Chapter 2

Framework for Economic Policy

INTRODUCTION

AUSTRALIA, including the island state of Tasmania, has a total land area of 7.7 million square kilometres. It is in southern hemisphere and spans some 4,000 kilometres from Indian ocean in the west to south pacific ocean in the east, and 3,700 kilometres from cape york in the north to the south east cape in the south. Australia is the sixth largest nation by area after Russia, Canada, China, United States of America and Brazil. It has a population of 18 million. Although Australia has a huge landmass, about 70% of the population reside in the three states namely New South Wales, Victoria, and Queensland (ABS, 1998).

Australia is a market based economy, and the significant sectors are mining and energy resources, agriculture, value-added resources, manufacturing, services, tourism and hi-tech industry. Australia’s distinctive physical characteristics, such as low population, isolation from its trading partners, and abundance of minerals and pastoral land in relation to its landmass, have been very important in shaping its economic
behaviour restricting its scale of manufacturing, choice of technology and extent of competition. The Australian economy is enjoying a period of sustained, moderate growth for the last six years. This has been made possible by supportive economic policies that provide stable and conducive economic environment for businesses to make sound investments.

OVERVIEW OF THE ECONOMY

The real gross domestic product (GDP) has grown steadily, increasing by 3.2%in 1993, 4.3% in 1994 and 4.1% in 1995. In 1996 strong private consumption and investment led to GDP growth of 4.1%. Inflation has averaged 2 .25% in the five years to 1997. A detailed industry wise break-up of the GDP has been shown in the Table 2-1.

Service sector is the largest sector in the Australian economy, contributing to just over 68% of GDP during 1996. Retail and wholesale trade is the largest service industry accounting for 19.6% of the GDP. The manufacturing sector, which is the new focal point for growth, accounted for 14.4% of the GDP during 1996, with the production of machinery and equipment accounting for about one-quarter of total manufacturing output. This was followed by mining (4.4%), agriculture (3.7%) and electricity, gas and water utilities 3.2%.

Most of the economic activity in Australia is concentrated around the three states namely New South Wales, Victoria & Queensland. These states contribute to approx. 77% of the GDP and 70% of the population resides in these states. A detailed break-up of the individual state's contribution in the GDP has been provided in the table 2-2.

	Gross State Product	% Share
State / Territory
New South Wales	178,214	35.00
Victoria	132,180	26.00
Queensland	82,497	16.00
Western Australia	54,402	11.00
South Australia	36,023	7.00
Tasmania	10,562	2.00
Australian Capital Territory	10,498	2.00
Northern Territory	5,393	1.00
Australia	509,769	100.00

Source : Australian Bureau of Statistics (1998).

The instruments or "tools" of the economic policy are – monetary, fiscal, balance of payment and microeconomic policies. All policies are linked with respect to the objective outlined above with occasional conflicts occurring in the use of the above "tools". The policy "mix" refers to the particular combination of all four tools of economic management. For instance, in an effort to overcome the effects of the early - 1990s recession, the government undertook an expansive (and expensive) programme of fiscal stimulus, aimed mainly at the labour market. Initially, the results were disappointing from the perspective of cutting employment but when combined with a subsequent easing of monetary policy, the economic growth responded strongly.

GOVERNMENT STRUCTURE

Australia’s system of government is based on the liberal democratic tradition, which includes religious tolerance and freedom of speech and association. Its institutions and practices reflect British and North American models but are uniquely Australian. Australia has a federal system of government whereby legislative, executive and judicial powers are divided between the federal administration, known as the Commonwealth and based in the national capital, Canberra, and those of a number of states and territories. The constitution defines a large number of powers that the Commonwealth can exercise concurrently with the states.

The Commonwealth has sole responsibility for specific areas such as defence, customs and excise duties, coining of money, foreign relations and trade and immigration. The governments of Australia’s six states and two self-governing mainland territories are responsible for matters such as education, health, law enforcement, housing and urban development, regulation of intrastate commerce and industry, provision of water, gas and electricity, and transport and land management within their boundaries. The commonwealth also administers national policy in these areas (Foreign Affairs and Trade, 1997). On a local level there are more than 700 local government authorities that have been created and controlled by State government legislation. Local governments in Australia do not have any significant policy or administrative role in education, police or health services. They remain primarily the suppliers of local infrastructure (roads, drainage and so forth) and services to residents such as garbage collection. (Walsh, 1997).

The Commonwealth

The Commonwealth of Australia was created in 1901 when former British colonies-now the six States-agreed to federate. Government is based on a popularly elected Parliament with two chambers, the House of Representatives and the Senate. Ministers appointed from these chambers conduct executive government. Legislation and policy decisions are made in Cabinet meetings. Ministers are bound by the principle of Cabinet solidarity.

The House of Representatives has single-member seats. All 148 members face the voters at the same time. The number of members elected from each state is proportional to the population of each state, subject to the requirement that no original state shall have fewer than five members. Each house of representatives may continue for up to three years, after which general elections for a new house must be held. Elections are often held before the end of this period. The House's central function and the one which takes up most of its time is the consideration and passing of new laws and amendments or changes to existing laws. The government cannot collect taxes or spend money unless allowed by law through the passage of taxation and appropriation bills.

