When most Australians are asked about ‘the X factor’ they think the question is about a short-lived TV talent show (a derivation of Australian Idol). However, ‘the X factor’ is also talked about in the less glittery world of economic forecasting too. Economists refer to ‘the X factor’ when an unforseen event of shock – such as a natural disaster, political or security event – blows all the carefully laid forecasts away. Events such as the MX missile crisis in 1985, the stock market crash in 1987, the Asian Crisis of 1997 and, of course, the terrorist attacks of September 11 are all examples of ‘X factors’ that stunned the world as well as experienced economic forecasters.

Amongst Australian economists, ‘the X factor’ has been around for a long time. It’s a term largely made famous in Australian financial market circles by the distinguished economics commentator and forecaster, Dr Don Stammer.

There have been a number of competitors for the title of ‘the X factor’ in 2005. Of course, the Boxing Day Tsunami hit South East Asia and South Asia before the New Year had actually arrived. Other natural disasters included hurricanes in the Americas and earthquakes in Turkey. There was a major terrorist attack in London and another bombing in Bali. There have also been significant concerns about rising oil prices as well as the fear of an avian bird flu pandemic.

For the most part, economists down play the economic effects of individual natural disasters (although having many events together can have a marked global economic impact as well as an obvious humanitarian one) but a major pandemic like bird flu can have considerable economic consequences across the whole global economy.

Does the existence of an external shock or ‘X factor’ make all economic forecasting obsolete? Not at all. There are still economic trends in the world that can be drawn upon when making assumptions about the future. We work in a world of ‘knowns’ and ‘unknowns’ and having a good grasp of what we know can help us. Even in the difficult craft of scenario planning, analysts still look at economic trends when trying to tell a story of the future.

In fact, many of the main trends (and key events) we have seen continue in 2005 will help us to anticipate the outlook in 2006 and beyond.

The big picture – a macroeconomic overview

Most economic forecasts anticipate a continuation of growth in the world economy. The Consensus Group – which bases it research on a survey of the world’s major private sector forecasters – expects the world economy to have grown by 3.1 per cent in 2005 and by 3 per cent in 2006. In contrast, the International Monetary Fund (IMF) – the main survey of member countries’ ‘official’ forecasts – expects a 4.3 per cent growth rate in both 2005 and 2006. In short, the world economy is still in a growth phase and Australia is benefiting – particularly from the boom in our resource sector, stemming from increased demand in the Asia-Pacific region.

Enter the dragon

Part of the reason for Australia’s reasonably strong prospects is the rise and rise of Asia (with China, of course, being the main engine of growth). Where once Australia worried about its ‘tyranny of distance’, it now seems to be concerned by ‘the power of proximity’.

Strong demand from China has driven up resource prices – and together with falling prices of imported goods like manufactures, including ICT – has enabled Australia’s terms of trade to be at its highest level in 30 years. On current forecasts, according to UBS chief economist, Scott Haslem, “China is on track to be our largest one export market in five to six years”.

Intra-Asian regional trade is an important part of this tale too, with Australia involved at all ends of the production chain, both onshore and offshore. Australia’s raw materials (coal, alumina, iron ore, liquefied natural gas) are helping fuel China’s rapid industrialisation. Our high value manufactures (particularly in design and engineering) are being utilised in South East Asia and our in-market professional ‘knowledge-based’ services (particularly in architecture, construction, project management) and are in demand throughout the region.

Australia is even developing a market for our manufacturing exporters in China. Whilst our resource exports to Asia are well known, Australia also exports road vehicles, pharmaceuticals and medicines, food and beverages, electrical machinery and various industrial components to the People’s Republic.

India plays catch up

Of course, many commentators are also focusing on India as another global growth engine. While India has not attracted the same levels of foreign direct investment (FDI) as China, it has significant home-grown businesses – especially in software and related services.

However, India’s demographics are believed to be working in its favour with a relatively young population opening up a large consumer market with mass purchasing power. This will particularly help Australian services exports to India – especially in education and tourism.

Education is an important part of the Australian-Indian economic relationship. According to senior trade commissioner Moignard: “Student numbers have grown ten-fold since 1993. We are receiving regular visits from universities from all Australian states as well as TAFE colleges.”

Education also helps tourism numbers as well, as visits generally follow from parents, friends and relatives. In fact, the new direct flights between Mumbai and Sydney by Qantas are partly in response to the growing number of Indian students and tourists heading off to Australia. “Tourism numbers have grown from 3,000 to 30,000 over the past decade,” says Moignard.

The return of glory to the land of the rising sun

At the other end of the demographic scale, Japan’s ageing population has been a focus, but the land of the rising sun has had better economic news recently in terms of exports and industrial production, coinciding with Prime Minister Koizumi’s re-election. The Koizumi reforms are expected to open up Japan’s heavily protected services sector with increased potential opportunities for Australian exporters of health, education and recreation services.

According to Professor James Kondo of Tokyo University: “The healthcare, education and the leisure sectors have traditionally been closed in Japan, but as a result these developments (Koizumi’s re-election) this will soon change to the benefit of many countries – including Australia. We still haven’t realised the impact of the growth of Japan’s mature age female cohort – the Japanese equivalent of Bill Clinton’s ‘soccer mums’ – and their associated spending power and demand for high quality services.”

Storms brewing for the America(s)

The US economy is still growing at a moderate rate despite fears of some drag from current account and fiscal imbalances as well as fuel price rises, and major weather shocks associated with Hurricane Katrina and Rita. However, some commentators believe the US current account deficit is just a reflection of high savings rates in Asia. Down in the Southern Hemisphere, Brazil’s economic growth rate is slightly higher that that of the US, but the Latin American industrial giant is still struggling to emulate a successful modern economy like Chile.

