How the mining boom is shared (or not)

One of the more interesting, persistent, rancorous and important debates that transpires here at MB, is the degree to which the mining boom is shared with the broader economy. I actually set out to answer this question a couple of days ago and was some way into a post when I discovered a new piece of research on the topic called The Mining Industry: From bust to boom presented at a very recent RBA conference.

This research was overdue. The last attempt to define the extent to which the mining boom benefited Australians was in 2005. The RBA paper was called Commodity Prices and the Terms of Trade. It concluded that:

A substantial part of the increase in profits accrues to state and federal governments. Royalties, which are a pre-tax item, are payable to state governments on mineral and onshore petroleum production. These are mostly at ad-valorem rates, and although there is substantial variation in rates and definitions, they probably imply that around 5 per cent of additional revenues from higher commodity prices typically accrue to state governments. More significantly, based on the statutory corporate tax rate, up to 30 per cent of the increase in profits would be payable in corporate income tax to the Australian government.

… The remainder of the initial boost to revenues (roughly two-thirds of the total) accrues to shareholders of the companies. This occurs either in the form of higher dividends, or if earnings are retained, in the form of capital gains. Domestic shareholders include both households and institutional investors such as superannuation funds. However, to the extent that there is foreign ownership of the Australian resources sector, part of the addition to incomes will accrue to foreigners. Although there are no precise figures on aggregate foreign ownership, some ABS data for 2000/01 suggest that foreign ownership in the resources sector is around 50 per cent. This is probably somewhat higher than at the time of earlier resource booms.

So, the conclusion was that roughly two-thirds of the boom is retained by Australia, in one form or another.

The new research is more comprehensive and represents a significant downward shift down from this earlier conclusion:

Putting all this together, the increase in mining revenues in the 2000s made a significant direct contribution to economic activity and incomes of Australian residents. The main channels identified were through direct labour costs (around 10 per cent of total revenue), the mining industry‟s demand for domestically sourced intermediate inputs especially services (perhaps around 25 per cent of total revenue), tax and royalty payments (close to 15 per cent of total revenue in recent years), and the share of the after-tax profits owned by Australian residents (around 5–10 per cent of total revenue). While it is difficult to be exact, these estimates suggest that overall Australian residents accrued a little over half of the total receipts earned from current mining operations. In addition, perhaps half of the total costs of mining investment was spent acquiring domestically supplied labour and other inputs, which generated further activity in the Australian economy.

The biggest change has come in the RBA’s assessment of to what extent producing Australian mines are foreign owned and, therefore, where the dividends end up. From the new research:

The foreign ownership share of the mining industry is difficult to determine for several reasons: many publicly listed equities are held in the name of nominee companies; holdings of companies listed on the ASX that are less than five per cent of their total equity do not need to be disclosed; and the degree of foreign ownership varies by industry and even by specific mine. Overall, based on published data by the iron ore, coal and LNG producers, effective foreign ownership of the current mining operations in Australia could be around four-fifths, with the share for iron ore producers a little lower and coal and LNG producers a little higher. Part of the earnings to Australians is distributed by mining companies as dividends, with the balance retained by the companies and reflected in rising share valuations. Indeed, mining equity prices increased by 180 per cent relative to the broader market over the 2000s, providing a significant boost to the wealth of Australian residents over the decade.

That is not to say that Australians share of the boom is neither sufficient nor fair. Much of the boom would not transpire at all without the huge inputs of foreign capital. But let’s examine the question more closely. From the new research, here is a table breaking up the distribution of mining revenues:

Direct spending on labour is a low quotient of revenue and indeed constitutes only a small fraction of the benefits, as the paper says:

Direct labour costs in mining operations have been equivalent to around 10 per cent of total mining receipts. After falling gradually during the 1990s, employment in the mining industry grew rapidly during the 2000s, rising by around 10 per cent a year, compared with growth of around 2 per cent a year in the national economy. Indeed, the pace of mining employment growth during the decade was significantly higher than for other industries. However, mining is very capital intensive and hence the amount of labour demanded for mining operations has remained comparatively small. Despite its rapid growth over the decade, total employment for mining operations increased by only 110,000 over the decade (to around 200,000 or 1.7 per cent of total employment), representing a small share of the 2.2 million increase in employment nationally.