The 76 Senators are elected for a six-year term and in an ordinary general election, only one-half of the senators face the voters. Each state is treated as a single electorate with twelve seats and each territory has two senators.

The most basic and fundamental power of the parliament is the legislative power, which is shared virtually equally by the House of Representatives and the Senate. Both houses must pass all proposed laws. There are, however, limitations on the power of the Senate over financial matters.

After an election the political party (or coalition of parties) which has the majority of members in the House of Representatives becomes the governing party. Its leader becomes prime minister and other ministers are appointed from among the party's Members and Senators (APH, 1998).

State Governments

All six states and the two territories have their own parliaments. The Australian states are New South Wales, Victoria, Queensland, South Australia, Western Australia and Tasmania. The two self-governing Territories are the Northern Territory (NT) and the Australian Capitol Territory (ACT). Each has an upper and lower house except Queensland, where the upper house was abolished early this century. ACT and the NT both have legislative assemblies. The leaders of state governments are called premiers and the leaders of territory governments are called chief ministers.

Head of State

Although it is an independent nation, Australia’s Head of State is Queen Elizabeth II of Great Britain, who is also formally Queen of Australia. The Queen appoints the Governor General on advice of the elected Australian Government. As the Queen’s representative, the Governor General appoints ministers on the advice of a prime minister, who leads a party or coalition with a majority in the House of Representatives. The Governor General has wide powers but by convention acts only on the advice of ministers on virtually all matters. In the states, governors represent the Queen.

Regulatory Environment

Business enterprises are subject to three levels of government regulation. The federal government provides national policy directives in finance, industry, social services and matters extending beyond state boundaries. These areas specifically encompass customs and excise arrangements, loans, taxation, banking, foreign trade and foreign investment. Recently, the federal government has pursued a policy of privatisation and deregulation. It has sought to eliminate several government monopolies and deregulated domestic airlines, banking and telecommunication.

State governments are responsible for implementing, within their boundaries, the national policy directives of the federal government. They also regulate certain areas not exclusively within the federal jurisdiction, such as education, housing, conservation, the environment, and commercial and criminal law. Administrative activities are financed through financial assistance from the federal government and funds raised through state taxes. Industry incentives and industry development are administered through joint programmes with the federal government.

Local governments regulate social and industry services. Local councils provide services to their own communities and regulate matters that cannot be handled by the larger bodies, such as real estate zoning. They consist of elected representatives who usually act in an honorary capacity. Local government councils are funded by property taxes known as rates (Ernst & Young, 1995).

Current Political Configuration

Mr. John Howard from Liberal National Coalition emerged as Prime Minister from the March 1996 elections. The Liberal Party of Australia secured 75 seats and, together with the National Party of Australia (19 seats) have formed a coalition resulting in majority of the 148 seats in the House of Representatives. The Australian Labour Party, with 49 seats and five Independents form the opposition. The next election for the House of Representatives is scheduled to be held in May or June 1999. In the Senate there are 31 senators from the Liberal Party, six from the National Party, 28 from the Labour Party, while seven belong to the Australian Democrats, two are Independents and two are Australian Greens (APH, 1998).

At the state level, the Liberal Party governs in Victoria, South Australia, Western Australia, Tasmania and the Australian Capital Territory. The Labour Party rules in New South Wales. The National Party controls power in Queensland. In the Northern Territory, the Country Liberal Party is in Power (Commonwealth and State Governors and Leaders, 1998).

Ideologies of the Main Political Parties

Although Australian commentators observe that elections have become more "presidential" in the sense that some American campaign methods are used, the basic structure of the Australian system tends to emphasise policy stances rather than the character of individual politicians. The political parties represented in the House are the Australian Labour Party, the Liberal Party of Australia and the National Party of Australia. In recent years there have been one or two independent members

The importance of money in an economy and the money-creating powers of the financial system make it necessary for a government, or its agent, to exercise control over the money supply (Gregory1993). Even with deregulation, some degree of control is exercised through monetary policy. Monetary policy comprises measures which seek to affect the supply, direction and price of money and credit. Its aim is to influence the level of investment and spending by inducing changes in liquidity in the financial market. The agent of the government responsible for monetary policy is the central bank which, in Australia's case, is the Reserve Bank.

Objectives of Monetary Policy

The framework for the operation of monetary policy is set out in the Reserve Bank Act 1959. The framework requires the board to conduct monetary policy in a way that, in the board's opinion, addresses the following: contribute to the objectives of maintaining the stability of Australia's currency; pursues full employment in Australia; and ensures economic prosperity for the people of Australia. The first two objectives lead to the third and, ultimately to the economic policy as a whole. These objectives allow the Reserve Bank to focus on price (currency) stability while taking account of the implications of monetary policy for activity and, therefore, employment in the short term (RBA, 1996).

Implementing Monetary Policy

Monetary policy is set in terms of an operating target for the cash rate, which is the interest rate on overnight loans made between institutions in the money market. When the Reserve Bank's board decides that a change in monetary policy should occur, it specifies a new target for the cash rate. A decision to ease policy will reflect in a new lower target cash rate, while a decision to tighten policy will reflect in a new higher target level for the cash rate.

