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The shape of economic recovery: 1991-92 and beyond

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NO. 61




This is my first opportunity to address EPAC as Treasurer. I value the opportunity, especially given EPAC's important role in advising the Government on medium-term economic issues.

Since Paul Keating spoke to EPAC in April, it has become more apparent that the economy is now either at or approaching a turning point. Economic signals at these times typically change rapidly. The current circumstances are no exception. Indeed, recently published forward indicators are painting a

somewhat different picture to those of only a few months ago.

In light of this, today I would like to say a few words on the shape of the recovery we are expecting and the policy requirements necessary to ensure that the recovery leads to sustained medium-term growth.

There are three main messages I want to leave with you:

. First, the most recent economic indicators are consistent with our expectations that the economy will recover at a moderate pace over the course of 1991-92;

. Secondly, to secure sustainable growth over the medium-term there is a need for on-going low inflation; more flexible goods and labour markets; and reduced levels of foreign debt.

. Thirdly, from a policy perspective this means: continuing firm monetary policy settings; maintaining the structural integrity of the budget; and further progress on industry reform.


At the last EPAC meeting, it was suggested that while the economy remained subdued there were encouraging signs pointing to recovery. Because economic data becomes available only with lags, that view of the economy was necessarily intuitive. It reflected anecdotal evidence backed up by

judgements about changes in economic fundamentals as well as the timing of cyclical factors.

Although such judgements are the bread and butter of economic forecasters, it is encouraging that the economic news released over the past month or so has been consistent with our expectations.

Some of the more important recent forward indicators released include:

. the May building approvals statistics which contain the first hard evidence that building activity may be turning around -- especially in the private residential sector;

the latest housing finance statistics which also show increased interest in the housing market;

the Index of Consumer Sentiment which rose in June for the fourth consecutive month to be at its highest level since Mav 1989: and


. the CAI/Westpac Survey of Industrial Trends which suggests that the decline in manufacturing may be bottoming. Indeed, in commenting on this survey, its authors noted that the turning point in expectations recorded in the June quarter was similar to that which preceded the 1983 recovery in manufacturing production.

These early signs indicate that the economy will recover through 1991-92. .

The main factors providing the impetus to a recovery will be from the non- farm stock cycle, net exports and the dwelling sector. I have already mentioned that the dwelling sector is now showing signs of responding to the improved * affordability of houses. Also important will be a modest pick-up in private consumption — especially in the second half of the year as the labour market improves.

The decision to allow the automatic budget stabilisers to operate in the face of an unexpectedly sharp slow-down provided an important cushion to demand in 1990-91. But in 1991-92, I expect that the contribution to growth from public demand will be much less given the expected pick-up in private demand and the need to maintain the structural integrity of the budget. I will return to

fiscal policy later.

As is typical in any turnaround, business investment is expected to recover with a lag. Recent data on investment expectations suggest that after declining by around 8% in 1990-91, plant and equipment investment is likely to

pick up moderately over during the coming year. The immediate outlook for non-residential construction is, however, less favourable. This is mainly because of the current over-supply of office and hotel space.

In the medium-term, of course, business investment plays a crucial role in underpinning sustained growth in demand and employment. It is the Government's goal to put in place a policy framework that will foster business confidence and encourage strong growth in business capital.

There are signs that the decline in job vacancies, advertisements and employment might be bottoming out. The unemployment rate of 9.3% recorded in June, marginally lower than in May, provides some encouragement. But the lagged nature of the employment response to output means that for some time to

come, there will probably be an absence of good news on the employment front. This is because in the initial stages of recovery, businesses often draw on unused capacity and increase the overtime of existing workers to meet increased demand.

Of course the current state of the labour market gives the Government no satisfaction. An unemployment rate of over 9% represents a significant cost to the Australian economy It reflects the real hardship that is being suffered by hundreds of thousands of Australians.

Ultimately, however, policies that produce sustained growth in output and employment will be in everyone's best interest. Having endured the costs of the recession, we now need to take full advantage of the opportunities that exist to achieve sustained low-inflationary growth.

This in turn has implications for the type of recovery that is on the way. Although recovery is now clearly on the agenda for 1991-92 it will, by historical standards, be relatively moderate. This reflects a number of factors:

. although the world economy is expected to remain relatively benign and activity to pick up, international conditions are unlikely to provide a major fillip to growth in the next twelve months;


. the rural economy is likely to remain weak — this is, of course, a matter of special interest to me;

. the non-dwelling construction sector is likely to remain depressed; and

. the policy requirement for overall demand to continue to grow less quickly than production. .

