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Australia's Competitiveness: Reversing the Slide

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Three different measures of Australia's competitiveness all suggest Australia has a serious competitiveness problem and this is showing up in lower growth. Australia will not durably improve its competitiveness without serious fiscal and structural reform.
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06 SEPTEMBER 2014
06
A PUBLIC POLICY ANALYSIS PRODUCED FOR
THE MINERALS COUNCIL OF AUSTRALIA
TONY MAKIN
Australia’s competitiveness:
Reversing the slide
MINERALS COUNCIL OF AUSTRALIA
September 2014
TONY MAKIN
Australia’s competitiveness:
Reversing the slide
Tony Makin is Professor of Economics and Director of the Grith
APEC Study Centre at Grith University. He has previously served as
an International Consultant Economist with the IMF Institute based in
Singapore and as a senior economist in the Federal Departments of
Finance, Foreign Aairs and Trade, Treasury and Prime Minister and
Cabinet. He has a PhD from the Australian National University.
This paper has been sponsored by the Minerals Council of Australia,
but the views expressed are those of Professor Makin. Professor Makin
gratefully acknowledges constructive comments made by Henry
Ergas, John Kunkel and Ed Shann.
The Minerals Council of Australia represents Australia’s exploration,
mining and minerals processing industry, nationally and internationally,
in its contribution to sustainable economic and social development.
This publication is part of the overall program of the MCA, as endorsed
by its Board of Directors, but does not necessarily reflect the views
of individual members of the Board.
ISBN 978-0-9925333-1-1
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Copyright © 2014 Minerals Council of Australia.
All rights reserved. Apart from any use permitted under the
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publication may be reproduced, stored in a retrieval system or
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permission of the publisher and copyright holders.
Contents
Executive summary 7
Section 1 Australia’s international economic performance 13
International trade 17
The mining boom and the economy 19
Is the “Dutch disease” really a disease? 21
Economic growth 23
Section 2 Competitiveness: Measures and trends 27
Competitiveness measure 1: 31
The real exchange rate
Competitiveness measure 2: 36
The relative price of non-tradables to tradables
Competitiveness measure 3: 40
The World Economic Forum approach
Competitiveness and productivity 44
Section 3 How policy settings have worsened 49
our competitiveness
Expansionary fiscal policy at home 52
Expansionary monetary policy abroad 60
Section 4 Policies to reverse the slide 63
Reduce government spending 65
Manage the exchange rate? 69
Accelerate structural reform 70
Section 5 Conclusion 75
References 81
Endnotes 83
6MINERALS COUNCIL OF AUSTRALIA
Charts and tables
Charts
Chart 1 World commodity prices 19
Chart 2 Australia’s terms of trade vs other commodity exporters 20
Chart 3 Real gross domestic product vs real gross domestic income 22
Chart 4 Economic growth in Australia’s top 10 trading partners 24
Chart 5 Competitiveness vs productivity measures 30
Chart 6 Real eective exchange rate – trade weighted 34
Chart 7 The slide in competitiveness measure 1 35
Chart 8 The slide in competitiveness measure 2 39
Chart 9 The slide in competitiveness measure 3 42
Chart 10 The slide in multifactor productivity 44
Chart 11 Australia’s relative labour productivity 46
Chart 12 Federal government budget balance 56
Chart 13 Net capital flows 60
Tables
Table 1 Index of trade openness 16
Table 2 Australia’s top 10 two-way trading partners 2012 1 8
Table 3 WEF Global Competitiveness Index, 2013-14 rankings 43
Boxes
Box 1 Purchasing Power Parity and competitiveness 3 2
Chart B1 Currency undervaluation and overvaluation 33
Box 2 Government spending and competitiveness 54
Chart B2 Eect of increased government spending on R* 55
7
Since the turn of the century, Australia’s competitiveness has
collapsed, contributing to the economy’s rate of growth falling
below potential. Over this time, Australia has experienced an
unprecedented mining boom which sustained income growth
and minimised the macroeconomic impact of the global financial
crisis (GFC) in 2008-09, greatly assisted by the flexibility of the
exchange rate and strong trade ties to Asia, most notably China.1
However, the fact that Australia has not fared as badly as many
other advanced economies since then has bred complacency
in policy circles about the need to address a persistent
competitiveness problem.
Executive summary
EXECUTIVE SUMMARY
A key economic dierence between
Australia and other advanced
economies is the relative dominance
of commodity exports, which in turn
means high exposure to volatile
terms of trade (the ratio of export
prices to import prices). For roughly
a decade from 2002-03, booming
commodity prices, particularly for
coal and iron ore, greatly improved
Australia’s terms of trade. As well
as boosting national income and
spurring massive mining related
investment, the commodity price
boom contributed to a strengthened
real exchange rate (the nominal
exchange rate adjusted for
domestic inflation relative to
inflation in major trading partners).
While the boom-related
appreciation of the exchange rate
led to a loss of competitiveness,
this does not imply Australia has
been producing goods the rest
of the world no longer wants. On
the contrary, world demand for
Australia’s natural resources has
substantially increased.
Interpretations dier about
the mining boom’s impact on
Australia’s economy. On one hand,
the “Dutch disease” perspective
highlights the negative impact of
a higher real exchange rate on the
competitiveness of sectors outside
mining. A more plausible and
positive view emphasises pursuit
of the economy’s comparative
8MINERALS COUNCIL OF AUSTRALIA
advantage which has raised
national income and households’
international purchasing power.
A higher real exchange rate can
be seen as a necessary part of
adjustment to a new equilibrium.
From this perspective, the more
worrying factor has been the role
of domestic policies (notably fiscal
and industrial relations policies)
in aggravating competitiveness
problems. A central argument of
this Monograph is that Australia
will not durably improve its
competitiveness without serious
fiscal and structural reform,
including labour market reform.
Measures of competitiveness
reflect an economy’s ability to sell
goods and services to the rest of
the world and to compete against
goods and services produced
abroad. Competitiveness has
traditionally been gauged by the
standard measure of the real
exchange rate, or variants of it.
However, an alternative exchange
rate-based measure based on the
relative prices of non-tradables
(products not traded on world
markets) to tradables (products
which are, or which could be,
traded internationally) can also
be used for this purpose. This
relative price reflects the
opportunity cost of shifting
resources between the traded
and non-traded goods sectors.
A third, broader measure devised
by the World Economic Forum
(WEF) provides an alternative
approach. It aims to benchmark
individual economies based on
various “pillars” of economic
growth (for example, economic
institutions, macroeconomic
environment, product and labour
market eciency and technological
readiness), in the process linking
drivers of both competitiveness
and productivity.
Each of these measures has its
limitations. For instance, both
the traditional real exchange rate
and the alternative exchange
rate measure can be criticised for
being too narrow. Meanwhile, the
WEF measure may be criticised
for being too heavily influenced by
business perceptions. Nonetheless,
taken together, all three measures
have somewhat disturbingly
exhibited the same dramatic slide
over recent years.
The real exchange rate has been
up to 25 per cent stronger so far
this decade compared with the
previous decade average. As has
been noted widely, this is a key
reason Australia’s manufacturing,
tourism and the higher education
sectors in particular have found it
harder to compete internationally
than they did in the 1990s.
The alternative real exchange rate
measure based on the relative
9EXECUTIVE SUMMARY
prices of non-tradable goods and
services to the prices of tradable
goods and services reveals
competitiveness has deteriorated
by close to 30 per cent since the
late 1990s. This reflects a shift of
resources to the non-tradables
sector (including publicly-
provided services such as public
administration, education, health
and welfare) and away from the
tradable sector due to domestic
demand pressures.
The third metric, the WEF
competitiveness measure, also
shows Australia’s economic
performance has seriously
deteriorated since the turn of the
century. From being ranked in the
top 10 most competitive countries
in the world in the early 2000s,
Australia now ranks 21st – outside
the top 20 most competitive
countries for the first time.
These three measures sit alongside
trends in productivity, a distinctly
dierent measure, which has
attracted more attention in an
Australian context. Productivity
indicators have also shown a
marked deterioration over the
last decade suggesting there may
be insights to be gained from
examining those factors which bear
on both concepts.
Domestic and foreign
macroeconomic policy settings
have severely damaged Australia’s
Australia will not
durably improve
its competitiveness
without serious fiscal
and structural reform,
including labour
market reform.
10 MINERALS COUNCIL OF AUSTRALIA
competitiveness since the global
financial crisis by influencing
real exchange rate behaviour.
Specifically, overly expansionary
fiscal settings of federal and
state governments in Australia
in the wake of the crisis, settings
that have yet to be fully reversed,
contributed to the dollar’s strength
and have been a major home grown
source of the competitiveness
problem. In addition, foreign
central banks that implemented
expansionary monetary policies
to weaken their exchange rates
so as to improve their economies’
competitiveness, worsened
competitiveness here.
To reverse Australia’s
competitiveness slide, several
compatible policy responses are
needed. In the short to medium
term, fiscal consolidation in the
form of reduced government
spending at all levels of government
would lessen pressures on domestic
interest rates and the dollar, to
the benefit of all internationally-
exposed industries in the economy.
The Abbott Government has so
far undersold the importance of
fiscal consolidation to Australia’s
competitiveness and to future
economic growth. It should
broaden its fiscal repair message
beyond the need for government to
“live within its means”.
The Abbott
Government has
so far undersold
the importance of
fiscal consolidation
to Australia’s
competitiveness
and to future
economic growth.
11EXECUTIVE SUMMARY
Australia’s economic future is
inextricably bound to Asia whose
dynamism stems from highly
flexible goods, services and labour
markets and relatively low income
taxes. To become more competitive
in our region, there is therefore
an urgent need for structural
policy initiatives to make the
labour market more flexible and
to further reform the tax system.
And the more flexible is the labour
market, the more readily private
sector employment expands as
government’s call on resources
diminishes. Here again, the Abbott
Government should construct a
reform narrative more squarely
around the need to reverse the
slide in national competitiveness.
13
Australia’s
international
economic
performance
SECTION
01
14 MINERALS COUNCIL OF AUSTRALIA
15
It is widely recognised that the
mining boom has put pressure
on parts of the economy highly
exposed to international trade,
particularly via the exchange rate.
Less well appreciated is the degree
to which certain government
policies have clearly exacerbated
our competitiveness problems.
How competitive an economy is
determines how well it performs in
the international economic arena.
Measures of competitiveness reflect
an economy’s ability to sell goods
and services to the rest of the world
and to compete against goods
and services produced abroad.
Conventional price-based measures
of competitiveness dier from
productivity measures which gauge
how eciently the economy’s inputs
of labour, capital and technology
combine to produce these goods
and services. An economy can
have low levels and growth rates of
productivity and still be competitive,
if its costs and incomes, expressed
at world prices, are suciently low,
bolstering world demand for its
exports while reducing domestic
demand for imports. Hence
competitiveness has traditionally
focused on the expenditure or
demand side of the economy,
whereas productivity centres on
the output or supply side.
While Australia has outperformed most advanced economies
over the last two decades, our economic growth performance
in more recent times has not been strong. Growth has slowed
to below potential. Meanwhile, Australia has been performing
worse than it could have on both the competitiveness and
productivity fronts since the turn of the century.
SECTION 1
Australia’s international
economic performance
AUSTRALIA’S INTERNATIONAL ECONOMIC PERFORMANCE
16 MINERALS COUNCIL OF AUSTRALIA
Yet the two concepts are also
interconnected, with labour
market arrangements forming
one important common thread.
