How the MRRT 'Super Profits' tax failed on basic economics

How the MRRT 'Super Profits' tax failed on basic economics

First, the good news. Figures from the Bureau of Resource and Energy Economics released last week show that current ‘committed’ investment in the Australian resources and energy sector is a record $268 billion.

Now for the bad news. In the past year, $150 billion of new project investment has been delayed or cancelled. Investment in coal and iron ore, the boom commodities of the past decade, has dried up. 80% (by value) of committed projects now are in liquefied natural gas (LNG). Committed investment is likely to fall to between $25 and $138 billion by 2018. Unfortunately, $25 billion is the ‘likely’ number reported by the Bureau.

The media has greeted these figures with shock. But, the course of the current mining boom is following exactly the path that economics would predict.

The current Australian mining boom took off around 2004. The key areas were coal and iron ore. So why did these minerals ‘boom’?

First, consider coal. China is the world’s largest coal producer. Its rising domestic demand for energy, however, meant that China reduced its coal exports in the early 2000s and, in 2008, actually became a net coal importer. Chinese economic growth led to an increase in the world demand for coal and prices for (thermal) coal peaked in 2008, just before the global financial crisis. Current prices are less than half the peak. At the same time, despite the fall in prices, global coal output has kept rising steadily from around 5.3b tonnes in 2003 to 7.7b tonnes in 2011.

Iron ore tells a similar story. Increased demand, particularly due to economic growth in China, caused international prices to rise rapidly from 2004 to 2008. The iron ore price has been volatile since 2008 with current prices at a five month low after a ‘mini boom’ last year. But the output of iron ore has kept rising.

This is the predictable pattern of most booms. The boom begins with a rise in demand. In the case of the current mining boom, this rise in demand was driven by rapid economic growth in China. In the short term however, the supply of minerals like coal and iron ore is relatively insensitive to price (or, in economic parlance, inelastic). It takes years to develop new mines or to expand existing mines. So the initial impact of the rise in demand is to push up the price.

Of course, for existing miners, this initial price rise is a windfall gain. These miners were happy to produce and sell their minerals at the previous low price. Any price increase simply goes to the bottom line, increasing profits. Indeed, it might be claimed that these miners make ‘super profits’ at the start of the boom.

Unfortunately for the miners, this situation does not last. Neither coal nor iron ore is a rare mineral. They are relatively common and easy to find. So the increased world price leads both existing miners and new competitors to increase exploration and to start to develop new mines. Mining investment rises and, from a naïve perspective, it appears that the economies of countries that export coal and iron ore, like Australia, have entered a golden age.

The boom, however, has sown the seeds of its own destruction. As new mines begin to produce, the supply of the relevant mineral increases. This starts to drive the price down again. Indeed, over the course of a decade or so, it is likely that the price ends up back where it began. Total output will have risen but the marginal miners will make little profit. And the ‘super profits’ of the original miners will have faded into history.

While this boom and bust cycle is predictable, it appears to be ignored by policy makers. Thus, in 2010, Australia looked at introducing a mining super profits tax. Given the previous six-years’ experience, this probably looked like a good idea. While resource prices had come down from their 2008 levels, it appeared that there were still super profits to be taxed.

After considerable compromise (and the over-throw of a Prime Minister) a minerals resource rent tax (MRRT) commenced on July 1, 2012. The MRRT only applies to coal and iron ore. However, the revenue generated by the tax has been well below the estimated $2 billion for 2012/13. This has largely been due to the drop in world coal and iron ore prices. Put simply, you want a super profits tax at the start of a boom, not as it is ending.

So as the iron ore and coal booms fade into history, what are the lessons for Australia?

First, booms will come and go. Growing demand for food products in Asia has led to a boom in dairy products in recent years. It is following the same pattern as the mining booms, with New Zealand, the world’s biggest dairy exporter, significantly increasing its output. If you are in the industry when the boom starts then, for a short period of time, you will be making abnormally high profits. But don’t expect them to continue.

Second, politicians should avoid the temptation to follow short-term ‘pick winners’ policies during a boom. By the time the new laws, such as the MRRT, are in place, the price boom has probably faded.

Finally, booms matter. The mining boom will permanently change the structure of the Australian economy. While prices may go back at long-term levels, we will be producing far more iron ore and coal compared to the early 2000s. The same will happen with LNG. When the boom finishes, eastern Australia will be a major LNG exporter. In the longer term, it is the quantity effects of a boom that matter, not the prices.

For other articles by Stephen (and other economists) see the CoRE Economics Blog at and Stephen’s column at the Conversation,