AustralianManufacturingand the commoditiesboom

Australian manufacturing: performance of industry
sectors from 1989 to 2008 and the impact of the
commodities boom.
Charles Millward
January 2009

Table of Contents
1. Introduction
2. Australia & ‘Dutch Disease’.
3. Commodity Booms & Industrialisation: the view in the literature
4. Theoretical Background
a. The Corden Neary Model
b. Paul Krugman
c. The Theory re-visited
5. Methodology
a. Criteria for firm selection
b. Analytical Approach
c. Macro-economic background
6. Company Analysis
a. Non-traded Goods
b. Traded Goods
c. Manufacturing Companies exposed to the Commodities Boom
d. Summary of Company Analysis
7. Policy Implications
8. Conclusion
Annexures
One: GICS sectoral classification & definitions
Two: List of all companies in the Industrial and Consumer Discretionary sectors of the ASX
Three: List of companies extracted from 3 chosen GICS sectors with manufacturing capacity in
Australia
Four: Key financial information on list of companies in Annexure Three extracted from Aspect
Huntley Financial Analysis database
Five: Graph – Real exchange rate & the terms of Trade
Six: Graph – Consumer Price Inflation, Import prices and tradable & non-tradable prices
Seven: Graph – Wages
Eight: Graph – Profitability
Nine: Graph – Industry share of output
Ten: Table, Indexes of Industrial production

1. Introduction
This paper seeks to examine the impact of the recent minerals boom on Australian
manufacturing in the context of the performance of Australian manufacturing companies
during 1989-2008. The motivation for this paper is that the public discussion on the fate of
manufacturing industries is often an emotive one with two identifiable camps, a free trade ‘let
markets do the adjustment approach’ and an interventionist ‘let’s keep jobs’ approach. But
whatever the rights and wrongs of these two arguments it seems to me that there is an
analytical middle ground where there need not be any particular emotion. That is that if during
a cyclical commodities boom firms’ cost structures, as a result of the appreciation of the
exchange rate, are such as to make them uncompetitive, but this phenomenon is temporary,
then a case exists to subsidise those firms during the boom.
Broadly this can be considered to be an examination of the ‘Dutch disease’ phenomenon and
an attempt is made in the paper to link findings with the existing literature on the subject. In
particular two pieces of theory form the analytical context of the study. The first is the classic
paper by Corden & Neary (1982) and the second is a speculative piece by Krugman (1996)
suggesting an analytical method for examining the impact of an exchange rate appreciation on
manufacturing industries.
I have picked 3 sectors of Australian manufacturing listed on the Australian Stock Exchange
(“ASX”): Automotive & Components, Consumer Durable & Apparel and Capital Goods.
From approximately 400 firms I picked the 50 with manufacturing capacity in Australia and,
on a representative cross section, analysed their financial performance on the stock exchange
since 1989. The motivation here is that firms in these sectors are likely to be predominantly in
the traded goods sector and hence most vulnerable to exchange rate appreciation. And the
analytical method was to examine the impact of the exchange rate appreciation since 2003 on
the underlying profitability of these manufacturing companies.
From a methodological point of view I have chosen a qualitative rather than a quantitative
approach. A more formal econometric analysis was not attempted. The reasons for this are
twofold. First, the process is unfolding as we speak so it may be too early to attempt this type
of quantitative analysis. But more importantly it is highly likely that aggregated manufacturing
data will be deceptive presently. The minerals boom has caused a spurt in output in mining
related manufacturing industries which will probably obscure statistically any de-
industrialisation impact of the commodities boom. This possibility is discussed further in the
paper.
The qualitative results are very clear though. Firms in the identified sectors manufacturing non-
traded goods have in general fared very well in recent years. Firms competing in the traded
goods market however have, almost without exception, seen their competitive position

completely undermined by the exchange rate appreciation. Given that these firms are generally
fairly large and well-capitalised they have been able to take corrective action which in almost
all cases has meant re-locating production offshore. What the implications are for smaller
firms, generally not listed on the stock exchange, one can only guess but without the resources
to shift production offshore the likelihood must be that many of them have simply gone out of
business.
Going back to the theoretical analysis, if Krugman is right, that de-industrialisation consequent
upon sustained exchange rate appreciation is a permanent phenomenon, the welfare
consequences are very negative. After the commodities boom ends the new equilibrium may be
one of lower wages and higher unemployment all round. And this is particularly true of
Australia which moved from high levels of protection to low as a conscious switch of policy in
the 70’s and 80’s. In general such Australian manufacturing as has survived has done so
because of its inherent viability not because of government assistance or protection .
I have tried to locate the Krugman analysis within the framework of the broader Corden Neary
model. But I found it necessary to change one of the key assumptions of the model, being that
the relative prices of the two traded goods sectors (energy & manufacturing for example) are
constant. It appears that a far more realistic assumption (certainly dealing with Australia
recently) is that the real exchange rate will appreciate because of higher commodity prices and
higher output of commodities. So unlike the Corden Neary model where adjustment occurs to a
large extent through wage pressures in the economy, the analysis below suggests it happens
primarily because of changes in the money exchange rate.
So to sum up this paper will try to show that, given the stability of manufacturing firms in
Australia since 1989, such manufacturing as exists is probably worth preserving if threatened
by a temporary phenomenon such as a commodity boom. And per the analysis, the impact of a
sustained real exchange rate appreciation (and two to three years is sufficient) is disastrous for
this sector. So it is well worth a government’s while to consider a serious policy response to
exchange rate appreciation, if perceived to be temporary, in order to preserve otherwise
competitive manufacturing industries.
2. Australia & Dutch Disease
As noted above, this paper concerns itself with the effects of ‘Dutch Disease’ as it applies to
Australia. Surprisingly, given Australia’s dependence on mineral exports, beyond the original
papers by Snape (1977), Gregory (1976) and Corden & Neary (1982) there has not been much
discussion of the phenomenon beyond a re-statement of the principles established by Corden in
the 80’s. Here is Anderson from Pomfret (1996) ‘In summary real income has increased but
resources have also been re-allocated towards the minerals component of the tradable goods
sectors and away from the traditional producers of tradables.......Given the combination of
Australia’s resource discoveries, its trade and industry policy changes in favour of resource-

based industries and the improvement in international prices for energy raw materials in the
1970’s, the changes in the mix of Australian exports and in the composition of GDP and
employment in Australia following the series of big mining booms in the late 1960s and
beyond are understandable’.
And the fact is that manufacturing in Australia has shrunk substantially as a percentage of GDP
since the 1970’s. Then it ran at just over 20%; currently, as of 2005, it stood at just over 10%
(Lewis et al, 2006).
3. Commodity booms & industrialisation: the view in the literature
I thought it appropriate here to review the work by Rowthorn and Wells (1987) on de-
industrialisation and foreign trade which set out to examine Britain’s poor post-war economic
performance and analyse the reasons therefor. A key concern of the book was to establish
whether North sea Oil had contributed to Britain’s industrial decline.
There are two aspects of this book which are of interest to the current study.
The first relates to the theoretical discussion at the beginning of the book as to why a country
which is a primary producer cannot abandon domestic manufacture to grow successfully. The
authors advance three reasons as to why a developing country (admittedly Australia is not
directly in point) might find this to be the case:
1. The large volume of non-manufactured resources which would need to be exported in
order to pay for all its requirements in manufactures.
2. If the primary producers are large enough they may find themselves operating on the
price inelastic portion of their commodity demand curves so any attempt to increase
output may negatively impact the terms of trade.
3. Non-manufacturing specialists are likely to find themselves vulnerable to external
shocks whether due to demand fluctuations in consuming countries or supply shifts in
other producer countries.
The thrust of the argument is that a country’s long term economic structure is determined by
the demands of its commercial account which will ultimately need to balance. But even if the
pattern of trade shifts substantially so as to make a reliance on manufactured exports to pay for
primary imports such as food reduce (this was precisely Britain’s case in the 30 years post war
where its substantial deficit in primary goods – 11% of GDP immediately post war shifted to

