The reforms we need to help Australia avoid economic stagnation

by Jim Minifie

Published by Australian Financial Review, Monday 30 May

Australia’s economy has come back to earth after a wild ride through the mining boom but that does not mean we are destined to join the rest of the rich world’s economic malaise.

The economy is adjusting reasonably well to the mining slowdown. Gross domestic product growth has averaged above 2 per cent over the past five years and has picked up a little of late, as this week’s first quarter GDP release is expected to confirm. While national income per person has fallen and real wage growth has slowed to a crawl, that is mostly because resource prices have dropped by about half. Our post-boom pivot is almost a textbook case: output soldiers on, while incomes absorb the declining terms of trade.

But the pivot is not perfect. Inflation is dropping further out of the Reserve Bank of Australia’s 2 to 3 per cent target band. That is what you would see if demand were generally weakening across the economy.

And non-mining investment is yet to pick up; in fact it has hardly budged for a decade. Senior executives in many sectors are focused on cost reduction, not growth. The dollar hasn’t dropped far enough to drive a strong rebound in tourism, agriculture and education, let alone in manufacturing. Firms have not lowered their investment hurdle rates much, even though real interest rates have fallen.

Such weakness in prices and investment warrants careful analysis because they are key ingredients in other economies’ post-GFC slumps. Inflation in the European Union hovers just over zero and Japan has slipped into deflation at times. Low investment, too, has dogged the rich world. In the EU and Japan gross investment remains more than 10 per cent below pre-crisis levels. US investment has recovered but the capital stock is well below its pre-crisis path, contributing to a 15 per cent shortfall in US output.

Australian financial authorities are the first line of defence against such a slump. In the early 2000s, US and EU regulators permitted excessive private leverage and private lending, and central banks were slow to respond when demand began to collapse in 2008. The RBA has had ample time to reflect on the need to act strongly when needed. Australia has tightened its prudential regulation and bank capital has risen strongly in recent years. There is now a case for cutting the cash rate while further tightening property lending standards: the exchange rate would probably drop, helping trade-exposed sectors to rebound.

But a successful pivot from the boom will take more than an artful manoeuvre of interest rates. Government can take action in seven areas.

First, it needs to deliver a credible path to surplus as soon as possible. There is little reason to believe that the persistent deficits of recent years have supported growth much, even if support at the time of the financial crisis was warranted.

Second, government should cut income taxes while broadening the GST base and/or increasing the GST rate, to increase incentives to work and invest. It should encourage the states to switch to land taxes from stamp duties. A company tax cut, as announced in the budget, would boost the domestic capital stock but the net benefits may be modest: foreign investors would capture much of the upside, and other distorting taxes would need to rise or spending would have to be cut.

Third, government should seek to draw people back into the workforce. Female labour force participation is below that of many other high-income economies. Careful design is needed to develop affordable tax, transfer, leave and childcare packages that encourage workforce participation.

Fourth, government should implement Harper review recommendations on flexibility and competition. Regulations on shipping and airline cabotage, industry supports such as anti-dumping tariffs, planning and zoning restrictions and occupational licensing raise the costs of doing business, delay the exit of uncompetitive firms, and increase costs to consumers.

Fifth, government should improve productivity in regulated sectors such as superannuation (as the Murray Inquiry recommended) and in government services including health and education, and improve the quality of infrastructure investments. The Commonwealth’s asset recycling initiative has been closed to new projects, but extending it could help state governments invest in high-quality infrastructure.

Sixth, government should remove barriers to innovation. The National Innovation and Science Agenda is a strong start, with initiatives to improve research-business collaboration and support new business creation. Removing barriers to the local spread of global innovations, such as idiosyncratic local product standards that hamper the local spread of global innovations, could make a bigger impact than subsidies for Australian inventions.

Finally, government should toughen greenhouse gas emissions limits. Such policy needs to be understood as an investment: global action on emissions is strongly in Australia’s long-term interests, and Australia can do more to strengthen co-operation from other major emitters.

None of these policy moves will pay off immediately but that is no reason to delay Australia’s successful pivot from the mining boom into a new era of growth.