More fundamentally, economies
that are highly competitive and
productive experience higher
economic growth rates per head
which improves the overall living
standards of its citizens.
While a number of studies have
focused on productivity trends in
Australia in recent years, the concept
of competitiveness has attracted
rather less attention.2 Redressing this
situation is an important motivation
for this Monograph. Before focusing
on measures of competitiveness, it
is useful to provide some context
on the Australian economy’s
international trade profile and
growth performance since the turn
of the century.
Country 1992
(%)
2012
(%)
Australia 33 42
Canada 55 61
China 36 52
India 18 55
Indonesia 53 50
Japan 17 31
Korea, Republic of 54 110
Malaysia 151 162
Mexico 36 67
New Zealand 59 59
Phillippines na 65
Russia na 52
South Africa 39 60
Thailand 78 149
United Kingdom 51 65
United States 20 30
Source: World Bank
Index of trade openness (exports plus imports, %GDP)Table 1
17
International trade
Australia is usually regarded as a
highly internationalised economy,
one that is heavily integrated with
the global economy. Yet, compared
with many other economies, this
is not the case. Many emerging
economies, as well as many
advanced economies, are more
open to international trade and
investment. Table 1 shows that,
according to a broad measure
of trade openness computed as
the sum of exports and imports
expressed as a proportion of gross
domestic product (GDP), Australia is
less open to international trade than
many of its major trading partners.
This in itself may be indicative
of a lack of international
competitiveness, although it also
reflects relatively high international
transport costs (due to distance,
among other factors) and a classic
form of trade specialisation based
on large resource endowments
(with very low levels of intra-
industry trade compared with many
other industrialised economies).
Most fast growing Asian emerging
economies are significantly more
integrated with the global economy
than Australia. Measured as a
percentage of national production,
Australia’s exports are close to 20
per cent, whereas the proportions
for large faster growing emerging
economies like China, India, Russia
and South Africa are higher. Relative
Most fast growing
Asian emerging
economies are
significantly more
integrated with
the global economy
than Australia.
AUSTRALIA’S INTERNATIONAL ECONOMIC PERFORMANCE
18 MINERALS COUNCIL OF AUSTRALIA
import shares for these economies
show a similar pattern in that they
are mostly higher than Australia’s.
From a competitiveness perspective
it is also worth noting that more
than 70 per cent of Australia’s trade
is with countries that are members
of the Asia-Pacific Economic
Co-operation (APEC) forum. Of
its major trading partners, eight of
the top 10 are APEC members on
the basis of two-way trade, with
the top three – China, Japan and
the United States – also the world’s
three largest economies. The United
Kingdom is the only European
OECD country which ranks in
the top 10 of Australia’s trading
partners and then accounts for less
than 4 per cent of total two-way
trade (Table 2).
Total top 10 65.8
Source: Department of Foreign Aairs and Trade
Australia’s top 10 two-way trading partners 2012 (% share)Table 2
1 China 20
2 Japan 11.4
3 United States 9.0
4 South Korea 5.1
5 Singapore 4.7
6 United Kingdom 3.6
7 New Zealand 3.4
8 Thailand 3.0
9 Malaysia 2.8
10 India 2.8
19
The mining boom and
the economy
By international standards,
Australia has a very large per
capita endowment of exploitable
natural resources which exposes
the economy to highly cyclical
movements in world commodity
prices.3 Exports of commodities,
the largest being iron ore and
coal, account for well over half
of Australia’s exports, whereas
imports are mainly manufactures.
Prices received for commodity
exports rose markedly in the first
decade of the 21st century, giving
rise to a major improvement in the
terms of trade (the ratio of export
prices to import prices). Despite a
retreat in mineral commodity prices
in the last three years, Australia’s
terms of trade remain well above
the long-term average.
Chart 1 shows that in the last decade
world commodity prices have been
exceptionally high by the standards
of the 1980s and 1990s. Commodity
prices, especially for minerals,
rose markedly above historical
norms from 2000 onwards, with
the exception of a V-shaped dip
during the GFC.4 Prior to that prices
fluctuated considerably, but around
a relatively flat trend line.
Based on the proportion of
commodity exports in total exports,
it so happens that, contrary to
popular perception, a select group
of advanced economies – Australia,
Source: Reserve Bank of Australia
World commodity prices (2012–13=100)Chart 1
SDR US$
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2006
2012
2008
2014
2004
2010
140
120
100
80
60
40
20
0
140
120
100
80
60
40
20
0
Index
2012-13=100
Index
2012-13=100
AUSTRALIA’S INTERNATIONAL ECONOMIC PERFORMANCE
20 MINERALS COUNCIL OF AUSTRALIA
Canada, New Zealand and Norway
– are more heavily reliant on
commodity exports than many
developing commodity exporters
in Asia and Latin America.5 Indeed,
after declining slightly for three
decades, commodity exporting
advanced economies (CEAEs)
increased their dependence on
commodity exports significantly
from 2000, with their commodity
exports reaching an average of 60
per cent of total exports in 2010.
Moreover, Australia appears more
exposed to fluctuations in the terms
of trade than other commodity
exporters, including those with which
we compete directly (Chart 2).
Source: International Monetary Fund 2014a
Australia’s terms of trade vs other commodity exporters (2000=100)Chart 2
New Zealand Canada Brazil
South Africa Australia
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
200
180
160
140
120
100
80
200
180
160
140
120
100
80
Index
2000=100
Index
2000=100
21
Is the “Dutch disease” really
a disease?
There are conflicting interpretations
of the eects on an economy of a
positive terms of trade “shock” like
that experienced by Australia in
the early 21st century. A pessimistic
view highlights “Dutch disease”
eects, a term coined by The
Economist magazine to convey the
plight of the Netherlands in the late
1970s. Following the discovery and
export of large reserves of natural
gas from the North Sea, the (pre-
euro) Dutch guilder appreciated
significantly. This was widely
seen as harming international
competitiveness, causing the Dutch
manufacturing sector to contract.
This perspective stresses the
loss of competitiveness due to
real exchange rate appreciation.
Relatedly, volatility in the terms
of trade is considered to impact
on long-run economic growth.6
Resource booms can also adversely
aect the level and quality of public
spending which can feed back to
aggravate the cyclical eect of the
upswing. Hence the argument that
a sudden expansion of commodity
exports may be oset by costs
borne by traditional industries
elsewhere in the economy.
In contrast, an optimistic view of
a resources boom interprets it as
a national income windfall.7 This
more positive view starts from
the presumption that Australia’s
commodity specialisation is
appropriate from an international
trade theory perspective, reflecting
the pursuit of the economy’s
comparative advantage in
commodities. On this interpretation,
industry restructuring is necessary
to capture gains in income with
necessary resource reallocation
signalled by relative price changes.
Hence, it is not really a disease at all.
Higher commodity prices increase
the economy’s international
purchasing power. This enables
higher national spending, including
on imports, and implies a rise in
Australia’s overall standard of
living. In the national accounts,
a separate measure of national
income adjusted for changes in the
economy’s terms of trade called
real gross domestic income (RGDI)
captures this improved international
purchasing power eect.
The RGDI measure reflects the
fact that the economy earns more
income when the prices it receives
for its exports of goods and
services rise relative to the prices it
has to pay for its imports of goods
and services. In other words, under
these circumstances a given volume
of exports can pay for a larger
volume of imports which means
the economy in eect has higher
income. On this income measure, the
Australian economy has performed
much better in recent years than
AUSTRALIA’S INTERNATIONAL ECONOMIC PERFORMANCE
22 MINERALS COUNCIL OF AUSTRALIA
the standard real gross domestic
product (RGDP) data would
indicate (as shown in Chart 3).
In short, interpreting the impact
of high commodity prices on
the economy as a disease is a
misdiagnosis. A better physical
analogy may be to think that
high commodity prices act like
a performance-enhancing drug
on the economy, but one which
has side-eects. These are best
dealt with by initiatives that
ensure maximum flexibility in the
economy’s product and factor
markets, including initiatives to
improve labour mobility. Moreover,
in the longer run the higher
savings typically associated with
terms of trade gains, along with
increased immigration of skilled
labor and foreign investment, will
augment existing factor inputs,
thereby enabling an expansion of
national product.
Source: Australian Bureau of Statistics
Real gross domestic product vs real gross domestic incomeChart 3
Real gross domestic product Real gross domestic income
Mar 1994
Mar 1995
Mar 1996
Mar 1997
Mar 1998
Mar 1999
Mar 2000
Mar 2001
Mar 2002
Mar 2003
Mar 2004
Mar 2006
Mar 2009
Mar 2012
Mar 2011
Mar 2014
Mar 2007
Mar 201 0
Mar 201 3
Mar 2005
Mar 2008
150
140
130
120
110
100
90
80
70
60
150
140
130
120
110
100
90
80
70
60
Index
2003-04=100
Index
2003-04=100
23
Economic growth
Australia’s long-term real GDP
growth rate as measured by
average annual real GDP over the
past half century has been more
than 3 per cent, although annual
growth rates tended to exceed this
long-run rate during periods of
productivity-enhancing economic
reform. But since the GFC of
2008-09, economic growth has
fallen below its long-term trend.
During the Rudd-Gillard-Swan era,
per capita GDP grew on average
less than 1 per cent per annum,
less than the almost 2.5 per cent
average rate of the Howard-
Costello years. In no single year
between 2008 and 2012 did
economic growth per head exceed
2 per cent per annum which had
hitherto been the norm.
While Australia’s growth rate in
the wake of the GFC looks good
by European standards, this is a
very poor benchmark. In ocial
commentary, the floundering
European economies were
incongruously treated as Australia’s
economic peers, even though
international trade links with Europe
were minimal compared with Asia.
In the wake of the GFC, it was Asia
that pulled the Australian economy
along by buying commodities
at elevated prices while mining
investment rose strongly to exploit
Asian growth. Yet Australia has
still registered sub-normal growth
in recent years – despite a mining
boom without historical precedent
and a $95 billion budgetary
stimulus by the Australian
Government in response to the
GFC; a response that in the end did
more harm than good.
In short, the mining boom could
not compensate for a worsening of
competitiveness and productivity.
Australia’s escape from the worst
eects of the financial crisis
bred complacency about the
need to address competitiveness
and productivity problems via
economic reform. Improving
competitiveness remains critical to
restoring economic growth to its
long-term average rate.
Comparing Australia with an
OECD outlook centred on Europe
is especially misleading since
Australia now has limited two-way
international trade with that part
of the world. A simple comparison
with Australia’s major trading
partners in Asia shows that growth
in most Asian economies has
consistently exceeded Australia’s
by a significant margin. Chart 4
shows Australia’s average annual
growth since 2009 has been
easily exceeded by China, India,
Malaysia, Singapore, South Korea
and Thailand, even though some
of these economies experienced
recessions in the immediate
aftermath of the crisis.
AUSTRALIA’S INTERNATIONAL ECONOMIC PERFORMANCE
24 MINERALS COUNCIL OF AUSTRALIA
One obvious reason for this higher
growth is that Australia, as an
advanced economy, is much closer
to its technology frontier; we have
a capital stock per capita that is
a multiple of those in China and
other Asian economies, most of
which have a way to catch up both
in terms of capital stock and in
terms of productivity levels. Yet this
is not the full story.
Sub-normal growth has
occurred due to worsened
competitiveness and productivity.
Without improvement in both
competitiveness and productivity,
Australia will fail to take advantage
of new opportunities in Asia, in the
process constraining the domestic
speed limit for economic growth.
