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

2006 No.3 Western Australian Economic SummaryWestern Australia’s recent experience, of rapidly rising commodity pricesinducing strong growth in resource investment but as yet no commensurateincrease in output volumes, seems consistent with such a model.For a cobweb to eventuate, however, at least two other conditions wouldneed to be satisfied: other producers around the world would similarly needto be increasing supply, and producers would need to be unaware of thissupply response and thus fail to anticipate lower prices in future. While thefirst of these conditions is plausible, the second is less so.Business as usualThe final scenario is business as usual, meaning a resumption of theprevailing trend before the recent commodity price rises, not a continuationof current trends. For global commodity markets this would mean that thecurrent round of prices is no more than an exceptionally strong example ofthe normal volatility of commodity prices. Once supply has adjusted anddemand perhaps eases a little, the prices of commodities would drop back.In the longer term, commodity prices would resume their trend declinecompared to prices of other goods and services.This scenario assumes that recent price rise is no more than a temporaryphenomenon as supply adjusts to new demand levels. It reflects suspicionthat the “super cycle” theory ignores the economic reality of supplyresponses, and is reminiscent of the hype of the “new economy” and otherpast property, share and other price bubbles, which have almost alwaysbeen attended by optimistic speculation that this time the boom will not endin a bust.Modelling the EffectsIf the IMF and World Bank are right in their expectations that prices willdecline, but not to pre-boom levels, then the effects of the recent demandshock will not fade completely once prices peak in the current cycle.The DTF 1 has attempted to model the economic implications of theresources boom for Western Australia using the MMRF-Green computablegeneral equilibrium model 2 . The aim was to determine whether apermanent increase in global demand for the State’s key commodity exportscould improve welfare, notwithstanding an assumed decline in miningsector productivity. The simulation was carried out in two parts.1 This analysis was presented by Kurt Sibma at the 2006 CGE Modellers’ Conferencein Perth. A paper describing the results and methodology in more detail will bepublished later in 2006-07.2 The MMRF-Green model is a multi-regional, dynamic model developed by theMonash University Centre of Policy Studies, with Australia separated into differentregions. MMFR-Green is documented in detail in Adams, Horridge and Wittwer(2003).Department of Treasury and Finance 69