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Full employment and free trade in Australia.

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Bert Kelly Lecture series


No 1

Sydney, February 18, 1999

Full Employment and Free Trade in Australia

Achieving the Unachieveable?  

Ross Garnaut


One of Bert Kelly's great strengths was to see simple truths clearly when the vision of others was blurred in the fog of popular opinion. Bert used to joke that others would come to see the free trade truth in time for them to honour him with a state funeral. Like C.Y. O'Connor, author at the turn of the century of the revolutionary scheme to pipe water from the coast to the Western Australian gold fields, he died in the time between the political leadership's acceptance of the simple truth, and the flow of water out of the desert end of the pipe.

In contrast to the tragic end of O'Connor, enough of the good and the great knew that the water was coming properly to honour Bert Kelly's passing. But even Bert would have been surprised on the good side by the extent of the blooming that followed some time after the turning on of the tap. The dismantling of protection in many countries has led to larger benefits than its advocates had promised for it. Australia since the liberalising decisions between 1983 and 1991, is now one of the many, having moved from near the sclerotic to near the dynamic end of the range of the world's high-income economies. The blooming is manifest in the Australian economy's reasonably strong output and employment growth through the absorption of its greatest negative external shock since the Great Depression. The success of internationally-oriented economic reform in Australia allows us to aspire realistically to the return of full employment in Australia, after a quarter century of acceptance of disastrous underperformance.

In the lag between the turning of the tap of trade liberalisation and the flow of sweet water from the pipe, the ignorant rushed in with misrepresentation, mockery and abuse. Some created a witch that was called "economic rationalism". If not swept away in the flood, the hunters have at least been dampened by the increasing evidence that the economic change associated with trade liberalisation has brought benefits to Australia that are too large simply to be denied.

Although the costs of protection were Bert Kelly's main interest, and perhaps his obsession, the Modest Member wrote about a number of truths beyond free trade. From late in the 1970s, he was part of the growing discussion of the way the Australian industrial relations system held back economic performance and held up unemployment.

That discussion has gained new momentum over the past two years. After a quarter of a century of tolerating intolerable levels of unemployment, Australians have at last focussed seriously on full employment as a central objective of economic policy. It is of significance that the Treasurer has said recently that 5 per cent unemployment is attainable with good policy, and that the Opposition has committed itself to the objective of reducing unemployment to 5 per cent. More interestingly, part of the debate has come to analyse the role of long-cherished Australian institutions as part of the unemployment problem. In this old and conservative democracy, a long period of talking about the advantages of and need for change precedes far-reaching reform. So it was with free trade, when Bert Kelly initiated and sustained debate. So it will be with the return to full employment.

The focus on full employment is long overdue. We know well enough the social tension, the ill-health, the demoralisation, the deprivation of opportunity for children and the perpetuation of poverty into new generations, and the huge economic loss that has accompanied high unemployment. Our society has made reasonable provision for social security payments to the unemployed, but it seems, increasingly, that this has generated envy by those who have to work and pay taxes.

Unemployment has generated fear and insecurity which, in turn, has encouraged the hunt for witches in many places, including in economic reform. This has introduced fragility into many areas of national policy, including the successful productivity-raising economic reforms of the past one and a half decades. While high unemployment continues, economic reform and therefore economic growth are at risk, and with them the opportunity to return to full employment.

We need clear movement towards full employment because unemployment is itself such a large direct cause of personal and social problems, because it weakens the political base for continued productivity-raising reform and economic growth, and also because u nemployment is a source of political tensions that divide our community.

In 1999 we need early movement to full employment for another large reason. This is a time of political instability and disintegration in the islands that lie right across our northern borders, in the Southwest Pacific islands, Papua New Guinea, and the eastern end of Indonesia. This will come to be a large challenge to the comforts of life in Australia. We are likely to be called upon to make a great national effort in relation to communities and states across our vast border regions, at considerable economic and political cost. It is an effort in which we will need to call upon the resources of a successful, rich and cohesive society. Not only our prosperity and our happiness, but also our national security, will come to need the special strengths that would derive from a return to full employment.

