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Sydney Institute, Sydney, 11 June 1998: address.

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Thursday, 11 June 1998


6.00 pm






















The fortunes of the Australian dollar over the past week or so have dominated the media. And so tonight I will address some comments on the way the Government sees the economy - what needs to be done and what should not be done. I will not be arguing a particular price for the Australian dollar. I often read that I am trying to talk up the dollar. Just as in 1996 1 was used to reading that I was trying to talk it down. I make it clear at the start: Australia has a floating exchange rate. We have a floating exchange rate because experience shows us that this assists adjustment to external developments which we neither create nor control.


Over the long term the exchange rate will be determined by fundamentals - growth, inflation 7 trade, fiscal settings and monetary settings. In the short term, with dealers making hour by hour) day by day decisions it can be determined by a host of factors ?some logical and some not. A raft of financial analysts have suggested that given Australia’s fundamentals, the dollar is trading below what they believe is “fair value”. I will leave it to them to determine what they believe is “fair value”, but what I want to talk about tonight is Australia’s economic fundamentals. Ultimately it is the fundamentals which count. This policy is the appropriate focus for Government decision making.


Obviously, the big issue of the moment is Asia. Much of Asia is now in recession. Some countries are in deep recession. Once upon a time 6% growth in Asia would have been considered ‘recession’ but this is actual contraction. In some cases deep contraction.


The key point I will be making is that the Australian economy is starting in a strong position and is adjusting successfully to this downturn in Asia. You might suggest that anything else could hardly be expected from the Treasurer. But the economic data are clear. And I believe not seriously contested. While it is not the subject of racy headlines - “strong economy adjusts to regional downturn” is no match for the “World set to end tomorrow” type of headline it presents a picture that is a better base for policy analysis.


Where we are


The Australian economy has one of the highest growth rates in the developed world, negligible inflation and a budget now in surplus. The Government’s program of budget repair has the budget in surplus across the four year forward estimates with debt falling to 10% of GDP by 2000-2001 (1½% by 2001-2002 following the sale of Telstra)


* The growth rate of 4.9% over the year to the March quarter 1998 is exceeded among OECD nations only by Mexico (6.7% over the year to the March quarter) and Finland (6.2% over the year to the December quarter 1 997).


* Australia’s growth rate compares favourably with


- New Zealand 2.1% to Dec qtr


- France 3.0% to Dec qtr


- Germany 2.3% to Dec qtr


-   UK 2.8% to Dec qtr


- OECD total 3.1% to Dec qtr


Australia obviously compares favourably with regional ec onomies, many of whom, as I mentioned, are facing deep contraction.


Australia is growing faster than any of the countries of East Asia with the possible exception of China.


The effect of Asia on Australia


While the crisis in Asia will slow the rate of growth in Australia in 1998-99, which is consistent with the Budget forecasts, we are starting from a high base. A mechanistic view of the impact of Asia on Australia - fails to take account of such factors as:


* The continuing solid growth in the rest of the world, particularly in the US and Europe, and the importance of this to a commodity producer like Australia.


* The flexibility and adaptability of the Australian economy and the extent to which exporters can and are diversifying their markets.


* The role of our open financial markets in facilitating adjustment.


* The soundness and robustness of Australian policy making.


The rise in the current account deficit


Much has been made of the rise in the current account deficit in the March quarter with claims that it reflects a more extensive impact on the Australian economy from the Asian crisis than was expected.


An initial widening of the current account deficit as a result of the Asian crisis was clearly expected. In fact the March outcome was consistent with forecasts, and on close analysis a little better than expected.


The downturn in Asia has come at a time when growth in domestic spending is strong, which is leading to continued strong growth in imports.


While our import growth will ease over the course of 1998-99 as economic growth in Australia moderates, our export growth will pick up as the decline in the Asian economies moderates and as Australian exporters increasingly diversify their markets.


An early increase in our current account deficit as a result of the Asian crisis was expected, but it will be temporary, and the deficit will narrow over the course of 1998-99.


On balance, the rise in the current account deficit in the March quarter - which is by no means the largest rise in the current account deficit in one quarter relative to the size of the economy - partly reflects the strength of domestic demand. However, it also partly reflects a number of transitory factors on both the export and import side which are likely to be reversed in coming quarters. Some of the exports that normally would have occurred in the March quarter in particular, cereals, will now be shipped in the June and September quarters, and some of the imports that would normally have occurred in the June quarter were brought forward into the March quarter, as part of a stock build up ahead of the waterfront dispute.


