Australia can address economic decline

This article argues that Australia can uphold a decent economic/social policy mix by streamlining public spending and promoting a more dynamic economy.

I make the following points on the expectation that the trend towards freer trade continues as the best means of promoting prosperity. One can note Donald Trump's recent claim that US jobs have shifted to China largely through the actions of US corporations and lawmakers, yet The Economist indicates that only a fifth of the six million US manufacturing jobs lost between 1999 and 2011 was caused by Chinese competition.

First, it is necessary to defend freer trade, despite fears about the rise of authoritarian and mercantile China. As The Economist reports, a study by university economists calculates that median US income earners would lose 29 per cent of their purchasing power if the US was closed to trade, the poorest would lose 62 per cent given they spend proportionately more on traded goods, and innovative US goods would lose access to a growing Chinese market as global competition and low-cost inputs for consumer goods raises the productivity of American designers. The same is true for Australia.

Second, being an advanced liberal democracy that gives greater consideration to social issues in line with its pluralist tradition, Australia will remain attractive to those who generate new wealth. While the global economy provides enormous benefit to low cost nations in terms of costs for manufacturing and services, new wealth does move and/or invest in Western liberal democracies for lifestyle reasons alone. While foreigners are often blamed for rising housing costs, 2014 surveys indicate that Australia ranked third behind the US and Canada as the first choice for wealthy Chinese looking to emigrate with 47 per cent of wealthy Chinese indicating a desire to emigrate.

Australia can effectively balance workplace, wealth and humanitarian considerations to enhance Australia's economy and labour force where and when needed, despite foreign purchases helping raise the price of housing, albeit that most of the price increases occur in a "handful of metropolises that attract people, capital and ideas from all over the world" (including Sydney with a 12 per cent annual rise for the past three years).

In investment terms, while early UNCTAD data for 2015 indicates that Australia dropped out of the top ten countries in terms of foreign investment inflows, partly due to a significant divestment of mining assets, Australia received a further net inflow of $57.5 billion of foreign investment in 2014. Of gross inflows of new direct investment (valued at $140.1 billion in 2014), the largest sources came from the US ($32.0 billion), Singapore ($31.8 billion), the European Union ($28.3 billion), and China/Hong Kong ($14.7 billion) (Dept. of Foreign Affairs and Trade, International Investment Australia 2014, September 2015).

Third, Australia does have a diverse economy with industries that will ensure reasonable prosperity for years to come, notably mining, agriculture, tourism, education. Recent free trade deals have the potential to benefit Australia's services and food producers, although agricultural products only comprised 9.5 per cent of world merchandise exports in 2014 compared to 66 per cent for manufactures (non-food) (WTO, International Trade Statistics 2015). Tourism Australia indicates there were 1,023,600 Chinese tourists arrivals in Australia during 2015 (up 22 per cent from 2014) spending $8.3 billion (up 45 per cent), with total international arrivals increasing to 7.4 million (6.9 million in 2014) and spending $36.6 billion ($31.1 billion in 2014).

Fourth, and this is where the feel good story ends, Australia has to consider age-old competitive imperatives rather than look at soft options like Australia having a low level of debt and overall taxation when compared to other developed countries.

Quite simply, Australia cannot assume that the good times will re-emerge anytime soon to reignite our terms of trade. For example, after the dotcom bubble burst in 2001, the US Federal Reserve eased monetary policy until 2004 with easy credit boosting the housing market, the world economy and commodity prices. This factor helps explain the high demand for Australia's mining products which resulted in mining investment rising from around 2 per cent of GDP in the early 2000s to 8 per cent in 2012. But as world economic growth fell from 5.37 per cent in 2010 to be around 3 per cent from 2012, so the value of our mining exports has fallen as Australia's terms of trade declined from its record peak in 2011.

Since the global financial crisis (2007-08), however, and despite the use of QE and very low interest rates, the governments of most developed countries have relied on debt to maintain public spending levels. In terms of net government financial liabilities, while Australia's surplus declined from 31.5 per cent of GDP in 2007 to 12.9 per cent in 2015, some OECD nations now have a deficit level over 75 per cent of GDP (including the USA, Japan, France, UK, Italy and Spain). Sooner or later, public debt in such countries will need to be addressed.

One should also be careful of relying on China for Australia's future growth. While it was recently reported in March 2016 that China was ready "to roll out other stimulus measures to meet targeted growth of 6.5 per cent between 2016 and 2020", Michael Pettis (Professor of finance at Peking University in Beijing) argues that any commitment to achieve growth through much higher debt levels will inevitably mean that "China's longer-term outlook will be worse than ever" (Vern Gowdie, Daily Reckoning Australia, 9 March 2016).

And with Australia's total public and private debt around $2.5 trillion (mostly private), it can also be argued that public fiscal discipline is of crucial importance because Australian governments are committed to bailing out the banks if they get into trouble thanks to "the borrowing binge of the past few years" which has seen Australia "leveraged" to record high levels (Greg Canavan, Daily Reckoning Australia, 8 April 2016). Hence, there is a need to address recent budget spending given that the Australian government alone has produced an average deficit of 2.8 per cent of GDP between 2008-09 and 2014-15.

