prices. The mining variable is expressed in per capita terms.

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The zero coefficient for the mining gross product variable indicates that in both real and price terms mining has had no impact on non-mining and construction national net disposable income. At this level of abstraction, mining seems to add to income overall, although without any positive multiplier effects into other industries.

The results suggest a degree of additionality. In the full additionality model run considered above the ratio of the increase in NNP to the increase in mining gross product was 1.18. However, the equation just estimated indicates that full additionality does not apply and the mining production phase has contributed no more than mining’s direct contribution to NNP. The contribution from the full additionality sensitivity analysis is 0.53 per dollar of gross product, or an increase of $A3.6 billion a year between 2010 and 2015. Therefore, taking the ratio of $A3.6 billion to the $A8.0 billion increase in NNP from Table 3 suggests an average net additionality factor of 45 per cent, suggesting that while Australia has not avoided the Dutch disease it has at least managed to gain some net benefit from the construction phase. This case is referred to elsewhere in this study as the 50 per cent gross crowding-out case or the 50 cents in the dollar crowding-out case.

However, the conclusion does not adjust for the increase in population to support mining expansion. This is done in Table 7.

The conclusion from Table 7 is less optimistic than the conclusion derived in the section above on the Dutch disease, where it was found that the mining construction boom from 2006 to 2012 added approximately 1 per cent to NNP per capita. Table 7 relates to a longer time period which includes both periods of mining expansion and periods when the mining industry has been producing but not expanding. The conclusion for this longer period is that the annual mining contribution to net national income has been a little less than the per capita net national income attributed to the one million population increase to support mining construction phases since 1979. In other words, there has been no net additionality in terms of benefits to the original population, defined as the population that would have existed if net mining investment since 1979 had been zero. This means that, on a per capita basis, Australia has been subject to the resource curse, if not in terms of headline outcomes, and suggests that the main impact of the mining expansion since 1979 has been to expand population without loss of per capita net national income but no doubt at a cost of housing shortages and decline in infrastructure quality.

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Resource expansion: Impact on non-primary GDP capacity
Our discussion in a previous article of the difference in investment drivers between commodity producers (now chiefly miners) and producers of differentiated and branded goods and services indicates that a major driver of displacement is foregone non-mining capacity that results from the pressures of the construction phase (Brain, 2012). Time-series estimates of non-agricultural capacity utilisation are available at the state level from National Australia Bank surveys on a quarterly basis and can be readily adjusted to exclude mining.

To test for the crowding out of non-mining activity during the construction phase the following model was estimated for the five main Australian states (estimation from the fourth quarter of 1989 to 2010):

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Because of the interaction between import share and capacity it is not possible to interpret outcomes directly from equation coefficients. However, simulations suggest that for a $33 billion annual mining investment, the decline in MM gross output will be around $12 billion if the previous peak import share is exceeded or approximately $8 billion if this is not the case. Given the gross product to gross output ratio, this suggests a loss of output in terms of gross product of between $3 and $4.2 billion directly and perhaps double this after inter-industry flow-ons. This, in turn, would represent a plausible one third to one half of the reduction in aggregate displaced capacity estimated in the previous section.

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Household debt and net additionality
We now have an apparent contradiction. It would appear that there has been headline net additionality, if not on an adjusted per capita basis. The results from the last two sections suggest a situation close to zero net additionality. The two can be reconciled by the recognition of the role of household debt in driving Australian economic growth since the early 1990s.

The accumulation of household debt stimulated growth through equity withdrawal by the household sector, including an increase in debt above the levels required to finance housing and other household investment. The net additional stimulus to growth is measured by the change in household equity withdrawal as a percentage of GDP. This series is given in Figure 2. Between 1992 and the middle of 2008 the average annual stimulus from the change in equity withdrawal was 0.5 percentage points, so that the growth in household debt contributed at least half a percentage point to annual growth. This was a powerful mechanism for producing headline positive net additionality which coincided with the construction phase of resource expansion – and was related to that phase by overseas willingness to lend to the Australian banks. The inference is that without the growth of household debt, mining expansion over the past two decades may well have produced headline zero net additionality. Under these circumstances it is likely that population growth would have been less. However, significant negative per capita additionality may well still have occurred.

The problem is that with the ratio of household debt to net disposable income now at 200 per cent there is only limited further stimulus to economic growth available from this source. It follows that it is likely that the economic stimulus from the current episode of elevated mining expansion over the next few years is will fall well short of expectations based on the last decade.

Macroeconomic policy and crowding out
An important link in all of these effects is the overvaluation of the exchange rate. We therefore revisit the question of why the exchange rate appreciated as it did.

One suggestion is that the appreciation could have been avoided by tighter economic policies. If, at the macroeconomic level, the objective is to protect the domestic non-resource sector an appropriate response to ensure internal/external balance would be to introduce contractionary fiscal policies to prevent the exchange rate appreciating and release sufficient labour resources to resource both mining construction and the maintenance of the non-mining sector activity at pre-mining boom levels. However, Australia took a less painful alternative, at least in the short-term, which was to increase the supply of labour by immigration so that both domestic supply and demand could be expanded and upward pressure on the current account balance neutralised. Australia imported 400,000 additional people which would have been more than enough to prevent crowding out of the non-resource sector and should have been more than enough to prevent upward appreciation of the currency. However, the estimated equations suggest that crowding out was not prevented. Despite a significant deterioration in the current account deficit (Figure 3) the exchange rate appreciated significantly between September 2004 and June 2008. The economic textbooks suggest that this should not have happened – the exchange rate should not have appreciated either due to the increase in the current account deficit or because of the additional population.

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What then drives the exchange rate? The latest theory of financial sector analysis is that the high Australian exchange rate is being driven by the Australian currency being a ‘proxy’ for the Chinese currency. The Chinese currency is not fully convertible and is a non-market driven, controlled currency. The Australian currency is market driven. Therefore, international investors are reluctant to invest directly in Chinese financial assets to capture the benefits of China’s economic growth. They reason that the safest next best strategy is to invest in Australian dollar-denominated assets which, because of the dependency of the Australian economy on the Chinese economy, should in value ‘shadow’ the free market outcome for the Chinese economy. The inference is clear. Australia has no ability to control crowding out by macroeconomic policy instruments. The only solution is direct intervention to increase the direct benefits to the Australian economy from elevated periods of mining expansion.

This is not to suggest that increasing the migration rate has not lessened the degree of crowding out from what would otherwise have been the case. What is clear is that textbook policies are necessary, but not sufficient factors, to reduce the degree of crowding out. The textbook policies being insufficient, direct action is required if to crowding out direct action is required if crowding out is to be minimised.

Mining expansion and the national productivity slowdown
The central argument of this article is that the mining boom, by crowding out non-resource activity, has created unutilised resources which can be exploited to increase the direct benefits from the current mining expansion. This argument applies not only to capital and labour resources but also to the potential impact of mining expansion on the rate of productivity growth. This potential stems from the relationship between the rate of growth of productivity and the rate of growth of economic activity. For this to be correct, the evidence must suggest that the current productivity slowdown is related to the slowdown in the rate of growth in the economy. As is indicated below in this section, this is the case. From the December quarter 2011 National Accounts, the rate of growth of productivity measured by GDP per hour worked has fallen from between 0.5 to 0.8 per cent, depending on whether the September or December quarter of 2010 is selected compared to the corresponding quarter a year earlier. Figures 4 and 5 leave out the poor recent quarters and run to the June quarter 2010. Even so, productivity growth was still trending down. What is important here is not so much what the recent rate of growth of productivity has been, but the extent to which the slowdown in productivity growth was due to the changes in the pattern of economic activity.

Figures 4 and 5 indicate such a relationship. In Figure 4, in general the higher the rate of growth of GDP the higher the rate of growth of productivity. This finding is expressed in Figure 5 by a larger gap between the rate of growth of total hours worked and GDP. This gap is larger the higher the rate of growth of GDP.

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The sample period is the first quarter of 1989 to the second quarter of 2010.

The two key coefficients are the sum of gdpg coefficients and the cute coefficient. The cute coefficient indicates that the lower the capacity utilisation rate in the economy the lower the (labour) productivity growth rate, no doubt in part due to the underutilisation of overhead hours. The sum of the gdpg coefficients is 0.68, indicating that a 1-per cent growth rate of gdpg is associated with an additional labour productivity growth rate of 0.32 per cent.

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To demonstrate this impact of economic activity on GDP growth, the 2007 calendar year will be compared with the 2010 calendar year. The 2007 calendar year was the last year of sustained high productivity growth over all four quarters. The average GDP growth rate for 2007 over the four quarters was 4.6 per cent, compared to 2.7 for 2010. The difference  in  growth was 1.9 per cent,  suggesting that the growth difference would explain a productivity growth decline of 0.6 per cent per annum.

However, productivity growth has also declined because of a fall in capacity utilisation rates between 2007 and 2010. The average non-farm capacity utilisation rate over 2007 was 83.8, compared to 81.6 for 2010. The lower capacity utilisation rate explains another 0.6-per cent decline in productivity. The average labour productivity growth rate in terms of hours worked in 2007 was 1.9 per cent, compared to 0.3 for 2010. Therefore, the slowdown in economic activity between 2007 and 2010 explains 1.2/1.6, or three-quarters of the decline in productivity.

The crowding-out effects of mining expansion would have contributed to the decline in national productivity over the last year. However, to date, the largest contribution to falling productivity would have come from the unwinding of the fiscal stimulus (Brain, 2010).

In the years ahead, however, the cumulative effects of the Dutch disease, if allowed to continue, can be expected to reduce national productivity growth rates from levels that would have been expected given longer-term historical trends.

The important point is that the crowding-out effects of mining expansion are likely to have a larger negative impact on national productivity growth compared to recent past crowdings-out. It follows that the impact of measures to increase the direct benefits from mining expansion will have a positive impact on national productivity and, therefore, will be mildly anti-inflationary, because they will enable existing employed resources to be used more effectively.

Conclusion
Given the changed circumstances that are likely to prevail over the next few years, extrapolation of past responses to mining expansion into the future suggests that there may be little headline net per capita additional benefit. This will come at a time when the resource claims to meet the infrastructure and service demands of the increased population induced by the current episode of mining expansion will be presented in full, creating very difficult political and economic constraints, and adding to those from climate change. This will be compounded by the national productivity growth remaining below historical trend levels other than occasionally, such as in 2011–2012.

The alternative is to change the way resource expansion is managed to maximise its net additionality. As discussed in a previous article, such management would include increased harvesting of resource rents and measures to increase the domestic content of mining investment.

 

References

ABS (Australian   Bureau   of   Statistics), 2010, ‘Australian  System  of  National  Accounts,  2009–10’, ABS Cat. No. 5204.

