Terms of Reference 1 (continued)

Date

Contribution of structural reforms to enhancing Australias growth performance

  1. While beyond the terms of reference of this inquiry, Australias economic performance, and its ability to prosper in an increasingly globalised world is also dependent on the flexibility and responsiveness of product and labour markets, and the regulatory infrastructure that governs the behaviour of firms

    2. and financial institutions. We have seen in Australia ongoing structural reform over the past decade and a half: including sustained tariff reform; financial market reform; reform of the operation of government business enterprises; enhancing national competition policy; changes in foreign investment rules; tax reform; labour market reform; reform of corporate governance arrangements and the like.

  2. A prime focus of reform has been to subject the private sector in Australia to more competition from both domestic and international sources and to improve the performance of public utilities. The direct benefits of these reforms are lower prices and increased productivity, which in turn reduce input costs for other industries and increase aggregate employment opportunities. Aside from lowering the cost structure of downstream businesses, such price falls also exert downward pressure on inflation and inflation expectations and assist the macroeconomic management task.

  3. In recent years, in particular, a number of reforms stand out.

  • Significant reforms to workplace relations arrangements and labour market regulation and assistance have increased the responsiveness of the labour market to changes in the economy, and reduced impediments to job creation, participation in employment and improving productivity. The Workplace Relations Act 1996 accelerated the move from centralised wage fixing to enterprise bargaining and imposed tighter limits on industrial action. Other policies, such as the mutual obligation principle, have been directed at assisting and encouraging job search by the unemployed.

  • The quality of regulation required to ensure well functioning markets and financial system stability has been enhanced, through the financial sector reforms that arose from the Wallis Inquiry.

  • The recent reforms establish a more flexible regulatory system, with a functional rather than institutional focus, that is better able to respond to a rapidly changing environment without stifling innovation and competition. This will meet the need for regulation to ensure stability and integrity, without endangering efficiency.

  • The Corporate Law Economic Reform Program is modernizing and giving an economic focus to regulatory requirements regarding fundraising, takeovers, corporate governance, financial reporting and conduct and disclosure practices in financial markets. The focus is on providing the regulation necessary for well-functioning markets, without compromising efficiency.

  • These reforms will help to maintain a high level of business and investor confidence thereby reducing the risk of damaging swings in capital flows and spending. This also makes the macroeconomic management task easier by reducing the likelihood of booms and busts and thus allowing strong sustainable growth. The events of the 1980s with the corporate cowboys and the early 1990s with impaired bank balance sheets due to increases in bad loans are much less likely to recur.

  • A fundamental reform of the taxation system which is badly in need of repair is also being undertaken. The aim is a tax system designed to increase incentives to work, save, invest and export. The central elements of the tax reform include: abolishing the Wholesale Sales Tax (WST) and the most inefficient State indirect taxes; introducing a Goods and Services Tax (GST); reforming Commonwealth-State financial relations; cutting income taxes; and increasing benefits for families, pensioners and self-funded retirees.

  • The Review of Business Taxation will also bring forward a comprehensive agenda for reform of the business taxation system on two fronts. This involves applying a framework of redesigned company taxation arrangements to all limited liability entities consistently and considering the scope for more consistent taxation treatment of business investments with the prospect of achieving a 30 per cent company tax rate and further capital gains tax relief.

Globalisation and Australian economic development

Benefits from policy reform

  1. The benefits of the economic policy reforms discussed above are now clearly visible.

  • Low inflation has been consolidated, with underlying inflation remaining below 2 per cent over the last two years. Low and stable inflationary expectations reduce the likelihood that domestic inflation will respond in a sustained way to transitory pressures. Consequently, there is less need for monetary policy to respond to such developments.

  • The onset of the East Asian financial crisis in 1997 contributed to a significant but orderly depreciation of the Australian dollar, particularly against the currencies of the major economies. In the past, falls in the currency have flowed through into higher consumer price inflation. This time, assisted by declining international producer prices, a better policy framework and a more competitive economy have helped minimise the flow-on of import price rises into domestic prices and wages.

  • More stable and low inflationary expectations should mean less need for policy to be tightened aggressively in the face of an increase in inflation. In the past, policy often had to be tightened aggressively in order to avoid strong growth being translated into a rise in inflationary expectations. These expectations tended to rise with rising growth and inflation with the consequence that wages and prices rose further leading to an inflationary spiral. The policy tightening required to rein in these spirals often led to sharp falls in economic activity and steep rises in unemployment. If inflation expectations remain low and stable in the face of strong economic growth, this reduces the need for sharp tightening of policy and wide swings in economic activity. This reduction in output volatility and policy uncertainty should provide a supportive environment for employment growth over the longer-term.

