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Leader of the Opposition

Check Against Delivery

?■ "

i* 7

ADDRESS BY

DR JOHN HEWSON, MP LEADER OF THE OPPOSHION

ON THE OCCASION OF

CEDA'S ANNUAL ECONOMIC AND POLITICAL OVERVIEW

'THE POLITICAL AND ECONOMIC ENVIRONMENT1

REGENT HOTEL, MELBOURNE

WEDNESDAY 30 JANUARY 1991

Parliament House, Canberra, A.C.T. 2600 Phone 77 4022

Good Afternoon, Ladies and Gentlemen.

I am grateful for the opportunity to speak to this the Twelfth Annual CEDA Overview Conference.

The CEDA Overview Conference has become known as one of the leading analytical forums in Australia.

The strength of the CEDA framework has been that it combines detailed economic assessments with political Insights from experts close to the action.

This Conference has been no exception. You have now received excellent papers from the experts on the global and domestic political and economic outlooks.

And Ivan Deveson has provided a stirring message on what needs to be done from somebody who has not only had to deal first hand with our basic industrial problems, but also has a knowledge of how Government works,

I will try to bring some of these threads together with the aim of focussing on the economic outlook for Australia and what that means for the domestic political scene in 1991.

Inevitably, my comments will reflect a view from the Federal Opposition of likely events and will differ in some respects from the analysis of Richard Farmer, which benefits from his insights into Government thinking.

But I hope that contrast itself will be of value to you. The fact of the matter is that rarely in our history have there been so many uncertainties about the economic and political outlook.

If one is to add value to this Conference, therefore, it is

essential to "chance one's arm" and look beyond immediate events to underlying trends and the way they will manifest themselves in political life.

An .QYegyjLgtf

The general theme of my remarks is that, despite the considerable longer run promise of recent developments, the world economy is in the grip of a severe credit crunch which will lead to a period of flat growth in 1991 and 1992. Essentially this slowdown can be seen as an inevitable consequence of a prolonged period of excessive credit creation and the increasingly poor credit quality of international banking.

As the current situation was some time in the making, it is

unrealistic to expect it to be resolved in six months.

Australia will experience a rolling recession in the next two years. We are presently experiencing the consequences of the domestically induced recession and, in the near term, we may see some slowdown in the rate of deceleration in the economy as stock

rebuilding proceeds and housing demand responds to reduced interest rates.

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But the current slowdown has left us with a current account of about 4 per cent of GDP and foreign debt still rising. We are therefore exposed to a secondary wave as the consequences of the slowdown in the world economy and the full effects of the rural crisis hit in the latter part of 1991.

Indeed, I am concerned that the recent easing in monetary policy, coupled with the significant loosening of fiscal policy since the Budget, may mean that the next significant move in interest rates is upwards.

- perhaps to deal with the balance of payments crisis which may soon follow any pick up in domestic demand in the

context of a world recession.

This, then, would ultimately push unemployment to 10 percent of the workforce or higher.

This period of stagnation and despair will see continuing leadership pressures in the Labor Party with a temptation to swing back towards its "traditional roots". Mr Hawke is now seeking to re-establish his authority over the Party and Mr Keating.

- As it has been said, the first casualty of the Gulf War may

be Paul Keating.

And now, the Prime Minister is using these circumstances as a base to change the thrust of economic policy in Australia towards a more interventionist stance.

Any short-run rebound in the economy may then be used as a

springboard for an early election or for his retirement and the passing of the leadership mantle to Beasley or Kerin or whoever.

A crucial question for business is whether a leadership change will come before or after another election.

I will provide you with my view on that after I have tackled the background against which this decision will be made. To explain how I come to these conclusions, let me start by

running through the main international political and economic influences operating at present.

The International Political Environment

The Gulf War is dominating our thinking at present. The main message here is that we must be prepared for surprise. The fact that the Coalition of forces arraigned against Saddam Hussein has a technology edge in weaponry should not blind us to the fact

that Iraq has the capacity to inflict considerable pain along the way - both on the battlefield and through acts of terrorism, and in inciting aggression and resentment among Muslim groups around

the world.

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While we must, hope otherwise, my view is that we must factor in the possibility of a long war and an ultimate military solution which will complicate the already difficult challenges to be faced in prosecuting a lasting peace in the Middle East.

But the Gulf War should not blind us to other developments.