For all the talk about Australia
seizing opportunities in Asia, the
great anomaly is that the economic
policy mindset in Australia has
closely resembled that which
has served Europe so badly. For
instance, in the European tradition,
the labour market has become less
flexible in recent years, company
and marginal income tax rates
Sources: Asian Development Bank 2014, International Monetary Fund 2014b.
Economic growth in Australia’s top 10 trading partners
(annual average growth 2009-13, %)
Chart 4
Australia
China
India
Japan
Malaysia
New Zealand
Singapore
South Korea
Thailand
United Kingdom
United States
10
9
8
7
6
5
4
3
2
1
0
-1
10
9
8
7
6
5
4
3
2
1
0
-1
% %
2.5
8.9
7.9
0.3
4.3
1.5
5.4
3.0 3.0
1.2
-0.1
25
remain high by Asian standards
(and in some cases even by OECD
standards), future entitlement
expectations have been raised and
income redistribution has become
an overarching policy goal, though
without any specific income
distribution target in mind. Add to
this a preoccupation with climate
change policy and the quest
for compatibility with Europe’s
emissions trading scheme.
Such policy priorities sit oddly with
the eciency enhancing orientation
of Asian economic policies aimed at
expanding production as the route
to higher living standards.
How then do we measure
competitiveness? The next section
canvasses three competitiveness
measures – all of which point to
significant deterioration over the
past decade, implying that corrective
policy action is overdue.
For all the talk about
Australia seizing
opportunities in Asia,
the great anomaly is
that the economic policy
mindset in Australia
has closely resembled
that which has served
Europe so badly.
AUSTRALIA’S INTERNATIONAL ECONOMIC PERFORMANCE
27
Competitiveness:
Measures and trends
SECTION
02
28 MINERALS COUNCIL OF AUSTRALIA
29
There are several dierent ways to gauge an economy’s
competitiveness. This Monograph focuses on three key measures:
the real exchange rate, the ratio of the prices of non-tradable to
tradable goods and services and the more multi-dimensional
World Economic Forum approach.
SECTION 2
Competitiveness:
Measures and trends
First, the real exchange rate has
traditionally been used to convey
the degree to which domestic
producers can compete on price
grounds with suppliers of goods
and services in other economies.
Real exchange rate measures
along this line vary according to
the weighting system used for the
currencies of trading partner or
competitor economies.
Second, an alternative exchange
rate measure is based on the
relative prices of non-tradables to
tradables. A rise in this ratio implies
that domestic labour and capital
resources are drawn away from
industries competing on world
markets to industries producing
goods and services that are not
traded internationally.
Third, the World Economic
Forum publishes annually a
broader competitiveness measure.
This measure of competitiveness
aims to comprehensively account
for key economic, social and
environmental variables in order to
benchmark individual economies’
overall performance and identify
specific areas of economic strength
and weakness.
Competitiveness is often talked
about in the same breath as
productivity, but it is important
to understand the conceptual
dierences. Multifactor and other
partial productivity measures,
such as capital productivity and
labour productivity, dier from
competitiveness insofar as they
primarily focus on how eciently
factor inputs are combined in
production without explicit regard
to other economies’ performance
or international trade dimensions.
Of the three competitiveness
COMPETITIVENESS: MEASURES AND TRENDS
30 MINERALS COUNCIL OF AUSTRALIA
measures examined in this
paper, the one that does have
a productivity dimension is the
WEF measure. Chart 5 provides
a schematic for thinking about
competitiveness and productivity.
Each of the three competitiveness
measures outlined here has its
limitations, so care should be
taken in using them on their own.
However, when taken together, they
all embody elements of Australia’s
competitiveness problem. And they
all have exhibited a disturbingly
similar slide over recent years.
Competitiveness vs
productivity measures
Chart 5
Competitiveness
Real exchange rate:
trade, export, import, competitor
country, GDP, capital account weighted
Non-tradable to tradable price ratio
Productivity
Multifactor
Capital
Labour
Sectoral
World Economic
Forum ranking
Each of the three
competitiveness
measures ...
have exhibited
a disturbingly
similar slide
over recent years.
31
Competitiveness measure 1:
The real exchange rate
The exchange rate is arguably the
single most important price for
an economy which is significantly
integrated with goods, services
and asset markets in the rest of
the world. Exchange rate changes
alter the prices of domestically-
produced goods and services
relative to goods and services
produced in other countries. Hence,
they aect the profitability of all
exporting industries and of import
competing industries, as well as the
cost of importing from abroad.
Movements in the multilateral
(or eective) measure of the
exchange rate, the Trade Weighted
Index (TWI), indicate “average”
movements of the exchange
rate against the currencies of an
economy’s major trading partners.
The “real” eective exchange
rate (the nominal exchange rate
adjusted for domestic inflation
relative to inflation in major trading
partners) is the conventional
index of competitiveness used
by economists.
Competitiveness by this measure
either improves or worsens over
the short term due to nominal
exchange rate movements or
due to domestic prices or costs
changing in relation to prices or
costs of major trading partners.
In reality, nominal exchange rates
are far more variable than price
levels, inflation rates or labour
costs. Hence swings in nominal
exchange rates account for most
real exchange rate movements over
shorter periods.
Real exchange rate movements
are important over short
periods because they impact
on real activity, particularly
export and import volumes
and the profitability of local
industries. Large appreciations
make exports of goods and
services more expensive from
foreign buyers’ perspective,
simultaneously making imported
goods and services cheaper than
domestically produced products.
Hence real appreciations worsen
the economy’s international
competitiveness while real
depreciations improve it in the
short term.
The age-old purchasing power
parity (PPP) theory of exchange
rates (see Box 1) implies that
the real exchange rate should
gravitate back to its long-run value
through time and that the real
exchange rate is either overvalued
or undervalued if it rises above, or
falls below, the long-run average
for extended periods.
COMPETITIVENESS: MEASURES AND TRENDS
32 MINERALS COUNCIL OF AUSTRALIA
Purchasing Power Parity is the most durable long-run theory
of the exchange rate which links exchange rate movements to
changes in national price levels and inflation rates.
PPP has a long history, dating
back to the writings of the
classical British economists,
David Hume and David
Ricardo. The modern form
of PPP is attributed to the
Swedish economist Gustav
Cassel who revived the idea
after the First World War. Since
the breakdown of the Bretton
Woods fixed exchange rate
system in the early 1970s, a
large academic literature has
focused on this approach to
exchange rate movements.
The absolute version of PPP can
be understood as a long-run
equilibrium condition for the
exchange rate. It simply states
that in long-term equilibrium
the domestic price level (P)
should be equal to the foreign
price level (P*) when converted
by the equilibrium eective
exchange rate (e).
That is – where e
is defined as the price of
Australian dollars per unit of
foreign currency. If we define
the real exchange rate as
and PPP holds, then the value
of the real exchange rate is
unity (1) because the numerator
equals the denominator in this
expression. Any deviation in
the real exchange rate above
or below unity can therefore
be interpreted as a change in
international competitiveness
with values above unity
implying an improvement in
competitiveness and values
below implying a worsening in
competitiveness.
The PPP approach can also be
used to gauge whether particular
exchange rates are overvalued
Purchasing Power Parity and competitivenessBox 1
33
Currency undervaluation and overvaluationChart B1
Source: Makin 2002.
Exchange
rate
($A/FX)
Undervalued region
(gain in competitiveness)
Actual value
Implied
PPP value
Overvalued region
(loss in competitiveness)
Time
or undervalued compared with
an implied PPP value, with PPP
providing a long-run equilibrium
condition for the exchange rate.
The notions of undervaluation
and overvaluation of the
nominal exchange rate relative
to implied equilibrium exchange
rate values are illustrated in
Chart B1. Note that when the
local currency is undervalued,
competitiveness improves
whereas competitiveness
worsens when the local
currency is overvalued.
COMPETITIVENESS: MEASURES AND TRENDS
34 MINERALS COUNCIL OF AUSTRALIA
As Chart 6 shows, over the longer
term Australia’s real exchange
rate measured in trade weighted
terms has exhibited mean-reverting
behaviour for the most part by
gravitating back to its long-run
average value.
Nonetheless, since the turn of
the century the real exchange
rate has appreciated significantly,
the exception being the sharp
depreciation that occurred at
the height of the GFC. The real
exchange rate has been up to 25
per cent stronger so far this decade
compared with the previous
decade average, a key reason
Australia’s manufacturing, tourism
and higher education sectors
have found it harder to compete
internationally on price grounds
than they did in the 1990s. On
a PPP basis, the dollar has been
substantially overvalued in real
terms for an extended period of
time, implying a significant loss
of competitiveness among trade-
exposed sectors.
Chart 7 inverts the left axis values
in Chart 6 to better convey the
slide in competitiveness by this
measure. The Reserve Bank of
Australia publishes other measures
of the real exchange rate weighted
by import and export shares rather
than two-way trade which convey
essentially the same picture.
Source: Reserve Bank of Australia
Real eective exchange rate – trade weighted (1971–2014)
Chart 6
Real exchange rate Average
Mar 1971
Mar 1973
Mar 1975
Mar 1977
Mar 1979
Mar 1981
Mar 1983
Mar 1985
Mar 1987
Mar 1989
Mar 1991
Mar 1995
Mar 2001
Mar 2007
Mar 2005
Mar 2011
Mar 2013
Mar 1997
Mar 2003
Mar 2009
Mar 1993
Mar 1999
190
170
150
130
110
90
70
Index
March 1995=100
Index
March 1995=100
190
170
150
130
110
90
70
35
An even more revealing picture
of export competitiveness could
be derived based on countries
Australia competes with, rather
than major export markets.8 Such
a measure could include the
currencies of commodity exporting
rival countries – for example,
Canada, Brazil, Indonesia and South
Africa. Other conceptual variants
of the standard measure of the real
exchange rate include a measure
using domestic labour costs
relative to those abroad. Instead of
composite foreign price levels, this
measure expresses competitiveness
in terms of relative production
costs, a measure once published by
the Australian Treasury. Eective
exchange rates can also in principle
be weighted by GDP or sources of
foreign capital.9
While PPP is useful as an indicator
of long-term exchange rate
movements, many factors influence
Australia’s exchange rate over the
short to medium term causing
deviations from its long-run
equilibrium value. In particular,
federal and state budget deficits
in Australia have contributed to
real exchange rate appreciation by
ramping-up government borrowing,
the bulk of which has been financed
by foreign capital inflow. Another
macroeconomic factor influencing
the dollar has been excessive
monetary expansion abroad relative
to Australia’s monetary stance, most
notably by the United States Federal
Source: Reserve Bank of Australia
The slide in competitiveness measure 1 (R)Chart 7
Jun 1998
Jun 1999
Jun 2000
Jun 2001
Jun 2002
Jun 2003
Jun 2004
Jun 2006
Jun 2009
Jun 2012
Jun 2011
Jun 2007
Jun 2010
Jun 2013
Jun 2005
Jun 2008
80
90
100
110
120
130
140
150
160
170
R
COMPETITIVENESS: MEASURES AND TRENDS
36 MINERALS COUNCIL OF AUSTRALIA
Reserve’s “quantitative easing”
program which has been mimicked
on smaller scales by the central
banks of the United Kingdom
and Japan.
World prices received for Australia’s
commodity exports have also long
been considered an underlying
medium-term determinant of
Australia’s exchange rate, reflecting
the dollar’s “commodity currency”
status.10 Although commodity prices
have fallen notably since 2011, the
trade weighted exchange rate has
remained high by historical standards
due to domestic and foreign
macroeconomic policy settings.
