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Tuesday, 19 August 1980
Page: 107

Background

As is now well documented, Australia suffered a series of major shocks in the earlier years of the 1970s which fundamentally distorted the workings of the economy. While much has happened since, the developments of that period continue to affect the performance of the economy and therefore have relevance both for an understanding of the present situation and for the design of appropriate policies for the future.

The shocks of the 1970s can be traced to a number of factors. Important among them were an inadequate domestic response to the boom in the world economy and consequent developments in the balance of payments and the money supply and, later on, a rapid expansion of the public sector following a downturn in the economy, together with an inflationary wages policy.

The expansion in overseas demand in the early 1970s in conjunction with these domestic developments created intense pressure on resources, particularly labour supplies. This followed an earlier cut-back in immigration which reduced traditional supplies of skilled and unskilled labour and heightened wage pressures, particularly in a number of lower-skilled occupations dependent on migrant labour.

In the consequent scramble for available labour, wage rates were bid up in an explosive manner and, for a time, large numbers of people were enticed into the workforce. Abnormally pronounced shortages of less skilled workers contributed to a squeeze on wage relativities which further aggravated overall wage pressures. Although prices also soared, profits dropped sharply. The consequence was a general collapse in business confidence, leading to a major fall in private investment and a precipitous rise in unemployment as product growth fell away and as the jump in real wages caused labour to be priced out of jobs. High real wages also encouraged marginal members of the workforce to go on searching for employment and this, combined with high welfare benefits, further swelled the unemployment statistics. Australia's international competitiveness foundered and the balance of payments deteriorated.

The attempt to revive the economy by boosting public expenditure in 1974-75 did nothing to restore the private sector and left a gaping Commonwealth deficit, higher interest rates and pressures on financial markets. To the extent that it offset lower private sector economic activity it diminished the forces which, normally in such circumstances, would have helped reduce the distortions that had been created.

As a result the economy was left saddled with excessive real wages, dangerously low profitability, high inflation and poor international competitiveness, a large public sector deficit, excessive growth in the money supply and a financial market unreceptive to the raising of capital. It was thus ill-placed to generate the growth necessary even to absorb an increasing labour force, let alone to reduce unemployment.

Thereafter there commenced a slow haul back which has involved a policy of fiscal and monetary restraint directed at reducing the rate of inflation and correcting the fundamental distortions inhibiting private sector performance. As a result, there has been a gradual strengthening in private sector activity over recent years, demonstrating (if that needed to be demonstrated) that the economy can expand without significant stimulus from public sector expenditure. The strengthening in non-farm product growth in 1978-79 and particularly 1979-80 was associated with very low contributions from the public sector (see Table 4).

The basis of this economic strategy was set out in some detail in last year's Statement.

A number of the main economic policy indicators for recent years is presented in Table 18.

Table 18- Policy Indicators

Total public

Commonwealth Budget Real growth sector Volume Degree

(a)   Direct expenditure on goods and services by the public sector; this differs from total outlays in that transfer payments to the private sector are excluded.

(b)   Percentage increase, June-on-June.

(c)   Weighted average level of indexation of award wages to the CPI in the national wage case decisions handed down in each year. (The decision handed down on 14 July 1980 is included in 1979-80.)

(d)   Trade-weighted index of value of Australian dollar; May 1970 = 100; end-period.

(e)   Treasury estimate.

Though progress in the strengthening of economic activity has been fairly slow in the years since 1975-76, the Government's strategy has achieved considerable success in reducing distortions, and thus in restoring the pre-conditions needed to allow stronger growth in private sector activity on a sustained basis. Foremost has been the progress against inflation. However, as a result initially of external influences, including particularly higher oil and meat prices, price inflation in Australia has again crept upwards over the past two years. Now, with the high degree of wage indexation and the overly rapid growth in monetary aggregates, higher prices are being reflected in higher wages.

As the lift in the rate of price inflation in Australia has been well below that occurring in many overseas countries there has, nevertheless, been a continued improvement in Australia's international competitive position. This has been reflected in the strong growth in Australia's exports, particularly manufactured exports, but it has also resulted in strengthened output and investment in many traditional import-competing industries. The potentially massive growth in natural resource based investment, which is already under way and which, given appropriate economic policies, can be expected to continue throughout the 1980s, is also related to Australia's new-found competitive position.