The cash rate is used as an operational target for monetary policy because it underpins all other interest rates in the money market and, through its effects on banks' costs of funds, also underpins banks' lending interest rates. For example, in determining interest rates on 3-month securities, market participants take into account the return that they expect on overnight money on average over the next three months. The close relationship between the cash rate and other money market interest rates can be seen in figure 2-1. The Reserve Bank uses its domestic market operations (sometimes called "open market operations") to influence the cash rate (RBA, 1997).
 
 

With inflation well under control but unemployment stubbornly high, and signs of cyclical slack in the economy, monetary policy is now aimed at sustaining low inflation while keeping monetary conditions conducive to stronger economic growth. The monetary policy has been easing, inducing interest rates of all maturities to decline. Between the second half of 1997 and early 1998, the interest rate on three-month bank bills moved closely in line with the cash rate, on several occasions leading rather than following the decreases in the latter. This reflects the money market's anticipation of changes in the cash rate target by the Reserve Bank. Altogether, the yield on the three-month bank bills fell from 0.5% in mid-1996 to 4.9 % in October 1997 (OECD, Australia, 1997-98). During the same period business lending rates of banks also fell by around 2.5 % to 8.75% for small business loans and to about 8.5% for large business loans in October 1997. Altogether, in October 1997 business and mortgage interest rates were at their lowest level in around 25 years.

Exchange Rate management through Monetary Policy

The Australian dollar has been on a flexible exchange rate mechanism since December 1983 (Gregory, 1993). The Reserve Bank is the traditional custodian of Australia’s gold and foreign exchange reserves, and still holds foreign exchange and intervenes in the market at its discretion. The government does this in order to maintain the dollar within certain broad limits. Various factors can effect the exchange rate, such as the consistency of the nation’s economic policies, external accounts, the position of the monetary policy and export prices. Figure 2-2 shows the exchange rate of the Australian dollar in the period since the float.

Source: Adapted from Datastream, Reserve Bank of Australia 1998

The general rise in the U.S. dollar exchange rate against major currencies since late 1996 also brought to an end the trend appreciation of the Australian dollar against the US currency, which had begun in the second half of 1993. The Australian dollar declined further in response to the narrowing differential of Australian interest rates over US rates. However, with the Australian dollar strong against other currencies, in particular the yen, the effective (trade-weighted) exchange rate continued to appreciate until May 1997. It has softened since then, due to declining capital flows from Japan in response to the shrinking interest premium of Australian financial instruments and changing short-term outlook for export markets to South East Asia. Altogether, during the first ten months of 1997, the effective exchange rate of the Australian dollar stood a little below its average level in the second half of 1996. (OECD - Australia 1997).

Inflation and Monetary Policy

One of the indicators of a stable growth in an economy is negligible inflation and the most important role of the monetary policy is to achieve this. The instrument which monetary policy uses is the overnight interest rate in the money market – the "cash" rate. The Bank exercises quite close control over cash rate through its domestic market operations.

For many years, inflation in Australia was too high, hampering economic and financial efficiency, diminishing the economy's long run growth potential, and having adverse effects on equity. In the 1990s, a climate of low inflation has been re-established.

Inflation has averaged 2.25 % in the five years from 1993 to 1997. This has coincided with average growth in real output of 3.5%. The centrepiece of the policy framework is an inflation target, under which the Reserve Bank sets policy to achieve an inflation rate of 2%­3% on average, a rate sufficiently low that it does not materially affect economic decisions in the community. The target provides discipline for monetary policy decision-making, and serves as an anchor for private sector inflation expectations (RBA, 1997). The figure2-3 shows the inflation rate over the long run.

Source: Adapted from Datastream 1998
 
 

THE FISCAL POLICY

The fiscal policy of a government aims at influencing the aggregate demand through changes in taxation (revenue) and budget outlays (expenditure). The Australian Government has been using fiscal policy in the past to stimulate the economy. The fiscal stimulus injected into the economy to overcome the recession of the early nineties has been successful and now that the recovery is nearly complete the present coalition government is reducing fiscal spending (RBA, 1997).

However, the use of fiscal policy has its share of problems. First, the fiscal policy is generally accused of crowding out private investment and secondly it has resulted in increasing the current account deficit. Australia's large structural current account deficit reflects both inadequate national saving and inadequate investment returns overall. On the saving side, the principal cause is a deficiency in public saving especially at the national level. One initiative that has been introduced to increase the national savings has been the implementation of the "superannuation guarantee charge" (SGC). The intent of the SGC is to make individuals fund their own retirements through a system of compulsory saving. This has the twin aim of reducing the level of public sector outlays by lowering the government’s expenditure on the pension while at the same time raising the level of national savings (Clayton 1997).

The government through its fiscal consolidation programme is addressing this problem and has put in place a policy framework that will maintain the adequacy of the national contribution to public saving. The previous labour government achieved a budget surplus in fiscal year 1995-96 through asset sales. The present government aims to achieve the same target trough reduction in fiscal outlays.