- there is the power struggle going on in Moscow over the future of the Soviet Union's economic and political reform program which has so encouraged the world over recent years

- there are the serious economic problems that now

confront the economies of Eastern Europe after all the euphoria that surrounded the death of their bankrupt communist systems last year

- there is confrontation in the Baltic States where the Soviet Union has used the Gulf crisis as a distraction from its totally unjustified military crackdown which to date has caused at least 18 deaths. The Baltic

States have legitimate aspirations to independence and democratic rule. The Soviet Union needs to accommodate those aspirations through peaceful negotiations and not the barrel of a gun

- there is the continuing tragedy in Cambodia.

- the GATT system of open international trade that has operated so effectively since the late 1940s is

teetering on the edge of collapse.

Of course, it is not all bad news.

. The threat of superpower nuclear conflict has diminished greatly

. A new Europe has arisen, particularly in the European

Community where there is the prospect after 1992 of a market approaching 340 million people with strong growth potential.

. There is the continuing economic dynamism of our own

Asia-Pacific region

My summation of these international developments is that they offer considerable longer-run promise for both world peace and stability and economic growth, but in the shorter term they are likely to make life more difficult for the world economy.

This is particularly so of the Gulf War which seems likely to add considerably to the costs confronting the Western nations, particularly the US, than had perhaps been foreseen.

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Ironically, perhaps, in view of earlier fears, that cost will not come in the form of higher oil prices but in higher budgetary costs, and more pronounced trade imbalances, particularly to the

The World Economy

Perspective on the world economy is changing rapidly.

The recently released OECD forecasts suggest that the major industrial countries would experience merely a mild slowdown in 1991.

Output in the OECD was forecast to slow from close to 3 per cent in 1990 to 2 per cent in 1991 before accelerating modestly in 1992. As a consequence, the unemployment rate in the region was expected to pick up slightly towards 7 per cent.

Two positive aspects showed in the forecasts.

One was that inflation is expected to head down after the current blip stemming from Gulf induced oil price hikes and the tail end of pressures against industrial capacity which emerged in the last two years.

The second was that further progress was expected in closing the current account imbalances which had been widening at a worrying rate in the period to 1989. But since these forecasts were prepared we have seen a sharp deterioration in the economic situation, particularly in the US where business and consumer confidence has dived sharply. And

national account data released a few days ago showed that output dipped by 2.1 per cent in the last quarter of 1990.

Several private forecasters in the financial markets are now expressing concern that the US will move into a very marked recession lasting four quarters or more.

Meanwhile, Leading Indicators prepared by the Centre for International Business Cycle Research show only 3 out of 11 countries confirmed experiencing strong growth in the period up to October. Those three countries were Germany, Italy and South Korea. All others including the US, Japan, UK, Prance and Canada were showing weakness and the Centre talked of "signs of an

international recession continuing to darken the horizon."

And the USSR and parts of Eastern Europe such as Poland now

appear to be experiencing an economic depression with massive falls in production and fears of famine in some of the regions effected.

But the US and other Western administrations still express confidence that the recession will be short and relatively shallow.

How do we reconcile these different views?

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My own view is that the differences largely reflect the different orientations of the two sets of forecasters.

- The "real sector" forecasters, whose modelling dominates the official view, are looking at their conventional indicators. Low stock/sales ratios, continuing real disposable income flows, containment of inflation and, of course, the

stimulatory impact of defence spending. Some are also looking ahead with enthusiasm to the potential stimulus to the world economy from the integration of markets in the EEC and the collapse of communism in Eastern Europe.

But the "financial sector" forecasters are concerned about the backwash of the asset price boom and bust of the 1980s. Their concern is that many corporates and individuals have overgeared themselves and now see their equity being eroded

in what were in many cases "marginal" investments.

They focus on the banks and other financial institutions who must carry the debts based on the previously over-valued assets. At this stage they are effectively running a debt moratorium - debtors are allowed to continue to operate their businesses - but gradually the institutions are assuming the poorer quality assets onto their books. Sooner or later these assets must be liquidated.

If that can be done on a rising market then the institutions may remain viable - but if not then severe repercussions could follow.

Who will be correct? In some ways we are looking at a replay of the 1987 stockmarket crash but this time around it is led by property and related assets. In 1987 the "real sector"

forecasters were correct. They assessed that the fundamental economic conditions dictated continued growth as Central Banks reacted quickly to prove liquidity to a panicked market.

