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The challenge of structural change - why Labor has failed business: address to the CEDA State of the Nation Conference, Canberra



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SPEECH

HON JOE HOCKEY MP

SHADOW TREASURER

ADDRESS TO THE CEDA STATE OF THE NATION CONFERENCE CANBERRA MONDAY 20TH JUNE 2011

THE CHALLENGE OF STRUCTURAL CHANGE - WHY LABOR HAS FAILED BUSINESS

**CHECK AGAINST DELIVERY**

I last spoke to CEDA two years ago and I am delighted to be back here tonight to address

CEDA’s state of the nation conference.

It is a curious time for business. The Australian economy is performing well, partly as a

result of good luck, but mostly as a result of past good management. But not all businesses

are sharing the joy.

The good luck is the result of us being at the right place at the right time. For most of our

European history Australia has not been well placed from a business perspective. We were a

long way from the rest of the developed world and in an awkward time zone.

Now of course we find ourselves near the fastest growing and largest economic bloc on the

planet. And our near customers have an apparently insatiable demand for the commodities

that we happen to have in abundance.

The transformation of the Chinese and Indian economies into manufacturing powerhouses

and the aspirations of their peoples to first world standards of living has led to unprecedented

demand for our natural resources. Australia has found itself well placed in terms of its

geography and its God-given wealth of resources to tap into this demand. Prices for

Australian commodities have more than tripled since 2003 in foreign currency terms. Our

terms of trade is now at the highest level in a century and a half.

 

This boom is good for Australia. Mining companies are recording undreamed of

profitability. The gross operating profits of the mining sector totalled $87bn in 2010, an

increase of 35% on 2009. That increase was well ahead of the rest of the economy, with non

mining businesses recording an increase in gross profits of just 8%.

Not surprisingly, mining companies are lifting their investment very rapidly. In 2010 mining

companies increased their investment by over 12% in real terms, and in that year mining

investment made up over a third of all business investment. Surveys show that mining

companies plan to increase the dollar value of investment by 63% in 2011-12. If realised,

that investment will mean that around 60% of all investment by businesses in Australia will

be in mining and resources.

This investment is helping to drive current growth in the Australian economy. Moreover, it

will build new production capacity and infrastructure that in turn will lift the speed limit of

our future economy.

Our country is rich, our financial system is stable, and our unemployment rate is lower than

in many other developed countries. Yet many of you in the room tonight will not be feeling

as if you are in boom times.

Our success in some areas has brought unique challenges for others.

This boom is not without pain. Australia has been through commodity booms in the past -

though not of this scale - and they have not always been well handled by the authorities. The

classic mistake has been to let the boom feed into excessive domestic demand and inflation,

which the authorities have had to belatedly suppress through higher interest rates.

This time there has been a concerted effort by the Reserve Bank to get ahead of the game. It

has pre-emptively lifted interest rates to dampen inflationary pressures before they pick up a

head of steam. Together with higher commodity prices, this has pushed the Australian dollar

to around the highest levels since the float in December 1983.

The effect of these changes in the financial environment has been to “make room” for

increased mining investment and production by squeezing other business sectors. The

pressures for this reshuffling of the deck have escalated quite rapidly. Interest rates have

increased seven times since late 2009. Effective interest rates paid by borrowers are now

slightly above their long term averages and the Reserve Bank has signalled that further

increases are imminent.

 

The Australian dollar has lifted from the mid 60s against the US dollar in early 2009 to

between US$1.05 and US$1.10 today, an increase in its value of two thirds in a little over two

years. Moreover news that the Russian Central Bank has confirmed that it is building its

Australian dollar presence whilst reducing US dollar exposures merely confirms what many

suspect, that is whether we like it or not, we have a new role as a reserve currency for non

western central banks.

If the United States extends its quantitative easing program then our currency will remain

very strong.

This restructuring is producing winners and losers.

Manufacturing is one sector which is clearly feeling the strain, particularly from the effects of

the higher exchange rate. Our manufactured exports are less competitive on international

markets and goods made for domestic consumption have to compete with ever cheaper

imports. Gross value added by the manufacturing sector in the March quarter was 3% lower

than a year earlier.

