Pete Wargent blogspot
Co-founder & CEO of AllenWargent property advisory, offices in Brisbane (Riverside) & Sydney (Martin Place) - clients include hedge funds, resi funds, & private investors.
4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.
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Friday, 25 January 2013
Australia's comparative advantage
We have a tendency to believe in life that for any winner there is a loser, such as there is at a day at the footie.
But this isn’t so in economics at all: economics is not a zero-sum game.
Economist David Ricardo (yes, that Ricardo, he of Ricardian equivalence fame) introduced in the early nineteenth the idea of comparative advantage in his book On the Principles of Political Economy and Taxation.
In economics, the law of comparative advantage is the ability of one party to produce a particular good or commodity at a lower marginal cost than another.
Thus even if one country produces goods at a lower cost than another, through trading with each other both countries will be better off in the long run, provided that their relative efficiencies are different.
Ricardo used the 19th century example of Britain and Portugal: Britain should focus on producing cloth and Portugal on producing wine. Provided that trade costs are not too high and tariffs do not distort the market, Britain and Portugal through trading with each other should be better off.
This key law of economics – comparative advantage - is vitally important to the future economic health of Australia.
Only so many heads…
With a population of around 23 million and only a relatively small percentage of that number actually in the workforce Australia is limited in what it can achieve – there are only so many pairs of hands and so many hours in the day.
Have you ever had a CEO who is “detail-focussed and hands on”? And you thought: “he could add more value by just being a CEO and managing the company - which is what he’s good at - instead of wasting my time checking whether accounts payable is up to date!”
It’s a little like that with countries. We need to focus on our core competencies and stick to what we are good at.
We don’t need to excel at everything
This is where the law of comparative advantage comes in – Australia does not have to excel at everything.
We do not have to compete with China in the production of cheap consumer goods and we can outsource, for example, our call centre jobs to India. Australia will focus on what it does well: digging up resources and exporting them, tourism, financial services expertise.
It might be argued that by sending our call centre type jobs to India that we lose and India gains. In one sense this is true and in the short term this costs Australia jobs. And certainly India benefits from our outsourcing.
But the argument is that over the long run Australian companies become more profitable by cutting costs and thus shareholders and executives in our companies become wealthier.
By each country concentrating on what it does best, we can all be better off. China does not have to focus on ripping up copper, instead it can concentrate on fulfilling one of the greatest booms in the history of the world.
Australia does not have to manufacture cheap consumer goods for export – we simply need to capitalise on our mineral wealth and our main cities becoming financial centres.
The rules have changed
The world has moved on since Ricardo’s day and it has been warned that as it is so easy to transfer wealth and assets between countries, to some extent the old rules no longer apply.
At the click of a computer button companies and individuals can elect to invest their assets overseas and funds are flowing faster than ever before.
High cost country
There is a downside to these trends which you may have already noticed occurring.
Australia is becoming a high-cost country. Whatever the inflation figures may say, the cost of living in Australia has increased. Property prices in the major capital cities are also increasing.
Wages have increased by 11.3% over the last 3 years, but do we really feel any better off?
Ask most people and I doubt they would say so unless, of course, they own some of that prime location real estate.
Over time those with solid share portfolios will be winners too, but at the moment share market sentiment is only in the process of returning to where it was before the financial crisis.
Over the last couple of decades I’ve watched London shifting from a mildly unaffordable city into one which is grossly so.
With so few restrictions on foreign capital flowing into the city and panicked investors fleeing the Eurozone, house prices have become so far removed from salary multiples that there is almost no link today.
Depending on your source a median salary might be a little over £30,000. The median cost of a dwelling? I shudder to think and again it depends upon your source, but try around £400,000.
Whichever way you look at it, the multiple of income is very high.
In other regional parts of Britain, property prices have tumbled very sharply and have hardly shifted in half a decade. They may start to do so as more aggressive mortgage products filter back into the market such as 95% loans.
If Australians are looking at buying property today as an investment, it would not make sense to me to look at regional Australia. Funds are flowing faster than ever before - and where they flow to is major financial centres.