Opportunities for Growth: Australia’s economic future

Author: Christopher Findlay

NZ Prime Minister John Key said in a speech last week:

We simply must ensure that decisions taken now neither undermine the future prosperity of our country nor diminish the opportunities available to this and future generations of New Zealanders.

We simply must weigh up the fiscal costs of initiatives we take now against what those costs will mean for the Government books in the longer-term.

Because I know, and you know, that if we borrow excessively to look after the taxpayers of today, we will end up saddling our children with a mountain of government debt. In the more immediate future the prospect of an excessive level of debt would swiftly bring a downgrade from credit agencies, leading to higher interest rates and lower growth rates into the future.

Australian PM meets with New Zealand's PM John Key

And that

When it comes to the recession we need a dose of reality but we also need a dollop of confidence.

During this global downturn, we can work to improve the performance of our economy relative to other countries, and we can emerge better off.

That’s the second, longer-term goal of the Government’s Jobs and Growth Plan.

It’s about improving the fundamentals of our economy. A tax structure that rewards hard work. Reform of the Resource Management Act to allow people to do more things. Reducing the red-tape that saps initiative and good ideas.

It’s about policies that will future-proof our economy and set us up for a strong recovery.

These include our “Build New Zealand” proposals to future-proof our country with investments in roads, public transport, schools, housing and broadband.

When our economy starts to recover we don’t want New Zealand to be constrained by inadequate transport networks and essential facilities. We want to be ready to grab opportunities for growth.

Tony Makin in The Australian today backs up the strategy. Follow the Kiwi leader, he says, not Obama.

There is much to commend such a supply side story current circumstances. A convincing story about long run growth in Australia

– helps settle expectations and changes the willingness of people to even out their consumption, and to bring it forward as the government begs us

– assures the community about the capacity to repay debt, their own and the government’s

– works on creating new jobs, rather than simply reallocating them or shifting the costs of adjustments to downturns between groups in the economy now and between generations

– convinces our international creditors we know what we are doing, and that we look like a good place to get reasonable returns on an investment

What might be included in a story about growth? Here are some talking points.

  • reversing the productivity slow down
  • working in a world with rising costs of environmental resources
  • and working out a new story about Asia.

Productivity growth slowed in Australia in the 2000s compared to the 1990s. Last year’s annual report from the Productivity Commission refers to a ‘substantial decline in (MFP) productivity growth from 1.6 per cent over the 1990s to 0.6 per cent over the seven years of the current decade for which data are available’.

The Commission goes on to talk about the role of innovation in promoting productivity: government spending is part of that and as the Commission notes ‘there is an important role for government in building human capital and supporting R&D where the knowledge will be made generally available.’

But the Commission says two other things in this context. First it welcomes the Cutler Report’s emphasis on

‘sound cost-benefit evaluation of proposed programs to support innovation, and their regular review to ensure programs remain cost effective’.

And then second it says

‘more fundamentally, sustaining and advancing reforms to enhance market competition and to reduce regulatory constraints on enterprise flexibility remain the keys to stimulating innovation, and must continue to play a central role in an effective innovation policy.’

Based on its experience and its research, the Commission is saying that the regulatory environment matters.

Productivity will rise naturally in the recovery, as output increases from existing capacity. And in the current circumstances, many businesses are probably busy cutting back capacity to the parts they are really good at, in anticipation of being competitive in the recovery.

But the policy environment also matters. Key contributors to productivity growth in Australia in earlier periods have been the service sectors. They account for 74 percent of income in the national economy – a bit lower in SA because the manufacturing sector here is bigger than the national average (21 vs 17 percent). 30 points of service sector output is in retail and wholesale.

According to the Productivity Commission

In the 1980s, service industries explained only one-third of market sector productivity growth — this rose to almost two-thirds in the 1990s. So far this decade almost all of the growth in market sector productivity has occurred within services. The distributive trade services (wholesale, retail and transport and storage) contributed to the 1990’s surge, as did the then recently deregulated and rapidly expanding industries of finance and insurance and communications. Some of the traditional ‘engines of growth’, such as manufacturing, did not.