  • The Commonwealth budget has been returned to surplus (and is projected to remain in surplus over the next four years) reducing concern in relation to the current account. It is now much clearer that borrowing from abroad is for private purposes, assessed against commercial criteria.

  • Long-term bond differentials with the US have narrowed considerably, remaining below 0.5 percentage points over most of the past two years.

  • Average multi-factor productivity growth since 1993-94 has been a full percentage point higher than the long-run average. The economy is expected to record its second successive year of economic growth in excess of 4 per cent, with the expansion now in its eighth year.

  • Importantly, the recent period of strong economic growt
    h has not been associated with the emergence of unsustainable wage pressures that have contributed to increasing inflation in past periods when the economy has grown strongly at an advanced stage of the expansion. More flexible workplace arrangements have sharply reduced the tendency for wage-setting processes to contribute to inflationary pressures that might otherwise have necessitated a contractionary policy response.

  • Sound corporate governance and prudential supervision of the financial system have enhanced foreign investor confidence in Australia at a time when many economies around us were being buffeted by uncertainty.

  1. It is clear that national economic policies will, in part, determine how well we manage the consequences of global markets.

  2. The robustness of the current policy framework has been stress tested in the aftermath of the financial crisis that emerged in East Asia in late 1997. This resulted in a severe economic downturn in many of our major trading partners in the region, and a large fall in world commodity prices.

  3. In the past, such developments might have created severe difficulties for Australia. Indeed, many observers expected that Australia would experience a serious economic downturn on this occasion. The decline in the $A might have contributed to domestic inflationary pressures. Investor confidence might have declined in the face of a widening current account deficit (CAD), putting further pressure on the currency. The result would likely have been higher short and long-term interest rates.

  4. The key difference on this occasion has been that sound fiscal, structural and monetary policy frameworks have maintained foreign investor confidence in Australia. A fiscal surplus, together with a sound microeconomic environment underpinning private sector investment decisions, has been essential to market acceptance of a widening CAD. Currency depreciation has not fed through into higher inflation. Consequently, the Australian economy has been able to benefit from an increase in competitiveness arising from an orderly currency depreciation, while maintaining low interest rates.

  5. Other developments have reduced the level of risk attached to Australias external liability position and helped to reduce our vulnerability to external shocks.

  • Australias net foreign debt to GDP ratio has stabilised in recent years, with the moderate expansion in our net liabilities being largely met by increased net equity investment.

  • The net debt-servicing ratio has gradually fallen to 10 per cent of exports, the lowest ratio since 1984.

  • Australias foreign currency denominated liabilities are now outweighed by foreign currency assets, so that the net income deficit no longer tends to escalate when the $A depreciates.

  • The public share of net external debt has also fallen to its lowest level since 1984.

  • Over 70 per cent of short-term debt is held by the Reserve Bank and prudentially-regulated depositary corporations.

  1. There is, however, no room for complacency. Continuing structural reform is necessary to reduce constraints to growth by raising productivity growth, increasing flexibility and extending competitive pressures throughout the economy.

    2. Losers from structural change

  2. There have been concerns that globalisation has hurt some in the community.

  3. Globalisation, like most significant economic change, while contributing to an overall lift in economic performance as constraints on financing are raised, may also result in there being some (individuals, enterprises, industries) who are made worse off, in particular during a transition period. In aggregate, change can bring significant benefits to the economy as a whole. Scarce resources can be redirected into those sectors that yield the highest return and at the same time are likely to provide the most stable employment prospects and strongest employment growth. The adjustment process may involve people retraining and/or changing jobs within a region, or moving to locations with expanding opportunities.

  • There has been no upward trend in job losses due to retrenchment or business closures over the past 20 years. Typically, these account for 15 to 20 per cent of total job separations.

  • While regional fortunes have changed over the past 10 years, more have grown (those in coastal areas, or near capital cities or associated with growth industries) than those that have contracted (those inland in wheat/sheep belts and dryland grazing or mining regions).