This continues a long term decline in manufacturing as a share of the economy from around

16% in the mid 1970s to just 8% today.

The construction industry is also feeling the pain, particularly from higher interest rates.

Higher interest rates are now clearly impacting demand for homes and commercial property

and are holding down construction volumes. Growth in home mortgage loans outstanding is

running at a relatively modest pace of around 7% per annum, well down on the double digit

increases in excess of 20% through 2003/2004. New secured housing finance approvals are

running about 22% below the peak of mid 2009.

It is no surprise that construction activity is weak.

Housing starts are now running at an annual rate of about 150,000, well below the 180,000 a

year building requirement it is estimated we need to meet ongoing household formation.

Non residential building approvals have slumped, with the value of approvals over the year to

March 2011 fully one third lower than a year earlier.

This restructuring of the Australian economy is a not a bad development overall. It allows

capital and labour to flow to those sectors where productivity and returns are higher,

ultimately lifting the efficiency of the economy and the average standard of living of the

Australian people as a whole.

 

Businesses and people directly involved in the mining sector benefit most clearly through

higher returns on their investment, increased employment, and higher wages.

The challenge is to ensure that the benefits also flow to those businesses and people not

directly involved in the mining sector.

This is where the question of the quality of economic management comes into play.

Our success is not all the result of commodity booms mark 1 and 2, which as I have noted

before should really be viewed as one boom with an interruption for the GFC. Our

emergence as a successful modern economy began well before that.

Australia was performing strongly before commodity prices began to take off in 2003. We

negotiated the Asian financial crisis of 1998 with hardly a tremor. We sailed cleanly through

the near recession in the developed world in 2001 in the face of significant headwinds. And

we were arguably the developed country least affected by the North Atlantic financial crisis

of 2007 and 2008.

This resilience reflected several decades of economic reform by both major political parties

across trade, the financial system, monetary and fiscal policy, and the labour market. The

central theme of these reforms was to liberate the power of the market while putting in place

sound institutional arrangements and appropriate regulatory measures to ensure transparency

and a level playing field.

The drag from the government sector was reduced through lowering taxes, both company

taxes and personal taxes, and by reducing the role of government through the sale of those

publicly owned business activities and assets that were best placed in the private sector.

No one knows how long the boom will last.

Treasury forecasts the boom will last at least for the next two years, with the terms of trade

easing by just ¼ of one per cent from its current record highs in 2011-12 and by 3% in 2012-13.

The Reserve Bank expects the prices of iron ore and coal to decline over the period ahead as

new supply comes on line, although strong growth in steel demand in Asia is expected to see

them remain at historically high levels. Overall it expects the terms of trade to remain at

historically high levels over the next few years, coming off maybe 10% by 2013.

On a more cautionary note, Standard and Poor’s has recently expressed concern that the

current situation represents an unsustainable bubble, subject to sudden correction. It notes

 

that China has had a far more significant role in driving appreciation of commodity prices

than any other country and that a significant deceleration in China could ultimately cause the

rupture. Indeed, S&P has already incorporated a modest deceleration in Chinese growth and

a significant weakening in commodity prices into its oil and metals pricing assumptions.

Recent news from China clearly illustrates the risks. Inflation has risen to uncomfortably

high levels and the authorities are tightening policy to cool these price pressures. If

successful these actions would lead to some slowing in growth and this could be expected to

remove some froth from commodity prices and from Australia’s terms of trade.

Alternatively, if inflation in China remains high, there could be upward pressure on import

prices into Australia which would also produce some deterioration in Australia’s terms of

trade.

The trouble with unsustainable booms is that they are usually only recognised after the event,

and usually then, only after the bust.

The mining boom may last for a long time or it may not. That part of the story is out of our

hands. It is not something which keeps me awake at night - I have three small children for

that.

What does concern me though is that the long period of quality economic management has

come to an end.

In the current environment of rapid structural change there is a role for government to assist

smooth adjustment and also to ensure the benefits of change are widely spread.

In saying this I must stress that I am not an advocate for industry protection. It is

counterproductive to shield industries from change because such measures inhibit the flow of

resources to more productive activities within the economy. This makes us all the poorer.

