What real reform looks like: increase wages and tackle inequality, climate change

Dec 30, 2020

The economy has been stagnating for years under successive Coalition governments. It badly needs fixing, but it can be done. This is how.

So much of the political discussion in Australia is founded on the presumption that more economic reform is always necessary. As Paul Keating noted exasperatedly back in 1989 when the Hawke Government was pursuing serious economic reform:

‘If you walk into any pet shop in Australia, what the resident galah will be talking about is microeconomic policy.’

But 30 years later, in 2020, what should be the agenda for economic reform in Australia be? In my my view, it should be based on an assessment of why the Australian economy performed so poorly in the years before the Covid recession.

Thus, the critical issues to tackle are:

  • why was the average annual rate of increase in real GDP over the five years from 2013-14 to 2018-19 only 2.5 per cent, when economic growth averaged 3.3 per cent between the two previous peaks in 1989-90 and 2007-08? and
  • why was the increase in productivity and real wages only 0.7 per cent over that five-year period pre-Covid when the previous long-run rates of increase were 1.9 and 1.4 per cent respectively?

The orthodox explanation for the secular stagnation experienced before Covid has focused on the supply-side of the economy. The economic model used is determined by the three PPPs – population, participation and productivity growth. Of these, productivity growth is assumed to be the main source of growth in income per head. As the figures cited above show, it has been the stagnation in productivity growth that underlies the poor economic performance immediately prior to the Covid recession.

Consequently, recent proposals have mostly focused on microeconomic reform to improve productivity growth. Other reforms previously led to improvements in the efficiency and flexibility of markets, which minimised the disruption to the economy from various shocks, and that is the key reason we went almost 30 years without a recession.

The microeconomic reform agenda is no longer the most relevant. Essentially, this is because the supply-side agenda ignores the main reasons for the economic stagnation of the years before the Covid recession.

As the former US Treasury Secretary Lawrence Summers, pointed out: if supply-side constraints were the principal source of lower growth, inflation should have accelerated as the capacity to supply fell short of aggregate demand; but inflation has in fact decelerated too.

The focus instead needs to be on why demand for goods and services has been too low. And as the Governor of the Reserve Bank identified back in 2017: ‘The crisis really is in real wage growth’.

This low wage growth and its associated increase in inequality has led to low rates of growth in household consumption. In addition, if the rate of return for business investment is adequate, then such investment is principally determined by demand for their products, which mainly means consumer demand. But when business investment slows, that can slow the take-up of new technology, and thus retard the growth in productivity.

Over time, a decline in aggregate demand can thus slow the growth of future potential output. Supply and demand will then be equilibrated and there will be full employment, but there will lower growth in incomes – as we have experienced immediately prior to Covid.

The key focus of an economic reform agenda, therefore, should be on how to improve wage growth and achieve greater equality in the distribution of incomes.

A Demand-side Reform Agenda

Wage growth and equality

Through the 1980s, 1990s and 2000s, technological change hollowed out the middle-level jobs in Australia. The increasing share of employment at the top and bottom of the income distribution inevitably led to a more unequal distribution of income, and while income inequality seems to have stopped rising, inequality in the distribution of wealth has continued to rise.

The middle-level jobs that were lost were heavily unionised, and many jobs have also become more precarious. These changes have probably weakened the bargaining power of labour and largely explain the low wage growth.

The top priority should therefore be how to increase the rate of growth in wages and household incomes and restore a more equal distribution of incomes and wealth.

As Thomas Piketty concluded at the end of his monumental study of inequality:

‘The best way to increase wages and reduce inequalities in the long run is to invest in education and skills.

The first, and arguably the most important item on the agenda should be to improve the education and training systems so workers have the skills to move into the higher skilled jobs being created. The government will therefore need to:

  • restore the funding of universities and vocational education and training (VET),
  • ensure greater equality of opportunity by insisting that school funding is needs-based according to the Gonski formula.

Other policy changes that will lead to higher incomes include:

  • offering more protection for workers in precarious jobs
  • stop the public sector wage freeze and support a generous increase in the minimum wage
  • improve the social wage by increasing funding for childcare, social housing and rental assistance

Tax reform

Achieving greater equality will require money. This should be the focus of tax reform – not the lower taxes traditionally seen as the core of “tax reform”.

However, raising more revenue is complicated by the fact that increasing the GST makes no difference to federal government revenue. The most obvious sources of additional revenue are the various tax concessions, in particular, capital gains tax and negative gearing.

In addition, if the income tax scales remain as legislated they become increasingly regressive over time. Projections by the Parliamentary Budget Office show that only the top quintile of income earners will have a lower average tax rate in 2030, while the average tax rates of the second and third quintiles will have risen by 4 percentage points.

A further restructuring of the income tax should therefore be a key part of tax reform.

Economic development 

Although I have been sceptical about reforms to improve the supply-side of the economy, governments can do some things to promote economic development.

The biggest challenge facing all countries, and especially Australia, is the impact of climate change on the economy and more generally to life itself.

Unfortunately, the Morrison Government does not have a coherent policy to tackle climate change. Instead, it portrays any action to reduce the risk of climate change as a cost to the economy – at least in the short run. But this is not true.

As Ross Garnaut has shown, Australia can cut carbon emissions and make money in the process.

Second, research and development is the prime source of technological change and therefore productivity. However, Australian spending on research and development is well below that in other similar industrial countries. Increased tax incentives and funding for universities would help lift our research and development effort.

Equally important, if not more so, is the commercialisation of research results. Unfortunately, the record shows that Australia also lags behind in this respect. Too many Australian inventions are brought to market overseas, but Australian governments could make a difference if they tried.

Productivity improvement and public sector reform

Finally, there are opportunities to improve productivity, but not where the business lobbyists are looking. The Productivity Commission’s 2017 report, ‘Shifting the Dial’, largely ignores the old (“neoliberal”) agenda, with its recommendations focusing on ‘areas that many would not traditionally associate with productivity: health, education, cities and confidence in institutions’. The report’s aim could be broadly described as improving the quality of the services for which the government is responsible. Much of the improvement would come from better decision-making processes, including proper evaluation before and after the money is spent.

So perhaps it is not surprising that the recommendations in this report sank without a trace. Similarly, and presumably for the same reasons, the Morrison Government rejected the recommendations of the Thodey review of the public service, which were designed to improve its capacity for evaluation and the policy advice based thereon.

Conclusion

Unlike the old supply-side agenda for economic reform, a valuable agenda starts from what is needed to ensure an adequate increase in future aggregate demand.

This agenda recognises that while climate change represents possibly the most important policy challenge, climate change also presents Australia with a considerable opportunity for economic development.

Finally, an increase in productivity mainly involves reform of the public sector, and does not reflect the traditional agenda of the business lobbies.

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