RDP 9612: External Influences on Output: An Industry Analysis 1. Introduction

It is, by now, a well-known feature of the Australian economy that the domestic business cycle is highly correlated with that of the OECD, and that of the United States in particular (McTaggart and Hall 1993; Gruen and Shuetrim 1994). There is not only a high contemporaneous correlation between Australian and OECD/US output growth, but domestic output seems to track the path of foreign output over time, indicating that this relationship is persistent and long run. Gruen and Shuetrim (1994), Debelle and Preston (1995) and de Roos and Russell (1996) sought to explain this relationship by using data from the expenditure side of the national accounts. This paper takes a different tack to explaining international output connections by exploring production linkages across a range of industries in Australia and the United States.

In Section 2, summary statistics on output in the two countries are examined. The strength and nature of the relationship between domestic and US production is explored using cointegration analysis in Section 3. In particular, the focus is on identifying the relationship of sectoral outputs in Australia with the corresponding US sector and aggregate private output in both Australia and the United States. In Section 4, some implications of the analysis are explored in more detail. The conclusion summarises the paper.

We find that Australian and US industrial structures are basically similar, and that about two-thirds of Australian sectoral output is affected by US output, often both in the short and the long run. The US links in agriculture and mining largely occur through aggregate demand. There are also some strong links between corresponding industries. These are clearly stronger in goods than in services, and for manufacturing durable or non-consumable goods in particular. The distinguishing feature of these types of goods is that their production processes are technology intensive and changing over time. These links are most important in explaining long-term, rather than transitory, developments in production. This suggests that intersectoral output links to the United States are driven by changes in the supply side. Institutional features, like foreign ownership or trade orientation, do not appear to explain the links, at least on available aggregated data. Service sectors are dominated by domestic aggregate demand, although US aggregate demand affects some of these sectors, particularly finance and property. While foreign developments are important, especially in the longer term, domestic policy and events, such as monetary and fiscal policies, affect output over the business cycle. Monetary policy, for example, has a substantial effect on manufacturing output, either directly or indirectly through the exchange rate or through policy's influence on aggregate demand. Indeed, policy has important short to medium-term effects, even when output is determined by overseas developments in the long term.