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Garnaut on economic reform « Previous | |Next »
March 31, 2005

I see that Ross Garnaut has an op.ed in The Australian entitled 'Cracking our Complacency.' It is an edited extract from his address to the Sustaining Prosperity: New Reform Opportunities for Australia Conference. Garnaut has been an important economic voice in economic governance in Australia, and he is more of an independent voice than many of our economists, who are content to recycle the dogmas of libertarian politics that provide good economic analysis. So we should listen to what he has to say.

What does good economic analysis look like? What does it offer us?

Garnaut says that for 14 years following the 1990-91 recession, Australia had experienced strong economic growth. Lately that growth has been built on a property boom fuelled by cheap money and cheap credit. Garnaut avoids the widespread Panglossian self-congratulation (the "miracle economy") to point to the signs over the last year of a slowdown on the side of supply capacity. He spells out the signs and interprets them as a deterioriation in economic growth:

The imbalance between growth in domestic demand and supply capacity is being reflected in shortages of labour, goods and services that threaten to re-ignite inflation. It is being reflected in extraordinarily high current account deficits and rapidly increasing net external liabilities as a share of gross domestic product, despite external circumstances that in the past have been associated with lower external deficits - exceptionally favourable export prices and terms of trade.

All this is restating what is known. But it needs restating as the current account deficit is not taken seriously. Garnaut then says that we need to ask the following questions:
What went wrong? What is the remedy? And what are the prospects if Australia takes corrective action?

Garnaut's diagnosis is that Australia has turned away from rational economic analysis and reverted to having popular politics in command of resource allocation and economic policy-making. Only the Reserve Bank stands strong against the re-embrace of the 'traditional approach to economic policy-making that favours the ad hoc and expedient over the economically rational.'

That is a good diagnosis. It gently highlights the way the Howard Government has been captured by economic interests. I can think of energy, agriculture, media, environment. If so, then what corrective action do the rational economists reckon is needed to turn this situation around? What does a professional economic analysis suggest has to be done to ensure ongoing development? What policy instruments do the econocrats reckon they need to ensure the smooth adjustment away from the current market disequlibrium?

Now we know the answer from the Australian Financial Review. Bold reform to restore strong economic growth is what is required. And the Howard Government now has the political power to establish its creditionals as a bold economic reformer.

Garnaut says that we need to retrieve what was done in the 1980s. Okay, so what does that mean today? For Garnaut it basically means tax and social security reform, squeezing excess demand through high interest rates and running budget surpluses. More specifically it means improving:

...the trade-off between generous provision for the disadvantaged and economic efficiency. To fail in this task will lead to continued economic underperformance as well as poor outcomes on employment and equitable distribution.....The most urgent task is to reduce considerably the effective marginal tax rates for social security recipients, the high levels of which contribute to relatively low labour force participation and high levels of part-time employment.
I note that there is nothing in the address about reskilling those shifting from welfare to work. Does that mean Garnaut is pushing for a low wage economy? Does it mean that it's an old paper? Garnaut says that tax reform also means:
A reform of taxation rates that established a flat 30 per cent marginal effective tax rate for all corporate and personal income, including capital gains, would be most advantageous for people at the bottom of the income range, and most disadvantageous for Australians on the highest incomes and with the greatest wealth.
Garnaut then justifies this as progressive. This reads like a defence for the Business Council of Australia position. On the need for higher interest rates Garnaut says that:
It is always difficult to judge how much fiscal and monetary tightening is required to bring excessive demand expansion back within prudent limits. But the extent of excess demand is so large that several more interest-rate rises may be required.
He connects this monetary policy to fiscal policy thus:
Further to raise the requirement of monetary tightening through additional fiscal expansion at this time would increase the risk of recession. Recession would be damaging for long-term reform, long-term growth and equity. It is much better to save the growing budget surpluses until the growth in demand has fallen back below the growth in productive capacity. By then we will have a clearer view of the extent to which the recent improvements in the terms of trade can be expected to continue for a long period.
So the economic reforms are linked to belt tightening. Tough times lie ahead.

Now I do not see the Howard government undertaking the welfare to work reforms by reducing the high marginal tax rates for social welfare recipients. Their reforms will be more coercive as they will aim to shift people off welfare, rather than help them to reskill so they can get jobs. And the flat 30% tax rate has been pushed to one side by the Treasuer. So that leaves belt tightening through monetary and fiscal policy. That means increases in interest rates, and big budget surpluses despite big flows of revenue into the government's coffers from the resources boom.

| Posted by Gary Sauer-Thompson at 12:08 PM | | Comments (0)
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