Australia’s Economy Presentation to the

Foundation for Young Australians Leadership Forum Saul Eslake Chief Economist ANZ Bank

Australian Maritime College Launceston, Tasmania 7 July 2001

View this presentation on-line at http://www.anz.com/go/economics

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What economists focus on and care about l Economic growth – not simply for its own sake, but also because it contributes to the achievement of individual, community and national goals

l Employment and unemployment – because employment is a major influence on most people’s standard of living and sense of identity or self-worth

l Inflation – because history shows that persistent high inflation has detrimental effects on economic and employment growth

l Income distribution – whether the costs and benefits of economic activities are distributed ‘fairly’ across households and regions

l Sustainability – whether the current rate of economic and employment growth is excessively dependent on inefficient or unsustainable levels of borrowing, resource usage, environmental depletion etc

l Australia’s place in the world

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Economic growth

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The past five years have witnessed some of the fastest economic growth since Federation Real gross domestic product (GDP) growth 6

% per annum

5 4 3 2 1 0 1901- 1911- 1921- 1931- 1941- 1951- 1961- 1971- 1981- 1991- 1991- 19961910 1920 1930 1940 1950 1960 1970 1980 1990 2000 1995 2000 Sources: Commonwealth Treasury Economic Round-Up (Centenary Edition); ABS.

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In per capita terms, growth over the past five years has been equal to the best in 100 years Real GDP growth per capita 4

% per annum

3 2 1 0 -1 -2 1901- 1911- 1921- 1931- 1941- 1951- 1961- 1971- 1981- 1991- 1991- 19961910 1920 1930 1940 1950 1960 1970 1980 1990 2000 1995 2000 Sources: Commonwealth Treasury Economic Round-Up (Centenary Edition); ABS.

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Australia’s economy has become more resilient to downturns in our major trading partners World and Australian economic (GDP) growth 8

%

7

Australian economy

6

Forecasts

5 4 3 2

World economy

1 0 -1 -2 1970

1974

1978

1982

1986

1990

1994

1998

Note: shaded areas denote periods when world economic growth dropped below 2½% per annum. Sources: International Monetary Fund; Australian Bureau of Statistics; Consensus Economics, Inc.

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2002

Some problems with GDP as a measure l GDP is designed to measure the value of goods and services which are bought and sold in exchange for money – it does include activities which are not directly ‘bought’ or ‘sold’ but which are instead funded eg by taxpayers, such as publicly funded health care, education and cultural activities

l However it is not necessarily an accurate or complete measure of people’s ‘welfare’ or standard of living – an observation which goes beyond the observation that there’s more to life than money or material possessions

l GDP does not include many activities where money does not change hands directly or indirectly – most obviously, the value of work done in the home, volunteer work etc.

l GDP takes very little account of the costs of pollution or environmental depletion, crime and other ‘bads’ l GDP values each dollar of measured activity equally and takes no account of the distribution of income

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Some analysts have devised a ‘Genuine Progress Indicator’ (GPI) as an alternative to GDP GDP vs ‘GPI’ per capita

l Since 1950, real GDP per capita has risen by 200% while ‘GPI’ has risen by 73% l Since 1996, per capita GDP has risen by 13.4% while ‘GPI’ has risen by 3.6% l The difference reflects the way the ‘GPI’ treats factors such as costs of climate change, working hours, unemployment, foreign borrowing, gambling, advertising, and who spends what

Source: The Australia Institute, www.gpionline.net

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However the ‘Genuine Progress Indicator’ is also laden with assumptions and value judgements l The GPI makes a number of very arbitrary assumptions about what adds to or subtracts from ‘well-being’ – for example subtracting 75% of government spending on defence and law, order & public safety - and then deducts a further $11.7 bn for ‘the costs of crime’ – it arbitrarily deducts 50% of the cost of advertising from consumption expenditure

l The GPI arbitrarily deducts $4 per hour (in 1995-6 prices) for each unemployed person from GDP – even though GDP is already by definition lower than it would be if unemployment were lower

l The GPI arbitrarily assigns lower values to consumer spending by high income earners than by low income earners l The GPI goes to great lengths to measure and deduct the depletion of ‘natural’ capital but makes no attempt to measure and add the accumulation of human capital

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The structure of the economy has changed considerably over the past 25 years Economic activity (GDP) by major sector 20

%

60

%

18 Manufacturing

16 14

50

All other services

40 Commodity production

12 10

30

8

Transport, storage and distribution

20

6 4

Construction

10

Retailing

2 0

0 76

81

86

91

96

01

76

81

86

91

Sources: ABS National Income, Expenditure and Product; Economics@ANZ.

