© 2019 by Henry Thornton. 

  • Grey Twitter Icon

On Australia's Economic Policy

January 1, 2002

 

 

An Australia day offering on the necessary next wave of economic reform.

 

 

Australia is currently “defying the world recession”. This is a result of past economic reform – much of this initiated by the Hawke-Keating Labor government. But our chronically weak dollar is a clear sign that the global investment community thinks our economic prospects are dim. Another surge of economic reform is needed to maintain economic momentum and to again make Australia an attractive place for investment.

 

Australia has become more internationally competitive in many respects - strong productivity growth and low inflation being the best indicators. There has been a massive temporary boost to our competitiveness from a low dollar, which is the main reason for our current economic buoyancy. However, the low dollar has many costs and its beneficial effects on our global economic competitiveness are not sustainable. Either the Australian dollar will recover to a more sensible value, such as the US 75 cent level estimated as appropriate according to “purchasing power parity” by the OECD in 2000 or the competitive advantage we are gaining will gradually be eroded by relatively high inflation or there will be some combination of these outcomes.

 

Whatever the precise combination, the special benefit from the low dollar will eventually be eroded and we shall again be struggling to compete in a highly competitive world economy. The weakness of the Australian dollar has been the subject of much discussion, not least by me. (See The Currency Question, published in Quadrant in December 2000.) INSERT LINK

 

Economists have still not come up with a convincing explanation of our dollar's chronic weakness, although the Reserve Bank have recently argued that some gradual recovery is likely, which implies that it understands the issue. The Australian dollar has been losing value for a century now, and I see no reason to believe this trend has yet been arrested, although temporary recovery is possible.

 

Big is beautiful.   Globalisation has had many benefits, but a major consequence is that 'big is beautiful' in the minds of global investors. Australia seems big when one is here, but the reality is that we are both small and distant from the major centres. We have made many improvements to our economy, having decisively thrown off the protectionism that so bedevilled much of our first century as a nation. But we have still done nowhere enough to make us a 'must buy' for global investors, and certain unhappy features of our commercial past linger in the minds of investors. (As a novice stockbroker in 1990 I was trying to interest a canny Scottish investor in Australian stocks. He listened politely enough, but concluded our discussion by saying: 'I remember the Posiedan debacle, laddie'.)

 

For many investors, including the smarter Australian investors, the attractions of the big international stocks are simply overwhelming. Australia needs to be so dynamic that it commands a share of a sensible global portfolio. We need to be more dynamic than the benchmark US economy and competing far more convincingly with the best of the small economies. This would be possible but requires hard policy decisions that we seem to lack the political courage or cohesion to implement.

 

Australia if it wishes to have continued economic success must continue the process of economic reform. The single biggest impediment to continued global economic success is our tax system, which is not yet globally competitive Trying to do well with our tax system is like trying to win the America's cup with a coating of barnacles on the hull.

 

There are many dimensions to our tax system, but the single biggest problem is the relatively high marginal rates of personal income tax and the relatively low income levels at which the various tax rates cut in. The single most important policy change that we could make is to cut the top marginal rate of income tax to 40% and have it cut in at an income level of $200,000. (With equivalent changes throughout the tax schedule.)

 

This policy is privately endorsed by many politicians and most economists. But there are two supposedly fatal flaws - it would drive the budget into deficit and it would help the rich more than the poor. As to the first point, I believe that the negative effect on the budget would only be temporary, and that the strong positive effects on savings, investment and sheer entrepreneurial effort would within a few years mean the budget would be stronger, not weaker. International investors would welcome this policy and would not punish Australia for a budget deficit created by tax cuts; indeed the currency would strengthen with such a policy.

 

These assertions are controversial. I believe we need a thorough analysis of the issues and only Treasury can do this with authority. I ask Treasury the following question. 'What would be the five year economic effect of cutting the scale of personal income tax so that the top rate was 40% and cut in at $200,000?  Examine and explain your assumptions carefully. Please provide a range of outcomes depending on the size of the assumed responses of saving, investment and additional personal exertion. Also advise on the likely response of international investors if Australia implemented such a policy.'

 

As to the distributional effects, it may be that such a policy would have as its immediate effect the further stretching of relativities. However, two points must be made about this. The first is that there are strong global forces making for a less equal distribution of wealth and incomes in capitalist societies and fighting these forces with tax policy is probably futile and will certainly make Australia less competitive.

 

But there is a more basic point. Australians are already among the wealthiest people on the planet. Growing Australia's wealth and income as rapidly as possible will mean there is more potential to help the disadvantaged in Australia as well as in the poor countries in our region. Serious reform of Australia's personal income tax schedule would be a reform equivalent to floating the dollar. Floating the dollar was the most important post-war economic policy reform and it was done by Labor. The Coalition could match this if they wish, or at least give it their best shot, but will they?

