Where is the Australian economy headed?

Issue 

With the economy growing rapidly, DICK NICHOLS looks at the prospects for an extended upturn.

As a group, Australia's economic forecasters have a rather poor record. Few predicted the heights that interest rates would reach in 1988-89; even fewer predicted the depth of the following slump, which sent official unemployment up to 11%.

This time the economic seers have slightly underestimated the strength of the long-delayed recovery (growth is presently running at around 5%) and totally missed the target on long-term interest rates (now at 10.65%).

The basic reason for these errors lies in the forecasters' assumption that wise and timely government intervention can moderate capitalism's boom-bust cycle. If that cycle gets out of control, the fault must lie with the wrong policy on interest rates or the budget deficit — it's certainly not the fault of the system.

The assumption that an inflationary spiral or a slump could have been moderated if only the right medicine had been applied leads to an unending misreading of history. Each economic episode produces a received wisdom about what should have been done (for example, now "everyone agrees" that in 1988-89 interest rates should have been raised earlier and more sharply). With this goes a determination not to repeat the last "mistake" (so the Reserve Bank has already increased rates early in the upturn).

Of course, government policy has some impact on the business cycle. Without Labor's "One Nation" spending, the recent recession would have been even deeper. But the econocrats consistently overestimate the degree to which policy can mould the cycle. The fundamental forces driving a capitalist economy are either out of the control of government or are so intractable that there's no way a government can manipulate them rapidly enough to affect the economy in the short term.

The federal Labor government hopes for an upturn that will deliver sustained job growth in the 1990s. This is possible, we are told, because inflation is under control and the reforms of the 1980s have produced an economy that can grow faster without running into a current account crisis. How well founded are these hopes?

Inflation

While inflation is low at present because of the recession and the large amount of slack still in the economy, it's premature to say that the back of inflation has been broken.

First, it's not excluded that Australia will suffer a further bout of imported inflation because of a collapse of the Australian exchange rate, although this isn't likely at present with the Australian dollar appreciating on the back of rising raw material prices.

Second, the deeper integration of the Australian economy into the world economy in the 1980s has increased competitive pressure on Australian businesses. How many patriotic Australian firms will be able to take advantage of rising demand to restore profit margins by jacking up prices?

Third, it's not yet settled whether enterprise bargaining will throttle wages growth as efficiently as Accords Mark I and II did in the 1983-85 upturn. Even though the ACTU remains as committed as ever to policing "responsible wage outcomes", and even though enterprise bargaining is supposed to have finally driven a stake through the heart of such old notions as "flow-on" and "comparative wage justice", the impact of such claims as the TWU's 15% still remains to be felt.

The key point is that the Reserve Bank will act to keep inflation from reigniting by jacking up interest rates as much and as rapidly as deemed necessary. The threat of interest rate rises will be held over everyone's head to make sure that enterprise bargaining works as intended (as a system of wage rises funded by productivity gains). As Reserve Bank governor Bernie Fraser told some business economists in March:

"If there were to be a return to the adversarial and cost-increasing mentality of the past, the consequences for inflation would not be something that monetary policy could ignore."

Current account

The recent run of bad balance of payment figures raises the spectre of the economy quickly running up an unsustainable current account deficit. Australia has traditionally run a deficit, which basically means that part of new private investment (around 30% in the 1980s) is being funded by overseas savings.

This doesn't mean that "the country's going broke", nor (as is the case with the Philippines) that some 40% of the government budget goes on debt repayment. It does mean that the Australian economy is more vulnerable than would otherwise be the case to swings in "financial market sentiment". If these markets became nervous about Australian government and company ability to service foreign debt and dumped Australian assets, they would force the government into sharp increases in interest rates, cuts in government expenditure or both.

It is largely the need to minimise this possibility that is driving the Keating government's economic agenda. Hence the push (initiated by the Fitzgerald Report) for moves to boost the Australian savings rate.

However, it's not easy to manipulate an increase in the savings rate. Tax breaks for savings can simply change the form of saving (from public to private, from banks to superannuation funds etc), with little net gain. And although there is some evidence that the Australian savings rate has been increased by Labor's forced superannuation arrangements, this is still very small.

This leaves the public sector as the lamb for sacrifice on the altar of a higher domestic savings rate: the pressure is on for Treasurer Willis to speed up the government's program of deficit reduction.

And, since there's no expectation of business or the rich making an increased contribution to the public purse, the only options available are (1) to hope, as Labor fervently does, that the natural growth of the economy will yield the tax income to repair the budget deficit, or (2) to cut government expenditure or raise taxes.

Keating and Willis face some difficult problems on this front. By this stage in the cycle, the government should have already moved towards a sharp cut in the budget deficit. In 1985-86, the equivalent year in the last cycle, the budget deficit stood at 2.4% of GDP: at present it amounts to 4.5%.

Secondly, because of the determination to hang on to a low inflation rate, the government will probably pocket much less than last cycle in "bracket creep" gains (arising from the non-indexation of tax thresholds).

Concern is growing among the pundits that Keating is hanging on just a bit too long as the Keynesian Dr Jekyll, and that it's past time for him to revert to being Mr Hyde, the great deregulator of the 1980s.

It's not excluded that the economy will grow strongly for a couple of years, especially if business investment stays strong and the upturn in the world economy lasts. What is certainly excluded is that this upturn can take place without the continuation of Labor austerity.

That's another very good reason why workers should be doing all they can now to win back some of the wages lost under the Accord.

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