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Australian Reforms Accelerate Growth and Help Resist Contagion from Asian Crisis

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
January 1999
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Australia’s economic performance in the 1990s has been impressive. The country has experienced healthy growth since the early years of the decade, with inflation averaging just 2½ percent over the same period. This strong showing has helped Australia resist contagion from the Asian crisis and maintain a relatively high growth rate. The recent performance contrasts sharply with the previous three decades, when falling productivity and rising inflation prompted Australia’s per capita income to slip from one of the highest among Organization for Economic Cooperation and Development (OECD) countries.

How did Australia overcome several decades of lackluster performance? Beginning in the mid-1980s, the government embarked on two broad phases of reforms. In the first phase, the exchange rate was floated, exchange controls were dismantled, the market was allowed to determine interest rates, external tariffs were reduced, and competition was encouraged in a number of sheltered sectors. Moreover, public enterprises were corporatized or privatized, and the Reserve Bank adopted an inflation target. In the second phase, from 1996 onward, fiscal reforms were intensified to raise public saving, steps were taken to consolidate the credibility of monetary policy, and reforms were undertaken in the labor market and remaining sheltered product markets. As a result of these reforms, Australia’s annual growth potential is estimated to haverisen from 2½-3 percent in the late 1980s to about 3½percent in the 1990s. (Potential growth rates provide economists with a measure of the rate of increase in the economy’s productive capacity and may differ from actual growth rates over the economic cycle due to changes in the extent to which this capacity is used.)

But several problems persist. The unemployment rate remains stubbornly high, and national saving, relatively low. Continued structural reforms, particularly in labor and product markets, would help sustain high potential growth rates as well as Australia’s resilience to external shocks.

Background

Based on GDP levels per capita, Australia was the thirdrichest OECD country in 1960, after the United States and Switzerland, and its per capita income was more than 50 percent higher than the OECD European average. Economic performance declined during the 1960s, however, as growth in the capital stock slowed and productivity dropped. Inflation also took hold. By the 1980s, Australia had slipped from near the top of OECD rankings in growth, productivity, and capital.

The factors underlying these trends were

  • Poor productivity. Much of the poor productivity performance had its roots in the high external tariffs and extensive product market regulations that protected large sectors of the Australian economy for much of this period. In the mid-1960s, the average tariff on imports was 9½ percent, compared with 6 percent on average in the OECD countries. In the 1970s, when many OECD countries lowered tariffs, Australia’s average import tariffs rose to more than 12 percent. The high tariffs damaged economic performance by diverting production away from areas of comparative advantage, thereby reducing productivity, and by raising the prices of imported and import-competing goods. Key sectors of the economy were also dominated by public enterprises, which in many cases had monopoly rights that enabled them to raise prices for their services above the level in other countries.

  • Inflexible labor market. Traditionally, employment conditions have been governed by a large number of minimum wages and legally binding agreements specific to individual occupations or industries. While these arrangements were developed in response to social equity goals, they were not tailored to individual enterprises and slowed the economy’s adjustment to the changing global economic environment.

  • High inflation. In the 1970s and the 1980s, Australia’s inflation was higher and less predictable than in most OECD countries, generating economic uncertainty and detracting from a macroeconomic framework conducive to growth.

  • Low saving. Another problem that emerged during this period was low national saving, which declined from about 24 percent of GDP in the 1970s to 17 percent of GDP in the 1990s—among the lowest in the OECD. Saving has dropped in both the public and private sectors, leading to a structural deterioration in the current account deficit. This deterioration has raised Australia’s external debt and liability ratios and potentially increased vulnerability to external shocks.

First Phase of Reform

The government moved across a wide front from the mid-1980s to the mid-1990s to strengthen economic performance—reducing trade barriers, liberalizing key areas of the economy, corporatizing or privatizing public enterprises, and adopting an inflation target.

Beginning in the late 1980s, the government carried out several rounds of unilateral tariff cuts; a maximum tariff of 5 percent now applies to most goods. Australia’s Industry Commission estimates that, by 2000, the average tariff will be less than 3 percent.

