ADDRESS TO AUSTRALIAN BUSINESS

‘ENSURING AUSTRALIA’S ECONOMIC PROSPERITY:
THE INTERGENERATIONAL REPORT’

LONDON

10 April 2007

It is a pleasure to be here today to talk to you about some of the strengths and some of challenges facing the Australian economy.

Australia is now in the longest period of continuous economic expansion ever recorded, unemployment is at 30-year lows, and inflation is moderate.

We are now reaping the benefits of policy which was set for the medium and longer term more than a decade ago. Policies like our fiscal settings, our monetary objectives, our tax reforms. More recently, some of the longer term trading factors that swung against us for nearly a century swung back in our favour.

But there are other factors that are still working against us. The longer term demographic trends that affect our country – indeed nearly all western developed economies – are working against us. And so the task now is to set policy again for the medium and longer term challenges.

In today’s speech, I would like to talk to you about the intergenerational imperative that must underpin our economic policy – the challenge to secure prosperity not only for today and tomorrow, but for future generations.

By adopting a truly intergenerational perspective, we intend to plan for, and respond to, long-term pressures, pressures that might not dominate the headlines today, but which have been set in motion and will dominate our prospects with remorseless effect.

Before turning to the Government’s 2^nd Intergenerational Report, let me describe the recent Australian economic story.

Australia’s recent economic history and reform experience

The Australian economy has grown continuously since the severe recession of the early 1990s – a decade and a half of economic growth.

The economy has grown at an average of 3.6 per cent over the past 16 years. Over the same period, the OECD ‘25’ averaged growth of only 2.5 per cent. And during that period we have weathered a number of global and regional shocks, including the Asian financial crisis, the bursting of the ‘tech bubble’, and the US recession in 2001.

Australia’s unemployment rate has fallen from nearly 11 per cent in 1992 and 8.2 per cent when I became Treasurer, to 4.6 per cent now – around the lowest rate in over 30 years.

Business investment is around historically high levels, providing a solid foundation for future growth.

And, in contrast to the 1970s and 80s, growth has not come at the cost of inflation. During the current expansion, inflation has been kept under control, averaging 2.5 per cent a year, right in the middle of our medium-term target range. During the 1980s inflation averaged 8.3 per cent a year.

Not surprisingly, Australia’s relative economic standing has improved markedly. In GDP per capita terms, from the 1990s we have moved from the bottom third of the OECD to the top third now. Indeed, Australian living standards are higher than those of all G7 countries, with the exception of the US.

Recent data indicates that the economy remains strong, despite one of the most severe droughts on record. The Government’s latest forecasts, published last December, are for GDP to grow by 2½ per cent in 2006-07, after drought has detracted around ¾ of a percentage point from growth. Farm sector output is expected to contract by one-fifth. Assuming a return to average seasonal conditions in 2007-08, GDP growth is forecast to rebound to 3¾ per cent. Agriculture makes up about 3 per cent of GDP and mining 5 per cent, however both are very important to our export performance.

Over much of the 20^th century, prices for agriculture and mining commodities declined relative to prices for industrial goods. These terms of trade worked against Australia. More recently in the last few years, prices for mining commodities have risen strongly while prices for manufactured goods have fallen. This is sometimes described as “the China effect” and it has worked in Australia’s favour.

While I expect that mining commodity prices will stabilise and gradually fall in the years ahead, I expect that the prices of manufactured goods will remain low – the result of global competition from emerging countries. As such, our terms of trade will moderate, but will not be in long term decline which was the story of the 20^th century.

The increase in commodity prices will bring problems of its own. Each time we have had an increase like this in the past it has ended in unsustainable wage outcomes, inflation, and eventually a recession – the boom bust cycle.

We have better policy settings in place today. Our monetary policy is set by an independent Bank with an explicit inflation target, our Budget is in surplus and we have eliminated Government debt. The end of centralised wage fixing has given us an enormous advantage. In the past, wage settlements passed from profitable sectors of the economy to less profitable ones and transmitted general inflation. But we cannot afford to relax. We cannot afford any backsliding on our key reforms.