The 1997-98 budget continues the government's fiscal strategy initiated in 1996-97. The underlying budget balance will continue to narrow in 1997-98 from its 1996-97 level, and is projected to be in surplus in 1998-99. Beyond 1998-99, increasing underlying surpluses are expected in line with the projected economic outlook. For 1997-98, the underlying budget balance is estimated to be in deficit by $3.9 billion or 0.7 per cent of Gross Domestic Product (GDP). This is an improvement of $3.0 billion or 0.6 per cent of GDP on the expected outcome for 1996-97.

The underlying budget balance in 1998-99 is projected to be in surplus by $1.6 billion or 0.3 per cent of GDP. This is an improvement of $5.5 billion on the projected deficit in 1997-98 and $3.7 billion or 0.6 per cent of GDP on the projected deficit of $2.2 billion for 1998-99 published in the 'Mid-Year Economic and Fiscal Outlook'1996-97 (Commonwealth of Australia, 1997). The budget sector outlays for 1996-97 to 2000-01 are shown in Figure2-4.

Source: Adapted from Australian Budget 1997-98,Fiscal Outlook, PartII, "Underlying Budget Aggregates".

The underlying deficit for 1996-97 is now expected to be $6.9 billion or 1.3% of GDP, an improvement of $1.6 billion or 0.3% of GDP on the estimate published in the MYEFO. This improvement reflects both stronger than expected revenue collections in recent months and lower outlays (Australian Government Budget, 1997).

Objectives of the Current Fiscal Policy

The main objective of the fiscal policy is to increase the national savings level. With the fall of public sector borrowing from 2.6% of GDP to 0.3% of GDP over the fiscal year 1996/97, the demand for increased private savings will fall. The above savings strategy should assist in reducing the current account deficit by reducing consumption and therefore imports.

The government's budget priorities have been developed within a framework that takes account of the government's broader economic and social objectives. In framing its 1997-98 budget, the government has given priority to providing an economic climate that supports enhanced employment opportunities and rising living standards. The other items in the priority list include increasing national savings, a fair social safety net, assisting families through child disability allowance and domiciliary nursing care benefits, employment and training, encouraging small businesses, drought relief and farm risk management, environmental initiatives, defence, infrastructure, investment to make government more efficient through information technology and revenue base protection measures (Australian Government Budget, 1997).

The government has laid the rules for the future conduct of the Fiscal policy and in the medium-term the central objective is to balance the budget over the economic cycle. This objective was chosen with a view to reversing the structural deterioration in the Government's budgetary position.

The budget deficit has occurred in the past two decades, largely accounting for the rise in Australia's structural current account deficit (i.e. the decline in net national lending) over this period. Balancing the budget will ensure that in the future, Australia's structural current account position only reflects the private sector's (and possibly, other parts of the public sector's) net lending decisions. At the same time, it was recognised that fiscal policy should continue to play a short-term stabilisation role, especially through the functioning of the automatic stabilisers.

Consolidation measures to be implemented over two years were announced in 1997 budget (OECD Australia, 1997). These measures cut A$ 3.9 billion from the forward projections of the deficit in 1997 and A$ 7.2 billion in the following year. Further consolidation measures were announced in the 1997 budget, mainly relating to future years. As with the previously announced measures, these also focused mainly on outlays. In all, official projections show that the budget position is to improve from a deficit of A$ 10.3 billion (2.1% of GDP) in 1996 to a small surplus in 1999, rising to a surplus of A$ 10.7 billion (1.6% of GDP) by 2001.

Taxation Policy

The tax rates in Australia are low when compared to the tax rates of other OECD countries. Income taxes, broad-based sales taxes, and excises (excluding the state government levies on Government based enterprises) are collected at the national or commonwealth level. The states collect payroll tax, stamp duties and other financial transactions taxes, motor vehicle taxes, business franchise fees and a variety of minor sources. The local government is solely responsible for property ‘rates’ and other property based taxes, such as land taxes.

The absence of value-added taxes (VAT) in Australia makes its tax system different from that of most of the other OECD economies. This has placed a relatively large burden on personal income tax payers, the main source of revenue in the taxation system. The government recognises the pressure on individual taxpayers and it is likely to introduce a VAT in the next four to five years. Though the issue of a VAT has been a politically sensitive issue, it has slowly gained the acceptance of the public since the last public elections in 1995. The VAT, if introduced, is expected to be in the range of 10% to 15%. However it is also foreseen that this would be cushioned by a cut in the individual tax rates, especially the upper tax limit of 47% being cut down to the equivalent of the existing corporate tax rates of 37%.

The principal indirect tax is the Commonwealth's Wholesale State Tax (WST), which is levied only on goods (OECD Australia, 1997). This tax base is steadily eroding as the share of services in GDP rises. Moreover, with services now constituting 78 % of GDP, the base for the WST is already narrow.