near balance over 30 years) does not mean that manufacturing success is not essential to
economic success.
The second aspect of interest is their findings on the impact of North Sea Oil. They conclude
that Britain’s lack of success industrially in the post war period may have been a result of the
negative impact on industry of the sudden rise in oil prices in 1973 rather than the impact of
North Sea Oil (which came on stream in 1976) which they see as having a minimal impact
albeit some manufacturing jobs were certainly lost in the process of ramping up oil production.
They argue further that the main failures of the Thatcher years were in pursuing contractionary
monetary policies although North Sea Oil would have allowed fiscal flexibility as a
consequence of a stronger balance of payments. Interestingly they do not focus on the impact
of the real exchange rate appreciation (consequent upon the tight monetary policies pursued
from 1980 on) as being decisive in Britain’s massive losses in industrial employment post 1980
although at the time the refrain from business was unanimous, that the high pound and high
interest rates were strangling industry (their view is in contrast to that of Krugman who, in
developing his model below, explicitly cites the ‘Economic consequences of Mrs Thatcher’).
Nevertheless a significant conclusion of the Rowthorne and Wells book is that even a country
producing primary products needs to have some manufacturing capacity in order to develop
successfully. The vagaries of the market for commodities plus the inevitable balance of
payments constraints dictate that at least some manufacturing capacity should exist in resource
rich countries.
4. Theoretical background
a. The Corden Neary Model
The key paper which is used as the starting point for any discussion of Dutch disease in the
literature is Corden & Neary (1982). This paper develops a ‘core model’ comprising two traded
goods sector manufacturing and energy, the latter of which is the booming sector, and one non-
traded goods sector. They develop this model under certain assumptions then extend it to allow
for a variety of situations including capital mobility etc. The essence of the core model is
summarised below.
Principal assumptions:

1. The booming sector comes about due to a once and for all Hicks neutral improvement
in technology in that sector.
2. Only relative prices (expressed in terms of non-traded goods) are determined and
(overall) trade is always in balance.
3. The terms of trade are given so the relative prices of the two traded goods do not
change. The prices of the traded goods are determined exogenously.
4. Only labour is mobile between sectors, other factors are specific.
5. Wages are measured in terms of all traded goods, both manufactures and energy)
Given these assumptions the analysis proceeds as follows:
a. Initial full employment is at point A
b. LT is the total demand for labour in both traded goods sectors,
c. LM is the demand for labour in the manufacturing sector.
d. Thus LT is the sum of LM plus the demand for labour in the energy sector.
e. Ls is the demand for labour in the services (non-traded goods) sector.
Wage
LabourOs OT
LT
LT’
Ls
Ls’
LM
A
B

The paper uses a PPF analysis to determine the effects of the booming sector on the labour
market:
The analysis proceeds as follows:
1. The PPF shifts out from ST to ST’.
2. The analysis differentiates between a ‘resource effect’ – the result of the expanded
production in the booming sector – and a ‘spending effect’ – the result of the rise in
incomes pursuant to the expanded output in the booming sector.
O
Tradables
ServicesS
T
T’
n
A
C
G
B

3. The resource effect on its own at constant prices would serve to move the equilibrium point
to point B at constant relative prices.
4. But the spending effect (assuming the PPF shifted upwards uniformly) would lead to a new
equilibrium on the income-consumption curve, On, being point c
5. Both effects require an appreciation of the real exchange rate for equilibrium giving a new
equilibrium point G, although the one would lower the output of non-tradables, the other
raise it, there being no presumption which would pre-dominate.
Moving back to diagram 1 the impact of the above analysis then is to shift the demand for
tradables curve LT to the left to LT ‘ – the impact of the booming sector on the demand for
labour. But pursuant to the PPF analysis above the price of non traded goods rises which
will increase the demand for labour in that sector, hence the service sector’s demand
schedule for labour will shift to the left from Ls to Ls’. Thus a new equilibrium is reached
at point B. The key features of this equilibrium are that wages have shifted upwards
substantially as a result of the increased demand for labour in the booming sector as well as
the rise in the prices of services. Manufacturing output contracts as a result of the rise in
wages.
So the net effect is a clear decline in manufacturing output as wage rates rise due to the initial
resource effect. And then a further decline in manufacturing output caused by a further rise in
the wage rate resulting from an increase in the price of non-traded goods. Thus this analysis
shows a clear tendency towards de-industrialisation (defined as a reduction in manufacturing
output) as a result of rising wages.
Corden and Neary extend the analysis under several scenarios the most important for present
purposes being the situation where capital is mobile between the manufacturing and Services
(non-traded goods) sectors. In this case if manufacturing is capital intensive then the reduction
in labour availability caused by the booming sector will have the effect implied by the
Rybzinski theorem and see production shift to the manufacturing sector from the services
sector. Thus the initial effect is ‘pro-industrialisation’. The spending effect though will cause
an increase in the demand for and thus price of services leading to a de-industrialisation effect
as before.
Interestingly, in considering different scenarios they address the case where the boom in the
energy sector is caused by rising world prices and, still using the assumption of a constant
terms of trade between the two traded goods sectors, simply conclude that although the
resource movement effects of a rise in energy prices are equivalent to the technology change,
the spending effect on national income is different and a rise in energy prices has a substitution
effect on the demand for services.
b. Paul Krugman

In Paul Krugman’s 1996 book ‘Re-thinking International Trade’ he included a section on
Dutch disease and made a proposal for analysing the response of manufacturing industries to
an appreciation of the real exchange rate.
Underpinning the model he develops is a dynamic theory of comparative advantage which
assumes two countries, home and foreign, each producing any of n-traded goods with output
given by:
I=1,........,n
where Xi and xi are outputs of traded good i in the home and foreign countries respectively;
Ai(t), ai (t) represent indices of the productivity of resources in each country and Li(t), li(t)
are the respective Labour allocations. Without reproducing Krugman’s mathematics, which are
fairly simple, he postulates an industry learning curve where specialisation in an industry is an
increasing function over time of production in the home country and, allowing for cross border
spillovers, to a lesser extent from production of a good in the foreign country. Using the
‘experience indices’ derived he calculates relative productivity as a function of the relative
experience indices and from there shows that the relative indices will converge to a steady state
holding the relative labour allocation constant.
Briefly, the model is developed as follows:
1. He assumes a two country model and a Ricardian allocation of labour.
2. In particular, assuming the learning function discussed above where specialisation
comes about through domestic learning and diffusion of knowledge internationally,
tradable industries are ranked by their relative productivities, Ai(t) and ai(t).
3. For equilibrium the condition is:
4. The other equilibrium condition is balance of payments equilibrium where the
condition is:
Where l,L represent labour allocations in each country and the term on the right hand side
(σ) represents participation levels as a proportion in tradable goods industries in the two
countries.

5. So short run equilibrium is established by the intersection of these two schedules the
relative productivity schedule being downward sloping and the Balance of payments
schedule upwards.
6. Assuming that no shocks occur to upset the pattern of relative specialisation established
above, the dynamic learning function from which the relative productivity indices were
derived will operate in the long-run to deepen the pattern of specialisation that has been
established. This is shown graphically as follows:
Long run specialisation
The key point to note here is that the ‘deepening of specialisation’ represented by the vertical
portion of the curve flows directly from Krugmnan’s assumption of the nature of specialisation,
that learning is a direct function of domestic manufacture over time. Thus the moment a
country specialises in a particular industry, this ‘deepening’ is an inevitable consequence.
So the schedule above shows long run equilibrium according to Krugman with the AA
schedule giving equilibrium in industry specialisations and the BB schedule representing
balance of payments equilibrium. The issue is what happens if there is a real exchange rate
appreciation as shown by schedule B’B’. In Krugman’s model he considers the case of an
increase in the real exchange pursuant, say, to the discovery of oil in a country and models this
as if it were a pure transfer payment from abroad.
As Krugman notes ‘if the transfer does not last too long, when it ends BB returns to its
previous position, the old pattern of specialisation and relative wages will re-assert itself. If the
transfer lasts longer, however, some of the industries will not come back when it ends. For a
transfer of sufficiently long duration, all the industries that move abroad in the short run will
remain abroad even when the transfer ends. In either of the latter cases the home country’s
market share and relative wage will turn out to have been permanently reduced by its
temporary good fortune.’
B
B
B’
B’
A
A
σ