The reasons for the deviation from
the PPP equilibrium value of the
exchange rate will be explored
subsequently in greater detail.
For a number of reasons, the theory
of purchasing power parity needs
qualification. Among them are
varying weights used in national
price indexes, the eect of trade
restrictions and transport costs,
as well as the fact that a large
proportion of goods and services
produced and consumed in the
economy are not internationally
tradable. This last factor in particular
motivates discussion of a second
competitiveness measure.
Competitiveness measure 2:
Relative price of non-
tradables to tradables
Another way to measure
the economy’s international
competitiveness is to gauge how
the prices of non-tradable goods
and services behave relative to
the prices of tradable goods
and services. This perspective is
based on the assumption that an
economy produces and consumes
these two distinct classes of goods
and services. The prices of non-
tradables are set by domestic
demand and supply factors,
whereas the foreign currency prices
of tradable goods and services
are set in world markets, and
converted to domestic values via
the prevailing exchange rate.
In essence, tradables are goods and
services which can potentially be
bought and sold on world markets.
They consist of exports, imports,
close substitutes for exports (such
as coal used for domestic power
generation) and import competing
goods (such as locally brewed beers).
In other words, tradables include
domestic production which is not
necessarily shipped abroad, but
which is nonetheless subject to the
forces of international competition.
The nominal exchange rate
translates foreign currency prices
of tradables into domestic currency
37
values, and if domestic producers
and consumers exercise limited
market power they can export
and import any particular good
or service without aecting its
price. The share of tradable output
in GDP is another measure of an
economy’s trade openness and is
likely to be larger than the simple
trade openness measure of the
value of exports and imports
relative to GDP.
Non-tradables, on the other
hand, are those domestically
produced goods and services
which are eectively isolated
from the eects of international
competition and whose prices
are therefore determined by the
forces of domestic demand and
supply. Services, including public
administration, health services,
legal advice, school education,
construction and entertainment,
are among the most obvious
non-tradables.
The key characteristic of non-
tradables, a portion of which is
non-market traded and therefore
valued in the national accounts
at labour cost, is that they are
provided exclusively to domestic
residents and hence cannot be
bought or sold by foreigners.
Apart from public and private
services, some commodities and
merchandise goods are also non-
tradable, especially if international
transport costs are high, making
shipment unprofitable, or if the
goods are perishable in some
sense. Ready mixed concrete is a
good example of a non-tradable
good. Artificial trade barriers, such
as prohibitive taris and quotas,
can also make goods and services
non-tradable in practice.
For the purposes of this discussion,
a second measure of an economy’s
competitiveness is reflected in the
ratio of the prices of goods and
services in the non-tradable sector
(PN) of the economy relative to
prices paid or received for goods
and services paid or received for
goods and services produced
in the tradable sector (PT), this
sector being the sector exposed
to competition from the rest of the
world. If we denote this particular
measure of competitiveness as R*,
then
N
T
P
R* P
=
.
On this basis, if non-tradables
prices are rising faster than
tradables prices, competitiveness
is worsening, whereas if the prices
of tradables are rising faster
than those of non-tradables,
competitiveness is improving. From
a production perspective, if this
ratio is rising labour and capital will
be drawn away from the tradable
sector to the non-tradable sector.
Hence a diminishing share of the
economy’s output will be exposed
to international competition,
other things the same. The result
COMPETITIVENESS: MEASURES AND TRENDS
38 MINERALS COUNCIL OF AUSTRALIA
is de-internationalisation of the
economy’s production. At the same
time, domestic consumption of
relatively cheaper tradables will
increase, thereby adding to the
import bill and widening the
trade deficit.
In other words,this relative price
reflects the opportunity cost of
shifting resources between the
traded and non-traded goods
sectors. As increased demand
for non-traded goods raises their
relative price, and increases the
opportunity cost of using resources
in the traded goods sector, a
country’s competitiveness declines,
and conversely when the price of
non-traded goods falls relative
to that for traded goods. The
relative price (and changes in that
relative price) therefore measure
the pressures on an economy’s
competitiveness.
Chart 8 illustrates that based
on this measure Australia’s
competitiveness has deteriorated
over the past 15 years, sliding by
close to 30 per cent. Again, left
axis values have been inverted
in the Chart to convey the
competitiveness slide based on
this second measure.
The dramatic decline in Australia’s
competitiveness from before the
turn of the century according to
this alternative measure reflects
the fact that inflation in the
non-tradables sector, mainly
services (including publicly
provided services such as public
administration, education, health
and welfare) has persistently
exceeded the rate of growth in
the prices of tradable goods and
services.
Prices of tradable goods and
services are influenced by the value
of the exchange rate and have
usually grown by less than the
Reserve Bank’s 3 per cent upper
target limit for overall inflation over
recent years. Meanwhile, inflation of
non-tradables, mainly services not
aected by the exchange rate, has
tended to exceed 3 per cent.
Over the longer term, a fall in the
value of this measure can also
reflect an underlying trend decline
if the goods sector, which is largely
tradable, has faster productivity
growth than the services sector,
which includes many non-
tradables. If wages rise similarly
across both sectors, non-tradables
prices would increase more over
the longer term than tradables
prices, other things equal.11 In
recent years, however, this has
not been the case, as productivity
performance in many non-tradable
industries, including construction,
financial services and transport
services has actually outperformed
productivity in the key tradables
sectors, mining, agriculture and
manufacturing.12
39
Source: Reserve Bank of Australia
Note: The ratio of non-tradables to tradables prices based on ocial CPI data
The slide in competitiveness measure 2 (R*)
Chart 8
Jun 1998
Jun 1999
Jun 2000
Jun 2001
Jun 2002
Jun 2003
Jun 2004
Jun 2006
Jun 2009
Jun 2012
Jun 2011
Jun 2007
Jun 2010
Jun 2013
Jun 2005
Jun 2008
0.7
0.75
0.8
0.85
0.9
0.95
1
1.05
1.1
R*
The so-called Balassa-Samuelson
hypothesis is also relevant here.13
It proposes that inflation rates
and hence real exchange rates
should be higher in faster growing
economies with relatively more
productive tradables sectors than
in slower growing economies,
although empirical support for this
hypothesis is mixed across a range
of countries.
As increased demand
for non-traded goods
raises their relative
price, and increases
the opportunity cost
of using resources
in the traded goods
sector, a country’s
competitiveness
declines...
COMPETITIVENESS: MEASURES AND TRENDS
40 MINERALS COUNCIL OF AUSTRALIA
Competitiveness measure 3:
The World Economic Forum
approach
Apart from these exchange
rate-based measures of
competitiveness, there is a
more comprehensive measure
published annually by the World
Economic Forum in its annual Global
Competitiveness Report. The WEF
competitiveness rankings now
cover 148 economies, capturing
elements of both an alternative
competitiveness measure and a
productivity measure.
Produced under the direction of
Professor Xavier Sali-i-Martin from
Columbia University and a team of
economists in collaboration with
a global partnership of relevant
organisations,14 it combines a
large dataset covering a wide
range of economic and social
indicators from sources including
the International Monetary Fund,
Organisation for Economic Co-
operation and Development,
International Labour Organisation,
the World Bank, World Trade
Organisation, and World Health
Organisation. These data are
combined with results from the
World Economic Forum’s annual
Executive Opinion Survey, which
garners the views of more than
13,000 business leaders worldwide
on dierent dimensions of national
competitiveness.
The WEF measure scores and
ranks countries across a range of
economic indicators for a set of
so-called “pillars” that are thought
to drive economic growth. These
pillars are individual economies’
institutions, infrastructure,
macroeconomic environment,
health and education, product
market eciency, labour market
eciency, financial market
development, technological
readiness, market size, business
sophistication and innovation.
Disaggregated scores are published
for each of these pillars.
The survey component, which
accounts for well over half of the
overall weighting of the results, is a
clear limitation of the WEF measure
to the extent it colours the rankings
according to business perceptions.
While business perceptions about
an economy are not irrelevant in
the global trading environment, the
sharp deterioration in perceptions
about labour market eciency
does seem to have exaggerated the
fall in Australia’s ranking.
In view of this limitation and a
degree of opaqueness about
construction of the WEF measure,
it should therefore be used
with care. The WEF measure
nonetheless has important
strengths based on the range of
factors bearing on competitiveness
that it looks to capture. And while
specific rankings at any point in
41
time may be debatable, the WEF
measure also has the virtue of
providing a consistent means of
tracking relative movement through
time. Notwithstanding possible
methodological deficiencies, the
onus is on critics of this longstanding
internationally-recognised measure
to make a case to the WEF for
remedying any perceived problems.
For the purposes of this Monograph,
what is striking is the extent to
which movements in the WEF
competitiveness measure mirror
other measures. Chart 9 shows that
Australia’s economic ranking has
seriously deteriorated since the
turn of the century. After declining
sharply from the beginning of the
century, there was some recovery
later in the 2000s, but the decline
has resumed since then.
In the early 2000s, Australia
was ranked in the top 10 most
competitive countries in the
world. However, the 2013-14
Global Competitiveness Report has
Australia ranked 21st, outside the
top 20 most competitive countries
in the world for the first time. New
Zealand has overtaken Australia to
come in 18th in the 2013-14 report, up
five places over the previous year.
Table 3 outlines the range of other
economies that now rank above
Australia – in descending order,
Switzerland, Singapore, Finland,
Germany, the United States, Sweden,
The 2013-14 Global
Competitiveness
Report has Australia
ranked 21st, outside
the top 20 most
competitive countries
in the world for the
first time.
COMPETITIVENESS: MEASURES AND TRENDS
42 MINERALS COUNCIL OF AUSTRALIA
Hong Kong, the Netherlands,
Japan, the United Kingdom,
Norway, Taiwan, Qatar, Canada,
Denmark, Austria, Belgium, United
Arab Emirates and Saudi Arabia.
The overall WEF ranking for any
country reflects both strengths
and weaknesses in the way its
economy works. Notable positives
for Australia are its well-developed
financial system (ranked 8th in
the world) and its banking sector
in particular (ranked 5th). The
standard of higher education
and training (ranked 11th) is also
noteworthy. The standout weak
points continue to be a highly
inflexible labour market and
excessive government regulation.
Ironically, the labour market has
become less flexible when massive
structural change in the economy
due to the mining boom implies
greater flexibility is needed.
Debate continues about the
relationship between the degree
of labour market flexibility and
overall productivity, particularly
since the conventional measures of
productivity fail to show a strong
relationship between the degree
of flexibility and productivity
growth. But as Australia’s WEF
competitiveness ranking implies, it
may well be that the conventional
productivity measures inadequately
capture the significance of labour
market flexibility. This issue is
examined later in this paper.
Source: World Economic Forum (Annual Global Competitiveness Reports)
Note: Left axis shows Australia’s WEF competitiveness ranking
The slide in competitiveness measure 3Chart 9
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2009-10
2013-14
2012-13
2010-11
2008-09
2011-12
1
5
9
13
17
21
25
Rank
43
Country/economy Rank
(out of 148)
Switzerland 1
Singapore 2
Finland 3
Germany 4
United States 5
Sweden 6
Hong Kong SAR 7
Netherlands 8
Japan 9
United Kingdom 10
Norway 11
Taiwan, China 12
Qatar 13
Canada 14
Denmark 15
Austria 16
Belgium 17
New Zealand 18
United Arab Emirates 19
Saudi Arabia 20
Australia 21
Luxembourg 22
France 23
Malaysia 24
Korean, Rep. 25
Brunei Darussalam 26
Israel 27
Ireland 28
China 29
Puerto Rico 30
Source: World Economic Forum (2013-14 Global Competitiveness Report)
WEF Global Competitiveness Index, 2013-14 rankingsTable 3
COMPETITIVENESS: MEASURES AND TRENDS
44 MINERALS COUNCIL OF AUSTRALIA
Competitiveness and
productivity
By explicitly examining supply-
side factors of economies such
as institutions, labour markets,
infrastructure, technology and
business sophistication, the WEF
approach merges areas traditionally
thought to influence both
competitiveness and productivity.