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96

01

Australia is no longer as dependent on exports of commodities as we once were Composition of Australia’s exports 100

% of total

Services (incl. tourism and education)

90 80

Manufactured and other goods

70 60 50

Minerals, energy and processed metals

40 30 20 10

Rural commodities

0 1951

1960

1970

1980

1990

2000

Sources: ABS Balance of Payments and Net International Investment Position; Economics@ANZ.

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Inflation, interest rates and debt

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The past decade saw a return to stable prices after 20 years of high inflation Annual change in consumer prices 12

% per annum

10 8 6 4 2 0 -2 19011910

19111920

19211930

19311940

19411950

19511960

19611970

19711980

19811990

Sources: Commonwealth Treasury Economic Round-Up (Centenary Edition); ABS.

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19912000

One of the main benefits of low inflation has been lower interest rates Interest rates 25

% per annum Business overdraft rate

20 15 10

Standard variable home mortgate rate 5 0 60

65

70

75

80

85

90

95

00

Source: Reserve Bank of Australia.

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05

Lower interest rates and financial deregulation enabled households to take on more debt Household debt as a proportion of household disposable income %

110

Interest payments as a proportion of household disposable income

100

11

90

10

80

9

70

8

60

7

50

6

40

5

30

4

20

3 80

%

12

85

90

95

00

80

85

90

95

Source: ABS, National Income, Expenditure and Product; Reserve Bank of Australia Bulletin.

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00

Australia’s national saving hasn’t been enough to fund the desired level of national investment Types of national saving (as a % of GDP) 20

% of GDP

15

National saving and investment (as a % of GDP) 30

Businesses

% of GDP

27 Investment

10

24 Households

5

Governments

0

21 18

-5

Saving

15 60 65 70 75 80 85 90 95 00 05

60 65 70 75 80 85 90 95 00 05

Note: data shown as three-year moving averages. “Investment” includes residential, business and public sector fixed capital investment but excludes inventories. Source: ABS national accounts.

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Inadequate national saving has been the main reason for the rise in Australia’s foreign debt The saving-investment ‘gap’ and the current account deficit 3

% of GDP

1 0

30

-2 -3 -5 -6

50 40

-1

-4

% of GDP

60 Difference between national saving and national investment

2

Net foreign debt

20 Current account balance 60 65 70 75 80 85 90 95 00 05

10 0 80

85

90

95

00

Note: National investment excludes inventories. The current account balance is the balance on trade in goods and services plus the balances on income payments and current transfers. Source: ABS.

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05

Unemployment

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After rising for almost 20 years, unemployment has (generally) trended down in the past decade Unemployment rate 12

% of the labour force

10 8 6 4 2 0 60

65

70

75

80

85

90

95

00

Source: ABS.

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05

The official measure of unemployment may - to some extent - understate the problem Alternative measures of unemployment 9

%

D = C + those wanting but not actively looking for work because they don’t believe they’ll find it, but available to start within 4 weeks (8.0%)

8 7 6

C = B + those wanting & actively looking for work but not available to start within 4 weeks (7.0%)

5

B = A + those wanting & actively looking for work but only available to start within 4 weeks (6.9%)

4 3

A = Those who want to work, are ‘actively looking for work, and are available to start work within one week - the ‘official definition’ (6.5%)

2 1 0 Sep 2000

Source: ABS, Persons Not in the Labour Force (6220.0), September 2000.

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From a different perspective, the proportion of the population with a job is at a near-record high Employment as a percentage of the population % of the population

48 46 44

42 40 38 60

65

70

75

80

85

90

95

00

Source: ABS; Economics@ANZ.

