Restoring Hope to the Australian Economy

When he was the federal Treasurer, Wayne Swan never tired of boasting that Australia was one of only a handful of nations to hold prized AAA credit ratings from “all three major ratings agencies” (Moody’s, Standard & Poor’s and Fitch). The current Treasurer, Josh Frydenberg, is equally happy to trumpet that Australia has just “completed its twenty-eighth consecutive year of economic growth—a record unmatched by any other developed country”.

Certainly, these are significant achievements—nor should Australia’s success in emerging relatively unscathed ten years ago from the Global Financial Crisis (GFC) be under-rated. Nevertheless, for many Australians the past dozen years have been a difficult and dispiriting period—in contrast to the optimism, strong jobs growth and rapid real wage rises that marked much of the Howard government (after a rocky start). Nor can Australians shake a sense that, as a nation, we are more exposed to sudden setbacks in global growth than we were before the GFC.

Since the end of the Howard government, annual growth in GDP per capita, one common albeit imperfect proxy for the pace at which living standards are rising, has been anaemic. At 0.9 per cent, it has averaged less than half the strong rate (2.4 per cent) achieved under Howard and Costello. Contributing to this unsatisfactory performance, labour productivity growth over the decade to 2016 was more than one-third weaker than over the preceding decade—resulting in annual GDP being fully $160 billion smaller in 2018-19 than it would otherwise have been.

Disappointing productivity has, in turn, constrained household incomes—with annual wage growth barely above the trough of 1.9 per cent to which it fell through 2016-17. That rate was the weakest in the twenty-odd years for which the Australian Bureau of Statistics (ABS) has been assembling its Wage Price Index—and just half the pace routinely achieved for much of the 2000s.

At the same time, for those looking to enter the housing market, prices have surged higher relative to incomes, and remain sky-high despite a recent correction. (Sydney house prices, for example, are still over 50 per cent above their level in mid-2012.) Households have also faced dramatic policy-induced increases in the costs of many necessities—electricity prices, for instance, doubled between the end of 2007 and the end of 2013, and rose by a further 19 per cent under the Turnbull government (after a brief respite in which they actually fell while Tony Abbott was Prime Minister).

These developments have contributed to continuing concerns about cost-of-living pressures, despite low overall consumer price inflation.

The jobs market has also been performing less well—notwithstanding strong jobs growth over recent years—leaving Australians feeling insecure about their current employment and uneasy about future job prospects. Annual jobs growth slipped to 1.6 per cent for the decade following the collapse of Lehman Brothers in September 2008, compared with 2.3 per cent over the decade before. In addition, massively increased annual immigration has dampened the way that even this weaker pace of jobs growth feels to ordinary Australians.

In the last decade of the Howard government, 2.1 million new jobs were created while net overseas migration (NOM) to Australia totalled 1.3 million. With only some of those 1.3 million seeking employment, jobs were plentiful, wage growth was strong and unemployment declined towards its lowest level in thirty years. By contrast, in the following decade just 1.85 million new jobs were created, but NOM almost doubled to 2.25 million. In addition to placing pressure on housing and infrastructure, this huge ramp-up in immigration meant that jobs felt harder to find for many Australians, and the number of unemployed rose by 220,000.

Management of Australia’s finances has also been materially worse for the past dozen years, imposing a burden on future generations and undermining a key element of the macroeconomic insurance arrangements which stood Australia in such good stead through the GFC. When that crisis hit, ten surpluses from the preceding twelve Howard–Costello budgets meant that Australia had paid off all its Commonwealth net debt and entered the crisis with $40 billion “in the bank”.

Unfortunately, the budget deficits which followed have only just been wound back. In 2017-18, Australia recorded its tenth straight sizeable deficit—even though we did not experience a recession after the GFC and our unemployment rate barely topped 6 per cent. This was already the longest postwar run of Commonwealth deficits, with a further (albeit tiny) shortfall also recorded for 2018-19. By contrast, even after the severe early1990s recession, when unemployment exceeded 11 per cent, Australia only recorded seven consecutive deficits (and one of those was negligible, at just 0.1 per cent of GDP).

As a result of these repeated deficits, Commonwealth net debt has come roaring back, exceeding 19 per cent of GDP in 2018-19. This was a new record for the post-1970 period (as far back as the historical tables in the Budget Papers go), surpassing the previous peak of 18.2 per cent in 1995-96.

Finally, looming over all of these economic and fiscal problems are demographic developments that will make them more acute over time, while magnifying the political obstacles to their solution with each year that they remain unaddressed. The fundamental issue is that Australia’s birth-rate is below “replacement rate”, as it has been since the late 1970s, resulting in an ageing population.

