11 March 1996 - 3 December 2007
ADDRESS TO THE
YOUNG PRESIDENTS' ORGANISATION
AUSTRALIA'S ECONOMIC PERFORMANCE, POLICIES AND CHALLENGES
Thank you for inviting me to speak with you today.
Today I will discuss Australia's experience in implementing economic reforms and creating a dynamic economy. These policies have been commended by many including the IMF who recently praised Australia for the sustained strength of [our] economic performance, which [the IMF] attributed to an exemplary setting of economic policies and institutions. Australia's reform experience is directly relevant to the YPO mission to create better leaders through education and ideas exchange.
I would also like to take this opportunity to outline some of the key challenges that demographic change will present over the next 50 years.
When our Government was elected to office in 1996, GDP growth in Australia had been suffering from a large degree of volatility. For example, periods of strong growth were followed by recessions in 1983 and 1991. On both occasions these economic busts' wiped out a large portion of the gains of the preceding growth, and created substantial disadvantage.
The effects of a recession can be costly and long lasting. Some of the people who become unemployed have difficulty finding jobs once the economy again begins to grow. Banks accumulate bad debts, as businesses and individuals are no longer able to meet their obligations. And the confidence of businesses, consumers and investors is sharply reduced, which can act as a drag on economic growth for a substantial period of time.
The 1991 recession in Australia was no exception. The unemployment rate reached nearly 11 per cent in 1992, and was still averaging over 8 per cent in 1996.
Prior to 1996, inflation was high and persistent. The recession in 1991 had brought inflation down, but by the end of 1995 inflation had again crept up to over 5 per cent. Mortgage interest rates were also high, having reached a nominal rate of 17 per cent in 1990, and they remained above 10 per cent at the start of 1996.
Once elected in March 1996, our Government set about implementing a set of reforms designed to improve the flexibility, stability and resilience of the Australian economy.
Discussing all of the policies that have been implemented following our election would be a very long speech. Some of the most important reforms include: changes to the workplace relations system to increase flexibility and reduce the role of centralised wage bargaining; the introduction of a broad based consumption tax with accompanying reductions in income tax; and changes to the welfare system to encourage those receiving welfare to return to work.
But, today I want to focus on macroeconomic policy. Good macroeconomic policies are key to ensuring that other reforms can have their maximum impact.
Australia's macroeconomic policy framework has two principal elements, fiscal policy and monetary policy.
In 1996, Australia's fiscal position was in need of considerable improvement. From 1991 the Government had a run of underlying cash deficits ranging from around 2 to 4 per cent of GDP running up debt and weakening the financial position.
To address this issue, the Government introduced a new framework for fiscal management, which was legislated through the Charter of Budget Honesty Act 1998. The primary objective of the fiscal strategy is to maintain budget balance, on average, over the course of the economic cycle. An important element of the framework is its medium term focus, which allows for short term flexibility to respond to economic shocks, while maintaining discipline on policy makers.
This framework has helped us to deliver Budget surpluses for 7 of the past 8 years, and the Budget is projected to remain in surplus in the foreseeable future.
As a result of this improvement in the fiscal position, together with the privatisation of a range of government business enterprises, the Government is expected to eliminate net debt in the current financial year, 2005–06. This is an outcome matched by few developed countries and is a remarkable improvement given that in 1996 Australian Government net debt was over 18 per cent of GDP.
This improvement in the fiscal position has paid dividends, helping interest rates to remain low, and opening the way for cuts to personal income tax rates in successive Budgets since 2003.
In relation to monetary policy, a Statement on the Conduct of Monetary Policy was agreed between the Government and the Central Bank (the Reserve Bank of Australia) in August 1996, which formalised the operational independence of the Reserve Bank. This Statement, updated in 2003, included a commitment by the Reserve Bank to hold consumer price inflation between 2 and 3 per cent on average, over the course of the economic cycle.
Since the mid 1990s, the average rate of inflation has remained remarkably stable at around the mid point of the target band, with the exception of the one-off price increase due to the introduction of a consumption tax in 2000. Credible, independent and transparent monetary policy has been the major driver of this improvement.
The implementation of sound fiscal and monetary policy frameworks, combined with a range of other reforms, has seen a historic improvement in Australia's economic growth. Australia is now experiencing its longest economic expansion on record, with strong average rates of growth. The unemployment rate has also fallen from over 10 per cent to just over 5 per cent, around 30 year lows.
This strong and stable performance has also helped improve Australia's relative position in the OECD, with GDP per capita climbing from well below the OECD average to above the OECD average.
Over the next few years, we expect to see a continuation of this strong economic performance.
GDP growth has slowed somewhat as the recent increase in house prices and related strong consumption growth moderates. But unlike previous cycles and unlike much of the developed world we have avoided recession.
