A speech I delivered this week in Hobart at the invitation of CEO Tasmania on the economy and the forthcoming election.
Thanks for the invitation this evening. Tonight I thought I’d talk about the coming federal election, and of course it may come sooner than previously expected, through the prism of policy, by looking at the major challenges facing the Australian economy and use them as a guide for an assessment of the major parties’ positions. I’ll also be throwing in several non-challenges for the same purpose.
The key short to medium term challenge for Australian policymakers at the moment is to engineer the transition from the peak of the mining boom to a more business-as-usual economic growth pattern. As the peak of the mining investment booms arrives, which may well be happening as we speak, the RBA is trying to make sure the pick up in domestic demand from a recovery in construction arrives roughly at the same time to start replacing the easing demand from the resources investment boom. That’s the challenge for policymakers in Martin Place and Canberra.
Yes, the boom still has a long way to go and will still be outsized compared to historical levels in three to five years time. Mining investment will total an estimated $105.1 billion this financial year, up from $82 billion in 2011-12, and $46.8 billion the year before, and the first estimate for 2013-14 is a still solid $100.2 billion. But once the peak has passed, the long tail of the boom will in effect be withdrawing its powerful stimulus from economic growth. RBA monetary policy has been aiming at this transition point in the economy to try and kick start housing and commercial construction to pick up the emerging slack in the non-mining sectors of the economy.
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But the problem for the RBA is that the monetary policy loosening it has driven since late 2011 has yet to work its way through the wider economy, so it can’t really do much more by way of stimulus.
The signs about the extent of its success are mixed, and have been for some time. For every poor indicator in investment, participation or construction activity or company profits, there’s a good indicator on car sales or employment or wages and salaries.
This means the transition to the post-mining boom is in the balance, and that takes us from Martin Place down to Canberra, and what role fiscal policy can play in managing the transition.
A too loose fiscal policy could accelerate the stimulus from the RBA and reignite inflation and wage pressures. But the greater risk is the opposite. All state governments, including Tasmania’s, have been cutting back on spending and, despite Wayne Swan’s disappearing surplus, the federal government is also engaged in an aggressive fiscal contraction. We’ve already seeing the impact of that mutually-reinforcing contraction in areas like public sector and health employment in Queensland.
Now, in the good old days of spendathon election campaigns and “budget bounces”, the RBA could have relied on a Budget just a couple of months out from an election to provide some domestic stimulus. But both sides are instead trying to convince voters the other can’t be trusted on spending.
The focus of the beleaguered Gillard government is to use the May budget to construct the “structural savings” needed to pay for its Gonski education reforms, and the national disability scheme. Both will take heroic efforts of long-term budget cutting and rebalancing, and I’ll have more to say about that later.
That focus is appropriate in the long-term, yes, but the May budget also needs to complement the RBA’s focus on kickstarting a housing-led recovery and lifting the performance of the non-mining economy. The Government would argue its recent ‘manufacturing package’ will help boost investment, but, that package, where it will be effective, is more about making our manufacturing sector more innovative and competitive in the long-term.
And the Coalition’s fiscal policy is a bizarre mix of magic pudding and ferocious discipline. If you listen to Joe Hockey, a new Coalition government will be slicing a huge whack of demand out of the domestic economy with further big spending cuts. If you listen to Tony Abbott, everyone will somehow come out ahead.
There are certainly plenty of fiscal disciplinarians around to urge Hockey on, despite Australia’s low level of debt. Indeed, there’s a righteous tone of self-flagellation that many austerity advocates adopt, as though voters should be punished for electing politicians prepared to pander to their wishes and engage in unsustainable spending. Maybe that’s legitimate, if rather self-defeating, in places where fiscal laxity has indeed been the order of the day, like Greece. In Australia, where government of all persuasions have been reasonably disciplined and public debt is low by international standards, it’s absurd.
What’s remarkable is the number of commentators who have failed to learned the lesson evident from Europe’s embrace of austerity: that as a debt management tool, it doesn’t work, and it doesn’t work at the same time as inflicting serious economic damage in the form of socially-disruptive rates of unemployment.
In the early 1990s, another Labor government was tasked with managing the climb-down from a period of unsustainably high growth brought about by the unleashing of Australia’s finance sector by the Hawke-Keating reforms. “Soft landing” was the mantra from the Hawke government as the RBA ratcheted rates up and the government applied the brakes and embraced further reform. But there was no “soft landing” — policymakers both in Martin Place and Canberra botched it, badly, and gave us a recession that people now joke about as “the one we had to have” but which cost hundreds of thousands of Australians jobs and left many unemployed for years. That’s the sort of stakes policymakers are playing for.
