Australia's economic fragmentation

All figures in this post are $Australian.

A report from Deloitte Access Economics, commissioned by Google, puts the direct contribution of the Internet to the Australian economy at $50b, the wider benefits through productivity increases at $27b and the value of the benefits to households at $53b. You can find a full copy of the report here.

Yesterday the Australian Bureau of Statistics released estimates showing Australian sales rose a meager 2.6 per cent during 2010-11 - the worst result for half a century, since the 1961-62 recession. NSW was especially hard hit. Reporting here, ABS data here.

Yesterday, too, the ABS released trade figures showing that Australia had an estimated surplus on trade of goods and services of around $2 billion in June. Imports of consumption goods were down, imports of capital goods up.

Then the Federal Chamber of Automotive Industries released figures showing that the July sales total of 80,991 cars was down almost 2 per cent on the same month last year, compounding a string of negative results that mean 36,000 fewer cars left showrooms this year compared with 2010. The Chamber blamed consumer uncertainty and the flow-on effects of the Japanese natural disaster in March.

Finally, the NSW Government released State Treasury estimates suggesting that the proposed carbon tax would hit NSW harder than any other state on the mainland and cost at least 31,000 jobs, particularly in regional areas.

The analysis suggests the carbon tax could cut $3.7 billion from the annual output of the NSW economy by 2020, rising to $9.1 billion by 2030.

The confidential cabinet document estimates the federal tax will result in the loss of 1850 jobs in the Hunter region and 7000 fewer jobs would be created in the Illawarra. The central west would lose 1000 jobs.

Five stories, all linked to change in the structure of the Australian "economy". I put the term "economy" in inverted commas because, increasingly, the concept of an Australian economy is becoming little more than a statistical construct.

It has always been the case that patterns of economic activity varied across the country. However, for a considerable period those variations were largely ignored because the large Eastern states population centres - Sydney, Melbourne and, to a lesser extent, Brisbane - that dominated key statistics were actually doing okay as a whole.

Back in the late eighties and early nineties my then Aymever consulting and research team argued that fragmentation of the Australian economy was inevitable. Our conclusion was based in part upon the decline in the importance of the Australian customs union.

One part of the Federal compact that formed Australia was the imposition of tariff barriers that rose with time. This created a dual economy: an inwardly focused manufacturing sector serving a domestic marketplace and that supported a variety of service activities along with an outwardly looking agricultural and mining sector servicing international markets. The progressive redistribution of economic activity that followed the creation of the customs union favoured the domestic over the international, and also favoured those areas servicing the domestic.

By the time we were writing, the opening up of the Australian economy to global competition was well underway. Our then view was that this must inevitably lead to some fragmentation of the Australian economy since its varying constituent parts would be increasingly and varyingly affected by  global rather than domestic change. We were also monitoring other changes such as the patterns of internal migration that were already clear and were likely to affect both economic activity and political power.

We got some things wrong. For example, the process of change was actually slower than we had forecast. That's quite an important error because it affected the value of our advice to clients. At the same time, we did get the broad pattern right.

Within Australia, the process of fragmentation has been most pronounced in NSW. Up to the 1970s, you could still talk meaningfully to some degree of a NSW economy. As late as 1960, a considerable proportion of economic activity was still state based, from ice cream to beer to professional services.

Starting in the 1950s, state based economic activities were increasingly replaced by national based activities. This started first in manufacturing and then spread as companies looked to expand activities. The process accelerated during the 1980s, aided by new technology that facilitated centralisation of services.

Sydney and Melbourne as Australia's major corporate headquarters benefited most.  Other areas suffered.

I have plotted this in most detail in New England as part of my study of economic and social change in the period 1950-2000. To illustrate the scale of change, in 1950 all the New England media was locally owned. By 2000 local ownership had shrunk to a handful of independent papers. In 1960, retailing was predominantly locally owned. By 2000, retailing was dominated by the chains.

I have given a local example. More broadly, the capital cities outside Melbourne and Sydney saw a transfer of previous state headquartered business activities to Sydney and Melbourne, The exact effect varied, but the overall trend was clear.

One side effect of this was a growing disconnect between economic activity in Sydney and the rest of NSW. Global Sydney as the city came to call itself became less dependant on, less affected by, economic activity in the rest of its traditional economic activity.

This trend was reinforced by other changes - from the 1990s, the rise of South East Queensland in the north, renewed growth in Melbourne in the south, the growth of Canberra, all drew increasing proportions of NSW within their economic spheres. Today, NSW consists of a myriad of regions and sub-regions, each with very different economic drivers. The economic statistics for NSW actually say little in real terms beyond the extent to which they act as a proxy for Sydney as the largest economic entity.

If you look at the NSW Treasury report on the impact of a carbon tax, the state element is the impact on revenue from lower dividends on electricity generation. Everything else is essentially expressed in sub-state regional terms. 

What has happened in NSW is an extreme example of a broader trend towards economic fragmentation as Australia continues through a new period of change. What can we say about this change?

