Introduction
Thank you very much for the invitation to be here today to talk at this seminar. Today I want to talk about Australia’s economic policy. I will mention some of the challenges we face. I want to make some observations about global financial integration and Australia as a financial services hub. And then I would be happy to take your questions.
Australia’s Recent Economic Performance
After ten years of sound economic and fiscal management Australians are now enjoying unprecedented prosperity. Income and wealth have increased markedly. The standard of living in Australia now surpasses all G7 countries except the United States.
The Australian economy is in its 15th year of consecutive economic growth. This is set to continue. Economic conditions remain supportive of growth — corporate profits are high, inflation is moderate, and the unemployment rate remains at a historical low. The strong global economy should also provide impetus to the Australian economy.
In 2006-07, we forecast the economy is expected to grow by 3percent.
Over 1.9million new jobs have been created since March1996. The unemployment rate is currently around its lowest level in 30 years, while the percentage of working age people participating in the labour market is at a record high.
Combined with sustainable wages growth, this has led to strong incomes growth — gross labour income has increased by an average annual rate of 5.9 per cent per annum since March 1996.
And household wealth has increased. The latest ABS data indicate that household net nominal wealth is now over $5 trillion, almost 3 times the level when our Government first took office 10 years ago.
Supported by household wealth, consumption is forecast to grow around a sustainable trend in 2006-07. This continued moderation in the household sector is welcome following the surge in house prices and consumer spending in previous years. Meanwhile, the downturn in housing construction that began in the second half of 2004 has been very mild by historical standards.
The past year has seen a continued transition from growth driven by consumption to growth driven by investment. Over $32billion of new investment has occurred in the mining sector alone since the start of 2004. And investment growth has also been solid in other sectors of the economy, including finance, property and business services, and wholesale trade.
This investment is increasing the capacity of the Australian economy and providing a basis for future economic growth. In particular, the increased capacity in the mining sector is expected to support an improvement in Australia’s export volumes.
Australia is thus well positioned to reap the benefits of the global commodity boom. This boom has seen the terms-of-trade increase to its equal highest level since 1974.
But in contrast to previous terms of trade booms, inflation has remained at relatively moderate levels. Since March 1996, prices have grown at an average annual rate of 2.6 per cent — around the middle of the Reserve Bank’s target band for inflation. Households benefit from this through lower interest rates.
The current standard variable home loan rate is around 7.8 per cent. This is well below the level of 17 per cent at the start of the 1990s and the level of 10.5 per cent when the Government came to office.
Australia has received some recent recognition for its economic performance.
The recent 2006 OECD Survey on Australia notes:
“Recent macroeconomic performance continues to be impressive: gross domestic product (GDP) growth since the turn of the millennium has averaged above 3 per cent per annum and, including the terms-of-trade gains, growth in real gross domestic income has averaged over 4 per cent, among the handful of OECD countries achieving such rapid growth; the unemployment rate has fallen to around 5 per cent, its lowest level since the 1970s; inflation has remained within the target range; and, following a long stretch of fiscal surpluses, Australia is now one of the few OECD countries where general government net debt has been eliminated.”
This performance has required disciplined economic management. The OECD points out that:
“Wide-ranging reforms, particularly to promote competition, were instrumental in this respect. They promoted productivity growth, most notably in the second half of the 1990s. The greater flexibility engendered by these reforms, together with the introduction of robust monetary and fiscal policy frameworks, has also bolstered the economy’s resilience to a series of major shocks over the last decade.”
Commenting on this report an editorial in the London Financial Times (1 August 2006) said:
“What can you say about an economy that is a textbook case of good policies, well executed? That is the challenge facing the authors of the latest survey of Australia by the Organisation for Economic Co-operation and Development, which struggles to find any serious blemishes in the country’s recent performance. Though the OECD identifies some causes for concern, its report card is mostly straight "A"s.
Australia’s Policy Settings
Australia's macroeconomic policy framework has two key elements — monetary policy and fiscal policy.
Our monetary policy is set out in the Statement on the Conduct of Monetary Policy as agreed between me and the Governor of 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 to hold consumer price inflation between the target band of 2 and 3percent, 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.
Recently, the combination of rising world commodity prices, strong domestic demand, and tight capacity has contributed to increased inflationary pressure in Australia. The Bank’s current forecast is that underlying inflation over the next two years will be around 3 per cent. In the short term, headline CPI inflation can be expected to remain higher than that, but will decline to the underlying rate when temporary factors drop out of the calculation.
The framework for fiscal management is legislated through the Charter of Budget Honesty Act 1998. The primary objective of the fiscal strategy is to provide stability for the economy by maintaining budget balance, on average, over the course of the economic cycle. An important element of the framework is its medium term focus.
I have now delivered eleven Budgets, nine of which were in surplus. These surpluses have allowed the Australian Government to eliminate its debt in net terms.
