Mission is to manage politics of prosperity

HAVING survived the global recession, can Labor also survive the resources boom?

TREASURY chief Ken Henry warns the present resources boom is almost surely the greatest external shock to Australia's economy in our history, the implication being that Gillard Labor's defining task is to manage the boom.

Yet the Prime Minister rarely defines her challenge this way, surely an oversight. The politics of the boom remain poorly grasped though its dangers are seared into Labor's psyche after the pre-election revolt over Kevin Rudd's resource super profits tax.

Let's not forget this boom has a list of victims: it claimed Rudd, who would have survived as PM but for his resources tax; it undermined John Howard, who was diminished for failing to invest properly the boom's proceeds and who embarked on Work Choices only because the labour market was so tight; and it is guaranteed to create vast problems for Julia Gillard.

The boom, in fact, is fragmenting national politics because it operates as a massive disruptive force generating new sets of winners and losers by job, industry and location. Firm policy responses are needed to manage such disruptions. Labor would deny this, but the signs are that the government lacks any integrated response to the terms of trade boom.

The challenge for the Rudd-Gillard Labor era is fantastic in its conception: having steered Australia through the worst global downturn for 80 years, Labor's historic mission is actually to manage the dangers of success. The pivotal question becomes: with its victory over the global recession behind, will Labor fail at managing the politics of prosperity?

The task is daunting because boom is stunning. Treasury estimates the mining industry is planning an extra $55 billion of investment in 2011-12 mainly in liquefied natural gas and iron ore, five times the pre-boom level. Over the decade resource export prices have risen by 300 per cent.

The economy is forecast to grow above trend, with unemployment falling to 4.5 per cent, the dollar at its highest level since the float and the budget at surplus by 2012. In other rich nations net debt will peak at 14 times that of Australia's projected peak. West Australian Premier Colin Barnett says the west presides over one of the greatest resource developments in world history. This boom is chaining Australia as never before to the economies of China, East Asia and India. The upside is very good.

But the boom means, in Henry's words, a three-speed economy: a fast-growing mining sector, a slow-growing trade sector outside mining, with the domestic economy in the middle.

In short, not everybody's income gets a boost. The benefits are spread unevenly. The high dollar raises costs and makes much of industry more uncompetitive, with the mains losers being tourism, manufacturing, farmers and the tertiary education industry.

This is a dangerous coalition. Complaints are loud and sure to grow louder.

Hence Henry's warning this week: the worst government response is to panic, go to retail politics and offer special deals to struggling industry.

How long will the dollar stay high? Nobody knows, but Treasury and the Reserve Bank see the boom extending over a couple of decades. It is a long-run structural event for Australia.

The key to its management is the floating exchange rate, the most important economic reform since World War II. The float means the boom is absorbed by a higher dollar, not higher inflation. Inflation will not reach 17 per cent as it did in the 1970s terms of trade shock. Yet the boom coincides with an economy close to capacity creating a serious inflation risk.

Central bank governor Glenn Stevens has the task to deny higher inflation beyond the 2-3 per cent band and nobody doubts his resolution. This is the reason interest rates are rising and will continue to rise. Higher rates are the bank's chief policy weapon to manage the boom. Here is the black hole in the retail politics now being played over the banks. Yes, Labor is feeling the political heat but the temperature via higher rates has a long way to run. What is Labor's message for next year?

Consider wages. Unsurprisingly, wage deals are on the rise, with workers responding to pricing pressures. Labor has created expectations in terms of gender equity, a strong minimum wage and more union negotiating power. Australia will not return to the destruction of a centralised system but the test is squarely on the table: how compatible is Labor's new industrial system with managing the resources boom? The trade-off is obvious: if wages spill into inflation then Stevens must lift rates even higher. Such a policy failure is not being predicted but any such failure would terminate Labor's right to govern.

Meanwhile, Henry keeps emphasising the role of tax policy in managing the three-speed economy and spreading the boom's benefits. Gillard's immediate test is to turn her modified mining tax pledge into an acceptable and viable policy. It remains an article of Labor faith.

Yet the design is flawed and the task is filled with multiple risks. Beyond that, tax reform to manage the resources boom is a shocking political brief with Henry's message being the need for less tax on capital and workers and more tax on consumption, land and minerals. Don't expect Gillard Labor to jump this way.

The bigger picture suggests Australia is becoming a split political personality courtesy of the resources boom. In the pro-Labor base of Australia's southeast where Gillard saved her political neck, the issues are carbon pricing, broadband, gay marriage, the Labor-Green alliance, fairness and redistributing the benefits from the boom that remains out of sight and out of mind. On the opposite side of the continent, WA is alienated from the Labor establishment, its policies and the agenda of Henry's Treasury. Gillard's primary vote at the August poll was below 32 per cent in the west. There is insufficient Perth-Canberra policy collaboration over how to make the boom work.

Barnett, no state rights fanatic, refuses to accept the mining tax, surrender a third of his GST revenue to Canberra or tolerate the distribution of GST revenue where the west's subsidy to other states has become untenable.

The risk for Gillard is that Labor will surrender to the Coalition the west and north of the nation with its rhetoric and policies geared to its southeastern base. This does not constitute a national strategy for a big nation undergoing a boom that has attracted the attention of the world.

Labor will sink or swim this term on one test: can it manage the benefits and dislocation caused by the resources boom?