Australia’s Economy: Performance and Challenges

Australia’s Economy: Performance and Challenges
Speech to National Institute of Accountants Conference, Melbourne

In 1993 the Business Council of Australia released a landmark report which stated:

'Australia has been in economic decline. In 1970 unemployment of 2% was considered the norm and we had one of the highest living standards in the world. But now unemployment is disastrously high at 11% and Australia’s living standards have fallen alarmingly in the world rankings.'

Ten years later The Economist opened an assessment on Australia with:

'To a visitor from the northern hemisphere, Australia is like another planet. …Even as the economies of America, Europe and Japan appear to be stumbling for the second time in less than three years, Australia continues to boom.'

We have achieved a remarkable turnaround. Our GDP has grown faster than the OECD average in every year since 1992. Only one other country has achieved this feat – Ireland – and they have received considerable external assistance.

Consider these statistics:

  • Australia’s economy is currently in its 12th consecutive year of growth. Our average growth rate over the past decade was almost 4%, the highest in the OECD .
  • From 1980 to 2001 Australia was one of only three OECD countries to increase their share of world GDP .
  • Unemployment could fall below 6% in coming months, less than that in the US.
  • While in 2002 the percentage of the population in employment at 60% was the highest on record .
  • According to Standard & Poor's we have one of the strongest fiscal positions in the world .
  • According to the OECD’s recent report, the Australian economy is one of the best performing of all OECD countries, a situation that is expected to continue .

I could go further, but the point is already well made.

In the face of major external shocks including the Asian economic crisis, the ‘dot-com’ crash, weak global growth, terrorist attacks and severe drought, this is a remarkable achievement.

Australia’s outstanding economic performance over the past decade raises two important questions: How did we achieve it, and how do we maintain it?

Performance

There have been two key drivers of Australia’s strong economic growth: economic policy and reforms that have underpinned improved productivity, and strong population growth.

Economic Reform
The seeds for Australia's recent economic success were sown by the reforms of the 1980s and 1990s, which increased the competitiveness of the economy and companies. These reforms included reducing protection, floating the exchange rate, privatisation of government enterprises, deregulation of major industries – including financial sector reform, enhancing the independence of the Reserve Bank of Australia (RBA), deregulation of the labour market, an improved fiscal framework and debt reduction. It has been estimated these reforms increased GDP by 2.5% over the last seven years and average annual household incomes are $7,000 higher than they would otherwise have been .

An important feature of Australia’s recent economic performance is low inflation. The RBA’s monetary policy target and independence from the Federal Government since the mid-1990s has been crucial to sustaining low inflation and reducing inflationary expectations. As these expectations are generally self-fulfilling, this has been important in reducing pressure on prices and wages. Compare the annual average 2% rate of inflation in the 1990s with the significantly higher 8% in the 1980s. As a result, movements in interest rates are now much less volatile, providing significant benefits for businesses and households.

On the fiscal front, the Government has instituted important reforms. The government has committed to maintaining a balanced budget over the economic cycle. This provides flexibility in dealing with external shocks and changing economic conditions without structurally worsening the current account deficit or increasing the level of long-term public debt. In addition, the transparency of fiscal policy has been enhanced by the introduction of the Charter of Budget Honesty and accrual budgeting.

This fiscal policy framework coupled with the use of privatisation proceeds to pay down debt has seen a significant reduction in debt. Net Commonwealth Government debt has fallen from a peak of 18.9% of GDP in 1995-96 to 5.4% in 2001-02 . This underpinned Australia's ability to withstand fluctuations in market sentiment and capital flows.

Perhaps most importantly, Australia has achieved a significant improvement in productivity. Over the period 1975 to 1990 Australia’s labour productivity growth was consistently below the OECD average . Since 1991 the position has been reversed, with significant growth in output per hour worked. Over this period Australia has exceeded the OECD average in almost every year, and is expected to do so until at least 2004.

In terms of multi-factor productivity Australia recorded the second highest improvement from the 1980s to the 1990s in the OECD (behind Finland) .

Productivity improvements are partly attributable to workplace reforms. As just one example:

The number of working days lost due to industrial disputation fell by 85% from 1980 (3.3m days) to 2000 (469,100 days) . Remarkably, over the same period the number of people in employment rose by 43%.

Removal of trade barriers and deregulation of key industries such as the financial sector has supported a significant increase in exports from below 15% of GDP in the early 1980s to 23% in 2001 .

