Will China's insatiable demand for resources save Australia from a global downturn? Two of Australia's leading economists say no. Sophie Loras reports.

Morgan Stanley economist Gerard Minack has no qualms about the role the resources boom will play in protecting Australia against a global downturn - none. The prospect of rising export volumes (especially from China) won't save Australia from going bust, he says.

In a recent report, Minack says the mining boom is ‘relatively trivial' compared to other economic factors. "The boost in national income from higher mining exports could easily be offset in any one year by a set-back in either prices or a decline in mining-related investment," Minack says. "Any fall in the terms of trade could easily - and in my view, most likely will - offset the likely volume acceleration.

His concern is that the mainstream view - that mining exports will ensure a ‘Tefloncoated economy' in Australia for some years to come - is misguided. "The key support from the mining boom has come from rising export prices and the investment ramp-up, with the strong spillover effects to the domestic property, financial and retail sectors."

He points to 2007 figures which show the mining boom collapsed last year. "Having recorded three years of 30 percent annual growth, mining exports fell last year because of price declines," he says.

Minack believes the mining boom has most likely already passed its peak and it is unlikely Australia will see another three where growth was as strong as it was in the three years to 2006.

Finance, business and property sectors have contributed more to GDP growth over the past five years than mining and construction.

Last year, finance, business services and property contributed more than 20 percent to Australia's total GDP compared with just over 14 percent from mining and construction. "These sectors have also been big hirers. Add in another secondary benefit of the boom - retail and wholesale - and you have the two biggest employment sectors."

It is the booming financial, property and retail sectors - not mining and mining-related sectors - which have been behind Australia's lowest unemployment rate in 30 years, says Minack.

The concern for 2009 is that while mining export volumes rise, the domestic economy could simultaneously move into near recession conditions. "Whether GDP actually contracts will be a moot point - the rise in mining export volumes will be an important statistical support, but an irrelevant one ."

The view that a mining boom will not save Australia is echoed by Westpac chief economist Bill Evans. During a recent trip to Beijing, Evans told Australia China Connections he firmly believed the mining boom would not protect Australia from a global recession. Like Minack, Evans believes the root of a financial downturn in Australia is unrelated to the mining sector.

"The economy is going to slow down, there is no doubt about it, but it's not going to be because of the mining boom - it's going to be because the Reserve Bank is raising interest rates, because of the tightness of credit and the rising interest rates associated with that not the mining boom," says Evans.

Evans' argument centres on the composition of world growth so that while world growth has ranged between 4 percent to 5 percent a year, the developed world has contributed just 1 percentage point to that growth.

"The issue is not will the downturn in the developed world lead to a collapse in global growth, the issue is, will the impact of a slowdown in the developed world lead to a major slowdown in the developing world which is contributing about 3.5 percentage points of the 4.5 percentage points of global growth," says Evans.

Looking specifically at China, which is responsible for about 2 percentage points of that 4.5 percentage points of global growth, Evans argues that growth in China, which grew by 11.5 percent last year, can be broken down to 4.5 percent of growth coming from investment, about 4.25 percent from consumption, and 2.75 percent coming from net exports.

"Our assessment of the likelihood of investment slowing down substantially in China because exports slow down is [that] the effect will be somewhat moderate," says Evans.

While Evans can see exports slowing, and therefore net exports only contributing 1.5 percentage points to China's growth next year, he doesn't see the export sector slowing as having a major impact on overall investment in China.

"We would still be looking at China investment to be growing at around about that 23, 24 percent pace. As a result, I think that the global economic outlook is still reasonably solid, and therefore from Australia's perspective, the stimulus coming from the global economy will still be of great assistance to Australia."

The biggest concern for Australia is that while the demand side of the economy will do very well from the external sector, Australia is also reliant upon financing its current account deficit. And while the demand stimulus comes from the new world, the supply of capital to finance current account deficits comes from the old world.

"We have seen the dislocation that the weakness in the global credit market has had on the cost of funding for the Australian banks," says Evans. "It is the Australian banks that have evolved as the vehicle to finance most of Australia's foreign debt in recent years."

The biggest impact on the Australian economy, is not a collapse in activity in the world economy - Evans remains confident of the sustainability of China and other developing countries - but relates to the dislocation in capital markets linked with the subprime crisis in the US.

"That's already showing up as sharply increased funding costs for banks which are being passed on to corporate, business and retail borrowers," says Evans. "And it's that particular mechanism that is the real source of the slowdown in the Australian economy."

Evans says the economy would have continued to slow as the Reserve Bank lost patience with the inflation environment in Australia. "There are recent forecasts which suggest they expect inflation to remain above the top of their confidence band - 2 percent to 3 percent - for the next three years, and that is clearly an unacceptable position for the Reserve Bank."

Evans says the Reserve Bank would have continued to raise interest rates until it became clear that the momentum of domestic demand growth in Australia was slowing substantially.

And while Evans believes that objective has been achieved, he expects that where domestic demand grew by nearly 6 percent in 2007, it will slow to 2 percent in 2009. "So Australia will slow down but it won't be because of the weakness in the global economy - partly because of the resilience of China and the other developing economies - Australia's slowdown will come as a result of higher interest rates, tighter credit associated with the blow-out in inflation in Australia and the deterioration in global credit markets."