Brain, P. J. ‘Australia and the Global Financial Crisis: A Highly Efficient Policy Response at the Cost of Locking in Structural Imbalances’, National Economic Review, 65, pp. 1–22.

Brain,  P.  J.,  2012,  ‘The  Mining  Boom  in  Context’,

National Economic Review, 67, pp. 1–18.

Air-Source heat pump water heaters in Australia and New Zealand

National Economic Review
National Institute of Economic and Industry Research
No. 68   October 2013

The National Economic Review is published four times each year under the auspices of the Institute’s Academic Board. The Review contains articles on economic and social issues relevant to Australia. While the Institute endeavours to provide reliable forecasts and believes material published in the Review is accurate it will not be liable for any claim by any party acting on such information.

Editor: Kylie Moreland

©  National Institute of Economic and Industry Research

This journal is subject to copyright. Apart from such purposes as study, research, criticism or review as provided by the Copyright Act no part may be reproduced without the consent in writing of the relevant Institute.

ISSN 0813-9474

Air-source heat pump water heaters in Australia and New Zealand
Graham Armstrong, Consultant, NIEIR

Abstract
This paper is based on a study prepared and presented by Graham Armstrong to the Air Source Heat Pump Water Heater Asia (ASHPasia) Forum in Shanghai, China on 17 November 2012. This study draws on two main information and data sources: the National Institute of Economic and Industry Research and Saturn Corporate Resources database for projects undertaken for a range of Australian electricity and gas distributors (low voltage wires and metering responsibilities) and retailers (customer billing, energy end-use advice and liabilities under government end-use programs); and a study for the Australian and New Zealand Governments’ E3 Equipment Energy Efficiency joint initiative entitled ‘Product Profile: Heat Pump Water Heaters, Air-source Heat Pump Water Heaters in Australia and New Zealand’ (June 2012; E3 report, available at www.energyrating.gov.au). An outline of E3 programs is provided in the Appendix.

Introduction
Although similar in many ways (e.g. having mild climates very suitable for air-source heat pumps), Australia and New Zealand have quite different energy supply and demand characteristics. Australian electricity generation is greenhouse gas intensive (GHGI), averaging approximately 1 t CO2e/MWh, and is predominantly based on coal.1 Australia has substantial gas production (approximately 50 per cent exported as LNG) and reserves (i.e. conventional, mainly offshore and onshore; coal seam methane; and shale (no production as yet)). Renewables account for approximately 10 per cent of electricity generation. Water heating is increasingly based on gas (48 per cent), with 45 per cent electricity (declining), and growing contributions from a low base (5 per cent) of solar hot water (SHW) and air-source heat pump hot water (HPHW) systems. Regional variations are significant. There is a national policy to phase out electric resistance water heating because, on average, it is GHGI. A carbon tax was implemented in July 2012 at A$23/t CO2e, which will be replaced by an emissions trading system (ETS) in 2015–2016.

New Zealand electricity generation has low greenhouse gas intensity, averaging approximately 0.15 t CO2e/MWh, and is predominantly based on renewables (hydro-electricity, geothermal and wind). New Zealand has limited gas production and reserves. Water heating is dominated by electricity (80 per cent). Natural gas contributes 16 per cent and SHW 1.4 per cent. An ETS is in place.

The above summary of the two national energy systems indicates that the drive for low end-use GHGI water heating is far greater in Australia. However, the wide availability of reasonably priced gas has meant that, without incentives, low GHGI SHW and HPHW systems are not competitive with gas in reticulated gas areas. Liquefied petroleum gas/propane is also widely available but is relatively expensive.

In Figure 1, data on average annual mean temperatures in Australia (annual) indicate favourable conditions for air-source HPHW systems. The efficiency of heat pumps, measured as the coefficient of performance (COP), depends on the temperature differences between the medium to be heated (i.e. water or air) and the desired service (i.e. hot water or warm or cool air) delivery temperature. The smaller the seasonal difference, the higher the COP.

In New Zealand, the low GHGI of electricity does not raise climate change concerns for electric resistance water heating. In both Australia and New Zealand, residential water heating economics can be attractive for SHW and HPHW systems replacing ERHW units when incentives to install SHW and HPHW units are available.

In Australia, replacement of a typical ERHW unit using 4 MWh annually with a heat pump with an average COP of 2.2 provides a saving of 2.4 MWh per year. Under the average current tariff for water heating using the two systems, the annual savings would be approximately A$350 when a HPHW heater replaces an ERHW unit. In New Zealand, the savings would be approximately NZ$600 per year (E3 report (Australian and New Zealand Governments, 2012)). Note, however, that the savings depend on the tariffs ($/MWh) applied to the ERHW units and the heat pump. In Australia, domestic electric water heaters are typically storage heaters using off-peak (22:00 to 07:00 hours) electricity, at approximately A$150/MWh.

In Australia, a heat pump system producing hot water on demand would use electricity at an average price of approximately A$230/MWh, thus reducing the efficiency advantages of a HPHW system. Most HPHW systems installed in Australia are off-peak storage units and seldom require non-off-peak boosting. Smart (interval) meters are being installed in Australia but, as yet, time-of-use tariffs are not mandated.

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The residential water heating market: Current and potential
In 2011, there were approximately 8,602,000 residences in Australia (see Table 1). By comparison, there were approximately 1,730,000 residences in New Zealand.

Water heating proportions by state/territory are presented in Table 2. Gas dominates in Victoria and is also the major energy source for water heating in South Australia and Western Australia. In all states, solar penetration increased markedly over the 2009–2011 period, albeit from a small base. SHW systems (and HPHW) are subsidised under the Federal Renewable Electricity Target (RET) and state initiatives, and were, until 1 July 2012, under the Federal Renewable Energy Bonus Scheme. SHW and HPHW are also encouraged in new homes in Victoria (SHW or plumbed water tank must be installed), New South Wales (under the Building Sustainability Index (BASIX)) and South Australia. SHW and heat pump hot water installation rates peaked in 2009 but then dropped as households preferred to invest in photovoltaic (PV) rather than SHW/HPHW installations. HPHW heating is not reported separately by the Australian Bureau of Statistics (2011).

In terms of the residential water heater market in Australia, there are approximately 800,000 units installed annually: 650,000 are replacement systems and 150,000 are for new residences. In 2011, there were approximately 70,000 residential SHW installations and approximately 15,000 residential HPHW installations.

Average annual energy use for water heating and potential heat pump hot water savings

There are variations in annual energy use for water heating in Australia by region and household structure and characteristics. Electric resistance heating produces the highest level of GHG emissions and running costs are high. At approximately $150/MWh ($42/GJ) off-peak and using 4 MW per year, the annual cost is $600. For gas, consumers pay approximately $20/GJ. Using 25 GJ per year, an average household pays $500. Hence, for electricity and gas, a 60-per cent reduction in use when a HPHW unit replaces an electric resistance (ERHW) or a gas water heater saves the household $360 and $300 per year, respectively.

If a 10-year payback were acceptable to consumers, the maximum capital cost for HPHW units would be approximately $3,600 for electricity (ERHW unit) and $3,000 for gas (GHW) replacement (undiscounted, with no energy price increases).

In November 2012, Chromagen was offering (in Victoria) a Midean HPHW unit of 280-L capacity for $2,300 (total subsidies approximately $2,000; i.e. without the subsidies the cost would be approximately $4,300). At this price, capital payback from savings is approximately 6.4 years in non-gas areas for this replacement, which assumes the ERHW system replacement is relatively new. However, at ERHW or GHW unit end-of-life, the economics for an HPHW unit are much better. In this case, when the ERHW or GHW unit fails (end-of-life), the choice is between an HPHW unit and a new unit of the same type that has failed (i.e. like-for-like replacement). In this situation, the real cost of an HPHW unit for the householder (consumer) is the difference in cost between the HPHW and conventional units. These costs vary but are approximately $1,000 for an HPHW unit versus a new ERHW unit, and $800 for an HPHW unit versus a new GHW unit. At a cost for the HPHW unit of $2,300 (as in the case above), the paybacks would be: 2.8 years for an HPHW unit replacing an ERHW unit and, when the new HPHW unit is displaced (early in life or later (or end) in life (average non-HPHW unit is approximately 12 years)), 2.7 years for an HPHW unit replacing a GHW unit. These paybacks should be attractive for most householders. As indicated above, paybacks will vary. Paybacks will depend on:

  • if end-of-life, price differential between non-HPHW units and HPHW units;
  • gross costs of HPHW units (e.g. $4,000) net of subsidy cost (e.g. $2,000);
  • efficiency of hot water units (HPHW, ERHW and GHW) (for HPHW units COPs will be higher in warmer regions);
  • electricity and gas prices (vary by region);
  • hot water usage per year (lower hot water usage reduces HPHW attractiveness; reverse for higher hot water usage); and
  • life and maintenance costs of units.

Given, as indicated above, the attractive paybacks of HPHW units in Australia, why do HPHW units not have a higher market share (now approximately 2 per cent)? One of the main reasons is that although the cost of an HPHW unit is not much greater than the cost of a conventional unit and paybacks are good, many householders will purchase equipment on a first (capital) cost basis and ignore operating CO2 advantages of HPHW units. Second, there are concerns about the reliability and life of HPHW units. Third, there is very limited promotion of the benefits of HPHW unit technology and, finally, the tendency for like-for-like replacement, particularly at end-of-life situations when replacement with an HPHW unit, might take 1 to 2 weeks (hot water is seen as an essential service and delay in restoration of the hot water service is very inconvenient). These issues need to be addressed by the air-source HPHW industry (manufacturers and retailers) in Australia. For example, at end-of-life, a temporary hot water unit could be immediately supplied and used until a new HPHW unit is installed.

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Residential sector gas and electricity prices
Electricity and gas prices have a significant influence on water heating economics and, thus, the consumer choice of water heating systems. Australian retail electricity prices have risen significantly in real terms over the past 5 years due mainly to increases in distribution (‘poles and wires’) costs. Costs of ‘green’ policies passed on to consumers, and since 1 July 2012 carbon pricing, have also contributed to residential electricity price increases. The estimated breakdown of retail electricity and gas prices (variable energy, not including fixed supply charges) in 2011 in Victoria (typical of other States/Territories) is presented in Table 3.

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Carbon (CO2 equivalent) pricing impacts
Carbon pricing increases the prices of electricity and gas according to the carbon dioxide equivalent (CO2e) price, the CO2e content of fuels used to produce electricity and the CO2e content of end-use combusted gas. In end-use markets energy users will respond to increased energy prices by reducing energy demand, particularly in the longer term when energy using equipment can be changed. Carbon pricing also changes the generation mix required to balance demand and supply towards gas and renewables.

The Australian CO2e price is $23/t from 2012–2013 to 2014–2015 (see Figure 2). Then, as the ETS phase is linked to the European Union (EU) scheme, the estimated price falls to $15/t by 2015–2016, rising linearly to $18/t in 2020 and $22/t in 2025.