The diversification of Australian exports


While the rise in the current account deficit in the March quarter shows that the downturn in Asia is impacting on our export growth, the trade data also clearly demonstrates the success of Australian exporters in diverting exports to other markets.


In the March quarter, there was a 2.2% fall in export volumes of goods and services -in fact less than most expected - and some part of that was the delay in cereal shipments noted above.


Part of the reason Australia’s exports are holding up is that much of Australia’s exports to the region are of essential commodities, including those that feed into the production of Asia exports. The net result is that Australia’s market share of imports by the affected countries has increased; for example, by around 20% in the case of Korea and by around 10% in the case of Japan.


However, the principal reason for Australia’s export performance holding up has been the success Australian exporters are having in diverting exports to other markets. Australia’s exports to the US and to a number of European countries have increased by more than Australia’s exports to the troubled Asian economies have declined.


For example, merchandise exports in the three months to April 1998 to Indonesia, Thailand, Malaysia and the Philippines have declined significantly - by around 30% compared with the three months to April 1997. But over the same period there has been significant growth in exports to Germany’ the UK and the US - in excess of 40%. Over the same period there has also been a moderate increase in the value of merchandise exports going to Hong Kong, Japan and Taiwan.


Australian exporters are clearly taking advantage of the demand elsewhere in the world and the increase in their competitiveness which has resulted from the depreciation of the Australian dollar against most non-Asian currencies.


The diversification in our exports demonstrates the inappropriateness of applying a static trade share model to assessing the impact of the downturn in Asia on the Australian economy. This diversification is, of course, not a new development. It is relevant that in recent years Australia’s fastest growing export markets have not been East Asia, but in countries such as India, New Zealand, the Middle East and South Africa.


This diversification is also evident in our services trade. Services, particularly tourist arrivals, were an early casualty of the crisis in Asia with dramatic declines in arrivals from the troubled Asian economies. Total service exports in constant price terms fell by about 8% in the December quarter but were stable in the March quarter.


While the impact of Asia resulted in lower tourist arrivals in the March quarter, it was more than offset by other service exports, such as the export of education and building consulting services.


Moreover, we are seeing an increasing number of tourists from North America, Europe and even Singapore. Through the year to April, arrivals from the US increased by 27%, Europe by 18% and Singapore by 34%.


The more recent data suggest that the downturn in both East Asian tourist arrivals and merchandise exports to the troubled Asian economies may be stabilising. For example, tourist arrivals in April grew by 14% compared with March and tourism increased from al1 the troubled South East Asian economies. Merchandise exports to Korea actually rose in April, after large falls in preceding months.


Strongly growing domestic demand


All the data, both on the domestic economy and on our trade position, have been in line with the outlook presented in the Budget, if anything a little better than expected. It was noted in the Budget that while the events in East Asia would be dampening our export growth, the strong growth in domestic demand would nevertheless provide considerable support for economic activity over the course of 1998-99. This picture has been confirmed by subsequent data.


The March quarter National Accounts confirmed the outlook presented in the Budget of strong growth in domestic spending; domestic final demand grew by 4.5% through the year to the March quarter. Care, of course, always has to be taken when interpreting any initial set of Accounts; they can be subject to sizeable revisions, not only in terms of the bottom line but also in the composition of growth.


The continuing strong growth in domestic spending is evident not only in the National Accounts but is supported by indicators on employment growth, ongoing credit growth and import growth.


Some commentators have suggested that the composition of growth in the Ma rch quarter is a cause of concern because of the large rise in stocks. However, the composition of growth in the quarter does not suggest that the outlook for the domestic economy may be weaker than forecast.


While some of the rise in stocks in the quarter may be unintentional, stocks are not at an uncomfortably high level relative to sales. The stock to sales ratio rose in the quarter, but only after sharp falls in the ratio in previous quarters. Relative to sales, stocks are only back to levels they were a few quarters ago. The rise in stocks in the March quarter therefore has a component of rebuilding to catch up with sales. This is supported by recent business surveys which do not indicate that there has been an excessive run-up in stocks nor do they indicate any plans by business to run down stocks. As noted previously, part of the rise in stocks was in advance of the waterfront dispute and some of the build up in stocks will translate into increased exports in subsequent quarters.


Consumption growth was flat in the March quarter, but this follows strong growth in the preceding quarters, particularly in the December quarter 1997 with growth of 1.7%. In the last three years we have seen a pattern in the National Accounts data of very strong growth in consumption in the December quarter followed by a very weak or flat March quarter with a rebound in the June quarter. Flat growth in consumption in the March quarter may well be followed by solid growth in the June quarter 1998 on the basis of past experience.