Putting in place protection also involves the government in picking winners and losers and

governments in Australia have a very poor record in doing that.

But governments should avoid making life harder for those industries which are already

feeling stresses and strains from rapid structural change. It should avoid loading them with

additional regulations and taxes. It should avoid competing with businesses for scarce funds

in the capital markets. It should avoid being overly prescriptive in labour markets.

Unfortunately this Labor government does not understand this.

 

This Labor government, under both Rudd and Gillard, believes in big government. It

believes government knows better than business and individuals how best to conduct their

affairs.

Labor sees business as the enemy which can’t be trusted to deliver services and out of which

every last drop of tax must be squeezed.

Labor is implementing its agenda by increasing government expenditure, funded by increased

debt and increased taxation. It is taking over functions that properly belong in the private

sector. And it is increasing regulation and winding back previous reforms.

None of this is helping business adjust to the new financial environment. Rather than

greasing the wheels of commerce, Labor is putting sand in the gears.

Let me give you some examples.

The Coalition left the ratio of government spending to GDP at a low 22.9%. Labor lifted this

to 26.2% in 2009-10, higher than in any year of the Coalition. By the end of the forward

estimates the ratio will still be a high 23.5%. And that is without the spending linked to the

carbon tax, which is not in the budget, and without the spending on the NBN, which is not

classed as “on budget” expenditure. There is no doubt this is a big spending government.

And to fund this increased spending there has been a significant increase in deficit and debt.

The last Budget showed a further blowout in the financial position. Over just this financial

year and next, the budget bottom line is worse by $18 billion compared with MYEFO only 6

months ago. Debt is higher across the forward estimates, peaking at $107 billion versus

MYEFO of $94 billion in 2011-12. And interest payments are higher across the timeframe

with a new high of $7.5 billion in 2014-15.

Labor has introduced or increased 19 taxes, including prospective significant new taxes on

mining and carbon.

The government has made much of its promise to keep taxes to GDP below the level of the

last year of the Coalition government which was 23½% of GDP. But when you add in the

carbon tax - which was excluded from the budget - you find that the ratio in the final two

years of the forward estimates will likely exceed that benchmark.

There is no doubt this is a big taxing government.

This brings me to the carbon tax. I believe it is pretty clear that the carbon tax will not

benefit business. What is not in dispute is that the carbon tax will increase the cost base of

 

business. A few businesses will be partially compensated. Some trade exposed industries -

particularly exporters in direct competition with businesses offshore - will receive some

compensation.

Emission intensive domestic industries - particularly electricity generation and coal

businesses - may also receive some compensation, although at what level this will be

maintained is unclear. But the rest of you will not be compensated. So if you are competing

with imported goods and services you will not be compensated. If you are a business that

mainly services the domestic economy, you will face higher power and other costs, but you

will not be compensated. Maybe you can increase your prices, but in the current environment

of consumer caution, you are unlikely to fully recoup your costs. So you will suffer higher

costs and lower profits.

The government wants you to believe that imposing a new tax on everything will have almost

zero impact on the economy. The Treasurer has quoted Treasury modelling which he says

shows that economic growth and incomes will be barely affected by the imposition of a

carbon price and that employment will continue to grow.

The Treasurer has not released the details of the modelling. However, we surmise from

Senate Estimates that it is simply an update of the work that was done for the earlier Carbon

Pollution Reduction Scheme. And on this basis I have some issues with the assumptions

underlying the modelling. The first is that the Treasury model assumes full employment.

Rather than evaluating the impact of a new tax on employment, it basically assumes there

will be no net impact. By definition, all workers displaced from carbon intensive industries

will be magically relocated into jobs in greener industries.

The problem of unemployment has been assumed away. I find it difficult to believe that

things will be so easy that every coal miner displaced from an underground mine or every

worker who loses his job in an aluminium smelter will find new employment. And the

Treasurer declined to tell the workers of Australia how much their real wages will have to be

curtailed to achieve this magical outcome.