On the other hand:

Intermediate input costs have been much larger than direct labour costs, typically representing around 40 per cent of total mining revenue. Goods and materials used in mining operations constitute around one-third of intermediate input costs with the remainder being services, such as freight, contractors, rent and repairs. Intermediate input costs grew quickly after the onset of the mining boom, rising at an annual average rate of 15 per cent, or 3 per cent of GDP over the decade.

Yet the report also admits that two thirds of these are spent on local services:

…for instance mining companies often contracting Australian businesses to undertake their ongoing service and maintenance due to their locational advantage. Around one-quarter of these purchases are support services provided by the mining industry itself, such as drilling, draining and plumbing. Another one-quarter are property, finance and business services, which includes a wide range of services such as engineering consulting, employment placement, legal, accounting, computer system design, marketing, rental and hiring of equipment, and mine support staff provided by service operators (e.g. cooks, cleaners and bus drivers). The rest of the intermediate service inputs covers activities such as transport and storage, distribution, accommodation and services provided by utilities companies.

Such provides myriad jobs but largely on site and, therefore, doesn’t do much for the big metropolitan populations, given locally means the ‘back-a-Bourke’. So, the first observation we might make is that regional Australia often benefits directly considerably more than do city-slickers.

The next distribution of mining revenue mentioned by the RBA is the dividends that flow from increased profits:

The gross operating surplus of the mining industry, after deducting royalties and tax payments, rose from around $15 billion in 1999/2000 (2.2 per cent of GDP) to around $65 billion in 2008/09 (5.2 per cent). Earnings (after tax, interest and depreciation) are distributed to shareholders as dividends or retained within the company. Since the mining industry in Australia is majority foreign-owned, most dividends and retained earnings accrue to foreigners and therefore do not add to national income.

But now we come to the real dividend. The great equaliser is tax. There are two points of collection:

Royalties and company income taxes paid by the mining industry increased from around ½ per cent of GDP at the start of the decade to around 2 per cent in 2008/09 (the latest available data) – their highest share of GDP since at least the late 1960s. As a share of annual mining receipts, these payments increased from around 10 per cent to almost 15 per cent over the decade. The rise in royalties and taxes was driven by the significant increases in global prices and to a lesser extent export volumes for bulk commodities, while the share of the oil and gas industry in payments to governments fell over the period reflected the gradual depletion of Australia’s oil fields. Most of this increase was driven by mining income taxes; company income tax is levied on taxable profits, while mining royalties are generally levied on production and hence are less sensitive to movements in commodity prices.

That looks impressive doesn’t it. But it’s not easy to judge how much this actually is when expressed as a percentage of nominal GDP. So, here are some charts I made up for my original post. These are State government revenue splits and listed from the highest impact from royalties to the least. Note that the “other” category includes taxes raised from public corporations and royalties but I’m betting its mostly the latter. Another category to keep an eye on is “grants and subsidies”, which is GST and special project money provided by the Federal Government. First is WA:

A very nice accelerating ramp in royalties from $1.9 billion in 2001 to $5.6 billion today. One wonders, however, why it isn’t a lot higher given the iron ore boom. Next is QLD:

A much more delayed response presumably owing to royalties not enjoying a boost until volumes took off after the GFC and, perhaps, when new mines came on stream. Nonetheless, royalties are now rivalling other tax revenues combined with growth from $3.3billion in 2001 to $8.3billion in 2010. Next is NSW:

A good stream of revenue that has tripled since 2001 from $3.4 billion to $10.4 billion in 2010. Now SA:

Again a delayed response with $770 million in 2001 growing to $2.8billion in 2010. Finally VIC:

Poor old Victorians got nuthin’. Except a fiscal transfer so gargantuan it would make Greece choke with envy.

