Tuesday 21 January 2020

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Australia: the economic miracle caught up by the climate crisis 

By Juliette Cohen and Bastien Drut, Strategist at CPR AM

The Australian economy has long seemed protected from the global economic and financial crises of the past decades. Indeed, the last recession that the country experienced occurred in 1991... almost thirty years ago! Australia has indeed thrived on the development of its mining industry (iron, coal, gold), which has prompted a number of criticisms for its role in climate change. However, the country is facing new domestic and international challenges. In particular, the massive bushfires that Australia has experienced in recent weeks show that the island is directly threatened by climate change. This text looks into the exceptional climatic events that occurred this year in Australia, as well as their consequences for the economy of the country. 

The Australian economic miracle

The Australian economy has long seemed protected from the global economic and financial crises of the past decades (Asian crisis of the late 1990s, Great Recession of 2008/2009, crisis in the euro area). In fact, the last recession that the country experienced occurred in 1991... almost thirty years ago! The rapid economic development of China and the colossal needs of this country in raw materials constituted an obvious outlet for the raw materials extracted in Australia (iron, coal, gold): over the last quarters, China represented around 40% Australian exports (compared to less than 10% in the early 2000s). The development of the mining industry initially propelled Australian growth thanks to massive investments made in the sector then thanks to exports. In 2017, Australia was the third largest coal producer in the world and the largest net exporter (narrowly ahead of Indonesia).

As a corollary of this economic strength, the Australian central bank (RBA) has long been, with the New Zealand central bank, the central bank of developed countries with the highest policy rates: the rate of RBA was 7.25% in 2008. The sharp drop in key interest rates that followed the Great Recession of 2008/2009 led to a very sharp acceleration in property prices (+ 8% per year on average over the period 2013-2017) and generated a sharp increase in household debt (from 110% of disposable income in 2008 to 142% in 2019). With the exception of Switzerland, Australia is the developed country with the highest household debt when taken as % of GDP. The combination of this high household debt and the downturn in the real estate market (prices have been falling since the end of 2017) has implied a very marked slowdown in economic growth. The Australian economy is therefore now facing major domestic challenges (household debt and very high property prices) as well as international challenges (slowdown in China). And as we will see, global warming is now an additional threat. 

2019, the year of all-weather records 

Since September 2019, Australia undergoes fires of an unprecedented scale that affect more particularly the south and the east of the country. But beyond these dramatic fires, 2019 turns out to have been an exceptional year since other extreme climatic phenomena took place throughout the year. First, temperatures throughout the year exceeded on average 2.1 ° C over the years 1961-1990. This trend was noticeable from the start of 2019 when in Victoria State for instance, historical temperature records were broken (47.6 ° C on January 25, 2019). 

Between February and April 2019, floods hit certain regions (notably Queensland, in the northeast of the country), causing significant losses of livestock. These heavy rains did not prevent the year 2019 from being the year when the drought was the strongest of the period 1900-2019 with only 277.6 millimeters of rainfall on average on the country, that is to say 40% less than the long-term average. We have to go back to 1902 to find an almost similar drought. Dust storms and hailstorms also hit the country and destroyed vineyards. 
MétéoFrance explains these extreme phenomena by the fact that in 2019 Australia experienced strong atmospheric circulation anomalies in addition to the context of global warming. Two phenomena explain more particularly that the climate was warmer and drier this year. First, the “Indian Ocean Dipole” in a strongly positive phase during the second half of 2019 caused warmer than normal waters on the west side of the Indian Ocean, and colder waters to the east on the Indonesia side, favoring downward atmospheric movements and chronic drought towards Australia. Secondly, the “Antarctic Oscillation” in negative phase led to lower pressure in the south of Oceania than 'in Antarctica, involving a supply of hot and dry air in the Australian desert. The Australian Bureau of meteorology did not expect the situation to improve before the return of precipitations in late January 2020. 

What is the economic impact of the bushfires?  

Beyond the financial cost of destruction, which is relatively limited since the bushfires affected sparsely populated areas, the bushfires will have a direct impact on GDP growth in the 4th quarter of 2019 and at the start of 2020, the extent of which varies greatly depending on the estimates. This direct impact will be felt on tourism, which is one of the main resources of the country (just over 3% of GDP and around 5% of employment), on agricultural production and on private investment.