COMMONWEALTH			STATE AND LOCAL GOVERNMENT TAXES
	($m)	% of Commonwealth taxes			($m)	% of state and local taxes
Taxes on Income	89,222	71.6	Payroll tax		7,632	20
Individual	66,278	53.2	Taxes on Property		14,352	37.5
- personal	64,185	51.5	-Land tax		1,614	4.2
- prescribed payments	1,671	1.3	-Rates		5,384	14
- other personal	421	0.3	-Other		301	0.8
Company	21,706	17.4	-Stamp duties		4,986	13
- income tax	18,966	15.2	-Financial institutions tax		1,983	5.2
- super funds	2,595	2.1	-Govt. borrowing g'tee levies		85	0.2
Employers' Payroll Tax	3,104	2.5
FBT	3,062	2.5
Property Taxes	11	0	Taxes on Goods and Services		5,721	15
Wholesale and Services	30,486	24.4	-Agricultural pdn. taxes and levies on state enterprises	440		1.1
Sales tax	13,291	10.7
Excise	13,893	11.1	-Gambling		3,497	9.1
- excises	13,291	10.7	-Insurance		1,784	4.7
- agricultural produce	603	0.5
International trade	3,350	2.7
- imports	3,350	2.7
Gambling	3	0
Goods and Activities	424	0.3	Goods and Activities		9,069	23.7
			-Motor vehicle taxes		3,592	9.4
			-Franchise taxes		5,221	13.6
			-Other		256	0.7
Fees and fines	1,392	1.1	Fees and Fines		1,549	4
Total Commonwealth Taxes	124,638	100	Total State and Local Taxes		38,323	100

Another concern is that high marginal income tax rates become effective at modest incomes. The marginal tax rate (including employee social security contributions or, in Australia, the medicare levy) for the average wage is 45%, one of the highest rates in OECD outside the continental Europe. This is striking considering that individual income tax receipts and employee social security contributions amount to only 12 % of GDP, lower than in most other OECD countries.

With the objective of encouraging private saving, and consequently boosting domestic growth, the government has announced a 15% tax rebate for individuals. This measure will be introduced in two stages with a 7.5% rebate from July 1998 and the full rebate from 1 July 1999. This is expected to benefit about 6 million taxpayers.

Vertical Fiscal Imbalance

Although taxation powers are constitutionally accessible to the states and the Commonwealth, except that over duties of customs and excise, revenue has mostly been collected by the Commonwealth (Walsh 1997). In 1995-1996, it raised 76 % of the total taxation revenue, though its spending represented just over 50 % of public sector outlays. By contrast, the states collected 20% of taxation revenue and spent 43 % of the total public sector outlays. The imbalance between expenditure responsibilities and own-source revenues at different levels of government that are reflected in these figures is termed vertical fiscal imbalance (VFI).

The degree of VFI in Australia is more than that of other comparable federations like the U.S., Canada and Germany. In responding to the states' pressure for access to additional revenue, the commonwealth has periodically reassigned areas of taxation that it had under its purview, sometimes concurrently with the states. A recent move by the Hawke Government under its ‘new federalism’ initiative was to transfer revenue from its bank accounts debit tax to the states. Previously, this had been viewed by the states as competing against their tax on financial transactions. The commonwealth also has permitted a few of its statutory authorities to become subject to state payroll taxation in recent years. However, these changes also have been offset by a substantial cut in grants made to the states.

Tax Reforms

Comprehensive tax reform has remained elusive in Australia. An attempt was made to negotiate such a reform in 1985, including the introduction of a general consumption tax, but it floundered because of opposition against the latter. The Liberal-National Coalition parties, now in power, lost the 1993 election on a platform of comprehensive tax reforms involving the introduction of a general sales tax (GST), abolition of most other indirect taxes and substantial income tax cuts. This policy was dropped in the last election, with the coalition promising not to introduce a GST during its first term in office. Since then, however, public opinion has become more favourable to tax reforms, including the GST. Moreover, a recent High Court ruling that state levies (franchise fees) on petrol, tobacco and alcohol were invalid has both added urgency to the issue of tax reform and underlined that it must be set in the context of Commonwealth- state financial relations (OECD Australia, 1997).

The first reason for the ongoing tax changes is the growth of the services sector relative to the manufacturing sector which has made the tax base narrower in relative terms (Thompson 1995). The choice, therefore, would seem to be between an indirect tax decline as a proportion of total taxes and increasing indirect tax rates on manufactured goods. Consequently, the narrow tax base increases the distortionary impact. Including more service goods could expand the tax base. However, this poses a dilemma. The services sector is among the fastest growing sectors of the economy, so it represents the greatest opportunity for increasing revenue. However, fast growth means that it is the sector with the greatest job creation.

The second reason for possible tax changes relates to increasing demand for public sector goods. To the extent that areas like health and education grow quickly and remain within the public sector, there will be an increased need for tax revenue. This will place extra pressure for broadening the tax base or for more payments for services by users.

TRADE AND BALANCE OF PAYMENTS

The Australian economy was relatively closed until 1980. The Australian dollar was floated in 1983, and in March 1991, the government began a general tariff reduction program. Currently, most existing tariffs are 5%, except for passenger motor vehicles and textiles, clothing and footwear industries where the tariffs are still about 25 to 37%. These tariffs are likely to be reduced to 15 to 25% by 2000 (U.S Dept of State, 1997).