The next challenge is decarbonisation. And I say that word full well knowing how ugly it is.
Australia has the most carbon-addicted economy in the developed world, and regardless of the current state of play internationally, at some point in coming decades we’ll need to address that. Criticism that we shouldn’t take unilateral action on climate, or “lead the world”, apart from being wrong about the lack of international action, misses the point that Australia has a considerable way to go before it achieves only the same level of carbon dependence as other developed countries.
The carbon pricing package, which originally looked like a rather half-baked pricing scheme supplemented by a significant direct action renewables investment policies, has in nine months of operation turned out to be characterized by two features. First, its impacts on business and consumers look to be slightly less than predicted by the government’s modeling. Second, in conjunction with the RET and the unexpectedly rapid fall in the cost of renewable energy, it appears to be having a more rapid impact on carbon emissions than skeptics like me expected.
The Coalition’s “Direct Action” policy was released in early 2010 after being cobbled together by Greg Hunt over the previous summer following Tony Abbott taking over the Liberal leadership. Significantly, it has not been updated in terms of costings in over three years. Structured around a massive grants program for big polluters and farmers, the proposal relied heavily on biosequestration via soil carbon, or what Lenore Taylor called “soil magic”.
The policy itself is grossly underfunded for what it is proposed to achieve — a 5% cut in emissions by 2020. Originally costed at $1.2 billion per annum or around $10 billion to 2020, it relies, according to the Coalition’s own policy document, on 60% of its carbon abatement task being achieved via soil magic for $8-10 a tonne, and the rest delivered at higher prices, for an average cost of around $11 a tonne.
When the policy was released, independent experts estimated soil carbon at more like $20-40 a tonne. This has been backed up by on the ground experience. In August 2011, when Hunt visited a Victorian farm to promote the policy, the farm owner, who had already undertaken soil carbon initiatives off his own bat, said that the Coalition’s scheme wouldn’t provide enough incentive for farmers. Experience of Direct Action-style carbon abatement grants programs under the Howard and Rudd governments was that they delivered abatement for an average of $168 a tonne.
Direct Action makes even less sense since the government announced it would be linking Australia’s pricing scheme, once its trading phase starts, to the European emissions trading scheme, ensuring that the cost of permits falls substantially, and possibly even as low as $7 a tonne i.e. below even the cheapest abatement that the Coalition on its own admission can achieve.
Tony Abbott’s blood oath to repeal the carbon price thus has a high risk of increasing the cost we’re paying for carbon abatement while eliminating a scheme that appears to be delivering abatement already.
There’s also the short to medium term challenge of the high dollar.
The strength of the Aussie dollar has been a decidedly mixed blessing.
It’s certainly been bad for politicians. The dollar’s strength and stubborn refusal to respond to the factors that have traditionally seen it weaken, has been a persistent handbrake on corporate profits both in the mining and non-mining sectors, and as a result on tax revenue.
But it has also helped keep inflation low, which along with the government’s tight fiscal policy has given the Reserve Bank room to keep reducing interest rates.
And, more subtly, it’s sent a shock through the trade-exposed sector, particularly in manufacturing, that has forced lazy managers and unions to focus on cost-cutting and productivity.
Perhaps that’s why manufacturing, supposedly at death’s door in Australia, has actually contributed to GDP growth for several quarters.
The challenge posed to the trade-exposed sector by the high dollar is one to which the government has come a little belatedly, at least in rhetorical terms, but it is now front and centre in Labor’s economic policy and the narrative for the remainder of its term. It provides a handy public spur for reform in an economy otherwise dominated by good news, in the same way Keating used the current account deficit and talk of a “banana republic” to focus Australians’ minds on the need for reform in the ’80s.
In dealing with the problem, the government declined to take advantage of the advice offered by various parties. It has rejected the suggestion from both unions and conservative commentators like Warwick McKibbin that direct currency intervention should be undertaken to lower the dollar.
It rejected the protectionist arguments of unions and the Greens that it should simply order large companies to use more Australian content. And it has rejected the galahs in the national papers and in business who think just cutting wages can make up for a high dollar. As the prime minister has noted, average wages would have to fall from nearly $70K to $50,000 pa to offset the recent strength of the dollar.
The government’s manufacturing policy announced in February is instead a mixture of red tape and some shuffling of incentives to encourage greater use of Australian content, without mandating it, and encourage genuine on-the-ground innovation. It’s a package that, unlike the other options urged on the government, is unlikely to cost much or do much harm while manufacturers get on with the challenge of improving productivity themselves – and I’ll come back to that.