But this time around I believe the "financial sector" forecasters have a better case.

We should recall that the long upswing in activity from 1982­ 89 was fuelled by abundant credit. In this period, US broad money supply increased by an average of 8 per cent per year. In Japan the increase was 9 1/2 per cent? Britain 15 1/2 per cent; and Germany 6 1/2 per cent.

Much of that credit found its way into asset prices. Wall Street rose 250 per cent over the five years to mid 1987 while the

Nikkei Dow went up over 300 per cent in the run to its peak in

December 1989.

Property prices have experienced a similar increase. Although comprehensive indices on property prices are not available, the nature of the problem can be seen by looking at bank lending to real estate in the period 1984-90. An increase of 118 per cent

in the United States; 585 per cent in the United Kingdom; and 155

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per cent in Japan (the latter figure is understated because much real estate lending is channelled through non-real estate companies).

The result of this surge is now becoming evident for all to see. Salomon Brothers estimate that the US has about a ten year supply of office space. In Paris the stock of office space will rise by about 8 per cent in the next two years. In Japan a massive 68

percent increase in property space is expected in the period 1991-95 compared to the previous 5 year period.

Not surprisingly, vacancy rates are rising and returns falling in North America, the UK and elsewhere in Europe,

And they will continue to fall through 1991, exacerbating the degree of financial stress on financial institutions in those countries.

Indeed it is not being alarmist to say that the US authorities are clearly worried about the viability of many of their major institutions.

Aside from the well publicised collapse and subsequent publicly funded bail-out of many savings and loans institutions, we are seeing increasing evidence of stress in the US banking system. We have already seen major problems develop in the North-East of

the US with the Bank of New England and the temporary closure on Rhode Island of 45 local banks threatened with a run on deposits.

And it is no coincidence that we have just seen Moody's downgrade the credit rating of Citibank, the largest bank in the USA. That downgrading came on the eve of an announcement that Citibank needed to raise US $5 billion to Improve its capital base.

One of the real problems facing world financial markets in the next ten years is the need for banks and other financial

institutions to improve their balance sheets in the context of capital shortages.

But serious as the American problems are, they pale by comparison with those confronting Japan.

Just reflect for a moment on the extent of the Japanese property boom. The value of property in Japan has been theoretically valued at 200 trillion yen - five times the country's GNP and four times the value of the total stock of property in the US.

Does this make sense? Certainly Japan is a mighty power with enormous corporate strength and reserves but what happens if that power is temporarily damaged or constrained by trade or exchange rate variation?

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And the factors which have driven this boom are changing, perhaps foreveri

- Japan's huge current account surplus is disappearing as both private and much needed public spending on infrastructure picks up;

- Inflation is being driven by domestic as well as offshore factors;

- The highly regulated financial market which delivered such low interest rates is being unwound; and

- The yen is no longer markedly undervalued.

We shall have to see how events unfold but the risks are clear. If the cost of capital is to rise in Japan many projects will no longer be viable. The banks will suffer losses and have to pull back their lending.

The risk now is that the disease will spread quickly across the international banking community and the credit crunch will become self-fulfilling just as it did in the 1930s.

We have seen growing interdependence in the financial system over the last decade and there is a risk that a major company collapse in one country will affect the credibility of its bankers, and that in turn can affect its other bankers through the swap and

foreign exchange markets. And as each bank tightens its credit stance or enters into an asset disposal program it can impinge directly on the financial position of others.

Many express confidence that this problem can be handled by the US Federal Reserve and other central banks of the world. Perhaps this is so but I am not sanguine about that outcome for two

reasons.

First, there are serious constraints on their immediate capacity to ease. In the US, for example, the Fed must be content with a Federal budget deficit now in excess of $300 billion and growing daily, still high inflation, and a shaky currency and the

stimulatory effect of the Gulf War. Meanwhile in Japan inflation is running at a nine year high.

Second, even if credit was eased sharply there is no guarantee that it would assist affected institutions for some time. •

• In this context it is worth recalling, without necessarily drawing strict comparisons, that between the initial stockmarket crash in 1929 and the end of 1930 the Federal Reserve slashed key interest rates to almost a third of

their pre-crash levels. But all the while banks were going broke. The credit ease did not help them because they had invested poorly and found themselves holding low quality loans in a falling market where liquidity vanished.

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The ultimate solution therefore lies in rebuilding the quality of banks' balance sheets. That will require the banks' to earn reasonable margins on their operations so they can gradually write off bad loans and rebuild their capital. Until they do so they will not be able to lend.

