Dutch Disease

Earth Track Blog Post

Harvard economics Professor David Glaeser has an interesting editorial on the role of mining in Australia, published yesterday by Bloomberg.  The basic thrust of his argument is that capital-intensive coal and iron ore industries dominate Australian exports, but harm long-term competitiveness.  He mentions two main causes.  The first is the role of natural-resource-led exports bidding up the value of Australian dollars (sometimes referred to as the "Dutch Disease"), making it more difficult for other sectors to be competitive.  This dynamic is important, but is not particularly novel:  it has been documented in many countries around the world.  More interesting is his conclusion that the capital-intensive, mining-led, exports also crowd out small scale entrepreneurial ventures.  The mining firms themselves are huge, and tend to buy and sell with other massive mulitnationals. The lack of smaller firms diminishes the vibrancy and flexibility of regional job creation and entrepreneurial risk-taking.  (Link to his review here).

Coal Mining Creates Few Jobs, Stifles Entrenpreneurship

The conclusion is based not just on Australia, but on a historical review Glaeser has done with co-authors William Kerr and Sari Pekkala Kerr on mining regions in the US.  They conclude that:

...greater historical mining deposits are strongly correlated with reduced entrepreneurship in the middle of the 20th century. The link between entrepreneurship and local employment growth persists when instrumenting initial entrepreneurship with historical mines. These effects are evident in industrial clusters that are not directly related to mining, such as trade, fi…nance and services. They are also present in cities with warm climates, suggesting that these results do not simply re‡flect the Rust Belt’'s decline.

Glaeser further notes that

In Australia, iron ore and coal are mined by giant corporations such as Rio Tinto Plc and BHP Billiton Ltd., and giant enterprises typically work best with other big companies. Across U.S. metropolitan areas, we found that historical mining cities had fewer small companies and fewer startups, even today in sectors unrelated to mining or manufacturing, and even in the Sunbelt. These mining cities were also experiencing less new economic activity.

What about Coal Subsidies?

Glaeser touches only tangentially on the issue of subsidies, noting that "the share of miners’ 'resource profits' returned to the Australian government in the form of taxes and royalties fell from about 40 percent in 2001 to less than 20 percent seven years later."

Surface mining of coalHowever, there is much more that can, and should, be said about this issue. In our review of G20 actions to meet their commitment to phase out fossil fuel subsidies, (see Phasing Out Fossil-Fuel Subsidies in the G20: A Progress Update, June 2012)  Australia's response was simple:

  1. “Australia does not have measures related to the production of fossil fuels that fall within the scope of the G20 commitments.”

No subsidies, no need to report to the G20.  Which they didn't. 

But surely there is more.  Political economy suggests that large and powerful firms with concentrated financial interests in a particular set of policies will be far more successful in shaping their policy environment than will emerging or fragmented industries.  Thus, although the mining and mining services sector contribute only about 10% to Australian GDP and employ about 2% of the Australian workforce, one would expect the sector to be politically powerful well beyond those numbers.  Further, the expectation is that at least part of that power would be used to extract favorable financial concessions from the government. 

This does seem to be the case.  The Australian government has narrowly interpreted the reporting requirements under the G20 commitment in order to better meet its objectives of not having to report at all.  Non-reporting is the most favorable outcome for subsidy recipients, as they continue to benefit from the financial support, but the absence of public data on how much they are getting greatly reduces their risk of a political backlash.

Consider these two further statements on subsidy reporting in updates to the G20 -- in both cases I've added the emphasis:

Government position:  “Australian Government budgetary support for fossil fuel production is limited to measures that are intended to support production of clean energy.” 

Implications: Policies that have the effect, but not the intent, of subsidizing fossil fuels don't count.  The framing also excludes any level of subsidies that make fossil fuels burn more cleanly -- even if those subsidies are what allow the fossil fuels to continue competing in the marketplace with emerging renewable resources.  In the same way that wind power pays an economic price for intermittency, one would want coal to pay a price for the development and implementation cost of lower-carbon power production or for carbon capture and sequestration.  Such pricing transparency is critical for the market to more accurately weigh complex trade-offs between energy options with differing strengths and weaknesses.

Goverment position:  “Australia does not have any sector-specific tax expenditures for fossil fuel production (although fossil fuel producers are able to access general measures that apply across the economy or across the mining and quarrying sectors as a whole).” 

Implications: 
With this sleight of hand, the Australian government has excluded reporting on subsidies to extractive industries entirely.  Favorable provisions to expense (i.e., immediately write-off investments from taxable income), for example, have long been available.

A successful Freedom of Information Act request by Greenpeace resulted in exposure of some of the political considerations behind Australia's reporting strategy to the G20.  Many, though not all, of the released documents are now accessible online.  Unfortunately, even the subset of documents that are online have been substantially redacted prior to posting.  Further, the releases did not contain any correspondence between industry and the government, which is surprising:  such correspondence with industry is often part of FOI releases in the US and would be expected to exist in Australia as well. 

The core point here is that subsidies exacerbate the problems of concentrated mining investment that Glaeser et al. document.  Too few jobs, increased and risky rigidity in the economic structure of regional economies, suppression of entrepreneurial activity -- all of these get worse when subsidies elevate mining activities and industrial concentration above the level that market economics alone would justify.  And interestingly, these subsidies likely apply not only to Australian coal producers, but to coal transport and consumption in some of the country's large export markets as well. 

The subsidy picture from non-governmental sources is quite different from the official Australian position of "nothing to report."  Some examples:

  • One report pegged coal and coal-seam gas subsidies in Queensland alone at A$6.9 billion over the past 5 years, with another A$13 billion in forecasted spending.  Another put national fossil fuel subsidies at A$12 billion per year, though includes a variety of subsidies to driving as well those directly to fuels.  Still, that study found nearly A$150 million in additional funding went to support clean coal research each year.
  • China is the largest outlet markets for for Australian coal.  A scoping review we did two years ago on Chinese subsidies to fossil fuels indicated significant government support to coal transport and usage in the power sector.
  • Although Australia introduced a new tax on coal profits this month, the change came with a bunch of benefits to the industry as well that make the net effect quite difficult to assess.  Consider just these three:
    • New investments will be given an immediate write-off, rather than depreciation over a number of years. According to the goverment, "this allows mining projects to access deductions immediately, and means a project will not pay any MRRT [Minerals Resource Rent Tax] until it has made enough profit to pay off its upfront investment."  Perhaps.  But massively capital-intensive mining operations can deduct all of their investments immediately, a clear and lasting subsidy that may distort capital investments across sectors and likely reduces the relative benefits of less-capital intensive strategies on the demand-side of the energy marketplace.
    • The MRRT will carry forward unutilised losses at the government long term bond rate plus 7 per cent.  There are two interesting elements of this concession.  First, the immediate deduction now allowed for all capital is likely to trigger much larger tax losses than in the past -- losses that can now be carried forward with interest.  Second, in a financial environment when money market funds earn less than 1/4% in interest, the risk-free financial return on loss carryforwards of 7% could be among the top performers in the firm's investment portfolio.
    • The MRRT will provide transferability of deductions. The government notes that "this supports mine  development because it means a taxpayer can use the deductions that flow from investments in the construction phase of a project to offset the MRRT liability from another of its projects that is in the production phase."  Look for declining tax revenues across the board.  I'd need to read more of the fine print of these rules to gauge whether the transferability is limited to other projects of the same firm, or extends to other firms as well (the US sometimes allows firms to sell unused tax credits).  If the latter, even bigger distortions may arise.