Another important aspect of Australia’s international trade growth is the greater range of products we are exporting to an increased number of countries. There are many examples. Australia's total automotive exports have increased from $1b in 1990 to almost $5b in 2001 . Exports of passenger motor vehicles to the Middle East increased from $1.5m in 1990-91 to $1.8b in 2001-02 . Australia now exports one-third of all locally manufactured passenger vehicles, compared to 10% a decade ago . Australia is now the world's fourth largest wine exporter, from having a almost non-existent export industry before the 1980s, to exporting over $2b in 2002 . In 1981 a mere 1.2% of our exports were services. They now account for 20.3% . Japan and the US were our top two markets in 1981, accounting for 38.4% of exports. While these countries are still our two largest markets, they now take less than 30% of our exports .

To put it simply, the Australian economy is now more flexible, diverse, competitive and dynamic.

The benefits of these reforms have clearly been highlighted by the ability of the economy to weather the shocks faced in recent years. Almost everyone expected the Australian economy to falter during the Asian crisis, but strong growth was sustained and we were dubbed the 'miracle economy'. Again when the US economy collapsed, we were meant to follow suit – but we didn't.

In years gone by an Australian economy confronting these shocks would have struggled to avoid recession and rising unemployment. This time around the flexibility of the Australian dollar certainly helped. But the surprising and pleasing aspect of this is that the weaker Australian dollar did not result in higher prices and interest rates. It afforded our economy breathing space and gave our exporters the opportunity to compete successfully in wider markets. We are now able to reap the benefits of a more flexible, adaptive economy.

Businesses can no longer sit behind comfortable tariff barriers and not think about competition or innovation. They now have to compete for customers and markets. Businesses are experiencing greater pressure to manage costs, develop new products and services, and produce quality products on time.

The benefits to consumers have been greater choice and lower prices. Since 1990 the price of imported vehicles has fallen by an average of 10% . While the average real price of vehicles manufactured in Australia is about the same, there have been significant improvements in vehicle quality, so they are better value for money. Since the mid-1980s the choice of models has increased from 70 to about 250. The price of long-distance telephone calls and domestic airline tickets have fallen significantly since these industries were deregulated. And of course with economic growth has come greater job opportunities. Since 1990 over 1.5 million jobs have been created .

Population Growth
Population growth has been an important driver of Australia’s economic performance. In fact, the increase in the number of people of working age has been the greatest single factor in Australia's economic growth over the past 40 years: explaining two percentage points of the 3.75% average annual GDP growth .

From 1987 to 2000 Australia had the third highest population growth rate in the OECD, an average of 1.3%p.a. .

Since 1981 the number of people aged 15-64 has increased by 34% . Reinforcing this, the labour force participation rate increased from 61.2% in 1981 to 63.7% in 2002 . These factors combined to give Australia one of the largest increases in total working hours since 1990 in the OECD .

Without this increase in total working hours we would not have achieved such a significant rise in our standard of living. This is illustrated by comparing Australia’s performance from 1990 to 2002 with Ireland and Finland. While all three countries made significant gains in productivity relative to other OECD countries, only Ireland and Australia made significant relative gains in GDP per capita. The reason for Finland's failure to increase GDP per capita was that while it experienced strong productivity growth it did so with a fall in the total hours worked by its workforce .

The strong rise in labour force participation was driven by a dramatic rise in female participation, from 44.7% in 1981 to 55.3% in 2000-01. Much of this was part-time employment . This is another reflection of enhanced flexibility of the economy and workplaces. Contrary to views that these jobs were the only ones people could get, part-time employment opportunities enable more people, especially women, to participate in the workforce with more flexibility. This was shown by a recent survey that found casual employees have a level of job satisfaction equivalent to people with permanent jobs .

Challenges to Sustaining Growth

To fully understand the size of the challenges facing Australia we need to put our performance into an historical context. While Australia is the OECD’s current star performer, others have come and gone. From 1950 to 1973 Japan’s growth was exceptional and Japan remained a strong performer during subsequent years to 1990. Since then Japan has virtually stagnated . Germany was another star performer which is now struggling with low growth and unemployment is stuck at high levels.

The lesson for Australia is that we cannot rest on our laurels.

So the question is how do we maintain our outstanding performance?

This would be a significant challenge in itself, but compounding it is our demographic future. The implications were outlined recently by Ken Henry, Secretary to the Treasury . Australia faces significantly slower population growth and declining labour force participation as the proportion of the population of working age declines. This means that while today, six of us in work support every retiree, in less than 30 years, there will be only three in the workforce for every retiree.