The latest survey of business investments intentions indicated a picture consistent with the Budget forecast. While the first estimate of business investment intentions in 1 998-99 that was taken in January and February this year suggested continued double digit rates of investment growth next financial year, the second estimate of investment intentions suggests more moderate growth. But it was specifically noted in the Budget papers that business investment was expected to ease from the growth rates of recent years; the second estimate of investment intentions is fully in line with the Budget forecasts.


The uncertainty coming from Asia can be expected to hold back some business investment, but business investment will continue to be underpinned by relatively low interest rates and a continuing high profit share as confirmed in the March quarter National Accounts.


The most recent business surveys are consistent with the Budget forecasts of growth slowing from the high March quarter rate to around 3 per cent.


Appropriateness of policy settings


The keys issues to focus on when assessing the Australian economy are the appropriateness of policy and the quality of economic settings. .These are Australia’s strengths; they are the factors that clearly distinguish the Australia of today from the Australia of the 1980s.


The current account is not the result of an overheating in the domestic economy, there are no domestic inflationary pressures. Australia is not losing competitiveness through having a higher inflation rate than its trading partners. Moreover a framework is in place to: ensure monetary policy is applied in a consistent fashion and will maintain low inflation over the medium term.


It has been suggested that the recent fall in the Australian dollar will result in higher inflation than forecast in the Budget. The Budget forecast is for underlying inflation of 2¾ % by the June quarter 1999 and incorporates a substantial increase in import prices arising from the depreciation of the Australian dollar in recent months. The more recent fall in the dollar will only impact on the inflation outlook if it is sustained at that level and to the extent that higher import prices are fed into higher retail prices. But inflation will also depend on a range of other factors, in particular wages and productivity.


The economic environment in which the rise in the current account deficit is occurring is significantly improved compared with previous increases. This reflects low inflation, including the absence of speculative asset price rises; microeconomic and regulatory reform; land a sound financial system with world class prudential supervision.


Fiscal policy


The first policy response to a high current account deficit is to ensure that fiscal policy is in good shape. The Government has already done this - it has turned around a Budget deficit of $10 billion to surplus in just three years. And Commonwealth fiscal policy will maintain surpluses across the forward estimates and reduce the Commonwealth’s debt position back to historically low levels.


The Charter of Budget Honesty Act will substantially increase the accountability of government - now and into the future.


The Charter requires the Government to produce regular reports, including an annual fiscal strategy statement, budget and mid-year economic and fiscal outlook reports and a final budget outcome report. It also requires the Government to produce an intergenerational report every five years.


The Charter also provides for a Pre-election Economic and Fiscal Outlook report to be issued by Treasury and Finance department within 10 days of the announcement of an election. This means that in Australia there is no capacity to conceal the true fiscal position as Labor did before the last election. Concealing the position would be exposed at the worst possible time - in an election campaign - by officers outside the political process.


It means that a government frames its Budget on the official assumptions, not on assumptions written by the Prime Minister’s office as happened under Labor. The Budget is framed on the official assumptions now because officials will get the final word in an election.


Labor from time to time claims that it can’t release policies because it does not know what the budget position is. This is completely false. The Budget position is fully disclosed by the mid year review and annual budget papers. What is more the pre-election report acts as a discipline on the reporting situation. Because Australia’s fiscal reporting is produced in accordance with legislation, the public and the Opposition have more information and more reliable information than any other time in history. If the Opposition cannot frame policies it is a competence problem not an information one. Indeed, if it chooses, an Opposition can even have policies independently costed by the Department officials - an opportunity no other Opposition has ever had before.


The Charter of Budget Honesty and the transparency it enshrines in Australian fiscal policy is now the state-of-the-art in world terms.


Reform of the Australian Financial System


Let me turn briefly to the financial system - the lifeblood of the economy - an area of particular focus for reform by this Government. As we have seen, financial regulation was one of the weak areas in the troubled East Asian economies and one of the main contributing causes to their current crisis.


Immediately after its election the Government set up a Financial System (“Wallis”) Inquiry to consider improving regulation in this area. Our policy motivation was:


* the fact that the financial system has entered an era of accelerated change that is likely to continue into the next century; and


* the Government’s recognition that the performance of the financial system - its stability, integrity and efficiency - and the cost effectiveness of its regulation, are critical to the performance of the entire economy.


