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Australia at a Crossroads: A Brief Overview of the Current Options for Economic Reform

Key points

  1. Even before the twin crises of bushfires and COVID-19, economists were warning that Australia was in need for a significant round of economic reform. 
  2. Wage growth and productivity have stalled and compounded the inequality gap, leaving 700,000 Australians stuck in entrenched poverty.
  3. Since its election in 2013, the current federal government has largely focused on tax reductions, which has increased the size of government debt without stimulating productivity growth.
  4. An economic plan that ignores climate policy leaves Australia vulnerable to the negative effects of climate change, as well as squandering an opportunity to lead the world in effective mitigation of carbon emissions.

The National Accounts released in early June indicate that the Australian economy shrank by 0.2% in the bushfire and coronavirus affected March quarter.  With a further drop in economic activity virtually certain in the June quarter, Treasurer Josh Frydenberg pre-empted the technical confirmation of a second quarter of negative data, announcing on June 3 that Australia is now in recession.

The recession ends a 28 year long period of sustained economic growth, the longest period of continuous economic growth of any developed country in the world.  The feat has been sustained as Australia avoided an economic downturn through the 1997 Asian financial collapse, the 2001 dotcom bust and, most remarkably, the Great Recession brought about by the global financial crisis.

The emergence of a recession now will bring hardship to many people.  Like the coronavirus crisis which has formed its immediate trigger, it is likely to be hardest felt by young people who are not yet financially established, thus exacerbating pre-existing intergenerational inequities in the Australian economy.

The Federal Government will be technically correct when it blames the recession on external shocks though in reality the economy the economy was coming well off the boil before bushfires and coronavirus hit.

Australia has not experienced a period of deeply considered and sustained economic reform since the Hawke/Keating period which provided the foundation for the long boom which is now coming to a close.

The new circumstances have re-invigorated calls for Australia to embark on a serious round economic reform.

This paper provides a brief overview of that debate:

  • What are the structural economic issues?
  • Just how healthy is our federal budget?
  • What do the reports upon which the government will draw actually say?
  • And where is the debate likely to go from here?

Before coronavirus, the Australian economy was facing longterm, structural changes

Coronavirus has created an immediate, unexpected and serious hit to the Australian economy.  As previous McKell analysis has demonstrated, between 15 and 20% of the workforce have been effectively forced out of work with the impact being most heavily felt amongst the already low paid, consumption has fallen and business confidence has been severely impacted.

The budget implications of the crisis are not yet known with the government, which had earlier deferred the May budget, subsequently announcing a scheduled budget update would also be deferred until after the July 4 Eden Monaro by-election.

In May 2019, the Coalition won the federal election having promised “we have brought the budget back into surplus next year.”  The significant cost of bushfires had placed that mangled combination of election promise and false claim in jeopardy well before coronavirus hit.  It now appears virtually certain that the government will deliver significant budget deficits this year and next.

Nonetheless, even before the twin crises of bushfires and COVID-19, economists were warning that Australia was in need for a significant round of economic reform.  Through 2019, economists warned specifically that Australia’s GDP growth was low, with GDP per capita sitting barely above zero, that a sustained period of low wage growth was placing pressure on households and stifling consumer demand, that productivity growth was sluggish and that wealth inequality has remained “stubbornly high” over Australia’s long period of economic growth with the Productivity Commission estimating that about 700,000 Australians are stuck in entrenched poverty.

These trends are measurable and evidenced in the data below

1. GDP per capita growth is low

Having grown consistently since the recession of 1991/92, Australia’s rate of GDP growth has slowed dramatically in recent years, sitting at between 2 and 3% each year since 2013.

2. GDP per capita growth is well below the long term average

While Australia’s pre COVID-19 rate of GDP growth (to December 2019) of 2.2% was significantly higher than that of the G7 (1.4%), our growth is largely fuelled by increases in population, with Australia’s population growth of around 1.6% a year, being the fifth highest rate in the OECD.  The consequence is that per capita growth is virtually stagnant.

3. Wage growth is flat – and has been stuck that way for some time

Low GDP per capita growth is experienced by workers as low wage growth.  In the five years to 2018, annual wage growth in Australia sat at just 2.2%, well below the 3.3% experienced in the previous 5 year period.  Factoring in inflation, real wage growth was just 0.5% a year.  Real wages for full time workers have actually dropped.