The regulatory environment in which all these sectors operate is critical to their performance and it’s not only national regulation which matters but also state regulation.

There have been calls for national audits of regulatory arrangements in the service sector, transparency exercises they are also called, and that is a good idea. It is also something that state government could take a lead on. Philippa Dee and I have written in these pages about how international cooperation can support the domestic reform program.

Infrastructure is another part of the story, and a part of the stimulus package. Adding to the supply side capacity of the economy is important but the projects referred to in the stimulus package may be smaller scale, necessarily so to get an impact on the short term.

Infrastructure Australia has been developing a list of big project priorities. It’s currently asking for more information so these can be prioritised, so I guess that means they are not ‘shovel ready’.

There is a big reform agenda here. Treasury officials’ assessment is that

Australia’s infrastructure reform currently is incomplete, with many sectors operating an inefficient half-way house between the direct provider and competitive supplier models. Government-owned infrastructure competing with private operators, prices which do not reflect the full cost of provision, uncompetitive market structures and artificial restrictions on new suppliers entering markets all undermine the operation of efficient, competitive infrastructure markets, including in water, electricity and possibly ports. This can inhibit timely and efficient investment. Regulatory processes also can be slow and economic and safety regulation varies between jurisdictions creating uncertainty and potentially delaying investment. In land transport and electricity, inadequate network planning and investment appraisal probably reduce their contribution to national productivity growth.

Environmental constraints have not gone away. We still face the risk of significant changes in climate and the costs of adaptation and mitigation, the mix of which depends on the incentives put in place now to reduce emissions.

There’ll be more policy debates of this type, around a more careful costing of environmental inputs into production, and an interest in making sure we get those costs right. This will require some new institution building, and better mechanisms for allocating resources we now realise are scarcer than we thought. We’ll learn from the carbon debate in that process.

An integrated market for water across locations and uses would be a good place to start. Dollars spent on buybacks of water rights might be part of the story but the solution has to ‘reset the system’, as water economist and Wentworth group member Mike Young puts it.

There is a lot of work to do here, including the R&D investments, and doing it now helps the path of adjustment in the future. Quentin Grafton in these pages provided some examples of what might be done.

The third of the talking points was about Asia. What is our Asian story?

Some have referred to the ‘end of the commodities boom’. I don’t think so. We expect low income countries to return to high growth rates. China in particular has the capacity to recover quickly, with its large pool of mobile labour.

What will happen, particularly in Asia, is a real debate about whether there is another growth model that is less reliant on exports outside the region and how the new growth model will take into account the same environmental constraints we are now struggling with too.

The answer to the question of whether a return to high growth can be decoupled from the developed world will not be a ‘yes’ but there will be an effort to divert accumulated resources into domestic projects. Even so, that does not diminish the opportunities for Australia in its traditional areas of interests, such as resources and human capital.

The Asian debate about sustainable, or ‘green growth’, creates new opportunities for us. Indonesia for example could be a vital partner for us in our response to climate change. But this is not straightforward. There’s a lot of work to do to develop the mutual understanding in the business community in both countries and various levels of government there for that to happen.

There are some bigger questions too about how Asia projects its interests in the world economy, and its role in international agencies like the IMF. But of more immediate interest to us are these questions – how will those economies recover and what development strategy will they put in place?

At least, we need to be part of the Asian debate, not just listening to it from a distance but involved in it, through all our research, business and policy networks.

The bottom line is an old story – it’s growth that matters. Expectations have been raised in the stimulus packages but we have loaded obligations onto taxpayers of the future. We also have to explain how we have added to their capacity to repay – our creditors will be looking for that. That means being more articulate about a national agenda for growth which talks about productivity, about the environment and about Asia.

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