The remainder of the address has five parts. The first discusses the causes of contemporary unemployment, and the reasonable ambitions that Australians can have for full employment in modern conditions. The second assesses whether the programme of productivity-raising reform since the mid-1980s has raised unemployment. The third introduces four essential elements of a full employment program. The fourth defines the three policy stages through which one of these elements can be provided ¾ the provision of income security alongside the introduction of wage flexibility and effective incentives for labour force participation. I then conclude with a few remarks on the prospects for economic reform, economic growth and full employment in Australia.

Causes of Unemployment and Reasonable Ambitions for Full Employment

Economic growth can go some way to reducing unemployment, and to this extent unemployment is caused by a failure of economic growth

Economic growth alone cannot be relied upon to generate full employment. It can only generate full employment if the incentive structure brings supply and demand for the range of economically relevant categories of labour into balance with each other at all locations, at times when economic growth has led to full employment for some categories of labour.

With the current incentive structure affecting supply and demand for labour, shortages of some major categories of labour skills in some regions could emerge when the overall rate of unemployment was still around 7 per cent. This point, at which significant areas of labour shortage and inflationary pressure begin to emerge with continued economic growth is what economists clumsily call the "NAIRU", the non-accelerating-inflation-rate-of-unemployment. The NAIRU is the lowest level to which unemployment can be driven by economic growth alone at the time under consideration, within the institutional framework ruling at that time.

Is the NAIRU a relevant concept at all at times of low inflation such as the present? One cannot be sure that unemployment has fallen to the NAIRU until economic growth has proceeded strongly enough for long enough for inflation actually to be accelerating. The Reserve Bank of Australia, now with its firm commitment to holding inflation in the range 2-3 per cent, would be wary about taking the risk of pushing inflation above the top of the range. But with inflation now having been below the bottom of the range for a year and a half, this doesn't appear to be an important concern for the period immediately ahead. There is room for monetary policy to support a somewhat faster rate of growth, without significant inflationary risk. The use of this room would eventually tell us whether the NAIRU is indeed around 7 per cent. It might turn out to be a bit lower, but if so, probably not much lower.

Unemployment could be pushed below the NAIRU for a while by stronger economic growth. But the accompanying acceleration of inflation would, for good reason, prompt corrective tightening of monetary policy. This would, in turn, lead to a period of lower demand and economic growth, and to unemployment rising back to the NAIRU, and probably for a period above it. The dip in unemployment below the NAIRU would therefore turn out to be temporary.

Why does inflation accelerate when unemployment falls below the NAIRU, even when there is still considerable unemployed labour available? Why doesn't increased demand lead to the absorption of unemployed labour into the work force, without inflation, for a s long as there is unemployment?

In a smoothly operating labour market, surpluses of some types of labour skills in some locations would gradually attract labour in from locations and skill categories in which there is unemployment. Some employers facing particular skill shortages would sometimes be prepared to share the cost of training and relocation. The unemployed would be encouraged to contribute to the costs of preparation by the expectation of higher incomes accruing to the scarce categories of labour. Even in a smoothly operating labour market, it would take time ¾ time for the unemployed to identify the opportunity, and to prepare themselves for its utilisation by relocation and the learning of new skills. The time that the learning of the required new skills or relocation takes, depends on the initial education and skills of the unemployed.

So there is some unemployment at the NAIRU, even in a smoothly adjusting labour market ¾ a smoothly operating labour market in which wages rise and fall with excess demand and supply for labour, in which there are low costs of geographical re-location from labour surplus to labour deficit regions, and in which the institutions for education and training at all stages of life are effective in developing the skills that are necessary for employment. In Australia in the 1950s and 1960s, the NAIRU was around or a bit below 2 per cent. In the United States today it is probably around 4 per cent.

Why is the NAIRU higher in Australia today than it was three decades ago, or than it is in contemporary United States? And what unemployment rate should we accept as "full employment" in Australia today? Let us examine the factors that determine the lowest rate of unemployment that can be achieved by economic expansion without causing inflation to accelerate.

First, the NAIRU is greater in a more sophisticated, differentiated, technologically complex economy. This would tend to cause the NAIRU to be higher today than in earlier decades, in both Australia and the United States.

