Australia is now enjoying its 14th year of economic expansion. Unemployment has fallen to less than half its 1992 level, real incomes have risen rapidly, inflation has remained low, and net government debt has been virtually eliminated—all in the context of an increasingly stable and resilient economy (see chart below). These excellent results reflect wide-ranging structural reforms and improved frameworks for monetary and fiscal policies.
The start of Australia’s structural reform process is often linked to the floating of the Australian dollar in December 1983. While the float was driven by the need to restore Reserve Bank of Australia (RBA) control over domestic interest rates in the face of increasingly volatile capital flows, this step proved to be a launching pad for broader structural reforms. The sustained implementation of reforms was also motivated by Australia’s relatively weak economic performance in preceding decades, which had resulted in a long downward slide in per capita income levels relative to other advanced economies.
At the outset of reforms, Australia’s economy was sheltered by high tariffs, domestic competition was limited by government monopolies, and labor markets were rendered inflexible by the centralized “awards” system for setting the wages and working conditions of most employees. The initial phase of reforms in the mid-1980s included financial sector deregulation, reductions in external tariffs, commercialization and privatization of public enterprises, and the liberalization of key sectors such as aviation and telecommunications. Removing interest-rate controls, liberalizing international capital flows, and allowing the entry of foreign banks brought deeper and more competitive financial markets. However, this phase was also associated with rapid credit growth, rising asset prices, and external current account deficits that were large by historical standards at around 5 percent of GDP a year in the latter half of the 1980s.
Domestic concern about Australia’s external position was a key factor behind public support for policies that would help improve Australia’s competitiveness and also raise national savings. For example, initial steps were taken to enhance labor market flexibility by allowing firms to agree to higher wage increases in exchange for productivity improvements, although still subject to centralized approval. Public savings rose substantially, with the overall fiscal balance rising some 5 percentage points of GDP in the five financial years to 1988/89. To help increase private savings, Australia adopted a private pension system in 1993 with mandatory contributions by all employees.
On top of the large fiscal consolidation, the RBA also tightened monetary policy in the late 1980s to moderate inflation, which had persisted at around 7–9 percent in the second half of the 1980s. Against this background, a global economic slowdown led to an unexpectedly severe recession in Australia in the early 1990s. The weakening in banking and corporate sector balance sheets associated with high credit growth likely increased the depth and duration of the recession. In hindsight, stronger financial supervision had been needed, although it is unlikely that this would have fully prevented the side effects of financial deregulation. Indeed, the government strengthened the supervision framework by establishing the Australian Prudential Regulation Authority in 1997.
Second round of reforms
Nonetheless, the 1990–91 recession also provided an opportunity to establish medium-term macroeconomic policy frameworks. Inflation fell below 3 percent by mid-1992, and the RBA adopted an inflation targeting framework for monetary policy in 1993. Since then, consumer price inflation has averaged 2½ percent, consistent with the target of 2–3 percent. The RBA pursues this inflation-target on average over the economic cycle, allowing it greater flexibility to take into account implications for employment and economic activity, an approach that some other central banks have since adopted. Similarly, the authorities have aimed their fiscal policy at balancing the budget over the economic cycle since the 1998 enactment of the Charter of Budget Honesty, which commits the government to set out its medium-term fiscal strategy in each budget. Within this framework, the federal government has achieved a surplus in six of the past seven years, and net government debt fell to just 1.3 percent of GDP in mid-2005.
Data: IMF World Economic Outlook database.
A second round of structural reforms in the mid-1990s was motivated in part by the sharp rise in unemployment in the 1990–91 recession. Labor market reforms adopted in 1993, and most importantly in 1996 under the Workplace Relations Act, changed the award system into a safety net, with most employees bargaining at the enterprise or individual level. By 2004, the wages of only one-fifth of all employees were set by centralized awards, compared with two-thirds in 1990. This allowed greater flexibility in relative wages across sectors and enterprises, and also enhanced businesses’ ability to adopt productivity-improving changes in work arrangements. In addition, the competitiveness of the goods market was increased through the National Competition Policy agreed to by state and federal governments in 1995, while reforms of welfare policies, such as the 1996 Mutual Obligation Initiative, have enhanced incentives for the unemployed to take jobs or participate in programs to enhance their employability.
Rewards and lessons
The returns on these reform efforts have been handsome. Australia has enjoyed an uninterrupted economic expansion since 1992, with real GDP growing at an average annual rate of about 3.7 percent (see chart above). As a result, per capita incomes have risen to almost 10 percent above the OECD average. Gains in both productivity and employment have been strong, and unemployment has fallen to 5 percent from almost 11 percent in 1992.
The resilience of the Australian economy has been particularly noteworthy, with the economy shrugging off the impact of the Asian crisis in 1997–98, the global information technology slump in 2000–01, and a severe drought in 2002–03. The floating exchange rate has adjusted to help the economy absorb shocks and has freed monetary policy to promote domestic economic stability, while the automatic fiscal stabilizers have operated fully. Recent research shows that the structural reforms of the product, labor, and financial markets have also contributed to increased macroeconomic stability, by tending to reduce both the scale and impact of shocks.
Outpacing the G7
Data: IMF World Economic Outlook database.
Australia’s success with reforms may offer lessons for other countries. The broad coverage of reforms appears to have been crucial to the strong overall benefits that have been realized: increased domestic and external competition, for example, complemented improved labor market flexibility in driving productivity gains. Positive feedbacks between macro- and microeconomic reforms have been evident, too. By increasing flexibility at the microeconomic level, structural reforms may have eased the task of preserving macroeconomic stability; and enhanced stability due to improved macroeconomic management and exchange rate flexibility has aided Australia in realizing the benefits of structural reforms. It has also provided an economic environment more conducive to public acceptance of further reforms.
Finally, while some countries have pursued a so-called big-bang approach, Australia’s reforms have been more incremental, partly in reaction to the failure of a large tariff cut in the early 1970s. The incremental approach is most evident in the labor market and in trade liberalization: spreading adjustment costs over time may have helped Australia sustain its reform efforts over the past two decades.
For more information on Australia, please refer to IMF Country Report No. 05/331 and the Selected Issues Paper No. 05/330. Copies are available for $15.00 each from Publication Services (please see page 332 for ordering details) or on the IMF’s website (www.imf.org).