Is Australia’s economic luck about to run out?

Tim Soutphommasane says Prime Minister Kevin Rudd, who is in London this weekend, inherited a boom but now faces threats from China, inflation and global downturn Australia’s residents are fond of referring to the place as ‘the lucky country’ but most are blissfully unaware of the phrase’s origins. ‘Lucky’ was never meant as a compliment. When the late Donald Horne, a giant of Australian intellectual life, conjured the tag in the 1960s he intended it as a putdown: ‘Australia is a lucky country, run by second-rate people who share its luck.’ Much of this rings true for the Australian economic story. For most of the 20th century the Australian economy flourished because of its natural mineral endowment and its agricultural sector; commodity exports were its lifeblood. Such industry as existed was cosseted by high tariff barriers and indulged with government subsidy.

When a globalised economy arrived, ending the days of living off the farm, many thought Australia’s luck had run out. And so during the 1980s and ’90s the Australian economy underwent a dramatic transformation. The financial system was deregulated, the Australian dollar floated, the tariff walls came down, and by the turn of the century the services sector accounted for around 70 per cent of the economy.

Yet today Australia has reverted to its old ways. While other developed economies are slowing in the face of a global credit crunch, Australia has rediscovered its luck. China’s insatiable demand for coal and iron ore has fuelled a resources boom, leading to unprecedented volumes of trade. Remote mining towns in the Outback are coming back to life as miners and other workers flock to cash in on this modern variant of a gold rush. Plugged into China, the Australian economy continues to grow at 3.9 per cent — one per cent higher than the OECD average.

But there are growing fears that this time, the luck really is running out. Mining giants BHP Billiton and Rio Tinto have been blackballed from selling Australian iron ore on the Chinese daily spot market — the boycott costing some $A300 million (£138 million) in export profits so far this year. The Chinese government claims that new foreign investment rules aimed at sovereign wealth funds are preventing Chinese companies from competing for Australian natural resources. In a sign of growing Chinese economic muscle, the state-owned Chinalco combined forces with Alco in February to buy a 12 per cent stake in Rio Tinto. This was seen as a move to block BHP Billiton’s £75 billion takeover bid for Rio, reflecting Chinese concerns about concentrated power in a market that is critical to its relentless expansion.

The recently elected Labor Prime Minister, Kevin Rudd — who is in London for talks with Gordon Brown this week, having stopped off in Washington en route — will have to confront this mounting conflict when he makes his first official visit to China on his way home. A former diplomat who speaks fluent Mandarin, Rudd has close ties to the Chinese president, Hu Jintao. Hu has invited Rudd to be his guest at this summer’s Olympic Games. The two became friends during the Sydney Apec summit last September when Rudd, then the opposition leader, stole the limelight by addressing Hu in Chinese (leaving the then prime minister John Howard to listen to the translation through headphones). But Rudd now finds himself having to stand up to a waking dragon threatening to breathe fire. This will come as the first real twist to a script that has run very smoothly so far for Rudd. At last November’s general election, he vanquished his rival Howard in emphatic fashion: after four election victories and 11 years in office, Howard ignominiously lost his own seat in parliament. As if to underline the humiliation, Rudd’s approval rating in his first three months soared to 70 per cent. Most notably, he won plaudits by making it his first act in parliament to offer an apology to the ‘stolen generations’ of Aboriginals, a long-awaited gesture of reconciliation.

Rudd’s ‘new leadership’ campaign platform included a claim to be an ‘economic conservative’ — one who was determined to keep interest rates low and the budget in surplus — that locked in the votes of middle Australia. The most important moment of the campaign came when Labor promised to spend less than the incumbent government. When Howard decided to make a $A9 billion (£4.2 billion) splurge in the final two weeks of the campaign to entice voters, Rudd responded that ‘this reckless spending must stop’, accusing Howard of making ‘a bagful of irresponsible promises’ that could put upward pressure on inflation and interest rates.

Many election watchers didn’t know which was more surreal: a politician promising to spend less than his opponent, or the sight of Labor’s rank-and-file cheering and applauding a promise by their leader for less government spending. This really was ‘new leadership’.

But how will Rudd respond to a possible interruption of the mining boom? He cannot afford to be complacent. The scourge of inflation has re-emerged, with domestic demand outstripping the economy’s capacity. The fiercely independent Reserve Bank has made 12 successive increases in the cash interest rate to 7.25 per cent in an effort to haul prices back under control. The Bank’s hawkishness is an indication that supply-side problems in the economy are formidable.

Productivity growth has slackened. Skill shortages mean that more than 250,000 vacant jobs lie unfilled, with the economy operating at full employment. A lack of investment in infrastructure has created bottlenecks in the nation’s transport networks and ports.

For all that the resource boom has delivered, much more has been squandered. There are stories of train derailments delaying the transport of extracted ore to ports, only for export shipments to be held up even further by ships having to queue at the ports to pick up their cargoes.

One of Rudd’s first moves on this front has been to appoint Sir Rod Eddington — a native Australian better known to British audiences as the former chief executive of British Airways and the author of a recent review of British transport policy — to head a new co-ordinating body for infrastructure projects. Rudd has also commissioned the distinguished economist Ross Garnaut to head a comprehensive review on climate change — Australia’s version of the Stern Report.

Politically, Rudd is in a strong position to undertake reform. He has enjoyed good fortune in the timing of his rise to power. Just as voters were growing weary of Howard, he offered a fresh and forward-looking alternative. He benefited from the strange paradox of an economy that was delivering strong growth but failing to deliver security of mind to mortgage-laden families facing the prospect of higher interest rates. And for now he continues to ride a wave of goodwill.

If Rudd has a weakness in the public mind it lies in the Labor party’s problematic relationship with trade unions. Labor made it a central campaign promise to repeal Howard’s ‘WorkChoices’ industrial relations laws, which business strongly supported and which the unions fought tooth and nail.

But Rudd is no enemy of enterprise. His wife, Thérèse Rein, is a successful businesswoman who runs her own international human resources company, the Ingeus Group. Business has warmly received the new government, putting the issue of industrial relations firmly to one side.

The greatest danger for Rudd and the Australian economy, however, is clear. The unfolding global financial crisis may not spare even the world’s economic strongmen. Morgan Stanley’s chief market strategist, Gerard Minack, has warned against the prevailing wisdom that the Antipodes would be immune from recession, pointing to a ‘rickety’ housing and property market. Macquarie, Australia’s largest investment bank, has shed some A$3 billion (£1.4 billion) from its listed property trusts since December — a direct result of exposure to American subprime chaos. On the day Bear Stearns was rescued by JPMorgan, more than A$31 billion (£14 billion) was wiped off Australian equity valuations, the local market slumping to an 18-month low.

It was a demonstration that even a robust local economy might not be enough to shield Australia from the fallout of the ongoing credit crunch. Add to this the problem of negotiating with an increasingly assertive Chinese government, and the outlook begins to look challenging, to say the least.

Rudd hasn’t done much wrong in his opening months, but even he conceded in a speech last week that ‘slower world growth will inevitably affect Australia’, and that he ‘can take nothing for granted’. It would be a cruel irony indeed for the new Prime Minister to have enjoyed such good political fortunes in claiming the premiership, only to be robbed by an economy that has used up all its luck.

Tim Soutphommasane worked on Kevin Rudd’s staff during last year’s election campaign.