According to the credit rating agency Moody's, the economic impact of the bushfires should be limited since it would be less than 0.1% of GDP in 2020 and 2021. However, while the agency is rather optimistic in the short term, it is much more cautious about the long run because it believes that "more frequent and more severe natural disasters are likely to result in increasing and recurring costs, testing the ability of the federal and state governments to pay debts”. On the other hand, the cost of the water- and electricity supply cuts for numerous households and businesses, road closures and mass evacuations is difficult to assess. The same is true for the air pollution generated from the bushfires, which also has a significant impact on activity. In addition, as we have seen previously in this text, Australia experienced several extreme weather events during 2019 and it is therefore likely that the "total climate cost" for the Australian economy will be much higher. In a speech on March 12, 2019, i.e. well before the episode of massive fires in recent weeks, RBA deputy governor Guy Debelle already estimated that drought should cost 0.15% growth to the economy Australian market in 2019 mainly through its impact on agricultural production. Finally, focusing only on the direct impact on GDP growth (which constitutes a flow) of natural disasters is obviously very simplistic since they mainly affect the wealth of a country, whether it is the environment, the biodiversity, real estate or means of production. The high human, environmental and economic impacts as well as the country's vulnerability to climate change make it difficult to understand the current government's small ambition on the subject. And Australia is starting to be singled out internationally. In November 2019, the Riksbank announced1 that it would no longer invest its foreign exchange reserves in bonds of issuers with a high carbon footprint.

It therefore proceeded to sell securities issued by the states of Queensland and Western Australia (as well as securities from some Canadian provinces).

Australia's controversial climate and energy policy

Australia has long held the sad record for per capita CO2 emissions. Even if efforts have been made since 2008, Australia produces 15.4 tonnes per capita (2014 data) which makes it the 2nd most polluting country on the planet behind the United States (16.5 tonnes) or almost double the OECD average (9.5 tonnes) and much more than its neighbor New Zealand (7.7 tonnes). 

The country's energy mix offers an important place for coal (30%) and oil (39%). The share of coal reaches almost 60% in the electricity production and fossil fuels 80%. Although Australia has very large uranium resources (33% of the world's resources), the country has banned the development of nuclear power plants to generate electricity. Over the past decade, the nuclear debate started again with the need to lower the country's CO2 emissions, reduce electricity prices and manage the aging of coal-fired power plants. Investigations into the exploitation of nuclear energy and the lifting of the ban on the exploitation of Uranium started in mid-2019 by the Ministry of Energy under the impulse of the Prime Minister, Scott Morrison, favorable to the repeal of the nuclear ban. 

The share of renewable energy is still relatively low in Australia and especially if we consider solar energy relative to the country's capacity.
From a CO2 emissions standpoint, it is mainly its mining sector and more particularly the production of coal and gas to produce energy that generates almost three quarters of its emissions.

Carbon Tax: Because of its dependence on the mining industry, Australia has always been reluctant to adopt binding measures to fight rising CO2 emissions and climate change. The rapid reversal of position on the carbon tax illustrates this.After years of debate and on a proposal from the Labor government, the introduction of the carbon tax was passed by parliament in November 2011 in an ambitious form since the price of carbon had been set at 23 Australian dollars per tonne against an equivalent between 8 and 13 dollars in Europe. The law planned to transform the carbon tax into an emissions trading system (ETS) from 2015. It came into effect on July 1, 2012 and quickly became unpopular despite offsetting measures, lower taxes and higher retirement pensions, for low-income households, because mining groups have passed on the increase in costs generated by the carbon tax in electricity sales prices.
The 2014 elections saw the Liberal government come to power with the promise to abolish the carbon tax. Its leader, Tony Abbott, will succeed in abolishing the carbon tax in July 2014. Since then, no binding mechanism to reduce CO2 emissions has emerged, successive governments having favored incentive measures. In 2014, an Emissions Reduction Fund with $ 2.5 billion funding was created to encourage the implementation of solutions aimed at reducing emissions. Australia then developed its voluntary carbon credit market, initiated in 2011, which allows project developers who meet strict reporting criteria and standards to generate carbon credits. A project can earn an ACCU (Australian Credit Carbon Unit) for each tonne of carbon dioxide equivalent (tCO2-e) stored or avoided. Then, owners can sold ACCUs to generate income, either to the government through a carbon reduction contract, to private parties under contract, or through secondary market.  

Despite an unprecedented scale and a terrible human and environmental toll, this fire season should not have a major impact on the country's growth in the short term. Nevertheless, it is likely that the economic impact of climate change is set to increase with the frequency of extreme climate events in Australia. In the short term, it would seem that the major impact is more of a political order for this economy closely linked to fossil fuels. Critics go up on government for its timid action on the climate and could push for a change in its policy, particularly in the energy field. According to the Lowy polling institute, 64% of adult Australians see climate change as a "major threat", up 6 points from 2018 and 18 points from 2014.   

Date of publication: 20 January 2020 

1 Monetary policy in a changing world, Gouverneur Martin Flodén, 13 novembre 2019 

Find below the full document.

Juliette Cohen 

Strategist at CPR AM 

Bastien Drut

Senior Strategist at CPR AM

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