Second, the NAIRU is higher in an economy experiencing rapid structural change. Conventional wisdom says that this makes it higher in the 1990s than in earlier decades, in both Australia and the United States. This may be true. But we should not forget the extent and speed of structural change in Australia during the postwar boom, with the sharp relative decline of rural employment, the rise of the mining industry in decentralised locations, and rapid expansion of the urban service industries.

Third, the NAIRU tends to be lower when population growth is relatively high, whether from natural increase (over time increasing the proportion of relatively young people in the labour force) or immigration (to the extent that immigrants are younger, and also because immigrants can move directly to locations where their own labour is in strong demand). Australia and the United States both do better on this criterion than European advanced economies and Japan, although Australia does not do as well as three and four decades ago. Immigration is more likely to be associated with a lower NAIRU the better the education and skills of new arrivals equip them for the jobs that are available. Australia in recent years does better than a decade ago, and possibly better than in the early postwar decades.

Fourth, the NAIRU is likely to be lower after a long period of steady economic growth. This is because large cyclical fluctuations, and periods of high unemployment in recession, devalue the skills of people who are out of work for long periods. The economic instability in the two decades of economic instability from the early 1970s contrasts with the steady growth in the two decades that preceded them in both Australia and the United States. The return to steadier growth in the 1990s, if it is sustained, can be expected gradually to reduce the NAIRU.

Fifth, the NAIRU is lower the greater the geographic and social mobility of the labour force. The rise in female labour force participation and the associated increase in the proportion of households in which more than one member would like to work for pay has reduced mobility and increased the NAIRU. Greater cultural and linguistic diversity has probably worked in the same direction.

Sixth, the NAIRU is lower the stronger the educational base from which workers build skills that are in demand in the labour market. A general rise in education levels, especially from the mid-1980s, has probably facilitated the absorption of new skills and worked to lower the NAIRU.

Seventh, the NAIRU is lower the higher the living standards that can be drawn from social security while unemployed. I myself see the increasing support from the Australian social security system for lower-income Australians over the past quarter century as an achievement of our democracy. But alongside its virtues, the social security system's support of individuals and families whose incomes would otherwise be low, and high effective marginal tax rates, diminish incentives to prepare and to search for employment, and raise the Australian NAIRU above its level in the 1950s and 1960s. The shift in the United States over this period is less pronounced.

Eighth, the NAIRU is raised by any regulatory or institutional arrangements which inhibit the adjustment of wages to changes in supply and demand for labour. In Australia in the 1990s, the system of minimum award wages administered by the Industrial Relations Commission is a significant constraint on adjustment. The award wage system has its main effects on wages of people whose skills have relatively low value in the market, and on wages and in regions which are experiencing decline or sluggish growth. It holds up wages for types of labour experiencing relatively high unemployment. The legal minimum wage system in the United States has no comparable effect in holding up wages for groups of people experiencing high unemployment, because the minima are set so low relative to the wages that would be generated in the market that they have little effect on the wages that are actually paid.

The first of this list of influences on the NAIRU ¾ the technological complexity of the economy ¾ is an important point of differentiation between the late 1990s and the early postwar decades. The two last ¾ the social security and wage regulation systems ¾ are important points of differentiation between Australia and the United States.

The interaction between the first and the last influences creates special difficulties for full employment in Australia.

On the first, Australia is like all other industrial economies in experiencing increasing technological complexity, combined with finer specialisation in production to supply markets with increasingly wide geographical spread. This is the phenomenon that has come to be known as "globalisation", driven by the rising power and falling cost of information technology and more generally reduced transaction and transport costs in inter-regional and international exchange. Trade liberalisation in Australia, and just as importantly in Australia's trading partners, has reinforced these but have not been the main force behind them. One consequence of increased technological sophistication and differentiation, lower transaction costs and finer specialisation in production ¾ that is, one consequence of "globalisation" ¾ has been greater dispersion in the distribution of earnings in the market place, in all advanced economies.

