Economic policy is likely to remain the central policy concern, notwithstanding terrorism, climate change and family values. Some commentators, who are already comfortably off, may argue that further economic growth will not result in a commensurate increase in well-being, but even they must acknowledge that it is difficult to maintain well-being and a fair distribution of incomes in a depressed economy. Judging by their behaviour, most people want further material gains, while the capacity of government to respond to many demands largely depends on the revenues that flow from sustained economic growth. Furthermore the last election showed that despite his dissembling over issues such as children overboard and Iraq, John Howard continues to be trusted to best manage the economy. The most likely challenge to Howard’s economic competence is an internationally inspired economic downturn, and even then he might be able to argue convincingly that he is best able to manage the Australian response.
So what is a credible set of alternative economic policies? the Centre for Policy Development‘s Reclaiming our Common Wealth is correct in arguing that ‘Election campaigns have become popularity contests rather than competing public ideas’. Too often the so-called policies that emerge from this poll-driven process lack any longer-term vision and coherence. But as the Centre for Policy Development has recognised, a credible alternative needs to go beyond criticism of current government policies and present a viable economic strategy that is focused on a sustainable economic future and a fairer society over the longer term.
The importance of markets
A viable economic strategy must be founded on a general disposition in favour of competitive markets. Unfortunately this proposition can provoke a reaction from many on the Left who are often ambivalent about their attitude to markets. For example, the Centre for Policy Development‘s Reclaiming our Common Wealth accused the Howard Government of doctrinaire privatisation, involving a reduction in the role of government to a reluctant provider of last resort. Similarly Kevin Rudd has attacked what he perceives to be Howard’s slavish ideological adherence to market fundamentalism — arguing that ‘John Howard is the intellectual creature of Friedrich Hayek’. But like many other observers I doubt whether the Howard Government can be convincingly characterised in this way. In fact the Howard Government is more often distinguished by its pragmatism, involving many, many handouts to all sorts of interest groups. Thus, rather than creating a market economy, the Howard Government is perhaps better described as pursuing its own particular mix of populism and crony capitalism.
More importantly Howard’s critics need to avoid the pitfalls of appearing to be ideological and opposed to free markets. It should be remembered that the Hawke-Keating Government introduced a range of reforms to improve market competition involving financial deregulation, reduced tariffs, a range of public sector reforms including national competition policy, corporatisation and some privatisation, and the introduction of enterprise bargaining covering wages and other employment conditions. Although these market-oriented reforms were initially attacked by some as economic rationalism or neo-liberalism, they are now widely perceived as providing the platform for our subsequent prosperity.
What the experience of the Hawke-Keating Government should teach us is that the shift to markets represents a change in means and does not have to mean changing fundamental goals or objectives. Government must, for example, continue to have the capacity to intervene and reduce the uncertainty and sometimes the unfairness that can result from market-imposed solutions. Similarly, Kevin Rudd is right to insist that social democrats reject sole reliance on the values associated with what he calls market fundamentalism, and that social democracy is properly concerned to achieve equity, solidarity and sustainability. But markets can often be managed by governments in ways that increase the capacity of government to achieve a more compassionate and cohesive society. Thus more reliance on market-oriented policies does not have to lead to market dominance over government and a distortion of our values. Instead, as the reforms of the Hawke-Keating Government have demonstrated, governments can often better realise their policy objectives by relying more on market-based instruments than on other alternatives such as traditional command and control regulation.
The advantage of market-based instruments over regulation is that these instruments can be structured to create desirable incentives for individual actors to pursue the government’s policy objectives. In effect governments can aim to construct and manage markets so as to create a synergy between the objectives of the individual, or individual interest groups, and the broader collective objectives of society. In that way the apparently independent activities of free agents become the instruments of government, and these instruments are politically attractive because they are the least coercive possible. To paraphrase Adam Smith, the government can guide the invisible hand of markets so as to ensure that individuals pursuing their own self-interest also act in the public interest.
The discussion of economic policy that now follows will seek to show how government can manage markets in future to achieve this fairer and more compassionate society that is properly concerned for a sustainable future.
Macro-economic policy: Sustaining economic growth
Labor’s credentials as an economic manager will depend particularly on confidence in its capacity to continue the present long economic expansion. Here the principle risk in the short-term is inflation. An independent Reserve Bank will bear the immediate responsibility for limiting inflation, and the Bank will increase interest rates if inflation rises. But the need for such increases depends importantly on the structure of the economy, which can be significantly influenced by the government.
