Two Speed Economies: What you should know.

With the ushering in of the Global Financial Crisis and the accompanying “Great Recession”, the concept of the two-speed economy has become increasingly pronounced to the global community. While my Australian counterparts have most likely become familiar with this phenomenon, this concept is neither new nor foreign to the global community.

Background     

By definition, two speed economies are economies whose industries experience unevenly distributed rates of growth.

Historically one of the best examples is England’s experience of the Industrial Revolution. During this period, newly established manufacturing to the North easily outpaced traditional agriculture found in the South.

In the past, two speed economies had minor effects within one nation. Workers often moved to areas with greater growth to capitalise on perceived better wages. Conversely the modern example is vastly different.

The interconnected dependence of different industries within one nation, as well as the increasingly connectedness of economies throughout the world suggests that two speed economies represent an increasingly complex challenge.

Managing currency policies, trade relationships and monetary flows are some of the global challenges. Domestically, economic policies must balance the need to address workers and industries caught out whilst extracting the maximum from faster growing industries.

Operating the world on a two speed economy

As mentioned earlier, historic examples of the world at a two-speed economy are most evident when we view migration patterns. Listless Europeans looking to strike their luck in the New Worlds flooded the US and Australia.

Today the challenge is managing economic powerhouses, such as Brazil, China and India, whilst stabilising and improving economic conditions in Western Europe and the US.  Currently developing nations are forecasted to grow at a rate of 6.2% for 2012, with high-income nations sitting at 2.2%.

Theoretically nations adjust accordingly to these variations. Nations looking to improve their numbers growth should focus on lowering their prices through wage reduction to compete competitively. In the real world however, the case is much different.

This challenge is apparent when we view the complex economic relationship between China and the US. Despite its mammoth economic growth, China’s fixed exchange rate and low levels of income still make US exports highly unattractive to their consumers. Whilst in the United States, their complex and well establish money markets allow money to flow freely and with relative security throughout the nation. Conversely in China, their banking system often results in public savings to be poured freely from state managed banks into state owned enterprises.

What’s important to take away from this example is how domestic policies concerning wages, fixed exchange rates and the banking system alter how these countries relate to one another. Subsequently the challenge of managing economies experiencing two speeds is best described as a compromise for the most agreeable solution. Effectiveness is often a work in progress.

Australia running at two speeds

Riding the wave of a mining boom, Australia’s economy has benefitted from exporting their minerals to resource hungry nations around the world. This has benefited those working within the mining industry as well as those involved within mining complementary industries. Further this growth has appreciated the value of the Australia currency. Conversely industries sensitive to a high value Australian dollar, such as manufacturing, education and retail have experienced painful readjustments.

There are numerous complex issues involved with managing an economy in this phase. Concerning monetary policy, the Reserve Bank of Australia must move delicately. The goal is to stimulate growth in areas feeling an economic slowdown whilst trying not to overinflate the economy amidst a resource boom.

For the government, the challenge is more complex given the multitude of political considerations. Taxation is one of the greater concerns. While it is arguable that governments do have the prerogative to maximise tax receipts on booming industries, the unpopularity of the Mining Tax best articulates the difficulty in applying these policies.

Further there are equal numbers of opponents and supporters concerning the transfer of tax dollars from resources rich states to those facing economic slowdown.

Using our money wisely

For Australia, our political system does have the capacity to manage a two-speed economy well. Money generated through income, corporate and sales taxes are generally recycled well throughout the system.

This redistribution is important as money granted from the commonwealth to states is vital when we consider most of the day to day publicly provided services, such as education, hospitals and infrastructure are provided at the state level. Considering that taxes at the state level are often victim to unstable revenue streams, such as payroll taxes and stamp duty, the onus is on the commonwealth government to distribute wisely.

For this reason Australia’s current government policy for a budgetary surplus should attract great criticism.  Currently states facing lower levels of growth, such as South Australia, Tasmania and Victoria, should be investing in vital infrastructure. Money spent on these projects not only stimulates economic growth in themselves, but also improves the productive capacity of these states that is needed to attract new business.

Further wealthy times call for sensible spending. If Australia doesn’t capitalise on its current wealth, by the time the global financial situation improves, Australia will be fighting with bigger economic giants to attract business.

While some commentators may argue that there are definite monetary pressures associated with increasing government spending, the current situation calls for the Commonwealth government to act in promoting the slower economies. Changing interest rates have the blunt like force of using a sledgehammer to a walnut. Even if the government reduces its spending, a lowered interest rate may negate government austerity by fuelling already high growth in the resource sector. Yet by focusing government spending on specific projects or within specific locations, we can see much more targeted benefits.

Whilst the concept of operating within a two-speed economy is not new, how to manage it requires a more dynamic approach. Policies applied at the domestic level have a clear impact on the effectiveness of managing this phenomenon. Therefore the onus is for responsible political leaders to manage. At least that is the hope.