Business struggles in an inflation straitjacket

In recent years, businesses increasingly outsourced products and services to combat the rising Australian dollar. With the currency now falling, and inflation rising, that logic is coming back to bite.

The spike in the Australian inflation rate has given us a peep at what is ahead for our nation. And it also helps explain why Ross Barker, the managing director of Australian Foundation Investment Company, Australia’s largest investment company, thinks the Australian market is overvalued.

In recent years, the mining investment boom boosted our dollar which then put pressure on a vast array of Australian enterprises. Managers could respond in three ways – increase prices, manage their business better or outsource products or services offshore.

It was hard to increase prices and a large number of Australian managers thought it was too hard to increase local productivity given unions and the industrial relations act. So they sourced more and more of their services and production offshore. Chief executives patted themselves on the back, boasting about cost-cutting and triggering executive salary rises. But the logic of the more marginal of these overseas outsourcing decisions is now looking shaky as the dollar falls in value and lifts their costs.

The failure to lift local Australian productivity in the private sector was compounded by the public sector which, for the most part, lifted prices with costs. We all know that there is enormous scope to use technology to lower costs and improve services in areas like health, but often it’s just too hard for the managers.

In claiming the Australian market is overvalued, Ross Barker pointed to the fact that Australia had not done enough to lift underlying productivity. That means as the dollar falls, so inflation will rise.

During 2014, the removal of the carbon tax will lower inflation and mask the underlying problem which will become more and more serious as the US tapers its bond-buying program and the American dollar rises.

Can we reverse the trend? It’s not easy. I am urging Treasurer Joe Hockey to tag government aid to the motor industry to three simple and logical management moves. (Hockey’s purse can perform industrial surgery, January 20.)

If Hockey was prepared to go down that path (and I suspect that neither side of politics fully understands the problem) we would take an enormous step in lifting Australian domestic productivity not just in the motor industry but in food processing and many other areas as well. The investment return to the country would be many times the motor outlay.

Higher interest rates ‘solve’ the problem because they keep the dollar up and restrain demand. That means higher unemployment. But there is just a chance that yesterday’s inflation figures will alert corporate and public service managers that outsourcing overseas in many instances (but not all) is the lazy alternative. Starting to manage local operations more efficiently is a far better longer term choice, albeit a harder one.

That way we are not completely at the mercy of the currency and can afford high levels of economic activity and employment.

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