WHY WE HAVE HAD IT SO GOOD

The following article appeared in today’s AFR.

Australian living standards (measured, albeit imperfectly, by real net national disposable income per head) have soared by about 16% or nearly $8000 per person in just the last five years a great leap forward unequalled in any similar period in recent history.

I estimate that approximately 20% of the improvement in living standards has been due to rises in the employment to population ratio (increased labour utilization), 40% to productivity growth per worker and 40% to gains in our terms of trade.

Our performance on employment participation has not been exceptional by world standards. With the global economy growing at the fastest rate for more than 30 years, employment has been rising faster than population almost everywhere, with many OECD countries such as Denmark, Ireland, Netherlands, New Zealand, Sweden, Switzerland, UK and USA currently boasting workforce participation rates and unemployment rates comparable or superior to Australia.

Again, the rate of growth in Australias productivity (real GDP per worker or per hour worked) has been barely average in recent years, with many smaller European and Scandinavian economies as well as the USA doing better than us.

Moderate inflation of 2 to 3% p.a. over the last five years has helped to make Australias growth more sustainable. But low inflation has been common across most of the developed world, reflecting the liberal trade environment, technological innovation and the increasing dominance of China and India (which helped relieve labour shortages and reduce prices in many sectors of manufacturing).

Where Australia does stand out in the world is in the terms of trade effect. ANZ Chief Economist, Saul Eslake, has estimated that, so far this decade, the improvement in our export prices relative to import prices has had the effect of boosting national income by some $3600 per head. Few countries in recent history have enjoyed such good luck.

While the global economy and soaring resource prices have been the leading drivers of our success, it does not mean our economic leaders have been passive observers. Through steady structural economic reform over two decades, governments did much to sustain productivity growth and enhance the resilience of the economy to shocks. It started with the Hawke-Keating policy revolution in the 80s and early 90s (floating of the dollar, opening up the banking sector, reducing tariffs, decentralizing wage bargaining, introducing compulsory superannuation, investing heavily in education and improving public sector management). This was followed by useful Howard Government reforms (such as on tariffs, taxation, industrial relations, the waterfront, welfare to work and the restructure of immigration policy).

At the more macro-economic level, one should acknowledge the role of monetary policy. The Reserve Bank was somewhat slow and heavy handed in the late 80s and early 90s, thus helping to create the recession we had to have in 1991. But over more recent years the Bank has hardly put a wrong foot forward. It refused to panic during the East Asian crisis in the late 1990s and the recent rises in interest rates have been timely, gradual and well managed. Costellos formalization of the Banks independence in 1996 may have given it more confidence but in practice the RBA had almost complete autonomy well before that.

Fiscal policy has less to boast about. Sure, Costello ran fiscal surpluses of ½ to 1% of GDP over the last five years but he benefited from a much more dynamic global economy than his predecessors (a good many of the smaller OECD countries have been running handsome fiscal surpluses in recent years). And his job was made even easier by the revenue boost from the improved terms of trade, which added a few hundred billions of dollars to federal revenue. Despite the claims of Howard and Costello that the States have been swimming in GST money, the share of GST revenues in GDP has remained unchanged during the last five years but Federal company tax receipts have increased by 1% of GDP over this period.

Indeed, one could criticize Costellos failure to save more of the revenue windfall from the commodities boom. Measured by the change in the fiscal balance over recent years, the past three Federal Budgets have done nothing to dampen aggregate domestic demand, relieve inflationary pressures or slow the steady rise in Australias foreign debt.

The Howard Government deserves credit for many fiscal initiatives during its 11 year term. For example, it introduced its Charter of Budget Honesty, created the Future Fund and highlighted the fiscal and economic challenges of an ageing population. But these achievements have no great bearing on Australias recent surge in living standards. And the Government is also responsible for some doubtful measures such as the recent superannuation reforms (which will cost tens of billions of dollars and could have mostly perverse effects on saving, work participation and wealth distribution) and the further explosion in middle class welfare. It must also take much of the blame for the neglect of education, training and public infrastructure.