For the purpose of the analysis that follows I will use the framework developed by Krugman
and explore what happens if this framework is correct, that in fact if an exchange rate rise
persists long enough, industries will disappear and this will represent a permanent loss with
negative welfare consequences. And I integrate Krugman’s analysis into the Corden Neary
model to show the welfare effects of the de-industrialisation process Krugman which suggests
as a consequence
c. The theory re-visited
The ‘Core Model’ with different assumptions.
There are several problems with using the core model to analyse the current Australian
situation.. Although Corden and Neary claim that it is extendable to cover most all real world
situations, I do not think this is right particularly as it applies to the specific situation of a rise
in commodity prices which has lead to a big expansion of mineral exports. Both of these
effects have caused a sharp appreciation in the real exchange rate of the Australian dollar
recently. Consider for a moment the impact of a rise in energy prices. The core model suggests
that the resource movement effects will be the same as in the case of a Hicks neutral
technology improvement in the energy sector. And provided energy is a net export the
spending effect will be similar as well. But this completely ignores exchange rate effects as the
increase in the price of energy directly impacts the real exchange rate, not simply through
resource movements.
In general, there are certain areas where, I think, the Corden Neary analysis needs to be
amended to examine the present case:
1. The entire analysis is predicated on the two traded goods having the same relative prices.
But in fact if energy prices rise, say, then this will likely as not cause a real appreciation
in the exchange rate which will result in a lower (but still positive) rise in energy prices.
Manufactured goods on the other hand will see a decline in their prices as a consequence
of the exchange rate movement.
2. The Corden Neary analysis then relies purely on wage adjustments to impact on output of
traded goods. But the price effects could be at least as important if not more so.
3. The extension of the analysis to the case where capital is mobile between manufacturing
sectors is potentially invalidated if price effects are taken into account. The analysis relies
on constant prices; but tradable goods’ prices are determined exogenously and it is simply
not credible that an abundance of capital will allow output to expand in the manufacturing
sector. Admittedly the Corden/Neary model probably does not contemplate the export of
capital but realistically this is what would happen rather than earn a sub-par return on it.

(In fact in his 1983 paper Corden extends the core model to the case where capital is
mobile internationally).
4. Although the analysis is concerned with de-industrialisation it does not consider the
adjustment process in the reverse direction – when an energy boom say caused by high
prices reverses itself. The model assumes that the booming sector stays that way.
So I want to re-formulate the model, as follows:
1. The model will try to approximate the Australian economy as far as possible.
2. In particular it will have a booming minerals sector caused by high commodity prices.
3. The high commodity prices will translate into a significantly appreciated real exchange
rate both because of the higher prices and expanded mineral output.
4. Thus the Australian price of minerals will rise by less than the world price.
5. But the Australian price for manufactures will fall by the amount of the exchange rate
appreciation.
6. Wages will be expressed purely in terms of manufactures.
7. Although minerals are an intermediate good, the impact of their price rise on
manufacturing costs will be ignored.
8. The impact of the mineral boom is felt directly in two ways: as an increase in income
spent on manufactures and services; and, second as a reduction in the price of Australian
manufactures.
9. We will assume capital is exportable so manufacturing output will be impacted only by
the exchange rate and wage rates.
10. We will consider the impact of adjustment in the reverse direction if the mineral boom
ends and mineral prices and the exchange rate revert to their original level.
Finally, and most crucially, I propose to incorporate a ‘Krugman effect’ into the analysis. By
this I mean that I will assume that the type of adjustment process described above where an
increase in the real exchange rate, if sustained long enough, translates directly into a permanent
de-industrialisation process. The key difference between the Krugman analysis and that of
Corden & Neary is in the adjustment process and the definition of wages involved in the
adjustment. For Krugman the real exchange rate appreciation automatically increases relative
real wages thus making domestic industries uncompetitive. But the Corden Neary analysis
holds the terms of trade constant and assumes that de-industrialisation occurs because of rising
wages priced in non-traded goods relative to traded goods. Here we use the same framework
except that now we define wages as wages priced in non-traded goods relative to manufactured
tradables only. And we show the Krugman effect as being a rightward shift of the LM curve
which occurs if the real exchange rate appreciation persists long enough.
Thus using the same framework as before we analyse the effect of a rise in the price of
minerals:

LM
Ls
LM’
The movements shown in the are discussed in detail below but before that I want to focus on
the key differences from the Corden Neary diagram above. There the relative prices in the two
tradable goods sectors are constant so the wage on the left axis is defined relative to all traded
goods with non-traded goods as the numeraire. And crucially in the Corden Neary analysis the
prices of traded goods are given exogenously and are assumed constant throughout the
analysis. Here the situation is somewhat different because the first thing that happens in our
analysis is the prices of both traded goods changes immediately. Booming sector tradable
prices rise and manufactured tradable prices fall. Of course this gives rise to an immediate rise
in real wages (WRA = Wage rate rise following the real appreciation) which causes an
immediate de-industrialisation effect. The Corden Neary model by contrast sees the booming
sector drawing off resources which, combined with higher spending consequent on the boom,
serves to drive up real wages and hence causes de-industrialisation.
As far as the Krugman effect goes, the process works as follows. From initial equilibrium at
W0 a new equilibrium is established at W1. If W1 is higher than the horizontal portion of the
function shown in the Krugman analysis above and the new equilibrium persists long enough
then the labour demand curve in manufacturing will shift rightwards representing Krugman’s
supposition of a permanent de-industrialisation.
Wages
M’facture
s
LabourOs OM
Ls’
LT
LT’
A
B
W0
W1
WRA

The PPF analysis is as follows:
1. The process starts with an increase in prices of commodities which causes an increase
in the real exchange rate as well as causing increased demand for commodities.
2. Starting at equilibrium point A, the booming sector draws labour from both
manufacturing and services and consequently the PPF shrinks from MS to M’S’.
3. The price of manufactures reduces relative to services as a result of exchange rate
appreciation so equilibrium in production shifts to point B.
4. But rising incomes due to the minerals boom shift the budget line outwards and causing
excess demand for manufactures.
5. So the price of services rises and a new equilibrium is reached at point D.
6. We make a simplifying assumption here that the new relative price of manufactures
(which is higher than at the initial equilibrium) and services is exactly that which causes
production of services at point C to equal the old level of services production at point
A. In fact the new equilibrium could be greater or less than the old level of services
production.
A
B
D
M
S
M’
S’
C
Manuf-
actures
Services

7. The relative price of non-tradables will rise initially substantially because of the fall in
the price of manufactured tradables but will then have to fall to re-equilibrate the
market.
8. Manufacturing output clearly shrinks by an amount of AC.
9. The difference in manufacture consumption and production, CD, is absorbed by
imports paid for by the rise in incomes pursuant to the minerals boom.
Turning now to the wages/labour diagram we see that we get a different result from the Corden
Neary core model. In particular:
1. The rise in commodity prices causes the equilibrium wage level, W0, to rise to WRA.
2. The booming sector shifts the schedule LT out to the left as the industry responds to
rising demand reflected in increased prices.
3. The shift in the LS curve is more complicated as discussed in the PPF analysis. On the
one hand the resource effect would shift the schedule to the left. But the spending effect
will shift the schedule outwards.
4. I have assumed here that the net effect is relatively small and the shift in the LS
schedule is just sufficient to restore output of services to their original equilibrium
level. This is done purely for simplicity of exposition as we want to concentrate in the
later discussion on the impacts on manufacturing.
5. So from initial equilibrium at Point A, the shifts in the Ls and LT schedules create a
new equilibrium at point B.
6. The essential feature of this new equilibrium is that it occurs at a slightly higher wage
with output of services unchanged. Total labour employed in tradable production also
remains unchanged and there is a reduction in manufacturing employment compensated
for by an increase in employment in the minerals sector.
7. From a consumption point of view the higher output of the minerals sector allows
greater consumption of manufactures although domestic manufacturing output falls.
8. And at some point, if W1 is higher than the ‘trigger level’ in the Krugman analysis, the
LM curve will shift to the right to LM’
In sum then, there are two crucial differences in the re-formulated model from the original one.
The first is that the main adjustments take place as a result of price changes pursuant to the fall
in the relative price of manufactures. And second, using the Krugman framework allows one to
suppose that if the de-industrialisation effect persists long enough there will be a rightward
shift of the LM curve which will result in lower overall tradable demand for labour once the
commodities boom ends.

