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Fix the States, fix inflation

By Jason Falinski - posted Tuesday, 27 May 2008

Three years ago the then Governor of the Reserve Bank, Ian McFarlane, when asked why monetary policy needed to be tightened pointed to four primary causes: infrastructure bottle necks, higher property prices, lack of skilled workers, and wage growth mostly in the public service.

At the time it appeared to go completely unnoticed that each of these areas of concern for the governor were the purview of state governments. Inflation is not the result of Federal Government spending, it is misleading for media commentators to suggest otherwise. Running a large budget surplus in a time of plenty is easy, microeconomic reform is not.

The 1990s were a time of great microeconomic reform. At a federal level Paul Keating ran effective arguments in favour of economic reform. The deregulation of the financial sector and the capital markets was critical for future reforms to take full advantage of the positive outcomes they produced. His introduction of the national competition policy, privatisation of the Commonwealth Bank and QANTAS also produced productivity improvements. He also commenced the deregulation of the labour market.


Unfortunately the real benefits come from reforms under the influence of state governments. And in this regard microeconomic reform was driven almost entirely by Nick Greiner and Jeff Kennett. The economic miracle that Australia has been enjoying for the last two decades owes most of its birth to these two premiers. Since both left the scene much of the reform has been wound backwards by rent-seeking interest groups attached to the Labor Party.

Microeconomic reform is hard. It generates a lot of political heat as formerly pampered interest groups have their privileges removed for the broader benefit of the community.

Public choice theory explains that while the overall benefits of microeconomic reform are huge, they are spread across the whole community. Whereas the subsidies lost, while significantly lower than the benefits from reform, are felt more specifically. In other words consumers receive a benefit of $1 per can of tuna, which totals $1 billion across the economy, but tuna producers lose $1 million, spread across a hundred or so people in the industry.

The car industry cost millions to subsidise but the cost to the whole community in higher prices was billions. At one point it would have been cheaper to send every worker in the Australian car industry home and give them $100,000 a year. The problem with reforming this disgrace was that the cost to each consumer was a few thousand dollars, the cost to individual workers was over $100,000.

In spite of this difficult political situation Greiner and Kennett forged ahead. The result was a large lift in Australia’s productivity, which in turn allowed the Reserve Bank to lower interest rates in full knowledge that higher growth would not result in inflation breaking out.

If the Federal Government really wanted to reduce inflationary pressure in the economy it would start by freezing public service wages, rationalising public service resourcing, including unwinding the growth in public service numbers, reallocating resources to infrastructure spending, releasing land for building, and getting the State Labor Parties to be parties of education not of the education unions.


In truth none of this will happen. The Labor Party is unlikely to take on the unions and rent seekers in its midst. In an Australian economy that is enjoying a once-in-a-generation economic boom all this does not worry an unworried Australian people.

But boom times never last, and opportunities pass. The states have been enjoying record revenues, which they could have used to build infrastructure, educate people, release land, build utilities, help improve the health of its citizens. Instead they have found it easier to cynically manipulate policy for the benefit of donors, while buying off interest groups, rent seekers and the favoured few Labor mates who have attached themselves to the party machine.

If we really want to lower interest rates, and preserve our wealth, we need to insist that the states do microeconomic reform. Absent that we had all better get used to lower growth, higher inflation, and higher interest rates.

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About the Author

Jason Falinski is managing director of CareWell a provider of furniture and equipment to the health sector, and a former national president of the Young Liberal Movement.

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