For electricity, at $23 to $27/t CO2e, the pass-through (CO2e price impact on wholesale electricity price) is approximately 85 per cent, resulting in an electricity price rise of $21 to $24/MWh plus goods and service tax (GST), or, at current price levels, approximately a 9-per cent increase in retail price. At higher CO2e prices the pass-through percentage decreases, and increases at lower CO2e prices.

CO2e content of end-use gas varies by state. For example, the CO2e content is 0.057t CO2e/GJ in Victoria and 0.71t CO2e/GJ in South Australia. At $23/t CO2e, the price rise in Victoria is $1.3/GJ plus GST, or a 9-per cent rise in retail prices.

The demand response, that is, the price elasticity of demand for electricity, is estimated to be approximately −0.3 in the long run. High real price increases such as the ones that have occurred in Australia over recent years could engender a short-run response close to the long-run elasticity, or even greater.

From an electricity demand viewpoint, the focus of electricity retailers on CO2e pricing impacts will be on CO2e pricing increasing electricity prices and reducing demand compared with no carbon pricing, and on gas prices rising. Accordingly, gas versus electricity competition may not be significantly affected.

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If the current Federal Coalition removes the carbon tax, electricity and gas prices could still rise as a result of Coalition climate change policies. The impact, however, is indeterminate at this time.

National Institute of Economic and Industry Research projections of residential electricity prices are presented in Table 4, together with a breakdown of price components in Victoria. These prices include fixed supply charges. Off-peak (22:00–07:00 hours) rates, mainly applying to water heating, are $100 to $120/MWh below peak rates (tariffs). Each retailer offers a range of tariffs (available on their websites). The above tariffs are the average of the most common peak tariffs. Tariffs may fall due to carbon price changes and as ‘green’ policies, and responses to them, change.

Gas prices have, where gas is available, made the fuel very competitive for water heating. In Victoria, where over 90 per cent of residences have access to natural gas, 66 per cent of residences used natural gas for water heating in 2011.

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As indicated in Tables 4 and 5, gas prices are low compared with electricity prices. However, higher efficiency electrical equipment, such as heat pumps (with efficiencies of 200 to 300 per cent), can offset the lower cost of gas (gas efficiencies are 65 to 95 per cent).

Note that electricity and gas prices post-2013 are difficult to predict mainly because of carbon pricing uncertainty.

Performance of heat pump hot water units
Heat pump water heater performance depends on several factors, including: the location and climate where it is installed; the heating efficiency or COP of the system under standard conditions; the heat loss of the storage tank; the quantity of hot water drawn off each day; the quantity, the duration and the time of day of each draw; the time interval between draws; the thermostat and control strategy settings; and whether the heat pump can run at any time or whether it is constrained from running at certain times due to electricity tariff structures, for example, lower off-peak rates. These factors contribute significantly to the competitiveness of HPHW systems with alternative water heating systems.

Most relevant standards for performance are AS/NZS 5125: 2010 Heat Pump Water Heaters (product performance assessment) and AS/NZS 4692.1: 2005 Electric Water Heaters (energy consumption, performance and general requirements).

Independent laboratory testing in 2010 and 2011 of heat pump water heaters of the most common models sold in Australia and New Zealand using AS/NZS 5125 generally gave similar results to the tests undertaken by manufacturers. Testing raised some concerns about heat pump water heaters that had very slow heat up times, particularly in colder temperatures. Key concerns raised as a result of testing include low energy efficiency in cold ambient temperatures in some models and slow reheat times, especially in cold ambient temperatures in certain models. In addition, many models had higher noise levels than expected.

While physical test results were largely consistent, the modelled performance estimates using AS/NZS 4234 were often inconsistent with manufacturer-modelled results. This divergence appears to be a result of: a lack of clarity in some definitions in the standards; inconsistencies between instructions and how the model actually operated; and the small, medium and large load categories in AS/NZS4234, which can result in step changes in calculated displaced energy if a product is only marginally below the requirements of a particular load category.

Testing of heat pump hot water units
The Australian and New Zealand standards that relate to the design, construction and performance of HPHW units are listed in Appendix 1 of the E3 report (Australian and New Zealand Governments, 2012).  The greenhouse gas performance of HPHW units in Australia depends on energy used and energy GHGI. These factors vary by region and over time. For example, in Victoria, with a cooler climate compared to other regions of Australia, there is high electricity GHGI and gas is widely availability and low in cost. For a HPHW system, average electricity use is 1.6 MWh/year, with GHGI of 1.3 t CO2e/MWh, resulting in 2.08 t CO2e/year. In contrast, a new high efficiency GHW system uses 20 GJ/year, with GHGI of 0.06 t CO2e/GJ, resulting in 1.20t CO2e/year. There is a clear advantage to gas unless GHGI reduces significantly and/or HPHW COP increases significantly.

In Queensland, the climate is warmer and there is lower electricity GHGI, and limited availability and higher costs of gas. For a HPHW unit, the average electricity use is 1.2 MWh/year, with GHGI of electricity of 0.90t CO2e/MWh, resulting in 1.08t CO2e/year. A new high efficiency GHW unit uses 18 GJ/year, with GHGI of 0.06t CO2e/GJ, resulting in 1.08t CO2e/year. For an ERHW unit, the average electricity use is 3.5 MWh/year, with a GHGI of electricity of 0.9 t CO2e/MWh, resulting in 3.15t CO2e/year. There is a clear advantage to HPHW compared to ERHW, the dominant hot water source in Queensland. In gas (limited) areas, there is similar greenhouse performance for HPHW and GHW units.

Suppliers of heat pump water heaters in Australia and New Zealand
There are 18 brands and approximately 80 separate models of HPHW systems registered with the Australian Clean Energy Regulator (CER) (see Table 6). (There may be other models that are not CER registered.) The GWA Group and Rheem Australia share approximately 60 per cent of total sales. As is evident from Table 6, China has a significant role in the manufacture and assembly of HPHW units. As noted above, Chromagen is offering Midean HPHW units at prices that are attracting sales, particularly in non-gas areas.

Regulations and policy initiatives applying to heat pumps
Mandatory energy efficiency regulations
Mandatory energy efficiency regulations do not apply to HPHW units in either Australia or New Zealand. In both countries, storage heat tanks, if a component of heat pumps, are exempt from standing tank heat loss provisions if resistance heating provides less than 50 per cent of annual energy supplied.

Building codes
Australian states and territories (except Tasmania and the Northern Territory) have rules that restrict the use of GHGI water heaters in detached houses, semi-detached houses and townhouses. This has virtually eliminated ERHW systems in new homes. In New South Wales, the BASIX energy rating system contributed to an increase in the HPHW share of the New South Wales water heater market. The New Zealand Building Code specifies maximum heat losses for all types of water heaters up to 700-L capacity.

In existing buildings, South Australia and Queensland have regulations restricting the replacement of ERHW systems. In 2010, the national Ministerial Council on Energy agreed to phase out GHGI water heaters for existing homes except Tasmania (mainly a hydro system). When the policy is implemented, water heater replacement in detached houses, semi-detached house and townhouses will be by heat pumps, SHW, gas or wood-fired water heaters.

The Australian Federal Renewable Electricity Target
Under the Australian Federal RET policy, the use of renewable energy for electricity generation and hot water production is provided with incentives delivered through electricity retailers (sellers of electricity to end-users). A target for renewable energy as a percentage of total electricity consumption (with some exemptions) has been set for 2020: now approximately 25 per cent. The retailers are liable for acquisition of renewable energy in proportion to their share of total electricity sales. The RET is divided into two parts:

  1. small renewable energy systems (SRES), which cover small-scale renewables, including PVs, and other small (up to 100 kW) generators and displacement technologies (SHW and heat pump units); and
  2. the large renewable energy target (LRET), which covers large-scale renewables.

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There is no maximum target (cap) for SRES. In contrast, 41,000 GWh by 2020 has been set as an LRET, with the target increasing gradually from 12,500 GWh in 2011. In recent years (2009 to 2012), SRES has been dominated by PV. In 2011, approximately 15,000 heat pumps and 70,000 SHW units were installed under SRES out of a total residential water heater market of approximately 800,000 for new and existing residences. The heat pump installations have declined from approximately 65,000 units in 2009 when state rebates (see Table 7) were very generous for heat pumps, resulting in a virtually zero price for heat pumps.

The SRES is delivered through Small Scale Technology Certificates (STCs) created following SRES regulations. In the regulations the number of STCs is specified for each type of equipment installed. When eligible equipment, such as a heat pump, is installed, STCs can be created and sold to retailers. At a price of $30 to $40 per STC, the price of HPHW systems can be reduced by approximately $900 to $1,200 per unit. Each electricity retailer must purchase and deliver to the SRES regulator (Clean Energy Regulator) STCs in proportion to their share of the end-use electricity market.

Since 2008, households  have preferred to put their ‘solar dollars’ into PV systems, mainly because of greater PV incentives under RET and state/territory feed-in-tariffs, and reductions in state/territorial incentives for heat pumps and SHW.

Rebates and subsidies
Federal rebates
Up to 1 July 2012, the Federal Government provided rebates to replace ERHW systems with SHW or HPHW units. The progress of the rebate over 2009–2012 is shown in Table 7: 250,000 water heater installations were covered by the program.

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New South Wales

From 2007 to 2011, 48,000 rebates were paid for HPHW units under a state program that terminated in June 2011. Rebate levels varied from $300 to $1,200 per unit.

Victoria

Under Victoria’s Energy Efficiency Target, a ‘white certificate’ program, HPHW units are eligible for subsidies to replace ERHW units. In addition, until March 2013, direct subsidies for HPHW and SHW units were available from Sustainability Victoria.

South Australia

Since 2002, low income households have been eligible for incentives to install SHW, HPHW and GHW units in new and existing residences. Incentives will end in June 2013. Approximately 1,200 HPHW units will be installed under the program.

Queensland

Since 2010, rebates up to $1,000 have been offered for SHW or HPHW units (heat pump take-up unknown).

Australian Capital Territory

The Australian Capital Territory (ACT) offers $500 for replacement of heat pump units to replace ERHW units. Heat pump take-up is not known.

New Zealand

Over 2009–2012, rebates of $575 to $1,000 were offered for installation of heat pump water heating units. Take-up data is not available.

Heat pump installations
Apart from the SRES element of the federal RET, incentives to install HPHW units have been significantly reduced since 2009 in Australia. As a result, HPHW installations appear to have dropped from approximately 80,000 in 2009 to fewer than 20,000 in 2011, partly due to reduced incentives and partly due to consumer preference for PV installations.

In New Zealand, installations are very low, perhaps 500 per year because of relatively low electricity prices and low climate change concerns associated with low GHGI electricity.

