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What Are Australia's Economic Prospects?

J. Bradford DeLong
delong@econ.berkeley.edu
http://www.j-bradford-delong.net/

July 2000


To someone politically left of center coming from the northern hemisphere English-speaking countries, Australia is extremely refreshing. Where else can you find the leader of the right-wing coalition offhandedly opining that of course the national health program should pay for in vitro fertilization for lesbians--that anything else would be discrimination against the poor? Australia seems to be what Britain might have been with good weather--so that the country did not suffer from seasonal affective disorder--and with plenty of fruits and vegetables. Australia seems to be what the United States might have been had the west been as harsh as the outback, and thus had the idea of the lone self-sufficient independent pioneer never taken root as a cultural archetype.

From the perspective of the rest of the world, Australia has (aborigines aside) an admirable degree of equality of opportunity, a remarkably narrow wage distribution, and a high PPP-adjusted relative standard of living. But there is a strong sense of relative decline since the days when Australia was the sheep-raising OPEC-equivalent of the world, the richest country because of the insatiable demand of world textile factories for Australia's merino-crossbred wool.

After thinking about it, however, I found myself relatively optimistic about Australia's future economic prospects.


Australia's Present

Over the past decade or so the country of Australia has been an effective poster child for neoliberal policy reforms. No matter what the political party in power, governments have pursued privatization of government enterprises and general microeconomic reform--reductions in regulatory barriers to entry and attempts to eliminate blockages to competitition in labor and product markets--in an attempt to accelerate Australian productivity growth.

These policies have been broadly successful, at least as far as their effect on real economic growth has been concerned. Australian economic growth in the 1990s at 2.3 percent per year per capita has been more than half a percentage point faster than in the 1980s. Labor productivity in the market sector has grown at 2.9% per year during the business cycle expansion of the 1990s, compared to 1.4% per year during the business cycle expansion of the 1980s. Moreover, this acceleration of labor productivity growth is not the result of a high-pressure macroeconomy in the 1990s: Australian unemployment at the end of the 1990s was unusually high, more than 7 percent.

However, the burst of productivity growth in Australia in the 1990s has been accompanied by a widening of inequality in income and wealth. (However, Australia remains one of the most egalitarian countries in the OECD.) This should not have been unexpected: if you reduce regulatory barriers to entry and eliminate blockages to competition, factors of production that are in low demand will lose (relatively speaking, at least). The factor of production that was in low demand in Australia in the 1990s was labor: hence a rise in inequality. But it remains the case that Australia has (aborigines aside) more equality of opportunity than any other English-speaking country, and an extraordinarily narrow wage distribution as well.

But rising inequality--a perceived unfair distribution of the benefits from neoliberal reforms--has substantial political costs. Even though the macroeconomic and microeconomic news from Australia's program of neoliberal economic reform has broadly been good, it is not clear whether the political coalition to sustain and enhance this program can be built. Policies that are not perceived as inclusive have little long-run chance of persisting.


Australia's Future

Looking forward, it is difficult to see how Australia's future economic growth prospects over the next decade or so can avoid being brighter than the present.

First, the communications revolutions of the past decade may have led to, in Frances Cairncross's words, "the death of distance," but networks are still very much alive--and it is infinitely easier to communicate with people in one's own time zone than with those who are asleep during one's own work hours. There are three English-speaking metropolises in East Asian time zones: Sydney, Melbourne, and Singapore. Since the dominance of English as the world's lingua franca is likely to grow further, one of these three is very likely to end up as the economic capital of East Asia.

Second and more important, the United States experienced a surprising burst of productivity growth in the 1990s. The consensus view is that this burst of productivity growth - a full extra one percentage point per year of increase in average incomes and in productivity - was the result of computers and communications technologies finally reaching critical mass, and the benefits from exploiting these new technologies finally became large in macroeconomic terms.

There is every reason to think that the same path of productivity-enhancing computer investment could be followed by Australia if the flow of savings to finance high investment were present. But Australia's domestic savings rate is low. There is little prospect for large government surpluses to indirectly finance private investment, and little prospect for large amounts of direct government investment. In part, at least, because of the perceived uneven benefits from liberalization and reform, the next decade seems likely to see all available tax revenues earmarked for the social insurance state.

Thus a high-investment Australia in the next decade needs to be financed, in large part, by a capital inflow: a large persistent current account deficit.

