Australia's future: slow growth, falling terms of trade, lower per capita incomes?

Some economists recently warned Australian real incomes will fall. Yesterday's national accounts remind us this has been so for about two years now (see Chart).

Real net national disposable income per capita (trend or seasonally adjusted) has fallen since peaking in the second half of 2011. Real per capita income in the September quarter, 2013, was about 2% lower than in the second half of 2011. Falling terms of trade and slower economic growth have been important causes. More declines in our terms of trade are likely.

Source: ABS, September quarter national accounts.

This economy-wide measure of changes in Australian incomes has been obscured by other indicators. For those with jobs, nominal wages growth has been modest, but still keeping pace with, if not running ahead of, modest inflation, so real wages are flat or increasing. Real consumption is still increasing, and was a significant driver of overall economic growth (albeit less, recently, than net exports).

But increasing living standards (measured by per capita consumption) cannot be sustained unless real per capita income growth returns.

What can we do about this?

We have little influence over our terms of trade. Further declines in future are likely. So we need to offset these before sustainable income gains are possible.

We have two choices. We can (i) increase the application of productive inputs, and/or (ii) increase the productivity of those inputs.

In the first category, dealing with current government-imposed impediments to increased labour force participation is needed.

Much lip service is given to encouraging older Australians able and willing to work to do so. Eliminating current high effective marginal tax rates (at least 50% or more) for those receiving the age pension once the income test applies is a concrete example of action. This 'carrot' is likely to be more palatable than forcing further increases in the retirement age for pension access, though that is needed too as longevity increases and the population ages.

In many cases, increased investment to repair and upgrade Australia's infrastructure is desirable. For example, investment in Australia's grain supply infrastructure seems urgently to be needed. Sometimes, that investment might need to come from foreign investors' savings – if that is permitted. Qantas come to mind here, too.

This first type of response to falling real incomes requires more inputs to lift output to support rising incomes. It involves using all available resources more extensively – working them harder – to do the job.

The second type of response involves working available inputs more intensively – working them smarter – to lift their productivity, lower unit production costs, and thus support rising real incomes.

For example in the private sector, do Australians pay too much for medicines? Is coastal shipping over-regulated, increasing its costs? Could the Government change these?

The second area for seeking productivity improvements is the public sector itself. At present, with large structural deficits extending (at best) well into the future, governments are directly increasing their claims on future incomes to service their growing debt. One can debate the merits of 'good' debt versus 'bad' debt, but debt used to finance present government consumption and/or investments failing proper cost-benefit analysis is both unsustainable and intergenerationally unfair.

This is properly a concern of the 2013-14 National Commission of Audit, which has broad terms of reference (suitably interpreted) to deal with this issue. I've had a go at this type of exercise in 1996. I don't wish to add to the mountain of specific advice and submissions the current Commission is receiving.

But I'd like to offer three general pieces of advice as the Commission develops recommendations to deliver a sustainable public sector in Australia.

First, if there is no strong case for governments doing something they are already doing, such programs should be scrapped. For example, whatever its commercial merits – and I don't regard paying for its own operations as one of them anyway – I don't see the Clean Energy Finance Corporation as a business where governments should play a role. If there is an information gap, then fill that gap, don't set up another government business enterprise with what is essentially a commercial mandate.

Second, as far as possible, be very clear and specific about program objectives, and as far as possible make sure these can be readily and objectively measured. Otherwise, the programs can become just so much waffle and soak up scarce taxpayer funds for little measurable benefit. Objectives and their close and effective monitoring should drive policy and taxpayer resource allocation.

Third, undertake a careful policy design review. The detail of government policy delivery mechanisms should be fit for purpose, understood well by those responsible for their implementation, and as far as possible free from ambiguity and unintended side effects. Pink Batts weren't. I suspect a lot of Australia's tax system would be found wanting from such a review.

Ultimately, of course, it does not matter what the National Commission of Audit recommends. What matters for future Australian living standards is the Government's response.