But I fear this process will take some time. The world is short of capital right now. Many countries in the Western world have just delved heavily into their savings to finance the Gulf War and others such as Germany face enormous infrastructure costs. As the peace in the Gulf is prosecuted and the problems of the USSR and Eastern Europe are tackled, the problems threaten to

grow worse not easier in the 1990s.

So I believe we face a two year slow-down driven by a credit

crunch. The resolution of the credit crunch cannot be eased simply by easing monetary policy. it will require measures to boost savings worldwide including a restoration of fiscal restraint in a period of economic stagnation.

The Australian Economic Outlook

When Mr Keating brought down his misguided and visionless Budget in August last year many private sector forecasters suggested the economic outlook painted then of continued economic growth was slightly optimistic but that a "soft landing- was still in prospect.

But as events have unfolded since, most official and private sector forecasters have ripped up their work and started again.

At present, the consensus is that the economy will bottom around the middle of 1991 and then could stage a recovery.

That consensus manifests itself in a small projected fall of up to 0.5 percent in GDP in the current financial year followed by a recovery to around 2 per cent in 1991/92. The consensus has unemployment edging up towards 9 per cent and then receding as

inflation winds down steadily towards 5 percent or lower by the end of 1991.

What, you may ask, will drive this steady recovery? Well, say the forecasters*

- imports will fall but exports will hold up;

- the stock rundown now in evidence will bottom;

- housing demand will respond to the lower interest rates now in place;

and

- the Government sector will continue to spend, buoyed as it is by Labor Governments in all States but NSW.

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In the nature of such "consensus" forecasts, they will almost certainly be wrong. Things will either be much worse or much better.

Many of you will know where I stand.

I am on record as saying that economic circumstances will be the worst in 1991 since the Second World War and most possibly since the 1930s.

Why am I so much in the camp of the pessimists?

Part of that pessimism stems from the picture of overseas

recession which I have painted earlier. As I see it, the US and Japanese downturns and related financial problems and the full effects of our rural crisis will hit us just as we are emerging from the first wave of the domestic

recession engineered by Mr Keating.

But the greater concern is that over the course of the 1980s we have destroyed, or at least extremely weakened, large sections of our industrial base.

And much of the new investment that has occurred in the last few years with such fanfare from Mr Keating has in fact gone into the non-traded goods sector of our economy.

- As the Governor of the Reserve Bank said recently, we are

up to our ears in office buildings when we need investment in plant and equipment for export and import replacement.

And misguided efforts to underwrite a spike in wool prices have created a large over-supply in our wool industry just as demand seems to be on the wane.

This has coincided with the collapse of the world wheat markets and other major agricultural and horticultural commodities. The result of this is that our current account remains stuck at around 4 per cent of GDP despite being hit with Mr Keating's recession sledgehammer.

We do not yet know just how badly our industrial base has been damaged. Perhaps imports will sag sharply in the months ahead and exports will pick up steam but I doubt it.

One look at the ABS trend estimates of the balance of trade and current account or the abysmal productivity performance revealed by the September national accounts should serve to bolster those fears.

It is becoming clear that Paul Keating has created a massively inefficient and uncompetitive economyi an economy laden with a massive foreign debt which must now be serviced in a recessed world economic environment.

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To date attention on these worrying trends in our current account has been diverted by the international tensions in the Gulf and associated concern about the oil price,

- As a perceived energy currency, the AUD has been able to

ride out the sharp narrowing in interest differentials which has occurred over recent months.

But what happens if, as many expect, oil prices head down once the Gulf War ceases?

And what happens if, as the forecasters suggest, the economy has found by that time at least a temporary bottom as housing demand picks up and stock rebuilding commences?

The AUD would be very vulnerable indeed, if not against the USD then against third currencies.

Of course, the risk of a shakeout very much depends on the policy stance adopted by the Government.

Policy has already been eased substantially.

We have seen monetary policy eased substantially.

- Cash rates have come down from a peak of 18 per cent in late

1989 to 12 per cent,

Fiscal policy has also been eased significantly.

The Commonwealth Budget deficit seems likely to come in under $5 billion in the current financial year - about $3 billion less than estimated.

And serious slippages are occurring in State Budgets.

