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

Western Australian Economic Summary2006 No.3Australia’s other mining States and Territories also fare well, but even with afavourable shift in the terms of trade, consumption in less resource-orientedeconomies – particularly Victoria and South Australia – falls relative to thebase case. For Australia as a whole, GDP increases marginally under thismodelling scenario (by 0.1% in 2024-25). However, the increase in householdconsumption and welfare is noticeably higher, again reflecting terms oftrade effects.Summary and ConclusionsThe main purpose of this paper is to explore the apparent paradox of strongeconomic growth but weak productivity growth in Western Australia in thecontext of the resources boom, and in particular what these trends mightmean for the economic welfare of the Western Australian community.Its key findings are that weak overall productivity growth inWestern Australia is almost certainly linked to the decline in mining sectorproductivity in recent years. Much of that decline is probably a temporaryeffect, as lags and long lead-times in capacity expansion mean that stronggrowth in mining investment has yet to result in strong growth in thevolume of outputs. At least some of the drop in productivity may bepermanent, however, as high prices have also made it profitable to exploitmore marginal and costly resources, so the average level of outputs relativeto inputs has fallen.However, from the point of view of the community’s capacity to consume,productivity and output growth are currently telling only part of the story.The same phenomenon that had induced the mining sector’s apparent lossof productivity – namely strong commodity prices – has also induced asharp increase in the terms of trade. This means that Western Australia’straded outputs can be exchanged for a larger volume of goods and services,so consumption possibilities are greatly enhanced.The question of whether Western Australia’s productivity paradox is atemporary oddity or a long-term phenomenon will depend on thelonger-term path of commodity prices. Several possible price paths arediscussed, but if the IMF and World Bank are right, prices will drop fromrecent highs, but not revert to pre-boom lows. Abstracting fromtechnological progress, such a sustained increase demand could induce apermanent one-off reduction in mining sector productivity, with higherprices and demand encouraging producers to exploit more remote and lessproductive deposits.However, a permanent shift in relative prices due to a sustained increase indemand could nonetheless generate significant welfare gains inWestern Australia. The DTF’s modelling suggests that an increase inresource prices could improve welfare in resource export-orientedeconomies even if mining sector productivity falls, if the fall in productivityis demand driven (and universal). In other words, there can be acounter-intuitive situation where an economy-wide reduction inproductivity is associated with positive welfare outcomes.72 Department of Treasury and Finance