In the 2015 Commonwealth Intergenerational Report, Australia’s median age was projected to rise to over forty by the mid-2050s. Moreover, that projection was based on a fertility-rate assumption (roughly, the expected average number of births per woman) of 1.9, whereas the latest ABS data show that, since the report, Australia’s fertility rate has continued to drift downwards—reaching a record low of 1.75 in 2017.

To be fair, Australia’s ageing challenge is less stark than that facing many European and Asian nations (some of which—Japan, Germany and Greece, for example—have for the past quarter-century had fertility rates of 1.5 or below, virtually locking in shrinking populations over coming decades). It is little comfort, however, that other countries will face even harsher, demography-driven policy dilemmas over these decades.

Nor is massively ramped-up immigration a solution to Australia’s ageing problem—despite widespread belief to this effect among Australia’s political class and public servants. Certainly, Australia’s immigration intake is strongly skewed towards younger age brackets, helping temporarily to slow the ageing process. But ultra-rapid immigration since the mid-2000s has also contributed significantly to supply-demand imbalances for housing and infrastructure, driving up housing prices and increasing congestion, with negative effects on younger Australians’ choice of family size. Moreover, young immigrants themselves age, so that their temporary slowing of the ageing of society gradually dissipates unless the scale of annual immigration, Ponzi-like, is perpetually ratcheted up. As demographers Peter McDonald and Rebecca Kippen observed twenty years ago (The Impact of Immigration on the Ageing of Australia’s Population, 1999, p. 21, emphasis added):

Levels of annual net migration above 80,000 become increasingly ineffective and inefficient in the retardation of ageing. Those who wish to argue for a higher level of immigration must base their argument on the benefits of a larger population, not upon the illusory “younging power” of high immigration.

Without policy action, then, Australia faces significant population ageing and a resultant marked decline in labour force participation. From the mid-1980s to the mid-2000s the economy received a sustained boost from rising female participation, which jumped by around eleven percentage points. Over coming decades, however, policy-makers can expect to be battling persistent headwinds to GDP growth from falling participation driven by ageing, even assuming rising participation rates in older cohorts.

Moreover, the 2015 Intergenerational Report highlighted growing pressures on the Commonwealth budget from expected demographic changes. With policy settings as legislated at February 2015, net debt was projected to climb over coming decades to almost 60 per cent of GDP—compared with levels over the past fifty years that have never exceeded 20 per cent.

Taken together, these economic and budgetary challenges paint a worrying picture for Australia. As I show, however, in a new book—Restoring Hope: Practical Policies to Revitalise the Australian Economy (Quadrant Books)—they are far from intractable for a sensible federal government, even with a quixotic Senate.

The first critical step is to address two concerns which have added considerably to the strains on Australians over the past decade, even though they are often not viewed as economic issues—namely immigration and housing prices. Tackling these issues is vital not only because of their intrinsic importance, but also to establish the government’s bona fides with the Australian people that their legitimate concerns are being heard and acted upon.

For the quarter-century to the mid-2000s annual net overseas migration to Australia averaged 100,000, a rate already faster (in per capita terms) than every other developed country except Israel and Luxembourg. Yet since 2006 this has been ramped up to over 225,000, an effective doubling (even allowing for a definitional change by the ABS). The upshot has been depressed wage growth, heightened job insecurity, surging house prices, and increased pressure on infrastructure (roads and public transport, parking, schools, hospitals and so forth).

Fortunately, this is an area where the federal government can take swift action (Senate approval not being required)—including phasing down foreign student and working-holiday visa numbers, and reducing the annual permanent migration cap from 160,000 to 110,000 over two years.

These steps would ease pressure on the cost of living, and on infrastructure and community amenity in our capital cities. They would also, in conjunction with firmer guidance to the Reserve Bank Board, and with carefully crafted changes to the rules on foreign investment in Australian housing (which, a few years ago, briefly reached ten times its average pace of previous decades), go far to addressing serious problems in the housing market. These problems have caused prices, especially in Sydney and Melbourne, to surge since 2012, notwithstanding some correction between mid-2017 and mid-2019.

Having established its bona fides on housing and immigration, the government would then be in a position to address the other two essential pillars of a comprehensive economic agenda, namely “strengthening economic growth” and “reducing Australia’s vulnerability to economic shocks”.

Lifting output growth—which in annual terms has been a full percentage point weaker since the end of the Howard government than during it—requires:

• stronger productivity growth; and
• less vital, but still important, improved workforce participation (though not in ways that would boost near-term growth but be counter-productive in the long run).

On productivity, the problem of course is to identify what exactly are the reforms the federal government should pursue. What specifically are the co-ordinated, politically achievable policy changes it should champion to lift productivity growth, with all the flow-on benefits this would have for wages, business profitability and investment?