The most serious situation is in Victoria where the public sector unions have prevented the cutbacks foreshadowed by the Kirner Government in their 1990/91 Budget. By some estimates the over­ run in the Victorian budget could exceed $1 billion but the final result will be dependent on how many assets the Victorian

administration can sell before year's end.

Not surprisingly perhaps, there are reports that Victoria's credit rating is under scrutiny again and the fear is that this could impact on the ratings for other States and the nation.

Of the other States, South Australia, Western Australia and Tasmania appear to be experiencing an over-run on Budget

estimates but even well managed States such as New South Wales and Queensland are finding their revenues cut back substantially.

The bottom line is that the public sector will have moved from a surplus of about 1 per cent of GDP in 1988/89 to a deficit of close to 1 per cent of GDP in 1990/91,

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Meanwhile, wages continue to run well ahead of productivity notwithstanding Mr Keating's latest ill-advised wage/tax trade­ off which had the effect of cancelling the adjustment which was to have been made after the September CPI outcome.

While the Government is congratulating itself on the prospect that wages growth in the year to June 1991 may fall below 6 per cent, that in reality is false comfort.

For it is unit labour costs (that is, after allowing for

productivity) that are relevant to international competitiveness. If the centralised approach to wage setting is unable to deliver productivity gains which allow our nominal unit costs to match those of our trading partners then we will continue to slip behind.

While the Government pays lip service to moves towards enterprise bargaining, the SPC and similar cases demonstrate that the union movement is not prepared to countenance genuine moves towards more flexible pay arrangements which are more closely attuned to

the capacity of their employers to pay and to the productivity of workers.

Meanwhile the Government is progressing its limited micro­ economic reform program at a snail's pace and, as I shall outline below, looking instead to move towards what is likely to be a costly and ineffective interventionist industry policy.

These economic portents are ominous indeed. They signal at best weakness in the currency after the current concerns about oil prices recede.

I will be so bold as to suggest now that, notwithstanding the rising level of unemployment, the next sustainable (as distinct from temporary) move in interest rates may be up not down as many in the market now expect.

Political Environment

As the media naturally focuses its attention on the Gulf War, the leadership battle between Mr Hawke and his Deputy Mr Keating is seething behind the scenes within the Labor Government. It is not only a source of embarrassment and concern to Labor M P s , who know that they have survived longer than they have deserved by being able to exploit disunity on the conservative

side of politics.

It has allowed Labor to place urgent policy responses to our emerging economic crisis in limbo.

Now that both Mr Hawke and Mr Keating have declared, through inspired newspaper stories, that they intend to fight it out for the leadership, there is a growing feeling within the ALP that the leadership issue must be resolved before the middle of this year.

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While many recognise that Mr Hawke has been a weak leader and that his obsession with popularity has led him to miss countless opportunities to make the necessary economic changes, they also know that Mr Keating, whatever his manipulative political skills, simply does not possess the overall national appeal or breadth of vision to lead the Party.

Moreover, many believe Mr Keating cannot be trusted to lead the Party. While he has tried to make the best of the current

economic situation by claiming to have "engineered" a recession which the nation "had to have", those in the Cabinet room know that was never his intention.

The fact of the matter is that the current recession is directly due to his and his advisers' blunders and miscalculations. His Cabinet colleagues know that and will not trust the leadership to someone capable of such massive errors of judgement - like

hie mentor Jack Lang, he could do untold damage to the Party, and not least to Australia, with more of his misjudged escapades.

Given that Mr Hawke is unlikely to have the courage to "force a vote", it's most likely that the next real sign post of the state of this leadership struggle will probably be the economic statement on March 12 which will not only indicate who is in the ascendancy in terms of economic thinking, but also who's in front

in terms of leadership.

The pressures are rising for the Prime Minister to move the Treasurer and make him the scapegoat in true Burke/Dowding/Cain style. The political knifing of Mr Keating will be a subtle but public affair. We could know on March 12.

The easiest solution will be for Mr Hawke to move him from the Treasury in a reshuffle.

It is most unlikely that Mr Keating will leave politics of his own free will - there has never been much substance to the "Paris option".

The forthcoming statements on the economy will effectively mark a "U" turn in Labor Party policy. The groundwork is now being prepared for this by Messrs Dawkins, Button and lately Howe and Kerin. It involves a concerted effort to undermine the so- called "rationalist" policies purportedly pursued by Mr Keating as too theoretical, too naive, too divorced from reality and so on.