Graphically the post boom situation is shown as follows:
LM
Ls
LM’
As demand for energy contracts LT shifts rightward but now shifts further than LT because of
the permanent shift in LM to LM’. And of course Ls’will shift to Ls as before. But now the
adjustment is no longer to the old equilibrium A but (assuming wages are perfectly flexible
downwards) to a lower wage level C. If wages are sticky of course there will be unemployed
resources.
5.
5. Methodology
a. Criteria for firm selection
The study relies on firm level data taken from the Australian Stock Exchange from 1989 to
2008 relating to three specific manufacturing sectors as defined by the GICS (‘Global Industry
Classification system’), a structure developed by Standard & Poors, inter alia, and
subsequently adopted by several stock exchanges. The three sectors with their associated
definitions are as set out below (the definitions are substantially abbreviated):
Wages
M’facture
s
LabourOs OM
Ls’
LT
A
B
W0
W1
WRA
C

Consumer Durables & Apparel
Includes: Manufacturers of electronic products including TV’s, VCR’s etc; of home
furnishings; of household appliances; and of durable household products such as kitchenware.
Automobiles and Components
Includes: Manufacturers of parts and accessories for automobiles and motorcycles; and
manufacturers of tyre and rubber.
The complete definitions are contained in Annexure One.
Capital Goods
Includes: Manufacturers of military or civil aerospace and defence equipment; of building
components and home improvement products; civil engineering contractors and large scale
contractors; producers of electric cables and wires; manufacturers of power generating
equipment and other heavy electrical equipment; diversified industrial companies;
manufacturers of heavy duty trucks and similar equipment; and, manufacturers of industrial
machinery and industrial components.
The dataset cover approximately 400 firms which have been listed under these categories since
1989 (including those that had de-listed). Of these some 50 were identified as having
manufacturing capacity in Australia. This was not a completely simple exercise because several
companies had manufacturing activities both in Australia as well as overseas making it difficult
to establish the impact of a real exchange rate appreciation on their profitability – given the
effects would then be both positive and negative. But in general there were not too many
companies like this so the study focused on those companies with clearly identifiable exposure
to manufacturing activities in Australia. And it excluded companies which were small –
broadly annual profits of less than A$1 million.
The complete list of companies examined is contained in Annexure Two. The list of companies
extracted on the basis of having manufacturing capacity in Australia is contained in Annexure
Three. And the financial data on this set of companies is contained in Annexure Four. All the
information in these three annexures was obtained from the Aspect Huntley Data Analysis
database or the Aspect Huntley Financial Analysis database.

The analysis below does not review all companies surveyed. But it takes what can confidently
be viewed as a representative sample given that the trends identified were so clear.
b. Analytical Approach
The methodology is essentially one of applying traditional tools of financial analysis to firms
identified to have manufacturing capacity in one of the three Stock Exchange sectors
examined. The idea is to analyse the underlying profitability of selected firms over the nearly
twenty year period since 1989. Crucially, I have identified two key ratios which measure a
firms underlying economic profitability as accurately as possible independent of extraneous
effects such as taxation or balance sheet structure (i.e. the extent of leverage). And these
measures are plotted against time over the entire period.
As noted in the introduction this analysis does not attempt to be rigorous from a quantitative
point of view in the sense that there are no regressions here trying to correlate the real
exchange rate of the Australian dollar with a decline in manufacturing output. But we have a
decisive advantage in doing a firm level analysis in that our data talks to us. So if the high
exchange rate is responsible for the erosion of competitiveness the company studied will tell us
in its reports to the stockmarket. And while the conclusion may be misleading in individual
cases, – an excuse for bad management say - it is highly improbable that a sector wide decline
in industry profitability, identified as such by the individual companies, is not just that.
I have used two fundamental financial analysis measures - Operating Margin and Return on
Assets. The definition of these ratios given in Brealey & Myers (2000) are:
1. Net profit Margin = (EBIT – tax)/sales
Where
EBIT = Earnings before interest and tax, also known as operating earnings
Since we are solely concerned with the economics of the firm I have ignored tax effects in
calculating this ratio. So ‘operating margin’ in the analysis is calculated AS EBIT/Sales.
2. Return on Assets
Return on assets = (EBIT – tax)/(average total assets)
Where
EBIT = Earnings before interest and tax.
And

Average Total Assets = the average of total assets at the beginning and end of the period
Again tax is ignored. And for simplicity I have calculated the ratio on assets at the end of each
period. So this analysis calculates Return on assets as EBIT/(Total assets at the end of the
period)
To show the analysis in as concise a form as possible the company analysis is shown
graphically. First Sales and EBIT are plotted against time. Then the two ratios above are
plotted. The key idea here is to show that simply because a company’s sales and profits are
rising it does not mean that all is well. Indeed if sales are rising much faster than profits then
the company’s underlying profitability ratios suffer, albeit the company remains profitable in
absolute terms. This is very often precisely what happens in the case of a commodities boom.
Consumer incomes rise and sales rise concomitantly but profits are squeezed because of the
exchange rate.
c. Macro-economic Background
The analysis is conducted against a background of the macroeconomic environment in
Australia, particularly indicators such as real exchange rates, terms of trade, wage rates,
tradable and non-tradable prices and overall manufacturing data. As noted earlier no formal
correlations have been attempted simply because if firms are adversely affected by exchange
rates they say so thus simplifying the analytical task.
We consider these indicators below:
1 Real exchange rates and Terms of Trade (Annexure Five)
These graphs show clearly the dramatic rise in Australia’s trade weighted real exchange rate
and terms of trade in recent years, Since 2003 both measures have appreciated nearly 50%
(these figures obviously do not include the precipitate decline in the Australian dollar in recent
weeks). Interestingly neither measure exceeded the index (established at 100 post the float of
the Australian dollar) during the period 1992 to 2002. Thus Australian industry during this
period lived with relative exchange rate certainty.
d. Consumer Price Inflation, Import prices and tradable & non-tradable prices (Annexure
Six)

The impact of the exchange rate appreciation is clear. From 2002 import prices (excluding oil)
drop sharoply at first and slowly but steadily thereafter. Non-tradable prices rose by 4% per
annum from 2002 onwards while tradable prices fell sharply initially and then stayed constant
with a slight upward movement in recent years (below 1% per annum). Consumer Price
Inflation has averaged 3% or so annually since 2002, spiking up sharply to 5% in 2008.
e. Wages (Annexure Seven)
The graph shows a steady rise in the wage price index after 2002 of slightly less than 4% per
annum rising to approximately 4% per annum after 2004. Wage costs over the period, per the
NAB survey, averaged perhaps 3% from 2002, trending up to 3,5% from 2005.
f. Profitability (Annexure Eight)
From 2002 corporate profitability has shown an upward trend with the gross operating surplus
(similar to the operating margin defined above) rising from 20% to 25%.
g. Industry Share of Output (Annexure Nine)
These graphs show the long term decline of the contribution of manufacturing to GDP, gfalling
from 17% or so in the late 70’s to approximately 10% in 2008. Total employment in
manufacturing has remained fairly constant since 2004 while mining employment spiked up
sharply in 2008.
h. Indexes of Industrial Production (Annexure Ten)
This table shows that the index of manufacturing output which stood at 100.8 in 2002-2003
stayed reasonably constant for four years then spiked up sharply in 2007-2008 to 105.6
The data above is all drawn from the website of the Reserve Bank of Australia, Chart Pack
(as at 5 November 2008) except for the schedule in Annexure Six which is taken from the
website of the Australian Bureau of Statistics.
6. Company Analysis

