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Lessons and reforms of the last twenty years and prospects for the 1990s



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SPEECH BY THE TREASURER, JOHN KERIN MP TO THE 1991 CONFERENCE OF ECONOMISTS, HOBART, WEDNESDAY, 2 OCTOBER 1991

LESSONS AND REFORMS OF THE LAST TWENTY YEARS AND PROSPECTS FOR THE 1990s

Introduction

Since I became Treasurer almost four months ago, my attention has been focussed on the recession. My aim is to generate sustainable economic and employment growth while preventing a re-emergence of inflationary pressure and reducing the current account deficit. I am confident that our policy settings can achieve this.

Tonight I would like to put current policy into its long-term context.

Over the past twenty years, Australia has not been able to sustain strong economic growth for more than a few years at a time without something going wrong. This reflects deficiencies in our economic performance. In his 1985 Edward Shann Memorial Lecture, Professor Fred Gruen noted that Australia’s

relatively mediocre economic performance was not a new phenomenon; economic growth in Australia had been relatively slow since World War 1.

Our history has been one of periods of rapid economic growth and external shocks contributing to imbalances which halted growth. Real wage shocks squeezed profits, leading to weak business investment. More recently high inflation has created uncertainties and distortions in economic decision-making and reduced growth. These were features of the recessions of

1974-75 and 1982-83. Weak fiscal positions contributed to.shortfalls in national savings, putting pressure on the balance of payments.

The inability of the Australian economy to sustain strong economic growth must be seen largely as a result of structural rigidities. In his Shann lecture, Professor Gruen highlighted the adverse effects of rigidities in product markets and labour markets (although he commented that the Accord had worked well to restore a more favourable economic climate). Tonight I would like to

focus on those rigidities and the Government's program to address them through structural reform.

In seeking to remove structural rigidities the Hawke Government has consistently adopted a consultative and staged approach to reform. The Accord and Special Premiers Conference processes and the phased reductions in tariffs exemplify this approach. At all times there has been concern to share the adjustment costs and benefits in an equitable manner.

This record contrasts sharply with the rhetoric of the Opposition Leader, Dr Hewson. The risks of inequitable outcomes are intensified when, as appears to be the case, an ideological fervour for' "dramatic and rapid change" becomes an end in itself.

By inhibiting productivity growth, structural rigidities have constrained the supply potential of the economy, limiting growth in output, employment and living standards. They have made it more difficult to control inflation by reducing competition in product and labour markets and providing impetus to wage-price spirals. They have also made it more difficult to meet domestic

demand growth without putting pressure on the external balance. And by reducing the flexibility of the economy, they have made it much harder to adjust to external shocks.

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Our Budget cushioned the effects of the recession by allowing the automatic fiscal stabilisers to work. As a share of GDP, the estimated 3.4 percentage point turnaround in the budget deficit over the two years to 1991-92 is not much less than the 3.8 percentage point increase in the two years to 1983-84

associated with the last recession. However, in contrast to the fiscal approach adopted in the last recession, the Government has consciously decided against discretionary fiscal stimulus. This strategy reflects the need to maintain the underlying structure of the Commonwealth Budget so that the call by the Commonwealth on national savings will steadily reduce as the economy recovers.

The prospects for the Australian economy in the 1990s depend largely on continued progress in addressing these factors which have prevented strong and sustainable economic growth. This will require holding recent improvements in inflation, fiscal consolidation across the three levels of Government to boost national savings, and continuing the process of internationalising the Australian economy and improving its productivity and flexibility.

The Imbalance Between Wages and Profits \

The worst feature of the Australian economy in the 1970s and early 1980s was the conflict between labour and capital. Excessive wage growth squeezed profits and produced a wage-price spiral making a large contribution to the recessions of 1974-75 and 1982-83.

By contrast the degree of wage restraint in Australia since 1982-83 has been impressive. Though some have sought to deny it, the Accord has made a major contribution to modifying behaviour and moderating real wage outcomes. This was particularly obvious between 1986 and 1989 when the economy and labour market were subject to strong demand pressures. Wage restraint, and the

resulting reductions in real unit labour costs, provided a substantial stimulus to profits, investment and employment growth.

