The Hon John Howard, Prime Minister
GPO Box 26 SYDNEY NSW 2001
12 January 1998

Dear Prime Minister

I know that you agree that unemployment is a matter of great concern. Unless we can reduce unemployment substantially, it will be difficult, probably increasingly difficult, for governments to pursue economic policies that will continue to increase Australia's productivity and competitiveness.

Over the last two years, the Melbourne Institute has been undertaking a major research program on unemployment. We were pleased that the Melbourne Institute's Director, Professor Peter Dawkins, was invited to speak to the Federal Cabinet in August on the subject, and you are probably aware that the Institute held a conference on the subject in November. (A copy of the leading paper is enclosed for your information.) The Institute's advisory board, which I chair, also had a full discussion of the issues after the conference. I am writing to present my summary of the debate on employment and its implications for public policy.

1. Main Causes.  Economists agree that the damaging growth in employment since the 1970's was due to a combination of:
- low growth;
- excessive labour costs; and
- interaction of the social security system with labour markets in ways which reduce incentives to save and to work.

Economists do not fully agree on the precise role of these factors or on the dynamics of the interactions among them. Yet there is broad agreement about why Australia has in thirty years gone from having one of the lowest rates of unemployment to being in the middle of the pack on this crucial index of economic well being.

2. Solutions.  A simple reversal of the adverse factors is not practical, nor would it be sufficient. However, the economic analysis shows where we need to focus remedial actions. The starting point transcends the economic analysis. We need the courage to make the attack on unemployment a major national objective.

Co-ordinated debate has done much to change the climate of opinion on the dangers of inflation and on the need for tax reform. Your government can provide similar leadership on the issue of unemployment, although solutions will necessarily involve all levels of government as well as the cooperation of capital and organised labour.

Solutions must recognise the reality of a fiercely competitive global economy. The unrelenting competitive pressures on our major corporations make it very unlikely that they will contribute directly to the solutions. By being successful in the global markets, they will generate export income (taking pressure off the balance of payments) as well as providing role models for smaller companies. This will provide important indirect benefits for the unemployed.

Most new jobs will be provided by smaller enterprises operating, initially at least, in the nontraded sectors of the economy. Reforms which remove or reduce obstacles to the growth of small business will contribute directly to the reduction of unemployment. These basic 'facts of life' need to be understood by all Australians if public policy is to be effective in reducing unemployment. I now offer some brief comments on the main economic policies which need to be focussed on the problem of unemployment.

Raising Growth.  Overall high rates of growth will be required if unemployment is to be substantially reduced. Australia needs to aim at 5 per cent growth rather that the 4 per cent figure which now seems to be the maximum which informed observers endorse. Setting cautious limits to growth is, of course, a legacy of bitter experience of the roadblocks created in the past by inflation and excessive current account deficits. Reducing the impact of these roadblocks is crucial if there is to be a lasting reduction of unemployment.

The need to contain inflation is now widely supported. The rampant inflation of the 1970s and the early 1980s was a major cause of poor economic performance. Great vigilance will be needed if inflation is to remain low during a period of sustained employment growth.

In my professional judgement, providing much stronger incentives to save is the single reform which would do most to raise the sustainable rate of growth. This judgement is not shared by all of my colleagues at the Melbourne Institute, nor by economists generally. Most economists would, I think, emphasise microeconomic reform generally and labour market reform in particular, and naturally I support these objectives.

How much the sustainable (non-inflationary) rate of growth can be raised is a crucial matter for judgement. But to the extent that the overall rate of saving is higher, the roadblock of external deficit will be less of a problem.

Reducing Labour Costs.  What practically can be done to reduce labour costs is another key question. Raising productivity is crucial, which again emphasises the need for effective microeconomic reform. Lower overall real wage growth would help sustain non-inflationary growth and would also make labour cheaper to employ at the margin. However, overall 'wage restraint' is likely to be resisted strongly. The best that can be hoped for is perhaps the avoidance of excessive increases.

The biggest and must useful direct impact on unemployment is likely to come from effective reductions in the wages of less-skilled members of society. The most practical immediate solution might be to achieve a freeze in the wages 'safety net'. There would need to be appropriate compensation for those earning below an agreed minimum decent level. We believe that this would best be achieved by using a system of income tax credits.

Tax and Social Security.  The Melbourne Institute remains convinced that full integration of the tax and social security systems, with eventual adoption of a negative income tax, is essential if unemployment is to be minimised, consistent with Australian values of a fair go for all. Tax reform is currently high on your government's agenda and is strongly supported by the Melbourne Institute. We endorse the aim of broadening relevant tax bases and of both reducing and harmonising rates of tax. We believe it will be possible to produce a much more efficient tax system that is also fairer and simpler. Our strong recommendation is that the reform package be designed so as to maximise incentives to save and to work.

One specific personal suggestion is that you consider the option of allowing families to be taxed as a unit. This would encourage those spouses now in paid employment only to earn a small net amount (for school fees in many cases) to leave the workforce, freeing jobs for those in greater need of paid employment. Having children more closely supervised in the home would have a number of indirect benefits for society in the longer term.

Other Policies.  The Institute strongly supports the continuation of special assistance (training and work schemes) for the long term unemployed, as our research shows these programs to be very effective in assisting the hardest cases. It is also important that all governments in Australia pay serious attention to improving the education system as a long-term strategy. Raising skill levels is much better than grinding wage levels down to match low skill levels.

3. In Conclusion.  Unemployment wastes valuable human resources and ruins lives. One of its most insidious effects is on the children of the unemployed, who disproportionately become addicted to drugs and various forms of antisocial behaviour. A serious attack on unemployment, far more serious than we have seen for the past thirty years, would be one of the best contributions to the welfare of all Australians that your government could make.

Co-ordinated and focussed discussion and debate is necessary if Australians are to understand that we do not need to accept the many costs of unemployment. Widespread public discussion will also prepare Australians for the changes needed if unemployment is to be abolished.

Prime Minister, Australia faces many challenges and you no doubt receive a torrent of advice. Please be assured that the resources of the Melbourne Institute are available should you or your colleagues and advisors wish to further develop the ideas outlined here.

Yours sincerely

P D Jonson
CHAIRMAN

cc Mr Peter Costello, Treasurer
Dr David Kemp, Minister for Employment, Education, Training & Youth Affairs