Several broad suggestions are often tossed about—including “tax reform”, “welfare reform” and “improved skills training”. For all the talk about tax reform over the past twelve years, however, including major reviews initiated by both sides of politics, little by way of serious tax reform has been accomplished—and certainly nothing comparable to the achievements of the 1980s under Labor or the late 1990s and early 2000s under the Coalition. Likewise, there is little to show, in terms of substantive change as opposed to additional spending, for the repeated focus of different governments on welfare reform and boosting skills.

A broader focus is therefore called for regarding the levers available to the Commonwealth to lift productivity growth—to include education more generally, red-tape reduction, infrastructure provision, the structure of Australia’s federation, and the state of energy markets. Based on such a focus—and paying particular attention to the practicality of achieving change, not just the theoretical merits of doing so—three areas stand out as ones that a reform-minded government should concentrate on, as central planks of an achievable near-term productivity agenda. These are:

• higher education;
• federal-state relations; and
• Australia’s energy markets.

Innovative approaches are called for. After all, the Coalition has already had two largely-failed attempts at higher education reform—the 2014 Pyne and 2017 Birmingham packages. Likewise, federal-state relations have for decades been stubbornly resistant to substantive change; and twenty years of Commonwealth meddling in Australia’s electricity and gas markets have made these dramatically worse, not better. Happily, however, policy options are available that, in addition to being novel, would also better address the core problems in each area (especially misaligned incentives and lack of accountability) than the approaches tried to date.

In higher education, for example, the option of turning Higher Education Loan Program loans into joint loans—that impose obligations on both the tertiary institution and the student, not just the student—would go far to untangling the current distorted incentives in the system, which encourage universities to exploit many students (especially academically marginal ones) rather than serve their best interests. This option would also fundamentally and helpfully transform the politics of achieving change, compared with earlier reform efforts.

The Pyne reforms of 2014, for example, attracted the support of forty-odd vice-chancellors but the active hostility of hundreds of thousands of students. By contrast, this proposal would likely do the reverse—and hence be much less politically daunting. Along with several other practical reforms, it would enable a far-reaching overhaul of tertiary education in Australia, improving quality and accountability, while still yielding a sizeable budgetary saving over time.

Likewise, in federal-state relations, an innovative reform option for income-tax sharing is available—though definitely not the ill-thought-through approach proposed by Malcolm Turnbull in March 2016 before being abandoned within days. This alternative would avoid the political pitfalls of most reform ideas in this area, while significantly boosting national productivity.

Broadly, this proposal would involve no change whatsoever to current arrangements for taxpayers, thereby neutralising any “double taxation” concerns; while allowing the states and territories to opt in to receive an agreed share of the income tax paid each year by taxpayers working in that jurisdiction. In conjunction with suitable, modest funding top-up arrangements, so as to encourage participation, such a reform would transform the incentives facing state governments, strongly boosting the returns to them from facilitating jobs growth. It would also allow the Commonwealth to withdraw from a raft of policy areas in which its involvement is inefficient and muddies accountability, and would reinvigorate competitive federalism, a (neglected) cornerstone of achieving good economic outcomes for the nation.

Finally, but most importantly in terms of achievable reforms to lift productivity, innovative options are also available to tackle the loss, over the past fifteen years, of Australia’s international comparative advantage as a low-cost-energy country.

Since the turn of the century, both the affordability and reliability of Australia’s electricity and gas markets have deteriorated sharply. For electricity, dismaying developments include a near-tripling of national retail electricity prices, even as major continuity of supply concerns have emerged. Such concerns were brought to the fore by the unprecedented blackouts and protracted disruptions to electricity supply in South Australia and Tasmania in 2015-16 and 2016-17—a situation our forebears would have regarded as almost inconceivable fifty years ago.

Likewise, with gas, retail prices have more than doubled over the past twelve years, compared with a rise of less than one-third in the general level of consumer prices. Just as alarming, commercial and industrial gas users across eastern Australia have, for the first time, begun to struggle in recent years even to secure gas supply.

Carefully identifying the underlying causes of these disastrous developments, and comprehensively addressing them in a politically achievable way, forms the third key element of an ambitious but practical near-term productivity agenda for the Commonwealth.

As for workforce participation, despite past difficulties with the Senate there are a number of politically achievable options available to improve the participation of three key groups (women, younger Australians, and those approaching retirement age)—but in ways that balance equity and short-term growth objectives against long-term demographic considerations.

There is also scope for a more far-reaching structural change to the whole architecture of Commonwealth support payments like Newstart Allowance. This change would yield long-run budget savings and increase the pressure on recipients to get off welfare and become self-reliant, but without reducing the near-term level of support provided to those temporarily down on their luck.

The final critical pillar of any federal economic agenda for the next three to five years must be to reduce the risks to the economy from future shocks like the GFC. When that crisis struck, four factors were crucial in helping Australia to emerge relatively unscathed from the global downturn which ensued.