As discussed previously companies were examined on the following basis – all information
was sourced from the Aspect Huntley Financial Database and Data Analysis databases.
Pursuant to the published description of each company in the three identified sectors on the
Aspect Huntley Data Analysis database, it was determined whether a company had
manufacturing capacity in Australia or not. The selected financial data on each company since
1989 was then printed out using the Historical analysis function of the Aspect Huntley
Financial Database. (this data is attached as Annexure Four). Then these companies were
divided into two categories, those manufacturing non-traded goods and those manufacturing
traded goods (the list of summarising this analysis is contained in Annexure Three).
This analysis proceeds then by looking at the trading histories of selected companies in the
non-traded goods sectors then moves to looking at selected companies in the traded goods
sector. It concludes with a look at two manufacturing companies which have been directly
exposed to the commodities boom as suppliers to the mining industry.
Companies have been selected on the basis of being broadly representative of each of the three
categories. And companies which were too small (annual earnings of less than $1 million) or
relied on a proprietary technology, say, were excluded.
a. Non-traded goods
We study two companies here one in the consumer goods market and the other supplying
infrastructural goods.
1. Fleetwood Corporation
This company has two core lines of business. It is Australia’s largest manufacturer of
recreational vehicles such as caravans and has a large division manufacturing portable homes
for use by personnel in the mining and construction industries. Demand for both its product
lines has been buoyant in recent years both because of the resources boom as well as strong
consumer demand. The operational results are as follows:

In fact this is an extraordinary performance with sales rising sevenfold in just 10 years. The
profit ratios are as follows:
Again these ratios reflect a superb operating performance. Typically a manufacturing business
would aim to have an operating margin of at least 10% so the recent margins of 15% which the
company has attained are very healthy indeed.
2. Crane Group
The company is in the business of manufacturing and distributing plastic pipeline
systems and supplies; distributing plumbing and electrical supplies; distributing copper,
aluminium and stainless steel products; and the manufacture and distribution of copper
tube. The group’s largest division and the major contributor to profits is its pipeline
division which has enjoyed solid demand for its products recently from spending on
water resource management projects.
The financial history is as follows:

Again, a very solid performance with sales rising two and a half times over a 10 year
period. Here are the profit ratios:
So even though sales have risen strongly profit margins have remained intact. It is
interesting to note that operating margins are of the order of 5% which is relatively low
for a manufacturing business. This is probably accounted for by high volume low
margin sales in the distribution divisions which would tend to depress overall margins.
But it is still a clearly healthy business although recent announcements by the company
suggest that demand is reducing.
b. Traded Goods
1. Pacifica Group
Pacifica is involved in the design, development, manufacture and sale of high technology
automotive components. It is also a producer of friction materials for braking systems. In
particular it makes advanced brake systems and clutch products for automotive manufacturers
in the original equipment market and aftermarket. The group is a major supplier to Toyota,
Holden, Ford and (previously) Mitsubishi in Australia.
The company’s operating results are:

The slump in sales here is attributable to a variety of factors which included reduced demand
for the company’s products in the North American market. But the declining profitability was
ascribed by the company’s chairman to a combination of increased raw material costs as well
as the strength of the Australian dollar. Certainly raw material costs were an issue for several
motor component manufacturers and tyre manufacturer Bridgestone which de-listed from the
ASX two years ago saw a significant profit decline in the two years before it de-listed which it
attributed mainly to increased prices for natural rubber.
These are the profit ratios:

It is clear from the sharpness of the decline that something has gone seriously wrong here.
There are several reasons why the company has performed so badly recently including
weakness in the US market and reduction in demand from its core domestic market as
consumers switched to smaller cars. Nevertheless the strength of the Australian dollar was a
factor. Here are some statements by the Chairman:
‘Our North American operations recorded a 15% fall in sales revenue, partly reflecting the
influence of the stronger Australian dollar..’ 16 May 2008
‘FMP Australia, the 49%-owned friction materials business has fallen back into loss as cheaper
competing imported product has benefited from the strength of the Australian dollar and gained
market share’ – 5 August 2008
The one bright spot for the company has been its joint manufacturing facility in China
established in 2004 and which appears to have been consistently profitable since.
In March last year the company was taken over by Robert Bosch of Germany.
2. Schaffer Corporation
Schaffer Corporation has three areas of business, automotive leather, paving and concrete
product manufacture and property leasing. Obviously then it is a mix of traded and non-traded
goods production but it was worth including because of the explicit commentary the chairman
gave on traded goods production.
Here are the numbers:

And the ratios are:
Given that one would expect non-traded goods manufacturers to be improving margins in
buoyant conditions, the margin squeeze in recent years suggests that the traded goods division
is impacting results negatively. And indeed here is what the chairman had to say at the AGM
on 14 November 2007:
“Our automotive leather division, Howe, is a global business with over 90% of its sales in
Europe, Asia and North America. Like all exporters, the stronger Australian dollar has eroded
both revenue and earnings. The strength or weakness of the Australian dollar is out of our
control. However, over the last two years, we have successfully repositioned the leather
business by relocating Howe’s labour-intensive operations offshore. The outcome was to
successfully reset Howe’s cost base. It now has 600 employees overseas and a bit less than 200
in Australia. These were necessary steps to ensure Howe’s long term future.’
3. Fisher & Paykel
‘Fisher & Paykel (“FPA’)....is a New Zealand based holding company .......involved in the
manufacture and sale of household appliances and the provision of consumer and equipment
finance.....FPA is the largest supplier of appliances in New Zealand and the second largest in
Australia. Refrigerators and washers are the main products and the Group also manufactures
and distributes dryers, dishwashers and cooking products.....’ – extracted from the Aspect
Huntley financial database

FPA is of course a household name and thus particularly interesting to analyse. Here are the
results (note the company only listed on the ASX in 2001 so data is only available from that
date:
And here is the ratio analysis:
The interesting thing here is that although Fisher & Paykel clearly benefited from the consumer
boom and saw sales rise substantially it nevertheless saw its profitability squeezed. On 17 April
2008, the company announced that it would shut manufacturing plants in Australia, New
Zealand and the US, relocating production to Thailand, Mexico and Italy.

Here is what the company said in its statement:
‘The relocations will lead to a reduction in the Dunedin based workforce of approximately 430
positions. Brisbane based positions will reduce by approximately 310 .....John Bongard ...CEO
and Managing Director cited ongoing manufacturing cost escalations, particularly in New
Zealand and Australia, as the main reason for relocating production. “We have been faced for
many years with an extremely unhelpful exchange rate fuelled by high interest rates.....On top
of these factors free trade agreements with low cost labour countries like China and Thailand
have created a playing field we are unable to compete in” said John’
4. GUD Holdings
‘GUD is a diversified brand management, marketing and manufacturing company operating in
Australia, New Zealand and Asia. Its portfolio includes Consumer products (Sunbeam, Victa),
Automotive products (Ryco, Wesfill, Goss), Water Products (Davey, Spa-quip) and security
products (Lock Focus)’ (4).
Historically the company has manufactured its products in Australia and New Zealand but has
gradually adopted an outsourcing model with design and engineering capability remaining in-
house and manufacturing being outsourced. The financial results are as follows:
And the ratios are:

Again the company has seen its sales increase substantially in recent years yet profitability has
been steadily reducing since 2004. Below are excerpts from the Chairman’s address on 2
November 2007:
‘On the first of these – cost competitiveness – the major recent manifestation of this
fundamental underpinning of our activities was the decision to close our automotive filtration
manufacturing plant in Auckland, New Zealand.
Following the outsourcing model put in place at Ryco’s Australian operation, it was no longer
possible to operate a production facility in New Zealand, especially as........had been completed
prior to Australian production ceasing in the previous year. ...........
The continued strength of the Australian dollar, coupled with a review of our competitive cost
position, led to the decision announced early in the financial year to similarly transition the
Oates cleaning products business to a design-develop-source-market business structure similar
to that at Sunbeam. Oates currently operates manufacturing plants in Melbourne and Perth, and
both of these will be closed in the current financial year. The process of identifying and
qualifying offshore suppliers in a number of locations, including China and Sri Lanka are well
underway.....’
So in recent years GUD has shut all domestic manufacturing capacity in favour of its
outsourcing model.