Australia is also going to have to improve productivity levels (both in terms of wages and output), despite the US Department of Commerce noting the disadvantages faced by low cost producers given that the cost of employee turnover represents around 12 percent of pre-tax income for the average Indian IT company.

According to the 2014 McKinsey Australia report, only Australia's agricultural sector is globally competitive. Of basic and advanced manufacturing, the report notes that Australia has a lack of high process sophistication and productivity levels that can offset high input costs. Of Australia's service sector, the report cited greater pressure from technology, as already seen in the print media, finance, retail, telecommunications and education. With Australians already exposed to call centres in low cost countries handling basic transactions such as billing enquires, it was suggested that other services such as paralegal work, book-keeping and accounting may increasingly be performed offshore.

With less government intervention the new norm with regard to Australian industry, albeit it remains to be seen to what extent national governments allow the demise of all given a recent suggestion that China's excess steel production could still be 300 million tonnes by 2020 (Greg Canavan, The Daily Reckoning, 11 April 2016), it makes sense that Australia adopts appropriate reform to ensure a dynamic and efficient economy.

At the government level, public costs should be removed where possible. For example, as I argued in the IPA Review (April 2016), why do taxpayers need to fund public broadcasting (over $1 billion per year) in an era where consumers have so many quality media news and entertainment choices?

At the social policy level, greater means-testing should accompany all welfare measures where possible, including education and health services. In other words, any public assistance should decline the more an individual or family earns.

While it may be understandable that both Labor and Coalition governments expanded public social expenditure from 11.6 per cent of GDP in 1983 to 16.3 per cent by 2007 in an era of considerable economic reform, Australia should temper its further rise (19 per cent of GDP spent in 2013 and 2014). This should include the family home being part of the aged pension assets test.

While the following table indicates the diversity of taxation options, and the reality that Australia's taxation of large corporations is not that high by OECD standards when all taxes are taken into account rather than corporate taxation alone, including payroll and employer social security contributions, it is worth noting that Denmark places much less importance on such taxation.

This leads to my final points to counter the arguments of those drawing inspiration from the Nordic countries.

As The Economist suggested in 2013, the main lesson "to learn from the Nordics is not ideological but practical" as the state "is popular not because it is big but because it works". Thus, such countries overcome "tired orthodoxies of the left and right" as they "forage for good ideas across the political spectrum".

While reducing government outlays considerably since the early 1990s, albeit they still employ 30 per cent of the workforce in the public sector (OECD average 15 per cent), the Nordic countries offer many examples of competitive capitalism working with a large state to promote quality, transparency and efficiency. For example, Denmark and Norway allow private firms to run public hospitals; Sweden has a universal system of school vouchers, with private for-profit schools competing with public schools; Denmark also has vouchers which can be topped up; Nordic nations measure the performance of all schools and hospitals; Sweden gives everyone access to official records; Sweden's support for free trade allowed Saab to go bankrupt with Volvo sold to China's Geely; Norway's has a very large sovereign-wealth fund serving as a safety net in difficult economic times; and Denmark has a system of "flexicurity" that "makes it easier for employers to sack people but provides support and training for the unemployed".

As The Economist notes, the Nordic model is proof that "you can inject market mechanisms into the welfare state to sharpen its performance" and ensure that entitlement programmes" are put "on sound foundations to avoid beggaring future generations".

Nevertheless, The Economist suggests that the Nordic countries will need further reform given that high levels of taxation now encourage entrepreneurs to move abroad, and too many people live off welfare benefits (especially immigrants) that require much greater means-testing.

In February 2016, it was reported that Sweden's wage setting model, which has served to protect industry's competitiveness by effectively putting a cap on wages for the rest of the labour market, was coming under greater pressure. Different unions now proposed separate wage demands during upcoming wage negotiations; major unions were at odds about how to halve the pay gap between women and men by 2028; the government had intervened to award teachers higher pay to improve teachers' status; and business groups argued that refugees should be paid lower wages (even frozen) to get them into work.

The extent of any policy reform is always a matter for national debate, but any reform should be promoted and defended as a policy to aid a dynamic economy rather than hinder it.

Take the taxation of housing in Australia. While state governments enjoy high stamp duty revenue from the recent housing boom, a recent March 2016 McKell Institute report urges an annual property tax on all owned land (not housing) based on a per square metre value with no tax-free threshold. Removing stamp duty would lower up-front costs; remove penalties for those moving house to find work or those who need to repurchase after unforeseen circumstances such as divorce; aid people downsizing in older age; and gain revenue from those who live in an expensive house and pay no tax (A plan to end stamp duty: making property taxation farer in New South Wales).

To conclude, Australia can long remain a great nation with a decent economic/social policy mix. It does retain a number of advantages that will remain attractive to domestic and foreign investment. Nevertheless, in an increasingly global economy, assuming that dangerous levels of protectionist sentiment do not re-emerge, ongoing reform is needed to ensure continued prosperity for Australia's liberal democracy.