  1. Government has a role in minimising the transition costs of structural change. It can do this by reducing the distortions in the economy, which retard change and peoples ability to manage it. For example, the government also has at its disposal generally available welfare, job search and training programs, as well as, depending on the circumstances, the option of targeted support measures.

    2. Globalisation and income distribution

  2. Over the last twenty or so years there has been a widening of income distribution in many countries. Some have argued that this is due to increased trade and globalisation.

  3. The argument is that countries with large supplies of skilled labour have switched to production of goods and services that make intensive use of skilled labour and to the import of goods and services that make intensive use of unskilled labour. The result in those countries is a decline in demand for unskilled workers and a resulting increase in earnings dispersion. However, there are two problems with this hypothesis. First, the compositional shift between skilled and unskilled workers has been found to be too weak to explain the increase in inequality and, second, there has been a relative increase in demand for skilled labour in virtually all countries.

  4. A more consistent explanation is that organisational change ¾ facilitated by computer and telecommunications technology ¾ has changed the type of employee skills that are now in demand. Skills that appear to be increasingly valued include versatility across tasks, ability to learn new tasks, aptitude to take advantage of complementarities between tasks, ability to communicate with other employees in a team, and increased responsibility and decision-making power. While this explanation is more consistent with observed compositional changes, further analysis is required.

  5. While it is not possible to be conclusive about the causes of increases in dispersion of earnings, it is important to understand that there is a trade-off between policies designed to achieve a more equal income distribution and those that might contribute to a higher aggregate level of income.

  6. Australia should seek to implement policies that place it in a strong position to exploit the opportunities of trade and globalisation. Such policies will include:

  • labour market policies which ensure jobs are properly rewarded and that em
    ployers and employees can negotiate to facilitate structural changes; and

  • education and training policies, which equip the workforce with the skills to adapt to and take advantage of organisational changes.

  1. While these policies may not prevent some increase in earnings dispersion, they do not imply a less equal distribution of national income. Importantly the operation of taxation and welfare policies in Australia has meant that family income distribution has improved progressively over the last two decades. In particular, those families on the bottom quintile have improved their relative position. Further, recent evidence suggests that there has been a reduction in job insecurity. In other words, while macroeconomic and structural policies have adopted a less interventionist perspective, it has been possible for policy to also address income distribution issues. The challenge will be to maintain this balance.

    2. Looking forward ¾ opportunities from globalisation

  2. The important role of IT in globalisation, together with pre-existing Australian strengths, provides an opportunity to conquer the tyranny of distance. Our potential comparative advantages in a globalised world are not just the obvious ones of reasonable telecommunications, good IT literacy, and a sophisticated domestic financial sector with good regional and global experience. Our advantages extend to the less obvious, but highly relevant institutional strengths of a rule of law, respect for intellectual property rights, good macroeconomic policy arrangements, good prudential supervision arrangements, and a strong civil society with capable professional groups underpinning good standards of accounting, auditing, and other professional skills that are likely to be easily exported into globalised markets.

  3. As one analyst noted of the globalisation of securities trading: In a global market environment, being located in a country with a long tradition of property rights security provides a competitive advantage. Thus, economies with a higher probability of the imposition of exchange controls, multiple exchange rates, restraints on foreign investments or interest equalisation taxes undermine the competitive position of their securities markets in global competition.

  4. Australias particular comparative advantages for the world of globalised finance should give us an even stronger national interest in ensuring that globalisation is advanced on a secure, sustainable basis, rather than crimped or slowed

41 It has been noted that, historically, when Australia was inward looking (economic nationalism was the overriding orthodoxy) Australia's growth rate of GDP slipped behind the OECD average, and, while other OECD economies closed their per capita GDP gaps relative to the then leader (the US), Australia slipped down the per capita GDP rankings. See Caves and Krause (eds) (1984).

42 Financial System Inquiry (1997).

43 Fraser (1999).

44 Productivity Commission (1998).

45 Ibid.

46 Analysis in Australia suggests that changes in the distribution of, and returns to, unobservable characteristics are important factors in explaining the increase in earnings inequality. See, for example, Borland (1996).

47 These issues are discussed by Dennis Snower, Causes of Changing Income Inequality, in Income Inequality: Issues and Policy Options, A Symposium sponsored by the Federal Reserve Bank of Kansas City, August 1998.
See for example Johnson, Manning, and Hellwig (1995).

48 See Wooden (1998).

49 Smith (1991), op cit, p. 88.