Trade is important for Australia given the small size of its internal market. Trade allows Australia to produce only those goods in which it is most competitive and import the remainder from countries that are more efficient at producing those goods. After Australia opened up its economy, both imports and exports as a percentage of GDP have grown at a higher rate. Trade in goods and services grew from about 32% in 1980 to 40% in 1996 (DFAT, 1997). The composition of exports has changed in the past two decades, moving towards value added items. Manufactured exports have grown at an average rate of 13% percent per annum over the last five years. Elaborately transformed manufactures (ETMs), which comprise items like high-speed ferries, telecommunications equipment and motor vehicles, have shown the best performance. The ETM now constitutes 22% of the total exports. However, primary products, such as, agricultural and mineral products still remain dominant export items. Most of the growth in trade has been to the East Asian region. Australia’s exports to East Asia have increased from 40% of its total in 1975 to 60% in 1995. With the East Asian region currently plagued by economic crisis, their exports have been declining.

Australia has accumulated a large current account deficit (CAD). In the period from 1996 to 1997, the CAD was A$20 billion and in the previous year A$20.5 billion which was nearly 5% of GDP. Only a small portion of this deficit is due to a trade imbalance while the major portion is due to foreign borrowing for private and public sector investment. So far, Australia has accumulated net foreign debt of A$235 billion (ABS, 1997) or nearly 50% of the GDP. Public and private sector debt is 45% and 55% respectively.

Foreign borrowing exists because of the consistent gap between national savings and investment. National saving has fallen markedly since the 1960s. It is averaging only 17% of GDP in the 1990s which is significantly below the OECD average (OECD Australia Outlook-1997). The difference between national savings and investment, which is the CAD, has increased gradually from 2% of GDP in the late 1970s to about 5% in 1997. In the absence of internal savings, the government and private firms have been borrowing foreign funds in the form of debt and equity to finance their investments. The payments in terms of dividends and interest in fiscal years 1994, 1995, 1996 has been A$17 billion, A$19 billion and A$21 billion respectively, about 4% to 5% of the GDP (ABS,1997).

The foreign debt is a serious problem Australia faces today. Australia cannot continue to run CAD for long without facing its associated risks. With such a high debt obligation it is prone not only to business risks associated with economic scenario but also to currency and interest rate risks. Depreciation of the Australian currency or the increase in the foreign interest rates will increase the debt burden further. Australia is currently facing such a situation with the depreciation of the Australian dollar by 15% in 1997. Due to the deteriorating economic scenario in the East Asian region, Moody's has revised Australia's credit rating from "positive" to "stable" (SMH, 1998).

Figure 2-5 shows the trend of national investment and saving. The consistent gap between the two is the current account deficit which adds on to the net foreign debt each year. Figure 2-6 shows the share of private and government savings in national savings. The compulsory superannuation scheme has been introduced to boost private savings which had dropped to negative figures in early 1990s.

National Saving and Investment as per cent of GDP

Source: Adapted from OECD Economic Survey Australia 1997

Source: Adapted from OECD Economic Survey Australia 1997

The government is attacking the deficit problem from three angles. First, the aim is to keep the budget in balance over the course of the economic cycle and make the associated savings available to the private sector. The government's target is to cut the budget deficit to 2% of GDP by 1998 and to generate a surplus by the year 1999. This means that the government cannot use fiscal policy to support the economy in the short-run. Secondly, the aim is to increase private savings which it being done through a compulsory superannuation scheme. Empirical analysis suggests that this could raise national savings by 1% of GDP per annum within next seven years, eventually amounting to about 1.5% of GDP (Australian Budget 1995). Thirdly, the government hopes to increase foreign direct investment.

ISSUES IN MICROECONOMIC POLICY

For most of this century the Australian industry has grown in a protected environment, its industries protected by tariffs and quotas on imports. The logic behind this was that, given the small size of the Australian population, the advantages of scale economies that the domestic industries would enjoy in a protected environment could offset the disadvantage of inefficiency that would occur due to lack of competition. This logic does not hold in the global economy of today. Australia realised in late 1970s that it had to give up this ‘mercantilist’ view, participate in the global economy and reap the benefits that came of it. In order to do so it too had to open up its economy, which it did gradually after taking steps to make its domestic industry more competitive to face the international competition. However, as it opens up, some of the inefficient domestic industries may lose out and free up the resources for the more efficient industries.

The microeconomic reform process started in 1979 and grew stronger in the late 1980s with an objective of increasing the efficiency of the Australian economy. This process has been associated with the radical break-up of some industries, introduction of competition into others, with privatisation, with labour and wages policy and with the generalised movement to reduce the barriers to competition in the economy (King et al, 1996). In 1990, as a part of the movement towards developing a more efficient economy, the Australian federal and state governments set in motion a process which produced the "Hilmer Report" and culminated in the National Competition Reform Act 1995. This new legislation provided strict limitations on what the government can do to restrict competition and creates an environment for freer access by firms to facilities owned by public enterprises. It establishes competition as a norm against which public policy will be judged in future.

