The porridge is badly allocated, Goldilocks

As the Australian economy opened to domestic and international competition, and as we deregulated various sectors, people suffered dislocations, particularly in previously sheltered industries.

Manufacturing centres such as Geelong and the outer suburbs of Melbourne and Sydney were hit hard. Unemployment rose and stayed high; indeed an unemployment rate approaching 5 per cent helped unseat the Whitlam Government in 1975, but it wasn’t until 2006 that we were to see it fall back to that level. Income disparities widened, as some felt the pressure of international competition, while others enjoyed the benefits of trade and financial liberalisation.

To provide for an ageing population, and to restore some equity for those whose wage income cannot provide a reasonable standard of living, the Commonwealth has been bound to increase personal transfers. By 2006-07 6.5 million Australians were in receipt of Centrelink benefits. As shown in Figure 1, social security payments have been forming an increasing share of household income over a long period, from around 6 per cent in the 1960s to 14 per cent at present. Recent reductions in that proportion reflect recent falls in unemployment, but that relief is likely to be short-lived.

To put it simply, governments have been supplementing private incomes with transfer payments because, for many, the Australian economy has been unable to provide well-paid jobs in the face of international competition. While some Australians are unemployed, even more are in low paid jobs, and are dependent on payments such as family supplements and child allowances to sustain what we may regard as a basic standard of living.

The growth in transfers has tended to squeeze out government expenditure on services and infrastructure. But these are the very public goods we need to bring our economy to a high standard of international competitiveness and to cope with challenges such as climate change, so that our private wage income is sufficient to sustain a reasonable standard of living without the need for supplementation through public budgets.

In some ways we are once again in a situation similar to that of the 1960s and early 1970s. Until then we had propped up incomes through tariffs and restrictive trade practices. Now we prop up incomes through government transfer payments. Both situations are unsustainable, because both are driven by insatiable demand.

Back then we had the options of continuing to increase industry protection or reforming our economic structure. Fortunately, after some hesitation, we took the path of reform; otherwise our economy today would truly have become Keating’s banana republic, and we would be looking with envy at the standards of those living in more open economies such as the United States, Singapore and New Zealand.

Now we face an equally hard set of policy options. The easy path is to sustain personal transfer payments (which will resume their upward trajectory as the economy slows) and sustaining a tight rein on expenditure on public goods. Prosperity can be assured in the short term, but at a cost to long term competitiveness as we continue to squeeze allocations on education, infrastructure, research and other public goods.

The harder path is to expand outlays on public goods, with some combination of reduced transfers and improved collection. Some “middle class” welfare could go, subsidies for private health insurance could be abolished, taxation of trusts could be tightened, generous tax concessions for self-funded retirees could be wound back, capital gains tax could be restored to its pre-1999 treatment, and double-counting of tax deductions for depreciation and interest on investment properties could be abolished, to name just a few possible measures.

That means some hardship in the short term, for it takes time to provide schools, colleges, ports, roads, urban transport, and research establishments. (Remember the folly of the Whitlam government which tried to expand education outlays too quickly.) And once in place these investments are slow to provide dividends.

That’s a tough call for a government to take, and, in the short term, it is unlikely to get much encouragement, for it provides many opportunities for an opposition party and a populist press to offer criticism.

Perhaps the Government can prepare the ground by shifting the economic debate away from simple talk about a “tough budget” and broad fiscal aggregates, and start engaging with the community on the basis of the choices we face and the way we allocate public expenditure. Or, as Goldilocks would suggest, changing the allocation of porridge between the bears’ plates.