Compounding that trend is that not everything within the basket of goods the ABS uses to calculate inflation has gone up at the same rate.  Essentials like utilities have gone up fast while consumer goods like cars and TVs have gotten cheaper.  For that reason, low wage earners, who spend more of their income on essentials, were experiencing real financial pressure even before the pandemic

4. Productivity growth has stalled

Productivity growth, the measure of outputs created from a set number of inputs has stalled. In 2018-19, market sector multifactor productivity fell 0.4% and labour productivity fell 0.2%, the first drops in either category for some time.

Productivity is the real driver of economic growth.

5. At last the terms of trade are ok – but that’s largely because of China

Australia’s last major round of economic reform was that undertaken by the Hawke and Keating Governments in the 1980s and 1990s.  Its focus was to restore Australia’s international competitiveness (without an assault on wages) and to fix the long term structural imbalance in the terms of trade which left the country unable to fund its own capital formation.

On both counts, there has been success.

Deregulation of the Australian economy saw trade restored to levels not sustained in peacetime since the early days of Federation:

And the terms of trade are positive after decades in negative territory.

Much of that recent prosperity has resulted from trade with China which replaced Japan as our largest trading partner in 2007. At present, nearly a quarter of all Australian two way trade is with China. 66% of it is with Asia overall.

6. Carbon emissions are rising

While Australia’s improved terms of trade may represent the solution to the country’s last major structural weakness, on today’s big question, climate change, Australia continues to have a significant, unresolved policy problem.

At more than 15 tonnes per capita, Australia has higher per capita carbon emissions than any of its major trading partners and since abolition of the carbon tax in 2014, emissions are again going up.  The environmental risks to Australia are obvious particularly in light of recent bushfires.

The economic risks are also becoming manifest.  The Business Council of Australia is now arguing that Europe’s move towards carbon border taxes poses an economic risk to Australia while eminent economist Ross Garnaut, the architect of the Rudd government’s early climate policies has recently published Superpower, a new book in which he argue that green power must serve as the basis for Australia’s future economic competitiveness.

7. The long boom has not fixed the problem of inequality

While the history of most of the twentieth century was a story of improving social equality, a recent comprehensive Productivity Commission review of the evidence found that the proportion of the population living in poverty remained unchanged through the recent long boom.  The PC findings are consistent with McKell Institute research which has shown that Australia has quite low levels of social mobility across generations, the key measure of a country’s fairness and meritocracy.

Further McKell analysis has shown that the impacts of COVID-19 have been greatest for those in low paid jobs, meaning the existing state of inequality has been exacerbated

8. Net debt is growing and we haven’t had a budget surplus since 2007-08

With interest rates already at historically low levels, the Reserve Bank has for some time expressed concern that there is little capacity for monetary policy to drive economic stimulus or reform.  The key tool through which the government can drive economic reform is the Budget – either with tax cuts designed to reduce business’ cost base and spur innovation or with counter cyclical spending to create employment or drive economic change.

So what is the state of the federal budget now that the pressure is on?

Australia has a budget of just under $500 billion or just under 29% of GDP (noting this includes GST which is transferred to the states).  Personal income tax is the greatest revenue source, collecting more than twice as much as company taxes.

At 36%, welfare is by far the largest federal expenditure followed by the private health and education sectors combined (23%).

The federal budget has not recorded a surplus since 2007-08 with net debt having doubled under the life of the current government from $184 billion when Labor left office to a projection of $392 billion on the last available economic data, the Mid Year Economic and Fiscal Outlook (MYEFO) which was issued in December 2019 before the bushfires and coronavirus crisis.

Nonetheless, Australia’s gross public debt, at around 40% of GDP, is well below the OECD average of 120%.

A number of economic reform reports are gathering dust in Canberra

As the debate has moved to reform, the Prime Minister has said he wants to “harvest” ideas.  While no single blueprint for economic reform exists, a number of comprehensive economic reviews have been undertaken by the Commonwealth public service and its statutory agencies in recent years.