We’re less clear on what the Coalition will do about the high dollar. It seems likely that their fiscal policy will be tighter than Labor’s, reinforcing our “safe haven” status but also giving the RBA more room to move on interest rates – although it doesn’t have a whole lot more room to move downward currently. A key Coalition theme is that they have governed successfully before and will therefore naturally do so again. But they governed pre-GFC, and when the Aussie dollar was in the 80s and 90s US cents, and in the first stage of mining boom when mining companies simply upped production to take advantage of higher mineral prices without the accompanying investment that we’ve seen since 2009. One suspects that Joe Hockey and Andrew Robb may be in for a rude shock when they get into office and discover economic management is much harder than simply calling a press conference.
Longer-term budget issues
Let’s come back to the structural Budget issues. As I mentioned, Labor’s fiscal policy is a commitment to identify “long-term” or “structural” savings in the May Budget to pay for the extended (decade-long) roll-out of its education funding reforms and the establishment of the full National Disability Insurance Scheme (NDIS) from 2015. These savings will not be immediate, and probably will have no short-term impact, but should be of the kind that reduce the long-term growth of large spending programs or tax expenditures, thereby freeing up funding to switch to NDIS and Gonski. Superannuation, where high income earners continue to enjoy significant tax breaks, is said to be in the gun for savings.
The quality of these savings can only be assessed once they are revealed, but some of them are likely to have only limited impact over forward estimates, meaning a proper assessment would require a 10-year forecast from the government of the kind it initially provided for its CPRS (but not for the subsequent version that was adopted).
This is something to watch out for on Budget night – do we get a long-term look at the structural savings. If we don’t, the government isn’t being fair dinkum.
But Australia has a structural budget problem. Or, rather, several of them.
We have an ageing population that will drive a massive increase in health and welfare spending in coming decades, with a proportionately smaller workforce to fund it. We have a tax base that, courtesy of cuts to personal income tax and the flaws of the GST, is more heavily dependent on corporate profits and therefore more pro-cyclical, than it used to be before the mid-2000s. We spend hundreds of billions of dollars via taxation concessions, often to conflicting policy purposes. And as Joe Hockey has accurately argued, we have a strong sense of entitlement as voters.
And all of our governments are currently dealing with the impacts on revenue of a high dollar, low inflation and the structural shift in consumer spending towards services.
Labor has shown a reluctance to come to tax reform – we saw what happened with the Henry Review. It also has paid little attention to the revenue problems facing state governments and the future shape of GST; further reform in this area looks to be off Labor’s agenda. But the GST needs to be reformed and restructured. Both sides need to get to grips with whether exemptions such as food should continue, or whether the rate should be increased (with appropriate compensation packages). Both sides could use it as an opportunity to redo Commonwealth-State financial agreements, or in Labor’s case sort out problems with the mining tax.
The reason we can’t tell is because the Coalition refuses to offer anything concrete about its fiscal strategy, and won’t until, probably, just days out from the election.
I want to talk now about some non-challenges, the myths of our economic debate that may well end up getting more attention in the election campaign than the real issues.
For a couple of years now business groups and the two national newspapers have been insisting there’s a productivity crisis in Australia, and it was the fault of Labor’s Fair Work Act IR laws. Some days you could barely open a copy of the Fin review or The Australian without being told that Something Needed To Be Done or Australia’s future prosperity would be destroyed by greedy unions, lazy workers and an indulgent Labor government. Indeed, one mining industry lobby group claimed there was a “tsunami of consensus” that Fair Work was killing productivity. What was needed was more workplace flexibility.
There was just one problem with this argument: the data didn’t support it. As each quarter’s national accounts emerged through 2012, labor productivity grew, and sometimes grew strongly. The business and media campaign in favour of productivity-driven IR reform began to falter. The government-appointed external review of the Fair Work Act of mid-2012 found
“Over the two decades labour productivity growth was slowest under WorkChoices, which arguably imposed the fewest constraints on management decisions. Of the four frameworks, the FW Act is most similar to the IR Act post-1993. While productivity flourished in the IR Act post-1993 period, however, it has grown only slowly under the FW Act. Differences between the legislative frameworks evidently do not explain the differences in productivity growth over those periods.”
Indeed, as old hands might note, Australia managed very strong productivity performance during the tightly-regulated 1960s and 1970s.
