What the U.S. Can Learn from Australian Coal Mines

Originally published in Bloomberg News

July 11, 2012
Edward Glaeser (Glimp Professor of Economics, Harvard University)

America became great because it transformed its vast natural resources -- Iowa farmland, Mesabi iron, Texas crude -- into human capital, equipped with skills to succeed in the Information Age.
Now, when human capital is king, some look toward Texas and North Dakota and see natural-resource extraction as a path to economic rejuvenation. But if we look at Australia, the model of a major mineral producer, we see that widespread prosperity comes not from the stuff beneath the ground but from the stuff between our ears.
Yes, the U.S. would be fortunate to exchange its painful 8.2 percent unemployment rate for Australia’s healthy rate of 5.1 percent. According to the International Monetary Fund, at current exchange rates, Australia had the highest per-capita gross domestic product in the world in 2011, among all countries with more than 10 million people.
Australia’s extremely high per-capita nominal GDP of $65,000 reflects high exchange rates more than outsized GDP growth, but by any measure Australia has had some good years. From 2006 to 2011, its real GDP increased almost 13.8 percent. Over the same five years, real GDP in the U.S. grew only 2.75 percent.
The popular explanation for Australia’s economic success is that it is Wyoming with good weather, and has the luck to be China’s energy supplier. In this view, fortunes are made by billions of tons of coal and iron ore, carried from the Pilbara mines in Western Australia by mile-and-a-half-long trains to cargo ships headed for the factories of Shanghai.
Coal Exports
The country’s iron-ore and coal exports are certainly vast. In 2011, it exported A$64 billion worth of iron ore and A$47 billion worth of coal. (Conveniently, Australian and U.S. dollars are almost equal in value.) Together, iron ore and coal represent 42 percent of Australia’s total exports. The three largest recipients of total Australian exports are China, Japan and South Korea, which got 27 percent, 19 percent and 9 percent of shipments, respectively.
The Pilbara region produced more than 400 million metric tons of iron ore in 2011, which is about 125 pounds for every person on the planet. Giant mining companies use 215-ton shovels to fill an endless line of trucks that carry the dirt to 3,500- ton crushers. The scale and logistics are daunting, and so are the profits.
Yet mining plays a relatively modest role in the overall Australian economy, and employs a positively tiny share of its people. The Australian Bureau of Statistics shows that mining and mining services together contribute less than 10 percent of the country’s GDP. Only 2 percent of Australians work in the mining sector.
In Western Australia, which produced more than A$62.8 billion worth of iron ore in 2011, iron-ore companies employed only 33,345 people. Iron-ore producers, as a whole, spent less than one-tenth of their total earnings on wages and salaries; 42 percent of those earnings became pretax profits.
Mining does little for Australian employment because mining is profoundly capital-intensive. Ore is pried from the Earth by computer-controlled blasts. One insightful article reminds us that mining is not men “wielding pickaxes, but sitting in prefab offices with keyboards, watching on video monitors.” Even those 1.5-mile-long trains will soon be driverless.
The Australians themselves seem to think their economy is far more mining-intensive than it is in reality. One recent survey found that, on average, Australians believe the mining sector “employs nine times more workers than it actually does” and “accounts for three times as much economic activity as it actually does.” Australians may prefer to see themselves as a nation of rugged extractors, rather than as a conventional service-based economy, but overestimating the importance of natural resources can lead to faulty public policy.
Dangerous Dynamic
Australia is lucky to have its mining revenue, but that cash has a cost. For decades, economists have fretted about the Dutch disease, which can occur when natural-resource exports push up exchange rates. Australia has experienced a steady increase in the value of its dollar, and a high exchange rate makes it more difficult to export other products. The really dangerous dynamic occurs when high exchange rates crowd out more innovative industries that employ more typical Australian workers.
A recent paper I co-wrote with William Kerr and Sari Pekkala Kerr examined the long-run impact of mining across the U.S. Fifty years ago, the economist Benjamin Chinitz noted that New York appeared even then to be more resilient than Pittsburgh. He argued that New York’s garment industry, with its small setup costs, had engendered a culture of entrepreneurship that spilled over into new industries. Pittsburgh, because of its coal mines, had the huge U.S. Steel Corp. (X), which trained company men with neither the ability nor the inclination to start some new venture. A body of healthy literature now documents the connection between economic success and measures of local entrepreneurship, such as the share of employment in startups and an abundance of smaller companies.
Our new paper documents Chinitz’s insight that mineral wealth historically led to big companies, not entrepreneurial clusters. In Australia, iron ore and coal are mined by giant corporations such as Rio Tinto Plc and BHP Billiton Ltd., and giant enterprises typically work best with other big companies. Across U.S. metropolitan areas, we found that historical mining cities had fewer small companies and fewer startups, even today in sectors unrelated to mining or manufacturing, and even in the Sunbelt. These mining cities were also experiencing less new economic activity.
Low Taxes
Australia’s economic future depends on using its mineral wealth wisely, following the example of Iowa farmers who once used their corn profits to fund high schools. Yet Kevin Rudd, a former prime minister of Australia, was ousted in a backdoor political coup in 2010 partially because of his support for an extra mining tax. I’m against almost all industry-specific taxes, but the share of miners’ “resource profits” returned to the Australian government in the form of taxes and royalties fell from about 40 percent in 2001 to less than 20 percent seven years later.
It is a fiction that U.S. economic woes could be solved if only the nation adopted a “drill, baby, drill” attitude toward natural resources. Less than 0.6 percent of American jobs are in natural-resource extraction. Even a vast increase in drilling employment would have a trivial impact on U.S. jobs. Oil prices are set in the world market, so American production can do little to radically decrease the global price of petroleum.
The wealth that comes out of the ground is a short-term windfall, not a long-term source of economic growth. The U.S. and Australia should both recognize that their futures depend on training smart, innovative entrepreneurs and reducing the barriers that limit their success.
(Edward Glaeser, an economics professor at Harvard University, is a Bloomberg View columnist. He is the author of “Triumph of the City.” The opinions expressed are his own.)