Fundamentally the reason why the Australian economy is no longer so inflation prone as it was in the 1970s and 1980s is because markets are now much more competitive. There is less risk of a wage-price spiral, as wage increases are no longer so readily passed on in price increases. In addition, following the introduction of enterprise bargaining, wage increases are much more likely to be limited to what the firm can afford to pay, and employees and employers have more incentive to work together to find ways to improve that capacity to pay. However, there are still significant areas of the economy which are not subject to competitive pressures — most notably in the public sector. An alternative economic strategy should therefore commit to extending the writ of what was intended by National Competition Policy in areas such as public transport, water and electricity supply, health and education.
The other principle risk to sustaining the present economic recovery is the threat of a downturn initiated by developments overseas. Here Australia is more vulnerable than it needs to be because of its high reliance on overseas capital and corresponding high current account deficit on the balance of payments. At present this deficit is being fairly comfortably financed by capital inflows, but it is doubtful that the present deficit, that is higher than the likely growth of GDP, is sustainable over time. Australia is therefore particularly exposed to a possible change in market sentiment, which could involve a collapse in the exchange rate which would then force the Reserve Bank to raise interest rates because of its concerns about the consequent risk to inflation.
Government action to minimise this risk from the current account necessarily requires an increase in domestic saving relative to domestic investment. But this requirement means that, contrary to some suggestions, it is just not possible to combine more infrastructure investment, financed by more government borrowing, and less reliance on foreign borrowing and ownership. In a fully employed economy a choice has to be made. And in our present circumstances, if the states are going to borrow more in future to finance infrastructure, then the Australian Government will need to aim for bigger Budget surpluses if we want to reduce the current account deficit and our reliance on foreign capital. Thus a commitment to keep the Commonwealth Budget in surplus over the course of the economic cycle will be needed. This commitment will also help establish Labor’s economic management credibility, and thus make the task that much easier.
Economic Development: Enhancing potential supply
In contrast with macro-economic demand management, where the focus is on minimising the risks to sustaining aggregate demand in the economy, the policy alternatives for economic development are intended to increase the supply potential of the economy over time. This increased supply potential should lead to a faster rate of economic growth in due course, and represents the main way for Labor to differentiate its policies from those of the Howard Government.
A critical issue is where and how far is government intervention needed to enhance the supply potential in a market-based economy. Intervention on behalf of specific industries or firms is out of favour, although it still occurs from time to time, and is what gives rise to concerns about crony capitalism. Fundamentally this type of approach to industry policy on behalf of specific firms or industries should be opposed as it always comes at a cost to other industries, and can undermine the long-run competitiveness of the economy. At most industry/firm specific assistance should be limited to adjustment assistance to help people exit gracefully from situations that are no longer economically viable.
Where government can play a more positive role is in developing our factor endowments and capabilities, especially where there is reason to believe that there may be market failure. For example, research and development, education and training, and infrastructure can all increase Australia’s future competitive advantage, and generate external benefits to the community beyond the immediate user. Government intervention for these purposes, however, should involve generic assistance and should not discriminate between specific firms or industries.
Already Labor has been very critical of the Howard Government for what it views as a lack of investment in infrastructure and in skills. Both physical and human capital are obviously crucial for economic growth, and Labor is right to concentrate on them. However, while it is easy to point to examples of dilapidated infrastructure, it is also easy to point to examples of infrastructure, such as dams for irrigation, non-metropolitan airports, and rural roads, which have been over-supplied in the past. And many of the trade skills which are presently in short supply partly reflect the loss of jobs for tradesmen since the 1980s. In fact we still have around 15-20 per cent more people with trade qualifications than there are currently jobs for. Unfortunately many of these people with trade qualifications have left their trades for a variety of reasons and have found work elsewhere, most often in jobs that require apparently less skilled qualifications.