Looking at these charts, it impossible to miss the distinct upwards trajectory in all State’s total revenues since 2003. We are living through a largely unrecognised government boom in this country. Give or take a few billion, every state government doubled its revenues in the decade between 2001 and 2010. There are some very large and important private sectors that cannot claim the same growth. Outside of WA, royalties played a small part in that growth but a far larger part has been played by fiscal transfers from the Federal Government. To understand how that was possible, we must take a look at the budget of the great sugar-daddy. Note, in particular, the boost to corporate taxes and to individual tax income (which we’ll come back to):

After flat revenues between 2000 and 2003, the next four years saw Federal corporate tax revenue rocket from $37billion to $66billion. I have been unable to disaggregate mining but its a fair bet that that is where much of the growth came from. The above RBA table of mining revenue distributions shows that in 08/09, which was a very poor year, mining tax revenue was $13 billion, versus $3 billion in 03/04.

BHP and Rio alone grew their tax bills from a combined $2.2 billion in 2003 to $14.8 billion in 2008 (though not all of this was in Australia):

All of this mining tax revenue had one direct benefit to all Australians: tax cuts. Between 2004 and 2007, the Howard government committed to some $70 billion in tax cuts. Another $20 billion in superannuation relief, as well as providing a raft of new middle class welfare reforms like the ‘baby bonus’.

In order to determine whether or not the whole kit and caboodle is worth it, against all of these distributions of mining revenue, we must weight the costs of the mining boom. As the Canberra eggheads love to tell us, mining has to be given room to grow and that means other industries must shrink or, at least, plateau, which is the same basic thing. The tradeable goods sectors are the ones in the gun: manufacturing, tourism and education.

So, in some very significant way, the mining boom is simply a transfer of wealth from one area of the economy to another, ie miners. It’s not, strictly speaking, a generalised boom at all.

But, as the growth in Federal tax revenue from individuals (as seen in the above chart) shows, we did have a generalised boom from 2003 to 2008. The difference then was that the world had not yet had its Minskian awakening, debt was free-wheeling the world over, and we were free to leverage up the gigantic commodity revenues. Low taxes and other benefits of mining revenues enabled us to borrow and pump up assets like stocks and houses. The banks fed this beast by borrowing enormous sums offshore and giving it away at home for next to nothing:

The leveraging of the resource revenues and the asset price appreciation that resulted was, in some large measure, the real redistribution mechanism of Mining Boom Mark I.

But it wasn’t real after all was it? As the chart above shows, the GFC suddenly returned global credit distribution to a more sensible appreciation of risk. And now, even though Mining Boom Mark II ploughs on, the changed world still does not want to lend us cheap money. Nor, indeed, does the RBA want it to, having realised its mistake the first time around. Hence the mining boom feels malignant second time around as neither the stock market nor the housing market can be jet-fuelled with new credit.

In my view, however, Mining Boom Mark II, for all its pitfalls, continues to benefit the nation in one very important way. As Glenn Stevens said recently,

That is partly because the change in the terms of trade, being a relative price shift, will itself occasion structural change in the economy: some sectors will grow and others will, relatively speaking, get smaller. That is particularly the case if the economy’s starting point is one that is not characterised by large-scale spare capacity.

But those pressures for structural change are also coinciding with changes in household behaviour that are associated with the longer-run financial cycles I have just talked about. Just as some sectors are having to cope with the effects of changes in relative prices – manifest to most of us in the form of a large rise in the exchange rate – some sectors are also seeing the impacts of a shift in household behaviour towards more conservatism after a long period of very confident behaviour.

It would be perfectly reasonable to argue that it is very difficult for everyone to cope with both these sets of changes together – not to mention other challenges that are in focus at the same time. However, if we were to think about how things might have otherwise unfolded – if households had been undergoing these shifts in saving and spending decisions without the big rise in income that is occurring, to which the terms of trade have contributed – it is very likely that we would have had a considerably more difficult period of adjustment.

That is, without the mining boom, we would almost certainly have faced the same constraints on borrowing that we do now. Indeed, they would likely have been far worse as the world would have made the cost of lending to us much more expensive given the risk that we might not be able to repay would have been higher. And all of this in an environment of falling incomes.

To be perfectly frank, we’d have been stuffed as the assets we’d so recklessly inflated reversed course in dramatic fashion.

None of that is to say that the boom couldn’t be managed better. It could, and without bidding farewell to diversified export industries. But, at the end of the day, I’ll take a poorly managed mining boom ahead of no boom at all any day of the week.