THE STATE OF THE AUSTRALIAN ECONOMY

Recently appointed Australian Secretary to the Treasury Dr Martin Parkinson gave an interesting post-budget speech on the Australian economy. Several themes are relevant to economic challenges in New Zealand.

Dr Parkinson opens by noting that Australia came through the global financial crisis well. Leaving aside the effects of stimulatory monetary and fiscal policy, he comments:

The Australian economy dodged a bullet and we did so because of 25 years of hard, and not necessarily popular, economic reform … Australian governments from the mid-1980s onwards recognised the need to transform our economy. They prosecuted the case for microeconomic and structural policy reforms that were crucial in increasing the economy’s capacity to ride out a severe external shock. They put in place robust monetary policy frameworks. And they demonstrated the resolve needed to bring deficit budgets back into surplus, and committed themselves to increasingly well-articulated medium-term frameworks for fiscal policy.

Too many New Zealanders think that Australia’s success is ‘all about mining’. The Economist makes the same point as Dr Parkinson in a leader this week:

[Australia’s] economic success owes much less to recent windfalls than to policies applied over the last 20 years before 2003. Textbook economics and sound management have truly worked wonders.

Note the ‘textbook economics’ – not the dreaded ‘neo-liberal’ policies that Helen Clark used to bang on about.

After discussing at length problems associated with assessing the structural budget deficit in Australia, Dr Parkinson goes on to address wider issues. He states: 

The global economy is undergoing a transformation unprecedented in the last 100 years. Geo-strategic and geo-economic weight is moving, inexorably, from the Western advanced economies towards the emerging market economies. And the pace of this transformation is faster than many anticipated. Key emerging markets from Australia’s perspective are China and India.

 … Indeed, some estimate that China should overtake the US to become the world’s largest economy by 2016 and, in turn, be overtaken by India by mid-century.

These developments will pose major adjustment challenges for Australia (and New Zealand). The paper notes that the Australian dollar, which is currently at record levels, can be expected to move roughly in line with the terms of trade over the longer term. This will put pressure on trade-exposed sectors such as tourism and manufacturing which are not benefiting from high commodity prices. On the other hand:

… it is important to highlight that a higher exchange rate helps to spread the benefits of the terms of trade boom through the community by reducing the price of imported goods and services. Unless the global environment changes, attempting to lower the nominal exchange rate simply results in the required real appreciation being delivered through higher inflation rather than a higher nominal exchange rate. In other words, a higher nominal exchange rate benefits consumers!

 Dr Parkinson points out:

… that the Australian economy is always changing – there are always new jobs and businesses being created as new opportunities are identified. By way of example, in a typical year, around 300,000 businesses are born and a similar number die; around 2 million people start new jobs and leave old ones; and half a million workers change industries.

Finally, the paper draws out the policy implications of the structural adjustment challenges:

A reform agenda that increases the supply of labour, improves the flexibility of the economy and boosts productivity will be vital for our future prosperity in the face of the long-term trends reshaping our economy. The most credible policy responses will be those that allow the economy to adjust, while protecting those most vulnerable.

This will not be easy. As I noted at the outset, the reforms of the past 25 years were difficult and hard won, with populist challenges to their need and their effectiveness.

and Dr Parkinson adds:

Importantly, structural reform is not a one-off – it is a process, not an event. Without continued effort the gains that were made can be eroded over time, particularly given the long lags between reforms and measured productivity improvements.

Contrast the widespread acceptance in Australia of the importance and benefits of its reform programme with Helen Clark’s silly mantra about ‘the failed policies of the past’. But Australia is at risk, at least in the short term, of throwing away some of the gains. As an Australian colleague emailed me last week:

… we are doing our best over the other side of the Ditch to close the gap. I think it is called the ‘winner’s curse’ and the government is doing pretty much everything it can to destroy the prize we have received by virtue of our endowments and the surging economies of China and India.

LESSONS FROM SINGAPORE

This week’s issue of The Economist contains an important special report by one of the paper’s most talented journalists, John Micklethwaite, on the role and size of the state.

He concludes that the prospects for reforming the state have improved with the fiscal crises buffeting Western nations:

… the incremental benefits of ever bigger government, even assuming it was somehow affordable, become ever smaller.  Decent-sized government can reduce inequality and poverty, but most of the evidence is that gargantuan government merely gets in the way of social progress.  A state that takes up more than half the economy begins to deliver an ever worse deal to ever more people in the middle: the extra benefits become harder to detect, the extra costs harder to hide.

The report argues that with good management the share of government spending in Britain could be reduced to 40% of GDP – a very modest goal and an outcome that would still be far too high for fast growth.

It rightly notes that the British welfare state, with high levels of social transfers and middle class churning, would remain twice the size of Singapore’s.  Unusually, for what is still a Eurocentric paper, the report devotes this section (scroll down) to observations about Asia and Singapore in particular.

