Michael [Roux], thanks for the invitation to join you here today.
It's wonderful to be back with you at a Retreat that has been such a valuable experience for me over the years. I regret I couldn't make it last year – I was a bit distracted, as was one of your speakers last night. I'm told that I missed some good discussions on what was then emerging as a serious financial crisis in the market for US sub-prime mortgages. It demonstrates the quality of discussion at this Retreat that even at the beginning of this crisis there was a widespread recognition here that it could be very serious indeed.
Even so, I doubt there would have been many among you who would have expected that only a year later global banks would have written down $500 billion in losses. Or expected that output in Japan and Europe would have contracted in the second quarter of this year, and that the US would be teetering on the edge of recession if it is not actually in one. I doubt there would have been many who expected that shares in Fannie Mae and Freddie Mac would today be worth less than a tenth of the value they had at your last meeting.
I mention those two businesses because they illustrate an important fact about the evolution of this episode in the United States. These businesses have some exposure to losses on sub-prime mortgages, but their main role is to buy and then insure and sell prime mortgages. Their problems underline the point that the wider housing market in the US is in considerable distress and has been for several years.
The difficulties of Fannie Mae and Freddie Mac remind us that the global economic slowdown still has quite a way to run. We are dealing today with the continuing impact of that crisis on output and employment, sharply lower credit growth, higher borrowing costs, and shocks to confidence. Some of that real economy effect is feeding back into the financial sector, which is one of the reasons Fannie Mae and Freddie Mac have been the centre of global financial market concerns over recent weeks.
The likelihood that global economic circumstances will be very difficult for some time is the first point I want to make to you here today. The outlook for growth in the developed world is sombre and challenging. And, as the theme of today's gathering suggests, the slowdown is uneven. It certainly includes the US, Canada, UK, Europe and Japan. While there is some evidence of slowing export growth in parts of East Asia, we have not seen a serious slowdown in growth in China or India. And there are good reasons for this. Let me explain.
The characteristics of the Asian financial crisis a little over a decade ago meant it did not significantly impact on the growth of the developed world. And so far the characteristics of this developed world financial crisis have had little impact on growth in developing countries. It is true that equity markets in developing economies have not escaped the global financial turmoil. But, in part because of a less integrated financial system, developing countries have not felt the same force of the global turmoil that is buffeting developed economies.
A decade or so ago, a decline in the rate of growth of US imports might have extended a US slowdown to the developing world. But it is now the case that the pace of growth in China, India and other industrialising economies, and their new weight in the global economy, mean there is very much less dependence on the US market.
The fact that the US has so far avoided a technical recession is due in part to the fact that it has substantially increased its exports – and particularly its exports to the developing economies. So, this time, the US economy is drawing on the economic strength of developing countries to help support its growth. This has important implications for us, because most of our exports are to East Asia, and a good deal of the investment that has driven Australian growth in recent years is designed to increase those exports.
Which all serves as a handy introduction to the theme of this session today – positioning Australia in the two-speed global economy I just briefly described.
Today I want to do two things. First I want to describe to you the immense challenges and opportunities that are presented to Australia in our part of the world, by comparing the performance of developed and emerging economies. Second, I want to briefly outline our comprehensive and coherent policy response – and situate that agenda in a broader reform narrative.
I doubt there has been a time in recent history where we've faced quite as many diverse economic forces as we do today. It is surely unusual to have so many of them at once, all of them so different. And it is remarkable just how many of our economic challenges have been imposed from beyond our shores.
The global oil price shock has contributed to a surge in global inflation, which has added to our own home-grown price pressures. Despite some welcome easing in global oil prices over recent weeks they are still well above their levels of a year ago.
At the same time, the US sub-prime crisis has spread throughout global financial markets, pushing up borrowing costs both here and abroad. It has made financial institutions everywhere more cautious about lending. It has seen global stock markets fall by as much as 20 per cent since the turmoil began. And it has left a dramatic imprint on confidence right around the world. Across the OECD consumer confidence has fallen to its lowest in 30 years.
The global credit crunch and the global oil price shock are slowing growth across advanced economies. Under the weight of these global problems the seven largest developed economies are struggling to grow. Japan, Germany, France, Italy and Canada have all recorded negative growth in their most recently reported quarters. Overall, growth across the G-7 is likely to have stalled over the three months to June this year, and will remain weak for the rest of this year. With Canada yet to report, G-7 economies are expected to have grown by an estimated 0.1 per cent in the June quarter.
Like the rest of the world, we haven't been immune from the turmoil which is slowing global growth. But though we confront the most difficult global circumstances in a quarter century, the fundamentals of our domestic economy are good. We have a strong, well regulated financial sector. We don't face the same problems being experienced in the US housing sector and sub-prime mortgage market. We have a substantial Budget surplus, which acts as a buffer and gives us the policy flexibility we need in uncertain global times. And we have begun providing substantial relief through our $55 billion Working Families Support Package, including tax cuts for working families.
But most importantly, emerging economies within our region continue to grow, and demand for our commodities is strong. In 2007, emerging economies including China, India, Russia and Brazil, drove around two-thirds of the growth in the global economy. In contrast, the US, Japan and the Euro area accounted for less than a quarter of global growth. And looking forward, the IMF forecasts China will grow at close to 10 per cent over each of the next two years.
This strong growth in the emerging economies of our region is driving the biggest increases in commodity prices we have seen in a generation. This of course means a very big boost to export incomes. We expect export income to increase by over 20 per cent this financial year. To give you some sense of scale, the expected increase in export income alone will add more than 4 per cent to nominal GDP in 2008‑09. Other than the Sydney Olympic year, this will be the biggest increase in export income for over 20 years.