The most comprehensive measure
of productivity – multifactor
productivity – reveals how
eciently the market sector is
combining the economy’s human
resources with capital, technology
and natural resources in generating
production.
Chart 10 shows that after improving
in the late 1990s, MFP has been
declining in line with the fall in
competitiveness since 2003-04.
Productivity according to this
broad measure has yet to recover
to the high levels achieved in
the 1990s. In terms of partial
productivity measures, labour
productivity fell in most years over
the past decade and there has
been an even more marked decline
in capital productivity which has
contributed to poor multifactor
productivity.15
The standout period of MFP
growth of 2 per cent per
Source: Australian Bureau of Statistics
Note: Multifactor productivity, quality adjusted hours worked index measure
The slide in multifactor productivityChart 10
108
106
104
102
100
98
96
94
Index
June 2012=100
Jun 1998
Jun 1999
Jun 2000
Jun 2001
Jun 2002
Jun 2003
Jun 2004
Jun 2006
Jun 2009
Jun 2012
Jun 2011
Jun 2007
Jun 2010
Jun 2013
Jun 2005
Jun 2008
45
annum in the second half of the
1990s resulted from significant
economic reforms initiated by
federal and state governments of
both political persuasions. This
wide-ranging reform eort that
began in the 1980s increased
the degree of competition faced
by Australian firms and reduced
business uncertainty. Reforms
included financial deregulation,
tari reductions, partial foreign
investment liberalisation,
privatisation, greater commercial
focus in the provision of economic
infrastructure, and greater
flexibility in labour markets.
Simultaneously, there was increased
internationalisation of the economy,
a shift to a lower inflation regime,
greater fiscal responsibility, and
more extensive education and
training of the workforce.
Productivity improved not
only relative to past trends but
compared with most other OECD
nations, suggesting the information
technology revolution at this
time was not the key factor at
work. What, then, explains the
deterioration of productivity
since 2003-04?
This is a puzzle. Undoubtedly, a
slowdown in the reform eort of
governments at all levels played
a role, but other special factors
appear also to have contributed.
For example, massive investment
in mining added to production
Productivity has
yet to recover to the
high levels achieved
in the 1990s.
COMPETITIVENESS: MEASURES AND TRENDS
46 MINERALS COUNCIL OF AUSTRALIA
inputs before output comes fully
on stream. Putting this extra capital
stock and enlarged labour force
to ecient use in coming years is
a key challenge facing Australia’s
mining industry. In addition, a
lengthy and widespread drought
held back agricultural productivity
for a period.
Labour productivity is measured as
national output per hour worked.
The OECD publishes this measure
for Australia and for other OECD
members. Australia’s measure for
2012 – expressed as a percentage
of United States labour productivity
(USA = 100) – was 82.7. This was
less than that of Austria, Belgium,
Denmark, France, Germany, Ireland,
Netherlands, Norway, Sweden,
Switzerland and the United States
as shown in Chart 11. At the same
time, Australia’s measure of labour
productivity was above levels for
Canada, Greece, Japan, Korea, New
Zealand, Portugal and Poland.
Notwithstanding early signs that
some productivity indicators have
started to improve, continued
economic reform remains central
to turning around Australia’s
recent productivity slump. Since so
much big-bang reform has already
occurred, significant options for
Australia
Sweden
Source: Organisation for Economic Cooperation and Development
Note: (i) Index values show GDP per hour worked relative to the United States (USA=100)
Australia’s relative labour productivity
(select OECD economies, 2012)
Chart 11
140
130
120
110
100
90
80
70
Index
USA=100
Norway
Ireland
United Kingdom
Belgium
Netherlands
Denmark
France
Switzerland
Germany
Austria
47
further reform are now more
limited. The present challenge is
to identify areas where further
reform would most fruitfully raise
productivity, both at the enterprise
level where it can improve for
myriad reasons, and at the
economy-wide level.
Based on international
comparisons on a sectoral basis,
the McKinsey Global Institute has
estimated that a few industries
in Australia (notably mining
and domestic transportation)
are more productive than in the
United States, whereas many
others (including utilities, finance,
insurance, real estate, agriculture,
manufacturing, IT, media, telecoms,
professional and business services,
and wholesale and retail trade)
are significantly less productive.16
A number of other studies have
also compared productivity at
the industry level with other
countries.17
COMPETITIVENESS: MEASURES AND TRENDS
49
How policy settings
have worsened our
competitiveness
03
SECTION
50 MINERALS COUNCIL OF AUSTRALIA
51
To answer these questions, it
is important to first distinguish
between medium and longer term
influences, and between those
factors Australian policy makers can
influence, and those they cannot.
In the medium term,
macroeconomic policy settings
both here and abroad, as well as
commodity price fluctuations,
influence real exchange rate
movements, and hence the
economy’s competitiveness
according to competitiveness
measures 1 and 2. However,
commodity prices are beyond
the control of economic policy
and, to the extent they signal the
need for industry restructuring,
are not necessarily barriers to
long-term growth.
By influencing real exchange
rate behaviour, domestic and
foreign macroeconomic policy
settings have damaged Australia’s
competitiveness since the GFC.
Overly expansionary fiscal settings
of federal and state governments in
the wake of the crisis, settings that
have yet to be fully reversed, have
contributed to the dollar’s strength
and been a major home grown
source of our competitiveness
problem. By implementing
expansionary monetary policies
to weaken their exchange rates,
foreign central banks have also
been responsible for worsening our
competitiveness.
Identifying longer term causes
of worsening competitiveness
is more complicated. The best
indicator for this purpose is the
broad-based WEF competitiveness
measure. As noted, this measure
has a supply-side dimension,
and so includes elements that
The three competitiveness measures introduced in
the previous section graphically illustrate how severely
Australia’s competitiveness has declined since the turn of
the century. What factors have been mainly responsible for
this deterioration and how?
SECTION 3
How policy settings have
worsened our competitiveness
HOW POLICY SETTINGS HAVE WORSENED OUR COMPETITIVENESS
52 MINERALS COUNCIL OF AUSTRALIA
also aect productivity. The
labour market plays a role that
directly or indirectly influences
competitiveness and productivity.
Labour costs influence the
economy’s cost structure and prices
relative to foreign costs and prices,
and domestic labour practices
influence the way the workforce
combines with the other factors
of production. How these various
factors have aected Australia’s
competitiveness over recent years
is examined in later discussion.
Expansionary fiscal policy
at home
The Australian dollar exchange rate
has undoubtedly been aected
over and above the influence of
commodity prices by continued
high levels of federal and state
government spending, a response
to the GFC which caused budgets
to go heavily into deficit.
Two questions arise in this context.
How eective is fiscal stimulus
in theory under Australia’s
circumstances? And what impact
did it have in practice?
How eective is fiscal stimulus
in an open economy?
Basic Keynesian economics
simplistically proposes that
additional government spending
can raise aggregate spending in the
economy by a multiplied amount.
If extra fiscally-induced domestic
spending raises national output,
multipliers are positive and fiscal
stimulus is eective, as presumed by
the Australian Treasury.18 However,
the eectiveness of stimulus
spending has been challenged on
the grounds it neglects important
open economy linkages.
The classic textbook
macroeconomic model, for
example, concludes that, even
during recessions, fiscal policy is
ineective in raising aggregate
demand in an open economy
with a floating exchange rate
Overly expansionary
fiscal settings of
federal and state
governments in the
wake of the crisis,
settings that have yet
to be fully reversed,
have contributed to
the dollar’s strength
and been a major
home grown source of
our competitiveness
problem.
53
because it “crowds out” net
exports.19 This is because extra
government spending in response
to an asset price collapse tends to
push up interest rates attracting
foreign capital inflow. In turn, this
strengthens the exchange rate,
worsens competitiveness according
to measure 1 (R), and therefore
causes job losses elsewhere in
industries such as manufacturing
and tourism, as indeed has
happened. If many economies
are implementing fiscal stimulus
simultaneously, the relative size of
the stimulus matters in this context.
Alternatively, if we look at
competitiveness measure 2 (R*),
if increased public spending falls
on non-tradables, as is usually the
case, this extra demand raises the
price of non-tradables relative to
tradables. This real exchange rate
appreciation increases the output
of non-tradables, while tradable
output decreases due to a loss of
competitiveness.
This rise in the relative price of non-
tradables to tradables is consistent
with the real exchange rate
appreciation predicted in the fiscal
transmission mechanism outlined
in Box 2. However, in this approach
the impact on national output and
hence employment depends on
whether the elasticity of tradable
output with respect to the real
exchange rate diers from the
elasticity of non-tradable output.
Other harmful side eects of fiscal
stimulus are that:
Higher public debt has to be
repaid, requiring higher taxes
or spending cuts in the future
Households save more in light
of the prospect of higher
future taxes, resulting in less
private spending elsewhere in
the economy (economists call
this the so-called “Ricardian
eect”).20 This implies that over
the long term private saving will
rise significantly to oset a fall
in public saving.21
Higher public debt not matched
by income yielding public assets
has to be serviced; when owed
to foreigners (as the bulk of it
is), this acts as a drain on the
economy’s national income.
In crafting the fiscal response to
the financial crisis, the Rudd-Swan
government assumed that fiscal
expansion, primarily focused on
spending, was an eective means of
countering an economic slowdown.
This was despite the theoretical
considerations outlined here and a lack
of compelling empirical evidence from
the international academic literature.
Importantly, the IMF concluded in a
survey of the eectiveness of fiscal
stimulus that the evidence was
ambiguous, with estimates of the
eects of fiscal policy on national
output diering “… not merely in
degree but in sign”.22
HOW POLICY SETTINGS HAVE WORSENED OUR COMPETITIVENESS
54 MINERALS COUNCIL OF AUSTRALIA
Consistent with textbook
demand and supply theory,
it simply shows that an
equilibrium value of the ratio
of non-tradables to tradables
prices will be established at any
point where the demand for
non-tradables equals the supply
of non-tradables. Government
spending is overwhelmingly on
non-tradable goods and services,
such as construction, welfare
and public service provision.
Hence, an increase in
government spending will boost
demand for non-tradables
in the economy, other things
the same. In the chart, the
demand for non-tradables
schedule therefore shifts to
the right, which raises the
relative price of non-tradables
to tradables which increases
R*. This higher relative price
induces a higher share of
non-tradable production and
hence competitiveness worsens
because the higher government
spending draws resources away
from tradable production.
Government spending and competitivenessBox 2
The impact of increased
government spending on
competitiveness according
to measure R* can be
illustrated with reference
to Chart B2.23
55HOW POLICY SETTINGS HAVE WORSENED OUR COMPETITIVENESS
The tradable sector becomes
less competitive as a result
because prices received for
tradables fall relative to those
of non-tradables. Meanwhile,
relatively lower tradables prices
stimulate spending on imported
products which widens the
trade deficit. This loss of
competitiveness is exacerbated
if accompanied by increased
labour costs in the non-tradable
sector which would shift
the supply of non-tradables
schedule upwards to the left
in Chart B2.
