A strong macro-economy cannot be built on weak micro-economic foundations – and whichever party wins the federal election will need to take on the challenge as the remaining fiscal stimulus wears off.
Under enormous pressure from bond traders and many economists, Reserve Bank Governor Phil Lowe deserves credit for refusing to appease them by raising interest rates. Those arguing the economy is in rude health seem oblivious to its poor shape before the Covid-19 pandemic struck.
From 2012 to 2019, economic growth averaged only 2.4 per cent per annum. Two-thirds of this was attributable to population growth
https://www.afr.com/politics/federal/morrison-riding-on-feel-good-factor-20210131-p56y8n
In raising material living standards, productivity growth is not only the main game, over the long run it’s pretty much the only game; in Australia since Federation it has contributed 95 per cent of Australia’s GDP growth per person https://www.pc.gov.au/research/ongoing/productivity-insights/long-term/productivity-insights-2020-long-term.pdf
Yet in the five years before the pandemic, productivity growth averaged only 0.7 per cent per annum. That was less than half its long-term average of 1.5 per cent and only one quarter the rate achieved during the productivity boom of the late-1990s and early-2000s https://www.pc.gov.au/research/ongoing/productivity-insights/recent-productivity-trends/productivity-insights-2020-productivity-trends.pdf
In the year immediately before the pandemic, productivity not only stopped growing, it fell.
Like much of the rest of the developed world, Australia had fallen into secular stagnation – slow economic growth, low inflation and weak wages growth in an economy well short of full employment.
Nothing that has happened during the pandemic or the bounce-back from it has structurally strengthened the economy. All that has happened is the economy received massive stimulus from both fiscal and monetary policy and responded as economic theory would predict.
But now the fiscal stimulus through programs such as JobKeeper and JobSeeker has largely been withdrawn, as has the quantitative easing component of monetary stimulus.
The idea that the economy is now all fixed and healthy, ready to create jobs and income sustainably, is absurd. In fact, GDP per person remains lower than before the pandemic started.
We will know we have full employment only if wages are rising broadly across the workforce – and they are not.
As Governor Lowe explained to a parliamentary committee on Friday https://www.afr.com/policy/economy/lowe-warns-of-abrupt-effect-from-us-rate-rises-20220211-p59vn3 the sharp lift in US inflation is not the Australian experience.
Nor is inflation a problem in China, Japan and most of south-east Asia.
For example, electricity prices have risen sharply in the US, but not so in Australia – owing to the much greater penetration here of low-cost renewable energy.
Even if Australian inflation were high, but the causes were transitory, the Reserve Bank should look through those temporary price rises as it has done in the past.
Australian monetary policy should be directed at inflation and employment in Australia, not in the United States.
If the Reserve Bank were to base its monetary policy settings on US inflation, its cash rate hikes would pump up the Australian dollar, damaging the competitiveness of Australia’s exporting and import-competing industries.
If and when the time comes for slowing down the economy, targeted cuts in government spending would have a more immediate and predictable impact than increases in interest rates with uncertain time lags and undesirable effects on the exchange rate.
A strong macro-economy cannot be built on weak micro-economic foundations.
And the brutal reality, confirmed by Australia’s terrible productivity performance, is that the micro-economic foundations of the Australian economy are crumbling.
Our education and training systems are not up to scratch.
Private investment embodying the latest productivity-raising innovations remains weak when you look beyond the pull-forward created by a time-limited investment allowance.
Many of our hospitals are not using the latest technologies and systems to restrain costs while improving the quality of care.
Whichever party wins the coming federal election will need to take on the challenge of micro-economic reform as the remaining fiscal stimulus wears off.
Microeconomic reform would necessarily include tax reform, in which the Morrison government has no discernible interest.
If the Albanese Opposition dared mention the words ‘tax reform’, the Coalition frontbench would scream ‘death tax’, ‘housing tax’, ‘retirees’ tax’ and ‘carbon tax’, as they scour documents for what Albanese said at NSW Labor conference 30 years ago when, wait for it, he referred to the conference chair as ‘Comrade Chair.’
Building the political case for micro-economic reform would require the next prime minister and treasurer to spend some time explaining the problem they are trying to fix, as Hawke and Keating did in the 1980s.
Apart from some useful deregulatory work being overseen by Minister Ben Morton, little micro-economic reform is going on inside the Morrison government – with much more effort being devoted to diverting scarce budgetary resources for purely political purposes.
Treasurer Frydenberg tasking the Productivity Commission to undertake its second five-yearly review of Australia’s productivity performance is a welcome beginning.
Let’s hope the report, due in a year, triggers a new reform effort by whoever forms government.
In the meantime, Governor Lowe should continue to resist the frantic efforts of those insisting he lift the cash rate quickly to squash inflation and crush the real economy.
Craig Emerson is managing director of Emerson Economics. He is visiting fellow at the ANU, director of the APEC Study Centre at RMIT and adjunct professor at Victoria University’s College of Business.