The government also liberalized a number of key sectors. In the financial sector, it floated the exchange rate, dismantled exchange controls, and allowed the market to determine interest rates. The telecommunications and aviation sectors were liberalized, while the government moved to corporatize or privatize a number of public enterprises. Moreover, the Competition Policy Reform Act of 1995 set up a framework to extend competition to sectors that had remained relatively sheltered from the increased competitive pressures—notably, public enterprises, unincorporated businesses, and professions. Consistent with this process, the state governments began to break up the electricity and gas industries that had a monopoly. The benefits from the reforms have been clear and extensive at the microeconomic level, with prices having fallen in the electricity, telecommunications, and aviation sectors, and public enterprises having experienced a marked improvement in productivity.

The adoption of an inflation target was another important reform. After relatively high inflation in the 1970s and 1980s, inflation fell to low levels in the early 1990s mainly as a result of a sharp recession. The Reserve Bank moved swiftly to lock in low inflation, adopting in 1993 a target aimed at maintaining underlying inflation between 2 and 3 percent, on average, over the economic cycle. Under the inflation-targeting regime, the Reserve Bank acts preemptively to counter expected future demand pressures, yet it tolerates some short-term deviations of inflation from the target range to reduce fluctuations in real output. This approach has helped achieve average inflation of just 2¼ percent since the early 1990s. Moreover, a comparison of Australia’s inflation and output performance with other inflation-targeting countries suggests that Australia’s approach has produced superior results thus far.

New Phase of Reforms

By 1996, Australia had carried out widespread and—for the most part—successful reforms over the previous ten years. But several longterm structural problems remained. The country faced a stubbornly high unemployment rate of about 8½ percent and national saving had dropped to low levels. Recognizing that these problems needed to be addressed if Australia were to boost longterm growth further, the government launched a new phase of reforms. The objective was to raise public saving, consolidate the credibility of monetary policy, and carry out another crucial wave of reform aimed at the labor market as well as sheltered product markets in the nontraded sectors.

The government intensified fiscal reforms with a view to making a decisive difference in the public sector’scontribution to national saving. The government announced in its 1996/97 budget a fiscal consolidation strategy to move the Commonwealth, or federal, budget sector from an underlying deficit of 2 percent of GDP to surpluses over the medium term. In addition, it adopted the Charter of Budget Honesty, underpinning the sound management of public finances by requiring greater public disclosure of budget information and observance of principles of responsible fiscal management.

Australia also introduced steps to consolidate the improved credibility of the inflation-targeting frame work. In particular, the government formally endorsed the framework for the first time in 1996 in a joint statement by the Treasurer and the Governor of the Reserve Bank.

The government also initiated reforms to the remaining sheltered product markets. The financial sector was reformed further in 1997 by, among other moves, liberalizing access to the clearing system and reorganizing the supervision of banks and nonbank financial institutions to increase the efficiency and effectiveness of prudential regulation. Other steps included further privatization of public enterprises (including the sale of one-third of Telstra, the public telecommunications company); the introduction of full and open competition in the telecommunications sector in 1997; and corporate law reform, with the aim of reducing transactions costs for firms and harmonizing Australia’s regulations and laws with those applying in major world financial markets.

To address concerns about the comprehensiveness of earlier labor market reforms, especially their lack of success in reducing unemployment, Australia undertook additional reforms in 1996. These initiatives aim to reduce the reach of industry and occupation- specific labor agreements and to tie enterprise-level wage bargaining more closely to productivity growth. Over time, these reforms should enable the unemployment rate to fall, and continued reforms would help achieve a decisive reduction in the structural unemployment rate.

Australia’s program of reform has thus succeeded in accelerating not only actual growth but also productivity and potential growth. It has also been instrumental in maintaining Australia’s impressive performance in the face of the financial crisis confronting its major Asian trading partners. The country appears to have shaken off the lackluster performance of the past several decades. Nevertheless, challenges remain. Vigorous pursuit of structural reforms will help sustain the recent high potential growth rates and cut unemployment.

Copies of Australia: Benefiting from Economic Reform, by Anoop Singh, Josh Felman, Ray Brooks, Tim Callen, and Christian Thimann, are available for $25.00 each from IMF Publication Services. See page 15 for ordering details.

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