The first was our scope for monetary easing—which allowed the cash rate to be lowered from 7.25 to 3 per cent in just five months, providing enormous and rapid cash-flow relief to indebted households.

The second—with the budget in strong surplus in 2007-08, and Commonwealth net debt fully paid off—was our scope for rapid fiscal easing (albeit that part of the budget blowout that followed was reckless and unnecessary).

The third was the scale of the mining investment boom then serendipitously under way, which had already seen capital expenditure in the sector treble over just five years, from 2003 to 2008.

And the fourth was the greater exposure of Australia’s economy to China than to the severely affected economies of North America and Europe. This proved especially helpful in reinvigorating domestic (particularly mining sector) activity following China’s decision to institute a huge stimulus program in 2009, focused heavily on housing and infrastructure construction, which created strong demand for Australia’s iron ore and coal.

By contrast, Australia today is much more exposed in the event of any major economic shock. To begin with, the cash rate is already at a record low, barely above zero, so the RBA now has limited scope to provide swift relief to Australian households (who are also, in aggregate, even more indebted than they were on the eve of the GFC).

Second, although the budget was finally back to balance in 2018-19, we are not currently in strong surplus (as we were in 2007-08), and Commonwealth net debt is at a record level for the past fifty years.

Third, Australia is no longer in the midst of a once-in-a-century mining boom (and output growth over 2018-19 was the weakest it has been for a decade).

Fourth, there is a greater risk now—especially in the light of heightened trade and geopolitical tensions—that any future external shock may be centred in China (or Australia’s major trading partners more generally), rather than in North America or Europe.

And finally, in the event of a China-centred shock, the direct impacts on Australia’s economy would likely be compounded by a major hit to our terms of trade—the average price we receive for our exports relative to the average price we must pay for our imports—with severe implications not only for household and business spending, but also for federal revenue.

Given these vulnerabilities, it is urgent that we strengthen our defences against any economic shock, especially one centred in China—requiring budget repair, as well as initiatives to enhance financial stability (by improving financial system regulation and the operation and objectives of monetary policy).

On budget repair, in conjunction with savings arising from other reforms (such as on higher education), it is possible to identify specific, achievable repair measures (predominantly on the outlays side) that, in total, would add up to over $20 billion a year once fully in place. These savings range across areas as diverse as superannuation, the age pension, immigration, health, and the size and efficiency of the public service. Together, they would allow a committed government to improve the Commonwealth’s budget and debt positions.

Finally, notwithstanding that cash rate decisions and day-to-day supervision of financial markets are undertaken independently by the RBA and other arms-length regulatory agencies, there are still important steps the government could take to improve the operation of monetary policy, and to reduce the risks to Australia stemming from financial markets. To understand what these steps are it is necessary to:

• Review the RBA’s conduct of monetary policy over the past decade (with little to fault until mid-2016, but growing grounds for concern thereafter);
• Understand the significant costs associated with sustained low interest rates—economic, fiscal, and in terms of political economy; and
• Consider various longer-term structural issues regarding monetary and financial stability policy—including whether the sensitivity of consumer price inflation to economic conditions has changed; whether the objectives of central banks like the RBA remain appropriate; and whether the “too big to fail” and “too complex and interconnected” dilemmas in financial system regulation, and their interaction with central banks’ traditional role as the lender of last resort, call for a thorough revamp of the regulatory framework and of this function as lender of last resort.

From such analysis, several sensible policy options emerge—along with the desirability of immediately exploring a profound regulatory reform proposal from Sir Mervyn King, former Governor of the Bank of England, that in his assessment:

• would be practically implementable;
• could replace “almost all existing prudential capital and liquidity regulations” on financial institutions with just a few simple rules; and yet
• would still better address the “heart of the [financial stability] problem” faced by regulators than current arrangements.

Immensely detailed and prescriptive regulatory approaches failed comprehensively to prevent the GFC. In view of this failure, such an overhaul may be required to directly tackle the root cause of periodic bouts of financial chaos—what Sir Mervyn King terms the “financial alchemy” inherent in the transformation of secure short-term deposits into longterm risky investments.

Over the past dozen years Australia’s economic performance has been sub-par, productivity-enhancing reform has largely stalled, and the nation has become far more vulnerable to an adverse economic shock than it was before the GFC.

As my new book Restoring Hope demonstrates, however, there is no reason for despair. Good government that addresses our key economic and budgetary problems and yet earns the respect and support of Australians is possible. Trust lost can be won back. And the coming years can again be a period of serious, honourable government that strengthens the nation and helps us to rediscover our native optimism. 

Andrew Stone was Chief Economist and senior policy adviser to Tony Abbott (as Opposition Leader and then as Prime Minister). His book, Restoring Hope: Practical Policies to Revitalise the Australian Economy, has just been published by Quadrant Books.