Australia’s economic performance has been impressive in recent years. Growth has been healthy, with real output climbing by more than 25 percent between the 1991 cyclical trough and the end of 1997. Moreover, in contrast with previous cycles, this growth has been evenly paced; “boom-and-bust” experiences have been avoided, and the expansion has been well balanced on both the demand and supply sides. Another striking aspect of this recovery has been the low rate of inflation. Since 1991, underlying inflation has averaged just 2¼ percent, and has never exceeded 3⅓ percent. Thus, with respect to both growth and inflation, Australia has compared very favorably with other Organization for Economic Cooperation and Development (OECD) countries in the 1990s.

Australia’s economic performance has been impressive in recent years. Growth has been healthy, with real output climbing by more than 25 percent between the 1991 cyclical trough and the end of 1997. Moreover, in contrast with previous cycles, this growth has been evenly paced; “boom-and-bust” experiences have been avoided, and the expansion has been well balanced on both the demand and supply sides. Another striking aspect of this recovery has been the low rate of inflation. Since 1991, underlying inflation has averaged just 2¼ percent, and has never exceeded 3⅓ percent. Thus, with respect to both growth and inflation, Australia has compared very favorably with other Organization for Economic Cooperation and Development (OECD) countries in the 1990s.

The recent good performance contrasts sharply with the experience during much of the postwar period. In fact, Australia’s earlier disappointing performance helped focus the economic and political debate clearly on longer-run issues of structural reform. The need for reform was motivated by a number of considerations. First, attention has been focused on Australia’s long-term performance of per capita income growth—averaging about 1¾ percent from the 1970s through the 1980s—which was virtually the lowest in the OECD. Second, the unemployment rate has shown a strong upward trend, rising from low levels in the 1960s to just over 8 percent by the end of 1997. There is a clear consensus in a number of recent studies that this increase has closely mirrored the increase in the “permanent” or long-run rate of unemployment.

As attention has focused on these two ultimate objectives of public policy—per capita income growth and unemployment—Australia’s economic challenge has been recognized as not just that of recovery from cyclical difficulties, but fundamentally that of long-run structural change crucial to Australia regaining its leadership role among the industrial countries. This book identifies the principal constraints that have affected long-run economic performance in Australia and discusses the extent to which successive reform agendas have reduced these constraints.

Long-Run Perspective

At least four principal forces explain the disappointing long-term economic performance in Australia until the 1990s:

  • Low productivity growth. Long-term trends in output, potential output, and productivity growth are reviewed in Chapter 2. On the basis of the estimation of a production function, and consistent with other studies, the author’s analysis confirms that the estimated growth rate of potential output in Australia—as in other industrial countries—has declined since the 1960s. This decline can be attributed largely to slower growth in the capital stock and to a decline in productivity growth (to less than 1 percent, among the lowest in the OECD) through the late 1980s. A productivity slowdown since the mid-1970s has been a common experience across industrial countries, but Australia’s productivity growth has been poor relative to other industrial countries over this period. Much of this performance can be attributed to the high external tariff levels and extensive labor and product market regulations that protected large sectors of the Australian economy from competition for much of this period.1 The book highlights the importance of policies aimed at raising potential output over the medium term to achieve a decisive and sustainable reversal in the unemployment rate. Raising potential output requires, in turn, policies that sustainably raise the capital stock, labor inputs, and productivity growth above current trends.

  • Low national saving. National saving declined from about 24 percent of GDP in the 1970s to 17 percent of GDP in the 1990s, one of the lowest levels in the OECD. This has placed a number of important constraints on sustainable growth. First, low national saving has been a key factor in the slow growth in the capital stock and in the low rate of per-capita capital accumulation. Second, with the decline in national saving outpacing the decline in investment, there has been a significant structural deterioration in the current account deficit, to an average of 4¾ percent of GDP during the 1980s and 1990s, almost double the level of the 1960s and 1970s. This has raised Australia’s external debt and liability ratios to among the highest in the OECD, increasing its vulnerability to external shocks (as recognized by the government in the 1996/97 budget). Chapter 3 reviews the background to the deterioration of the current account deficit, pointing out that it has been caused by both lower public and private saving. Chapter 4 discusses the deterioration in public saving that has reflected performance at the Commonwealth level and (until the early 1990s) the state level, with gross public sector saving estimated at only 2½ percent of GDP in the 1990s. Private saving has also fallen, principally reflecting a sharp decline in household saving to a level that has left Australia with one of the lowest household saving rates in the OECD.