In the past, Australia controlled most of the key sectors of its economy through publicly run enterprises. Mail services, telecommunications, electricity generation and distribution transport services, water supply, education and health services have traditionally been the domain of government. In most parts of the world, including Australia, publicly run enterprises have performed less efficiently and seem to be subject to poor productivity, over-staffing and inefficient customer service. These features resulted from the monopoly status that these firms enjoyed and the lack of proper management incentives. This problem of inefficiency of the public sector enterprises has been addressed in two ways. First, deregulation has been introduced to end the monopoly status of the publicly run enterprises except for sectors where natural monopoly makes sense. Secondly, the government business enterprises (GBEs) have been restructured such that they behave more as private enterprises. These strategies were quite successful and the return on assets (ROA) increased by four percentage points from 1983 to1988 (King et al, 1996). Most of these gains have been due to increased efficiency from cost cutting measures. However the ROA reached a plateau in the 1990s and increased by only one percentage point from 1988 to 1993. The issue before the government now is whether to take the next step into privatisation.

Privatisation means selling the shares of government controlled companies to private investors and, thus, placing the management in private hands. Privatisation maybe more efficient than mere corporatisation because private firms are likely to behave in a profit maximising way, explore new markets, innovate and grow. The decision to privatise has been fairly straightforward for firms that are already competing in a oligopolistic or a competitive environment, where the privatisation will yield the desired benefits of efficiency. This has been the case in Commonwealth Bank, Commonwealth Serum Laboratories, Snowy Mountain Engineering Company and Quantas Airlines.

However, in cases where GBEs are monopolies, such as electricity, gas, transport, telecommunications, water and sewerage, and education, the decision to privatise is not so straightforward. For example, the complete value chain in the electricity sector from production to distribution is operated by the GBEs. Power generation is a natural monopoly whereas competition is desirable in power distribution. However, in the absence of regulation, the monopolist could easily move into distribution and squeeze out competitors. Therefore, deregulation and privatisation without regulatory laws will not necessarily produce efficient results. It is these issues that the National Competition Policy addresses. Some of the industries that have been privatised include electricity, airports, the telecommunications company Telstra and the Moomba-Sydney gas pipeline. Potential benefits from wide-ranging microeconomic reforms have been emphasised in a number of studies. For example, the Industry Commission estimates that a range of reforms associated with the implementation of the National Competition Policy could boost GDP by around 5.5 % (AGPS, 1998).

Another important area of the microeconomic reform process has been in the area of labour relations. The unions in Australia have been very strong in the past and are represented by a supreme governing body called the Australian Council of Trade Unions (ACTU). The late 1970s witnessed a very high rate of industrial disputes the main causes of which were wages, hours of work and the managerial attitude (Gregory et al, 1989). Soon after the Hawke government came to power, ACTU entered into an agreement called an "accord" that related to wages, prices and economic policy and subsequently the number of disputes were reduced. The unionised bargaining system that existed made wage negotiations as well as the dispute resolution process very cumbersome and time consuming, resulting in high and inflexible wages. There are several problems associated with the inflexible wages. First, wages cannot respond to market conditioning and Australian industries cannot compete globally since they pay more for the same kind of job than their competitors in the other countries do. Secondly, high wages reduce the marginal returns of labour as compared to capital and investment moves away from labour intensive industries, which exacerbates the problem of unemployment. In 1996, the government introduced industrial relations reforms which promise an environment more favourable to enterprise level bargaining where workers and the employees can now negotiate with each other directly on matters of wages or other disputes.

AUSTRALIA’S ECONOMIC OUTLOOK

The Australian economy has grown at an average of 3% over the past decade. Inflation, which was source of a major problem in 1980s, has been contained to an average of 2.25% in the five years to 1997. Unemployment has still been ranging around 8-10 for the entire past decade, remains a constant problem in Australia. The combination of solid economic growth in recent years and stubbornly high unemployment suggests that more structural changes in the policies are necessary. A continual concern to the government is the size of current external deficit which has risen from a little over 2% of the GDP in 1970s to about 4.5% of the GDP. The trend rise has been due to a significant decline in the national savings.

Australia has benefited from the economic restructuring plan that began in early 1980s. Australia has a mature industrialised economy with a large and growing services sector and a broad based manufacturing sectors. The Australian government in its budget forecast in May 1997 had projected a positive economic outlook. Growth was expected to strengthen to 3¾ % in 1997-98, underpinned by rising private demand and favourable international developments. Underlying inflation was expected to remain low ¾  at only 2 % through the year to June 1998. The unemployment rate is expected to fall to 8 % over the course of 1997-98 as employment growth accelerates (Peter Costello, 1997).

The above growth projections would need a substantial revision in face of the economic crisis in the ASEAN region. The entire region has witnessed tremendous melt down of the financial markets as a consequence of highly interlocked competing economies. With 67% of Australian exports concentrated in the region, Australian trade has a lot at stake. Non- monetary gold exports remained Australia's largest exports in 1995-96, representing 7.8% of Australia's total exports. The fall in the gold prices to their lowest levels since 1973, shows the vulnerability of Australian exports to downturn in international commodity prices.