It is understandable that federal and state Treasurers want to take credit for the extraordinary increase in affluence over the last five years. But in truth, the fiscal authorities have been only marginal players. The main drivers have been the earlier structural reforms, the global boom, China and India, and the Reserve Bank of Australia.

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wilful
wilful
14 years ago

I’m sorry, did you just compliment the ‘Charter of budget honesty’?

Isn’t that of about the same status as the Ministerial Code of Conduct?

Fred Argy
Fred Argy
14 years ago

Wilful, in principle the Charter is a good thing as it is capable of adding to transparency and honesty but (like everything else done by the Howard Government) “the decks are loaded against the Opposition” (Peter Martin in CT 18/9/07). It needs more than a little fine tuning.

Jc
Jc
14 years ago

Fred

Coupla things.

1. RBA Independence has been a good thing. Not diwscussed.

2. To ensure continue prosperity the country basically needs two guard dogs. One guard dog in the PM office and the other in the Treasurers office. Each dog should ensure both officials get bitten every time they touch the levers of power. In other words you have to try really really hard to screw this economy up.

Guido
14 years ago

Interesting The Age Business section today has also an article titled – Stop Grumbling – you never had it so good, so fast

Jc
Jc
14 years ago

Fred:

And the Government is also responsible for some doubtful measures such as the recent superannuation reforms (which will cost tens of billions of dollars and could have mostly perverse effects on saving, work participation and wealth distribution

I can see your argument about wealth distribution, Fred. How do the other factors come into play. Please explain.

Fred Argy
Fred Argy
14 years ago

JC I do mention RBA independence. I say “Costellos formalization of the Banks independence in 1996 may have given it more confidence but in practice the RBA had almost complete autonomy well before that”.

You ask about my claim that superannuation reforms “could” have ‘perverse effects’ on saving and work participation. I believe they may provide incentives to retire early and to save less.

In an earlier posting (I forget where) I said that while the super reforms will simplify the system:

“The test of a sound superannuation policy must be judged on what it will do to national saving, workforce participation, future age dependency ratios and the future reliance of the population on the age pension. In my view, and that of many other economists, the 2006-7 reform has little or nothing to offer on any of these four criteria. Indeed it is possible that the high income people it targets will save and work less overall (since they need less to attain their retirement income target), that the fiscal burden on the young will increase and that lower income people (who gain nothing from the 2006-7 reform) will remain as welfare dependent as ever in the future. The superannuation co-contribution policy is a much more cost effective policy on these same indicators (although it too needs to be better targeted)”.

This is quite apart from the general distortion that the superannuation concessions are creating in the allocationb of capital.

And recent studies by the Melbourne Institute (Warren and Oguzoglu) and statemens by its chief, John Freebairn, confirm my worst fears.

But one cannot be dogmatic in this field. That is why I said “could”.

Bingo Bango Boingo
Bingo Bango Boingo
14 years ago

I could never understand why superannuation isn’t tax free on the way in (no contributions tax), tax-free as it accumulated, and then when it is drawn down just taxed at whatever marginal income tax rate applies. Can someone explain to me why this would be bad?

BBB

Jc
Jc
14 years ago

Fred:

I can’t quite see how savings distorts anything even if it is called super. Savings fuels economic growth and economic growth raises living standards. I can’t imagine how that is a bad thing.

Sorry, yes, you did mention RBS independence. my apologies.

wilful
wilful
14 years ago

BBB, ‘coz if taken as a lump sum it would virtually all be top tax bracket.

Bingo Bango Boingo
Bingo Bango Boingo
14 years ago

Well that can’t be the ultimate answer, can it? The ability to take superannuation as a lump sum on retirement is just a feature of the current regime which may or may not be necessary or desirable. Your answer doesn’t get at the underlying issue of whether it is better to tax the money going in rather than when it is coming out.

BBB

Jc
Jc
14 years ago

“Your answer doesnt get at the underlying issue of whether it is better to tax the money going in rather than when it is coming out.”

Don’t know if this is what you’re asking. It would be better taxing it when it comes out as it compounds at the untaxed rate through the period.