Euroclerosis?

The European Union (EU) has still disappointed analysts on the growth front, despite the promise associated with the European Monetary Union and the expansion south and eastwards. However, Germany still remains the world’s largest exporter (ahead of the US, China, Japan and France) while the UK and Ireland have been notching up impressive standards of economic performance. Major factors in Europe’s future still surround trade reform in Brussels, reform in the major economies of Germany, Italy and France and the negotiation with Turkey over accession to the EU club.

The ‘best of the rest’ – emerging markets

Economists at Goldman Sachs have famously predicted the rise of the ‘BRICs’, adding the emerging economies of Brazil and Russia to India and China as places to watch on the world stage. While there are always dangers in extrapolating current trends, there is certainly evidence to suggest that these economies are contributing significant demand and supply influences in the global economy.

A big question mark always remains over institutional reform – will the economies provide sufficient transparency, stability, rule of law and sound corporate governance to function effectively and consistently to maintain current growth rates?

In the case of Australia, China is already playing a substantial role in our export fortunes, but India still has a way to go. On the other hand, Australia is now beginning to play a role in key sectors such as energy (oil, gas and alumina) and infrastructure in both Russia and Brazil, which may lead to increased levels of economic engagement (albeit from a low base).

In the context of the ‘BRICs’, many commentators have highlighted the rise of other emerging markets in the world economy. Indeed, the Governor of the Reserve Bank of Australia, Ian MacFarlane, regularly talks about the increasing importance of the Middle East, Latin America (and even Africa) to the global economy along with the major players in the US, Europe and Asia.

At the coalface – the microeconomic story

While that’s fine at a macro level, what is happening at the coalface? What do exporters who actually do the business themselves think?

Despite facing some pretty serious headwinds in the global economy, Australian exporters have remained reasonably positive and remain committed to exporting as a core part of their business strategy. One of the key outcomes of the economic reform process that started in Australia with the float of the dollar some 20 years ago has been the growth of an exporter ‘heartland’ in the economy – particularly in manufacturing and services.

While Australia has traditionally depended on our comparative advantage in mining and agriculture, our other sector were traditionally protected and insular with exporting thought to be a one-off opportunity to clear inventory. A large proportion of exporters were ‘irregular’. However, as a result of openness and Australia’s economic reform, around 68 per cent of exporters now export on a regular basis (up from 55 per cent in the mid-1990s) and do so no matter where the exchange rate is or how commodity prices are fairing.

In short, Australia is slowly building up its ‘natural rate of exporting’ – that is, the level of exporter capacity that it can sustain despite external shocks (X factors) to the economy and for all states of the business cycle.

The Australian Trade Commission (Austrade) and DHL provide a regular bi-annual survey of the exporter ‘heartland’ – known as the DHL Export Barometer – to discover what exporters think about coming events and trends. In the latest edition of the survey, a majority of exporters (62 per cent) believed their orders will increase over 2006 – despite the level of exchange rates, oil prices and general global geo-political events.

Exporters were also confident about their sales increasing – particularly in China, North America, UK, Europe, New Zealand and ASEAN – and the manufacturing and services sector were particularly optimistic compared to mining, agriculture and tourism (despite the resources boom and tourism’s recent bounce-back). Overall, these exporters were more concerned about oil prices than they were about the exchange rate, with geo-political conditions also considered important in their confidence levels.

On the supply side, earlier in 2005, concerns about infrastructure ‘bottlenecks’ hit the headlines and led to the establishment of the Exports and Infrastructure Taskforce, chaired by Dr Brian Fisher, executive director of the Australian Bureau of Agricultural and Resource Economics (ABARE). While some exporters in Western Australia and Queensland mentioned transport bottlenecks as an issue, the latest DHL Export Barometer suggests these constraints will ease in 2006. On the general issue of capacity constraints, most exporters mentioned manufacturing capacity (indicating lack of scale, capital to meet growing demand) and skill shortages among tradesmen as a key labour issue.

The reduction of tariff protection or removal of trade barriers has also been another major reform of the past two decades. The survey shows that despite some of the headlines of stalled trade negotiations and the frustration experienced by Australian trade negotiators, the efforts around trade liberalisation have not been in vain.

In fact, the DHL Export Barometer shows a sharp rise in the proportion of exporters (47 per cent compared to 32 per cent six months ago) claiming that they face no barriers to export in global markets. The sharp fall coincided with Australia’s two new Free Trade Agreements (FTAs) – with Thailand and the United States – but with strong sentiments all round that formal trade barriers are being noticeably reduced.

This augurs well for 2006 and beyond with new FTAs potentially being negotiated with China, Malaysia, the United Arab Emirates (UAE) as well as an agreement between the CER partners, New Zealand and Australia, and ASEAN.

The bottom line

In conclusion, Australia’s export prospects are reasonably well balanced, given current global economic trends and our own abilities as a strongly performing economy. We are also benefiting from a strong showing by ‘the Australian brand’ in key global consumer surveys. However, there are some issues that need addressing (such as skill shortages) and we do need a better deal out of the world trading system (which negotiators are working strongly towards as part of the Doha round of WTO trade talks).

We can make progress on all these economic aspects in 2006, and we know from experience that there will likely be an ‘X factor’ waiting around the corner that will affect us – whether we like it not. How we cope with these external shocks will determine how well we perform economically, but if the last two decades are a guide, we should manage reasonably well in comparison to other economies that are in the same boat.

Original Title: Global times, global measures: Australia's global economic prospects in 2006
Tim Harcourt
Chief Economist
Australian Trade Commission
Sydney
Email: tim.harcourt@austrade.gov.au

Tim's articles are republished with his permission from his website, "Economists Corner".