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Getting economic policy right - and at the right time

By Nicholas Gruen - posted Tuesday, 5 April 2005


A while back I was on a tram on a business day-trip and got talking to the lady next to me. I was in Melbourne advocating a particular government policy and since she asked I explained my case. She said I’d convinced her and given my perseverance till that time, she expected I’d succeed.

Often if I think of a witty riposte, it’s after the event. That’s what the French call esprit d’escalier - literally “the spirit of the stairs”. I guess it’s what you realise you could have said as you go up the stairs. On that day I cut right to the chase. “Yes”, I yelled back to the lady as I alighted from the tram, “I expect I'll succeed, at about the time that what I’m advocating has become the wrong thing to do”.

That’s the long and the short of it. Most policies have specific short and long-term effects and sometimes they mutually reinforce each other. But sometimes they conflict. We spend so much time in grand ritualised ideological battles - right versus wrong, left versus right, governments versus markets - that we underrate the skill of matching policies to circumstances. As a result we’re not much good at it. For example, we should still tackle the excessive tax preferences for investing in housing - like capital gains tax concessions (50 per cent for investment housing, 100 per cent for your own home). But the best time for reform was a few years ago. That way its long-term benefits - less excessive investment in housing, lower house prices and stronger investment elsewhere - could have also helped us restrain the housing boom. Doing it now would impose short-term economic costs by exacerbating the housing downturn. And usually short-term costs attract more political hostility - as in this case.

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In my opinion we had something of a golden age of economic management from around 1983 to 1987. Former Prime Minister Paul Keating called it the “high wire” act, and he was right, as we discovered while we watched his stick like figure twisting and plummeting Icarus-like to earth.

The Accord partners - the government and the unions - would meet and thrash out an agreement that produced outcomes we needed in the long-term while addressing the short-term needs of the macro-economy. Twice in the first five years we engineered sharp reductions in real wages of around 2 per cent. On each occasion the short-term effects of this long-term policy couldn’t have been better. With the recovery in 1983 and the dollar’s collapse in 1986 the Accord took the edge off inflation and produced much needed strong employment growth. The alternative was slower growth and, at least on the second occasion, recession.

Our loss of improvisational élan can be dated to 1989 when we faced a ballooning current account deficit and rising inflationary pressures - déjà vu anyone? We turned to monetary policy - déjà vu anyone? The problem was, as we knew at the time, tighter monetary policy was not only a blunt instrument, carrying the risk of misjudgment and recession, but its short-term benefits came with counter productive long-term costs.

As I argued at the time - I’ve got the newspaper column to prove it - there was another option. Requiring workers to pay some small share of their wages into their newly established superannuation funds would have slowed consumption. But where tighter monetary policy did slow consumption it also resulted in less investment and a higher exchange rate which choked off desperately needed exports. Alternatively, increased super would have increased savings, lowered the cost of capital and the exchange rate, and therefore lifted exports.

We already had a long-term goal of dramatically increasing compulsory employer super. However increasing employee superannuation was also unusually attractive as a short-term economic tool as well. So the long and the short of it is we could have killed two birds with one stone. The “powers that be” said people wouldn’t like it. Funny isn’t it, how hard it is to get people to consider something new on a “level playing field” with what’s already in their minds? As I recall, they didn’t much like the alternative either: 17 per cent interest rates for which the ALP still pays the price.

So here we are again. Our once yawning current account deficit is now coming to resemble lockjaw. The labour market is tightening, with skills shortages emerging as they were in 1989. And in the absence of action by the Government, the Reserve Bank considers that it’s being forced to slow the economy with the wrong instrument - higher interest rates. Exports have stalled and, though mineral exports will lift soon, our dollar is already overvalued.

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I suppose we’ll get round to increasing compulsory superannuation one day. We’re just increasing the chances that when we finally get round to doing it, it will be at the wrong time.

Déjà vu anyone?

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Article edited by Angus Ibbott.
If you'd like to be a volunteer editor too, click here.

First published as “Too much too soon, too little too late” in the Courier-Mail, on March 23, 2005.



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About the Author

Dr Nicholas Gruen is CEO of Lateral Economics and Chairman of Peach Refund Mortgage Broker. He is working on a book entitled Reimagining Economic Reform.

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