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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