Too fast an expansion of demand would put at risk the sustainability of the recovery. In particular it would jeopardise continued improvement on the current account deficit and the stabilisation of our foreign debt. It could * also jeopardise the chances of controlling inflation.


As we enter the recovery phase of the current cycle, there are some important differences to the comparable situation in 1982-83. On one hand, inflation is considerably lower. On the other hand, our foreign debt and current account deficit are worse. I would like to explore how some of these differences might affect our growth prospects.

During 1991-92, inflation is forecast to remain at around 4%, which is comparable to the inflation rate in our major trading partners. This compares with a relatively high rate of 8% (Medicare adjusted) in the first year of recovery after 1982-83. The significant slowing in inflation over the past

year also contrasts with Australia's comparatively high inflation rates over much of the 1980s.

Significantly, there have also been encouraging signs of declining inflationary expectations recently.

. The Westpac/Melbourne Institute Index of Inflationary Expectations fell to record low levels in the June quarter to be only a third of the peak levels of the mid-1970s.

. Also, the CAI/Westpac Survey of Industrial Trends for the June quarter showed that, for the first time, manufacturers were expecting selling prices, on balance, to decline in the next quarter.

Thus for the first time in years there is the prospect of a sustainable, low inflation environment in Australia.

The benefits to be gained from this are very considerable. As well as leading to lower nominal interest rates, a lower inflation rate will be conducive to more efficient patterns of investment. Lower inflation should also create an environment of greater certainty for business; this, in turn, should reduce

the real interest rate required by both domestic and international investors. Lower inflation will also help lift our international competitiveness.

As the economy enters the recovery phase, the challenge is to consolidate the gains made on the inflation front. The Government’s medium-term approach to macroeconomic policy will be important in this respect. Monetary policy will continue to be focussed on inflation, but with an eye to the control of demand

as well. Wages policy will also have a significant role in constraining inflation.

Bringing our inflation rate into line with the rate in our major trading partners has been an important achievement. In reality, the industrial countries that have performed well on the inflation front have done well in

other areas as well. We need to learn from their experience.

(ii) Fiscal Poli ry

As you are aware, the revised estimate of the starting point for the 1991-92 Budget is a deficit of around $5 billion. This would represent a turnaround of $13 billion from the 1989-90 Budget outcome.

The Government has not attempted to offset the effects on the Budget of lo^er revenues and higher unemployment benefit payments. We have allowed the automatic stabilisers to work so as to moderate the effects of the recession. Now, in grappling with the formulation of the 1991-92 Budget, we must look to Australia's medium-term economic health. ·

It is important that we avoid decisions that boost the deficit. Our aim must be to protect the structural integrity of the Budget. As the economy emerges from recession, a firm fiscal policy will make an important contribution to

restoring public sector savings and, in the medium-term, help repair the imbalance on our external account.

We cannot afford any deterioration in the structure of the Budget in 1991-92. That would only make the medium-term adjustment task more difficult.

Accordingly, the main task confronting my ERG colleagues and I is to contain the growth of new outlays and ensure that, within the public sector, resources are used as effectively and efficiently as possible. That is never an easy task, but it will be the focus of our work during the next few weeks.

(iii) External Account

Over the past year we have made solid progress on reducing the current account deficit. For the eleven months to May, the current account deficit was $14.7 billion — or 30% below the level over the same period last year. The outcome for 1990-91 will be significantly below the Budget forecasts of $18 billion. There should be an improvement of at least 1% percentage points on the current

account to GDP ratio compared with that in 1989-90.

One feature of recent economic performance has been the improvement in Australia's export performance: total merchandise export values are around 8% above the level this time last year. Over the past year, there has been very strong growth in the volume of mineral and energy exports. Exports of

manufactures also continue to perform strongly.

This is encouraging because the growth in manufactured exports has been across the board. It does not appear to be just a cyclical phenomenon. Rather we seem to be seeing a pay-off from manufacturers becoming more outward oriented and becoming increasingly cost competitive. There are also signs of increased exports of higher value added manufacturing goods. In the year to date, exports of non-metal manufactures — a proxy for high value-added items — grew by around 20%.

This export performance is even more impressive when seen against the backdrop of a significant deterioration in Australia's terms of trade and major disruptions to some of our key rural export industries. Since the middle of 1989, our terms of trade have fallen by 11%, reflecting in particular falls in export prices for wheat and wool.

Some observers have expressed concern that imports have not fallen further given the extent of slowdown in the economy. However, endogenous import volumes fell by 6% in the first three quarters of 1990-91 compared with the same period a year earlier. The import penetration ratio has also fallen by

10% from its peak in the middle of 1989.