Dare a small open economy run a large persistent current account deficit? Remember Britain and Sweden in 1992, Mexico in 1994/95 and East Asia in 1997/98. The 1990s saw a stunning wave of largely unexpected financial crises driven in large part not be deteriorating economic fundamentals but by herd panic on the part of domestic and foreign investors. Growing foreign debt increases the likelihood and severity of such crises. To date, no country with a floating exchange rate has suffered one. But there is no compelling theoretical reason for this immunity - especially if the foreign debt is denominated in foreign currencies. Yet the potential productivity gains from a high level of foreign-financed investment are so large as to be irresistible. It looks as if the risks are worth running - although steps should surely be taken to minimise them.

In essence, therefore, Australia's future looks much like its past. In the late 19th century, Australia was a rapidly growing economy relying on imported capital and vulnerable to the whims of global finance. In the early 21st century Australia may well become the same.

Is this a good or a bad situation? It sure ain't Utopia. On the other hand, Australia is a rich and egalitarian country (albeit one with relatively high unemployment). And real economic growth over the next decade is--if investment can be maintained at a high level--likely to be very strong. Compared to how things might have been--compared to how the future looked even relatively recently--the outlook is relatively bright.


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As an Australian graduate student in economics (at UCLA) and as a sometime central banker, I feel I have to add a couple of caveats to your note.

1) Of course, given low household savings, Australia needs to finance its domestic investment by running a CAD. In fact, it has run a CAD for all but two or three years since 1945 and every year since 1970.

2) The point about foreign-currency denominated debt is well taken. Since the late 1960s, an unusually large fraction of our debt has been $A denominated. I really have never formed an opinion about how big a role the denomination of our debt has played in insulating us from the crises that have hit other open economies with persistently large CADs; some of my colleagues seem to think it's helped a lot. In any case, we've been playing this game for 30 years now. In fact, most of the micro reform in Australia in the 1980s was motivated (politically speaking) by a "need" to reduce the CAD and to start paying down the stock of foreign debt.

3) Have you ever noticed that the $A is about the most undervalued (relative to PPP) currency in the OECD? It currently trades at around 0.57 US per $A when PPP is about 0.95 US per $A (cf. the Economist's Big Mac index!) How much of this (persistent) undervaluation do you think is due to our (persistent) CADs?

Sincerely

Chris Edmond

PS. I hope you enjoyed the Coombs centre -- or the scenery anyway -- if that's where they put you up.

Contributed by Chris Edmond (cedmond@ucla.edu) on September 1, 2000.


>Re: Australia seems to be what the United States might have been had the west been as harsh as the outback, and thus had the idea of the lone self-sufficient independent pioneer never taken root as a cultural archetype.<

We spent a month in Australia two years ago and puzzled over the differences between the US and Australia. Eventually we learned the reason for them. Although England started off colonizing Australia with convicts, that policy quickly changed and the English actually recruited skilled people to emigrate to Australia, provided for long vacations to return home to see family, and generally made it worth people's while to move. Such policies were never applied to the American colonies, or even if they were considered, they never had time to take effect, eventually leading to the conditions that spawned the American Revolution.

To this day Australia feels kindly towards Britain, to the point where they even voted down a proposal to remove the Queen as the nominal head of state.

Fascinating place.

Contributed by Adam C. Engst (ace@tidbits.com) on September 1, 2000.

Re Australia:

I don't think Australia is as unique among English speaking nations. It is the United States which is the outlier, in terms of having a relatively high GDP per capita, high income inequality, and a lack of progressive social transfers (i.e. no universal health insurance, unequal funding of school districts, a regressive tax code which allows mortgage interest deductions, lack of public funding for election campaigns).

What sets the US apart from the others is the lack of a British-style parliamentary system, in which special interests have relatively less power to halt popular legislation than in the US system of checks and balances. This has retarded the growth of social democracy in the US.

To its credit, the US system has also achieved higher levels of economic and scientific success (mostly using foreign-born scientists), which also reflects its laissez faire system of government.

GDP per capita on PPP basis: (OECD estimates for 1997) USA: $24,849

Canada: $21,375 Australia: $19,647 Britain: $18,650 New Zealand: $13,975

Contributed by Peter von Maydell (peter.vonmaydell@csfb.com) on September 1, 2000.



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Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
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