Soon after election in 1996, the Government committed to maintain a budget balance, on average, over the course of the economic cycle. Budget surpluses in eight of the past nine years have allowed the Australian Government to eliminate its net debt. This compares to net debt averaging around 24 per cent of GDP in other OECD economies.

We pursued an energetic and wide-ranging structural reform agenda, including important initiatives on corporate law, prudential regulation of financial markets, the ownership and regulation of infrastructure, and reductions in trade barriers.

And we put in place landmark, generational changes to Australia’s tax and workplace relations systems.

A New Tax System was introduced in 2000, bringing in a Goods and Services Tax to replace a range of inefficient taxes. Income tax rates have also been cut substantially and thresholds adjusted to increase incentives to participate in the workforce. In 1999, capital gains tax rates were halved for assets held for more than one year.

And in last year’s Budget, I announced a plan to simplify and streamline Australia’s superannuation system, the most significant reform of the taxation of Australia’s superannuation system in decades. Simplification of the rules concerning superannuation contributions and benefits, and the removal of tax on benefits paid from a taxed fund for people over 60 will significantly boost incentives for people to work and save, and to provide for their retirement.

In the area of workplace relations, the Government has added flexibility, and choice to Australia’s labour market. The new workplace relations system, WorkChoices, which came into effect last year, builds on the Government’s earlier labour market reforms and consigns to history Australia’s tradition of rigid and over-regulated labour markets.

These reforms – our adoption of sound, medium-term frameworks for macroeconomic policy, our structural reform agenda, and our overhaul of taxation and workplace relations arrangements – underpin the economic success story I outlined earlier. They also provide a solid foundation for Australia’s future economic prospects.

The Intergenerational perspective

This brings me to the key point I want to make in this speech. The ultimate test of sound economic management is the legacy it leaves for future generations. When considering any economic policy idea, we should always ask whether it is being done at the cost of future generations or whether it will enrich future generations.

Governments which adopt an intergenerational perspective must set policy with an eye to long-term pressures, trends and opportunities. This point, I believe, is well recognised in the United Kingdom. It is the motivation behind the publication of the UK’s own Long-Term Public Finance Report.

Early in our first term in government, Parliament enacted a Charter of Budget Honesty – a law which requires the Government to adhere to transparent, accountable and prudent fiscal management. Under this Charter, the Government is required, every five years, to examine and report on the long-term sustainability of government policies.

Five years ago I released Australia’s first intergenerational report, as part of the 2002-03 Budget. The report proved remarkably influential. It re-framed public debate on economic policy in Australia, focussing attention as never before on the intergenerational consequences of current policies and practices. It provided an over-arching framework for the Government’s detailed reforms on Welfare to Work and health and pharmaceutical reform.

Last week I released the Government’s 2^nd Intergenerational Report – IGR2. This Report reveals that we have made progress in addressing the challenges highlighted in the IGR1, but Australia continues to face significant long-term economic and fiscal challenges.

Over the next 40 years, as the population ages, and the baby boomers move into retirement, the proportion of the population of traditional working age, 15-64 years of age, will decrease. The ageing of the population is projected to slow economic growth, with real GDP per person projected to increase by 1.6 per cent per year on average over the next 40 years, compared with 2.1 per cent over the past 40 years.

Over the same period, Australian Government spending is projected to rise by around 4¾ percentage points of GDP. After taking into account the strong fiscal starting position of a surplus of just over 1 per cent of GDP, spending is projected to exceed revenue by around 3½ per cent of GDP by 2046-47.

The main spending pressures for the Government will be in health, aged care and the Age Pension. These areas will be put under increasing pressure by demographic change. Other factors, such as new and improving technology, are also projected to increase costs, particularly in health.

Despite these pressures, the IGR2 shows Australia is making progress in better securing our country’s long-term finances.

The IGR2’s projected ‘fiscal gap’ of around 3½ per cent of GDP is an improvement against the first IGR’s fiscal gap of 5 per cent. The improvement is due to both projected lower spending per person, mainly in health, and higher projected nominal GDP per person, primarily attributable to the recent strong rise in the terms of trade.