And of course, the increases we have seen in global commodity prices is part of a much bigger shift in the global economic landscape. As you know, the rise of China and India is bringing the centre of gravity of world markets closer to our shores – and with it a myriad of opportunities. Over the past decade China and India have accounted for around one third of global economic growth. China is now the second biggest economy in the world and is on its way to surpassing the US as the biggest. India is now the fourth biggest. This means that three of the four biggest economies in the world now sit within our region. And within a few decades more than half of the world's output will be produced in the region stretching from India to Japan. Australia is finding itself closer to the centre of the world economy than either Europe or North America will be. At last, our geographic position is an advantage, not an obstacle.
And it's not just the size of the Chinese and Indian economies that matters, nor how fast they are growing. It's that as they grow, the global economic, political and strategic landscape will change in ways we can only just begin to imagine. How we and the region prepare ourselves will determine the extent to which we prosper from this dramatic shift in the weight of economic power.
This was the focus of discussions of the APEC Finance Ministers' Structural Reform meeting I chaired in Melbourne earlier this month. Many of the economies of the APEC region are looking to the Australian structural reform experience as they seek to enhance trade and competition and to harness the power of markets to drive growth in the years ahead. But just as our neighbours look to reform their economies to take advantage of this shift in economic power, so must we.
We are optimistic about the future, but far from complacent. We know the boom in resource exports won't last forever, so we are responsibly and diligently building a more modern and dynamic economy.
And as you know, the reality is that sustaining the economy's growth rate in the future will depend on our ability to expand our productive capacity. Australia's productive potential is largely driven by the rate at which the volume and quality of Australia's physical capital stock increases, and the size and skill base of our workforce. That's why our first Budget provided $41 billion to fund responsible investment in nation building and growth for the future. It's why we established a $20 billion Building Australia Fund to make a start to remedy our shortcomings in roads, rail, ports and bridges. Why we have started addressing our shortcomings in education and training, through an $11 billion Education Investment Fund.
We have also moved to strengthen our financial system. Australia's financial markets and regulatory system have responded well to global market turbulence compared to other countries around the world. The Government has also moved swiftly to identify and address areas where our own regulatory system can be strengthened. We are implementing the Financial Stability Forum recommendations in full and encouraging their implementation internationally. We have taken steps to support liquidity in the Government bond market to ensure our broader financial markets operate more effectively. We are strengthening protections for deposit holders in the unlikely event that a financial institution gets into trouble. And we are improving transparency around covered short selling and reviewing the disclosure requirements around equity derivatives.
This is all part of our agenda to modernise the economy for the long-term, and to respond to the challenges and opportunities of the future. Central to this effort are three key policy reforms, which I want to turn to now in a bit more detail.
They are reforms that will take years to fully accomplish, which involve considerable difficulties in design and implementation, which will test the skills of our governments and our public servants, and which I freely acknowledge also carry with them considerable political risks – not least for this Treasurer. But reforms which must be implemented if we are to position our nation in a fast-changing and complex global economic environment.
Three interrelated and interconnected economic policies make up our economic agenda:
The three reforms sit at the very core of our vision for a more modern and more competitive economy, that takes full advantage of our place in the world at a time when the greatest opportunities are at our doorstep. At the very core of a new economy that allows us to create more wealth and spread more opportunity, for the long-term benefit of working Australians. By re-tooling the economy for the future. By building productivity – delivering growth with low inflation. By lifting our competitiveness – getting ahead of the global game. And by creating new kinds of jobs and prosperity for the future.
One thing connects these reforms: They're each about having the foresight and anticipation to tackle long-term challenges and position us at the forefront of the global economy.
In tax, this means:
In climate change, a more modern and competitive economy that anticipates the big future challenges means implementing the Carbon Pollution Reduction Scheme in a way which secures the economy of today, in order to insure against risk, and seize the future's significant opportunities. And it means implementing the Scheme in the most economically responsible way, which is why:
So much can also be done to make the economy more modern and competitive and productive with our reforms to Commonwealth-State relations. Australian Governments have already taken concrete steps to reform financial arrangements and create a more integrated, more productive national economy:
Taken together, what we're doing in tax, COAG and the CPRS represent a policy triangle of enduring reforms, which will bolster that long-run economic prosperity we need to build for future generations. I truly believe this is an agenda more ambitious, more future-focussed, and more integrated than anything contemplated by our predecessors. It is central to our vision for a more modern economy, that takes full advantage of the opportunities our geographic location brings. And it is central to re-tooling our economy so we can build productivity and create new kinds of jobs and new kinds of prosperity for the future.
This is an agenda that comes straight from what the Prime Minister likes to call the 'reforming centre' of Australian politics. The 'reforming centre' is not an accidental formulation. It recognises Australians are practical and a bit cautious about reform, and they only trust it when it comes from the centre. This is why we will resist urgings to pick up radical agendas from the left or the right – to shut down the coal industry, for example, or the car industry. The lesson of successful reformist governments in Australia – Chifley after the war, Hawke and Keating more recently – is that they spring from the centre. They earn the people's trust by showing they are on their side, and reform with an eye to helping those who inevitably lose out from reforms.
Politics is the means to an end, and the end is a better life for Australians. It's the art of understanding the hard decisions, and applying skill, judgment and perseverance to making them happen.
We came in with a big agenda, and it has only crystallised with time. An agenda for a seamless national economy, a low-pollution economy of the future, and an economy with a globally competitive tax system which rewards effort and enterprise. It's an agenda I am throwing myself into, boots and all, because I firmly believe, after much thought and preparation, that the three reforms I have outlined today are the core of the new Australia, and a new economy. I'm passionate about these reforms because I'm passionate about our country – its economy, and its future. And because their delivery requires tough economic decisions at the heart of it, it's an agenda I intend to engage personally, with you, as Treasurer.
Thanks and I look forward to the discussion.