Henry and his fellow senior Australians have been privileged to live through several major episodes of economic reform.  The first was sparked by the float of the dollar in 1983.  This changed the rules of the economic policy game – more power to the Reserve Bank, less power to Treasury.  Following the float, economic reality intruded as never before into the Cabinet Room.

Related policy changes, including the deregulation of finance, Labor’s “Accord” with the ACTU and the adoption by the Hawke-Keating Labor Government of disciplined fiscal policy were partly, perhaps largely, a consequence of that fateful decision to float the Australian dollar.

John Howard’s Coalition Government continued the process, at first cautiously, even nervously.  It made the Reserve Bank responsible to achieve inflation targets – taking politics out of the setting of interest rates. It began cautiously to deregulate labor markets, introduced the GST and began to reduce rates of income tax.  Together this set of changes amounted to another serious economic reform package.

Internationally, the rise of China, its flood of cheap manufactures and its insatiable demand for commodities, has provided benefits to most Australians of massive proportions.  China has kept inflation low – making the newly “independent” Reserve Bank look good, boosting consumers’ buying power.  China has greatly increased demand for Australia’s commodity exports.  China has massively boosted Australia’s terms of trade but – and this is a vital but – this has not led to a wage explosion or a grossly overheated economy.  This is largely a consequence of past economic reforms, reinforced by the latest economic reform package

The latest burst of economic reform is that based on the Howard Coalition Government’s Work Choices Legislation.

There are various shreds of evidence that Work Choices is a major reform.  Most obvious are the vociferous objections of organised labor.  If Work Choices were not severely impacting union power, union leaders would not be fighting it so powerfully.  More evidence comes from the new policy’s unpopularity in published opinion polls.  Change is often unpopular, with the losers – in this case organised labor – complaining loudly while the winners quietly take the credit for their own presumed sagacity and business acumen.

The economic effects of Work Choices have been masked by unreliable economic data.  Statistics on even such a concept as total employment and total unemployment have been biased and inaccurate, as we have argued.  Official wage and labor cost data we suspect do not fully take into account the loss of traditional benefits -  “Union Rorts” might be a fairer description – such as long tea breaks, double or triple time after hours or on weekends, unrecorded sick days and other forms of working to rule or in some cases against the apparent rules.

The many business persons to whom Henry talks almost universally report liberation from irrational and outmoded work practices and a freeing from impediments to improved productivity.  Overall effects are hard to quantify but are palpable in the workplace. 

Despite the poor quality of official government (ABS) data on employment and unemployment, one obvious effect of Work Choices is the surge of employment revealed in the past year.    The magnitude of jobs gain has surprised everyone, sure evidence that something big has changed.  More (indirect) evidence is the subdued overall growth of wages despite major areas of the Australian economy operating at or even beyond any traditional definition of full employment. 

Now the latest evidence is the surprisingly low inflation numbers in recent quarters.  In the December 2006 quarter, “headline” inflation was -0.1% against the average economist’s expectation of 0.2%.  In March quarter of 2007, the outcome was an increase of 0.1 % against an average expectation of 0.6 %.  Or using the Reserve Bank’s measure of “underlying” inflation the run of quarterly increases is from 0.9% in June quarter 2007, to 0.75 % in September, 0.5 % in December and 0.5% in March quarter of 2007.

The graph shows inflation and inflationary expectations since 1958.  Note the upturn since the turn of the century.  The recent downturn – despite the boom - is the strongest evidence yet of Australia’s “new economy” at work.

Australia is undergoing a fundamental change in the relationships between workers and employers.  Consumers of course are workers, and as consumers they demand the opportunity to buy goods and services when it suits them, not when it suits a union boss who gets his jollies from telling employers what deals they will strike with their workers.  Suppliers of course are employers, and to service consumers efficiently (ie profitably) they need the freedom to operate without “instructions” from union bosses or their shop stewards.

There is of course a major threat to the Work Choices reforms – election of a Labor Government in thrall to its union supporter base.  Kevin Rudd is a clever bloke who works hard and so far at least has shown great discipline.  Henry’s guess is that Kevin Rudd is capable of understanding the extent to which Work Choices has helped the Australian economy, and the costs of rollback in this area.  However, while the jury of public opinion is still deliberating on this subject, the portents are not good.  It seems if Labor wins the Federal election that there will be at least some rollback, and this will reimpose the shackles on Australia’s growth and prosperity, at least to some extent.

One challenge for John Howard and Peter Costello is to sell the benefits of Work Choices far more effectively than hitherto.  Another is to give back the taxes collected in such volumes in ways best calculated to support growth and prosperity.  Education and infrastructure both need far better support than the have had so far from the Coalition.  But direct tax cuts must also become a regular and planned part of budget statements.

If the budget is as good as it should be, the next move in interest rates will be down rather than up.  Imagine the potential impact of this on Australia’s future economic performance.

We shall await next week’s Federal Budget with more than our usual interest.  A strong budget with carefully targeted new spending on infrastructure and education and a healthy overall surplus is vital.  A credible promise of a steady program of cuts to income tax, including for “Howard’s battlers”, is what is needed to give the Howard-Costello Government a realistic shot at another term in office.

Surprisingly strong employment and surprisingly low inflation have kept Howard and Costello in the political race.  Now they must gird their loins for the toughest fight of their political careers.  Selling the manifest benefits of their Work Choices legislation is the main challenge they face.

Sources: CPI Inflation, ABS; Underlying CPI inflation - "weighted median", Reserve Bank of Australia; Inflationary Expectations, Melbourne Institute and Henry Thornton.com

The data on inflationary expectations comes from three sources.  1. 1958(1) to 1971(2) from PD Jonson & DM Mahoney, Price Expectations in Australia, Economic Record, March 1973.(The relevant paper can be found here - PDJ_DMM_Price_Expectations.pdf) ( 2. 1973(1) to 1993(1) Melbourne Institute (Old series).  3. 1993(2) to 2007(1) Melbourne Institute (New series).  The gap from 1971(3) to 1972(4) is filled by linear interpolation, as indicated by dotted part of relevant line.

Published today in The Australian.