In the future, heat pump installations will depend on several factors, including HPHW performance (coefficient of performance); electricity and gas prices; subsidy/rebates for heat pump installations; promotion of HPHW units by suppliers to enhance consumer acceptance of the units; and regulation of water heating technologies.

There was a close correlation between the total level of federal and New South Wales rebates and installations up to 2011 (see Figure 3). New South Wales and Queensland installations accounted for the majority of HPHW installations to 2011 due to incentive levels, favourable climatic conditions and the limited availability of natural gas (see Figure 4).

New South Wales and Queensland have 76 per cent of the Australian stock of heat pump water heaters, even though they have 52 per cent of the total number of Australian dwellings. The higher rate of HPHW unit installations in these states is due to a number of factors. First, a lower share of households in these states have access to reticulated natural gas than in Victoria, South Australia and Western Australia, and, as a result, there is less competition from gas in the low greenhouse emissions water heater market. Second, there were favourable financial incentives (especially in New South Wales) over 2008–2010. Third, New South Wales benefitted from the effects of the BASIX requirements for new dwellings. Finally, large populations live in climate zones where HPHW units perform well. Final data for 2011 and 2012 are not yet available, but installations have declined in these years as the availability of rebates has declined, even though SRES has continued.

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In Australia, HPHW sales are forecast to increase, with current policies, from approximately 20,000 per year in 2011 to approximately 40,000 by 2030 (E3 report (Australian and New Zealand Governments, 2012). However, if the phase-out of ERHW system policy is fully implemented, sales of HPHW units could reach approximately 100,000 per year by 2020 for new heat pumps and heat pump replacement use. Sales increase factors besides the planned electric resistance phase-out are consumer acceptance of HPHW units (which could be enhanced by supplier promotion), increases in heat pump efficiency, a decrease in the price of units, an increase in electricity price and the introduction of favourable tariffs for HPHW units.

In New Zealand, approximately 350 HPHW units were sold in 2009 and 400 in 2010, with an expected 500 in 2012 (E3 report). The much lower New Zealand numbers are due to fewer residences (1.7 million versus 8 million in Australia), fewer climate change concerns, less favourable electricity prices, and overall less favourable air-source heat pump operating conditions.

Policy options to improve heat pump water heater performance
A range of studies, performance testing and comparison with global experience indicate that the market penetration of heat pump water heaters in Australia and New Zealand could be significantly improved.

Potential policy initiatives include improved information on heat pump benefits and costs, enhanced unit testing, improved publicity, better appliance performance labelling, Minimum Energy Performance Standards (MEPS), and research and development for units to ensure unit specific suitability for Australian and New Zealand conditions.

The E3 study (Australian and New Zealand Governments, 2012, pp. 36–37) proposes the following strategies for consideration by stakeholders:

  1. Establish a system of mandatory product testing and registration, based on AS/NZS 5125, as well as noise testing to ISO 3741. As heat pump water heater suppliers already conduct physical tests to AS/NZS 5125 and governments already maintain registers of other appliances, the additional costs should be relatively minor in comparison with the potential public benefits.
  2. Introduce MEPS and functional performance requirements, including addressing cold temperature performance and noise issues, with proposed notification of the requirements no later than mid-2013 and requirements to take effect by mid-2014. There are likely to be significant benefits from ensuring that all models are fit-for-purpose and achieve MEPS.
  3. Enable public access to the registered data, with models identified. This will provide potential purchasers, competing suppliers and regulators with an overview of the range of products and performance levels on the market.
  4. Develop energy labelling standards, either as a mandatory requirement or initially for voluntary use by suppliers.
  5. Develop a roadmap of potential future increases in minimum performance criteria and associated measures such as labelling.

From the author’s perspective, what is also needed is promotion of the costs and benefits of HPHW units. In Australia this is almost totally lacking.

Heat pumps in the residential sector for space heating and cooling
Based on heat pump technology, reverse cycle air conditioners (RACs) are increasingly used for space cooling and heating in the Australian residential sector. Space cooling penetration is now applied in the majority of Australian residences (see Table 8) mainly through the use of RACs. In the states/territories (New South Wales, Victoria, Tasmania and South Australia) where there is a significant heating load, RACs are increasingly being used for space heating, particularly in non-gas areas.

Except in Western Australia and the Northern Territory, new air conditioner sales are virtually all reverse air cycle (RAC) units, which can be used for heating and cooling. In hot, dry regions, evaporative air conditioners are very effective and space heating requirements are low.

In gas areas, the high efficiency of RACs (COPs of 3.5 to 4.5) virtually offsets the lower price of natural gas. With gas at A$16/GJ and electricity at $250/MWh, gas space heating costs per year are A$750/year and RAC space heating costs are A$794/year.

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Conclusions of heat pump hot water review in Australia and New Zealand
The following can be concluded after reviewing the use of HPHW in Australia and New Zealand. First, there is significantly more potential for HPHW in Australia compared with New Zealand. Second, in Australia, climate conditions and the policy environment are favourable to HPHW. Third, HPHW incentives, although reducing in Australia, continue to provide attractive payback returns to HPHW units. Fourth, payback returns and greenhouse performance vary regionally: potential for HPHW units is greater in New South Wales, Queensland, South Australia and Western Australia. Finally, greater HPHW market penetration requires monitoring and reporting of HPHW performance combined with enhanced promotion of the reliability and benefits of the technology and addressing the end-of-life, like-for-like issue.

The Australian and New Zealand MEPS initiative is an early (1999) and major element of national energy efficiency improvement (EEI) and climate change policies. MEPS was originally developed under the National Appliance and Equipment Energy Efficiency Program (NAEEP).

Minimum Energy Performance Standards now form part of and are developed under the Equipment Energy Efficiency (E3) Program, a joint Australian and New Zealand initiative. Energy labelling (part of E3) was introduced into both Victoria and New South Wales in the late 1980s, and the first MEPS were introduced in Australia in 1999. They now cover a range of residential, commercial and industrial appliances and equipment. Once introduced, MEPS levels are regularly updated and new energy using appliances and equipment continues to be added. In addition to this, the energy rating algorithms used for appliances are updated from time to time and made more stringent, so the labelling scheme continues to encourage the marketing of high-efficiency appliances.

The MEPS set a regulated minimum energy performance standard for appliances and equipment covered by the program. That is, MEPS prevent (subject to compliance) low energy performance units from entering the Australian market and, therefore, contribute to savings in consumer operating costs and reducing generation requirements. It is illegal to sell products which do not meet the required MEPS levels. Mandatory energy rating labels give an indication of energy performance (higher stars = higher efficiency). Some appliances (refrigerators/freezers, air conditioners and televisions) are subjected to both MEPS and mandatory energy labelling. In general, where both MEPS and energy labelling apply to an appliance, the sales weighted star rating of products sold exceeds the MEPS levels by a significant margin.

In 2007, a total of 5 appliance categories were subjected to mandatory labelling, and 9 appliance categories were subjected to MEPS. By the end of 2010, 7 appliance categories were subjected to mandatory labelling (plus 2 voluntary levels) and 16 appliance categories were subjected to MEPS. In 2009, MEPS were introduced for chiller towers, close controlled (computer room) air conditioners, external power supplies, set top boxes, self-ballasted compact fluorescent lamps and incandescent lamps. Both MEPS and energy labelling have been introduced for televisions.

The implementation of MEPS and energy labelling is coordinated through a joint Commonwealth, state and territory government E3 committee.

Given the long MEPS history and the regular updates and additions, the determination of the additional impact of the MEPS on energy use and greenhouse gas emissions is complex. It is very difficult to estimate how energy performance for each group of appliances would have changed in the absence of MEPS, and this becomes more difficult as the time elapsed since the introduction of a MEPS increases. Due to MEPS in countries to which export appliances to Australia, there may be improvements in performance not related Australian regulatory change.

George Wilkenfeld and Associates (GWA), the MEPS impact consultant to the E3 program, provided the GHGA MEPS national and state impacts to 2025 in a 2009 report. In the report’s analysis, GWA attempted to estimate the beyond business-as-usual (BAU, no MEPS) impact of MEPS. That is, the estimated impacts did consider EEIs, which would have arisen if the MEPS had not been implemented. The estimates also considered the impact beyond BAU of new MEPS initiatives scheduled to be implemented over the 2009, 2010 and 2011 period (the next MEPS triennium).

The resulting GWA estimates do not include adjustments related to estimates of rebound, non-compliance with MEPS and deterioration of appliance and equipment over time. These factors could reduce these estimates. However, the GWA estimates also assume that carbon pricing would be introduced but in 2011.

Estimates by GWA of E3 program savings in the National Electricity Market (annual) over 2000–2022, from a 1999 efficiency base for new appliances and equipment, are presented in Table 9. The estimates are additional in that they assume that without MEPS and labelling new appliances and equipment efficiencies would have been ‘frozen’ (i.e. fixed) at 1999 levels. On this basis and given the extensive range of appliances and equipment the MEPS apply to, the estimated savings are substantial.

Electricity savings in Australia from E3 programs from 2000 to 2009 were estimated by GWA for E3 to be approximately 6,750 GWh and from 2009 to 2022 increasing by approximately 26,500 GWh.

References

Australian Bureau of Statistics (2011), ‘Environmental Issues: Energy Use and Conservation’, Cat. No. 4602, March, Australian Bureau of Statistics, Canberra.

Australian and New Zealand Governments (2012), ‘A study for the Australian and New Zealand Governments’ E3 Equipment Energy Efficiency Joint Initiative: The study entitled Product Profile: Heat Pump Water Heaters, Air-source Heat Pump Water Heaters in Australia and New Zealand, June 2012 (E3 report – available at www.energyrating.gov.au).

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Economic Overview (NER 60)

National Economic Review

National Institute of Economic and Industry Research

No. 60               December 2006

The National Economic Review is published four times each year under the auspices of the Institute’s Academic Board.

The Review contains articles on economic and social issues relevant to Australia. While the Institute endeavours to provide reliable forecasts and believes material published in the Review is accurate it will not be liable for any claim by any party acting on such information.

Editor: Dr A. Scott Lowson

© National Institute of Economic and Industry Research

This journal is subject to copyright. Apart from such purposes as study, research, criticism or review as provided by the Copyright Act no part may be reproduced without the consent in writing of the Institute.

ISSN 0813-9474

Economic overview

Peter Brain, Executive Director, NIEIR

Abstract

In this article Peter Brain assesses the medium term outlook for both the world and Australian economies, including the importance for the latter of public sector demand and immigration as important drivers of growth.

An overview of the medium term outlook for the world and Australian economies

The medium-term outlook for the Australian economy remains shaped by a number of conflicting influences.

On the positive side these include:

  • the strong terms of trade gains which will exert upward pressure on growth, particularly in States such as Western Australia and Queensland.
  • a steady outlook for immigration; and
  • the fact that public sector balance sheets in Australia are very strong.