It follows that any attempt to impose minimum wages as a similar ratio to mean wages to that which had ruled when the market was delivering a narrower distribution of earnings, would cause the minimum wage to exceed the level that would have been generated in market exchange for a higher proportion of the labour force than it did before. The result is a higher NAIRU.

The seventh influence on the NAIRU also interacts with the first and last to increase the NAIRU in contemporary Australia. Even if the Australian government and Parliament decided to abolish the system of minimum award wages, the relatively high levels of social security provision for the unemployed relative to wages for low-skill workers, and the high effective marginal tax rates, would place limits on the downward flexibility of wages for categories of workers experiencing high unemployment.

It is above all the interaction of increased technological complexity, wage regulation and the social security system that holds up the NAIRU in Australia in the 1990s, relative to the early postwar decades. These same factors have raised the Australian NA IRU relative to the contemporary United States, which has experienced increased technological complexity in similar or greater degree, but without comparable wage regulation and social security.

What rate of unemployment on a sustained basis would we be happy to accept as "full employment" in contemporary Australia? What is possible depends on how much we constrain policy choice. Many Australians would exclude from the range of acceptable policy changes any that reduce the disposable incomes (including social security payments) of people on low-incomes. As I will explain, this still leaves a lot of scope for wage flexibility, if the reform of the wages system is combined with reform of taxation and social security.

Full employment in the late 1990s would be at a higher unemployment rate than in the 1950s and 1960s, if only because of the higher proportion of households that aspire to two or more incomes, and the richer provision of social security. Despite the very different levels of provision of social security in Australia and the United States, I do not see why unemployment in Australia needs to be higher than in the United States. While the richer Australian provision of social security raises its NAIRU, this is balanced by the higher proportion of Americans who are poorly educated and socialised for work. The Treasurer's and Opposition's 5 per cent is a reasonable ambition over the next five years or so, but there is no good reason why Australia cannot eventually again do better than that.

Economic Reform and Unemployment

How has internationally oriented economic reform since 1983 affected NAIRU and unemployment?

The answer depends on where we draw the boundaries of reform. The Hawke and Keating Cabinets would have included within the boundaries the expansion and enrichment of the social security system, the widening of access to secondary and tertiary education, and the other augmentations of the social wage that came to be connected with the Accord between the Labor Government and the Australian Council of Trade Unions.

Let us cast the net narrowly, and focus on the trade and financial liberalisation and competition policy issues that were at the centre of the popular reaction against reform.

An extensive literature in the United States concludes that expansion of trade with developing countries has contributed to the widening of the dispersion of incomes in that country but that this trade expansion has been much less important than technological change. In turn, trade liberalisation in the United States contributed only part of the expansion of trade with developing countries, which grew first of all from the increased competitiveness of labour-intensive manufactured goods from those countries.

It is doubtful whether the reduction in protection in Australia contributed even this much to the tendency for wider dispersion of income distribution in this country ¾ the tendency that was converted into higher unemployment by wage regulation. United States net imports from developing countries include a large preponderance of goods the production of which embodies relatively high proportions of low-skill labour. This is not true in Australia, where the expansion of exports to East Asia has had tourism as its largest single product, embodying directly and indirectly a high proportion of low-skill labour.

The longer-term effects of trade liberalisation in Australia have included a more flexible industrial structure and more diverse exports. This has provided a cushion against recessionary pressures from abroad, most dramatically through the East Asian financial crisis over the past two years.

Amongst the components of financial deregulation, the floating dollar has proven to be an effective instrument for insulating domestic economic activity against shocks from abroad. Banking deregulation contributed to the boom of the late 1980s and bust and high unemployment of the early 1990s, while business and the monetary authorities learned to operate in the new environment. Learn they did, contributing to the exceptional strength of the financial sector and stability of the economy through the problems in Asia.

Trade and financial liberalisation, and the competition policy reforms which were spurred by them, together contributed to a large lift in the rate of growth of total factor productivity in the 1990s relative to Australia in the 1970s and 1980s, and to oth er high income economies. It also contributed to a substantial lift in business investment. These developments lowered the NAIRU, since higher labour productivity reduced the effect of minimum wages, presuming that they continued to be set at the levels that would have operated without these developments.