Regulation of the b anking system in the post-WWII era was detailed and highly prescriptive, which led to the growth of non-bank financial institutions. Almost all banks established subsidiaries to overcome regulatory constraints on bank borrowing and lending practices.


The Campbell Committee, established in 1979, was given a wide ranging brief to recommend changes to the regulatory structure of the financial system so as to promote efficiency and stability.


Many of those recommendations were subsequently adopted.


But the world has continued to undergo significant change and the financial system has not been immune to such developments.


While there are a range of factors contributing to the changing structure of financial service industries, two key ones are technological change and globalisation.


Against that background, the Wallis Inquiry identified three main reasons for further reform.


* First, Australia’s financial sector performance was assessed to be close to the world average rather than the world’s best.


* Second , existing regulatory arrangements do not treat all new market structures and activities equally, and do not always ensure that we get the maximum benefits from change.


* Third, there are a number of areas of the financial system which could be more competitive.


The Government’s response to the Wallis Report seeks significant improvements.


It is directed at the fundamental goals of increasing competition and improving efficiency, while at the same time preserving the integrity, security and fairness of t he financial system.


By implementing microeconomic reform of this nature, Australia will have a more competitive and efficient financial system that will not only be positioned to compete strongly in the global economy, but will result in lower costs and an increased range of products and services on offer for those seeking to do business in Australia.


The Government’s legislation to implement financial sector reforms recommended by the Wallis Inquiry is currently in the Parliament. I take this opportunity to point out that new regulatory arrangements are due to commence on 1 July this year. The proposed legislation has been amended unacceptably in the Senate. The Government has now returned it so the Senate can reconsider its position. It will not be enacted until it is passed in the form required to implement the new system as recommended by Wallis. Labor and the Democrats attacked the legislation not because they oppose this reform but because they have sought to use this legislation to politically advance an altogether different issue - employee entitlements in company liquidations.


The issue of protection of employee entitlements has already been placed on the agenda of the Ministerial Council for Corporations and that is the appropriate forum to take a considered view of this issue.


Financial instability in Asia points to the need for strong and transparent financial regulation. Our opponents risk delaying a set of reforms which are widely supported within Australia and recognised internationally as leading edge policy. They must think again. This is too important.


If I were a financial sector institution, I would be asking Labor and the Democrats to justify how they can seek to delay the reshaping of Australian financial sector regulation for entirely unrelated reasons. Make no mistake, the time is short and we can not afford to let this legislation fall over because of political opportunism.


A sound policy framework must be sustained and enhanced if investor confidence in Australia is to be maintained.


Tax Reform


And now more than ever Australia must continue to work on strengthening its economy through the important economic reforms. I have spoken of fiscal policy and financial regulation. I could speak of corporate governance and industrial relations reform but I would like to mention one other area tonight - the issue of tax reform.


Tax reform is an imperative on many counts. But I would like tonight to put it in the context of the tax base.


We need to modernise the tax base. I say this particularly to those interested in the social security system. You won’t have a modern social security system on an outmoded tax base. If the tax base crumbles so too will the social security system. The serious thinkers have recognised this. There is no point talking about one’s commitment to social security and one’s opposition to reforming a crumbling tax base. The tax base must be put on a sustainable footing.


Two previous attempts at tax reform in Australia - 1985 and 1993 - failed. In 1985 when Labor tried tax reform they got a good deal of bi-partisan support. Since then they have never offered genuine support in the national interest even on the proposals they themselves put forward in 1985. I regret Labor’s position. It will make genuine reform harder. It does not make it less important.


Unlike 1985 and 1993 the Commonwealth Budget is now in surplus. Tax reform now is not about additional revenue.


The Government has no need for additional revenue. It is already in surplus. The Government is about improving fairness in two areas:


* Ensuring the tax base is robust enoug h to fund government services: health education and the social security safety net; and


* Ensuring that revenue is collected in a fair way.


The safety net provides a direct means for the Government to specifically address social disadvantage. In fact thi s is its purpose. In Australia we have never seen the tax system as the sole, or even the predominant means of addressing social disadvantage. It can complement it. But this is the principal role of the social security system: why we pay aged pensions as outlays, why we pay unemployment benefits as allowances.


The current Australian tax system is not efficient and it is not fair. It is not fair because it was designed for a 1930s economy. While the economy has changed dramatically the structure of the tax system has not.


The cornerstone of the Australian taxation system is the Income Tax Assessment Act 1936.