Higher labour force participation and skilled migration also have increased nominal GDP per person. And the progress we have made in the last 5 years has given us a stronger starting position.

Australia has placed itself in a strong position by eliminating its public net debt. We are one of only a handful of OECD countries to achieve this.

In addition, the Government has established the Future Fund to address fiscal

pressures arising from the Government’s liability for its employees’ superannuation. This liability is currently around $100 billion and is projected to be around $214 billion by 2046-47. Our Future Fund already has around $50 billion under management to make provision for this liability.

In addition, the Government is addressing the increasing pressures being placed on the health system, in particular the Pharmaceutical Benefits Scheme. Since 2002, the Government has put in place a range of reforms, which will reduce the cost to government and consumers of many generic medicines.

In addition, measures to lift economic growth rates play an important role in meeting future fiscal pressures.

Higher economic growth per person increases the capacity of both the government (and individuals) to meet increasing demands for public services, not only arising from the ageing of the population, but also for better quality health care and other services.

We have been establishing frameworks to maintain economic growth over time, by focusing on population, participation and productivity – the 3Ps.

Population refers to the number of people of working age. Australia is one of the very few developed countries which has seen an increase in its fertility rate, and we have a number of measures to support families, including a baby bonus and Family Tax Benefit which we have recently increased. An increase in the net migration intake, with a shift in favour of skilled migration has had a positive impact on the number of people of working age.

In regard to participation, Australia has achieved impressive results, with labour force participation rates increasing, with the trend towards increasing participation for women and older workers continuing. Also, there has been a significant reversal in the long-term decline in participation rates for men aged 55 to 64. Government reforms to help people rejoin, and stay in, the workforce include our Welfare to Work package, personal income tax cuts, and recent superannuation changes.

In an economy that is close to supply capacity, productivity is a critical area for policy action. In this area we have introduced reforms to create a more flexible labour market and have improved our links to international markets through tariff reductions and trade agreements. We are also working with State governments to: reduce unnecessary regulation across levels of government; boost competition in areas of energy, transport and infrastructure; and deliver improvements to human capital.

One of the other factors that is working against our longer term economic prospects is climate change. Climate change is recognised as a crucial environmental challenge – one that calls for a careful balancing of environmental and economic considerations, and a deep understanding of the long-term implications of actions taken today. Australia is on track to achieve its Kyoto target.

Coal is the source of much of the energy that powers the Australian economy. Domestic greenhouse requirements that significantly increase the price of that energy will adversely affect our economy, and it would prove a futile gesture if it wasn’t matched by the efforts of the world’s largest emitters such as the US and China. This is why we need to engage with our region on the environmental and economic issues of climate change.

Australia is working through the Asia-Pacific Partnership on Clean Development and Climate Change, known as AP6, which brings together Australia, China, India, Japan, Korea and the United States, sponsoring a range of activities to address energy and climate change issues.  Engaging China and India is vital to an effective global response to climate change. The Kyoto Protocol does not require China, India and other developing countries to commit to a target level for emissions.   

One of the greatest contributions we could make to help these countries would be in the area of clean coal technology. This is why we have a fund to encourage low emission technology. Last October, I announced a grant from this fund to build the largest solar photovoltaic plant in the world. It is hoped that the technology used there will lead to a new generation of power from solar sources, which will become more competitive with coal generated power in the future.

For a country that has huge resources of fossil fuel, like Australia, the economic cost of moving to substantial cuts in greenhouse emissions will be enormous. Our best strategy will be to pursue technological improvements which will allow existing resources to be used more efficiently. And technological improvements will be the greatest assistance we can deliver to our regional partners.

So these are some of the challenges now emerging for our future. The great demographic challenge is now in motion and irreversible. Anticipating these changes and responding to them allows us to begin the adjustment early. With the policy settings of the past – proven, tested and refined – we are making progress, and we will continue to do so in the decades that lie ahead.

Australians are very flexible. As a smaller country in a vibrant region we have learned to adjust to survive and prosper. We know that economic strength will ease the adjustment. And we cannot afford mistakes or complacency on that front.