It is argued that the productivity-raising reforms contributed to higher labour turnover and therefore a higher NAIRU during the transition. One would expect this to be true to some extent, although the gradual nature of Australian reform reduced frictional unemployment of this kind. It may be true, but this effect was not large enough to make its presence felt in overall data on duration of employment.

The effects of economic reform on the NAIRU during the transitional period of most rigorous reform would seem to have been mixed, but on balance with one qualification, positive. The qualification relates to the causes of the recession of 1990-91. The recession resulted from massive misjudgment in monetary policy. To the extent that the policy misjudgment resulted from the authorities taking time to learn the modalities of managing monetary policy after financial deregulation, there is a large mark against the effects of reform on unemployment.

Whatever the transitional effects, the longer-term effects, and the effects are positive, and essential supports for movement to full employment in the period ahead.

Four Elements in a Full Employment Programme

I would like to emphasise four elements in an effective programme to reduce the non-accelerating-inflation rate-of-unemployment.

The first element is the provision of effective education and training relevant to the generation of skills that are in relatively strong demand. This is of large importance, but I'm not going to say more about it this evening.

The second element is the maintenance of strong economic growth. Two of the sources of economic growth are particularly important: the technological progress and capital investment that raise labour productivity and so diminish the effects on the NAIRU of any particular setting for minimum award wages. Economic growth more generally raises the economy's capacity to compensate through fiscal means for divergence between labour market realities and minimum community expectations on real incomes.

The third core element is the management of fiscal and monetary policy to avoid another recession, at least over the period during which Australia is moving back to full employment. Each of the three recessions of the past quarter century have caused a ratcheting upwards of unemployment, a dislocation of normal accretion of labour skills that has diminished the real wages that can be commanded in the market by many people, and a retreat from policies conducive to increased productivity and economic growth. A myth developed in Australia that each of these recessions was caused by some overwhelming external shock over which Australia had no influence ¾ that each was "a recession we had to have". This was never the case: mistakes in policy played important parts in the recessions of 1974-5, 1982-3 and 1990-1.

The fourth core element in a programme to restore full employment is reform of social security and income taxation in Australia, to reconcile income security at Australian community standards in real terms with real wage flexibility.

The best news for full employment in Australia is that economic reform over the past dozen or so years is now being reflected in higher levels of productivity growth, and that business investments has risen to levels that can contribute to strong growth.

The latest ABS data point to a trend rate of total factor productivity growth of 2.3 per cent through to the end of 1996 ¾ around the levels of Australia's strongest postwar periods of growth. The recent labour productivity data suggest that something like this rate has been sustained since then. The improvement has been driven by the payments and trade liberalisation and enhancement of competition that were implemented in steps from the mid-1980s, supported by a wide range of other productivity-raising reforms. It is good news that the benefits of past reforms take a long time to come through, and that past reforms will have positive effects on productivity growth for some years yet. It is also good news for the prospects for growth that Australia's productivity levels in many industries remain well below the international frontiers. As a result, strong growth can continue for a decade and more before the opportunities for productivity growth through "catching up" have been seriously diminished.

The prospects for productivity growth depend on the continuation of commitment to liberal trade, and on the maintenance of momentum in reform in many areas where it is incomplete. No single reform alone takes us very far, and there is doubt about whether t he gains from any single reform in isolation are worth the trouble. But the effects of reform across a wide front accumulate into a lift in productivity growth that can transform Australian economic choices. There is good reason to expect that commitment to take every chance to remove obstacles to higher productivity would see total factor productivity growth sustained at an average rate of 2 per cent per annum or more through the first decade of the next century.

Recent growth in business investment has seen investment rise to levels that are consistent with significant capital intensification of Australian production, even with employment growing strongly within a full employment programme.

These developments in total factor productivity growth and investment suggest the feasibility of average growth rates significantly in excess of the past quarter century, at around 4 per cent over the next decade in the absence of decisive movement towards full employment.

The restoration of full employment together with the average net immigration rates of the past decade would require high rates of employment growth over this period ¾ an average of nearly 2 per cent per annum. About half the difference between work-age population and employment growth would represent absorption of the unemployed, and about half the movement of the discouraged into the labour force. This would suggest the need for and feasibility of an average rate of GDP growth a touch over four and a half per cent during a decade of movement to full employment.