On the negative side are:

  • the strong downward pressure on discretionary consumption expenditure from the weight of household debt;
  • increased import penetration of final and intermediate manufactured goods, particularly from China, leading to manufacturing closures, namely in New South Wales, Victoria and South Australia; and
  • the current downturn in new dwelling construction, concentrated in 2005-06.

The strong terms of trade gains made over recent years – shown in Figure 5 – are expected to exert strong upward pressure on Australian GDP growth over the next two years. The resource boom will bring higher levels of private business investment, infrastructure development and a higher exchange rate that would have otherwise have been case. This will support higher income growth. Actual expenditures will be concentrated in the resource rich states of Queensland and Western Australia. The developing imbalance in the world economy (US trade and budget deficits, China’s increasing share of world production) will produce a correction by 2009. The question is, how severe this correction will be. A sharp correction has not been factored into this forecast, however, world growth is forecast to weaken in 2009 and 2010, and the terms of trade to fall back significantly.

Whilst the contribution of the household sector to growth will be limited by debt constraint, the state of public sector balance sheets in Australia can increasingly drive growth. The public sector can drive growth by income tax changes, infrastructure spending (which is already occurring in some states) and also debt leverage through public sector partnerships and co-opting the superannuation sector, through their infrastructure funds, to play a direct role in driving growth.

Whilst the increase in the terms of trade will benefit the resource based sectors of the Australian economy, the higher exchange rate and increasing competition from imports have, and will continue to, lead to a downsizing of Australia’s established manufacturing sectors.

The import penetration has been steadily rising in Australia, both in terms of final manufacturing products and intermediate inputs. More and more Australian manufacturers are either shifting their operations overseas or stopping operations and importing products from overseas. Australian established manufacturers in older urban area have also seen a dramatic increase in their land values as a result of the housing boom. The profitability of these operations, under increased import competition, has narrowed against the actual income potential of the land they occupy. The high exchange rate has also blunted Australia’s manufacturing export potential.

Capture1As we have seen over the recent years in Australia, the gains by the commodity based sectors of the economy and the resource based sectors will be partly offset by the downsizing and closure of established manufacturing operations. The established manufacturing sectors are concentrated in New South Wales, Victoria and South Australia.

International outlook

The world economy continued to expand at a rapid pace in 2004 with continued strong growth in the United States, China and East Asia. Economic growth in the Western Europe and Japan also picked up significantly in 2004. World economic growth was around 5 percent in 2004. This follows growth of 4 per cent in 2003 and 3 per cent in 2002. China’s GDP growth rate was around 10 per cent in 2003 and 2004.

In the projections, growth in the Chinese economy is expected to continue at around 8 to 10 per cent level through to 2009. Growth is expected to fall following the Beijing Olympics. Australian commodity exports and prices are expected to weaken at this point, with Australian terms of trade and the exchange rate both falling.

The world economy appears to have passed its cyclical peak growth rate. World economic growth is forecast to weaken slightly over 2005 -06 and 2006-07, partly in response to high oil prices. Growth is still however between 3.5 and 4.0 per cent.

The United States economy, which grew by 4.4 per cent in 2004, is projected to grow by 3.5 per cent in 2005 and 3 per cent in 2006. With continued pressures on US public sector balance sheets, high household and corporate debt levels, growth in the US economy us expected to slow post 2006. The US current account deficit reached around 6.5 per cent of GDP in early 2005. The Federal Reserve has been successively increasing rates since mid-2004, and further rates rises seem likely.

Growth in Japan was 2.7 per cent in 2004 following growth of 1.4 per cent in 2003. Growth in 2005 is projected to be 1.4 per cent and 1.8 per cent in 2006. The fundamental of the Japanese economy definitely improved over the last 18 months, and even the banking sector balance sheets have improved.

World economic growth slows to 3.5 per cent in 2008-09 and then 2.7 per cent in 2009-10, mainly reflecting weaker US economic growth and growth in China contracting to around half current growth rates.

The recent drivers of Australian economic growth

The drivers of Australia’s economic growth over the last decade are now going into reverse. From Figure 2, the household debt service ratio reaches 28 per cent of net disposable income in 2004-05. The debt service ratio is the ratio of interest and repayment of loans to net household income. This is now considerably higher than the peak level that prevailed before the 1991 recession.

In the March quarter 2005, the Australian household debt to disposable income ratio reached 174 per cent as shown in Figure 4. By comparison, the ratio four years earlier in March 2001 stood at 123 per cent. This rate of increase cannot be sustained. Indeed, this rate of increase in the household debt to income ratio is declining, as indicated by Figure 3.

It is not only debt saturation that is leading to a decline in households’ ability to absorb debt. As Figure 3 indicates, there has been a decline in the household net worth to income ratio over the last four quarters, compared to the peak level in March 2004. Household net worth is household financial assets plus market value of housing stock less financial liabilities. The major reason for the decline/stabilisation has been the stabilisation of house prices in the context of further growth in household debt.

The deteriorating household balance sheets are being reflected in the current sluggish growth in retail sales and the current slower growth in household consumption expenditure. As a result, household consumption expenditure is forecast to slow to 2.9 per cent in 2005-06 and remain at between 2.5 and 3.0 per cent per annum till the end of the decade.

Capture2In the May 2005 Budget the Federal Government gave personal income tax cuts equal to 1.0 percentage point of household income. The commencement of severe downward pressure on household expenditures from debt saturation and falling net worth to income ratios (from expected falls in house prices over 2005-06) will either offset the impact of the expenditure enhancing effects of the tax cuts, or will force the additional income from the tax cuts to be saved.Capture4
Capture3The Australian medium-term outlook

Australian GDP growth over 2004-05 was 2.3 per cent, the lowest since 2000- 01. The slowdown in Australian growth over 2004-05 reflects a gradual slowing in private consumption expenditure growth and a small fall in new dwelling investment. Household consumption expenditure and new dwelling investment were drivers of Australia GDP growth over the 2001-02 to 2003-04 peri

High levels of consumption expenditure and rising levels of business investment have lead to sharp increases in imports over the last 3 years. Import growth over the 2002 -03 to 2004-05 period has been averaging around 12 per cent per annum. Imports significantly subtracted from growth in 2004-05.

Australian GDP growth is forecast to accelerate to 2.9 per cent in 2005-06 and 3.5 per cent in 2006-07. Private consumption expenditure and dwelling construction, however, will not be the key drivers of growth. Dwelling approvals have already fallen and private dwelling construction expenditure is expected to fall by 10 per cent in 2005-06. The decline could be more significant depending upon the rate of adjustment by builders in this sector.

The decline in private consumption expenditure growth over the course of 2004-05 confirms the household debt constraint is increasing taking hold. The Federal Government tax cuts announced in 2005 will mostly be absorbed by increases in the household savings ratio. Consumption expenditure growth will fall below that ratio of growth in real household disposable income.

For the next two years Australia’s export performance will be relatively strong.

Australia’s export performance will improve over the next two years. Average export volume growth is expected to be in the vicinity of 5.0 to 6.0 per cent per annum. Export volumes are also expected to be reasonably strong as resource projects commencing over the next year are completed.

The restructuring of the manufacturing sector is adversely affecting exports. As import penetration steadily increases and plants close, exports fall because many of these bigger plants also export. Between 2008 and 2011, given the world outlook, Australia’s export performance looks bleak, unless a significant devaluation occurs.

The Australian dollar is likely to devalue strongly after 2007 or 2008.

Given Australia’s current high terms of trade from the high commodity prices and the likely downward pressure on the US$ over the next one to two years, Australia’s currency, in US$ terms, could well appreciate to the 80 cents range. This will not last. The slowdown in world GDP growth post 2008 will return the Australian current account deficit, as a per cent of GDP, to the 7.0 per cent benchmark. The return of commodity growth to more normal levels will combine with these factors to drive the Australian currency to the 60 to 70 cents range, against the US$. Given the expected devaluation of the US$, this implies a significant weighted average devaluation of the Australian currency. This is 25 per cent by 2010. The weighted average exchange rate returns to close to the low levels of 2001.

Capture6Public sector demand will become a more important driver of Australian growth.

The 2005 round of Government budgets is the forerunner of what is to come. That is, Governments in Australia sustaining growth by using their strong balance sheets to offset the decline in the capacity of the household sector to sustain growth. The State Government’s 2005-06 infrastructure expansion will add 0.5 per cent per annum to Australia’s growth rate over the next two years.

More importantly, Governments are beginning to think long term. The Queensland Government has announced a $55 billion expenditure program, while the New South Wales program is around $20 billion. Over the next 20 years, depending on the PPP (private-public sector partnership) component, Australian Governments could spend between $700 billion and $1 trillion dollars and still maintain acceptable debt to GDP ratios.

The Government sector will take over the role from the household sector in driving total investment.

 Immigration will also become an important driver of growth.

The Federal Government has announced that permanent and long term immigration will be increased by 20,000 to offset Australia’s skill shortages. Over the projection period, immigration will become an important source of growth from a variety of linkages. These include:

  • workplace growth to offset the ageing of the population;
  • direct capital inflows associated with wealthy immigration; and
  • network integration with Asia to sustain Australia’s export performance.

The next movement in interest rates will be downwards.

The downturn in the dwelling cycle has commenced. In the Eastern States the level of approvals are 10 to 20 per cent below the levels that prevailed a year ago. Domestic demand growth is slowing. Interest rates are likely to be lowered at some point in 2006. However, the extent of the downward adjustment is likely to be limited. Inflationary pressures (currently from skill shortages and commodity prices) will be joined by currency devaluation post 2008.

This will keep nominal wages and inflation at near the upper bound of the Reserve Bank of Australia’s (RBA) acceptable range for much of the projection period, despite periods of weak labour market conditions. This will also occur despite downward pressure on low skilled wage rates that will flow from the Federal Government’s industrial relations reforms.

Overall, the outlook over the projection period is one described by the RBA Governor last year. It is a growth outlook for annual Australian GDP growth that “will sometimes have a 2 in front of it and sometimes a 3”.

Capture6 Energy trade

Despite rapidly rising oil prices, rising crude oil and product imports and static domestic crude oil and condensate production, net exports of energy continue to rise. Energy exports are expected to be strong post-2006, mainly due to large expected increases in LNG exports.

Capture7

The Economic Impact of Public Events

National Economic Review

National Institute of Economic and Industry Research 

No. 67 November 2012

The National Economic Review is published four times each year under the auspices of the Institute’s Academic Board.

The Review contains articles on economic and social issues relevant to Australia. While the Institute endeavours to provide reliable forecasts and believes material published in the Review is accurate it will not be liable for any claim by any party acting on such information.

Editor: Kylie Moreland

© National Institute of Economic and Industry

Research

This journal is subject to copyright. Apart from such purposes as study, research, criticism or review as provided by the Copyright Act no part may be reproduced without the consent in writing of the relevant Institute.