Shifting the Dial: 5 Year Productivity Review, Productivity Commission 2017

In many ways Shifting the Dial is a grab-bag of stalled microeconomic reforms, many of which are well known but have been held up for years by political roadblocks.  In stark contrast to the rhetoric used to describe it, Shifting the Dial’s primary focus is not on business de-regulation but on improvements in the internal business of government.

Its key recommendations are:

Health

  • develop local preventative health plans
  • eliminating unnecessary, low value medical interventions
  • apply technology to de-regulate the pharmacy sector

Education

  • improve outcomes by ending out of field teaching, testing pedagogy and redirecting NAPLAN to encourage proficiency, not competency
  • apply Consumer Law to universities

Infrastructure

  • improve business case planning for infrastructure
  • move to road pricing
  • simplify urban planning and streamline development approval through councils
  • replace stamp duty with land tax (one idea that looks highly likely to happen)

Governance

  • “fix energy markets”
  • seek formal State / Commonwealth agreement to a joint reform agenda, including on tax
  • require local governments to report consistently on outcomes

Review of the Workplace Relations Framework, Productivity Commission 2015

To the surprise of many, a major Productivity Commission review of the Workplace Relations Framework commissioned by then Treasurer Joe Hockey in 2014 found that “Australia’s workplace relations system is not dysfunctional” and recommended “repair rather than replacement.”

The report found that “Australia’s labour market performance and flexibility is relatively good by global standards,” that employer-employee relations were generally harmonious and “the view that existing levels (of minimum wages) are highly prejudicial to employment is not well founded.”

Specific recommendations included:

  • changes to the appointment processes for Fair Work Commission members
  • Sunday penalty rates to be brought into line with Saturdays (controversially implemented by the government)
  • the current Better Off Overall Test (BOOT) in enterprise bargaining negotiations to be amended to be more like the old No Disadvantage Test
  • consideration of wage subsidies and earned income tax credits to increase the wages of low income workers

Update to the Climate Change Review, Ross Garnaut (for the Commonwealth Government) 2011

Initially commissioned in 2007, the Garnaut Review recommended that Australia adopt a fixed carbon pricing scheme moving to a floating price on tradeable emissions permits.  It found that such a scheme was the most economically efficient means of reducing Australia’s carbon emissions with the need to do so being premised on two factors, Australia’s very high level of susceptibility to the negative effects of climate change and its “exceptional opportunity to do well in a world of effective global mitigation.”

The review was updated in 2011 ahead of the introduction of the carbon tax and in 2019, five years after that tax’s abolition, Ross Garnaut again updated his work releasing Superpower, an overview of the economic opportunity arising from mitigation.

Neither the original review nor the 2011 update are now available on the Commonwealth Government’s website.

Australia’s Future Tax System (The Henry Review), Treasury 2010

The Henry Review was the most comprehensive consideration of the Australian tax system since Ken Asprey’s review in 1975.  It recommended a suite of changes which it estimated would create budget sustainability and increase national output by around 2-3% (or $25 billion in 2009-10 dollars).

At the heart of the Henry Review was a simple proposition, that Australia had too many complex taxes, a phenomenon that can be viewed graphically when we look at the 2018-19 tax mix.  The top 10 taxes make up over 95% of the Commonwealth Government’s revenue, however, there are over 19 different taxes.

The review made 138 recommendations, including that all tax should be centred on 4 efficient tax bases – personal income tax, company tax, private consumption (the GST) and resource rents from natural resources including land.  Taxes outside those bases should be abolished except for those, like tobacco tax or road pricing, which served a particular policy end.

Specific recommendations included:

  • reducing the rate of company tax to 25% in concert with a scheme to charge for the use of non-renewable resources
  • simplifying personal income tax scales
  • streamlining tax and transfers to remove disincentives to work along with increasing the tax free threshold
  • removing a raft of personal tax breaks including those for primary producers, defence personnel serving overseas (to be compensated by higher pay) and the private health insurance rebate
  • significant changes to retirement incomes including reducing the tax on superannuation contributions and creating a scheme whereby individuals could purchase a lifetime annuity from government
  • introducing a consistent resources rent tax
  • replacing stamp duties with land taxes
  • introducing road charging and other sustainability measures, such as changes to FBT on cars
  • improving childcare and aged care funding

Having been specifically directed not to do so by the Rudd Government, the Henry Review did not contemplate increasing the rate of GST or broadening the base, through Henry has subsequently said both “will have to happen.” 