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05

Productivity growth and economic reform

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Improvements in Australia’s economic performance haven’t come about by accident l Reduction of trade barriers (tariffs and quotas) – encouraged re-allocation of resources from inefficient and highly ‘protected’ sectors towards industries better able to deal with international competition – resulting in increases in both imports and exports

l Reserve Bank independence – Reserve Bank given a target of 2-3% inflation and allowed to pursue it without political interference

l Privatization /de-regulation of financial and product markets – prices and pattern of resource allocation determined primarily (though not exclusively) by private sector decision-makers rather than by bureaucrats

l Partial de-regulation of labour markets – greater scope to organize and reward work according to conditions in individual work places rather than entire industries or the economy as a whole

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Productivity growth has been much faster in the 1990s than in previous periods Productivity growth over business cycles 3.5

% per annum

3.0 2.5 2.0 1.5 1.0 0.5 0.0 1965-1974

1975-1982

1983-1989

Labour productivity

1989-1994

1994-2000

Multi-factor productivity

Note: Labour productivity is output per hour worked; ‘multi-factor’ productivity is output per combined unit of labour and capital input. Source: ABS Annual National Accounts (5204.0).

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Some thoughts about productivity - what you get out for what you put in “Productivity is the prime determinant in the long run of a nation’s standard of living, for it is the root cause of per capita national income High productivity not only supports high levels of income but allows citizens the option of choosing more leisure instead of working longer hours. It also creates the national income that is taxed to pay for public services which again boosts the standard of living The capacity to be highly productive also allows a nation’s firms to meet stringent social standards which improve the standard of living, such as in health and safety, equal opportunity and environmental impact – Michael E. Porter, The Competitive Advantage of Nations (1991), page 6

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Some more thoughts about productivity “Productivity isn’t everything - but in the long run it’s almost everything – Paul Krugman, The Age of Diminished Expectations (1994), page 13 “Productivity growth underpins economic and social advance” – Commonwealth Treasury, Budget Strategy and Outlook (2001-02), page 4-3 “The simple fact is that higher productivity is the only sure road to higher living standards, no matter where you live” – Kim Beazley, as reported in The Australian (7 July 2001)

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Australia’s experience of globalization

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Australia is actually no more ‘globalized’ today than it was a century ago Exports and imports as a share of GDP 40

% of GDP

35 30 25 20 15

Exports 10

Imports 5 0 1901

1911

1921

1931

1941

1951

1961

1971

1981

1991

Sources: Reserve Bank of Australia; ABS; Economics@ANZ.

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2001

Australia has had some previous experience of ‘opting out’ of globalization Exports as a share of GDP 14

% of GDP

12 10 8 6 4 2 0 1870

1913

World

1929

1950

Australia

1973

l Like almost every other country, Australia turned its back on ‘globalization’ after World War I - contributing to and deepening the Great Depression of the 1930s l Australia ‘opted out’ of the post World War II rounds of trade liberalization in which almost every other developed country participated … l … with the result that the share of exports in GDP rose much less in Australia than it did for the world as a whole

Sources: Angus Maddison, Monitoring the World Economy 1820-1992 (OECD); ABS.

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Australia’s previous experience with ‘opting out’ of globalization doesn’t suggest it’s a good idea Australia’s ranking in cross-country measures of living standards Real GDP per head

UN ‘Human Development index’

1870

1st

1870

1st

1913

1st

1913

2nd

1950

4th

1950

2nd

1975

14th

1975

12th

1985

13th

1985

11th

1998

15th

1998

4th

Note: The ‘Human Development Index’ has 3 components: ‘income’ (GDP per capita), ‘longevity’ (life expectancy at birth), and ‘knowledge’ (literacy and school enrolment). Rankings based on 26-29 countries; HDI does not include New Zealand for 1870 (when it would otherwise have ranked 1st). Sources: Nicholas Crafts, Globalization and Growth in the Twentieth Century, IMF Working Paper No. 44, March 2000; United Nations Development Program, Human Development Report 2000.

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Globalization has not undermined the capacity of Australian governments to collect taxes Tax revenues as a percentage of GDP % of GDP

34 32 30 28 26 24 22 20 73

76

79

82

85

88

91

94

97

00

Note: data shown as a four-quarter moving total. Sources: ABS; Economics@ANZ.