Before major new investments in physical infrastructure are promoted we need to better establish precisely what is needed and what is the likely economic rate of return after allowing for all external costs and benefits – rather than the political pork-barrelling that has been all too common in the past. It is particularly important to get the prices right. More competition will help in this regard, but infrastructure provision frequently involves at least an element of natural monopoly and the external costs and benefits are often unusually significant. Nevertheless competition can be promoted by separating out that part of infrastructure where competition is possible, and developing third party access regimes for the remainder, as is being done for electricity and gas supply, and is now being started for urban water in NSW. An advantage of relying on competitive suppliers of infrastructure services is that this will increase the scope for private sector funding, and will avoid some of the pitfalls from inappropriate risk sharing that past public-private partnerships have involved. At the same time the issue of external costs and benefits can be addressed by relying more on market instruments, such as taxes and subsidies, which are better targeted and more transparent.
Education and training
Much of the public debate about education and training is focused on higher education and early childhood education. The rate of return from investment in both these forms of education appears to be high. In particular, the job growth in the last fifteen years or so has disproportionately favoured those people with professional qualifications. This evidence is often used to justify the provision of more university places. On the other hand around 40 per cent of the current generation of school leavers will enter a university at some stage of their lives. We might ask at what point do we start to run into diminishing returns from further investment in university education? Are more than 40 per cent of the population intellectually capable of making the best use of a university education if universities continue to aim at their traditional standards of excellence? Or are there better alternatives, involving improved preparation and selection of students for university, and the development of diploma courses aimed more at associate professional levels, such as used to be provided by the former colleges of advanced education and which vocational education and training is increasingly providing.
The most critical economic policy issue for future is to increase employment participation. Indeed, if nothing is done then an inevitable consequence of the projected ageing of Australia’s population is that the aggregate rate of labour force participation can be expected to fall from the present 64.4 per cent to 60 per cent in 2025 and around 57 per cent in 2040. Furthermore, government revenues will in turn decline and expenditures will rise relative to GDP because of the projected increase in aged-dependency associated with this decline in labour force participation. As a result, if present policies do not change, a fiscal gap is projected between government revenues and expenditures, equivalent to 5 per cent of GDP for the Commonwealth and 4 per cent for the States by around 2040. On the other hand, analysis by the Commonwealth Treasury has shown that policies to increase employment participation represent the best way to avoid these fiscal gaps — more effective than the alternatives of increased immigration or increasing productivity.
By definition increased employment participation must come from those people who are presently unemployed or on the margins of the workforce. Analysis has shown that almost all of these people who presently have low rates of employment participation are early school leavers who have no further post-school qualification. In principle the low rates of employment participation for these unskilled people who tend to be low paid could reflect their lack of financial incentive to move from welfare to work. However, it is most likely that their low participation rate mainly reflects their lack of job opportunities.
For example, a number of tax reductions and changes in arrangements covering welfare to work came into effect on 1 July last, which were intended to improve incentives to work. However, modelling by the Melbourne Institute of Economic and Social Research suggests that these measures would only increase labour force participation, but not necessarily employment, by almost 50,000 people (or less than half a per cent), while their annual full-year cost is estimated by the Government to be as much as $11.4 billion. By contrast, the Independent Pricing and Regulatory Tribunal for NSW (IPART), in conjunction with Access Economics, has estimated that increased vocational education and training directed at those people who are on the margin of employment, or at risk of becoming marginal, will increase employment by 90,000 in 2010 and by 860,000 jobs in 2025. This increase would be enough to prevent employment participation from falling, and in 2025 the additional cost would have gradually grown to be only $2.5 billion, compared to the annual cost of $11.4 billion to improve work incentives. Moreover the increased vocational education and training would more than pay for itself over time, as the projected 12 per cent real increase in GDP that would result from the higher employment participation would lead to much higher tax revenues and lower government expenditures.
The responses to the ABS labour force surveys suggest that sufficient numbers of people could be attracted back into employment if they were confident that jobs were available. Consequently it is likely that the additional training places would be filled fairly readily. In addition, Labor Senator Penny Wong has recently proposed that the present strategy to move people from welfare to work should be adapted to make training an additional option. This option would allow those people on welfare who are now being required to search for jobs, when they often lack the necessary skills, to instead choose to take up these new vocational education and training places.
A legitimate question is, of course, whether the supply of more trained people would actually result in extra employment. It is important to note that the training being recommended is more intensive and therefore more expensive per person than has typically been the practice in the past. Evaluation of results achieved elsewhere suggests that training of this intensity and quality will result in the amount of increased employment projected.