As a consequence of these changing demographics, Treasury projects average annual economic growth over the next 40 years will slow to around 2.25%. In addition, the ageing population will bring additional challenges in the form of a falling tax base and increasing government expenditure. Commonwealth Government expenditure is expected to increase from 22% of GDP to 27%.

This in turn means we will be dependent almost entirely on productivity improvements as our source of economic growth. These are projected to account for around 2 percentage points of the projected 2.25% growth.

Compounding our demographic challenges, we are a small market, distant from most of the world's trade. Australia is in a unique geographic and economic position. We face arguably the most challenging international trading situation of all developed countries. We do not have the advantage of large and wealthy neighbours that can serve to expand our domestic market. A recent study found Australia to be the second most remote country in terms of distance from world’s wealth. Our nearest neighbour New Zealand is the most remote . In an era when increasing international trade is one of the main drivers of world economic growth our continued prosperity is by no means assured.

The BCA's view is that 2% growth isn't good enough. Treasury figures demonstrate that moderately higher growth will enable us to deal with our ageing population. Like Treasury the BCA recognises that we need to do what we can to support all drivers of growth: population, participation and productivity.

Our work program is designed to address these issues.

The BCA’s Policy Priorities

The BCA's aspiration is for Australia to be the best place to live, work, learn and do business. Our current agenda is focused on five key policy areas integral to achieving this goal. They are:

  • Education
  • Population
  • Regulatory Reform
  • Taxation
  • Greenhouse and Energy

Education
Australia’s economic and social future depends on a well-educated and well-trained community. An important strategy to overcome the disadvantages of our small, remote economy is developing our intellectual capital and knowledge-based services. All levels of education have a crucial role in this development. This underpins our future productivity improvements.

Business, therefore, has a deep and enduring interest in maintaining and building a healthy and vibrant education system from schools through to university including vocational education and training.

We are concerned to ensure all young people have access to at least 12 years of education and training or equivalent. Early school leaving and non-participation in education and training or substantial employment is a major concern. Recent BCA research indicated that without concerted action at least 80,000 young people are likely to leave school early over the next decade and face long-term unemployment . The cost of not addressing this problem is estimated to be around $2b over time.

The BCA recognises the importance of both vocationally oriented training and higher education. The distinctive role and outcomes of both sectors must be recognised and encouraged. Successful enterprises will require the range of capabilities and skills that come from both the Vocational Education and Training sector as well as the Higher Education sector.

It is in the community’s interest that higher education is relevant and is provided efficiently and effectively. More effort is required in providing measurable outcomes data to drive informed and contemporary decision making in higher education. Significantly there is a need to partially deregulate the finance framework of universities and ensure they have governance structures suitable to the size, complexity and sophistication of university business.

Business expenditure is a weak link in Australian R&D compared to other OECD countries. In 2000-01 Australia spent 1.53% of GDP on R&D, 15th in the OECD . While government expenditure was fourth highest in the OECD and higher education was 10th, business ranked 16th.

While business funds almost half of Australian R&D , 84% of the research is conducted in universities . The BCA believes Australian businesses must work more closely with universities in undertaking and commercialising research as a vital factor in enhancing our international competitiveness.

Education and training are key drivers of a higher standard of living. The leadership, skills, ingenuity and know-how of our people will be the primary determinants of our social and economic success. This will be a driver of improved productivity and increased labour force participation.

Population
The BCA considers that Australia should seek to maintain population growth in line with that achieved over the past decade. That is around 1 to 1 ¼ per cent per annum.

Let me outline our arguments:

  • The BCA considers that sustained economic growth is fundamental to future prosperity and opportunity.
  • Strong economic growth will require sustained population growth - not only to underpin growth in the labour force but also investment and productivity.
  • Sustained population growth and active participation in the labour force are therefore priorities for the BCA.
  • Sustained population growth will require sustained immigration and efforts to stem the decline in fertility.
  • In terms of the composition of immigration - focusing on skilled immigration will boost productivity and is likely to be consistent with higher labour force participation among migrants.
  • Creating an environment that is more supportive of fertility choices is also an important element. This will need to include a review of factors that might better support parents who also choose to work.
  • And, against the backdrop of our population ageing, consideration needs to be given to better supporting ongoing labour force participation of older workers.

The BCA has a number of strategies to assist in addressing this problem. We will soon be releasing research commissioned with the ACTU on the factors contributing to Australia's relatively high early retirement rates.

Later this year we will survey our members on their work/family balance practices such as the availability of part time work, provision of paid maternity leave etc.

We will continue to push for higher levels of immigration.

