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Has Australia lost its appetite for economic reform?

By Ross Garnaut - posted Tuesday, 10 August 2004

The 2004 election contest is premised confidently on continued prosperity. But a harder reality is likely to intrude before the next parliament has finished its work.

Since the 1991-92 recession, the economy has performed better than that of other rich countries for the first time. Economic growth in the 1990s was underpinned by the strongest export expansion in our history.  All of this began during the mid 80s, when there was for a while a broad-based acceptance that economic analysis was relevant to economic policy. This acceptance was a sharp departure from the earlier Australian political culture, which had weighed pressures from vested interests more heavily in the balance of economic policy-making. The crucial measures included financial market deregulation and reductions in import protection.

I do not come to the view that the comfortable times are fading from any general predilection to gloom. In Australia and the “northeast Asian ascendancy”, I challenged the political orthodoxy of the time in anticipating the lift in productivity as well as the export diversification and growth that would accompany the internationalisation of the Australian economy. As the Thai economy was falling into depression in late 1997 and the contagion spread through East Asia, I wrote in a paper for the Australian Business Council that we could expect continued strong growth for our economy.  Prime Minister John Howard, in speeches inside and outside parliament, broadcast the optimism that I expressed at The Australian's 1997 conference, "Australia Unlimited". I spoke then about the shock that Australians would soon experience as they realised they were part of the third period of sustained prosperity in their country's history.


I have long expressed the view that no economic expansion is doomed simply on account of its longevity.

Australia's biggest economic problems before the recent prosperity came mainly from two sources. The first was expansion of domestic expenditure beyond the productive capacity of the economy. Sometimes the unsustainable increase came from spending the benefits of increased export prices (terms of trade), which turned out to be temporary.  The second source of problems was policies that constrained the efficiency with which Australian resources were used. Low productivity growth sharpened the difficulty of holding expenditure within the economy's (diminished) capacity.

There has been a gradual erosion of support for action on productivity-raising reform during the past decade. Much of the legacy of the reform period remains, including a much more open economy, more competitive domestic markets, deep integration into Asian economies, an economically productive immigration program and a somewhat more flexible labour market.  But there is now little political interest in removing remaining barriers to Australian economic efficiency. A new low-water mark for the influence of economic analysis was reached last Saturday, when an editorial in support of the US free trade agreement in The Weekend Australian asserted that "economic sense and political reality are rarely related".

The decline in support for productivity-raising reform in Australia has already contributed to less efficient resource allocation. It would compound the costs of any economic downturn in the period ahead.  The problems from excessive demand expansion are already acute. For several years real private consumption and total domestic demand have risen more strongly than over any comparable extended period, and real public expenditure has not been held back to offset them. Private consumption has been driven by one of the strongest sustained real expansions of bank lending.

The real domestic demand expansion of recent years is at least as virulent as that which precipitated the extreme monetary tightening of the late 90s. The savings share of household income fell in the boom of the late 80s, but remained in the range of eight per cent to ten per cent. It was minus three percent in the March quarter of 2004.

We now know that interest rates were increased too much in the late 80s. That error should not be repeated. But to react too little to the problem that has emerged would be to err in another way, with different immediate but regrettably similar medium-term consequences.


The economist's starting point for assessing changes in international competitiveness is the ratio of prices of non-tradable (domestic) goods and services to those of tradables (exports and imports). In the March quarter of 2004 this ratio was higher than at any time during the two decades for which we have data, despite export prices being the highest over that period. The inflation in domestic prices seems now to be deeply entrenched near one percent per quarter - far higher than in any of Australia's large trading partners.  The extent of the ongoing domestic inflation has been obscured by falling prices for tradable goods in the year to February, reinforced by a rising currency.

The fall in the foreign exchange value of the Australian dollar since then brings inflation into sharper focus. The increases in Australian dollar prices of imports and exports in the June quarter will find their way into the broad-based indexes through the remainder of 2004.  One symptom of the extraordinary expansion of domestic demand has been a current account deficit near record levels as a proportion of gross domestic product, despite record terms of trade and historically low international interest rates.

The collapse since 2000 of the strong export growth that began with the reforms from the mid 80s is symptomatic of the corrosion of competitiveness.  From the March quarter of 1986 to the March quarter of 2001, the volume of Australian manufactured exports increased by more than 600 percent and of services by more than 200 percent. The volume of agricultural exports grew by about three quarters and resources by almost 200 percent over the same 15 years.

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Article edited by Betsy Fysh.
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This article was previously published in The Australian  on 29th. July, 2004.

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About the Author

Ross Garnaut is Professor of Economics at the Australian National University.

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