One element can truly be described as a national economic trend. The desire of Australians to save more, to reduce debt, is a broadly national phenomenon. However, the consequent impact on retail sales varies greatly across the nation. Australians will not spend more until they feel more secure, until household budgets have been rebuilt. Yet the degree of insecurity does vary between places.

This graph from ABS shows the variation in retail sales across Australia by state and territory in June, You can see how varied the pattern is, even ignoring variations within states such as NSW. We don't know this.

The rise of the internet can, again in broad terms, be thought of as a national phenomenon. Some of the bricks and mortar retailers suggest that part of their problem lies in the increasing volume of on-line sales.

It's not just the substitution of on-line for store purchases, but also the substitution of international for domestic purchases.I am not sure if anyone has a proper handle on this. However, as a small personal example, my wife buys shirts for me in London at half the price including freight that I would pay in Australia. I still buy certain shirts in Australia, I love my R M Williams double pocketed country style shirts, but I have only brought one business style shirt in Australia in the last two years.

I haven't had time to properly review the Access Economics report on the Internet, but for present purposes I think that we can say a couple of things.

despite the hype, I don't think that we can assume that the overall economic affect of the internet will be as positive as presented from a narrow Australian perspective, nor can we make any real judgments about tits distributional affects taking Australia into account. We just don't know.

We can be sure, however, that the internet will, is, having two quite different effects.

First, it actively encourages size and centralisation in certain activities. The wild enthusiasm of a thousand flowers bloom has been replaced by oligopoly based upon the hard realities of network economics. As a test, can you name any of the Australian search engines that appeared in the early days of the internet? While one big player may replace another, the number of real players remains quite small.

Secondly, it has replaced one set of network economies with another.

The internet itself is centralised in infrastructure terms, but activities based upon it have challenged and are now replacing other networks. Sometimes the affect here is further centralisation. Job searches or real estate are examples. In other cases, it allows the small to challenge the big. We just don't know how these various influences will work out.

In the meantime, we can be sure that Australian economic activity over the next decade will be dominated by the physical act of digging things out of the ground. We can also be reasonably sure in the absence of change that the narrowing of the Australian economy will continue. Finally, we can be sure that the distribution of economic and political power in this country will be very different in twenty year's time.

As a measure of this, over the last five years the increase in the value of stocks on the Australian stock exchange has been very heavily influenced by WA mining companies. If you take these out, increases in returns have been quite modest.

I think that's enough for now.

Postscript

The Australian Productivity Commission draft report into retailing was released this morning.  The Commission summarises its conclusions this way:    

• There are almost 140 000 retail businesses in Australia, accounting for 4.2 per cent of GDP and 10.7 per cent of employment - the industry is one of Australia's largest employers.
• The retail industry exhibits great diversity by: size of companies, region, format, competition within sectors and in the range of goods sold - from food to furniture to footwear. While current trading conditions are challenging, longer term trends tell a larger story. Over the last three decades, retail sales growth has trended down; consumers are spending more of their rising incomes on a range of non-retail services including financial, property, travel and entertainment.
• This diverse industry has met many competitive challenges in the past and online retailing and the further entry of new innovative global retailers are just the latest.  This intensified competition is good for consumers, but is challenging for the industry which, as a whole, does not compare favourably in terms of productivity with many overseas countries. And the productivity gap appears to be widening.
• Australia also appears to lag a number of comparable countries in its development of online retailing. The Commission's best estimate is that online retailing represents 6 per cent of total Australian retail sales - made up of 4 per cent domestic online ($8.4 billion) and 2 per cent from overseas ($4.2 billion). In some other countries, online sales figures are higher and seem set to grow further, as will also happen here.
• Retailers operate under several regulatory regimes that reduce their competitiveness. Major restrictions which require improvements are:
  • planning and zoning regulations which are complex, excessively prescriptive and often exclusionary
  • trading hours regulations which interfere with the industry's ability to adapt and compete in a more globalised market
  • constraints on workplace flexibility such as obstacles to the greater use of enterprise bargaining and the adoption of best practice productivity measures.
• The current level of the low value threshold (LVT) for exemption from GST and duty on imports is $1000. The exemption is judged to be a minor part of the competition story, but GST is a broad-based consumption tax, and the LVT in principle should be reduced to a low level to ensure tax neutrality.
• The current processes for collecting taxes and duties at the border are not efficient.  As the threshold is lowered, costs of collection increase significantly - at very low thresholds (for example $20), the costs of collection would exceed tax revenue by over three to one. Such a cost impost on both importing businesses and consumers is unacceptable even without considering additional costs such as delays.
• The processing systems for incoming parcels to Australia need to improve, as has occurred in other countries. The Government should investigate this with a view to then reducing the LVT in a cost effective way.

This is the first best guess of the size of on-line retailing that I have seen. It is smaller than i would have expected.

The comment about planning and zoning regulations is interesting. There is anecdotal evidence, I can't give links, to suggest that just as as Australian house prices and rents are high by global standards, so are shop rents and for similar reasons. The development process is complicated and expensive.