Eect of increased government spending on R*Chart B2
Output, expenditure
on non-tradables
R1
O0
N= E0
NO1
N= E1
N
R0
PN
PTD0
N
D0
N
D1
N
D1
N
S0
N
S0
N
56 MINERALS COUNCIL OF AUSTRALIA
What impact did fiscal stimulus
have in practice?
In Australia’s case, the degree of
fiscal stimulus as a proportion of
GDP in 2008-09 was one of the
highest in the world and of similar
order to that of the United States,
the epicentre of the crisis itself.24
Focused heavily on government
spending rather than tax relief,
it exceeded the responses of
many economies whose banking
systems had failed, even though
the banking system in Australia
weathered the crisis intact.
Close scrutiny of the pattern of
aggregate expenditure recorded in
the national accounts, especially
for the December 2008 and
March 2009 quarters, reveals that
it was the behaviour of exports
and imports, not increased
fiscal activity, that was primarily
responsible for osetting the
fall in private investment due
to the GFC.25
In the case of the federal
government, fiscal stimulus
also contributed to a severe
deterioration of the Australian
Government’s balance sheet, the
most important item of which is
the “net financial worth” entry,
representing the dierence
between government financial
assets and liabilities (see Chart 12).
Source: Commonwealth of Australia (2014-15 Budget Papers)
Federal government budget balanceChart 12
Fiscal balance (accrual basis) Underlying cash balance
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2010-11
2013-14(e)
2011-12
2014-15(e)
2009-10
2012-13
3
2
1
0
-1
-2
-3
-4
-5
3
2
1
0
-1
-2
-3
-4
-5
% of GDP % of GDP
57
According to the 2014-15
Commonwealth Budget, net
financial worth will exceed negative
$329 billion (or minus 20 per cent
of GDP) in 2014-15, a giant leap
from the minus 1.5 per cent of GDP
net financial worth figure recorded
for the last year of the Howard-
Costello government. This balance
sheet deterioration overwhelmingly
reflects increased public debt run
up to finance the series of budget
deficits that arose as spending
blew out and persistently outpaced
revenue during the Rudd-Gillard-
Swan years.
Consistent with standard
international macroeconomic
theory and empirical work by
the IMF on budget deficits and
interest rates, higher government
spending by federal and state
governments contributed to
interest rate levels that have
been relatively high by advanced
economy standards. In turn, this
contributed to a stronger exchange
rate by encouraging capital inflow
into Australia.26 Curiously, however,
the impact of expansionary fiscal
policy on the exchange rate and
hence competitiveness has been
ignored by many policy makers,
market economists and most
commentators, even though
this linkage is routinely taught
in undergraduate courses in
macroeconomics.
HOW POLICY SETTINGS HAVE WORSENED OUR COMPETITIVENESS
The impact of
expansionary fiscal
policy on the exchange
rate and hence
competitiveness has
been ignored by many
policy makers, market
economists and most
commentators, even
though this linkage
is routinely taught in
undergraduate courses
in macroeconomics.
58 MINERALS COUNCIL OF AUSTRALIA
This experience can also be viewed
through the lens of the second
measure of competitiveness.
Higher government spending,
such as more than $16 billion
on new school halls under the
Building the Education Revolution
(BER) program, raised spending
on non-tradables. This worsened
competitiveness by increasing the
prices of non-tradables relative
to tradables, with non-tradables
inflation persistently exceeding
the Reserve Bank’s ocial 3 per
cent inflation ceiling. The result
was to increase imports and attract
resources away from tradable
sector production.
In other words, higher government
spending was economically
ineective as a macroeconomic
stimulus instrument since losses in
the tradable sector of the economy
oset any expansionary eect in the
non-tradable sector. Exactly how
much tradable activity is squeezed
out depends on the elasticities of
tradable and non-tradable output
with respect to the ratio of non-
tradables to tradables prices.27
Another flaw with the fiscal
response was that the spending
continued well after the worst
of any business cycle downturn
had passed due to administrative
and operational delays. Previous
empirical studies have concluded
that in general public infrastructure
spending has arrived on average
Another flaw with the
fiscal response was that
the spending continued
well after the worst
of any business cycle
downturn had passed
due to administrative
and operational delays.
59
around a year after a major
downturn began. This means,
contrary to intent, that in practice
fiscal stimulus is usually either
weakly countercyclical or pro-
cyclical in advanced economies.
Fiscal multipliers associated with
government programs like the
BER have been estimated for
dierent countries and for dierent
fiscal instruments using general
equilibrium models and econometric
approaches.28 These estimates
vary considerably, prompting a
survey of multiplier estimates by
Alan Auerbach, William Gale and
Benjamin Harris to comment that
the range is “almost embarrassingly
large”.29 Many multiplier estimates
are positive because they consider
short-term eects only and are
based on Keynesian assumptions
without regard to longer run public
debt-related implications. Or they
underemphasise exchange rate
eects in small open economies.30
The “short run” in this context refers
to up to a year, whereas the “long
run” refers to a subsequent period
of up to ten or more years’ duration.
Other research, including my
work with Ross Guest, has
estimated significant negative
long-run multipliers for the federal
government’s stimulus spending
using dierent, though compatible,
modelling approaches.31 The
multiplier in each case turns
negative in the longer term due
to implied higher interest rates,
tax rates and real exchange rates
that eventuate after the stimulus
episode.
A more specific claim is that
Australia’s fiscal stimulus response
saved 200,000 jobs. Yet, this
assertion is based on spurious
Treasury modelling of the long-
run relationship between GDP and
employment, without factoring
in the flexible labour market
which existed at the time of the
financial crisis. As Vito Tanzi, the
former Fiscal Aairs Director at
the IMF, has argued, workers in
advanced economies now have
more specialised skills than ever.
Hence, in practice, any jobs that
fiscal stimulus measures may create
are rarely likely to match those that
are lost, especially in the financial
sector during a crisis.32
The Australian Treasury predicted
in the 2009-10 Budget papers that,
reflecting the stimulus spending,
the economy would be growing
at an incredible 4.5 per cent on
the basic GDP measure in 2012-13.
In reality, GDP growth was under
3 per cent. In short, the fiscal
stimulus measures, most notably
the BER program, failed to deliver
as originally expected and left a
loss of competitiveness as a lasting
legacy.33 As a result, the federal
government’s fiscal response to
the financial crisis subsequently
weakened the economy by
HOW POLICY SETTINGS HAVE WORSENED OUR COMPETITIVENESS
60 MINERALS COUNCIL OF AUSTRALIA
contributing to the dollar’s
strength, and by creating pervasive
policy uncertainty about how the
large budget deficit it created was
to be reversed.
The extent to which the fiscal
stimulus of Federal and state
governments contributed to the
dollar’s strength and worsened
competitiveness is dicult to
quantify with precision. However,
the quantum of foreign capital
inflow directed toward acquiring
Australian government bonds
increased sharply at this time
suggesting the fiscal stance was a
major short-run factor driving the
dollar above its fundamental value
(see Chart 13).
Expansionary monetary
policy abroad
Another macroeconomic policy
influence on the exchange rate
has been highly expansionary
monetary policies abroad. Central
banks in the bigger advanced
economies most aected by the
GFC, notably the United States and
the United Kingdom, engineered
large scale quantitative easing
programs involving the equivalent
of trillions of dollars’ worth of
direct purchases of government
bonds to soak up public debt and
to oset money supply shrinkage
in the wake of the GFC. Japan has
also more recently engaged in
major monetary expansion.
Source: International Monetary Fund 2014a
Net capital flows (% of GDP)Chart 13
Ocial, government Ocial, RBA Nonocial, FDI
Nonocial, portfolio Net capital flows
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
10
8
6
4
2
0
-2
-4
-6
% of GDP
61
In the case of the United States,
this meant more US dollars
began circulating relative to
other currencies, so the US dollar
exchange rate depreciated against
the Australian dollar and the
currencies of many of its other
trading partners. While the Federal
Reserve acknowledged there
would be adverse international
spillover eects, it deemed the
macroeconomic benefits to other
countries were greater than the
costs. Meanwhile, central banks
in several emerging countries,
including China, resisted US
dollar depreciation by preventing
appreciation of their own
exchange rates.
With interest rates in major
advanced economies at close
to zero, the tens of billions of
Australian government bonds issued
to fund the large budget deficits
of recent years became highly
attractive and induced extra capital
inflow, again as reflected in Chart 13.
Alongside capital inflow to finance
mining investment, this led to
appreciation of the Australian dollar.
Monetary policy in Australia could
have been more relaxed during
and after the GFC to cushion
the impact of monetary easing
overseas. Unfortunately, for reasons
already outlined, fiscal expansion
limited the scope for lowering
domestic interest rates and likely
introduced a degree of caution to
the operation of monetary policy
at the time. Allowing monetary
policy a greater role would not only
have been a more eective means
of responding to the after-eects
of the crisis. It would have been
more ecient, as monetary policy
is more neutral between sectors
than the stimulus package proved
in practice, as well as less likely to
result in pure waste.
HOW POLICY SETTINGS HAVE WORSENED OUR COMPETITIVENESS
63
Policies to reverse
the slide
04
SECTION
64 MINERALS COUNCIL OF AUSTRALIA
65
For instance, fiscal consolidation
can in theory be used to improve
Australia’s competitiveness
according to measures 1 (R) and
2 (R*) where overvalued real
exchange rates are central, whereas
structural reform, including labour
market and tax reform can improve
competitiveness (and productivity)
based on measure 3 (W).
Reduce government spending
Deliberately increasing the budget
deficit by more than other countries
to stimulate economic activity in
the wake of the global financial
crisis strengthened the exchange
rate and reinforced the impact of
historically high commodity prices
on the exchange rate over recent
years. This worsened international
competitiveness and crowded
out activity in the internationally-
exposed sectors of the economy.
In addition, the escalation of public
debt sent a message to households
and firms that future taxes are likely
to be higher. As a consequence,
consumer and investor confidence
fell, dampening retail and non-
mining investment spending. The
high exchange rate and overly tight
monetary policy also contributed to
this loss of confidence.
Fiscal consolidation generally has
the reverse eects to fiscal stimulus
on the wider economy and can
be expansionary to the extent it
lessens pressure on both domestic
long-term interest rates and the
exchange rate, thereby assisting
competitiveness. As the Reserve
Bank sets short term-interest rates,
monetary policy accordingly needs
to be co-ordinated with fiscal
consolidation.
Since the government sector
primarily consumes rather than
produces goods and services,
a major cut in government
consumption spending also adds
to national savings other things
equal, and eectively augments
the supply of available funds for
productive purposes. In this way,
What policy responses can help reverse the slide in Australia’s
competitiveness? In part, this depends on which competitiveness
measure we are addressing.
SECTION 4
Policies to reverse the slide
POLICY SETTINGS TO REVERSE THE SLIDE
66 MINERALS COUNCIL OF AUSTRALIA
fiscal consolidation, in addition
to exerting downward pressure
on longer term interest rates and
the exchange rate, also reduces
reliance on foreign borrowing for
unproductive purposes. Without
continued fiscal consolidation,
public debt owed to foreigners will
keep growing and circumstances
could quickly change if foreign
lenders demand a higher interest
risk premium in light of the size of
Australia’s combined private and
public indebtedness.
Cutting government spending,
the bulk of which is non-tradable
activity, would also directly lessen
pressure on the prices of non-
tradables, as the reverse of the case
illustrated in Chart 2B in section 2.