The net effect of these changes is that the merchandise trade account is now firmly in the black. The deficit on goods and services has fallen from $7.5 million in 1989-90 to $1.4 billion in the eleven months to May 1991. This is a substantial turnaround in our trade performance. It means that the total export revenues we earn through merchandise trade now not only pay for our merchandise imports, but are helping cover the costs of servicing our

foreign debt as well. .

But the situation is not yet satisfactory. While we have made worthwhile progress in correcting our external imbalance, we must go further if we are to stabilise the foreign debt. The public sector accounts for only about * one-third of Australia's net foreign debt of $133 billion. International

comparisons in this area are difficult owing to a lack of reliable data. However compared with the situation in many other countries, the public share of foreign debt is relatively low in Australia. The servicing costs of the current stock of foreign liabilities (around 4.5% of GDP) are such that we

require a larger and long-term trade surplus to reduce the current account deficit as a proportion of GDP.

In order to prevent a spillover of demand into imports during the recovery, we need to ensure that growth in domestic demand is held below growth in output. As I said previously, the Government's medium-term macroeconomic policy will be directed to that end. To do this, we must continue to expand exports.

The moderate recovery projected for the world economy in 1992 will provide an important backdrop to those efforts, particularly in respect of mining and manufactured exports. The export performance of the rural sector in recent years has been adversely affected by a number of special factors, including

the collapse of the demand for wool in the face of record supply and the bumper world wheat harvest. The establishment of a more market responsive wool price structure is now encouraging the recovery of wool exports. Wheat prices should improve as world stockpiles are unwound. The rural sector

should therefore make a stronger export contribution in the medium term.

However, this contribution can only be fully realised if fundamental reforms to the agricultural policy distortions of the major economies are implemented soon through a successful conclusion of the Uruguay Round. There will need to be stronger political will in the major economies to achieve those reforms. This message was reaffirmed on 9 July by the Cairns Group Ministers.

I should also note that export success will only occur if there is genuine commitment at the enterprise level. In this increasingly competitive world, our foreign competitors are continually lifting their game by improving flexibility and innovation at the enterprise level. We must constantly match


Many factors lie within the direct control of individual managers. These include organisational practices, investment and technology decisions, industrial relations and human resource development. Australian management can also contribute by lifting performance to world class levels. The move by individual industries to establish best international practice will be a useful step in this direction.

Non price competitiveness — that is, elements of service such as good attention to design, marketing reliability and quality control — is the province of industry rather than government. Many times I have heard of Australian companies getting a toehold in foreign markets, only to lose it

after complaints about poor quality or reliability. We must develop a more long-term approach to export development based on a thorough knowledge of prospective markets and a willingness to stay in for the long haul.


While we must also continue to diversify our export base — trade in manufactures and services are two of the fastest growing areas of world trade — we must not forget that we are a rich, resource endowed country. Commodity exports will remain the backbone of our trade performance for the foreseeable

future. Hopefully, they will also provide the basis for new, internationally competitive industries based on downstream processing of natural resources and related manufacturing activities. .

(iv) Investment '

As mentioned earlier, in the medium-term private investment is needed to * underpin sustained growth. Some of the important lessons of the 1980s relate to the powerful positive influences that real wage restraint, factor share correction and fiscal consolidation can have on business confidence and


Although asset price inflation — and inflation more generally — contributed to a situation where not all of the boom in business investment in the late 1980s was put to its most productive use, the fact remains that there were significant increases in the net capital stock in this period. These enhanced the productive capacity of theeconomy. Together with the current low levels of capacity utilisation, this suggests that a substantial pick-up in activity

is possible without running up against domestic capacity constraints and spilling over unduly into imports.

Another positive factor for the medium-term investment outlook is that through the downturn the gross profit share has also remained at relatively high levels. This should encourage increased investment as demand starts to bounce


(v) Qn-Going Industry (Micro} Reform

Australia's experience over the 1980s emphasises the need to put in place a framework for a dynamic and competitive economy. We must continue to develop flexibility in goods and labour markets to improve Australia's capacity to respond to new opportunities, changing price signals and technological developments.

As well as added flexibility, productivity improvements associated with industry reform will increase the supply potential of the economy, thereby raising the potential for long-term growth. These reforms will also help hold down inflation. In recognising this, the Government has taken large strides

in reducing the level of protection afforded to Australian industry.

State Governments are important players in this area because many reforms to industry must be tackled at the State and local government level. The cooperation of other levels of government, particularly the States, is therefore needed. The Special Premiers' Conference is an important forum for advancing microeconomic reform — especially in the areas of transportation

and public trading enterprises.

