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.
Michael Keating is a former Secretary of the Departments of Prime Minister and Cabinet, Finance and Employment, and Industrial Relations. He is presently a visiting fellow at the Australian National University.
Comments
19 responses to “What real reform looks like: increase wages and tackle inequality, climate change”
Michael – I so admire your policy contributions. I agree that they offer Utopia as against “reality” (or ‘dystopia’).
I do not admire your reluctance to address, with that same dedication, political realities.
For example – are you implicitly agreeing with Albo’s determination to again present with a minimal target? If so, why? If not, why not? And what are you going to do about that?
Theory’s terrific. It warms the cockles of our intellectual hearts (if that’s not an oxymoron!)
But unless a majority of ordinary people are able to come to feel the benefits of what you espouse intellectually: what’s the use?
As a former Mandarin, you know exactly what I am saying.
Please address it.
Michael – I so admire your policy contributions. I agree that they offer Utopia as against “reality” (or ‘dystopia’).
I do not admire your reluctance to address, with that same dedication, political realities.
For example – are you implicitly agreeing with Albo’s determination to again present with a minimal target? If so, why? If not, why not? And what are you going to do about that?
Theory’s terrific. It warms the cockles of our intellectual hearts (if that’s not an oxymoron!)
But unless a majority of ordinary people are able to come to feel the benefits of what you espouse intellectually: what’s the use?
As a former Mandarin, you know exactly what I am saying.
Please address it.
Mike, I’m surprised you have not commented on our macro-economic policy of more than half a decade now which has been comfortable with settings consistent with forecasts for continuing slack in the economy into the medium and long-term. Garnaut has been very critical of this and here’s my two cents worth quite a few years ago now.
I’m no economist so willing to be flamed for my simplistic views, but I have 2 points to make:
Agree that it is inequality that seems to be the problem – when I watch the financial news segment it is sooo striking that interest rates are zero, COVID is reeking havoc on ordinary peoples’ jobs and incomes which have been stagnant for years, but at the same time the stock-market is booming!!!! This reveals to me the stark inequity between us ordinary folk who will spend every penny we get and the few grotesquely rich elite that have no hope of spending their wealth however hard they try. So what do they do with it? – they invest it speculating in shares and property where it stays out of the mainstream economy (Trickle down Ha!). This forces governments to print money, build (Keynsian) infrastructure, banks to invent credit to sustain the delusion of growth until it all ends up in the grotesquely rich speculations. Rinse and repeat. So this seems to me to explain the financial news. And my simplistic solution is a tax system founded on the principal that tax rates should ramp up massively for anyone who earns more than 100 times their poorest paid employee. The same principal could be extended to investments – corporate taxes should ramp up on corporate profits where these exceed 100 x the lowest salary x the number of employees. Of course that might mean corporations that exploit Australia’s population and resources leaving, but I’m not seeing a down-side to this.
Secondly, as a natural scientist, economics has always seemed a bogus discipline to me, especially the neo-liberal kind with compound economic growth forever on a planet with a finite budget of resources, energy and carrying capacity for our pollution. The lack of growth we see now just seems like the 1972 “Limits to Growth” forecasts coming inevitably true. Equally inevitable is the collapse of growth globally until we are living inside the earth’s carrying capacity again and all else is delusional. Steady state economics is the best possible future for us all – get used to it!
I recently read an article by George Monbiot in the Guardian that put forward the view that neo-conservative economics has been so successful that the top 0.01% of wealthy individuals/companies have sucked so much wealth out of the international economic system that there is insufficient liquidity among the rest of us to keep the economy functioning in a manner in keeping with the “laws” of economic theory that have prevailed for the past century. With wage growth, inflation and interest rates in their current, ridiculously unsustainable relationship with each other, I think he has a serious point. For example, in the past year of Covid lockdown, while most have been doing it tough, Elon Musk’s fortune has grown by something over $450 million per day. Monbiot describes it as a civil war between “house-trained” capitalism and “warlord” capitalism, where the latter has drained 99% of liquidity out of the system.
Whilst not diminishing the seriousness of increasing inequality, well documented, for example by Thomas Piketty in his book “Capital”, may I suggest we need to look elsewhere for the state of our malaise. I was hoping that Michael Keating would throw a light on these matters as we surely need a new policy approach.