Hence competitiveness measure
2, as measured by R*, would cease
to deteriorate via the accelerated
rise in the prices of non-tradables
relative to tradables. This would
alleviate the competitiveness lost
by the tradable sector and curtail
resources being drawn away
because price rises in that sector
fail to keep up with non-tradables
inflation.
An obvious target for spending cuts
is the billions of dollars’ worth of
government budgetary assistance
to industry in the form of subsidies
and tax concessions estimated by
the Productivity Commission to be
close to $8 billion for the federal
government alone in 2012-13. This
Without continued
fiscal consolidation,
public debt owed
to foreigners will
keep growing and
circumstances could
quickly change
if foreign lenders
demand a higher
interest risk premium
in light of the size of
Australia’s combined
private and public
indebtedness.
67
assistance is counterproductive
as it helps sustain the high dollar
through budget deficits and
paradoxically acts to worsen
the plight of internationally-
exposed industries. There is also
considerable scope for expenditure
reduction where there are major
overlaps of responsibilities and
programs at the federal, state
and local government levels, such
as water, transport, government
services, education and health
administration.
In addition, academic research
has shown that what matters
is not just the budget balance
itself, but the means by which
it is obtained.34 In other words,
whether fiscal consolidation takes
the form of reduced government
spending or higher taxes is critical
to the economy’s subsequent
performance. On that score, the
weight of evidence is that cutting
government consumption is
preferable to cutting government
investment, and even more
preferable to raising income taxes
which can be recessionary. It
should also be noted that the fiscal
consolidation that has occurred in
many economies since the fiscal
largesse in the wake of the GFC
has relied heavily on revenue rather
than expenditure measures.35
As set out in the recommendations
of the National Commission of
Audit, considerable scope exists for
cutting government consumption
by eliminating programs that are
not justified by the principles of
public economics.36 Returning the
budget to surplus primarily through
spending cuts would reduce this
source of upward pressure on the
exchange rate and alleviate the loss
of competitiveness of many trade-
exposed firms. It would also stem
inflationary pressures on the non-
tradables side of the economy.
The most general rule for
evaluating whether a public
spending program is warranted
is to ask whether a particular
program is achieving a desired
societal outcome which the private
sector is not suited to achieve.
Numerous other fundamental
questions arise when assessing
public spending at any level
of government. For instance,
what are the basic criteria for
assessing the worth of proposed
spending programs? What tier of
government should be responsible
for spending that meets these
criteria? And what overlap is there
between governments delivering
programs that are, in principle,
fully justified?
One argument against cutting
government spending is that
government spending needs
to be sustained in the form of
infrastructure investment now
that mining sector investment
is declining from record levels.
POLICY SETTINGS TO REVERSE THE SLIDE
68 MINERALS COUNCIL OF AUSTRALIA
However, this argument neglects
that the mining investment boom
has essentially been aimed at
increasing Australia’s export
capability and that this investment
should give rise to higher export
volumes after due lags, in the
process replacing investment with
net exports as a strong source of
demand for domestic product,
although perhaps not to the
same degree.
At a more fundamental level, this
argument is another manifestation
of the “hydraulic” Keynesian idea
that economic growth essentially
stems from the demand side,
rather than the supply side of the
economy. Increased spending
on infrastructure to maintain a
given level of aggregate demand
would, other things the same, also
sustain upward pressure on the
exchange rate in the absence of
accommodating monetary policy,
therefore prolonging the loss of
competitiveness Australia has
experienced since the GFC.
The case for more infrastructure
investment rests on its potential to
positively influence the supply-side
of the economy by adding to the
economy’s capital stock. Increased
infrastructure spending adds to
the economy’s total investment
requirement relative to its given
savings, other things the same.
This implies an increase in foreign
borrowing which must be serviced
at the going world interest rate.
Hence national income improves
when new infrastructure investment
generates a significant return above
the eective long-term foreign
interest rate in net terms.37
On this basis, the criteria should
be how worthy each infrastructure
project is on a cost-benefit basis
and whether the extra output it
facilitates, or its rate of return,
exceeds the eective foreign
interest rate. Of relevance here is
that world interest rates will most
likely rise in coming years following
the wind back of quantitative
easing by the United States Federal
Reserve and other central banks.
By the same reasoning, cutting
government consumption increases
national saving which reduces the
call on foreign funds. This improves
national income since higher
domestic saving, other things the
same, reduces interest paid abroad
which normally subtracts from
national income.
69
Manage the exchange rate?
Since the exchange rate is central
to competitiveness measures 1 and
2 it is reasonable to ask whether
the exchange rate itself should be
more tightly managed as a direct
means of improving Australia’s
competitiveness. No international
rules prevent Australia managing its
exchange rate more pro-actively, or
returning to a pegged rate system.
Much is made of the decision to
float the dollar more than three
decades ago, but Australia was an
international laggard on this score.
Many trading partners floated their
currencies without much fanfare
a decade or so earlier, following
the collapse of the Bretton Woods
system of managed exchange
rates in 1971.
It was ill-advised policy not to
have floated the exchange rate
sooner because Australia has
traditionally been a commodity
exporting advanced economy
(in company with Canada, New
Zealand and Norway) and floating
exchange rates are the best option
for economies highly prone to
international commodity price
shocks. Had the Whitlam or Fraser
governments floated the dollar,
the economy would have avoided
some of the macroeconomic pain
during their terms, including high
inflation and the booms and busts
of the 1970s and early 1980s. The
previous pegged exchange rate
system acted to magnify
earlier cycles via its eects on
the domestic money supply.
A lower Australian dollar
would immediately boost the
competitiveness of manufacturing
and tourism, and raise returns
to commodity producers. The
diculty with proposals for the
Reserve Bank to target a lower
level of the exchange rate is that it
would transform the way monetary
policy is conducted in Australia. If
the Reserve Bank prevented the
dollar rising above a certain value,
its purchases of foreign currency
in the foreign exchange market
would, other things the same, add
to the domestic money supply
(assuming it doesn’t sterilise the
intervention). This would ultimately
be inflationary in the absence
of productivity improvements
and Australia’s international
competitiveness would then be
eroded via the inflation channel.
A floating exchange rate helps
insulate a relatively small economy
like Australia from international
macroeconomic shocks, such
as severe commodity price
fluctuations and foreign financial
crises. Since it was floated, the
Australian dollar has generally
performed this insulation role very
well, including during the Asian
crisis of 1997-98 and the GFC
of 2008-09, when the floating
exchange rate was the key factor
POLICY SETTINGS TO REVERSE THE SLIDE
70 MINERALS COUNCIL OF AUSTRALIA
that saved Australia from technical
recessions at those times.
Over the three decades since the
float, commodity price upswings
have mostly been oset by
commodity price downswings, with
the exchange rate strengthening
in the medium term when
commodity prices were high and
depreciating when they were low,
thereby dampening the impact of
the commodity price cycle on the
domestic economy. Minimising
the impact of commodity price
fluctuations on the wider domestic
economy and aording the
central bank maximum control of
liquidity have been major benefits
of a floating currency whose
advantages are maximised when
the economy’s supply-side is also
highly flexible.38
Accelerate structural reform
When the Hawke-Keating and
Howard-Costello governments
purposely implemented structural
reforms, including financial
deregulation, labour market reform,
tari reduction, tax reform and
privatisation, it lifted Australia’s
growth performance substantially
above the OECD average and
strengthened the economy’s ability
to withstand major external shocks.
Expanding national income via
reform was at least as important
then as redistributing it.
However, a culture of complacency
has taken hold in public policy
circles over recent years,
encouraged by the relatively
better performance of Australia’s
economy compared with most
other OECD economies since
the GFC. This experience has
provided a convenient cover for
avoiding further reform to address
the economy’s poor underlying
competitiveness and productivity
performance.
If Australia is to remain competitive
in its own region, ongoing
economic reform is needed to
rectify the competitiveness and
productivity problems via further
liberalisation of international trade
and foreign investment, enhanced
labour market flexibility and
thoroughgoing tax reform.
Pro-market economic policies are
71
now needed to revive private sector
activity and entrepreneurship by
spurring competitiveness and
productivity.39 Such policies alter
incentives and business practices
in sectors that survive on subsidies,
as well as those cossetted from
competition through trade
protection or tax breaks. Policy
initiatives of previous Labor
and Coalition governments that
encouraged greater labour market
flexibility have been reversed
which will continue to stymie
competitiveness and productivity.
Labour market flexibility
Australia’s high exposure to terms
of trade volatility and its associated
economic costs support the case
for heightened flexibility. Although
the floating exchange rate acts
to smooth economic adjustment
across the economy in response
to external price shocks, it also
generates a higher degree of
uncertainty for many traded goods
industries, compared for instance
with other advanced economies.
This places a particular premium
on the need for ready restructuring
by firms along with reallocation
of labour and capital to support
new business models, products
and processes. This restructuring is
more readily facilitated if markets
are highly flexible.
During the early phase of the
mining boom, industrial relations
POLICY SETTINGS TO REVERSE THE SLIDE
A culture of
complacency has
taken hold in public
policy circles
over recent years,
encouraged by the
relatively better
performance of
Australia’s economy
compared with
most other OECD
economies since
the GFC.
72 MINERALS COUNCIL OF AUSTRALIA
arrangements did not have a
major eect on exports. Workers,
through their unions, were able to
extract higher returns permitted
by buoyant prices and profitability.
Some of these gains, however, were
taken in forms (such as restrictions
on rostering) that have severe
competitiveness implications now
that Australian mining companies
are no longer in a seller’s market.
Meanwhile, industrial relations
arrangements surely did play an
important role in the non-tradables
sector (for instance, for aged care,
child care, hospital services and
government schools) by driving
up costs and the prices of non-
tradables more generally.
The importance of labour market
flexibility to the economy’s overall
productivity performance, as
conventionally measured, remains
an issue of economic debate. An
important reason for this is that
standard measures of productivity
are not linked in any direct way
to the degree of flexibility in
labour markets.
Standard productivity measures
assume constant what economists
call the “elasticity of substitution”
between labour and capital. In
eect, the elasticity of substitution
is the rate at which labour can be
substituted for capital, and is likely
to be aected by the degree of
labour market flexibility.
Allowing variation through time
in the way labour and capital are
combined (where the elasticity
of substitution is not assumed
constant) can yield dierent results
when estimating productivity
performance. My own research with
Sam Strong has found this to be
the case during the reform era of
the 1980s and 1990s.40
Specifically, we found that labour
productivity rose significantly
and remained elevated during
the economic reform period.
Furthermore, our alternative
specification which allows the
substitutability of labour and
capital to change over time
suggests labour productivity
increased by more than was
recorded by conventional
productivity measures between
1998 and 2008, when the labour
market was more flexible than it is
now. The policy implication is that
labour market flexibility can play a
role in improving productivity.
Tax and welfare reform
Australia’s tax to GDP ratio is
close to the OECD average when
comparison takes appropriate
account of compulsory
superannuation and other levies.41
However, comparing the tax take
to OECD economies is increasingly
irrelevant given most of Australia’s
key trading partners are in Asia and
given our particular commodity
73
export profile where we compete
with countries such as Canada,
Brazil, Indonesia and South Africa.
It is also worth noting that
Australia’s tax structure relies
relatively heavily on mobile tax
bases (such as corporate income)
and that the interaction of the tax
system with the welfare system
also creates disincentives to work
and save. With quite a high tax
“wedge”, both on current income
and income from savings, the
economic impact of taxes in
Australia is likely to be similar to
that in higher tax economies.
Australia’s future is obviously tied
more to the East than to the West.