Treasury also apparently assumes that in the medium term all nations of the world introduce

an equivalent price on carbon. On this point I note the Productivity Commission report into

carbon emission policies in key economies found that “no country currently imposes an

economy-wide tax on greenhouse gas emissions or has in place an economy-wide ETS.”

So really we should be cautious about the Treasury findings.

 

Labour relations is another area where government re-regulation is preventing employers and

employees from tailoring conditions to suit their mutual preferences. We have all heard the

example of school kids who until now could not work an afternoon job because they could

not complete the mandatory minimum 3 hours, so I welcome today’s decision by Fair Work

Australia to reduce the minimum limit to 1.5 hours. This is a commonsense outcome.

However we still see the increased power of the unions which continue to flex their muscles

in the ports and the mines. And we have moved to an environment where workers can strike

before rather than after negotiations.

I stress I am not advocating a return to Work Choices. But I think it is worth making the

observation that none of Labor’s changes will assist businesses to adapt to structural change.

One of the unfortunate consequences of Labor’s expansion of the government sector, its

higher taxes and its increased regulation, has been a stalling in productivity. GDP per hour

worked in the March quarter this year was lower than in the last full quarter of the Coalition

government. I want to say that again - productivity has not just slowed its rate of growth, it

has actually fallen after 3 ½ years of Labor. By comparison, over the life of the Coalition

government GDP per hour worked rose by over 25%.

This is the direct result of the expansion of the dead hand of government. And it is a serious

failing because it is only through productivity growth that Australia’s long run standard of

living can be increased. Australians would be getting poorer under Labor if it was not for the

mining boom. This is the clearest example that Labor is benefiting from good luck not good

management.

The Coalition offers an alternative approach. The Coalition understands what business needs.

Business needs policy certainty and stability.

Business needs low taxes.

Business wants to be consulted on relevant changes.

Business wants the drag from government taxes and regulation to be minimised.

And business wants a policy and regulatory and taxation environment which lays the

groundwork for growth in productivity.

In my post budget address I outlined a four point strategy for reducing the size of government

and lifting productivity.

 

Step one is to get to surplus and pay off the debt through tight control of government

spending. Returning the budget to large surpluses will remove the government as a factor in

higher interest rates and will ease some of the upward pressure on the exchange rate.

Step two is to reduce the tax burden by repealing the mining tax and the carbon tax. Those

measures alone will substantially reduce the tax burden on business and will reduce the size

of government.

Step three is to address weaknesses in our competition policy and regulatory frameworks to

promote productivity growth.

The Coalition will undertake a comprehensive and independent review of the Competition

and Consumer Act including all aspects of competition arrangements in Australia. The

review will be focussed on giving small business a fair go. We also want the review to deliver

a new competition policy framework. The objective will be to deliver more competitive and

efficient markets.

We will also revisit the Financial Services Reform Act and ensure that product disclosure

statements are simpler and smaller. In Corporate Law Reform we will ensure that short form

prospectuses really are short.

In banking we will establish a new son of Wallis style root and branch review of the financial

system to explore ways to deliver better outcomes for bank customers while preserving the

stability and safety of the system.

In housing we will explore with the states ways to reform construction industry planning and

regulation. The objective will be to reduce the complexity of the regulations and the overlaps

between different jurisdictions. This will be delivered with a National Competition Policy

styled process that includes incentive payments to the states as a means of distributing the

economic and fiscal benefits of regulatory reform. The payoff will be more affordable

housing.

And in the area of business regulation more generally Tony Abbott has already committed a

Coalition government to reduce the regulatory costs on business by at least $1 billion a year

with a scheme that is very similar to the red tape reduction program in Victoria.

Step four is to explore better approaches to fiscal management.

In particular we will publish regular estimates of the structural budget position. This will

provide a measure of the budget balance adjusted for the impact of the economic cycle. A

10 

 

budget which is in structural balance over the cycle ensures the government is living within

its means.

Concluding Comments

Under Labor Australia has had good luck but not good management.

That is not a sustainable path for the future and is not helping business deal with rapid

structural change.

The Coalition will do what it can to keep the good luck. But it will also underpin prosperity

by re-introducing good management.

**ENDS**