  • Inflation environment. Australia was successful in reducing inflation to low levels in the 1990s, but its inflation rate in the 1970s and the 1980s was higher and less predictable than in other OECD countries, generating economic uncertainty and detracting from a macroeconomic framework fully conducive to growth. The difficulties and delays in entrenching a low-inflation environment in Australia are reviewed in Chapter 5 and constituted another important constraint to long-term economic performance. In the 1970s, inflation rose more sharply than elsewhere and, in the 1980s, it came down more slowly, remaining close to double digits. Although price stabilization emerged as a prominent objective of monetary policy in the 1970s, the Reserve Bank of Australia’s pursuit of multiple objectives—including full employment and growth—coupled with its lack of effective independence to implement monetary policy until the mid-1980s kept inflation high.

  • Centralized labor market. Inflexible labor markets have been among the most important causes of Australia’s declining productivity performance and have contributed to the increase in structural unemployment. Chapter 6 gives a historical account of the evolution of Australia’s labor market—comparing it to developments in other countries’ labor markets—and reviews estimates of the structural unemployment rate as well as the proximate causes of the steady rise in this rate. The traditionally highly regulated labor market—through minimum wages and working conditions for individual occupations and industries laid out in legally binding “awards”—contributed to meeting social equity objectives, but constrained the economy from adjusting fully to the structural changes stimulated by reforms. In particular, the awards restricted enterprise-level bargaining, kept real unit labor costs relatively high, limited flexibility at the lower end of the wage scale, and detracted from labor mobility between regions and occupations.

Reform Agendas

The First Phase of Reform: Mid-1980s to the Mid-1990s

During the first phase of reforms, the authorities moved across a wide front to address the problem of low and declining productivity. Most important, Australia opened its economy and enhanced competition in a number of sectors. Thus, most external tariffs were reduced to 5 percent or less, largely unilaterally; key areas of the economy were liberalized, such as the financial sector, aviation, and telecommunications; and public enterprises were corporatized or privatized. Moreover, in 1995, the Competition Policy Reform Act introduced a framework to extend competition to the remaining sheltered sectors, notably public enterprises.

Domestic and external liberalization was accompanied by a major structural reduction of inflation in the early 1990s, following the economic downturn of that period. This book points to the quick response of the authorities in seeking to lock in these gains by adopting an innovative inflation-targeting regime, aimed at limiting underlying inflation to 2-3 percent, on average, over the economic cycle. Australia’s formulation of its inflation-targeting framework had at least two key distinguishing characteristics: it required the Reserve Bank of Australia to act preemptively to counter expected future demand pressures, and it tolerated some short-term deviations of inflation to reduce fluctuations in real output (in recognition of Australia’s vulnerability to economic shocks through swings in its terms of trade). Thus, the authorities saw the new framework as defining a “central tendency” for inflation, rather than as a narrow target band with rigidly defined upper and lower bounds. The framework’s success—in conjunction with other reforms—in reducing inflation expectations in the 1990s is documented in this book, and Australia’s inflation-targeting regime is compared to that of some other industrial countries.

The book concludes that these important reforms contributed directly to the current economic recovery and to the prolonged period of economic growth experienced since 1991. In particular, the reforms helped make the economy more competitive and outward-oriented, and the recovery was firmly underpinned by rising private investment and improved productivity performance (above its long-run trend).

As this book points out, however, this first phase of reforms did not address all of the fundamental problems at the core of Australia’s long-term performance. In particular, there had been no structural improvement in national saving (or the current account), despite attempts at Commonwealth fiscal consolidation, the encouragement of private provisions for retirement, and aggressive reforms by the states that significantly improved their financial position. Thus, public sector saving remained at around only 2¾ percent of GDP in 1995/96, at a relatively advanced stage of the cycle, and there had been no upturn in private saving as a share of GDP.

