No. 3 - Department of Treasury - The Western Australian Government

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Western Australian Economic Summary2006 No.3Figure 43GROWTH IN GSP AND GSI7 Years to 2005-06, Annual Change8%7%6%5%4%3%2%6.8%6.5%6.0%4.9%4.3%4.3%3.8%3.6%3.4%3.1% 3.2%3.1%3.2%2.6%2.2%2.2%2.2% 2.3%1%0%NSW Vic Qld SA WA Tas NT ACT AusGSPGSISource: ABS Cat. 5220.0Western Australia’s real Gross State Income increased by 6.8% a year onaverage between 1998-99 and 2005-06, compared to growth in real GSP of4.3% a year. Nationally, the gap was less than a percentage point, withgrowth in Gross Domestic Income of 4.3% a year and growth in GrossDomestic Product of 3.2% a year.This has some important implications for output and productivity growthand their relationship to consumers’ welfare in Western Australia. Otherthings being equal, weak productivity growth indicates that thecommunity’s potential disposable income is also growing weakly. But ifproductivity growth is weak in part because the export sector is using moremarginal resources or increasing employment more rapidly than output, buta rise in export prices means that the sector’s exported output can beexchanged for a much larger volume of imported goods and services, thenproductivity growth will significantly understate the true growth in theState’s potential purchasing power.And if weak productivity now is necessary for higher output in future – forexample, because the export sector is spending heavily on investment, but isnot yet reaping the returns in higher output volumes – then there is thepotential for productivity to catch up most of its lost ground fairly rapidlyonce the new capacity under construction comes fully into production.The increase in Western Australia’s terms of trade in recent years hasboosted the State’s purchasing power substantially, but it is unlikely to lastindefinitely. Sooner or later export prices will stop rising faster than importprices, and at that point productivity and output growth will again be thekey determinants of growth in living standards.The key question for the short to medium term future of theWestern Australian economy is whether, when and by how muchcommodity prices fall once the current price cycle peaks.66 Department of Treasury and Finance
2006 No.3 Western Australian Economic SummaryCommodity Price ScenariosCommodity prices are notoriously hard to predict. Rather than trying to pickthe likely path of commodity prices in future, this section outlines fourscenarios for possible future trends in commodity prices. Three of these – asuper cycle, a return to business as usual (with relative prices declining) anda gradual decline in prices, but not to pre-boom levels – are based on recentIMF analysis of the commodity price outlook globally and of its implicationsfor Australia (IMF, 2006b, pp.26-27). The fourth is based on Grant et al.Possible TrendsSuper cycleThe “super cycle” scenario predicts that the current commodity boom willbe stronger and more durable than previous cycles. This is based mainly onthe strength and breadth of commodity demand underpinning current highprices. The industrialisation of China and India is adding to worldcommodity demand at an unprecedented rate, and demand growth is likelyto intensify as these countries move through stages of development that areparticularly resource intensive because they focus on the creation ifinfrastructure, capital equipment and consumer goods.Supply may also play a role in the “super cycle” scenario. Resourcedepletion may have brought resource production to the stage whereproductivity improvements will not be sufficient to ensure declining relativeprices over time. If the most readily and cheaply accessed resources havebeen exhausted, average costs may have to rise in future to meet growingdemand.This scenario would imply that the Prebisch-Singer hypothesis (see page 61)may no longer apply in future.Gradual declineA more moderate version of this scenario predicts that mineral commodityprices will peak and then decline, as production expands to meet demandand some exceptional factors driving current demand fade away. However,because of the demand, supply and cost trends outlined above, the rate ofdecline will be modest, and will not take prices back to levels prevailingbefore the boom. This is the view that the IMF believes most probable:Over the medium term … metals prices are expected to retreat from recenthighs as new capacity comes on stream, although probably not falling back toearlier levels—in part because higher energy prices have increasedproduction costs. That said, the timing and the speed of the price reversal isuncertain, because with current high capacity utilization rates and lowinventories, markets are very sensitive to even small changes in supply anddemand.(IMF 2006a, p.157)A similar conclusion on the outlook for metals prices was reached by theWorld Bank Group’s Oil, Gas, Mining and Chemicals Department in papersprepared for the G20 meeting in November 2006.Department of Treasury and Finance 67
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No. 3 - Department of Treasury - The Western Australian Government

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