 

There are various other smaller tax reforms that are desirable but which collectively are less important than basic reform to personal income tax. The principle should be to provide Australia with an internationally competitive tax system. We need to be competitive in all vital respects with tax policy in the most dynamic smaller countries as well as the US economy. Being “equal to the OECD average” (for example) is simply not good enough.

 

What else could be done by a third Howard government that had the will to really make a difference? Australian universities are under great pressure. When we can afford it, they need more money. But they need structural reform far more urgently - consolidation, specialization and above all deregulation so that all students can be charged (with loan schemes and scholarships for those who cannot pay) and teachers and researchers can be rewarded far more appropriately than they are at present. Improvements are gradually occurring through an inefficient Darwinian process, but rational reform could improve on this. Surely we do not need a major university to go broke before we acknowledge the scale of the problem?

 

Australia could also invest more on our research scientists to good effect, as is happening under the government's Backing Australia's Ability (BAA) program. But as well as more money the scientists also need structural reform, and in particular reform to the way in which scientific discoveries are turned into dollars. Over the longer term, Australia's universities and other research institutions could be far wealthier if their commercialisation efforts were more focused and successful. There is important work to be done here but in part this requires serious cultural change, always difficult and requiring time and effort by major opinion leaders.

 

Australia needs a larger and more rapidly growing population. Globally there is serious competition for talent, and our current system of personal income tax is holding us back. We should aim to substantially increase our immigration intake and as part of this double our refugee intake. Increasing the numbers of immigrants will strengthen the economy in many ways - helping to keep our population younger and more dynamic. Increasing our refugee intake will also help to repair the damage to our international reputation which has occurred as a result of our necessary strong action to try to discourage the flow of illegal immigrants.

 

Further industrial relations reform is also needed, with especial focus on the needs of small business. As a related issue I urge another look at the way the ATO treats taxpayers in general, and “independent contractors” in particular. Industrial relations reform, and the drive for competitive efficiency, has driven many people out of our larger corporations. Independent small businesspeople, with none of the support mechanisms provided within the standard corporate structure, deserve a lower tax rate than that applied to PAYE earners in regular employment. Much greater simplicity in all tax matters will help small business in particular.

 

Australia’s rate of unemployment is still far too high. Faster economic growth driven by tax and industrial relations reform would help substantially, of course, but there is one particular issue that requires more attention. This is the integration of the tax and social welfare system to eliminate, or at least minimise, so-called “poverty traps”, situations where there are large disincentives for poor people to enter (or re-enter) paid employment. Cuts to marginal rates of income tax across the income scale will alleviate much of the problem. But introduction of a negative income tax, or a system of earned tax credits, is needed to substantially improve the situation.

 

There is one further, more technical, issue, relating to the currency question. This is the year in which most of the EEC nations become a currency block, with the widespread adoption of the Euro. The Euro will become a powerful counterpoint to the US dollar, and besides these two powerful currencies, the Australian dollar looks increasingly vulnerable. So should we seek to join a major currency block? Joining a currency union is only one step away from complete immersion in a larger political and economic entity, so great caution is required. Even if the loss of sovereignty could be accepted, one needs to ask who would have us?

 

'We should take the lead in creating an Asian currency block' one innocent guru commented on the ABC news early in the new year. We are barely tolerated in ordinary economic and political discourse in Asia, and in any case currency union for such a diverse group of nations is a long way off. The UK said 'cheerio' to us when it first joined the EEC, and the Euro-peans would not want us in any case. The US is the only sensible possibility, and they also might not want us.

 

But if one thinks far enough ahead, joining the US federation might be the least-worst option, and no doubt some far-sighted econocrats are thinking about this by the shores of Lake Burley Griffin. Whether we could cope with the fierce competitive pressures that full membership of the US economy would bring is another question. The Australian Senate, if such an entity had any residual power after Australia joined an expanded US federation, would no doubt continue to do its best to block sensible economic reform. To the extent it were successful, Australia would languish as a larger version of Tasmania, and equally charming in its old-fashioned state.

 

What the Governors and Premiers of the sub-states of Tasmania, Victoria, etc, along with the Governor of the Reserve Bank, would do with their time is another question of course. This points to the entrenched vested interests that will inhibit discussion of this issue. If joining a bigger economic and political unit is out of the question, as it seems to be, what are we to do? 'Work as hard as we can to succeed as a small, independent economy with a floating currency' is the answer. I do not mean that ordinary Australians need to work harder, but rather our politicians and econocrats need to produce a new wave of serious economic reform. 

 

This article was published in the March 2002 issue of Quadrant.

Share on Facebook
Share on Twitter
Please reload

Recent Posts
Please reload