Similarly, the unemployment rate had remained stubbornly high at 8½ percent, well above its previous cyclical trough, despite incremental reforms since the late 1980s aimed at encouraging enterprise-specific agreements, reducing the role of third parties (notably, the unions and the Australian Industrial Relations Commission), and experimentation with more active labor market programs targeted at the long-term unemployed. This book points to a number of reasons why the previous pace of evolutionary reform of the industrial relations system has been insufficient to reduce structural unemployment. Other policies that have kept the unemployment rate high, such as the structure of the social security and welfare system, are also reviewed.

The New Phase of Reforms: 1996 Onward

A second phase of reforms has been launched aimed at sustaining the recent cyclical improvements and resolving the remaining long-term economic problems. This book examines three key elements of the government’s strategy—namely, raising public saving, consolidating the credibility of monetary policy, and carrying out another crucial wave of deregulation aimed at the labor market as well as sheltered product markets in the nontraded sectors. The strategy includes innovative institutional reforms in monetary and fiscal policy.

The fiscal reforms are aimed at making a decisive difference in the public sector’s contribution to national saving, and associated institutional reforms are an important part of the package. Thus, the government announced in the 1996/97 budget a fiscal consolidation stratergy to move the commonwealth budget sector from an underlying deficit of 2 percent of GDP to a surplus in 1998/99. The government also stated in the 1998/99 budget the medium-term objective of maintaining surpluses while economic prospects remain sound, and projected underlying budget surpluses to rise to 2 percent of GDP by 2001/02. This book also describes the Commonwealth government’s new Charter of Budget Honesty, which imposes fiscal discipline by setting out principles for legislated fiscal reporting requirements and responsible fiscal management.

Steps have also been taken to consolidate the improved credibility of Australia’s inflation-targeting framework, aimed at entrenching a low-inflation environment in Australia and bringing inflation expectations into line with the success in reducing actual inflation (especially for wage earners, where expectations have lagged compared with other sectors). This book describes these steps, which include the government’s endorsement of the framework and the greater emphasis on price stability.

This book also describes the steps being taken to complete the structural transformation of Australia’s economy. In the labor market, the main thrust of recent legislation is to further reduce the reach of the award system, allowing it to develop into a true safety net of working conditions, and to let enterprise-level bargaining secure a closer correspondence between wages and productivity growth. The envisaged deregulation of the still protected areas of the economy will introduce new competitive pressures in the financial sector and in the public utilities, spurring new advances in productivity growth (see Chapter 7).

On trade reform, the government has continued the program of phased, unilateral tariff reductions. This has been important in increasing Australia’s export orientation, thereby enabling the economy to take advantage of strong growth in world trade over the past decade. As a result, the ratios of exports and imports to GDP have risen significantly, while a new export base in manufacturing and services has been developed. Further, export markets have become more diversified. In particular, the emerging Asian economies have become important markets for Australia’s exports.

Given the closer ties with Asia, the recent financial crisis in several Asian economies will have a significant impact on Australia. In the near term, the crisis will likely slow Australia’s export and GDP growth, and widen the current account deficit. However, Australia is well placed to withstand the more adverse effects of the crisis, given the maintenance of the government’s fiscal consolidation program, a low-inflation environment, and progress on its structural reform agenda.

The book concludes that the economy’s potential growth rate has increased from the range of 2½–3 percent in the late 1980s to around 3½ percent currently, owing to an increase in both productivity and investment in the 1990s in response to the reforms thus far (see Chapter 8). Actual growth will, of course, depend on demand-side influences, including the near-term dampening effect of the Asian crisis. But the estimate of potential growth may be conservative, given the uncertain impact of the recent reforms on product and labor markets. Moreover, additional reforms in a number of areas have the potential to increase long-term growth further. Ultimately, Australia’s success in raising per capita income and reducing unemployment will depend on the strength of its structural transformation efforts.


Technological convergence may have also played a role. Given that Australia had the third highest level of per capita GDP in the OECD in 1960, technological catch-up may partly explain why other OECD countries recorded higher total factor productivity (TFP) and per capita GDP growth rates in subsequent years. Nevertheless, many of the poorer OECD countries not only caught up to Australia’s per capita GDP level but surpassed it, as Australia’s ranking fell to fifteenth place in the OECD by 1992.