Australia Pays the Price for Depending on China

The newly elected prime minister has to preserve growth.

Turnbull, an advocate of digital innovation in an economy that’s barely growing.

Turnbull, an advocate of digital innovation in an economy thats barely growing.

Photographer: Christopher Pearce/Getty Images

Throughout Australia’s industrial heartland, factories are closing. About an eight-minute car ride from the center of Melbourne, a General Motors plant that in 1948 produced the first automobile wholly made in the country is scheduled to shut for good in 2017, victim of a rising Australian dollar that caused labor costs to nearly double from 2001 to 2011. Toyota and Ford factories are set to close within two years, leaving Australia without any domestic auto production. Down the road from the GM plant is a facility operated by Boeing. In 2010 it sold the plant’s equipment for making metal aircraft parts to Mahindra & Mahindra, an Indian company that’s shipping the machinery to Bengaluru. Last year, Alcoa closed a nearby aluminum smelter.

Until recently the sad decline of heavy industry had little impact on the country’s highflying economy. Australia’s factories were closing, but its mines were booming. Chinese demand for Australian iron ore and other resources kept the economy humming. The country hadn’t suffered through a recession since the early 1990s.

The boom is over as the Chinese economy slows, and the woes of the manufacturing sector are complicating the job of new Prime Minister Malcolm Turnbull. Lawmakers from the right-of-center Liberal Party on Sept. 14 chose the former Goldman Sachs banker to be their new leader, ousting Prime Minister Tony Abbott amid concerns that Australia’s long run of economic growth was in danger. Gross domestic product in the second quarter expanded just 0.2 percent over the first quarter, worse than the 0.4 percent expected by economists. The unemployment rate is at 6.2 percent, holding near a 13-year high.

Turnbull, who was communications minister under Abbott, is promising action. “My government has a major focus on tax reform,” he told reporters on Sept. 20. That will mean less reliance on income taxes and more on consumer levies. An early investor in technology startups before entering politics, Turnbull in March co-authored an article in the Australian newspaper with Vivek Kundra, executive vice president of Salesforce.com and former chief information officer for President Obama. The pair lauded companies like Uber and Airbnb. “The most successful businesses in the 21st century will be those that embrace digital disruption as an opportunity, and not something to guard against,” they wrote.

For all his talk about the transformational power of the Internet, the Australia that Turnbull leads still depends on the old-fashioned business of digging things out of the ground and shipping them overseas. Resources account for 52 percent of exports, up from 31 percent in 2000, according to data from the Australian Bureau of Statistics and consultant AlphaBeta.

The value of exports from Australia’s service sector including banking and telecommunications fell from 26 percent as a share of total exports in 2000, to a likely 20 percent this year. The country’s export base has narrowed to levels approaching that of a “banana republic,” says Andrew Charlton, who was an adviser to former Labor Prime Minister Kevin Rudd. The last few Australian governments have assumed low interest rates and a falling currency would help revive the non-commodity industries. “No such resurrection is occurring,” he says. “Even some low-income countries like Nepal, Kenya, and Tanzania have greater export diversity than Australia.”

The commodities boom helped take the Australian dollar to a high of $1.10 in 2011. That clobbered manufacturers. By 2013 labor costs were higher than those of any Group of Seven economy. Since then, they’ve dropped 14 percent, according to the Organisation for Economic Co-operation and Development, but the decline is too late to save many factories. Manufacturing is 7 percent of the economy, down from 12 percent in 2001. “Heavy manufacturing in Australia is in some ways a lost cause, even with the Aussie plunging,” says Alex Gardner, an analyst in Hong Kong with Bloomberg Intelligence.

That lack of products to sell is making it harder for Australia to benefit from the 20 percent drop in the Aussie dollar over the past year. A weaker currency ordinarily gives exporters an edge over rivals. But not when China, the biggest customer of your chief exports—iron ore, coal, and other commodities—just isn’t buying more, no matter how low the price.

Not everyone agrees the situation is so bad. “There’s a bit of an obsession with iron ore prices in Australia,” says Mike Smith, chief executive officer of Melbourne-based ANZ Bank. Since services account for 8 out of 10 jobs and 80 percent of GDP, resources are “not the be all and end all,” he says. “The underlying economy is actually performing OK.” Tourism is thriving, and construction is booming thanks to low interest rates. Turnbull doesn’t have much time to convince voters Smith is right: He has to call new elections by late 2016.

The bottom line: Australia’s new prime minister must diversify the country’s export base and nourish the digital economy.

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