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03

The size of the public sector has not shrunk significantly over the past 15 years Spending by Federal, State and local governments as a percentage of GDP % of GDP

40 38

Total

36 34 32 30 28 26 24 22 20

Total excluding interest

71

74

77

80

83

86

89

92

95

98

01

Note: data shown as a four-quarter moving total. Sources: ABS national accounts; Economics@ANZ.

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The tax-social security system has moderated the trend towards increased income inequality Ratio of the income of the richest 10% of Australian households to the poorest 10%, 1990-2000 9

8.5 7.9

8 7 6 5

4.2

4.3

4 3 1989-90 Gross income

1994-95

1995-96

Disposable income (ie after tax, social security payments etc.)

Source: Peter Saunders, The Distribution of Household Income in Australia, in ABS, Australian Economic Indicators, June 2001.

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The decline in the Australian dollar and what it means

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The A$ has been on a more or less consistently declining trend since the mid-1970s Long-term trends in the Australian dollar 150

US ¢

130

May 1970 = 100

A$ vs US$ (left-hand scale)

140 130

120 110

120

100

110

90

100 90

80

"Trade-weighted index" of the A$ vs 24 other currencies (right-hand scale)

80 70 60

70 60

50

50

40

40 70

72

74

76

78

80

82

84

86

88

90

92

94

96

98

00

Sources: Reserve Bank of Australia; Thomson Financial Datastream.

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02

The long-standing link between commodity prices and the A$ seems to have broken down Commodity prices and the A$ 120 115 110 105

1994-95 = 100

US cents

RBA index of Australian export commodity prices (US$ terms) (left scale)

100 95 90 85 80

100

75

95

70

90

65

85

60 A$ vs US$ (right scale) (monthly average)

80 75

55 50 45

70 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 Sources: Reserve Bank of Australia; Datastream.

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The weakness in the A$ now seems to reflect our increasing reliance on borrowing abroad Australian current account deficit and its financing 40

A$ bn - four quarter moving total

35 30 25 20 15 10 5 0 -5 -10 91

92

93

Current account deficit

94

95

96

Net equity investment

97

98

99

Net borrowing

00 Other

Source: ABS; Economics@ANZ

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01

Australia’s relative attractiveness as destination for foreign direct investment (FDI) has declined Australia’s ranking in the AT Kearney FDI confidence index 0

5

Rank

7th 9th 10th

10

14th 15th

15

l AT Kearney FDI confidence index is based on responses to a survey of the world’s 1,000 largest corporations in 35 countries, indicating a high, medium, low or zero likelihood of direct investment in each of 25 countries l The US has consistently topped the rankings in each survey, followed by China, the UK and Brazil in varying order l Australia’s slide from 7th to 15th over the past two surveys reflects its diminishing attractiveness to Asian investors

20

25 Jun 98

Dec 98

Jun 99

Jan 00

Feb 01

l By contrast, Australia ranks 4th (equal with Canada) among USbased investors

Source: A.T. Kearney Global Business Policy Council FDI Confidence Index; at www.atkearney.com

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Australia’s productivity performance has fallen behind that of the US - especially in recent years Labour productivity growth in Australia and the US 5

% change from year earlier (4-qtr moving average)

4 United States

3 2 1

Australia

0 -1 92

93

94

95

96

97

98

99

00

Sources: US Bureau of Labor Statistics; Commonwealth Treasury website.

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01

Australia has a relatively high rate of usage of new information & communications technologies Information & communications technology (ICT) spending NZ Australia USA Switzerland UK Canada Japan EU

% of GDP 0

2

4

6

8

Australia’s ‘ranking’ for use of various technologies l Australia ranks 6th in the world in terms of computer use per capita l Australia was ranked 2nd (after the US) in ‘readiness for ebusiness’ in May 2001 l 56% of Australian households have PCs and 37% are on-line, while 56% of Australian adults access the internet from work or home - ranking Australia slightly below US, Canada and Scandinavian countries but ahead of most others

10

Source: OECD Science and Technology Outlook 2000; IMD World Competitiveness Yearbook 2000.