Singapore is certainly a standout country.  Only two generations ago Orchard Road looked like a third world thoroughfare.  In the 1970s I was involved with the administration of New Zealand aid to Singapore.

Today, Singapore’s per capita income (PPP basis) according to World Bank figures is US$47,940, roughly on a par with Hong Kong ($43,960), well ahead of Australia ($34,040) and nearly twice that of New Zealand ($25,090).

Some New Zealanders think of Singapore as a country that reflects the state paternalism of Lee Kuan Yew who ran the island from 1959 to 1990.  It is true that there are dirigiste elements in the Singapore model, such as mandatory contributions to the Central Provident Fund which finances  much of Singaporeans’ housing, pensions and health care.  Also some outsiders dislike Singapore’s limited political democracy, proselytising of ‘Asian values’ and attitudes that they find somewhat stifling, including of entrepreneurial vigour.

But to regard Singapore as an essentially statist country is to miss the wood for the trees.  It consistently rates behind Hong Kong as having the freest economy in the world.  As Micklethwaite notes, Singapore’s success owes far more to laissez-faire than to industrial policy:

Rather than seeing foreign investment as a way to steal technology or to build up strategic industries, as China often does, Singapore has followed an open-door policy, building an environment where businesses want to be. The central message has remained much the same for decades: come to us and you will get excellent infrastructure, a well-educated workforce, open trade routes, the rule of law and low taxes.

Government spending is around 19% of GDP, the top income tax rate is 20%, the top corporate rate is 17%, Singapore has been at free trade for years, and its labour market is highly flexible with no burdensome rules on dismissals and work hours.

Many other interesting features are noted by Micklethwaite:

• Singapore’s competitive advantage has been good, cheap government
• It provides better schools and hospitals and safer streets than most Western countries
• It is near to the top of educational league tables, yet education consumes only 3.3% of GDP (less than half New Zealand’s level of education spending)
• Teachers need to have finished in the top third of their class; headmasters are often appointed in their 30s and rewarded with merit pay if they do well but moved on quickly if their schools underperform
• The quality of Singapore’s civil service is exceptional, with those at the top being paid US$2 million or more
• There is a welfare safety net to cover the very poor and sick, but much greater reliance on personal and family resources.  Lee Kuan Yew once said that the only thing that would hold Singapore back would be the development of a Western welfare state.

Micklethwaite concludes:

… arguably the place that should be learning most from Singapore is the West. For all the talk about Asian values, Singapore is a pretty Western place. Its model, such as it is, combines elements of Victorian self-reliance and American management theory. The West could take in a lot of both without sacrificing any liberty. Why not sack poor teachers or pay good civil servants more? And do Western welfare states have to be quite so buffet-like?

By the same token, Singapore’s government could surely relax its grip somewhat without sacrificing efficiency. That might help it find a little more of the entrepreneurial vim it craves.

Neither Hong Kong nor Singapore have significant natural resources.  Their geographical position has not altered: Hong Kong grew rich while China was still poor.  They do not have great natural environments but there’s not much they can do about that.  Their prosperity underlines the lesson that the institutions and policies a country adopts basically determine its success in the modern world.  Singapore has an admirable focus on its own interests; one hears little about ‘leading the world’ on climate change, for example.

Many New Zealanders are sceptical about the idea that New Zealand could catch up with Australian living standards.  I have put the question the other way round: would any competent economist not think that New Zealand could overtake Australia if it moved towards the kind of economic framework of Hong Kong and Singapore?  So far none has come forward to take this position.

Friday graph: Sue Bradford’s legacy

Eric Crampton of the economics department of the University of Canterbury is a fine economist. Some months ago he estimated conservatively that the abolition of the youth minimum wage has cost the country over 9000 jobs.

Eric noted that youth unemployment during the current recession, relative to adult unemployment in prior recessions, seemed very high.

More evidence on this point is shown in the graph below (taken from The Economist).

It indicates that New Zealand’s current youth unemployment rates are an outlier relative to other OECD countries.

 Click to enlarge
The further north a country is, measured on the perpendicular from the ‘four times as high’ line, the worse youth unemployment is relative to adult unemployment. Only Sweden and Luxembourg have worse youth unemployment outcomes than New Zealand relative to adult rates. 

That is former Green MP Sue Bradford’s legacy to New Zealand.  We are talking here about the most marginal low-skilled young people.  Firms will pay young workers the minimum wage or higher wages if their productivity warrants it.  Indeed they will be forced to do so because of competition for labour by other firms.  But they won’t if young workers’ productivity doesn’t warrant it – they will make losses if they hire such workers.

Sue Bradford may have been well intentioned but it is outcomes that matter.  This outcome is tragic.  How does she sleep at night?

The government’s Welfare Working Group will have failed if it turns a blind eye to this appalling situation.