ISSN 0813-9474
The economic impact of public events

Ian Manning, Deputy Executive Director, NIEIR

Abstract

The present paper examines a small and ill-defined area of government–private sector interaction: the organisation of public events. In particular, events that receive subventions from the public purse and that draw patrons from outside as well as within the subsidising jurisdiction are considered. Neoclassical economics asserts that economic policy should concentrate on leaving decisions to markets. As applied to the analysis of events, the neoclassical policy recommendation is for reliance on user charges except where there are non-economic reasons for free or subsidised provision. However, NIEIR’s analysis of event provision shows that this recommendation relies on assumptions that have not applied in most parts of Australia over the past 30 years. Instead, subventions to events that increase tourist visitation can increase incomes and employment. Thus, the case for subventions becomes one of priority against other expenditures, preferably exercised in the context of a coherent strategy for the future.

 Mixed economies and government– private sector interaction

When the United States went into ideological overdrive following the end of the Cold War, it let loose a wave of propaganda for market economics. Soviet central planning and government ownership of business enterprise were discredited. Economies should, therefore, be reformed to the opposite extreme, with government curtailed to providing law and order and all else left to the private sector. Some of the most effective propaganda involved the promotion of sophisticated neoclassical economic modelling, which purported to show that a completely privatised economy delivered the best of all worlds. In countries dominated by the American way of thinking, this modelling became the standard by which economic policies were assessed. Its intended target was not the Soviet-style centrally-planned state but the mixed economies inherited largely from the wave of socialist reforms that followed the Second World War.

In Australia’s case, it was conveniently forgotten that the economy had been mixed ever since the 19th-century colonies found that private enterprise was unable to provide them with the infrastructure they required. For the most part, academics and treasuries influenced by the neoclassical wave of thought deliberately assumed away the insights of Keynes’s generation, which supported mixed economies. One of these was the finding that markets are generally ‘imperfect’, which is a polite way of saying that they cannot be relied upon to generate an optimum allocation of resources as described by neoclassical theory. This is not to claim that government action can be relied on to improve matters: far from it. However, there are occasions when governments have opportunities to increase employment and incomes. It is arguable that they should be on the lookout for such opportunities and take advantage of them when they arise.

Since its foundation in 1984, NIEIR has remembered the findings of the economists of Keynes’s generation and, accordingly, has stood apart from the neoclassical economic models favoured by the American economic evangelists. The intellectual problem with the neoclassical models is their high level of abstraction and the plethora of assumptions, many of which contribute directly to their pro-market findings. It should not be surprising that when attempts are made to apply them to policy problems, highly abstract models can generate misleading results. It is inevitable that economic models should simplify the intricacies of the mixed economy in which governments, privately-owned business and non-profit organisations have basically complementary tasks but can sometimes be in (necessarily imperfect) competition, but important that the simplifications capture the major causes and effects rather than being assumed from ideological principle.

The commitment to the vision of a purely private market economy has diverted attention from the realities of government–private sector interaction. These differ industry by industry. Although all industries rely on government for the enforcement of contracts and property rights, the dependence of the mining sector on the administration of exploration and mining licences differs from the dependence of the finance sector on the administration of debtors’ and creditors’ rights and its ultimate dependence on government as lender of last resort. Again, there is general reliance on governments for the provision of an educated workforce but skill requirements are frequently industry-specific. Despite the targeting of government-provided physical infrastructure in privatisation campaigns, one major industry, road transport, is, to this day, completely dependent on infrastructure owned and managed by the three levels of government. Others depend on infrastructure that is to various degrees government provided, guaranteed or assisted. The mixed economy refuses to go away.

 

Event organisation as an activity

This article looks at a small and ill-defined area of government–private sector interaction: the organisation of public events. In particular, the paper considers events that receive subventions from the public purse and that draw patrons from outside as well as within the subsidising jurisdiction. Public events in this sense include sporting, cultural and business-oriented events, such as trade fairs. The event may be as brief as a few hours or last for a season and may take place on a single site or a range of sites. Events can be organised by government agencies, non-profit organisations or commercial businesses. Event organisation includes the production and marketing of the event itself and the coordination of a range of suppliers, including (in various proportions) venues, entertainment, security, accommodation and transport.

The production of events is not recognised as an industry in standard industrial classifications. If anything, it would be a subsector of tourism, which again is not recognised as an industry in the standard classifications, although the Australian Bureau of Statistics (ABS) has a definition of the sector and from time to time releases statistics about it. Persons employed putting on events may be classified as working in sport, the arts, business services, religion or,if all else fails, in entertainment not elsewhere classified.

An important distinction is that between events themselves and associated economic activity. Although accommodation, meals and transport may be arranged as part of an event, they are provided by recognisable related industries. There is also a distinction between events and event venues, sometimes expressed as arm’s length transactions (the event organiser hires the venue). However, events are frequently organised by venue operators while, in the opposite direction, organisations that are primarily event promoters may branch out into venue ownership. In the closely-related field of tourist attractions, venue and events may coalesce.

 

The predilection for user charges

Economic theory distinguishes between excludable and non-excludable events. The latter, exemplified by street parades and fireworks displays, are conducted in public spaces where it is impractical to charge for entry and where, indeed, some of the attendees may be unwilling witnesses rather than beneficiaries. Because it is not possible to charge attendees directly, the source of finance preferred in neoclassical economics, user charges, is not available and non-excludable events must, therefore, be financed from sources such as public culture and recreation budgets, business advertising budgets or the demonstration budgets of groups wishing to apply political pressure. Neoclassical economics allows that where governments finance a non-excludable event, they cannot be faulted for failure to impose user charges, although (as with all government expenditure) their priorities may be criticised.

Excludable events are those where it is practical to charge entry fees. The neoclassical principle is that both the event and the venue should be financed from user charges or, if available, by the use of voluntary labour. However, it is common practice for governments to contribute to the staging of excludable public events, sometimes by way of direct subventions, sometimes through more limited assistance (e.g. for marketing) and quite frequently by contributing to the infrastructure cost of venues. These contributions are contrary to neoclassical principle, but have been defended in two major ways.

A government may decide that an excludable event has such merit as a community occasionthat entry should be free, an approach often taken for events with educational, cultural or commemorative content. Short of this, it may decide that the event should be available at subsidised prices, either through a subsidy paid to the event provider or indirectly through venue subsidisation. A great many arts events fall in this category.

It may be argued that the event generates spin-offs for businesses that justify the subvention. In the extreme case, it may even be argued that the addition to business activity generates increased tax revenue such that the subsidising government actually gets its money back.

The first of these arguments is not particularly amenable to economic analysis because the benefits can only be measured indirectly. This is the domain of cost–benefit analysis, which specialises in the imputation of market-derived values to costs and benefits that are not directly valued by market transactions. Sometimes reasonably satisfactory surrogates are available, but sometimes they are not: for example, it has proved very difficult to put a market value on biodiversity. Where such values are important, difficult decisions have to be made as to how to evaluate mixed bags of market, near-market and distant-from-market values. In some studies, particularly those with environmental costs and benefits, NIEIR has included non-market costs and benefits, but other studies have concentrated on the second, purely economic effects of events. This may be termed economic impact analysis, as distinct from cost– benefit analysis, and concentrates on effects on employment and incomes.

Approaches to economic impact assessment

The economic impact of subventions to events can be estimated by economic modelling. Assessment using neoclassical models produces predictable results: events are assumed to absorb resources that would otherwise be employed in other types of production and, therefore, have negligible overall effects. Given the underlying assumption that the economy is subdivided, without remainder, into a series of perfectly-competitive price-equilibriated markets and is therefore fully employed, this result is inevitable. There is no need to have recourse to models if these assumptions are made, except to identify which areas of production contract in order to expand the production of events.

The position is rather different if the industries impacted by the event have spare capacity. This requires that markets be imperfectly competitive, including that production can be marginally increased without affecting price. A typical case would be a chef who does not increase prices just because his or her restaurant achieves 95 per cent occupancy for a night or two. Whether or not production can be increased without affecting prices is a practical matter, and cannot be solved by assumption. NIEIR has frequently been contracted to estimate the economic impact of events where it can be argued that the concerned industries have spare capacity and production is, for a range of capacity utilisation, demand-determined. The institute has evaluated both events where the existence of spin-off benefits is the primary defence of a subsidy and events whose primary justification is cultural or educational but where spin-off benefits are welcome and help to justify the subvention. Impacts may be calculated in advance (as part of advice as to whether the event should be supported) or in arrears (as part of an audit process and also for reference in deciding future applications). Either way, the calculation requires a comparison of two scenarios: a scenario in which the event is held (in the ex-post case what actually happened) and a scenario in which the event is not held. The impact of the event is estimated by differencing the scenarios.

The construction of formal scenarios requires both geographic and time definitions. These are adopted primarily according to client requirements but might also reflect data availability. The geographic area impacted may be limited to the immediate surrounds of the venue(s) but may be expanded to include their Local Government Area (LGA), the state or the whole country, while time definitions may include the run-up to the event, the event itself and its lasting effects. NIEIR can match these definitions to its datasets and models and, hence, provide assessments at the LGA, state and national levels (the sub-LGA level generally requires additional data collection) and for time periods defined by quarters (with the peak day or week a possibility subject to additional data collection).

Because the argument for subsidisation from spin-offs is expressed in economic terms, it is appropriate to measure the impact of the event by the addition to gross income obtained by differencing a scenario that includes the event and one which does not. (Gross income, in this context, means cash income before deduction of depreciation.) Some clients are also very interested in benefits in terms of employment generation and governments are sometimes interested in estimates of the amount of additional tax revenue generated by the event. The benefits thus calculated can be related to the size of the subvention and different subventions can then be compared for effectiveness and (with a little further modelling) can also be compared with the benefits of equivalent tax cuts.

Measuring benefits in terms of changes to income and employment does not provide a full cost–benefit analysis. Two elements are missing:

  • assessment of additional external benefits, such as the educational value of the event or environmental benefits; and
  • assessment of additional external costs, such as environmental costs and alternative leisure foregone to participate in, or work for, the event.

The simplest approach to these costs and benefits is to limit assessment to market values. This approach is regularly accused of ignoring much that is relevant. However, attempts to be all-inclusive can end up giving excessive weight to shadowy and elusive effects. NIEIR prefers to err on the market-value side but includes major external costs and benefits where it assesses them as relevant and assessable.

In evaluating events, it is not common to spend much effort on environmental effects. This is because few events have the primary purpose of generating environmental benefits and for most of them environmental costs are incidental. There is a substantial literature on environmental costs and benefits and defensible conventional values are available for many environmental costs, such as noise and carbon emissions. If these are considered significant they can be included in the assessment.