The wholesale sales tax is a tax introduced during the period of the great depression.


The current tax system is designed for an economy dominated by goods with a manufacturing sector targeted at domestic consumption. This is the economy as it stood between the wars. This is the kind of economy our tax system fits. But it is not the economy of today.


Goods production now represents less than a quarter of the economy and will continue to decline.


While the economy has transformed, the tax system has not.


The result is that the contribution to the tax revenue from income taxation and indirect taxation has changed significantly over time.


This change has been particularly marked over the last 20 years since the deregulation of many sectors of the Australian economy.


Over the 1 980s, indirect taxation (comprising principally excise and sales taxes on goods) represented 7.2 per cent of GDP compared to5.8 per cent of GDP over the 1990s.


In comparison, direct taxation (individuals and companies) increased from 16.4 per cent of GDP to 17.2 per cent of GDP.


Over the same period, the contribution of revenue to the Commonwealth budget has also changed, with the share of indirect tax falling from 27 per cent to 24 per cent, whilst the share of income tax has increased from 63 per cent to 70 per cent.


What these trends show is that without reform of the tax system, the composition of the tax base will change automatically. By doing nothing the tax mix changes. To preserve the tax mix of today, requires reform. In a dynamic economy inaction means an ine vitable rundown.


Without a restructuring of the principles on which tax is collected, the Commonwealth, will become increasingly reliant on income taxation directly from individuals and companies if it is to maintain government services.


But not all individuals and companies.


As the burden of tax shifts to individuals and companies rates will climb. Those who have the opportunity to avoid or minimise their tax will do so.


Moreover, with international economic activity becoming more integrated, the histo rical barriers to mobility of labour will become less important, particularly for high skilled professionals.


A relatively high personal tax burden in Australia will provide additional encouragement for skilled Australians to seek employment in other countries.


Without change, not only will the burden of tax fall increasingly to individuals and business, it will fall more heavily on a smaller and smaller number of tax payers.


These will be the people who have no ability to minimise their tax; typically, low and middle income wage and salary earners and small business.


And as the base diminishes, the rate of tax on the smaller number of tax payers will have to increase to maintain the same revenue.


This unfairness is already apparent.


Soon after the turn of the century, without reform, taxpayers on average weekly earnings will be paying the top marginal rate of tax - 48.5 per cent including the Medicare levy.


In the 1950s a tax payer had to earn 19 times average weekly earnings before paying the top marginal rate.


Reversing unfairness is not a matter of tinkering and tuning. It is a matter of tax design.


This is an important point to grasp. To preserve revenue on a shrinking base means increasing the rates. Those opposed to broad-based indirect tax will, if successful, end up precisely where they did in the past - higher rates of wholesales sales tax and higher incidence of income tax. This is the lesson of 1993.


Unfunded tax rebates or tax credits with the additional complexity that entails - will do nothing to stop the inexorable change in the reliance of the Australian tax system on income tax.


The unfairness can only be addressed by changing the structure of the tax system to adjust to the changing structure of the Australian economy and Australian society.


That is what the Government’s tax reform program is about.


Alternative prescriptions


There are some other muddleheaded prescriptions which are put forward as the answers to tax or economic policy.


Foreign investment is currently a prime target for those who want to prey upon feelings of economic insecurity.


Those who want to restrict or chase foreign investment out of this country want to reduce the number of jobs. I can’t put it plainer. Less investment means more unemployment and family misery.


I want to list for you some of the Australians who have jobs as a result of foreign investment:


BP Australia - 2,200 employees


Cadbury Schweppes Australia - 3,600 full time employees


McDonald’s Australia - 55,000 employees


Toyota - 4,300 employees


Try telling these people that foreign investment is bad. This sort of policy is bad economics.


To seal Australia’s borders from foreign investment and foreign trade will not make us rich:


* rich through access to fewer overseas markets for Australian goods?


* rich through less investment in business and jobs?


* rich through declining tourism?


* rich through a declining education export sector?


We will not grow an economy if we pull down the shutters and put up the barriers. To look forward, we must seize the opportunities before us.




Seizing opportunities comes back to policy. Decent hardworking achieving policy:


* budget policy


* financial regulation


* corporate governance


* social security policy


* industrial relations reforms


* tax policy


None of this is easy. And in all of those areas there will be populist attacks from the right and the left, in many cases from similar positions. Which makes reform no less important. But to do nothing is not to leave things as they are. In a changing eco nomy inertia does not equal the status quo. Continuing economic reform is the best policy option.