This article first appeared on the Business Spectator web site in February 2013: At this link: 

The Australian dollar was around US$1.03 at the time this was written.

Western Australia’s easy ride

Contrary to most perceptions, the Western Australian economy has had something of a free ride courtesy of its membership of the Australian Federation. Rather than being held back by the weaker eastern states, the fact that the Australian dollar and interest rates have been held lower because of the soft economic conditions in the eastern states means its economic growth has received a terrific boost from having easy macroeconomic policy settings to support it.

Opposition Leader Tony Abbott was ebullient in his praise of WA when speaking at the official launch of the Western Australian Liberal State election campaign, where he said: “All of us owe a debt to you. Every Australian owes a debt to Western Australia.”

Always ignored when that type of gushing praise is heaped on WA is the fact that as a member of the Federation, the state is subject to the same interest rates and same currency as eastern Australia (defined to be everything but WA). In addition to that, it is overwhelmingly the case that the Western Australian coast line is expensive to protect in defence and border protection terms, national management issues that are paid for in large part by eastern Australian taxpayers.

To monetary policy and exchange rate matters first.

Let’s be clear. The mining boom has propelled Western Australia into the fast lane of economic growth. It is booming, with a rapid expansion and very low unemployment with wages growth and inflation generally above the national average. It is wonderful to see such strength and dynamism in such a small part of the world.

Given the resource sector underpinnings and blessing of geographic proximity to the boom part of the world economy, Asia, the economy of Western Australia would be doing exceptionally well in almost all circumstances.

That said, if Western Australia was its own country with its own interest rates and currency, as some mainly Coalition politicians suggest should be the case, there is no doubt the WA Dollar – let’s call it for now – would be massively strong not least due to probable large international trade surpluses. How strong is hard to judge but without the economic softness of the eastern Australia “holding back” Western Australia, it might well be the case that the WA dollar would already be $US1.20 or more. At the same time, the eastern Australian dollar would be lower, may be $US0.90 or so, giving it a significant competitive boost against the rest of the world, including Western Australia.

This means, quite simply, that the economic softness of eastern Australia has been a factor dampening the Australian dollar, which in turn has given WA a massive and free competitive boost. Even at $US1.03, you do not hear many WA mining companies complaining about the level of the Australian dollar, unlike the firms of eastern Australia who are operating without the good fortune of simply digging up dirt that someone wants to pay them a lot of money for.

At the same time, a separate Western Australia would have its own Reserve Bank of WA to set interest rates. Again, it doesn’t take much knowledge of economics to realise that RBWA interest rates would be higher than the 3.0 per cent rate prevailing now, Australia wide. Interest rates in eastern Australia would be lower.

See the point?

The fact that the economies of the eastern states are weaker than the West, but that everyone shares the same interest rates and currency, means that WA monetary settings (interest rates plus the currency) are significantly more stimulatory for WA than they would be if the state was on its own.

The final point for now is that the vast bulk of the border protection and defence issues for the nation as a whole involve managing the WA coast line. This would be a massively government expensive for a population of just 2.4 million (the current level for WA) so again WA should be grateful for the bulk of the funding for this is coming from the east. The saving to eastern Australia from not having to protect the WA coastline and only having to protect the border between WA and South Australia and the Northern Territory would be significant.

The bottom line of all of this is the fact that Australia is a wonderful Federation – it works well. There are of course financial swings and roundabouts for the states and Territories, but when looking at the structure of each economy things are probably more even that most people realise. Western Australia’s economy is booming, in large part due to its wonderful resource base. But it should not be forgotten that it is also benefitting what for it is a significantly lower exchange rate and lower interest rates than if it went on its own way, and that there are many costs, including defence, which are national issues that are heavily subsidised by the east.