When events have educational value, it is theoretically desirable to include a value for this benefit. Various methodologies have been suggested, such as estimates of the cost of providing the same education by alternate means or estimates of the capital value of the addition to earning power resulting from the education. Educational and entertainment values are sometimes hard to distinguish, and attempts have been made to tie them down by surveys of willingness to pay over and above the actual admission charge and documentation of how much people have spent travelling to the event. These types of evaluation can quickly become subjective. Similar arguments apply to health effects.

A category of cost sometimes put forward is the cost of leisure foregone by people who work as a result of the event, to which one might add alternative leisure foregone by those who attend the event. As with all allocations of time, the basic point is simple: if people didn’t do one thing, they would do something else. The problem is that evaluation is necessarily subjective. Take the case of those who forgo leisure to work. At one extreme, the foregone leisure may have been, for example, a family occasion that the worker would much rather have attended but forgoes in order to retain a reputation for reliability with his or her employer. At the other extreme, the foregone ‘leisure’ may have been moping around for want of anything better to do or money to do it with. In this latter case, hours worked are not a cost but rather bring the benefit of approved social participation. The cost of ‘reservation wages’ is further discussed below.

Event assessment methodology

A decision to concentrate on income generation as the measurable benefit of subventions to events has the great advantage of bringing assessment into the realm covered by the National Accounts and, hence, of economic models based on the National Accounts. Thus, additional income resolves into additions to wage and salary income and gross profits within the selected geographic area. Remembering that the income and expenditure sides of the National Accounts are, by definition, equal in aggregate, the increases in gross income are conveniently measured as net additions to expenditure. There are two dimensions to this: direct expenditures that would not have taken place in the absence of the event (with an offset for direct expenditures curtailed by the event) and indirect expenditures that arise as a multiplier result of the direct expenditures.

Direct expenditures for the geographic area that includes the event venue comprise, primarily, expenditures to the area by visitors who came to attend the event and also, pro rata, expenditures by people who visited partly because of the event and partly for other reasons. There may be other additions: for example, a trade fair will generally receive additional income from the local expenditures of out-of-region exhibitors and may generate income from additional sales of local products, while the accommodation and other expenditures of a visiting sporting team, its officials and visiting media may be offset against the share of the gate revenue that the team takes home.

Sources of information on the direct impact vary from event to event. Subject to judgements as to relevance, NIEIR has used the following sources.

Surveys of attendees are conducted face-to-face at the event. All attendees are asked their age and gender and, depending on the study, they may be asked about their marital status, number of dependent children, occupation, household income and ticket type. Where events run for multiple days or cover multiple venues, the questionnaires cover days and places of attendance. After asking normal place of residence, local attendees (those who live in the geographic area or region defined for impact assessment) are asked their expenditure at and associated with the event, whether they would have travelled elsewhere to attend a similar event had the event not been held locally and whether they ran down savings to attend. Visitors from outside the region are asked whether the event is a major or merely contributing reason for their visit, their expenditure associated with the event (including its broad composition) and the means of transport and type of accommodation employed. Data are also collected on satisfaction with the event and the likelihood of attendance at subsequent similar events, but these data are for market research purposes and do not affect the assessment of benefits.

Similar data may be collected from event participants themselves. At trade fairs these include exhibitors and buyers, at sporting events the competitors and visiting officials and at cultural events the performers. However, for sporting and cultural events, information from the organisers may be substituted for direct interviews with participants.

At trade fairs, locally-based exhibitors may be asked to estimate the value of additional sales generated at the event. It is admitted that such estimates are necessarily approximate, if only because sales concluded after the event can only be anticipated.

Information provided by the venue owner and the event organiser and their subcontractors generally includes the event budget (particularly cash flows into and out of the region) and total patronage (so that survey data may be expanded to total coverage).
Interviewers are supervised and endeavour to question a random selection of attendees. Participant data may, however, be collected by distribution and later collection of forms. Data are compared to the results for other events as a check on validity and also to dimension particular events in relation to others in the same region.

Although local visitors are asked various questions for market research purposes, their only contribution to the economic analysis is the amount they spend financed by reductions in savings or by forgoing travel outside the region. All other spending is, by their own admission, financed at the expense of other local expenditures and, hence, does not alter demand within the region.

Greater attention is paid to visitors from outside the region. The number of net additional visitors from outside the region (typically interstate and overseas) who would not have come apart from the event is estimated, as is the number of visitors who extended their visit because of the event. The resulting addition to visitor days is estimated along with the number of bed-days of additional accommodation, by accommodation type. (Overseas visitors tend to stay in hotels or backpacker hostels, but interstate visitors frequently stay with relatives or in a caravan.) Crucially, an estimate is made of additional expenditure in the region, divided into: event entry fees and other revenue to the event organiser or venue; meals, food and drinks; entertainment; accommodation; transport; additional sales by local businesses resulting from trade fair or similar exposure (if any); and other.
The estimate thus prepared may be termed the addition to the exports of the region promoting the event. The estimates will vary according to geographic definition: as the geographic boundary is broadened from local through state to national, a higher proportion of expenditure becomes local and exports diminish.

None of this has proved particularly controversial. It is the next step that brings out the difference between neoclassical and post-Keynesian approaches.
Neoclassical assumptions to minimise assessed impact
We must first dispose of the neoclassical trump card, known technically as the reservation wage. The underlying assumption is full employment, meaning that all people who want paid employment are at work for precisely their desired number of hours. In these circumstances, increases in employment are not possible without increases in wage rates. People who take on work as a result of the increase in wage rates are accordingly giving up leisure to the value of the previous wage rate (because by the full employment assumption they would have worked at the previous wage had they not valued their leisure more highly). Therefore, the benefits of any additional employment are negligible. However, it has been noted that the value of leisure foregone is highly subjective and can even be negative, and will argue below that the full employment assumption is questionable. Reservation wages are irrelevant when the focus is on income and employment, and even in a strict cost–benefit context their value is highly debatable.

We now turn to the main point at issue, which is the valuation of expenditures curtailed by the event: expenditures which would have been made in the absence of the event but are not made due to the event. As already noted, the neoclassical analysis depends on the assumption of full employment and means that curtailed expenditures are similar to event-generated expenditures. Two variants of the neoclassical story have been proposed, both of which depend on labour being fully employed.

One story runs as follows. An event transfers expenditure from the regions of visitor origin to the region holding the event. In all regions, labour is fully employed. Increased expenditure in the region holding the event causes wage rates there to rise, while reduced expenditure in the regions of visitor origin causes wage rates there to fall. These changes in wage rates precipitate a flow of labour from the regions of origin to the region of the event. The transfer of expenditure is matched by a transfer of labour. This prediction is easily tested in practice. For no event that NIEIR has examined has there been any evidence that the required changes to wage rates have taken place or that the event has been staffed (either directly or indirectly) by labour migrating from the visitors’ home states.

A more plausible version of the neoclassical story runs as follows. As in the first neoclassical story, visitor spending raises the demand for labour in the region that holds the event and workers can only be attracted to provide for the demand by offering increases in wages. However, in this story, the response to the increased wages comes not from different geographical regions, but from the effect of the increased wage rates in reducing profitability in all other local industries. These industries sack employees who promptly transfer to the industries serving the increased visitor demand. The net effect on employment and the total value of output depends on price responses, but it is normally claimed that they more or less balance out: the increase in production to meet the increase in visitor demand is countered by a decrease in local production. Thus, a subvention to an event, even when it increases income earned from outside the region, does not increase net income except perhaps marginally where the price responses fail to balance out.

In theory, similar reasoning could be applied to capital capacity. Neoclassical economics includes the concept of the ‘short run’, defined as a period in which capital capacity cannot be altered. Because events are ephemeral, this would appear to be the relevant assumption. If capital capacity is fully employed, no changes in real output can take place in the short run and the capital capacity required to service visitor expenditure can only be made available by shifting it from alternative production, the same result as for labour.

Realistic assumptions

The neoclassical analysis depends heavily on two assumptions:

  • labour supply is very nearly fixed, although labour can be found to service additional demand at the cost of transferring it from alternative production and/or from valued leisure; and
  • capital is fixed, although capital can be found to service additional demand at the cost of transferring it from alternative production (although this is the strict neoclassical position, some analysts assume that capital utilisation can vary and put the weight of their analysis on the labour supply assumption).

Whether or not capital capacity is assumed to be fixed, the operative assumption is that marginal costs are rising and translate into rising supply curves, not only in the industries serving visitor demand but generally. This assumption is made on purely theoretical grounds, without any investigation of labour market conditions applying in the area affected by the event at the time of the event. NIEIR does not contend that this assumption is always irrelevant: there can be times and places where additions to demand in one industry raise wage rates generally, and, more frequently, where they raise wage rates for particular skills; similarly, there can be times and places where additions to demand in one industry run slap into infrastructure or other capacity constraints. For example, mining booms raise wage rates generally in the remote mining regions and specifically for particular mining-related and construction skills, where they increase wage rates not only in the boom zones but across whole countries and, indeed, worldwide. Mining booms also crash against capital capacity constraints in the mining industry and for related transport, energy and water infrastructure. But is this universally true for events?

The obvious capacity constraint affecting events concerns venues. However, unlike mining booms, events are planned in advance with meticulous attention to venue availability. Only in the case of very large events, such as the Olympic Games, is venue availability a potentially limiting factor. Impact analysis for very large events is complicated by the need to evaluate the costs of the resulting planned construction program and to assess the benefits of the resulting assets after the event has taken place. Most events that NIEIR has been called upon to evaluate utilise existing venues. Where this is the case, the opportunity cost of the venue is reasonably represented by arm’s length venue hire charges. NIEIR includes these with the costs of staging the event.

Having dealt with venue and staging costs, the major question concerns the capacity of the local economy to service the addition to visitor expenditure, where visitors are defined as people coming from outside the region in which the venue is located. Judging by the composition of additions to demand revealed by the surveys conducted by NIEIR at events, these additions to demand chiefly concern accommodation, restaurants and other eateries, entertainment (not only the entertainment provided by the event itself) and transport. Except for the additions to transport demand, the additions are concentrated near the event venue.

The additions to expenditure on entertainment and private motor vehicle transport caused by a typical event (in size up to a Commonwealth Games or a papal visit) are minor in relation to total demand, even at the LGA level, and are likely to be within existing capacity: a few extra seats are sold and the average delay in the queue to pay the cashier at the petrol station increases by a minute or less.