In contrast to the two previous recessions, the recent downturn was not preceded by any sharp increase in wages. In fact both nominal and real wage growth remained broadly unchanged. The substantial turnaround in gross factor

shares that occurred in the mid 1980s has been maintained. This is testimony to the Accord and the extent to which it has engendered a spirit of co-operation and national purpose into labour relations. This has changed the whole character of wage bargaining.

The Fiscal Imbalance and Current Account Deficit

The second half of the 1980s saw a significant reduction in the call of Commonwealth and State Governments on national savings. This reflected the effects of strong economic growth on Commonwealth and State budget balances and fiscal consolidation by the Commonwealth. More recently, the economic downturn has had a significant impact on Commonwealth and State budgetary

positions and has contributed to the expected increase in the net public sector borrowing requirement in 1991-92.

Despite the substantial improvement in public savings, the overall imbalance between savings and investment deteriorated in 1988-89 and 1989-90, resulting in a sharp increase in the current account deficit and the level of foreign debt. This reflected increased private borrowing, a considerable part of which was based on unsustainable asset prices and even projections of

continuing rapid asset price inflation.

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This led some people to argue that fiscal policy is ineffective in addressing a current account deficit - particularly given our recent experience of increased public saving or reduced public borrowing being offset by reductions in private savings or increased private borrowing. There have also been calls for re-regulation of the financial system.

These are simplistic reactions. Financial deregulation certainly played a part in asset price inflation and the surge in borrowings, but it was only one of a number of factors. We now know that, like other OECD countries, our macroeconomic policy stance which was loosened as a conscious policy response

to the 1987 stock market crash was not tightened sufficiently after that critical period had passed. Our relatively high interest rates and low public sector borrowing requirement could not offset the strong impetus to borrowing

from high profits, buoyant commodity prices and high asset prices.

Many of the borrowing excesses reflected a process of adjusting to financial deregulation by households, companies and lending institutions. Further, regulators sometimes lagged behind new developments in the market, with the result that in some respects prudential supervision was insufficient. These lessons have been well learned. The same mistakes will not be repeated in the 1990s.

Anyone who thinks we could turn the clock back to the banking and foreign exchange regulations of the pre-1983 era needs to realise that these had become largely ineffective by the early 1980s. By then international financial markets were becoming increasingly integrated and some of the distinctions between different types of financial institutions were becoming obsolete. This is even more true today.

In the late 1980s the surge in private sector borrowings meant that increased public savings were not translated into an improved savings/investment balance. The lesson for the future is that fiscal consolidation by the public

sector will be an essential component of our policy mix to reduce the current account deficit and stabilise our foreign debt.

Structural reforms will also continue to have a role in addressing these problems. In order to reduce the gap between savings and investment, and thereby reduce the current account deficit, a wedge has to be driven between output growth and domestic demand growth. Raising sustainable output growth

through productivity improvements provides scope for growth in domestic demand without reducing net export performance.

Inflation

Since the early 1970s, Australian inflation has been consistently worse than the average of our major OECD trading partners. That has had a significant economic cost. It has distorted decision-making, created a less stable economic environment, reduced the efficiency of the taxation system and lead

to arbitrary redistributions of income and wealth. Arbitrary in the sense that inflation has a regressive effect on income distribution and does not reward productive economic activity.

For the first time in twenty years, our inflation rate is now significantly lower than our major OECD trading partners. Whilst this is, in significant part, a consequence of the recession, there are encouraging signs of reduced inflationary expectations. That provides an opportunity for a sustained

reduction in inflation. The fact that the CPI did not pick up significantly during the upswing to 1989, despite the strength of domestic demand and the rise in asset prices is evidence that we can grasp this opportunity.

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The challenge is to both realise the benefits of low inflation and restore steady and sustainable growth in economic activity and employment. Needless to say, monetary policy will have an important role in influencing inflation and inflationary expectations during the recovery phase, and given the lags will have to be managed with great care.

