CHAPTER 7 Economic Management Using Microeconomic Policy 237 7.2 Aims of Microeconomic Policy

chapter Economic management using microeconomic policy 7

7.1 Deﬁnition of microeconomic policy

Microeconomic policy has to do with a wide range of supply-side, cost include structural change, better productivity, cost cutting in cutting, efﬁciency measures designed to improve the way in which par- production and the application of the best international prac- ticular enterprises, industries and sectors within the Australian economy tices by business managers and workers. In turn, these undertake and organise production. reforms should collectively improve proﬁts, bolster national In essence, microeconomic policy includes reforms designed productive capacity and increase aggregate supply. to increase output from available resources. Reforms may

CHAPTER 7 Economic management using microeconomic policy 237 7.2 Aims of microeconomic policy

Although microeconomic policy can be used to pursue all the being allocated towards current consumption on the one government’s economic objectives, its main aim is increased hand and, on the other, adequate saving for financing future efficiency in resource allocation. Indeed, microeconomic reform is investment. almost entirely about lifting productivity by cutting costs, pro- By improving efficiency in resource allocation, ultimately moting competition and restructuring the way production is microeconomic reform promotes all other government econ- organised in both the private and government sectors. These omic objectives. For instance: measures involve allocating resources to get more output from I Domestic economic stability is helped by increased efficiency. the same quantity of inputs, in order to raise real incomes and This is because greater efficiency raises the economy’s speed raising material living standards. limit or sustainable rate of economic growth. More output Microeconomic reform aims to improve four aspects of can be gained from the same inputs. Increased efficiency also efficiency in resource allocation: helps to cut costs and slow inflation. This leads to increased 1. Microeconomic reform tries to increase allocative efficiency by profits, improved competitiveness and better sales. As a result, ensuring that resources are directed into areas where they over the medium to long term, the total level of employment best help to satisfy society’s needs and wants. Often allocative should grow more quickly and structural unemployment efficiency may be improved if there is strong competition should be reduced by fewer business closures. between producers and sellers in the market. This ensures I External stability should be improved through increased inter- that resources are directed into areas of comparative cost national competitiveness that follows better structural advantage. However, on some occasions, government inter- efficiency and lower production costs. Efficiency should lift vention may be needed to ensure there is allocative our exports relative to imports, help slow the rise in the CAD efficiency. 2. Microeconomic reform may aim to increase productive (tech- and rein in the foreign debt. I nical) efficiency by encouraging businesses to use the least cost Increased equity in the distribution of personal income may occur method of production. Firms need to cut costs and purchase in the long-term, when greater efficiency leads to higher fewer resources. This entails employing the best international levels of real incomes and production available for distri- practices available along with savings reforms to lower the bution among the population. Here, efficiency boosts the cost of firms purchasing new equipment. value of government tax revenues collected, thereby making 3. Microeconomic reform seeks to increase dynamic efficiency by the welfare system and the provision of community services encouraging firms to be adaptive and creative in response for the poor much more affordable. Greater efficiency also to changing economic circumstances. Policy needs to leads to the creation of more jobs and helps eventually to encourage firms to use the latest technology, upgrade lower structural unemployment caused by a lack of competi- employee skills and incentives for efficient work, promote tiveness and business profitability. This improves equity too. market research and product development, and encourage Moreover, increased efficiency helps to slow inflation that innovation among firms so that they better meet the would otherwise undermine the purchasing power of lower changing tastes of consumers. income earners. Overall, material living standards are 4. Microeconomic reform aims to improve intertemporal efficiency promoted through increased efficiency in the allocation of by ensuring there is a suitable balance between resources resources.

238 Economics Down Under Book 2 THE REASONS FOR USING I Efficiency grew very slowly I Australia’s material living standards fell from first place in MICROECONOMIC POLICY 1901, to fourth in 1950 to around fifteenth in the early 1990s. The 1950s and 1960s represent the golden age for Australian Because government macroeconomic measures on their own productivity. However, during the 1970s, 1980s and early 1990s, had failed to provide the necessary solutions to this economic our economic performance lagged behind that of many coun- decline, there was renewed interest in the possibilities offered tries: by effective microeconomic reform. I Our sustainable growth rate was often slower I The inflation rate was generally higher I Unemployment levels were excessive I The CAD:GDP ratio mostly was large (limiting our sustainable rate of economic growth) and overall, our dollar depre- ciated badly TRY SHORT ANSWER EXERCISE 1, p. 276

7.3 Speciﬁc instruments of microeconomic policy

During the 1980s, 1990s and 2000s, federal governments were 3. abolition of import quotas keen to pursue microeconomic reform. Let us now take a look at 4. increased number of free trade agreements with other coun- some of the most important ones. tries.