This attack will be directed not only at Mr Keating, but also at the Coalition. Although we have set the agenda for the past ten months on defence, foreign affairs, immigration, Federal/State relations, structural reform and a vision for Australia through the "Australia 2000" program, we will be painted as pre-occupied with "narrow" economic efficiency and devoid of feeling for broader national goals and unheeding of the needs of average Australians.

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The Australia Day speech by Hr Dawkins can be regarded as part of a "setting-the-scene" piece.

Indeed, the recent statements by both Dawkins and Howe as to whether they've done a deal to throw in their lot with Mr Hawke.

Mr Dawkins has deliberately harked back to the "cultural and social renaissance" of the Whitlam era. He looks beyond the current recession to call for policiest-- boosting science and the arts;

- building multi-culturalism;

- improving the quality of teaching? and

- redesigning Australian cities.

And he would fulfil these aims with a centralist approach to fiscal management. The Commonwealth will be asked to intervene more not less in the economy and the States will have a lesser role acting as agents for the Commonwealth's aims.

In the short-term, he sees a need for Government assistance to boost exports and similar industry incentives.

Mr Howe has already made supporting noises in his own citizenship address on the Australia Day holiday although he clearly doesn't understand the nature of our problems for he saidi

"we must develop positive strategies to encourage earnings from our manufacturing sector to help us address the long­ term structural imbalances in our economy."

The secret to improving our export performance is obviously dealing with our structural problems and not the other way around.

We can expect Mr Kerin, who is likely to replace Keating as

Treasurer, and Senator Button to again chime in with similar speeches in coming weeks as the Industry Policy Statement firms up.

The broad outlines of the Statement can be detecteds-- more training schemes, especially for those likely to be

affected by reductions in industry assistance;

- a revamped rural reconstruction scheme?

- increased research and development assistance?

- more export incentives?

- accelerated depreciation allowances for new investment?

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- changes to existing depreciation life definitions in the Income Tax legislation#

- exemptions of exports and inputs to exports from wholesale sales tax (in an attempt to negate industry calls to replace the wholesale sales tax by the broadly based goods and services tax advocated by the Coalition)?

- a series of minor reforms to "simplify'· the taxation system including perhaps a withholding tax arrangement for interest income and some changes to capital gains tax;

- a "promise" of an infrastructure package which will be

largely financed from the future proceeds of the sale of Qantas, Australian Airlines and so on;

- a package to help Victoria counter its disastrous financial position, including the acquisition of V-Line by the new National Railway Authority and a special Loan Council allocation to cover the VEF redemptions.

We can expect this package of selected assistance to be presented with much fanfare and support from a few selected industry leaders.

And the debate about the value of the package will be clouded by arguments about the second best. For example, accelerated depreciation allowances will be welcomed by some in the business community, not because they are the optimum solution to

distortions of inflation and taxation rules on different forms of investment, but because they will be seen as some sort of ad hoc correction to the serious bias against investment in plant and equipment that exists in the present taxation system.

If you cannot do the first best and reduce inflation or index the tax system then do the next best and grant depreciation

allowances.

But who will fund these depreciation allowances? Somebody will have to pay for them either through reduced spending, higher taxes or higher interest rates than would otherwise have existed.

The truth of the matter is that the Labor Party is on the way

back to its roots. More intervention, more public spending and taxation, reregulation of financial markets and limited if any change to inefficient work practices or protection.

That process will not occur straight away. I expect that there may be a period when Mr Hawke tries to reconcile the

"rationalist" and "interventionist" approaches. If, as may occur, that half way house gets his popularity rating up, we can expect him to look for another election ~ possibly before the middle of 1992.

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Available economic forecasts suggest the economy may appear to recover in the course of 1991/92 - with some pick-up in housing due to lower interest rates and some statistical effects in stock-building, Mr Hawke may see this as a rare window of

political opportunity. To go early, he will undoubtedly try to capitalise on whatever transient improvement in popularity occurs as a result of his handling of the Gulf Mar and a claim that his industry policy "U" turn is working.

An early election would be his best hope of going out on a

"high".

An Evaluation

The great tragedy of the current political and economic

environment is that there is a considerable disillusionment with rational economic policies.

The impression has been left with the Australian people that Mr Keating has failed and therefore that rational economic policies advocated by the Treasurer and his advisers do not work. There is great anger at Canberra based advisers who are perceived as

living in an ivory tower.