The tax system has been substantially reformed. A New Tax System was introduced in 2000. This involved the implementation of the Goods and Services Tax, all of which is paid to the States and Territories. The GST has given them a secure source of revenue with a growth path far exceeding the revenue that they would have received under the old tax regime. The GST paved the way for the elimination of a range of inefficient taxes, including financial institutions duty, listed marketable securities duty, and bank account debits tax. These reforms continue with the announcement in this year’s budget of an agreed schedule with the States and Territories to abolish a range of inefficient state government stamp duties.
Also announced in the 2006-07 Budget is a tax package that provides for cuts to income tax rates and thresholds thereby providing a range of incentives to participate in the workforce. Over 80 per cent of taxpayers now have a top marginal rate of 30 per cent or less.
I also announced a plan to simplify taxation on superannuation. A key element under the proposed plan is, from 1 July 2007, superannuation benefits paid from a taxed fund would be tax free for people aged 60 and over. This will improve retirement incomes and increase incentives to work and save.
Australia is a low-taxing country by comparison with other developed economies. A report on international tax comparisons, commissioned by the Government in April 2006, indicates that Australia’s overall tax burden, as measured by the tax to GDP ratio of 31.6 per cent, is the eighth lowest of the 30-member OECD. Further, Australia’s top marginal tax rate on personal income has been cut to align it with the OECD average.
The Australian Government is now debt free. Australia’s AAA credit rating for foreign currency borrowing was restored in 2003.
Australia has moved to a much more flexible labour market. Australia’s new workplace relations system, WorkChoices, came into effect this year. WorkChoices builds on the labour market reforms implemented since 1996.
Workplace reform is essential to improve productivity and to support high levels of employment, and WorkChoices complements other elements the Government’s reform programme.
Australia’s Policy Challenges
Australia is relatively well placed to deal with the fiscal pressures from ageing. In 2002, I released Australia’s first Intergenerational Report. In common with most other OECD countries, the report identified a fiscal gap between revenue and expenditure, projected to emerge over the next 40 years as our population ages.
Since that report the Government has been making progress to deal with this fiscal gap. Australia has at least three things working to our advantage. First, Australia’s workforce participation has increased since 2002, reflecting the strength of the economy and policies to encourage workforce participation. Secondly, as mentioned, we have just eliminated net debt, which provides fiscal flexibility. Thirdly, pension costs are less sensitive to ageing than in most other OECD countries. This advantage comes about because the public pension scheme is a flat rate and means tested and because an increasing number of elderly will rely on incomes from occupational superannuation.
The Australian Government has also established a Future Fund. This fund is being used to build up assets to meet future pension liabilities of the Government in respect of its own employees. The target is to grow to $100 billion by 2020. We are around a third of the way there.
Water is also a policy challenge for Australia. Australia is the driest inhabited continent on earth, our rainfall and our rivers are the most variable in the world, and drought is a constant threat.
Water reform requires extensive co-ordination between all levels of government in Australia. For the first time, all Australian governments have committed to a national blueprint for water reform. In support of this the $2 billion Australian Government water fund is delivering practical water projects to improve water efficiency and environmental outcomes.
But there is still too much back-sliding by the States. And there is still too little truly innovative thinking about Australia’s large-scale water challenges.
Water reform needs to be focused in a number of areas. All governments need to improve approaches to water pricing. They need to ensure that water entitlements are secure and tradeable. They need to facilitate permanent interstate water trading, ensure scientifically based and transparent water planning, improve water resource accounting, and integrate management of environmental water.
Global Trends
For the remainder of this speech, I would like to talk about global financial markets. But first, some general points.
Global growth peaked at a 30year high of 5.4percent in 2004. And we are now experiencing our fourth consecutive year of above 4percent growth for the world economy. Current projections are for continuing strong growth, although as usual there are a number of challenges to the outlook.
The growing economic weight and influence of Asia — particularly China and India — will have far-reaching consequences for the global economy. China and India have been key drivers of world growth, with China alone estimated to have contributed over 30percent of world growth in 2005. Together these two countries are bringing hundreds of millions of people into the global middle-class.
However, the growth path for these two countries, and the region as a whole, is not guaranteed — it will require an ongoing commitment to deeper structural reforms and ongoing international engagement. This will be particularly important in helping deal with the impact of demographic change.
In the coming 50 years China, somewhat unusually for a developing country, is expected to experience rapid population ageing, largely because of its one-child policy. The effects of ageing in China will be offset to some extent by the continuing shift of its vast pool of rural labour to more productive sectors. Around 7million workers are expected to move every year for the next 40 years.
By comparison, India, with its high fertility rate, will experience a huge bulge in its working-age population over the next two decades. A rise in the share of the working-age population has the potential to boost output growth and increase domestic returns to investment. For India to reap these potential benefits it is important that opportunities are created to move people from agriculture into manufacturing, which will require structural reform and deregulation.
The broader dimensions of Asia’s economic emergence bring the centre of global trade closer to Australia. And this shift accentuates the importance of global financial sector integration. Here domestic reforms have been complemented by regional and global financial initiatives.
Global Financial Integration
While financial services are a growing component of GDP for most countries, the importance of the sector goes well beyond the wealth it generates.