At one level Australia's attractiveness to foreign investors and our ability to compete strongly on export markets can be explained in terms of the leap in the international price of energy (a resource which, oil apart, Australia possesses in abundance). However, while this is undoubtedly an important consideration, such an explanation fails to give due weight to the fact that Australia has been one of the few countries that have been able to sustain over an extended period an improvement in their overall competitive position through an exchange rate adjustment made effective by firm domestic fiscal and monetary policies. In short, while the existence of abundant natural resources is an important element in the strengthening recovery, the improvement in underlying economic conditions has been even more important.

Additionally, the extended period of comparative stability in public policy has reduced the uncertainty attached to private decision-making. Whereas Australia has had in place for a number of years a policy strategy which holds out the prospect of a return to a lower rate of inflation, the same can be said of few overseas countries, including those which may enjoy a similar endowment of energy resources.

Important progress has also been made in reducing, though still not rectifying, the factor price imbalance - that is, the imbalance between the return to labour and the return to capital - resulting from the sharp jump in real wages in 1974. The past year saw a further reduction in real unit labour costs; as in previous years the reduction was effected through productivity growth rather than through real labour cost adjustment. The strengthening in the demand for labour and employment growth in 1979-80 suggests that, in aggregate, real wages are now less of a constraint on employment growth than they were some years ago. However, the structure of wage rates remains a major hindrance to a more complete utilisation of available labour resources and, hence, to the capacity of the economy to grow without inducing inflationary pressures. The high wage rates required to be paid (by law) to the young and the unskilled continue to make it difficult for the unemployed among these groups to find work - although it is of interest to note that, indicative of the general strength of labour demand, the 1979 school-leavers appear to have fared better in finding work than the school-leavers of other recent years. At the other end of the labour market, margins for skill appear to be insufficient to call forth enough skilled labour to meet demand, resulting in mounting shortages of such labour in a time of expanding activity.

Corporate profitability also appears to have made some progress back towards earlier levels, although the uncertain nature of relevant national accounts estimates for recent years makes it difficult to draw precise conclusions in this area. Following the surprisingly modest increase in 1978-79 the gross operating surplus of companies rose strongly last year. The very strong growth expected in private business investment in 1980-81 - which, though centred on resource projects, is broadly based - is consistent with a private sector that expects reasonable profitability in the future.

While the factor price imbalance has been slowly reduced, any renewed upward movement in real wages now could only increase the difficulty of employing the large numbers of people who seek jobs, including those who are not registered as unemployed. In addition, while the growth in product in recent years appears largely to reflect the growth in labour inputs rather than a growth in productivity, and while the expected strengthening in product growth in 1980- 81 is likely to be associated with continued growth in employment, businesses are still undertaking 'labour saving' investments whenever possible. Anything more than very modest growth in real wages could thus undo a large part of the progress made to date and put at risk the prospects of further expansion in employment.

There has been some, though as yet clearly insufficient, progress in reducing the public sector's call on both real and financial resources. Both the direct call of the public sector on real resources (expenditure on goods and services) and the total of public sector outlays (which include transfer payments) have fallen moderately as proportions of GDP since the peak in 1977-78. There was in 1979-80 the first reduction in the public sector's borrowing requirement since 1976-77, due entirely to the marked decline in the Commonwealth Budget deficit. During the intervening years the public sector's continued heavy borrowing, together with the need to roll over the increasing level of past borrowings, has been an important underlying influence on the continued high level of interest rates.

The Task Ahead

Given the progress of the strategy in gradually reducing various imbalances, it might be argued that there would now be scope to pursue a somewhat more relaxed' approach. However, it is clear not only that there is a need to make further progress in reducing imbalances but also that new problems are emerging which suggest that the capacity of the economy to grow without inducing inflationary pressures may still be more limited than it was in earlier years.