While the Prime Minister and some of his opportunistic generals are clearly using this for their own political ends, these arguments completely misrepresent the true situation.

Rational economic policy has never been given a reasonable chance in Australial Although the Treasurer and his officials have talked and promised rational policy, they have never really delivered.

Careful analysis will show that while the Government did move at times towards what might be described by the critics as classic Treasury policies they were not sustained.

Financial markets were deregulated but that reform was not carried through to the labour and product markets. And the deregulation process followed missed opportunities to bolster competition and ensure adequate protection of non-bank

depositors.

Fiscal policy was tightened in 1986 but then monetary policy was eased prematurely. Fiscal policy has since been eased requiring tighter monetary policy. Protection was reduced but other micro­ economic measures were not pursued with vigour. And throughout

its term the Government has continued to set wages policy through "deals" with the union market which are completely divorced from the needs to relate pay and incentives to performance in the workplace.

Moreover> the Accord process itself has elevated the ACTU leadership to a statue which enabled it to place a veto power over much needed structural reform.

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One consequence of this poor policy implementation has been that inflation and unit labour costs have run for most of the 1980s at close to double that of our major trading partners.

That environment has not been conducive to tackling our

fundamental problems.

The lack of progress on microeconmic reform is perhaps the greatest testimony to the Government's policy failure.

The recent announcement by Black and Decker that it intends to stop producing power tools and home goods is a case in point.

According to Kevin Cashman, the managing director of Black and Decker# protection is falling without the compensating benefits of micro-economic reform. For example, there has been no real improvement in labour on-costs or on the waterfront.

So while the tariff reductions announced in 1988 were to be commended# they were not matched by policies to reduce the costs of production - reforms in transport# communications, the waterfront and# most importantly, labour market reform.

While the Accord has delivered employment growth, our lack of competitiveness has meant that those jobs have been purchased at the cost of a massive build up in foreign debt.

This has not been explained to the public which has become

increasingly uneasy because things aren't getting any better.

There is a call now to Hdo something".

The only viable solution is structural reform.

It is essential to give efficiency a chance first.

Mounting pressures will affect both sides of politics and these must be resisted by cold headed analysis and strong leadership.

It is no time to panic; it is no time to lose our nerve.

Popular panaceas and "snake oil" remedies must be resisted at all costs.

To be diverted from the objective of efficiency will only

compound our future problems.

But events are clearly turning the Government in a different direction.

- towards the visionary slogans of the Whitlam era.

- a period of unmitigated economic failure from which the

nation took almost a decade to recover.

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While we will have to aee just what this Industry Policy

Statement brings, there is no reason to expect it will resolve our problems.

The Government can offer no quick fixes; it has no magic wands.

We simply cannot solve our basic inefficiencies, many of which stem from past government intervention by, in effect, calling on the Government to intervene in ways which will risk even more inefficiencies.

By its very nature the type of selective intervention which the Government proposes can only address part of an industry's or a company's cost sheet.

Recent evidence confirms the widely held view that the

manufacturing sector is not export oriented. The fact remains that only a few firms are responsible for the bulk of the

exports.

A BIB survey conducted last year on the impediments to exporting faced by manufacturing firms received an unusually high response rate suggesting that, although their involvement may not be significant at present, many firms are concerned about their poor export performance.

Of the 1200 respondents to the survey, 38 percent had not

exported during the survey period (1986-87 to 1989-90).

These non-exporters cited price competitiveness as the single most important obstacle to entering into export markets.

Of course the exchange rate and the level of domestic costs are the major influences on the ability of goods to compete overseas.

According to the survey data, those cost factors which impinged most as reasons for not exporting includedi

- labour costs (cited by 46 percent of respondents as "very important")

- transport and waterfront (39 percent)

- finance (37 percent)

- work practices and demarcation disputes (31 percent)

Similarly, those firms which are exporters gave price

competitiveness as the most important single impediment to their export performance.

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Interestingly, difficulty in competing on price was cited by 62 percent of exporters compared to only 39 percent of non-exporters as a "very important" impediment while 56 percent of exporters and 29 percent of non-exporters accorded the exchange rate that importance.

This indicates that, while non-exporters are aware of the types of problems encountered by exporters, once they start to export, these firms may be in for a rude shock concerning the true extent of those problems.

Very high interest rates applied at the time of the survey and the Bureau expected that the cost of finance would have been one of the most frequently cited of the factors which affect price competitiveness.