In the medium term, structural reforms in product and labour markets also have a crucial role. More competitive markets reduce the scope for cost padding and ensure that one-off price increases arising from external or other factors are not built into underlying inflation and inflationary expectations.

Structural Reform

It will be apparent that structural reforms have an important role to play in addressing the macroeconomic imbalances that have plagued the Australian economy over the last twenty years. In a static sense, structural reform can improve the allocation of resources within the economy by providing incentives

for resources to be used where they are most productive. However, the dynamic gains arising from increased competition, more outward looking and flexible attitudes and increased innovation, are potentially of greater significance.

Our Government’s structural policy strategy operates through five major channels.

Internationalisation of the Australian Economy

Internationalising the economy is the critical element of the strategy. Floating of the dollar and deregulation of financial markets were key early initiatives. The March 1991 Statement continued this process through further reduction of tariffs with: - *

- general tariffs phasing to 5 per cent by 1996;

■r - tariffs on passenger motor vehicles and components reducing to 15 per cent by 2000; and

- tariffs on textiles, clothing and footwear phasing to a maximum of 25 per cent by 2000.

The Industry Commission has estimated that the long run effects of the measures announced in the Statement would generate a 0.5 per cent increase in real GDP, a 2 per cent fall in the CPI and a small positive impact on the balance of trade. These estimates do not take account of the dynamic benefits

of changed behaviour.

Reforms to Improve Productivity and Competitiveness

Second, we have undertaken a range of measures to improve productivity and competitiveness. Increased productivity growth enables the profit share to be maintained whilst allowing increases in real wages and living standards. It is in this area where most work remains to be done.

We have had policies for several years to increase the flexibility of the wages system and relate wage increases more directly to improvements in productivity. One issue in the Industrial Relations Commission review of wage fixing principles will be how best to develop the framework for workplace

bargaining.

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Enterprise level negotiations have the potential to facilitate the removal of inefficient and outdated work practices, and to establish better incentive structures for skill acquisition, retraining and labour mobility. The transition will have to be managed. Too rapid a transition without an appropriate framework, has the danger of opening a gap between real wages and productivity.

Another important area of reform concerns education and training. Increasing the skill of the workforce contributes to productivity growth and flexibility. In periods of high unemployment in particular, it is also

essential to provide opportunities for the long term unemployed to improve their workplace skills. Apart from the human tragedy of long term unemployment, it is necessary to avoid the situation where shortages of skilled labour act as a brake to economic growth at levels well below full employment.

In contrast to the emphasis on direct job creation schemes, such as REDS in 1974 and CEP in 1983, much greater emphasis is now placed on training programs that will enhance the prospects of people^securing a permanent job in the workforce. Assistance for labour market and training programs is estimated to

increase by around 50% in real terms in 1991-92.

We have subjected our Government Business Enterprises (GBEs) to a series of reforms including freeing them from day-to-day control by the Government, to operate commercially provided they produce an appropriate return on their capital. In some cases we have taken the ultimate step of privatising them.

The big example of this is the abolition of Telecom's long-standing monopoly on network services.

Reforms to GBEs will benefit both households and business. These reforms are all the more urgent given the initiatives to subject Australian businesses mores fully to international competition.

In many areas structural reform requires co-operation from all levels of Government. The Special Premiers' Conferences are the main vehicle for achieving this.

Following the July Special Premiers' Conference, the National Rail Corporation (NRC) has been established to improve the efficiency of rail transport, a National Road Transport Commission has been established to regulate heavy vehicles on a national basis, and a National Grid Management Council has been

established to achieve efficiencies in electricity distribution. Principles have also been agreed with the States and Territories to achieve regulatory reform.

Another major area of reform has been taxation. The Government has comprehensively reformed the taxation system. We have reduced substantially both personal and company income tax rates and have broadened the tax base. We have removed many of the distortions which favoured speculative rather than

productive investment, a low inflation environment will reduce others.