The Australian dollar has suffered its worst year since being floated in 1983. The $A plunged 18 % against the $US in 1997, the biggest yearly fall against the greenback on record. From a high of US80¢ in March, the $A slid to US59¢ by June 1998. The immediate consequence is in terms of contraction on imports from US and Europe. However the devaluation would not benefit the exports as two thirds of the exports are in the ASEAN region, which has seen much higher devaluation of the individual currencies.

Standard and Poor’s projections indicate that the first round effects of the ASEAN crisis may call for a 0.5% reduction in GDP growth in the second half of 1998. The slow down in Asia will reduce export growth and see deterioration in the current account deficit over the next 12 months. At this point of time (July-1998), the region lacks in confidence and is still reeling under the crisis. Japanese recovery is central to the fortunes of East Asia. It is crucial that Japan takes measures to ensure its economy does not slide into deep recession, seeing further devaluation in the yen. Any clear projections only can be made once the crisis stabilises (Standard and Poor, 1997).

New South Wales

New South Wales (NSW) is Australia's most populated state, and has the largest share of the Australian economy. The gross state product of NSW is one hundred and seventy eight billion dollars, accounting for 35% of the National GDP for 1997. This was followed by Victoria (26%) and Queensland (16%). Services accounted for 80% of NSW's economy, followed by manufacturing (15%) and primary industry (5%).

	NSW $Million	% Share	Australia $Million	% Share	NSW as % of Australia
Industry
Finance and Insurance	7320	5.00	16,655	3.90	44.00
Property and Business Services	15,619	10.60	39,216	9.20	39.80
Wholesale Trade	9,788	6.70	25,796	6 .00	37.90
Accommodation, Cafes and Restaurants	3,651	2.50	10,149	2.40	36.00
Manufacturing	22,265	15.10	62,113	14.50	35.80
Cultural and recreational services	2,700	1.80	7,579	1.80	35.60
Communication	4,442	3.00	12,657	3.00	35.10
Transport and Storage	7,584	5.20	21,952	5.10	34.50
Construction	9,677	6.60	28,027	6.50	34.50
Retail Trade	11,102	7.50	33,462	7.80	33.20
Personal and other service	3,213	2.20	9,771	2.30	32.90
Electricity, gas and water	4,279	2.90	13,142	3.10	32.60
Education	6,553	4.50	20,488	4.80	32.00
Health and Community Services	8,378	5.70	26,407	6.20	31.70
Government Admin and defence	4,651	3.20	16,151	3.80	28.80
Agriculture, forestry and fishing	3,800	2.60	16,041	3.70	23.70
Mining	3,214	2.20	19,716	4.60	16.30
Total	147,096	100	428,181	100	34.60

Source: Australian Bureau of statistics (1997).

NSW accounts for 20.8% of Australia's total exports. Services account for 38% of the New South Wales exports followed by manufacturing (33%) agriculture (22%) and mining (16%). The New South Wales government has received "AAA" international credit rating, indicating a more stable outlook when compared to a rating of "AA" for the whole of Australia (Standard and Poor, 1997).

South Australia

South Australia (SA) with a size of 984,377 square kilometre and a population of 1.5 million is the fourth largest of six states and two territories in the Australian federation. SA's economy has grown from its traditional rural base to a trading area with strengths in mining, agriculture and manufacturing. Manufacturing is the largest wealth-generating sector contributing 17% of the state's GDP, more than the combined total of mining agriculture and construction. The major manufacturing sectors comprise automotive and components production, defence, electronics, pharmaceuticals and precision engineering. A detailed sector wise break-up of the SA's gross state product has been provided in the table 2-5.

Public Admin, Defence & Community Services	18.50
Manufacturing	17.50
Wholesale & Retail Trade	13.40
Finance, Property &Business Services	11.50
Ownership of Dwellings	8.90
Transport, Storage & Communication	8.50
Construction	6.20
Agriculture, forestry, fishing & hunting	4.40
Recreation, Personal & other Services	4.20
Electricity, Gas & Water	3.00
General Government	2.00
Mining	1.90

Source: Australian bureau of statistics, (1997)

The total exports from South Australia for the year 1996 were $4.5 billion a year. The major Export commodities are Cereals and cereal preparation ($713 million), Metal and metal manufactures ($610 million), Machinery ($340 million) Wine ($318 million), Motor vehicles, parts and accessories ($249 million), meat and meat preparations ($244 million) and Wool and sheepskin ($240 million). The major Markets are Asia (45%), Europe (15%), New Zealand (8%) and the United States (6%).

South Australia with a gross state product of approx. $36 billion forms only a 7% share of the Australian economy. The state government has therewith outlined growth areas enabling the state to contribute a higher share in the national economy. Table 2-6 provides a detailed listing of the SA's targeted growth industries.

REFERENCES

ABS, "Australian Bureau of Statistics", http://www.abs.gov.au, Belconnen, ACT, 1998

Grant Thorton, Tax Guide- 1997/1998, Sydney, 1997.

Quiggin J., Great Expectations : microeconomic reform and Australia, St. Leonard's,

NSW, Allen & Unwin, 1996