5. CMI Limited
The principal activity of the company is ‘the manufacture and marketing of precision
engineered components, particularly for the automotive industry, the manufacture and
marketing of components and parts for 4wd, light commercial and heavy transport vehicles, the
manufacture and marketing of specialist cabling and electrical products for a range of industry
sectors and the provision of Chattel finance to both consumer and commercial borrowers.’
Here are the financial results:
And the ratios:
What is really striking here is how suddenly disaster struck. But the signs were clear to the
company’s directors from mid 2006 onwards. Some extracts from company announcements:

31 August 2006: ‘Shareholders should take heed of the very difficult market conditions that
currently prevail within CMI’s engineering sector, due to the state of the automotive industry.
Cost pressures are relentless; steel and copper prices are at record highs and passing on these
increases is extremely difficult. The strength of the Australian dollar is increasing the
competition from imported goods and our export business to North America is at best break
even rather than profitable.....To further add to our difficulties we are experiencing customers
rushing to China for their component parts or to establish factories. Financial failure of some of
our customer base is a concern of an increasing nature. CMI may, over the next 3 years, have
to rationalize its production facilities......’
31 December 2006: ‘Manufacturing is not just suffering a cyclic downturn in the automotive
sector; it is suffering from a fundamental rush to China for considerably cheaper products. This
situation will not improve and we as a company face continual rationalisation and expensive
restructuring. We are constantly monitoring our customers as we see continued financial stress
appearing......’
These warnings proved prescient and the company’s core engineering division slumped to a
$14 million loss in the year to June 2007. Subsequent to the year end the company sold this
division for a nominal amount and now exists as a (much) smaller but profitable entity.
6. Kresta Holdings
‘Kresta Holdings is involved in the retailing of window treatments and the manufacturing and
wholesaling of blind components. ........[Kresta’s] retail outlets specialise in blinds, venetians
and soft furnishings......................The group operates several manufacturing plants involving
weaving and coating, plastic components and the fabrication of timber venetians, curtains and
vertical blinds.’ – Aspect Huntley Financial Database.
The company is in a solid if somewhat unexciting market niche. Here are the results:

And the
ratios:
The company represents a mix of retail and manufacture so it is not clear how to classify it. But
the results clearly show that margins have been squeezed in recent years probably as a result of
the strength of the dollar. The company has been very circumspect in what it says about its
manufacturing operations but here are some interesting comments from the Chairman:
a ‘The group operates several manufacturing plants....The manufacturing operations have
continued to be a major part of the group’s core activities’, Annual Report 31 August 2007
b ‘Important developments since my last report include......progressive outsourcing of
manufacturing operations where this can be achieved at a cost saving and without
sacrificing quality’, Annual Report year ended 31 August 2007, Chairman’s report.
c ‘Outsourcing Strategies – Develop/Purchase manufacturing capabilities in Asia’ –
Powerpoint slide, Investor briefing, February 2008
Interestingly there have been no subsequent announcements regarding locating manufacture
overseas so perhaps the company decided it was sufficiently diversified not to need to shift its
manufacturing base.
7. GWA international Limited
“Principal Activity:
Research, design, manufacturing, importing, and marketing of household consumer products as

well as the distribution of these various products through a range of distribution channels in
Australia and overseas” – Aspect Huntley Financial database
The company comprises some of Australia’s best known brands in Bathroom fixtures &
sanitaryware and kitchen fixtures & fittings(Caroma Dorf), building products and supplies
(Dux and Gainsborough), commercial furniture (Sebel) and garden mowing equipment (Rover).
The company comprises a mix of local manufacture and imports across its divisions. Here are
the results:
And the ratios:
The company, which is generally in very healthy shape, has seen some pressure on margins in
recent years. The company is very circumspect about locating production offshore presumably
because of staff sensitivity so some reading between the lines is necessary. Here are some

This is a company with a competent management which is predominantly in the non-traded
goods segment – sanitaryware and building products. But where the company was exposed to
offshore competition as a result of the rising exchange rate, the company reacted immediately
by shutting factories and re-locating production offshore.
c. Manufacturing companies exposed to the commodities boom
1. Ausclad Group
Ausclad was originally an industrial cladding based in Perth which diversified into metal
fabrication. Operating a large fabrication workshop south of Perth, it supplied steel structures
to the mining and oil industries in Western Australia.
comments from the company’s managing director:
30 June 2005: ‘...Meanwhile, Sebel’s exports will continue to be impacted by the high
Australian dollar.....at a group and divisional level the company has invested in a number of
critical activities to support our business strategies. These investments are in ....expanded
overseas sourcing services.... The Group’s businesses are further developing product sourcing
from offshore ....Our competitors are predominantly sourcing outside Australia and therefore
exchange rates, principally the US dollar, will increasingly drive market prices and impact
correspondingly on trading profits’
30 June 2006: ‘Restructuring Program: Mr Crowley pointed out the net profit was reduced by
the costs of major business restructuring, largely offset by related gains on property sales. The
restructuring program, including the reorganization of components and product supply, is
designed to improve the company's overall competitive position while reducing the Group's
exposure to import competition and currency movements against the Australian dollar. We are
in the progress of transforming our businesses and capitalizing on the opportunities being
created through our improved cost competitiveness and expanded market reach, both in
Australia and overseas. The scope of the restructuring program included the closure of the
Penrith tapware and Coburg Sanitaryware factories, the closure of the metals and timber
manufacturing facilities of Sebel and the integration of the head offices of the Caroma and Dorf
Clark businesses’.
25 October 2007 (Chairman’s address): ‘The group’s businesses have undergone significant
change through restructuring activities undertaken to date to reduce costs and improve long
term competitiveness....During the year the group continued to invest in the automation of the
Caroma Dorf vitreous China sanitaryware factory at Wetherill Park, closed the acrylic bath and
shower tray factory at Smithfield and the Rover lawn mower assembly operation at Eagle farm
and further invested in the sourcing and quality assurance services of the group’s China
operations, GWA Trading (Shanghai) Company Ltd’.

It was a business with no particular competitive advantage (although it acquired a definite
reputation for quality and on-time delivery) and when it decided it needed to raise capital in
2005 it found the ASX not interested in a low technology metal fabrication business. So it was
forced to list in Singapore instead. The company’s value at the time of listing was below A$50
million. But it listed just as the commodities boom was getting into full swing. Here are the
financials:
And the ratios:

The striking thing here is how sales have sky-rocketed since 2005 increasing by 150%
approximately. And profits have grown concomitantly with the company reaching a 10%
operating margin in 2007. Profits fell the following year but this fall related to a contractual
dispute and not a change in business circumstances. At its peak last year the company had a
stock market valuation in excess of A$500 million. Yet this is a business which most major
engineering groups regard as too low tech to be done in Australia. McConnell Dowell for
example has established a fabrication plant in Indonesia to do this type of work.
Clearly Ausclad found itself in the right place (Perth) at the right time (the commodities boom)
and prospered as a result. Of course, with the commodity boom ending it is likely that Ausclad
will revert to being an average low margin business. The point is though that there must be
many manufacturing businesses which have reported sparkling results in recent years purely as
a consequence of mining related demand. When the commodity cycle turns as it appears to be
doing though these companies turnovers and profits will revert to trend. In the meanwhile
though aggregate statistics for Australian manufacturing will reflect increased activity in
certain areas.
2. Ludowici Limited
‘Manufacture of : equipment for the mineral processing industry; fluid seals for hydraulic and
pneumatic systems; rubber and plastic products; and moulded fibre packaging products and
equipment’ – Aspect Huntley Financial database
This Queensland company is directly exposed to the coal mining industry and, like Ausclad,
has enjoyed rapid growth thanks to the commodities boom. Here are the financials:

So between 2002 and 2007 turnover nearly doubled. And operating margins reached a peak of
10% in 2005. Subsequently profits have slid as the company struggled with underperforming
businesses – some of which it sold to focus on its core mineral processing business – and has
been negatively impacted recently (company statement at 30 June 2008) by ‘increasing costs of
inputs, particularly labour, steel and increased costs from sub-contractors.’ Interestingly, this is
the first and only time in the analysis that wage pressures have been blamed for poor
performance.
d. Summary of company analysis
The analysis above suggests that the rising Australia dollar has made life very difficult for
Australian manufacturers of tradable goods particularly those which are not supplying the
mining industry. The question is to what extent canone draw conclusions from the analysis
given that it is largely qualitative. The answer I suggest is that the companies selected are
generally representative of their industry segments. The three segments chosen were picked
precisely because they were likely to be subject to foreign competition and the companies
listed above are typical. And certainly the responses to exchange rate appreciation by the
tradable manufacturers have been swift and their pain threshold per the Krugman analysis is
low – perhaps a 20% appreciation of the exchange rate is sufficient to precipitate de-
industrialisation after two or three years.
Interestingly, despite the extent of the commodity boom, wages were rarely cited as the reason
for closing plants, in virtually every case the key determinant was the money exchange rate.
Indeed wage growth was quite moderate from 2002 onwards considering the extent of the
boom and only in 2008 did wages show any sign of spiking up sharply.

