Australia slow to wake up to reality

BY ROD ORAM

OPINION: IS THE great Australian boom, the longest in any developed country, over? Yes, said Ross Garnaut, one of the country's most respected economists, in a seminal lecture last week.

It will be, the Australian treasury warned in a budget paper in May, if the country fails to cure the distortions created by its resources bonanza.

No way, say Prime Minister Julia Gillard and opposition leader Tony Abbott. Confident the boom's rolling on, they are campaigning on short-term fiscal rectitude and ignoring long-term economic strategy.

If the politicians have read the Garnaut and treasury papers, they either don't accept the analysis or they lack the political leadership to do anything about it. The papers, essential reading on Australia's economic challenges, are available at tinyurl.com/3amsb2e and tinyurl.com/37ry4sk.

Professor Garnaut's begins by reminding Australians that they weren't always so productive. Indeed, for the first 80 years of federation the country was the worst-performing among those now considered developed economies.

Then, from 1983, the country embarked on substantial economic reforms. They spurred strong growth in productivity, living standards and the wider economy. But, he argues, over the past decade or so, vested interests began to capture policy making, resulting in a series of botched policies.

Three examples he cites are the free-trade agreement with the US that damaged Australia's access to agricultural markets; the Work Choice industrial relations policies of the Howard government; and the Henry Tax Review's recommendation of a (badly designed) resource profits tax.

Although all three had merits, they also had serious flaws that "expanded their vulnerability to fierce attacks from and slaughter by sectional interests".

Other examples of bad policy include the blurring of responsibilities and incentives between federal and state governments on issues such as transport, infrastructure and health and the distortions created by a badly designed GST regime.

As a result, Australia's great run on productivity growth ended in 2005, Garnaut says. Some other economists reckon it ended as early as 2003. Either way, total factor productivity has flatlined since. Instead, the economy has been buoyed by debt-fuelled consumption and housing markets and the resources boom.

But both stimuli have run their course. Households are too indebted to drive growth and the China resource boom could peak as early as this year, he says. Fast expansion of mineral supplies elsewhere will drive down prices and thus ease investment in Australia. As a result, the country's terms of trade will fall back from their current peak, which is 60% above their 40-year average.

The treasury paper does not make such bold conclusions about the mining sector globally. But it shares Garnaut's concerns about the distortions the mineral boom is causing. Mining is sucking capital and labour from other sectors and its export success strengthens the exchange rate.

These factors make the rest of the economy less competitive internationally. That's a worry. As a small country, Australia needs to export more, but exports account for barely 20% of its GDP (compared with 30% in New Zealand) and 70% of merchandise exports are minerals. Australia needs to learn fast how to produce high-value, high-wage, non-mineral exports.

But that's not on the political agenda in this election campaign. Instead the economic debate is dominated by arguments about whom to trust to run the economy in the short term.

On that score, the Labor government deserves credit for its heavy, prompt stimulus package which ensured Australia suffered only one quarter of negative growth at the end of 2008. As a result, it was the only developed country not to go into recession.

Certainly some of the stimulus programmes were badly designed and executed. But the opposition coalition, led by Tony Abbott, has managed to persuade some voters that Labor's fiscal incompetence runs deeper.

That's far-fetched. The federal budget would have fallen into deficit regardless of which party was in charge of stimulating the economy.

Looking forward, both major parties are claiming they will be the most responsible fiscally and return the budget to robust surpluses sooner.

But on estimates of the costs of campaign promises to date, Labor is being more moderate. It has promised $A3 billion ($3.78b) of new spending over four years and savings of $A2.65b on current spending, resulting in a cumulative additional deficit of $A451 million. It has also promised to keep increases in spending to an average of 2% a year until budget surpluses return to better than 1% of GDP. Given only modest inflation, that would likely be a slight cut in spending in real terms.

In contrast, the Abbott-led coalition is promising to scrap a range of Labor's large programmes and redirect the spending. Thus its new spending would be $A38b over four years and its savings $A37.5b, resulting in a cumulative additional deficit of $A540m.

Mind you, this pattern might not hold. The spending pledges could escalate rapidly as the campaign races to polling day next Saturday.

Moreover, the coalition is acting out of political character for a right-of-centre party that should be business-friendly. For example, it is offering 27 weeks of paid maternity leave compared with Labor's 18, with the extra funded by a 1.5% supplementary tax on the country's most profitable companies.

It is promising to axe some of Labor's tax breaks. It needs to do so because it would not implement Labor's supplementary tax on coal and iron ore profits. While doing so appeals to many mining companies and to voters who enjoy mining shares in the portfolio, the coalition sees no need to offer instead policies to ease the adverse impacts of mining on other sectors.

Even stranger is the coalition's pledge to kill Labor's $A42b fibre-to-the home project. Instead, it has offered $A6b in a muddle of minor technology fixes to try to get ultra-fast broadband across Australia.

And then there are the fraught issues of energy and climate change. Both major parties are committed to reducing Australia's emissions by 5% from 2000 levels by 2020. They offer different ways of doing so, but few analysts give either a chance of reaching the target.

Labor says it will push once again to put a price on carbon and deliver a comprehensive set of policies on emission reduction, renewable energy and energy efficiency if it is re-elected. But given the tightness of the race, it might not get the support it needs from other parties, let alone hold on to power.

The coalition refuses to price carbon. Instead it says it can cut emissions through a multibillion- dollar competitive fund financed by taxes. Companies will bid to make reductions, with those with the lowest cost per tonne getting the money. It sounds simple and effective but the decisions will be made by bureaucrats, not the market.

Worse, Australian industries will still lack a long-term price signal on carbon so they will have little incentive to invest in new technology to clean up one of the most greenhouse gas and energy intensive economies in the world. The lack of investment will only further harm Australia's competitiveness.

The messages for New Zealand are clear:

Australia will want to keep working on bringing our two economies closer together regardless of whether Gillard or Abbott is the next prime minister.

But the danger is Australia, our largest trading partner, would suck us into its economic travails.

Instead, we should develop corporate and government strategies which deepen our engagement with China. It is our second-largest trading partner, having recently overtaken the US. In due course, it will be our largest.

But to engage more profitably with China we'll need to sell them something more valuable than commodities, land, companies and holidays.

If we do, we will enjoy a boom longer than Australia's. If we don't, we will suffer with Australia in the commodity trap.

- © Fairfax NZ News