It also did not contemplate carbon taxing.  At the time the Rudd Government was implementing the Carbon Pollution Reduction Scheme, the success of which was assumed by the Henry Review.

The Government’s record so far

Since its election in 2013, the current federal government has largely focused on tax reductions, the impact of which has been to increase the size of government debt (above) without stimulating productivity growth.

In 2018, the federal government legislated a decrease in the company tax rate for small and medium enterprises with turnover of less than $50 million from 30% to 27.5%.  The second tranche of cuts reducing the SME company tax rate to 26% is scheduled for 2020/21 with a further cut to 25% scheduled for 2021/22.  A parallel cut for big business was proposed in 2018 but failed in the Senate.

In 2019, immediately after the federal election, the Morrison Government legislated a third stage of personal income tax changes which are anticipated to cost the budget $300 billion over the coming decade.  Earlier analysis had shown tax cuts were already financially unsustainable after 2025 even before the deficits created by COVID-19.

When fully implemented after 2025 the changes will reduce the tax rate on all income between $45,000 and $200,000 to 30%, significantly decreasing both the overall tax take and the progressiveness of the system.  The change comes in the face of a Productivity Commission finding that “Australia’s progressive tax and highly targeted transfer systems substantially reduce inequality.”

So where to from here?

As the coronavirus pandemic has unfolded, a number of key stakeholders have issued calls for substantive economic reform.  The ACTU has issued calls for greater job security, the Business Council of Australia has reiterated a call, detailed in a February scoping paper for climate action to prevent trade isolation and the Reserve Bank has called for infrastructure spending.

Through the pandemic, the Labor Opposition has largely supported the government’s public health and economic policy strategy.  The Shadow Treasurer, Jim Chalmers has called for Treasury White Paper on post pandemic reform focusing on principles, including prosperity (indicating Labor’s continued commitment to growth), equality of opportunity and sustainability.

In a recent headland speech, Labor leader Anthony Albanese indicated the Opposition would seek to protect workers’ rights in the industrial relations system, prioritise climate and energy policy and focus on regional decentralisation and infrastructure provision through the recovery.

Having abandoned a much maligned promise that the economy will simply “snap back” once coronavirus has passed, the government in May began acknowledging calls for meaningful economic reform, indicating a preference for tax cuts, industrial relations reform and a productivity shake-up.

Of those options, industrial relations reform is the only one upon which the Federal Government has thus far elaborated.  Speaking at the National Press Club on 26 May, the Prime Minister indicated the government would seek to create a reformed and nationally consistent approach to skills training and that he was establishing specifically targeted union and business working groups which would be focused on achieving a consensus on reform in five specific elements of the industrial relations system:

  • award simplification
  • enterprise agreement making
  • casuals and fixed term employees,
  • compliance and enforcement.
  • greenfields agreements for new enterprises

Around the same time, the government released a discussion paper for a Technology Roadmap, a move which clearly indicated government would continue its current approach of picking winners in energy rather than adopting the more economically efficient approach of pricing carbon as a means of ensuring energy supply whilst decreasing emissions.

The policy challenges now facing Australia are substantial.  The country faced slow economic growth, stalled productivity, stubborn inequality and a climate policy desert well before this crisis induced recession came along.

Coronavirus has hastened the urgency of Australia’s reform debate right at the time the largesse Ken Henry argues is invaluable in compensating the losers from reform has dried up.

If the government’s public indications so far are to be taken at face value, it would seem likely the strategy will either be for very limited and specific reform (as per the industrial relations working groups) which ignore the larger, pre-existing economic challenges or for a  pro-cyclical round of cuts – to tax, industrial protections and, quite possibly, public services while the Opposition argues once more for climate policy, infrastructure and the social inequities exposed by the pandemic to be addressed.

With goodwill towards politics on a rare upswing, it remains to be seen who will convince the Australian people to trust them on the challenging path ahead.

Rachel Nolan is Executive Chair of the McKell Institute Queensland and a former Queensland Finance Minister.