The financial services sector is an essential component of any country’s commercial infrastructure, enabling other sectors of the economy to operate efficiently and providing a range of vital services to business and consumers.
It allows them to save, borrow, and manage their risks, while helping channel investment to the most rewarding and productive opportunities.
While a strong domestic financial system is a cornerstone of a sound economy, even more can be achieved by integrating financial markets across borders and throughout regions.
An integrated financial market can help deliver depth and liquidity than cannot be achieved by one country alone, bringing greater strength and stability to all the participating economies.
International capital flows can be a powerful force for the development and growth of economies. They can provide resources, enhance access to technology and management skill, and lower costs by improving competitiveness.
Flows of international capital have almost trebled in the past decade. This amounted to more than six and a half trillion US dollars in 2005.
This increasing international flow of capital has been driven by a number of factors:
- regulatory changes, liberalising capital accounts, and domestic stock markets have improved access to financial markets;
- the rapid development of information and communications technologies has lowered transaction costs;
- new technologies continue to reduce the information differential between local and foreign investors; and
- an investor’s physical location on the globe is becoming less and less of a factor in their ability to access investment information.
We can expect many of the remaining barriers to international capital flows to continue to erode and a greater cross-border movement of capital in the future.
To help maximise the potential benefits of this, all participants — investors and traders, regulators, governments, and international organisations — need to work together to strengthen the international financial architecture.
One of the most productive ways to strengthen this architecture is through greater harmonisation of international standards and practices.
To a large extent this cooperation is already happening through key international bodies such as the Bank for International Settlements, the Financial Stability Forum, and the International Monetary Fund.
In Australia, we have made big strides to improve financial sector integration in our close economic relationship with New Zealand.
Both Governments are committed to facilitating information sharing between our prudential regulators and we have made significant progress on many other issues relating to investment, competition and consumer policy.
Ongoing financial sector reform is also underway in the East Asian region, including the adoption of international standards and enhanced cooperation between regulators.
Hong Kong, Japan, Malaysia, and Singapore compare favourably to the US and Europe in terms of the total size of their financial assets relative to GDP.
However many emerging Asian countries have significantly smaller financial services sectors relative to the size of their economies.
It is also notable that the emerging Asian financial systems are still relatively bank dominated compared to more advanced financial markets. Overall the banking sector still accounts for more than half of all financial assets.
The Asian financial crisis showed that economies heavily dependent on bank finance tend to be more vulnerable and that alternative channels for investment finance can provide a valuable backstop.
More broadly, we know that well functioning financial systems perform a critical role in promoting economic growth and stability.
That is one of the reasons ‘deepening and integrating private capital markets’ is one of the themes of next year’s APEC Finance Ministers’ Meeting which Australia will be hosting.
Australia as a financial Services Hub
Finance and insurance is the third-largest sector in Australia’s economy, generating 7.5 per cent of GDP.
We have a mature deregulated system, with liquid markets in equities, debt and foreign exchange.
We have a large and growing pool of funds under management. This makes Australia an attractive destination for funds managers from across the globe and the clustering of expertise and activity reinforces Australia’s strength as a fund management destination.
Australia also benefits from a strong banking sector that is open, sound and efficient.
The World Economic Forum 2004 Global Competitiveness Reportranked the soundness of Australia’s banking sectorfirst in the world.
Outside Japan we have the largest and most liquid equities market in the Asia-Pacific region.
Australia’s foreign exchange market activity has also expanded significantly. The Australian dollar is now the sixth-most actively traded currency in the world.
Australian financial centres are the first major centres to open in the Asian time zone. The Australian trading day bridges the closing of the US and the opening of European markets and allows global financial services firms to provide after-hours coverage for their US and European operations from Australia.
Australia also benefits from its flexible labour force and skilled personnel. All languages are available in Australia. Forty per cent of Australians have at least one parent born overseas. Mandarin is the second most spoken language after English.
More people are employed in financial services in Sydney and Melbourne combined than in either Singapore or Hong Kong.
And with more than 230,000 tertiary students studying finance-related courses in New South Wales and Victoria alone, we have a pipeline of talent which will continue to underpin Australia’s financial services capacity.
This is the result of developing Asia’s largest and most liquid equities market outside of Japan.
Conclusion
In conclusion, I would like to say that Australia’s recent economic performance compares well with the performance of other developed countries and with historical standards.
Australia’s economic resilience has survived a number of shocks – the Asian financial crises, the global slowdown of 2001, a major drought, the uncertainty after the 9/11 attacks and geopolitical tensions, and now higher oil and other commodity prices. Any of these shocks could have triggered an economic slowdown and/or higher inflation in years past.
Economic growth has underpinned tax reduction whilst maintaining balanced Budgets. Sound fiscal management has contributed to a reduction in the Australian Government’s debt levels to among the lowest in the world. This improvement in economic performance is not accidental, but is the outcome of bold and disciplined macro and microeconomic reforms.
We have our challenges but we are well placed to deal with them. In fact we are well placed as a significant financial centre in the growth region of the global economy.