Many talking about “tackling climate change” have little or no idea what can be done in this regard even if governments were willing, since they have in fact stopped listening to climate science and climate scientists.
Reducing emissions is essential but unfortunately far from enough. Once climate tipping points have been crossed, even the top scientific authorities are not sure what can be done, since atmospheric and oceanic processes become self-amplifying.
https://www.pnas.org/content/115/33/8252
https://theconversation.com/hothouse-earth-heres-what-the-science-actually-does-and-doesnt-say-101341
http://arctic-news.blogspot.com/search/label/Andrew%20Glikson
Imagine if governments appointed economists and politicians to produce an anti-vial vaccine, excluding medical experts …
The “rich” are extreme consumers and are therefore disproportionately responsible for greenhouse gas emissions. They will fight to the bitter end to retain their wealth, sponsoring and funding the politicians who will push their interests. The mining industry killed a resources rent tax and opposes every effort to impose carbon emissions pollution charges. While I hope for a significant redistribution of wealth, I don’t know how we can bring this about.
So, in effect, you’re saying that there is little hope of a ‘Climate change mitigation led recovery’ providing the basis for the much needed renewable energy revolution while the political landscape is dominated by fossil fuel, mining, and traditional farming interests.
What this country needs, more than anything else, is a real Federal Anti-Corruption Commission and a ban on all forms private funding of political parties. Even the Ancient Greek democracies identified the influence of the rich as a major impediment to genuine people power. We citizens pay for the government through our taxes, but we are represented by politicians bought and paid for by private industry and sectional interest groups.
I support the setting up of a Federal Anti-Corruption Commission. I’m sure there’s corruption to be found. But this will make little difference to climate change mitigation. The campaigns the wealthy, the fossil fuel, mining and defence industries run are perfectly legal. They are immoral and damage the environment and they benefit the few greedy. I am a pessimist. I don’t know how to tackle the power and influence they wield.
Legal? My goodness! Then let’s make them illegal! Developers are banned from interfering in any way in NSW state politics. It’s called ‘change the rules’. Corporations aren’t actually allowed to vote in Australia (at the moment), so let’s use our democratic power to keep the bastards honest, and out of politics entirely. You might have picked that up from my original comment.
Come on Michael, there must be more policy options in your kit bag than this. Tell us what you really think!
It is pleasing to see that at long last you have “discovered” that inequality of income and wealth are major issues. It’s a pity that you couldn’t see this when you were in a position to do something about it.
Prof. Stephanie Kelton (MMT) teaches there are three purposes for taxation in a currency issuing country like Australia:
1. Inflation; an automatic stabilizer to withdraw money from the economy to manage inflation.
2. Maintain some semblance of an egalitarian society.
3. Modify peoples behavior.
The inequality “Wilpaulmalone” refers to represents a failure in our taxation system.
And a failure of our political system!
Of course Wilpaulmalone. The taxation system reflects the competence of our legislators and who pays them. -As does expenditure priorities!
Money is better than poverty, if only for financial reasons (Woody Allen)
We should give free money to everyone (Rutger Bregman)
Thank you Prof. Keating. I appreciate this contribution in the way it explains very clearly to someone like me without an economics background how demand and wage growth are related. I always wonder how the macroeconomics of international trade fits into the equation of wage growth and demand. I vaguely understand that Australia cannot have a viable home based only economy because we have too small a population and that we are dependent on international trade to bring in the bacon. For fear of sounding like a cracked vinyl record, the political elites of this country seem hell bent on destroying our external trade by making an enemy of our biggest trading partner, China. How will that affect our economy and the future of employment and jobs in this country? Does the government of the day consult experienced people like you before they decide to trade our bread and butter for something they call values? This idea of values above economic wellbeing seems to be also pervading the US. For this I quote what I read this morning in a column by Prof. Moon Chun-in in Hankyoreh. He cited Robert Wright:
“…warns that Biden’s foreign policy and national security advisors only pay lip service to liberal internationalism and actually hew closer to interventionism and progressive idealism. That means that values, rather than the national interest, could be used to justify military interventions, wars, and the loss of innocent lives.”
I think the public has the right to know how the reduction of trade with China and the alternative uptakes by other trading partners will shape our future. Where and how far will our “values” take us? I would love to read your opinion on this.
This economics is still being done without reference to climate change.