Nation must take its economic medicine
As the bubble bursts, painful policy decisions will have to be made in a hostile political culture.
The prosperity of the past two decades has been a wonderful thing. Since the recession of 1990-91, Australians have had the longest period of economic expansion unbroken by recession of any developed country.
It has enhanced Australians' financial security. Households have had wider access to important services. It has been a good time for business. Increased purchasing power has brought ordinary Australians a wonderful abundance of foreign travel, goods and services.
We have a big challenge ahead of us. The long expansion culminating in the decade-long China resources boom has left three legacies, which together will test the wit, will, values and cohesion of Australians.
The first challenge is that the real exchange rate has risen way beyond the levels consistent with full employment and continued expansion in output, once the resources boom dims its lights.
The increase is of historic dimension. The real effective exchange rate rose by 69 per cent from December 2002 to its peak in March this year. It must be reduced by a large amount. That means some contraction in the purchasing power of Australian households.
The second challenge is to change entrenched expectations that living standards will rise inexorably over time.
The third challenge is that our political culture has changed since the reform era of 1983-2000, in ways that make it more difficult to pursue policy reform in the broad public interest.
After the decades of prosperity, Australians must choose between two radically different approaches to our problems - "business as usual" and "public interest".
If we continue with "business as usual", we continue to live behind the veil of ignorance that has descended around our public life. But, sooner or later, we will experience deep economic recession with high unemployment.
The public interest is a harder choice with more wholesome consequences. For Australia to choose this, a lot of us - enough to influence policy choice at a high level - would have to put aside the slogans that have taken the place of thought about public policy. We would have to question the validity of propositions to which we've become attached. That's hard. Harder still, we would have to change our minds when the evidence supported change.
The resources boom was caused by a unique period of economic growth in China: the strongest, longest episode in "catch-up" growth the world has ever seen, using energy and metals more intensively than other countries, in the world's most populous country. It was a unique and fabulous episode.
China completed the investment-led period of economic growth around 2011 and entered a new period of transition to a modern economy, with much slower increase in demand for energy, especially coal and metals. The depth of the slump before us flows from commodity producers' failure to see this in advance.
The China resources boom has passed its highest point and will soon end. Export prices are falling. Resources investment is about to decline. We will be left with an extraordinarily high exchange rate, forcing contraction of trade-exposed industries essential for the expansion of employment and output as the boom recedes.
Where can growth come from, to hold up incomes and employment as metals and energy prices and investment decline?
Why not expand activity and employment by increasing government spending, cutting taxes and reducing interest rates to promote private spending?
Our external position is weaker now. If all we did was to increase spending at home, a large excess of foreign payments over foreign earnings would emerge. We would soon find it difficult to obtain enough overseas money on reasonable terms to cover the excess.
We need big contributions from investment and exports in services, specialised manufactures and agriculture right now, but we won't get them until the real exchange rate has fallen by a large amount and remained low for a considerable period.
You cannot fatten a pig on market day. The sooner we start the restoration of competitiveness with depreciation of the real exchange rate, the sooner we can enjoy the benefits.
A big fall in the exchange rate will happen sooner or later anyway. The recent fall in the Australian dollar is a start, but has to go many times further. The dollar's fall is the beginning of the adjustment that Australians must make. What matters is the real exchange rate, taking into account differences in inflation rates as well as the exchange rate. A fall in the exchange rate would raise prices. This reduces living standards, unless there are corresponding increases in productivity.
The greater the improvement in productivity, the less the reduction in real incomes and expenditures. Uninhibited efforts to restore Australian productivity growth should be at the centre of a public interest reform program.
There has to be downward adjustment in real incomes and expenditure as well. How much? That depends on how successful we are in restoring growth in our trade-exposed industries. Reform to tax and social security would allow us to minimise the reduction of the standards of living of average Australians. Substantial reform of business and personal income tax would remove expensive concessions that mainly provide benefits to people on high incomes, while reducing taxes that are genuinely deterring investment and employment. This is easier said than done.
Many changes in policy settings are necessary. Every one of these changes involves some loss of income for some people and some sacrifice of short-term comfort. Each element of reform is politically challenging.
Political leaders will have to introduce changes that disappoint their strongest supporters. That is hard; but earlier leaders of Australia were able to do such things when new understanding of the national interest required it.
It is a lesson of history that successful periods of restraint require the equitable sharing of sacrifice. Quality of leadership is partly about capacity to explain to citizens the nature of the choices that must be made on their behalf.
Policy change in the public interest seems to have become more difficult as interest groups have become increasingly active and sophisticated in bringing financial weight to account in influencing policy decisions. When asked to accept private losses in pursuit of improved economic performance, the response has been ferocious.
We need to be realistic about the difficulties we face. But we do have a choice. A leadership committed to the public interest, supported by the engagement in policy discussion of a substantial community of Australians, could choose the more wholesome outcome.