Regulatory Environment
The BCA believes the key challenge is to ensure Australia's regulatory environment doesn't undermine growth.

Regulation has a legitimate role in achieving public policy objectives. Business must work to ensure that regulation remains in step with Australia’s economic context, taking into account the opening up of the Australian economy and the dynamics of globalisation.

Competition policy is a critical issue for the BCA. It has delivered enormous benefits to Australia and will continue to do so. These include lower prices for consumers and creating additional opportunities and jobs for Australians. Our current competition policy does not take sufficient account of Australia's role in the global economy. As with all other regulations, great care has to be taken to ensure that regulations are designed to work in an open, trading world and are not focussed exclusively on the domestic economy. In this context we look forward to seeing the recommendations of the Dawson review, and the response of the Federal Government.

The BCA has also been closely involved in the development of improved corporate governance standards, particularly through the ASX Corporate Governance Council. While Australia has not seen some of the excesses in the US and while our corporate governance practices are basically sound, it is important for business to respond to community and government concerns in this area. There is always scope for improvement and we can always do more to communicate better the governance framework that underpins our markets. We must be at the leading edge of corporate governance if we are to continue to retain and attract investment in Australian companies.

Taxation
The BCA believes Australia’s international taxation system is retarding our ability to participate fully in the international economy.

As outlined in the BCA/Corporate Tax Association submission to the Review of International Taxation Arrangements, key areas for improvement are:

  • taxation of foreign source income;
  • improved taxation of non-residents working in Australia and for Australians working abroad; and
  • simplification of international tax law.

In the face of rapidly changing international tax regimes around the world, Australia’s international tax system is becoming less competitive.

The BCA believes the Review of International Taxation Arrangements should focus on four key outcomes:

  • Building the attractiveness of Australia as a location for foreign investment.
  • Increasing Australia’s appeal as a regional headquarters for international business.
  • Facilitating Australian investment opportunities abroad.
  • Improving Australia’s ability to attract and retain highly-skilled, internationally mobile personnel.

Our other objectives relate to monitoring the progress of business tax reforms and the adoption of further improvements to the administration of taxation including the reduction of adverse impacts and compliance for business.

Greenhouse and Energy
The aim of the BCA's greenhouse and energy policy agenda is to engage with a wide range of stakeholders to develop viable and acceptable greenhouse policy solutions, to be implemented within a national strategic framework. The framework should include a clear articulation of relative national priorities, and a set of guiding principles. It should be squarely focused on:

  • Minimising the adverse effects of climate change response policy on the international competitiveness of Australian industry through the adoption of least cost response options
  • Recognising and managing structural adjustment
  • Reducing uncertainty for business and investors. In this context efficient design of the international flexibility mechanisms is key.

At this stage the BCA is adopting a neutral position on whether Australia should ratify the Kyoto Protocol. This reflects divergent conclusions amongst researchers, as well as differences of opinion between Members of the BCA.

The BCA will continue to actively support and work toward achieving Australia’s greenhouse target of limiting total emissions in 2012 to 108 per cent of Australia’s 1990 emissions, as stipulated in the Protocol.

It is important to recognise that Australia’s response to the Kyoto Protocol and international climate change could have a profound effect on the structure of the Australian economy. The BCA believes business must take a leadership role among government and the community to develop positions on how we can meet our national goals on emissions, and the broader economic development goals of the nation, and to encourage individual company action where appropriate.

Conclusion

The OECD concluded their recent Economic Survey on Australia:

Australia's current and recent economic outcomes place it among the top performers in the OECD. This owes much to a good combination of prudent, medium-term orientated fiscal and monetary policies, and far-reaching reforms to labour, product and financial markets in the past two decades.

Our performance has put us on track to return to the top ten OECD countries, though it is vital that we do not rest on our laurels. In many areas we do not compare well internationally, and other countries are continually increasing their competitiveness. We have to continue to push to ensure that our policy settings and frameworks are supporting growth, innovation and productivity.

In 1970 Australia had the 4th highest per capita income in the OECD. By 1980 we had fallen to 7th and were down to 13th in 1990. Even with our strong economic performance and substantial reforms over the last decade, we only moved up one place to be 12th in 2001 . This highlights just how vital it is for us to continue reforming, improving productivity and increasing our population so Australia can be the best place in the world to live, to learn, to work and to do business.