As I have said, governments can only do so much. Changes need the support of workers and managers as well. The move to increased decentralisation of industrial relations — and in particular, enterprise level negotiations — will mean that the parties most exposed to the demands of a competitive

trading environment will play a larger role in the determination of workplace conditions. Ultimately, while government can provide the right overall economic environment in which these negotiations can take place, it is up to workers and enterprises themselves to exploit the opportunities.



Recently released economic statistics have tended to confirm our view that the economy is set to recover during the current half year. The overall pace of recovery through 1991-92 will, however, be subdued compared to past cyclical recoveries.

That, however, is entirely consistent with our longer-term economic needs. It will be conducive to making further gains on inflation and inflationary ' expectations and is consistent with our longer-term objective of repairing Australia's external imbalance. Tt will also be conducive to sustained *

employment growth.

With continuing sensible monetary and fiscal policy settings, together with further industry reform, I believe we can look to the future with confidence.


Balance on Merchandise Trade Account

The balance on the merchandise trade account is the difference between exports and imports of commodities and manufactured items. Merchandise trade excludes "services" such as travel, shipping costs, insurance and consultancy fees.

Current Account Deficit « *

The current account deficit is the difference between, on the one hand, exports of goods and services plus income and transfers from abroad and, on the other hand, imports of goods and services plus income and transfers to overseas.

Endogenous Imports

Endogenous imports is a measure which excludes irregular or 'lumpy' items (fuels, civil aircraft and government imports). Being more closely related to economic conditions than total imports, they give a better measure of underlying trends of imports.

Foreign Debt

The level of foreign debt is the total amount owed to foreigners as a result of borrowings. Debt can be either gross or net — the latter concept nets out Australian lending overseas and the stock of official reserve assets. The level of foreign debt is often expressed as a proportion of GDP to relate it

to the size of the economy. 'Stabilising the foreign debt' means that the growth of net foreign borrowing is growing no faster than GNP.

Import Penetration

Import penetration gives a measure of the market share of imports in the domestic market. The most common measure is the ratio of endogenous imports to domestic spending (GNE).

Net Income Deficit

The net income deficit is the difference between income payments to foreigners and income receipts from abroad. The main item in income payable abroad is the servicing of foreign borrowings (eg interest) and foreign equity (eg dividends) in Australia.

rmrei? i t e m s

Automatic Stabilisers

Automatic stabilisers are items in the budget which bring the government more revenue and lower outlays when private sector activity is strong and less revenue and higher outlays when private sector activity is weak, thereby cushioning the impact of economic activity fluctuations on the private sector.

Capacity Utilisation

Capacity utilisation is the extent to which a firm uses its factors of production. Factors of production include land, labour and capital. The optimum level of capacity utilisation is to have factors of production fully engaged — neither over-extended nor lying unused.

Fiscal Policy

Fiscal policy is that part of the government's economic policy involving decisions about the outcome of its Budget, including decisions about the level and allocation of spending and the sources of revenue and borrowing (if necessary) to finance that spending.

Inflationary Expectations t

Inflationary expectations are what the rate of inflation is currently expected to be for a given period ahead. *

Interest Rates

Interest rates can be nominal or real. Nominal interest rates are those quoted by financial institutions and money market participants for loans and deposits. Real interest rates are nominal rates adjusted for the expected

rate of inflation. It is often difficult to measure the expected rate of inflation, so actual inflation rates are frequently used as a proxy.


The medium-term is generally understood to range from one to five years. It extends beyond the period in which policy change and other shocks have their immediate (short-run) impact and covers developments over the subsequent phases of the business cycle.

Microeconomic Reform

Microeconomic reform involves removing barriers to achieving the greatest possible output from a given level of resources. This process of reform includes promoting increased competition, removing unnecessary regulation and addressing inefficient management and work practices.

Monetary Policy

Monetary policy involves government action to influence the cost and availability of credit in the national economy with the aim of affecting spending and pricing decisions.

Non-Farm Stock Cycle

The non-farm stock cycle will contribute to product growth over the coming year as the rate at which business cuts its stock levels in the recession continues to decline and as stock building subsequently gathers pace.

Public Trading Enterprises

Public trading enterprises are enterprises owned by government which produce goods and services for sale to the public and which aim to recover at least a significant part of their operating costs through charges. Other terms often used interchangeably are Government Business Enterprises (GBEs), Government Trading Enterprises (GTEs), and State Owned Enterprises (SOEs).

Structural Integrity of the Budget

The structural integrity of the budget would be protected by a fiscal stance consistent with approximate balance in the budget (that is, a situation where expenditures equal revenues) when the economy is operating at normal levels of activity (that is, when the economy is neither overheated, nor in recession).