Hopes for average rates of growth in this vicinity would be destroyed by any repeat of the major recessions of the three major recessions of the past quarter century.

Do we have to have another deep recession over the next decade, disrupting and perhaps derailing the return to full employment?

Recent institutional developments in monetary and fiscal policy will help us to avoid extremes of cyclical fluctuations in the economy.

It helps that in a gradual process since the early 1990s, a tradition of Reserve Bank monetary policy independence has been established around a low-inflation target.

It helps that the costs of politicisation of fiscal policy around the electoral cycle have been increased by the Charter of Budget Honesty.

The fiscal consolidation since the change of government in 1996 helps. Commitment to allow the budget outcome to fluctuate cyclically around a moderate surplus on average is establishing a macro-economic buffer against future domestic or international shocks.

The various steps in internationalisation of the economy since December 1983 are also helpful in avoiding deep recession. The floating exchange rate provides substantial protection of real domestic economic activity against the periodic adverse shifts in external markets to which Australia is subjected. The large diversification of exports into manufactures and services since the mid-1980s reduces fluctuations in Australia's terms of trade through the international business cycle. And the large increase in the export share of Australian production since the mid-1980s cushions economic activity to some extent through cyclical downturns in domestic demand.

This is all a good start towards the avoidance of another major recession. We will still rely on good judgement from our monetary and fiscal authorities, even with the diminished politicisation of policy that I hope has been firmly established. The Reserve Bank has been cautious on the deflationary side of the policy settings, leading to what is now a long period in which inflation has been below the target range. This leaves scope for monetary expansion and currency depreciation if Australian growth slows in the later stages of the growth crisis in East Asia.

I turn now to the fourth element of the full employment programme: institutional change to improve incentives to employ and to supply labour, with flexibility in wages as its centre. I take as a premise what I see as a reality: that the Australian community does not want full employment enough to accept reductions in take-home real incomes, at least for the low-skilled employed, or the current recipients of any major category of social security payments. The challenge, then is to introduce taxation and social security reform designed to reconcile income security with wage flexibility.

Fortunately, the reconciliation of real income security with full employment has become a major focus of policy discussion over the past two years. A glance at this morning's newspapers makes the point.

Three Steps to Incentives for Full Employment

I see a three-step process of reform of the social security and tax system, to support gradual relaxation of the legal limits on wage flexibility.

The first step is the Government's current reform package. The tax reform package can be expected to make a modest but a worthwhile contribution to continuing economic growth, through its effects on economic efficiency. I am here more concerned about the effects of the package on labour market efficiency. The flattening of the marginal income rate at 30 per cent for a large number of workers, and the consolidation of 12 different categories of social security benefits into 3 for the purpose of income tests, lays on important foundation for continuing tax and social security reform. Its value for these purposes need not be significantly reduced if the Senate forces the exclusion of food from the coverage of the proposed goods and services tax.

The second step is the proposal of the "five economists" in the letter to the Prime Minister October 21, 1998. Peter Dawkins, John Freebairn, Michael Keating, Chris Richardson and I propose the introduction of a tax credit for workers on relatively low wages. The first role of the tax credit is to reduce substantially marginal effective tax rates for low-skilled workers. The second role is to provide for the maintenance of after-tax and social security incomes of wage earners, to compensate for gradual downward adjustment in the real value of minimum award wages. If the tax credit were introduced from 1 July 2001, it could provide the context for Government putting to the Industrial Relations in February 2001, the proposal that there should be no further upward adjustments in minimum award wages for a period of 4 years.

The five economists estimated that, if implemented in full, in the context of average inflation at 2.5 per cent per annum (the middle of the Reserve Bank's target range), the 10 percentage point reduction in real minimum wages would allow reduction of unemployment by 1.5 to 2 percentage points to 5.5 or 5 per cent over the four years. This estimate is based on the macro-economic effects of a reduction in average wages on employment. As the five economists noted in their letter to the Prime Minister, the concentration of wage restraint near the bottom of the skill scale, where unemployment is highest, should strengthen employment effects.