References

  1. Business Council of Australia (1993) Australia 2010: Creating the future Australia.
  2. “Is Australia’s Economic Miracle Sustainable?”, The Economist, 8 March 2003, citing OECD data.
  3. “Is Australia’s Economic Miracle Sustainable?”, The Economist, 8 March 2003, citing OECD data.
  4. IMF World Economic Outlook, cited in McFarlane I. (2002) Relative Advance or Relative Decline?, address to The Economist Group’s 7th Foreign Investor Roundtable, Canberra, 25 June, Reserve Bank of Australia.
  5. Eslake S. (2002) Australia’s Economy, address to the Foundation for Young Australians Leadership Forum, 9 July; and Australian Bureau of Statistics (ABS) Year Book Australia 2003 (p.161).
  6. Mellish M. (2003) "Australia's Finances are Among the World's Finest", in The Australian Financial Review, 18 February.
  7. OECD, Economic Survey of Australia 2003, (http://www.oecd.org/EN/document/0,,EN-document-3-nodirectorate-no-3-39243-3,00.html ).
  8. OECD (2003) Economic Surveys – Australia, March, p.104, citing Productivity Commission modelling.
  9. Commonwealth of Australia, Budget Strategy and Outlook 2001-02 (Budget Paper no.1), Table A3.
  10. OECD (2002) OECD Economic Outlook, volume 2002/2, no. 72, December.
  11. OECD data, cited in McFarlane I. (2002) Relative Advance or Relative Decline?, address to The Economist Group’s 7th Foreign Investor Roundtable, Canberra, 25 June, Reserve Bank of Australia.
  12. ABS Year Book Australia, 1982 (p.168) and 2002 (p.148).
  13. ABS Year Book Australia 2003, cat. no. 1301.0, Canberra, p.864.
  14. Department of Industry, Tourism and Resources (http://www.industry.gov.au/library/content_library/automotive_131202.pdf).
  15. Murphy C. (2003) "Fears War May Douse Trade Spark", AFR, 2 April, based on AusTrade data.
  16. DFAT / AusTrade (2003) Australia's Trade: Fast Facts, March; and Productivity Commission 2002, Review of Automotive Assistance, Report No. 25, Canberra..
  17. DFAT / AusTrade (2003) Australia's Trade: Fast Facts, March.
  18. ABS Year Book Australia 1982, cat. no. 1301.0, Canberra, p.640; Department of Foreign Affairs and Trade (DFAT) (2002) Composition of Trade Australia 2001, Canberra, p.20.
  19. ABS Year Book Australia 1982, cat. no. 1301.0, Canberra, p.644; DFAT (2002) Composition of Trade Australia 2001, Canberra, p.43.
  20. Productivity Commission 2002, Review of Automotive Assistance, Report No. 25, Canberra.
  21. ABS (2002) Labour Force Australia, cat. no. 6202.0, Table 2.
  22. Henry K. (2003) Address to the Melbourne Institute’s 40th Anniversary Dinner, 7 February, Melbourne.
  23. OECD, Main Economic Indicators, September 2002.
  24. ABS (2001) Population by Age and Sex, cat. no.3201.0.
  25. ABS Year Book Australia, 1982 (p.141) and 2003 (p.156).
  26. The Conference Board (2003) Performance 2002: Productivity, employment and income in the world’s economies, New York.
  27. The Conference Board (2003) Performance 2002: Productivity, employment and income in the world’s economies, New York.
  28. ABS Year Book Australia 2003 (p.154).
  29. Jackman C. (2003) "Being a Casual Works Just Fine", The Australian, 2 April. Based on data from the Household Income and Labour Dynamics in Australia survey conducted by the Melbourne Institute of Applied Economic and Social Researchs for the Department of Family and Community Services.
  30. OECD (2002) OECD Economic Outlook, Paris, December.
  31. Henry K. (2003) Address to the Melbourne Institute’s 40th Anniversary Dinner, 7 February, Melbourne.
  32. B. Blum and E. Leamer (2002) Can FTAA suspend the law of gravity and give the Americas higher growth and better income distributions?, work in progress, UCLA and University of Toronto (on G-drive).
  33. BCA (2003) The Cost of Dropping Out: The economic impact of early school leaving, January.
  34. ABS Year Book Australia 2003 (pp.763-4). Refers to 21 of the 30 OECD countries for which data is available.
  35. ABS Year Book Australia 2003 (pp.763-4).
  36. Murray D., Chairman of BCA Education and Training Taskforce (2003) Address to The Australian FinancialReview's Higher Education Summit, Sydney, 28 March.
  37. OECD (2003) Economic Surveys – Australia, March, p.15.
  38. OECD (2003) National Accounts of OECD Countries, Main Aggregates, Volume 1. GDP per capita at current prices in $US based on current purchasing power parities.