Tax reform is a never ending process as we continue to focus on equity, efficiency and international competitiveness. In the March 1991 Statement, tax on business inputs was reduced by simplifying and extending the range of exemptions to the wholesale sales tax for goods producers. Last week Senator Button and I announced the details of changes to the depreciation arrangements which will provide for self assessment of effective life. For example this will allow manufacturers who have to change processes or equipment to maintain

competitiveness to depreciate those assets over the period they will be economically useful rather than their potential physical life.

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Other reforms are having a significant effect. The two airline policy ended last year. Our tourism industry is now seeing the benefits of increased competition in substantially reduced airfares. Thank you Brian Grey for demonstrating the value of contestability of markets. One of the areas I

intend to have a new look at is competition policy. This implies more than the rumours which are circulating about an amalgamation of the TPC and PSA.

Removing Trade Barriers Globally

The third arm of the strategy is directed at removing trade barriers globally. The Uruguay Round of the GATT is a major priority. This may be the last opportunity this century to strengthen and modernise the international trading system to underpin growth in world trade.

Australia is committed to achieving a successful outcome on agriculture. This would encompass substantial and progressive reductions in internal support, market access barriers and export subsidies. Reductions in EC coal subsidies and the signing of a liberal framework for trade in services are also high in

the Government’s Uruguay Round objectives. \

Interventions to Counter Market Failures

Fourth, the strategy recognises the need to design specific Government interventions to counter market failures. In a number of areas market outcomes fail to take full account of the social costs and benefits of particular activities. Government intervention to offset market failures may be justified in areas such as research and development, training, and trade promotion. As I mentioned earlier, intervention is sometimes also necessary

to ensure that markets function competitively.

One example of market failure is that those using natural resources often do not bear the full range of costs associated with their use. To this end, the Government has initiated the Ecologically Sustainable Development (BSD)

process to ensure these factors are integrated into decision-making.

It is also important that developments be allowed to proceed where there are no good reasons why they should not. Because of the lack of an integrated framework, processes for resolving conflicts between environment and development have in the past been more subjective than they need be. This has

led to uncertainty for developers. The establishment of a comprehensive BSD strategy is intended to provide a better framework for policy making.

Sharing the Costs of Adjustment Equitably

Finally, the success of structural reform depends on sharing the costs of adjustment equitably. The Government has introduced a number of programs to ensure that the adjustment costs of reform are shared amongst the broader community. For instance in the March 1991 Statement a total of $90m was

approved for labour adjustment programs to assist displaced workers in the passenger motor vehicles and textiles, clothing and footwear industries with relocation, training and wages subsidies for job redeployment.

Social Justice

The goal of strong and sustainable economic growth over the long term is fundamental to improving social justice. It is only through economic growth . that resources can be generated to achieve a more equitable society. The recession demonstrates how it is the disadvantaged and less skilled members of the community who suffer disproportionately from slowdowns in economic activity and the resulting unemployment.

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Hence over the longer term, economic growth and social justice are mutually reinforcing. Wage and salary earners are much more willing to accept wage restraint in the national interest when there is an obvious policy framework and Government determination to enhance social justice. Increases in the social wage, such as greatly expanded superannuation coverage of the workforce, and a well targetted social security system are critical to garnering support for this restraint. Whilst average weekly earnings are

lower in real terms than in 1983-84, real household disposable income has increased substantially, reflecting in part, increased employment and transfer payments, in particular the Family Assistance Supplement and wider

availability of fee relief for child care.

Concluding Comments

Tonight I have sought to highlight the contribution that structural reforms can make in addressing the factors that have impeded sustainable economic growth over the last twenty years. Whilst the Government has already implemented a broad reform agenda I do not wish to understate the task ahead. The critics would not allow such a luxury for it seems the greater the

achievements, the greater the demands for mbre.

A major goal of successful structural reform is to engender more outward looking and flexible attitudes throughout the community. In many cases that means abandoning narrowly defined self interest for mutual interest. That enlightenment is likely to be based on addressing real problems and

inefficiencies rather than an ideological market view of the world. In some cases that means making markets work better and reducing regulations, in others it means more focussed intervention. Achieving broad acceptance for this enlightenment requires that its costs and benefits be shared equitably.