Warwick McKibbin says look past volatility, Australian dollar assets will rise

Ben Potter

Updated Feb 4, 2016 – 3.10pm, first published at 10.36am

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Obsessed by weak commodity prices and volatility in global financial markets to the point of not thinking about the future?

Don't be, advises top economist and former Reserve Bank of Australia board member Warwick McKibbin.

Australia is better placed than most countries to benefit from long-term global trends - such as population ageing, fiscal adjustments and the shift in economic clout from Europe to Asia, Professor McKibbin says.

Australia is better placed than most countries to benefit from long-term global trends, says economist Warwick McKibbin. Michel O'Sullivan

Taking a five-year view, capital should flow out of economies battling rapid population ageing and slow growth - such as Japan and Europe - and into better-placed economies such as Australia, the US and emerging markets.

That means fixed assets such as housing - currently facing a "bubble" - and farms are likely to remain attractive, long-term investments, and the $A should strengthen too.

"It's a relative issue and on most of the key relative issues Australia is in a position to attract capital rather than lose capital," Professor McKibbin tells The Australian Financial Review.

Chinese middle class is expanding

"If you have got something like a fixed asset in a country and you are globalising the entire world then location becomes a valuable asset."

"Real estate on Sydney harbour for example is also from a national point of view attractive. But for foreign investors it's also very attractive because there's billions of dollars of wealth being generated in China.

"The middle class is expanding, and they're going to want to buy things, environmental goods - they're going to want to buy stuff which we actually have in abundance. But much of it is fixed assets so you can't change the supply of it, and so therefore it's value is likely to go up a lot."

Australia's population is among the word's highest

There are catches. High housing valuations could be less manageable if interest rates rise, which is unlikely but can't be ruled out, Professor McKibbin says.

Inflowing capital will make it cheaper to invest in capital goods and infrastructure to make the economy more productive.

But it will also drive up the real exchange rate, hurting the competitiveness of trade-exposed industries such as tourism - currently enjoying good growth with a lower Aussie dollar - and manufacturing. A stronger dollar means Australian goods and services are more expensive for foreigners while competing foreign goods and services are cheaper for Australians.

That increases the onus on governments to enact productivity boosting changes in the economy - for example to taxes - so that input costs for Australian businesses can be lower even with a higher exchange rate.

Prime Minister Malcolm Turnbull during the GST debate in Parliament last week. Andrew Meares

The Turnbull government is mired in debate over plans to ease labour market rules and raise the GST to fund income tax cuts and health spending. Backbenchers fear raising the GST could backfire on them in this year's election.

Professor McKibbin says the plan is on the right track. "I think the efficiency of taxing consumption rather than working is pretty clearly established," he says.

Reform is still challenge

Long-term trends favouring Australia include a relatively benign ageing problem, low public debt, proximity to giant emerging economies such as India and China and comparative strengths that match their needs such as mining, energy, education, food production and services.

The challenge for Australia is to enact major domestic reforms to improve competitiveness even with a strong dollar, cut deficits and to take advantage of sustained low global interest rates to build infrastructure and skills to boost productivity growth, Professor McKibbin says.

Australia's population is ageing more slowly than those of Japan and Europe Warwick McKibbin

That doesn't mean trying to become cost competitive in things we're not good at such as building cars, or picking "industries of the future", but it does mean fixing tax distortions that make it harder for these industries to emerge.

"The role of govt there is to create the environment where it's easy to start industries and to prosper and to do things, rather than to try and pick winners," he says.