But, in fact, as mentioned above, labour costs ranked higher than finance costs as impediments to both non-exporters and exporters.

In its conclusions on the survey results, the Bureau refers to the fact that labour costs were cited by many respondents as a significant problem inhibiting exports. It goes on to point out that wage rates in some countries, such as the former West

Germany and Sweden, have been much higher than in Australia, but, at the same time, these countries have been very successful manufacturing exporters. The Bureau concludes that;

"the issue is really about relative labour productivities. Australia should aim to become a high wage/high

productivity economy."

Well, I couldn't agree more.

While I concede that the world is not a perfect place, and

markets can fail in some circumstances, I believe that, as a general proposition, there is no evidence to support the view that Australia should now enter a competition in imperfection.

There is simply no substitute for the long, hard slog of

structural refora - so that we can produce more and start to trade our way out of our problems.

Competitiveness through greater efficiency is the main game; both at the industry and plant level.

The economic challenge for the nation in the 1990s will therefore be to make the changes necessary to transform our economy into a productive, internationally competitive economy capable of servicing its existing debt and at the same time attracting the new capital flows necessary to build our industrial base for the

future,

That is the only course which will avoid a further fall in our living standards.

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It 1b the only course which will sustain the nation's capacity to defend Itself, to look after its aged and sick, to preserve its environment, and to maintain its presence in international fora on issues affecting our region.

What Must Be Dong

We must boost our basic efficiency in the workplace by changing the rules and incentives to allow the nation to fulfil its

massive potential.

For the Government that involves two stepsi-- building a community understanding of what needs to be done; and - implementing public policy to improve the business

environment.

1. Community Understanding

The reforms necessary will not come about until there is a full community understanding of what must be done and how it will be done.

The present Government has failed badly on this score. Its initial denial that there was a problem has damaged its

credibility. Now it admits to a problem but has failed to

present an integrated package of measures to tackle it.

I strongly believe that Australians will accept reform - even if it involves changes which may temporarily affect them adversely - provided they can see that in the end it will lead to an

improvement in the overall welfare of the community in which they can share either directly through lower prices, taxes etc or indirectly by changing their behaviour, location, or occupation.

One of the objectives of the Opposition over the next year

therefore will be to explain how the process of change can be achieved and how the actions, or lack of it, of one group

influence others. For example, we must explain to workers how they can benefit from moving the pay bargaining process to the enterprise level. They must be encouraged to see the reason of flexibility in work practices. That it may make sense, for example, to give up some conditions of existing awards to enhance

the long run performance of their employer since it will enhance their own long term welfare.

2. Creating the Framework

In our public policy announcements before and after the last election we have sought to set down the basic public policy changes that need to be made in Australia to engender a recovery in our fortunes.

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They aret-i. introduction of more stable medium-term monetary and

supporting macro-economic policies to reduce and ultimately eliminate inflation. Lower inflation is critical to raising savings, reducing the real cost of capital to bossiness, achieving a more realistic exchange rate, and switching the

incentive towards productive rather than speculative investment;

ii. to reshape the taxation system through the introduction of a goods and services tax and associated changes to the existing income tax structure, including the taxation of capital gains, to give incentives to work, to save, and to

invest and to export.

iii. to expose our product markets to greater competition by accelerating the program of micro-economic reform we have mapped out for our wharves, our transport systems, and other vital infrastructure and moving rapidly towards full privatisation of public enterprises.

iv. To establish an industrial relatione system built around the settlement of wages and conditions in the workplace so that pay and performance are more closely linked.

v. Establish and then adhere to environmental policies and assessment procedures which provide an appropriate balance between development and conservation and minimise

uncertainty.

So, just to summarise -. The world economy is going into a steep downturn, the

outlook made even more precarious by the as yet unknown consequences of the Gulf War.

. Australia finds itself in a very vulnerable position because the fundamental structural changes which should have been made over the past eight years have not been made.

. Economic management in Australia is being diverted by the leadership tussle between Hawke and Keating and a strong push within the Labor Cabinet for interventionist industry policies. ;

. But I must warn that this is no time to lose our nerve as

a nation.

. No time to turn to popularist panaceas and "snake oil"

remedies.

There is no magic wand, no magic pudding, no quick fixes.

There 1» no substitute for the long, hard slog of structural reform so that we can improve productivity, increase production, export more and trade our way out of trouble.

Australia has a bright future if we take the right decisions and etick to our guns.

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