Structural effects of a sustained rise in the terms of trade

While previous terms of trade booms have tended to be short lived, there are reasons to believe that the current boom could be more enduring. This paper considers the implications for the Australian economy in the event that recent rises in the terms of trade are sustained, with a focus on labour market, industry and regional implications. Thus far, the economy’s reactions to the terms of trade boom have largely matched the predictions of economic theory: incomes have risen, as have employment and investment, in particular for the mining industry and regions where mining is concentrated. However, we have not seen so called ‘Dutch disease’ effects associated with a higher exchange rate flowing through as strongly as could be expected in the manufacturing industry and other traded parts of the economy. Adjustments to the boom have thus far taken place in a position of less than full employment, so the resources sector has to date been able to utilise previously unemployed factors of production rather than simply attract factors from other sectors of the economy. Going forward, expanding labour supply in the resource rich regions of the country will be a central policy challenge. If well managed, the transition to a higher terms of trade presents an opportunity to raise Australian living standards. But the challenges in ensuring a successful transition are significant and will test our policy frameworks in ways they have not been tested before.