Moreover, some of our policy goals in other areas directly contradict the goal of lifting productivity. We’re all in agreement that we need to lift Audtralia’s participation rate, particularly since the strong surge of recent years has faltered. But bringing the long-term unemployed, or those who have chosen to withdraw from the workforce because of parenting or retirement, back into the workforce will mean poorer labour productivity, given the relative skills of such workers compared to the current workforce. That’s why Workchoices saw a slump in labour productivity, as Treasury predicted.
The OECD reached the same conclusion as the government’s review. “the Fair Work Act has made the system more employee- friendly — in terms for example of a slightly higher relative minimum wage and unionisation rate — with little effect so far on labour market performance and productivity… major changes do not seem warranted at this stage”.
What is widely agreed is that Australia’s multifactor productivity performance had been poor in recent years. But as the OECD noted, about half of that has been due to the mining investment boom and associated lags, lags in energy infrastructure investment and drought.
I suspect it’s no coincidence that Australia’s labour productivity has improved at the same time as we’ve been hit by the high dollar. Nothing drives productivity like competition, and Australia’s trade-exposed sectors have faced intensified competition since the dollar reached and went over parity. Indeed, we may look back on the strong dollar as another key moment in Australia’s micro-economic reform history.
I suspect it’s also no coincidence that the Coalition has now gone very quiet indeed on IR. It’s not just fear of the scare campaign Labor could run on Workchoices, it’s an acceptance, whatever the rhetoric, that a return to Workchoices isn’t going to provide any economic benefits. Indeed, as the data shows, it might actually send Australian labour productivity plummeting again.
All this is related to my next myth, that of the cautious consumer. It’s true that Australians are saving much more now than they were before the financial crisis. A household savings rate of 10% means tens of billions of dollars a year not going into consumption. Is that necessarily a bad thing? When I grew up in the 1980s, we were constantly told that Australians didn’t save enough. Now, of course, retailers complain that we save too much.
But Australia’s retail “woes” aren’t quite what they’re made out to be. For a start, all the advocates of the “cautious consumer” keeping their wallets shut never explained facts like how Australians were still holidaying overseas in droves and buying new cars faster than ever (up 23%!), or why food retailing was continuing to enjoy strong growth. Traditional, non-food retailing has been subdued, but it has survived and local retail businesses started the painful process of structural adjustment in an era where, even if only 2-3% of retail revenue goes to foreign websites, the competitive threat of online demands changes to how Australian retailers operate (note that Gerry Harvey and Solomon Lew, the two main moaners about the internet, have fallen silent). Local retailers have started attacking their cost bases, reducing inventory and getting smarter with their suppliers. And all that’s a good thing for consumers and for retailers.
Tony Abbott argues that the big problem with Australian consumers is a Labor government, that his election as Prime Minister will send a jolt of confidence through consumers and spark a return to strong consumption growth.
That view I suspect says more about what I call Tony Abbott’s nostalgianomics, his apparently conviction that the moment he is elected, Australia will snap back to 2007, government coffers will fill up and consumers will empty their wallets as fast as he can fill them with tax cuts. As we know, that period ended with high inflation and high interest rates. It was unsustainable. Indeed, there’s a strong case to argue that the financial crisis was critical to slamming the brakes on an overheated Australian economy.
Australia, the high-cost place to do business. This has been another staple of the national newspapers and Australian business: Australia is too expensive to do business. Even the proponents of such a theory accept that the problem is partly caused by the strong dollar. But another key reason for the rise in business costs has been directly in the control of businesses themselves.
Cost pressures in resources and associated areas are now easing for the same reason they built up in the first place: Rio Tinto, Fortescue, BHP and a host of other miners have been curtailing expansion spending, and got serious about cost control and monitoring spending. The headlong charge to expand mines in WA and Queensland, plus the LNG investment boom, drove up the cost of supplies and labour. It wasn’t unions, poor labour relations or any of the other reasons trotted out by business, it was an uncontrolled investment splurge from miners, all trying to spend billions of dollars a week on similar projects, demanding the same resources.
Where does that leave us? I suspect that the outcome of the election is likely to make little difference to the Australian economy. That’s not to say there aren’t risks. Both sides could duck the problem of addressing our long-term budget issues. A re-elected Labor govt could turn protectionist, as it has begun doing on 457 visas. The Coalition could believe its fiscally hairy chested rhetoric and rip billions out of the Budget without heed to the actual state of the domestic economy. But our history since 1983 tells us that despite the vituperation levelled at both sides by their opponents, they’re likely to do a pretty reasonable job of managing the economy.