Two other mining related engineering businesses in the selected sample, Korvest and SDS,
both demonstrated characteristics like Ausclad and Ludowici producing very strong results in
the last five years – in fact SDS was bought over by a Swedish company in 2006.
Bridgestone in the motor industry had a poor year before being de-listed in 2006, attributing
the problem to high rubber costs. Austal a shipbuilder specialising in coastal patrol vessels for
the military has been a consistently strong profit performer presumably because it has a very
clear niche and minimal competition in that niche. CSR Limited a large diversified
conglomerate has some manufacturing activity but gets two thirds of its income from
aluminium and sugar so does not really help the analysis. And including a motor component
manufacturer like Autodom, which historically has shown equal ability to make and lose
money, would simply have accentuated the bleak picture of motor component manufacturing.
Most of the other companies studied were too small to be of consequence although even then
the small ones generally reported exactly the same issues as the larger ones.
In sum then, I think that the analysis fairly reflects issues for Australian manufacturing arising
from the commodity boom at least as it affects the three ASX sectors studied.
7. Policy Implications
In this paper I have tried to show the sudden and sharp impact on manufacturing that a real
exchange rate appreciation can have. It has been a particularly interesting exercise to do this in
the light of the original theory of Dutch disease developed over 30 years ago. I am quite sure
that when Corden & Neary first formulated their core model in 1982 the assumptions were
perfectly valid. I suspect foreign trade was a relatively small part of the overall economy in
most countries and thus the main effects economically were felt in domestic adjustments. Also,
it is likely that not only was foreign trade, particularly in manufactures, a much smaller part of
a country’s economy but also given the prevalence of tariff barriers and a much greater home
bias towards consumption in those days, price effects were probably much smaller so the
assumption of constant terms of trade between the two tradable sectors made sense.
But the reality is now that trade is a significant part of most countries’ economies, information
travels fast and loyalties to domestic suppliers are few. So economic impacts will work their
way through the system very quickly and if government’s wish to react they will need to do so
rapidly. The company analysis although qualitative is I submit significant. Apart from
companies in the non-traded goods sectors or which benefited directly from the commodities
boom, the impact of the exchange rate rise was uniformly harmful to manufacturing companies
and indeed in some cases disastrous.
The question is should government be worried? I argue that they should for a number of
reasons. First as shown in the discussion on the history of trade policy in Australia, Australia
has long since abandoned any formal trade policy so those companies which have survived the
80’s and 90’s have done so through developing genuine competitive advantages
notwithstanding being in a high wage economy. And the company analysis was very clear,
manufacturing has tended to be very stable in the sectors looked at with minimal movement in

the sense of firms going out of business and new entrants into the market. The very longevity
of these firms was encouraging so it really begs the question was it really necessary for them to
re-locate their manufacturing offshore, given that they had demonstrated a competitive
advantage for many years previously with manufacturing in Australia?
Second if the commodity boom was indeed temporary, and it very much looks that way
presently, what are the welfare implications? Using the re-formulated Corden Neary analysis
above but this time allowing for the Krugman effect, the demand curve for labour in non-
tradables will shift back to Ls. But the demand curve for labour in tradable production will now
shift back to a new level to the right of the old LT curve since the LM curve has now shifted to
the right. And the implications are clear, a new wage rate will be struck below W0 or, if wages
are sticky downwards, then unemployment will result (exactly as Krugman suggested).
So I suggest government would be well served to consider providing assistance to
manufacturing companies during a commodities boom. And while the conclusions drawn in
this study are necessarily speculative because we could not access complete population data,
this is not true of a government which, through the tax system, has accurate records of all
manufacturing companies (although, of course, it does not collate data in the format above
presently).
Based on analysis of company profitability gathered through the tax system governments could
develop analytical tools which would give them, with a lag of a year to 18 months, warning
that the profitability, indeed viability, of manufacturing companies were under strain due to a
high exchange rate and move to compensate the companies for the duration of the commodities
boom.
There would be many ways to achieve this of course but the most obvious one would be
through the tax system where companies were given temporary relief from income taxes say
or, in extreme cases, exempted from payroll taxes. The point is that it is clearly wasteful to see
skilled manufacturing jobs disappear as a result of a boom which turns out to last only 4 or 5
years particularly when those manufacturing skills were developed over a period of many
years, decades in some cases.
Research Issues
This paper has focused on Dutch disease and a commodity economy. But it’s conclusions
could, possibly, be generalised to a broader set of situations particularly in advanced
economies where cyclical movements in exchange rates can threaten otherwise stable
industries. What is clear from the analysis above is that companies with manufacturing
facilities in the developed world are keenly aware of the option to move manufacturing to
lower cost locations. And the trigger for companies to do so does not have to be very great – a
couple of years of an appreciated exchange rate does it. So perhaps the issue needs to be
researched further with a view to formulating a generalised response in developed economies
to exchange rate movements. Perhaps more so when economies like China practice a form of
‘exported Dutch disease’ by keeping their currencies deliberately undervalued. Perhaps a
policy response is called for here too.

8. Conclusion
Australian industry is a relatively small part of the economy presently but has proved itself
quite consistent in the period since 1990. The sample of companies studied showed minimal
movement in terms of companies going out of business or being displaced by competitors.
The appreciation of the Australian dollar was a catalytic event however. It may well be that
many companies had been considering shifting production overseas in any event, but the
exchange rate appreciation galvanised them. And the analysis shows that the more companies
were exposed to manufacture in the tradable goods sector the more their margins were
squeezed as the Australian dollar appreciated. This was in sharp contrast to non-tradable
manufacturers which enjoyed bumper conditions as a consequence of the resource induced
spending boom.
Also, manufacturers exposed to the mining boom enjoyed bumper conditions and often saw
turnovers double or even triple. And no doubt it is for this reason that aggregate manufacturing
data shows output constant or increasing slightly in recent years. The problem though is that
this demand is not sustainable. Very often these companies have no particular competitive
advantage and will revert to being mediocre performers under threat of foreign competition
when the boom ends (as it may have done). And when the boom does indeed end, the
contraction in aggregate manufacturing output could be severe.
Given Australia’s manufacturing industry is quite small anyway, I conclude it would be well
worth government’s while to subsidise tradable manufacturers during a commodities boom in
future. If the effects of a commodities boom are short lived, as they generally are, then it not
worth sacrificing skilled jobs unnecessarily.
And long term there may be a strategic balance of payments reason as well. As it is, Australia
seems to suffer a structural deficit on its trade account which has hitherto been easily financed.
But in a world where credit is likely to become tighter this easy access to international finance
could dry up.
So from both points of view, the preservation of jobs and concerns about the current account,
subsidising these manufacturers makes sense.
January 2009
References
Anderson K and Garnaut R (1987), ‘Australian Protectionism’, Allen & Unwin
Balassa B (1967), ‘Trade Liberalisation among industrial countries’, McGraw Hill

