The Government’s Mid-Year Economic and Fiscal Outlook (MYEFO) released on Tuesday 15 December outlines the Government’s economic and fiscal strategy and, equally important, what it expects that strategy to achieve. It is especially significant on this occasion, as it represents the first major economic statement by the still relatively new Turnbull Government. As such this statement allows us to put some more content into our assessment of what, in its short life so far, has principally been an “aspirational government”.
In this article I will discuss the Government’s economic strategy, as revealed in the MYEFO. In a second companion article I will discuss the fiscal strategy.
The Government’s Economic Strategy
According to its MYEFO the Government has an ‘integrated national plan for economic growth and jobs’. The Government is putting in place policies, which it hopes will ‘create a dynamic, competitive economy that rewards effort, incentivises innovation and sets Australia up to capitalise on the abundant opportunities in the fast-growing Asian region’.
The key elements of this strategy as stated in MYEFO are:
- The recently announced National Innovation and Science Agenda
- The free trade agreements concluded with China, Japan, Korea, and the Trans-Pacific Partnership
- Record levels of infrastructure investment through the $50 bn. infrastructure package, which allegedly will increase the economy’s productive capacity
- The Government’s response to the Financial System Inquiry, which is expected to strengthen Australia’s financial system further to meet new needs and support sustainable economic growth
- Strengthening Australia’s competition frameworks, including working with the States ‘to unlock the benefits of choice and diversity in areas such as health and aged care’
- ‘A comprehensive dialogue on how to create a “growth friendly” tax system,
- A strengthening budget position.
Assessment of the Economic Strategy
On the Government’s own admission, the results that it expects from its economic strategy are less than impressive, at least by past standards. In the current financial year GDP is only expected to grow at an annual rate of 2½ per cent, and by 2¾ per cent in the next year. The economy is facing a difficult transition from the resources boom, but nevertheless the short-term outlook for economic growth is disappointing bearing in mind the extent of excess capacity.
Furthermore, the forecast rate of productivity increase over these two years is only ½ and 1 per cent respectively – well under the normal rate of 1.5 per cent annual increase. And the forecast for non-mining investment, which should be an important part of the transition from the resources boom, has been revised down in the MYEFO to show a small fall in the current year, and a much slower rate of recovery next year.
Looking further ahead, the Treasury has now revised downwards its expectation for the economy’s long-run growth potential, with Treasury now believing that realistically potential output can only be expected to increase at an annual rate of 2¾ per cent. This rate of potential output growth compares very poorly with an average annual rate of economic growth of 3½ per cent over the 1990s and 2000s, let alone the 4¼ per cent and 5 per cent average growth rates experienced in the 1950s and 1960s respectively. Indeed, it was only in the period of stagflation from 1974-75 to 1982-83 that economic growth was as low as we are now being asked to accept as being the best that we can do.
In short, on its own evidence the results expected from the Government’s economic strategy, as outlined above, are disappointing, at least compared to past performance of the economy. While the individual elements of that strategy may appear reasonable, it equally seems reasonable to query whether the strategy as a whole is adequate to the task.
For example, the National Innovation and Science Agenda contained a number of useful new initiatives, but most of the money came from switching money from other science related programs, and arguably a lot more money is really needed to become an advanced economy that produces as well as uses leading edge technologies.
Similarly, the free trade agreements have been massively over-sold. Their principal focus has been on achieving improved market access, but that of itself does not improve productivity and economic growth potential. Instead, more attention is needed on how to extract productivity gains by switching resources to more productive activities.
In the case of infrastructure investment, every parrot in the pet shop is calling for more infrastructure investment. But most of this investment is not subject to proper cost-benefit analysis, which helps explain why such analysis is never publicly available. An informed guess suggests that more than half of the Government’s $50 bn. infrastructure package would be better not spent.
Finally, one can be sceptical whether strengthening Australia’s financial system, giving people greater choice and lowering taxes will really make much difference to Australia’s rate of productivity growth or employment participation – the key drivers of economic growth. It is not that these elements of the Government’s economic strategy are without merit – in particular, ensuring financial stability and the integrity of the financial system is critical. Rather these sorts of initiative are unlikely to lift the rate of economic growth to the levels that Australians are used to and to which they aspire.
Instead a bolder economic strategy is called for which would focus much more on:
- Achieving a major increase in skills, involving a substantial increase in investment to more than replace the cuts made in recent years
- A stronger focus on making the best use of our skills as the key to enhancing future productivity growth. This would require a renewed management focus on achieving improvements in the organisation of work, a principle source of innovation, and less focus on cost cutting, which at worst can lead to lower productivity
- Much more carefully targeted infrastructure investment, based on the introduction of proper pricing signals. As all conservatives should understand, pricing something for nothing is bound to lead to over-demand. Instead future infrastructure investment should be in guided by what will deliver the greatest economic returns, having regard to the value that users are prepared to pay for, and not in response to political whims.
Australia does face a difficult task adjusting to the end of the resources boom. It is being helped in this regard by the accompanying decline in the exchange rate and lower interest rates. But relying only on such market mechanisms is unlikely to achieve the results that Australians expect. The Government could and should do more to improve the supply-side of the economy, principally by improving the education and skills of the workforce, the way in which those skills are then used, and the quality of infrastructure investment, of which far too much is wasted on politically selected projects.