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But Australia ranks very poorly as a producer of these new technologies Information & communications technology (ICT) ‘value added’

Australia’s ICT trade deficit 90 91 92 93 94 95 96 97 98 99 00

Korea

0

Sweden

-2

USA UK

-4

Finland

-6

Canada Germany

-8

Italy

-10

Japan France Australia

% of GDP 0

2

4

6

8

10

-12 -14

Computer services Telecoms equipment Computers A$ bn

Source: OECD Measuring the ICT Sector 2000; ABS unpublished data

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By one reckoning, Australia’s ‘investment in knowledge’ has lagged well behind the US Investment in ‘knowledge’, 1985-1992 9

% per annum

8 7 6 5 4 3 2 1 0 1985

1992

1993

1994 US

1995

1996

1997

1998

Australia

Note: “Investment in knowledge” comprises public and private spending on education, research and development and software. Source: Chifley Research Centre, The Comparative Performance of Australia as a Knowledge Nation, April 2001.

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Is a weak Australian dollar a ‘good thing’ ? l Farmers, miners and other exporters would say ‘yes’ – they get more A$ for every US$ (or yen, or euro) of product they sell abroad - or they can sell at lower prices in US$, ¥, € etc and still receive the same A$

l Australian firms competing with imports would also say ‘yes’ – imported goods will tend to become more expensive in Australia

l But is it a ‘good thing’ in other respects? – technology and knowledge become more expensive – it’s more expensive for Australian businesses to establish themselves in foreign markets, undertake marketing campaigns etc. – Australian businesses are more vulnerable to foreign take-overs (conversely it’s harder for Australian firms to take over foreign ones) – the ‘gap’ between the earnings and wealth of people who are ‘internationally mobile’ and those who aren’t widens - ie, inequalities in income and wealth distribution are made worse

è If a continually declining currency is the route to national prosperity, how come Turkey, Indonesia, Bolivia etc. aren’t the richest countries in the world?

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Conclusion

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Michael Porter (again) “Cheap labour and a ‘favourable’ exchange rate are not meaningful definitions of competitiveness ... The process of expanding exports from more productive industries, shifting less productive industries abroad through foreign investment, and importing goods and services in those industries where the nation is less productive, is a healthy one for national prosperity ... The expansion of exports because of low wages and a weak currency, at the same time as the nation imports sophisticated goods that its firms cannot produce with sufficient productivity to compete with foreign rivals, may bring trade into balance but lowers the nation’s standard of living” – Michael E. Porter, The Competitive Advantage of Nations (1991), pages 6 - 9

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A ‘SWOT’ analysis of the Australian economy STRENGTHS l l l l l l

Political stability, strong social and legal institutions, diverse population More productive, competitive and outward-looking than 20 years ago Competitive strengths in commodity production, bio-tech, financial services High take-up rates of new technologies Low inflation and interest rates Low levels of public debt

OPPORTUNITIES l l l

WEAKNESSES l l l l l

A culture that doesn’t really value success or excellence, except in sport Comparatively low levels of educational attainment Lack of scale and isolation from major population, financial & cultural centres Poor track record in commercializing and producing new technologies Inadequate saving and declining ability to attract foreign equity investment

Globalization and technology offer ways of overcoming distance and lack of scale Resumption of rapid economic growth in Asia could provide substantial new and growing markets Sustained economic growth and demographic change could make ‘full employment’ a reality

THREATS l

l l l

‘Backlash’ against globalization and economic reforms prompted by failure to ‘explain’ and failure to ensure equitable sharing of costs and benefits Risk of being ‘locked out’ of emerging trade zones and especially out of Asia Continual reliance on a falling A$ as solution to recurring ‘shocks’ Inadequate response to national and global environmental issues

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Big economic issues for the next decade l Adequate national saving – to meet the costs associated with population ageing - and to ensure Australians have adequate control over their destiny

l ‘Fairness’ in the distribution of economic growth – across income groups, and across regions

l Having the ‘right’ range and structure of industries – is it enough just to be a big user of new technologies? If not how do we become a better producer of them?

l Generating sustained productivity growth – how do we ensure that the workforce is capable of adapting to technical innovation in ways that enhance productivity growth?

l Unfinished business from tax reform – is it right that people earning $US30,000 per annum should be expected to pay half of every additional dollar in tax? Do we tax income too much and wealth not enough?

l Environmental degradation – how do we address environmental issues such as climate change and salinity?

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