Finally, another key requirement is to ensure that the new skills are in fact used they once are acquired. We don’t want to add to the numbers of people who are not using their skills at present; indeed part of the training package recommended by IPART would involve refresher training for these people to get them back into jobs that make better use of their skills. More generally, however, policy should encourage TAFE to continue to evolve from being a supplier of skills, to being a key player in workforce development. TAFE can thus become an agent for change, disseminating new work practices and organisational approaches that support workforce development, by seeking opportunities to build partnerships with industry that enables it to encourage the development of high-performance workplace cultures, and to form networks to share these new practices and approaches.
Public sector reform
As the Centre for Policy Development has pointed out the debate about the size of the public sector is a false debate. Government should not become residual. As citizens we are members of our society; meaning that we are interdependent and have a mutual obligation to each other. In this interdependent society there are some social goods and services that should be available to all, and used collectively in order to promote social inclusion and cohesion. The public sector has an important role in the provision of these goods and services, although other groups can also provide such services on behalf of the government.
Fundamentally the level of government expenditure should be determined by the amount of services people want and their willingness to pay for them. The demand for publicly financed services tends to rise faster than incomes and accordingly government should be wary of populist promises to reduce the level of taxation, which then cannot be met. Nor is there any good reason to lower the level of taxation. With the possible exception of some people on welfare, there is no evidence that taxation is acting as a disincentive to work or to save. Instead the real problem with taxation is political. Unfortunately people can complain about high taxation while at the same time demanding additional government expenditures. The challenge for government is therefore to overcome this schizophrenia and forge a better public appreciation of the link between taxation and citizenship. People need to feel better connected to the taxes that they pay and the public services that they finance.
In addition, support for the public sector and indeed people’s willingness to pay the taxes to support it, depends significantly on those services being efficient and effective, and responsive to what people want. Too often the way in which work is organised and managed in public transport, in our schools and TAFE institutes, and in our health care facilities is not in the interests of the users of these services, and impedes our overall economic performance. The focus for micro-economic reform should therefore continue to be on the public sector.
Greater flexibility is needed in the provision of many public services, and more competitive markets for many public services have a key role to play. In particular, one size no longer fits all, if it ever did. The users of a service need to have more choice, and the presumption should be that these users are best placed to determine what best meets their needs rather than the staff of the service provider who often have conflicting interests. We can, for example, combine a universal public health system, based on patient care, as set out by John Menadue in the Centre for Policy Development, with choice of doctor. In addition, if funding were based on patient needs and followed the patient instead of being provided to institutions, then there would be better incentives to pursue the most cost effective treatment and the plethora of different health services would be coordinated by the purchaser on behalf of the patient.
We also want to promote excellence in the pubic sector. Public services should not be seen as providing a second class service, with those who can afford to go elsewhere, preferring to do so. Fortunately, for the most part public universities have always been seen to be of a high standard, but as Melbourne University Vice-Chancellor Glyn Davis has been saying, we will need to allow much more differentiation between our universities in the future if we want to maintain their excellence.
Excellence will also require greater flexibility in funding and remuneration in our schools and TAFE systems. Performance pay is understandably viewed with some suspicion by teachers because of concerns about how to define and measure performance. However, promotion long ceased to be based on seniority and merit based promotion requires an assessment of performance. The reality is that parents, students and other teachers reach a considerable consensus on who are the best teachers in an individual school. Some people are similarly concerned that school choice may be inequitable as they fear that it will favour schools in the richest localities. But the evidence is that school choice can be essential for the well-being of many children. It can also provide a powerful incentive to improve school performance and in the UK and the US school choice has been associated with improved results by children from disadvantaged localities.
More generally, such problems need not be insuperable and are not a reason for avoiding more choice and competition in education. Instead the focus should be on equality of opportunity, and the best means should then be chosen accordingly. Thus at present state schools in disadvantaged localities suffer under the current staffing and funding arrangements. These schools tend to have a higher proportion of students who are more difficult to teach and/or who tend not to do as well academically because they do not receive the same support at home. One consequence is that these schools have more difficulty in attracting the best teachers, and are often forced to take inexperienced teachers. A better approach to schooling funding in future would provide additional funds to these state schools in disadvantaged localities. These schools should then be allowed to use this additional funding to pay their teachers more where that is warranted by improved results, and it would then allow those disadvantaged schools to attract the best teachers.