The Australian economy is expected to grow solidly in 2005–06 and 2006–07, with GDP forecast to increase by 3 per cent in both years. An acceleration of exports is expected to support economic growth, while growth in household consumption and dwelling investment is expected to be relatively subdued. This gradual rebalancing of growth from domestic to external sources is desirable and will underpin the sustainability of the current economic expansion.
Easing employment growth should see the unemployment rate stabilise around current low levels.
Inflation is forecast to remain moderate, although, as is the case around the world, rising oil prices have pushed inflation towards the top of the Government's target band. Higher petrol prices are forecast to contribute ½ of a percentage point to inflation through the year to the June quarter 2006.
The current account deficit is expected to narrow to around 5½ per cent of GDP in 2005–06. The current account has remained relatively high and is around the same level as in the United States. However, in Australia's case the current deficit is driven by private sector borrowing, rather than public sector borrowing. This makes this current account deficit far more sustainable.
An important part of the recent economic story in Australia is the sharp increase in our terms of trade, driven by the recent commodities boom. Higher contract prices for Australia's exports, particularly coal and iron ore, are expected to take the terms of trade to around thirty year highs.
The previous peak in the terms of trade in the mid 1970s was associated with a sharp increase in inflation and wages. Strong wages growth in the mining sector carried over to other sectors of the economy. But, under the labour market reforms which I referred to earlier, the wage setting system today is far less centralised, and the generalised wage increases seen in the early 1970s are unlikely to be repeated.
These higher commodity prices are contributing to an improvement in the trade deficit, although the improvement in the current account deficit will be offset to an extent by the outflow of some of the resulting profits to shareholders and owners of foreign mining companies operating in Australia.
Notwithstanding this, Australia's real purchasing power has increased strongly due to these high commodity prices, with real gross domestic income increasing by 4.1 per cent in 2004-05, well above the equivalent GDP growth rate. Gross domestic income is expected to continue to increase faster than GDP for some time, as these higher prices are sustained by ongoing global demand, particularly from China.
Like many developed countries, Australia faces a significant challenge over the next few decades due to the increase in the average age of the population. However, Australia is expected to face a smaller challenge than most European countries, but larger than the United States.
In response to these challenges, the Government has put in place a number of policies to encourage participation in the labour force, and sustain strong productivity growth in Australia. Changes to the welfare system have helped to encourage people to move from welfare to work, and labour market reforms to increase flexibility will help allow older workers to remain engaged in the workforce.
As well as domestic demographic challenges, Australia also faces challenges from the international demographic and economic changes which are expected over the next 50 years.
Australia is a relatively small country in terms of population. According to figures for the year 2005, Australia is the 53rd largest country by population in the world.
However, using purchasing power parity (PPP) comparisons, Australia's economy is a much larger part of the overall world economy. Our share of global GDP is 4 or 5 times our share of population.
As we look out over the next 50 years, what changes do we see to the global power balance?
The global population is expected to increase by 40 per cent by 2050.
Through to 2050 there are expected to be significant changes in the shares of population. While the US proportion of global population is hardly going to change, the proportion of the world's population in Europe and China will fall. The big population shift in the next half century will be to Africa.
China's share of the world population is going to decline as a consequence of declining fertility rates.
Between now and then, the economic rise of China will be based on productivity growth, not on population.
China has been opening its markets, reforming its economy, and moving its people into more productive work due to rapid industrialisation. Together, these changes are generating huge rates of economic growth.
As India continues to further open itself to international markets, a similar process has started to occur, although it is not yet as advanced as in China.
Projections using PPP rates and drawing on OECD, IMF and UN data suggest that the share of global GDP accounted for by China and India will increase very rapidly over the period to 2050.
While such projections are fraught with difficulty, plausible assumptions can generate projections of China's share of global GDP rising from around 13 per cent now to over 20 per cent in 2050, and India rising from close to 6 per cent to over 12 per cent. In contrast, the shares of the US and Europe, both currently over 20 per cent, could fall to 14 per cent and 10 per cent respectively.
Although we cannot be too sure about the precise size of economies half a century away, we can be sure that on current trends, China and India will become increasingly important parts of the global economy. Indeed, with the recent revision to Chinese GDP, China already accounts for an even larger proportion of world output than previously estimated.
If Western countries account for a smaller share of the world's population and economy in 2050, it does not necessarily follow that their influence over global events will decline. Military power, technological leadership, the shape and focus of global institutions, the robustness of alliances, social cohesion, human skills, cultural influence, and financial weight also need to be taken into account.
But demography and economic growth will powerfully influence the strength of nations; they will place new pressures on global institutions; and they may lead to new sources of tension, conflict and insecurity.
With a small population by global standards, Australia is conscious that it must aim for the best practice in economic policy if it is to maintain its economic strength a strength far above its population weight and secure its economic and security interests in the changing global landscape. This is the reason why we have introduced such far-reaching reform and why Australia is determined to continue its program in this area.