So too our policy frameworks need
to be assessed against economic
practices in Asia and in commodity
exporting countries that directly
compete against Australia in world
markets. Relatively low income
taxes and welfare provision, as well
as highly flexible goods, services
and labour markets, contribute to
Asia’s dynamism, as evidenced by
its capacity to shrug o the GFC
even more quickly than Australia.
Present income tax rates remain
uncompetitive by the standards of
Asian trading partners and those
of other countries against which
exporters directly compete.
POLICY SETTINGS TO REVERSE THE SLIDE
75
Conclusion
05
SECTION
76 MINERALS COUNCIL OF AUSTRALIA
77CONCLUSION
This was a key theme of Adam
Smith’s The Wealth of Nations
published in 1776 which argued
that income and wealth creation
had much to do with expanding the
scope for the exchange of goods
and services by allowing freer rein
to markets. By implication, the
more flexible those markets were,
the more dynamic economies
could become.
This understanding was a key
thread running through economic
reforms pursued in Australia in
the late 20th century. However,
in recent years policy makers in
Australia have coasted on the
back of the mining boom, content
to compare Australia favourably
against North Atlantic economies
that have languished following
the GFC. For all the attention
devoted to Australia’s opportunities
and challenges in the “Asian
century”, policy makers have been
remarkably reluctant to benchmark
our performance against our major
trading partners in the region.
Australia urgently needs a more
searching national conversation
about our international
competitiveness. In many ways, this
is the missing link in the Abbott
Government’s economic narrative
as it struggles to come to grips
with Australia’s long-term budget
predicament and looks to flesh out
a meaningful agenda in areas such
as tax, reforming the Federation
and industrial relations.
The premise of this Monograph
is that Australia will not durably
improve is competitiveness without
serious fiscal and structural reform,
including labour market reform.
The Abbott Government should
grasp this narrative and own it.
For centuries, economists have been interested in exploring the
reasons why some economies prosper more than others.
SECTION 5
Conclusion
78 MINERALS COUNCIL OF AUSTRALIA
It has so far undersold the
importance of fiscal consolidation
to Australia’s competitiveness and
to future economic growth. It needs
to broaden its fiscal repair message
beyond the need for government to
“live within its means” and explain
why tackling our long-term budget
challenge is important to our
national competitiveness.
Similarly, there is a compelling
narrative around improving
national competitiveness which
can help stitch together a strong
policy agenda in areas such as tax,
improving the operation of the
Federation, broad-based regulatory
reform and workplace relations.
79CONCLUSION
80 MINERALS COUNCIL OF AUSTRALIA
81
1 While it is more accurate to describe the episode of 2008-09 as a
transatlantic banking and public debt crisis, this paper uses the more
common terminology for consistency and ease of expression.
2 See, for example, Eslake 2011, Banks 2012, and Parham 2012.
3 These price fluctuations stem predominantly from the high inelasticity of
demand for commodities relative to high inelasticity of supply.
4 Shann 2012 provides a comprehensive account of the scale and structural
implications of the boom.
5 See International Monetary Fund 2012.
6 Using modern trade and industrial organisation theory to explain trade
specialisation, Sutton 2012 shows that terms of trade volatility makes it
hard for commodity exporting countries to specialise in the production
of elaborately transformed manufactures where competition on quality is
important.
7 Makin 2013a and 2014a, and Van der Ploeg 2011 elaborate on the wider
macroeconomic consequences of commodity price fluctuations.
8 See Jones and Wilkinson 1990, and Ellis 2001 for earlier Reserve Bank
estimates and further discussion.
9 See Makin and Robson 1999.
10 See Makin 2013a for a theoretical rationale.
11 Goldstein and Ocer 1979 provide earlier estimates of this phenomenon.
12 See Parham 2012 for more detailed estimates and explanation.
13 See Balassa 1964, and Samuelson 1964.
14 Australia’s partner institution is the Australian Industry Group.
15 See McKinsey Global Institute 2012.
16 Ibid, p. 30
17 See, for instance, Young et al. 2008.
18 See Australian Government 2009.
Endnotes
82 MINERALS COUNCIL OF AUSTRALIA
19 The classic open economy macroeconomic model was outlined by Mundell
1963, and Fleming 1962.
20 This eect is named after the classical economist, David Ricardo. See also
Barro 1989.
21 Makin and Narayan 2011 provide evidence of an almost complete long-run
private-public saving oset for Australia.
22 See IMF 2008, p. 164.
23 See Makin 2013b for an extended treatment of this approach.
24 See IMF 2009, p. 38.
25 Makin 2010 provides more detailed analysis.
26 Makin and Narayan 2013 provide evidence that the consolidated budget
deficit of federal and state governments translates almost one for one to
increased capital inflow.
27 This is shown formally in Makin 2013b.
28 See Cogan et al. 2013, Forni et al. 2009, Ramey 2011, and Born et al. 2013.
29 See Auerbach et al. 2010.
30 See, for instance, Blanchard and Leigh 2013.
31 See Guest and Makin 2011 and 2013, as well as Humphreys 2012.
32 See Tanzi 2012.
33 This is elaborated in Makin and Humphreys 2014.
34 See, for instance, Alesina et al. 2012, Auerbach et al. 2010, Barro and Redlick
2011, Cogan et al. 2013, Favero and Giavazzi 2007, Guest and Makin 2013,
Makin 2014a, and Schuknecht and Stark 2010.
35 See Perotti 2011 for a related discussion.
36 See Australian Government 2014.
37 Makin 2014b formally derives this condition.
38 See Makin and Rohde 2012, and Stevens 2013.
39 See Banks 2012, Ergas and Owens 2012, and Shann 2012 for a related
discussion.
40 See Makin and Strong 2013.
41 See Carmody 2014 for further discussion.
83
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Three dierent measures of Australia’s
competitiveness all tell roughly the same story.
Australia has a serious competitiveness problem
and this is showing up in lower economic growth.
Tony Makin explores in detail how to think about
national competiveness and the policies that make
a dierence. He argues that Australia will not
durably improve its competitiveness without serious
fiscal and structural reform, including labour market
reform. There is no comfort in Australia comparing
itself with the low-growth economies of Europe. Our
policy frameworks need to be benchmarked against
those in the fast-growing economies of Asia.
MINERALS COUNCIL OF AUSTRALIA
Level 3, 44 Sydney Ave, Forrest ACT 2603
PO Box 4497, Kingston ACT Australia 2604
P. + 61 2 6233 0600 | F. + 61 2 6233 0699
w. www.minerals.org.au | E. info@minerals.org.au
TONY MAKIN
Australia’s competitiveness:
Reversing the slide
TONY MAKIN Australia’s competitiveness: Reversing the slide MINERALS COUNCIL OF AUSTRALIA
06
... Although Australia's public debt to GDP ratio at close to 30 per cent is not high by OECD standards, unlike other advanced economies, the bulk of around two thirds at federal level, is owed to foreign 23 See Makin (2014) for further discussion. 24 ...
Technical Report
Full-text available
Australia has experienced one of the fastest rises in public debt in the world since the Global Financial Crisis. Federal budget deficits have persisted for longer than previous fiscal stimulus episodes in the 1980s and 1990s. Subsequent fiscal repair has also been weaker and less than in the United States, United Kingdom, New Zealand and the Euro area. This paper briefly introduces a range of alternative perspectives on the efficacy of fiscal stimulus as a macroeconomic policy instrument, including the loanable funds, Mundell-Fleming, dependent economy, Ricardian and intergenerational equity approaches. Each of these perspectives suggest fiscal stimulus has damaging offsetting effects that eventually minimise or neutralise its effectiveness in stabilising national income and employment. The paper then examines how effective Australia’s fiscal stimulus response to the GFC actually was in light of the economy’s robust banking system, floating exchange rate, openness to international trade and capital flows, and dependence on mineral exports to Asia. What prevented Australia from experiencing a technical recession at the critical juncture in 2008-09 was a combination of lower interest rates, a major exchange rate depreciation, strong foreign demand for mining exports, especially from China, and a then more flexible labour market. There is no evidence fiscal stimulus benefited the economy over the medium term. Largely implemented after the worst of the GFC had passed, fiscal stimulus countered the effectiveness of monetary policy by keeping market interest rates higher than otherwise and therefore contributed to a strong exchange rate. This worsened Australia’s international competitiveness and damaged industries in the economy’s internationally exposed sector, including manufacturing. Although Australia’s federal public debt to GDP ratio is not high by OECD standards, unlike other advanced economies it is mostly owed to foreign bondholders and has become a significant component of Australia’s total foreign debt, unmatched by domestic asset accumulation. Public debt interest now exceeds budgetary outlays on the Pharmaceutical Benefits Scheme, unemployment benefits, higher education and foreign aid and could reach 1 per cent of GDP by 2020 on present fiscal settings. The servicing cost on foreign debt incurred to fund unproductive budgetary outlays is a net drain on national income and future budgets, and could potentially spark a vicious circle of deficits and debt requiring emergency fiscal remedies if higher world interest rates combine with an interest risk premium arising from a credit rating downgrade. Higher interest rates would also reduce private investment, reducing potential future national income. Reducing foreign public debt would staunch the national income loss arising from unrequited interest paid abroad. The scale of the fiscal consolidation effort required to improve the sustainability of federal public debt is around twice that currently projected. Necessary fiscal consolidation focused on reducing government consumption would exert downward pressure on market interest rates, lessen foreign investment in government bonds, lower the exchange rate, and hence lift international competitiveness. Fiscal repair can also be expected to lift business confidence, boost private investment and strengthen medium term economic growth. For these reasons, reducing public debt should be a top priority of fiscal policy.
... The primary focus is on how effectively inputs are combined in the production process, without explicit regard for international trade dimensions such as the real effective exchange rate, which is central to the measurement of competitiveness. Purchasing power parity (PPP) prices are frequently used as a proxy to reflect the impact of these trade dimensions on the relative competitiveness between countries (Makin, 2014). ...
... The primary focus is on how effectively inputs are combined in the production process, without explicit regard for international trade dimensions such as the real effective exchange rate, which is central to the measurement of competitiveness. Purchasing power parity (PPP) prices are frequently used as a proxy to reflect the impact of these trade dimensions on the relative competitiveness between countries (Makin, 2014). ...
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This article theoretically examines the impact of different forms of government spending on national income in a financially open economy with a significant net international investment position the central bank of which sets domestic interest rates to target inflation. It shows that whether government spending is expansionary or contractionary ultimately depends on the productivity of that expenditure, a result that has major implications for the efficacy of fiscal policy deployed for either stimulus or austerity reasons. The key prediction of the model is that public consumption and unproductive public investment are procyclical, whereas only productive public investment is countercyclical. (JEL F41)
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This book was originally published by Macmillan in 1936. It was voted the top Academic Book that Shaped Modern Britain by Academic Book Week (UK) in 2017, and in 2011 was placed on Time Magazine's top 100 non-fiction books written in English since 1923. Reissued with a fresh Introduction by the Nobel-prize winner Paul Krugman and a new Afterword by Keynes’ biographer Robert Skidelsky, this important work is made available to a new generation. The General Theory of Employment, Interest and Money transformed economics and changed the face of modern macroeconomics. Keynes’ argument is based on the idea that the level of employment is not determined by the price of labour, but by the spending of money. It gave way to an entirely new approach where employment, inflation and the market economy are concerned. Highly provocative at its time of publication, this book and Keynes’ theories continue to remain the subject of much support and praise, criticism and debate. Economists at any stage in their career will enjoy revisiting this treatise and observing the relevance of Keynes’ work in today’s contemporary climate.
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