Events can impose significant demand on local public transport. However, the transport authorities have the great advantage of fairly accurate estimates of likely demand and have shown themselves capable of marshalling their resources to meet the demand. Similarly, large events generate surges in air traffic, but the airlines have sophisticated demand management systems in place. If a surge in traffic is anticipated, their first step is to withdraw discount fares and the second is to schedule additional flights. If these flights require aircraft placement flights in the contrary direction the airlines may offer discounted fares to take people away from the event rather than to it. Additional flights are usually provided from reserve capacity in the existing fleet, including flying at unattractive times of day, and are manned from existing personnel resources. The increase in the demand for air transport that results from an event does not, therefore, withdraw labour from other industries. However, there may be an offset to the increase in demand from attendees at events from two sources:

Travellers who would have visited the event location in the absence of the event but who are put off by the increased fares (a group that also includes travellers who are put off by increased accommodation charges). Not all of these potential visitors are completely put off; some (helpfully) reschedule.

Residents of the event location who are persuaded to leave the area, either by discount airfares or simply to avoid being at home when the event is held. Once again, these departures may be opportunistic and merely rescheduled departures that would have taken place in any case.

For events significant enough to affect airfares, NIEIR estimates the offset to demand.

A stronger case can be made that events strain capacity in the hospitality industries: accommodation, restaurants and related services. Any event that is worth assessing will cause an increase in local demand for hospitality services sufficient to raise the demand for labour in these industries. The additional demand is met from two main sources:

  • the offer of additional hours of work, either to existing part-time employees or to persons otherwise not in employment, at standard rates of pay; and
  • the offer of additional hours of work at enhanced rates of pay.

Where additional employment is taken, at standard rates of pay, by people who would otherwise be in paid work there is no reason why rates of pay in other industries should be affected or that labour should be withdrawn from these industries. Whether or not labour can be recruited to an event on this basis is a matter of practical observation. The evidence that it can be includes the following:

The hospitality industries rely heavily on part-time workers. There is ABS evidence that, for most Australian locations and for most times since the end of full employment in the 1970s, many part-time workers desire additional hours at the going rate of pay.

The hospitality industries also rely quite heavily on low-skilled and semi-skilled workers. There is ABS evidence that, for most Australian locations and for most times since the end of full employment in the 1970s, many persons are available who would be happy to work at the going rate of pay were more jobs available at these levels of skill. Such workers include many more than those who are unemployed as officially defined. The surveys confirm the presence of significant numbers of people who do not meet the official definition of unemployment in terms of work search but who would, nevertheless, happily take on paid employment were it offered to them. We may also note that Australian labour-force participation rates are below those of many OECD countries, which would indicate the presence of potential employees to take jobs made available.

This said, some employers may prefer to meet the extra demand by raising wage rates. The obvious strategy is to employ existing staff on overtime, which raises costs in the hospitality industries but does not threaten to withdraw labour from other industries. If the increased costs are passed on in terms of increased prices there may, however, be a small offset to real demand in the form of reduced patronage by local residents who have to pay more to eat out.

Finally, demand may be met by the neoclassical mechanism of offering higher wage rates to attract workers who are already employed. In view of the excess supply of low and medium skill workers, increased wage rates are likely to be offered only to skilled personnel such as chefs. The point here is that hospitality skills are industry-specific; an increase in wage rates for skilled hospitality personnel cannot be guaranteed to generalise across all industry as required by the neoclassical hypothesis. However, as with overtime, there is a possibility of increased prices in hospitality reducing the real incomes of local residents and, hence, their real expenditures.

It can be concluded that an increased demand for labour in hospitality is unlikely to generalise to general increases in wages affecting all industries unless the region concerned is closer to full employment than has been the case in most Australian regions over the past three decades.

The position is similar with capital capacity. Event organisers generally organise hospitality at the same time as they organise the event and hospitality providers have shown themselves capable of a flexible response, much like the public transport providers and airlines. Hospitality providers customarily work with a level of excess capacity and also use flexible pricing. This means that a lack of discount accommodation reduces casual visitation during the event, although some of this is rescheduled. NIEIR makes an allowance for visitors who would have visited but for the event, deducting their estimated expenditures from those of the visitors who come because of the event.

For significant events occurring in the capital cities, it is possible to check whether an event was associated with price increases in the hospitality sector. The relevant indicator is the relationship between the price index for hospitality and the consumer price index in general. For several reasons it is expected that hospitality prices will trend upwards more rapidly than consumer prices: productivity increases in services are generally less than in manufactured goods; there is no competition from low-priced merchandise imports; and the hedonic price adjustment for information technology slows the rate of increase of the general index. Given these expectations, price increases for hospitality have been low and have not corresponded with surges in the demand for hospitality: indeed, the reverse has been the case, and periods of high increase in demand have tended to be associated with low increases in prices, as would occur if hospitality were an industry subject to increasing returns to scale.

It is argued by NIEIR that the supply of labour and capital to the hospitality industry in response to events has been cordoned off from the supply to other industries in most Australian locations at most times during the past three decades. This conclusion applies even in places like seasonal tourist resorts because the resorts draw on labour from the nearby cities or from sources such as young overseas tourists with 2-year work permits. If this is the case, additions to demand translate directly into increases in income. The offsets that neoclassical analysis assumes are, indeed, possible, but under typical conditions do not apply.

 

Multiplier effects

The stage is then set for multiplier effects. In traditional Keynesian fashion, an increase in demand generates an increase in incomes, the spending of which generates a further round of increased demand. The process continues subject to ‘leakages’, in the form of savings and capacity constraints, although we have checked the hospitality industry and noted that these are unlikely, and in conditions of generally less than full employment they are not particularly likely in other industries. However, it is admitted that skill supply and capital capacity constraints apply in some places at certain times, and when they do they limit multiplier effects as surely as leakage into imports.

NIEIR models these multiplier effects using:

  • input–output tables, concentrating first on income generation in industries that supply the hospitality industry and then in second and subsequent rounds being more general;
  • data on industry employee characteristics, to determine the kinds of household into which the additional incomes will flow, again concentrating on the hospitality industry in the first round;
  • data on the characteristics of households receiving capital incomes;
  • household expenditure patterns, to determine the directions of spending of households with increased incomes; and
  • data on commuting patterns and trade matrices, to determine the locations of spending.

The results of this analysis are directly contrary to the neoclassical analysis. Instead of the initial increase in export demand being whittled away by reductions in production in other industries, it is expanded by increases in demand for the products of those industries. The result is that public subventions to events that attract visitor expenditure from outside a region generally benefit the region, the exception being where they hit capacity constraints. The returns to public expenditure can be attractively high, although there is no guarantee: NIEIR has come across events that have failed to attract non-local visitors and where the economic impact has been negative. Subventions to such events may still be justified on cultural or other grounds, but not on grounds that the events generate income or employment.
Should generally positive returns guarantee priority in public budgets?

The finding that, under present circumstances of less than full employment, events are often effective means of translating public funds into employment increases is good news for event organisers but less to the taste of those in Treasuries whose unenviable but worthy task is to balance the public budget and to ensure that public spending yields value for money. Rather than rely on spurious neoclassical arguments that event subsidies cannot, by assumption, yield positive economic impacts, Treasuries would do better to rely on the following arguments.

First, the assessment that a subvention to an event yields increases in income and employment does not give the event an absolute claim on government funds. Technically speaking, the rate of return on each event should be compared with the rates of return on the following: subventions to other events; other government expenditures; tax cuts; and increasing government saving. These comparisons depend on the macroeconomic circumstances of the day and also rely on similar assessments being available for alternative government expenditures. Needless to say, this is a rather tall order, but the principle remains that governments have the unenviable task of deciding the relative urgency of different expenditures. Although rates of return are helpful in determining priorities, they do not do away with the necessity to choose.

A second argument sees event promotion as a zero-sum competitive game between the Australian states. According to this view, event promotion is as pernicious as local preference in awarding manufacturing contracts and it simply encourages inefficiency. This argument is incomplete in that it fails to recognise that events increase national exports as well as interstate exports; competition by states to stage events is not a zero-sum game. Competition between places goes beyond competition for the tourist dollar; it is, in part, competition for identity and recognition. Success in such competition brings intangible benefits to residents, which have not so far been mentioned in the analysis. Turning to a visitor point of view, competition between cities and towns increases the range of visitor experiences available: efficiency arguments that assume that events are homogenous miss the point of this type of competition. Also note that the Australian states not only compete for interstate tourism, but combine to promote international tourism. There may be a point where competitive tourism promotion by the Australian incurs diminishing returns but it is unlikely that this point lies at zero expenditure.

Third, events are not the only ‘industry’ to benefit from public support. For example, subventions for events and capital investment in venues are small compared to government expenditures on road construction and maintenance. Both provide direct consumption benefits to citizens and both generate benefits to private businesses. This is the exact point of calculating the income generation benefits from different forms of public expenditure. Instead of assuming benefits away, as they do when they adopt the neoclassical assumptions, Treasuries should compare the benefits of alternative spending patterns and adjust their spending accordingly.

Fourth, the benefits from event subventions need to be placed in the context of general macroeconomic policy, which in Australia for several decades has favoured the generation of demand by the encouragement of bank lending, and, more specifically, the encouragement of mortgage lending to households. The Commonwealth was so anxious to pursue this policy that it was unwilling to increase real taxes and limited government borrowing, thus limiting the flow of funds available for event subventions and for all other forms of government spending. The tragedy pointed out in recent State of the Regions reports was that the policy of high mortgage lending has failed to generate either full employment or affordable housing, the ultimate culprit being the constrained supply of accessible urban land, which is partly due to the constraints to government investment required to create an enhanced supply.

This brings us back to the question of constraints more generally. While it is argued here that there are no constraints that prevent the operation of income multipliers arising from visitor expenditure, there may be constraints at a more general macroeconomic level.

As described in the National Economic Review as far back as June 1987, Australia suffers from a number of serious macroeconomic constraints:

  • a public sector constraint – broadly, the unwillingness to pay sufficient taxes to finance desirable public expenditure, particularly public investment;
  • various capital capacity constraints, including shortages of highly specialised skills and an inability to make the public investments required to alleviate these shortages, and various infrastructure inadequacies arising again from low public investment; and
  • a balance of payments constraint, arising from reliance on an exchange rate that has failed to settle at rates justified by the economic fundamentals coupled with industry policies that pay insufficient attention to investment in export industries – not merely the mining industry, but industries that are capable of generating jobs that match the skills available.

In view of these constraints, the high benefit–cost ratios commonly observed for subventions to events should be assessed in the context of a long-term strategy for Australian economic development. Event assessments are but a tiny part of the analysis required to develop and implement such a strategy.

 

Conclusion
Neoclassical economics purports to show that economic policy should concentrate on leaving decisions to markets. As applied to the analysis of events, the neoclassical policy recommendation is for reliance on user charges except where there are non-economic reasons for free or subsidised provision.

NIEIR’s analysis of event provision shows that this recommendation relies on assumptions that have not applied in most parts of Australia over the past 30 years. Instead, subventions to events that increase tourist visitation can increase incomes and employment. Thus, the case for subventions becomes one of priority against other expenditures, preferably exercised in the context of a coherent strategy for the future.