The sweet spot

In his recent book, The Sweet Spot (Black Inc), Peter Hartcher depicts his fellow Australians as passive victims of complacency over economic policy. He argues that most people seem blissfully ignorant of how far up the various indices of economic and social development Australia has risen over the past three decades – whether the narrow economist's measure of per capita GDP or broader indices like the UN Human Development Index or the OECD Better Life Index.

By any measure the Australian economy has outperformed, and Australians live better than just about anybody else on the planet. Hartcher's fear is that too few Australians realise how much of this is due to the hard yards of economic reform required to break us of unproductive habits. Too many of us, he muses, put it all down to the mining boom and by implication to Australia's uncanny luck. If this is true, the focus of public policy will inevitably shift away from productivity-enhancing economic reform, and so too will Australia's relative living standards slip away from the heights we currently enjoy.

There is no doubt that Australia's economic performance has been outstanding over the past decade and a half. Much of this reflects good economic policy overseen by both sides of Australian politics. Equally important is the obvious influence of the rise and rise of the developing world, especially China but also India and Brazil. China's industrial revolution is occurring at a pace and on a scale unprecedented in human history.

The impact on the Australian economy is direct, through increased exports of primary commodities, including agricultural products as well as the usual cast of coal, iron ore, LNG and other minerals. But it is also indirect, as the growth of developing countries as a group raises commodity prices and lifts Australia's terms of trade to levels not seen since the mid-1800s.

The process is not without stress, however, and we should know this from our history if not from experience. When the great commodity boom of the nineteenth century – a boom in minerals, especially gold, but also in wool and wheat – lifted Australia's relative living standards to the highest in the world (measured by per capita GDP) in 1880, the strains on the economic and social fabric became evident. A widening gap between wages earned by workers employed in the booming sectors and those employed in what passed for manufacturing and services prompted those who framed Australia's constitution to include a federal power to determine wages centrally. Essentially, to spread the largesse more broadly in an era before the advent of income tax and social security.

Australians have long held a concern for the just or equitable distribution of the bounty we enjoy in this country. Many would argue that this is one of Australian society's more humane and endearing features. Yet the focus on equity stands in tension with the desire to raise living standards overall, something Australians are also keen to ensure if not to the exclusion of social conditions.

Peter Hartcher describes the slow oscillation between the pursuit of rising living standards and concerns for the equitable distribution of the fruits of economic growth as one of the organising themes of Australian economic history. Indeed, the 'sweet spot' of the title of his book describes the balance we currently enjoy, reflecting the rapid improvement in overall living standards leavened by the strongly redistributive influence of Australia's income tax and social security apparatus. But if the historical pattern repeats as he fears, the emphasis on equity will overwhelm the impetus for reform and living standards will stagnate, as they did for much of the first half of the twentieth century.

So the times we live in are good – perhaps the best we've ever known. With more and more Australians travelling abroad, egged on in recent times by the high value of the $A, and saturation media coverage of economic hardship in Europe and the USA, it's probably safe to say (pace Hartcher) that most Australians do have some idea of how well we live here relative to other parts of the world.

Yet it's also true to say that the times are perilous. It is perfectly possible for the troubles in Europe to find their way, albeit in some diminished form, to Australia's shores. The direct route is via China, where a slowdown in exports to Europe and the USA would affect global demand for commodities and immediately reverse the rapid rise in our terms of trade. Arguably this has already begun, although there's still a good way left to go. The indirect route is via conditions in global capital markets and the international banking system. If Europe's banks fall foul of efforts to restructure the embattled euro, and in any case if global investors fear default or restructure of government bonds in Europe, Australia, as a heavy importer of capital from global markets, will not be immune.

The times are also perilous because the flood tide of economic prosperity masks the rocks that lie just beneath the surface. The high income growth Australians have enjoyed over the past half-decade derives overwhelmingly from the surge in our terms of trade. Productivity growth, meanwhile, has been negative, and it is productivity growth which underpins rising living standards in the absence of valuation effects like movements in the terms of trade. Once the economic tide recedes we will, to quote Warren Buffett, "find out who's been swimming naked" – and it won't be a pretty sight.

Our greatest challenge is to build a consensus for economic reform during what most people recognise as the best of economic times. The wave of reform we undertook in the 1980s, which sparked a marked rise in productivity growth and living standards, occurred against the backdrop of falling terms of trade and fears of descent to the status of a 'banana republic'. Perhaps it needs some latter-day Lee Kwan Yew to taunt us again as the 'white trash of Asia' before the imperative for reform grabs our attention.