The five economists' tax credit could take several forms. Keating and Lambert have illustrated how the three social security categories for income tax purposes in the Government's current p ackage, could be consolidated into one. At moderate budgetary cost (less than $1 billion per annum for each of the four years in an astringent version of the Keating and Lambert proposal), the incomes after tax and social security receipts of all minimum wage earners could be maintained at or above the real levels that would have been present under the government's tax and social security package, with full indexation of minimum wages for inflation. In addition, the maximum marginal effective tax rate of social security recipients could be reduced to around 60 per cent. The tax credit would be increased each year to maintain the real value for minimum wage earners incomes after tax. But it is not ideal. Many members of the labour force would still face high effective marginal tax rates. The many arbitrary distinctions that constrain access to social security would remain in place, generating the envy amongst many who just miss out that has been a seed-bed of Hansonite sentiment. That is why the five economists' proposal is the next practical step, with the potential to reduce unemployment significantly, but not the end of the path towards taxation, social security and wages system reform for full employment.

The coup de grace could be delivered to unemployment by a large third step.  

This step would see the complete integration of the income tax and social security systems into a negative income tax. Each adult Australian would receive a lump sum payment, paid fortnightly, subject only to an assets test analogous to but not necessarily the same as the assets test currently applied to the aged pension. There would be no income test. The lump sum would be equal to the current unemployment benefit, but would be higher for a parent with primary care of children, and for the aged (over 65 years) and those with specified disabilities. In general, the system would be designed to leave people who are totally dependent on social security roughly in the same position that they are in at present.

The third step could be introduced after the four years of trading off minimum wage increases against the five economists' tax credit. If economic growth in the intervening years is broadly in line with the levels that this paper judges to be feasible, and most of the growth in fiscal capacity deriving from economic growth is applied to this proposal, it should be possible to set the rate at which income is taxed at 36 per cent about half a dozen years into next century.

The third step in some ways runs against the current discussion of reciprocation of support from the community. It raises many issues that will require extensive debate, to which I look forward to contributing on other occasions.

The Prospects for Full Employment

The political base for continued reform was seriously damaged by the deep recession of 1990-91, which fuelled populist reaction against new and some old measures to raise productivity and economic growth. There are inevitably long lags in the reflection of economic reform in improved economic performance, and the gradual nature of the Australian reform programme attenuated the lags. The descent into deep recession early in the emergence of economic benefits from reform encouraged populist reaction. The persistence of high unemployment through what is now a long period of reasonably strong non-inflationary growth since 1991 has sustained the populist reaction.

The momentum of steady economic growth at higher average rates since 1991 holds out promise of Australia being able to maintain real incomes of its lower-income people while introducing the minimum wage flexibility that is necessary for movement to full employment. If this opportunity is not utilised, and high unemployment persists, there will be continuing risk of the popular reaction against reform of recent years building dangerously, and in unfavourable circumstances blocking and reversing policy change.

Movement towards full employment will in itself raise economic growth, and expand the resources available for investment in income security and stronger incentives for employment.

Bert Kelly's work for free trade helped to produce the current opportunity for the restoration of full employment in Australia. The utilisation of that opportunity will turn out to be important for holding and extending economic reform and the improved economic performance of the 1990s.


About the Author:  

Ross Garnaut is Professor of Economics in the Research School of Pacific and Asian Studies at the Australian National University, and is the Foundation Director of the university’s Asia Pacific School of Economics and Management. The Australian ambassador to China from 1985 to 1988 and a Senior Economic Adviser to former Prime Minister Bob Hawke, Professor Garnaut also served as Director of the Sydney Institute from 1991 to 1996 and as editor of Australian Quarterly. He is currently Chairman of the Asia Pacific Economics Group. Professor Garnaut authored the 1989 Report to the Prime Minister and Minister for Foreign Affairs and Trade, Australia and the Northeast Asian Ascendancy. He has also written extensively on international economics, public finance and economic development, particularly in relation to East Asia and the Southwest Pacific. His latest book, The East Asian Crisis: From Being a Miracle to Needing One? was published last year.