Apart from merit goods such as health and education, user charging to fully recover costs is a must for many other public services. We will not conserve scarce water and energy resources, for example, unless we get the pricing right. Nor will the desired level of investment, and especially private investment, be forthcoming without proper pricing. Where there are important externalities taxes and subsidies should be used, but they need to be better related to an assessment of these externalities. For example, public transport is properly heavily subsidised because of the community wide benefits that flow from less congestion and pollution. However, the amount of subsidy varies substantially between different forms of pubic transport and for no apparent reason — indeed the average subsidy in Sydney is lowest for bus transport, whose customers on average have lower incomes than commuters on trains and ferries.
A common concern about economic and other associated policies based on a stronger role for market forces and competition is that this will lead to less equity. In particular, critics of the Howard Government’s Work Choices legislation are concerned that the changes introduced have been at the expense of families, and increased inequality.
Labor believes correctly that there is an imbalance of power between the employer and an individual employee, and that accordingly there is a role for unions in protecting the interests of employees. The Howard Government also seems to accept that employees need protection from unscrupulous employers, because in its words it has set up an Office of Workplace Services to police rogue employers. But the Government’s legislation is very anti-union by any standards — past or overseas — and should be amended to allow unions to do their job. This is not possible for unions at present, although under national competition policy the government allows groups of small businesses to combine and collectively negotiate with a monopoly or duopoly suppliers of services.
Labor will need to introduce a better balance between promoting desirable flexibility in the labour market and providing proper protection for individuals who might otherwise be exploited. This balance may mean that high paid individuals whose skills are in short supply can largely be left to bargain with their employer on their own — as used to happen in the past. For many people, however, collective bargaining will provide a fairer result. The necessary flexibility can still be achieved through enterprise bargaining which emphasises the common interests of employees with their firm and has regard for the circumstances of each specific firm. Nor should this form of enterprise bargaining lead to any deterioration in economic performance. It didn’t in the past, and economic performance has not improved since Work Choices was introduced — rather there is evidence that the rate of increase in productivity has declined.
Some increase in the number of conditions, beyond the present five that can presently be incorporated in awards and certified agreements, will also be appropriate, but too much prescription should be avoided. In particular, it should be remembered that concerns about labour market flexibility and family life cut two ways. Flexibility in hours often suits many families and what government must seek through industrial regulation is that neither party to an industrial agreement is in a position to put undue pressure on the other.
Concerns that enterprise bargaining unfairly favours the strong and the rich, and should be replaced by centralised arbitration are also not very convincing. The distribution of earnings has become more unequal, but except for a very small number of highly paid executives, the evidence is that there has been little change in relative wage rates and no systematic change in favour of the wages paid to occupations in the upper income deciles. Instead the reason why the distribution of earnings has changed over the last two decades is primarily because the composition of jobs has changed. Australia has created a lot more jobs, especially for professionals, at the top of the earnings distribution, while the number of jobs in the middle of the distribution has tended to contract, and this has led to a more unequal distribution of earnings.
Thus the best way to improve equity is to focus on providing equality of opportunities. The increased provision of vocational education and training opportunities, previously canvassed, will provide the best foundation for ensuring equality of opportunity, and by increasing employment participation it will move people away from welfare dependence. Furthermore by up-skilling people there will be much less risk that they will be required to accept third world wages in jobs that are increasingly moving to the third world. The Australian tradition of egalitarianism can thus be maintained, not by seeking to regulate wage rates, but more effectively by up-skilling and re-skilling people so that they can get the jobs that are being created.
To sum up, economic policy for the future should be founded on support for competitive markets that promote efficiency, innovation and choice. Governments will most effectively achieve their traditional objectives by maximising their use of market instruments to manage and develop the economy, and for the provision of infrastructure and public services.
Competition is the reason Australia is no longer inflation prone. Increased saving and less reliance on foreign capital would also reduce Australia’s risk exposure. Equally important, too much scarce public capital has been wasted in the past. This waste is best prevented by user charging wherever possible, with prices that cover the efficient cost of the service provision, and explicit taxes and subsidies to take account of any externalities.
The most critical priority for economic development, however, is to increase employment participation. Education and training is essential, and especially vocational education and training. Such training directed at disadvantaged people is also the best way to improve equality of opportunity.
Tax reductions are less important for participation and for economic development more generally. The government therefore needs to be wary of any reduction in its taxable capacity and thus in its ability to fund the services that a prosperous community will expect.