Bell S., (1993), ‘Australian Manufacturing and the State’, Cambridge University Press
Brealey R.A, and Myers S.C.,(2000) ‘Principles of Corporate Finance’ (6th
ed). McGraw Hill
Corden W.M. & J.P Neary, (1982), ‘Booming Sector and de-industrialisation in a small open
economy’, The Economic Journal , pp828-846
Corden W.M., (1984) ‘Booming Sector and Dutch Disease Economies: Survey and
Consolidation’, Oxford Economic Papers, pp359-380
Davis, GA (1995). ‘Learning to love Dutch Disease: Evidence from the Mineral Economies
Gregory R.G., (1976) ‘Some implications of the growth of the mineral sector’, The Australian
Journal of Agricultural Economics’, Vol 20
Krugman PR and Smith A,(1994) ‘Empirical Studies of Strategic Trade Policy’, University of
Chicago Press
Krugman, PR, (1996), ‘Re-thinking International Trade’, MIT Press
Lewis P, Garnett A et al (2006), ‘Issues, Indicators and Ideas: A guide to the Australian
Economy’, Pearson
Lipsey RG and Dobson W (eds), (1987), ‘Shaping Comparative Advantage’, C.D. Howe
Institute
Pomfret R (ed), (1995), ‘Australia’s Trade Policies’, Oxford University Press
Quintieri, B (1995), ‘Patterns of Trade, Competition and Trade Policies, Avebury
Rowthorne R and Wells Jr, (1987), ‘De-industrialisation and Foreign Trade’, Cambridge
University Press
Snape, R.H., (1977), ‘Effects of Mineral Development on the Economy’, The Australian
Journal of Industrial Economics, Vol21
Annexure Three
Companies Examined from a financial perspective

Company Sector Nature of
Business
Tradable or
Non-tradable?
Included in
Study?
Advanced
Braking
Technology
Automobiles &
components
Proprietary
braking
technology
Tradable No.Technology
company, too
specific
Autodom
Limited
Capital goods Automobiles &
components
Tradable No.
Performance
erratic, continual
losses
Austin
Engineering Ltd
Capital Goods Manufacture &
repair of mining
attachment
products,
steelwork
structures
Non-tradable
(largely)
No. But very
successful
resource based
engineering
company, like
Ludowici
Austal Limited Capital Goods Design &
manufacture of
high
performance sea
vessels
Tradable No. Niche
producer, very
successful, large
defence
contracts for
naval vessels
Automotive
Technology
Group
Automobiles &
components
Superchargers &
Motorcycle
specialty
components
Tradable No. Enthusiast
market, very
specialised
Berklee Limited Automobiles &
components
Manufacture
and fitment of
mufflers
Tradable No. Too small
but typical of
companies
squeezed by
exchange rate
Bremer Park Ltd Capital Goods Manufacture of
masonite for
construction
industry
Non-tradable No. Poor
performance,
litigation issues
etc

CMI Limited Capital Goods Motor
component
manufacture
Tradable Yes
Computronics
Holdings
Limited
Capital Goods Manufacture of
agricultural
electronics
equipment
Tradable No. Small, very
specialised
Crane Group
Ltd
Capital Goods Manufacturer of
plastic piping
Non-tradable Yes
CMA
Corporation Ltd
Capital Goods Metals re-
cycling
Non-tradable No. Successful
company
protected by
transport costs
CSR Limited Capital Goods Diversified
industrial group,
sugar and
aluminium
Tradable No. Primary
producer
Dexion Limited Capital Goods Manufacturer of
industrial
storage systems
Non-tradable No. Protected by
transport costs
Dulhunty Power
Ltd
electrical
distribution
systems
Tradable No. Too small
Embelton
Limited
Capital Goods Manufacturer &
distributor of
flooring
products
Non-tradable No. Small.Some
specialty
manufacture in
support of
operations
Essa Australia
Ltd
sampling
equipment for
the mining
industry
Tradable No. Very niched
manufacturer,
highly
successful
though

Fisher & Paykel
Appliances
Holdings Ltd
Consumer
Durables &
Apparel
Manufacture of
white goods
Tradable Yes
Frigrite Limited Capital Goods Manufacturer of
refrigerated
display cabinets
Non-tradable No. Loss
making
Fleetwood
Corporation
Automobiles &
components
Manufacturer of
Caravans &
portable homes
Non-tradable Yes
GUD Holdings
Ltd
Consumer
Durables &
Apparel
Manufacturer of
small
appliances,
lawnmowers,
poll equiopment
Tradable Yes
GWA
International
Limited
bathroom fitting,
doors,
lawnmowers
and household
furniture
Tradable Yes
Hastie Group
Limited
Capital Goods Installation of
air-conditioning,
commercial &
industrial
Non-tradable No. Limited
local
manufacture
JV Global
Limited
building
materials,
property
investment
Non-tradable No. Small
Korvest Limited Capital Goods Galvanising,
sheet metal
fabrication
company,
mining related
Kresta Holdings
Ltd
Consumer
Durables &
Apparel
Window
coverings and
retail
Tradable Yes. Mixture of
manufacture &
distribution
Ludowici Ltd Capital Goods Equipment for
mineral
Tradable Yes. Successful
company,

processing
industry
mining related
Maxitrans
Industries
Limited
Capital Goods Design &
manufacture of
transport
equipment
(trailers)
company
Nylex Limited Capital Goods Manufacturer &
distributor of
branded
products
(Gardena) and
plastic tanks &
garbage
containers
Tradable No.
Performance
erratic. Difficult
to determine
extent of local
manufacture
Nomad Building
Solutions
Limited
modular
transportable
buildings
Non-tradable No. Similar to
Fleetwood.
Massively
profitable
company
Oldfields
Holdings
Limited
Capital Goods Manufacture &
distribution of
paint brushes,
garden sheds etc
Tradable/Non-
tradable
No. Tradable
production done
in Indonesia.
Successful
company
Pacifica Group
Ltd
Automobiles &
Components
Manufacture of
braking systems
for the OEM
market
Tradable Yes
Quantum
Energy Ltd
Consumer
Durables &
Apparel
Manufacturer of
energy saving
hot water
systems
Non-tradable No. Erratic
trading history.
Regulatory
barriers to
import of similar
product
Rectifier
Technologies
Ltd
power rectifiers
Tradable No. Small and
heavily loss
making in recent

years
Schaffer
Corporation Ltd
Automobiles &
Components
Automotive
leather, building
products
Tradable &
Non-tradable
Yes
Skydome
Holdings Ltd
skylights
Non-tradable No. Small &
loss making
Saferoads
Holdings
Limited
road safety
equipment,
roadside barriers
etc
profitable
manufacturer
Style Limited Capital Goods Manufacturer of
floor coverings
Tradable No. Small &
loss making
Zicom Ltd Capital Goods Manufacturer of
oil hydraulic
equipment and
precision
manufactured
machinery
Tradable No. Successful
company but
production
spread over
Australia,
Thailand &
Singapore
Companies which de-listed prior to 2008
Company Sector Business Tradable or
Non-tradable
Included in
Study?
Bridgestone
Australia
Limited
Capital Goods Tyre
Manufacture
Tradable No. Profitable
but declining
trend due to
input costs
CDS
Technologies
Ltd
waste water
treatment
systems
Tradable No. Technology
start-up went
broke

Dream Haven
Bedding Ltd
Manufacturer of
floor coverings
Furniture
manufacturer
Tradable No. Went
bankrupt in
2002
Farnell &
Thomas
Capital Goods Light
engineering
Non-tradable No. Went out of
business in 1999
National Forge
Limited
forged metal
components
Tradable No. Went out of
business 2004
Rib Loc Group
Ltd
Capital Goods Proprietary
technology in
pipe renovation
market
Tradable No. Small And
loss making, de-
listed 2004
SDS
Corporation
Limited
equipment for
mining
construction &
oil industries
Tradable No. Very
successful and
profitable.
Taken over by
Sandvik of
Sweden in 2005

AustralianManufacturingand the commoditiesboom

Empfohlen

Empfohlen

Weitere ähnliche Inhalte

Was ist angesagt?

Was ist angesagt? (20)

Andere mochten auch

Andere mochten auch (11)

Ähnlich wie AustralianManufacturingand the commoditiesboom

Ähnlich wie AustralianManufacturingand the commoditiesboom (20)

AustralianManufacturingand the commoditiesboom