Foremost among these is the danger that the prospective surge in private business investment and the (in some cases associated) increase in public sector infrastructure investment could result in straining the existing capacity of the economy, leading to an upsurge of wage increases and an acceleration in cost and price inflation. Skilled labour is already in short supply in many areas; and while immigration and increased training will add to available supplies, there will be pressures for higher wages to attract additional labour to expanding areas. Under Australia's centralised wage determination processes, there is a very real danger that such wage increases, however desirable they may be in themselves, could flow on into a general lift in wages. The current so-called 'work value' round - which, notwithstanding what it purports to be, is in the process of spreading a wage increase of a fairly uniform magnitude through most of the workforce - is an indication not only of the momentum that this flow-on process can gather but also of its basic economic irrationality.

That wage pressures have continued to mount is not open to doubt. These pressures stem both from indexation decisions which have built into the ongoing rate of wage increase the effect of the lift in prices since 1978, and from movements outside indexation, particularly in the form of 'work value' increases which are, for the most part, nothing of the kind. These influences alone make it inevitable that the increase in wages in 1980-81 will be higher than last year.

A wage system which continued to award a high degree of indexation, and to allow additional across-the-board increases on top of that, would pose significant problems during the period ahead. In several major overseas countries the acceleration in the rate of inflation has been accompanied by a more subdued rate of increase in wages, and the prospect of a downturn in the rate of inflation overseas could threaten Australia's international competitive position unless inflationary pressures in the domestic economy can be contained. This is of particular concern given that non-national wage case settlements appear to be an increasing force in the determination of overall wage levels. Some such development is not surprising; with the somewhat improved outlook for profitability, firms would naturally tend to be rather more amenable to granting wage increases.

In these circumstances, macro-economic policies - and particularly monetary policy - will need to play an even more important role in maintaining an economic environment which asserts an adequate degree of discipline upon the parties involved. As the Commonwealth pointed out in its submission in the latest national wage case, the higher the increase in wages that is awarded by the Conciliation and Arbitration Commission the firmer the settings of other policy instruments have to be for the consequential inflationary pressures to be contained.

The prospective surge in private business investment will also add to calls on capital markets as firms seek finance for new projects. This will be occurring at a time when the public sector will continue to have a large demand for finance, with the 1980-81 public sector borrowing requirement expected to be broadly similar to that of last year. The net result is likely to be continued pressure on domestic interest rates and increased resort to overseas sources of finance by the private sector.

The slowdown in the world economy and expected large imports of capital equipment mean that the current account deficit is likely to widen appreciably in 1980-81; such a result is, indeed, necessary if the prospective excess of domestic investment over domestic savings is to be validated. But the prospect of a significant increase in private capital inflow (including infrastructure borrowings overseas by State authorities) means that, overall, the balance of payments is likely to contribute appreciably more to domestic liquidity than it did last year.

Economic prospects for the year ahead are discussed in some detail in Part III of this Statement. Without going into detail here, it is clear that we are facing potential growth prospects which, in the next few years at least, are different in kind and in magnitude from the experience of much of the 1970s.

The mainspring of that potential growth is, of course, resource-based investment. But both private consumption expenditure and government expenditure also seem set to increase more strongly in 1980-81 than in recent years, indicating that total domestic final demand should also increase more strongly.

These improved growth prospects come at a time when, notwithstanding that the grosser distortions besetting the economy throughout the 1970s have been ameliorated, important imbalances remain. In these circumstances, policy must continue to be directed towards the correction of those imbalances as well as to containing and beginning to turn back the increased inflationary pressures which have emerged during the last two years. In this regard, monetary policy will need to play an enhanced role.

The present Budget has been framed against the background of these developments and prospects. The further reduction in the Budget deficit (including for this purpose the domestic deficit) will, of itself, make an important contribution to moderating the growth in monetary aggregates. Even so, monetary policy will be operating in a more difficult environment, given that likely faster real growth in public sector outlays will be occurring at a time of faster real growth in private sector outlays; and that, in these circumstances, pressures for wage increases will be the more difficult to contain. The expected larger surplus on private sector foreign exchange transactions will place upward pressure on money supply growth, but will also provide a further opportunity for external policy to assist in containing inflationary pressures.

With its abundant natural resources Australia has frequently been characterised as 'the lucky country*. But the realisation of our good fortune in those natural resource endowments will be dependent not on luck but on the intelligence with which policy is conducted. In particular, it will depend on ensuring that the settings of policy instruments are conducive to an economic environment in which downward pressure on inflation is restored and maintained and the continuing distortions which are still retarding growth are progressively removed.







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