The Australian economy—supporting the transition

Robert Dolamore, Economics

Key issue
With resources sector investment probably having peaked, other sources of demand will need to strengthen if the economy is going to grow at a rate consistent with full employment. How smoothly this transition unfolds will have important implications for Australian living standards. Economic policy can play an important role in supporting this transition.

As the Australian economy moves into the production phase of the mining boom a significant transition is underway. With resources sector investment probably having peaked, other sources of demand will need to strengthen if the economy is to grow at a rate consistent with full employment. A smooth transition from one set of growth drivers to another is not guaranteed, subject as it is to the influence of changes in global economic conditions and consumer and business confidence. Economic policy can play an important role in supporting this transition in the near future and in facilitating strong and sustainable economic growth in the medium to longer term.

This brief is intended to be read in conjunction with The Tools of Macroeconomic Policy—a Short Primer, which explains many of the economic terms used here.

Macroeconomic policy

The macroeconomic environment exerts a strong influence on the economic decisions of households and businesses, and hence on the level of economic activity. For example, such decisions are influenced by how fast prices are rising, labour market conditions and the availability and cost of credit. Reflecting this, maintaining appropriate macroeconomic policy settings is essential if households and businesses are going to respond positively to changes taking place in the economy.

Monetary policy is playing a key role in supporting economic activity, with interest rates at their lowest level in 50 years. While the economy appears to have taken longer to respond to the current round of monetary policy easing than in the past, demand should nonetheless strengthen in interest rate sensitive parts of the economy, including dwelling investment and non-mining business investment.

The exchange rate, which surprised many commentators by remaining at historically high levels even after Australia’s terms of trade peaked in late 2011, has subsequently depreciated. This should provide an important adjustment mechanism for the economy by boosting the international competitiveness of Australia’s export and import-competing industries. Key issues in this regard include: how far the Australian dollar needs to fall to be consistent with full employment, how orderly this adjustment is and how long it may take relative to the effects of the decline in resources sector investment being felt.

Fiscal policy is currently on a consolidation path with a view to returning the budget to surplus. This is consistent with seeking to ensure the medium to longer term sustainability of Australia’s public finances. One challenge is to ensure that any reprioritisation of expenditure is as ‘pro-growth’ as possible. Some areas of public expenditure, such as education and infrastructure, are likely to have a greater effect on Australia’s long-term growth prospects than others. If the rebalancing of Australia’s growth does not go smoothly, so that the level of economic activity significantly falls short of what is required for full employment, then fiscal policy may need to be more supportive of aggregate demand in the short-term.

Microeconomic reform

While supportive macroeconomic policies are important, they will not be sufficient to ensure Australia makes a smooth transition. There is a need for complementary microeconomic reforms that seek to increase the productivity of Australian businesses, lower their cost structure and encourage innovation. This is fundamental to improving the international competitiveness of Australian firms and securing higher future living standards.

The Productivity Commission has identified three main channels through which government can influence the productivity of business:

  • incentives—the external pressures and disciplines on them to perform well
  • capabilities—the human resources and knowledge systems, the institutions and infrastructure needed to devise productivity-enhancing changes and support them effectively and
  • flexibility—the scope to make the necessary changes.

The Productivity Commission emphasises the need for a reform agenda that proceeds on all three fronts and for policy consistency to avoid sending mixed signals.

Distributional policies

Structural adjustment in the economy inevitably focuses attention on the distribution of costs and benefits across the community.

During the upswing in resources sector investment, the high Australian dollar increased the purchasing power of Australian households, but also put considerable pressure on trade exposed industries. As the surge in resources sector investment winds down, there will likely be discussion of how the distributional effects of this are playing out.

In thinking about this it can be useful to distinguish between adjustment costs that are borne widely across the community and those that fall disproportionately on particular groups.

For example, the depreciation of the Australian dollar imposes a cost on Australian households by reducing their purchasing power. How far the dollar depreciates will determine how large this cost is and its impact on living standards. It will be important that this cost is absorbed without compensating households through higher wages, while recognising this may be painful in the short-term. Otherwise, the positive effects of the depreciation in terms of boosting the international competitiveness of Australian businesses will be offset by cost increases.

However, lifting Australia’s productivity performance provides a way of moderating the cost of this adjustment. This is because higher productivity would further enhance the international competitiveness of Australian firms and provide some scope for paying higher wages.

Job losses in certain industries may be concentrated in particular geographic locations. When this occurs, there is a case for seeking to reduce some of the costs of adjustment for those individuals adversely affected by structural change. As well as more equitably sharing the costs of adjustment across the community, providing assistance may also improve community acceptance of difficult changes.

Policy action across a broad front

All of the policy areas discussed above have their limits in terms of what they can do to support Australia’s transition to a different set of growth drivers. This suggests the need for policy action across a broad front and consistently focused on improving the growth prospects of the Australian economy.

Further reading

G Banks, ‘Productivity policies: the ‘to do’ list’, Economic and Social Outlook Conference, Melbourne, 1–2 November 2012.

R Garnaut, Ending the great Australian complacency of the early twenty first century, Victoria University 2013 Vice-Chancellor’s Lecture, Melbourne, 28 May 2013.

P Sheehan and RG Gregory, ‘The resources boom and economic policy in the long run’, The Australian Economic Review, 46(2), June 2013, pp. 121–39.

G Stevens, ’Economic policy after the booms’, address to The Anika Foundation Luncheon, Sydney, 30 July 2013.

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