TRADE LIBERALISATION Tariff cuts Until the 1970s, Australian governments strongly protected local Especially during the past thirty-five years, a debate has raged industry from competition. They did this mainly by using high about the appropriate level of tariff protection for Australian tariffs (taxes on imports to make them dearer than the local industry. Tariffs or import duties represent an indirect tax levied item), generous subsidies (cash payments to exporters or on selected imported goods. In general, tariffs are added on to import competing firms to help them cover their production the price of imports to make them dearer, or less attractive, to costs to allow them to sell more cheaply), and restrictive import local consumers. Because this limits foreign competition in local quotas (legal restrictions on the quantity and type of imports markets, economists agree that high tariffs cause resources to be permitted). Assistance like this sought to help local firms (often infant industries) survive foreign competition and, supposedly, allocated inefficiently into industries where we have a compara- to create more jobs for workers. tive cost disadvantage. The existence of high tariff rates means However, starting in the early 1970s, the Australian Govern- that local households and businesses consuming Australian- ment signalled the start of a change in its policy of protecting made goods and services must pay higher prices or costs for local industry from foreign competition. Increasingly, it liberal- these items. This offsets any possible increase in income and ised international trade. This involved the progressive reduction employment in the short term arising from having tariffs. Addi- of tariffs, subsidies and import quotas, and a shift towards the tionally, when one country raises its tariffs, this becomes a justi- idea of free trade. Increasingly, national borders no longer restrict fication for other nations to retaliate. As a result, world trade the movement of goods, services and money capital between volumes and domestic economic activity contract. countries. With freer trade (associated with globalisation), we are Figure 7.1 (p. 240) shows that there was a huge reduction in forced to allocate resources into areas of production where Aus- the general tariff rate on most manufactured items from 36 per tralia has a comparative cost advantage (or least disadvantage). In cent in 1968–69, to effectively zero by 2005–06. It all started with other words, resources will flow into areas where we are most a 25 per cent overnight tariff cut in 1973. However, reductions efficient. It will mean that more national output (or GDP) can continued in different industries, at different rates. Effectively be gained from the same inputs of resources. This leads to by 2007, most goods were tariff free. Of the few remaining higher incomes and material living standards. In addition, in imports still protected, around 90 per cent were at a rate of less the long-term, greater efficiency also leads to lower inflation, than 5 per cent. Even so, tariffs are still applied to local indus- improved international competitiveness and increased employ- tries making passenger motor vehicles, textiles, clothing and ment. footwear. Traditionally, these areas were starting off from much Our investigation here will focus on the four key aspects of higher levels of protection and to suddenly remove tariffs would trade liberalisation policies: have meant certain collapse. However, for these special indus- 1. tariff cuts tries, scheduled tariff reductions are continuing so firms know 2. reduced subsidies and other assistance that efficiency must continue to rise, if they are to survive.

CHAPTER 7 Economic management using microeconomic policy 239 200 General ma

180 Passenger motor vehicles (PMV) 160 Clothing apparel

140 White goods Agriculture 120

100

60 Effective tariff rate (%) tariff Effective 40

0 2000–01 1970–71 1980–81 1990–91 2010–11 1995–96 1968–69 1985–86 2005–06

INDUSTRY 1968– 1970– 1980– 1985– 1990– 1995– 2000– 2005– 2010– AREA 69 71 81 86 91 96 01 06 11

General 36 35 23 20 16 5 4.2 0 manufacturing

Passenger 50 50 96 125 60 25 15 10 motor vehicles (PMV)

Clothing 97 91 140 148 176 35 25 17.5 apparel

White goods 55 55 30 19 8 5 2.5 2.5

Agriculture 32 28 12 12 13 10 6 0

Figure 7.1 Changes in estimated effective rates of tariff protection of selected Australian industries, 1968–69 to 2005–06 Sources: Data derived from the Industry Commission, Productivity commission reports, ‘Trade policy review, Australia, 2002’, AGPS and other sources.

Reduced subsidies and other companies with significant export orientation. However, there assistance to local producers are problems with giving government subsidies. For example, they tend to increase inefficiency in resource allocation among Subsidies are government cash payments made to local pro- firms that come to depend on their continuation. There is also ducers to help them cover some of their production costs. They the extra cost of subsidies to taxpayers who have to foot the bill. can enable Australian firms to export at a more competitive As part of its trade liberalisation measures, the Australian price. Some even involve special assistance to accelerate Government has increasingly reduced subsidies or used them to industry restructuring. For example, there is the one billion help restructure the industry more efficiently. dollar ‘Automotive competitiveness and investment scheme’ for Figure 7.2 shows us that in the period between 1971–72 and 2000–05 to help car firms upgrade plant, equipment and tech- 2006–07, there was a general reduction in gross subsidies, from nology, and an $800 million grant to help textile firms restruc- around $25 billion in 1971–72, down to an estimated ture, with tax rebates as high as 45 per cent offered for $4.3 billion or less by 2006–07.

240 Economics Down Under Book 2 30 In addition, by 2006–07, negotiations were underway for striking FTAs with China, Malaysia, ASEAN and Japan. The aims 25 of this type of trade reform include lifting the competitiveness of our exporters, establishing a business presence abroad, 20 expanding Australia’s market share in overseas countries, deliv- 15 ering stronger economic growth, reducing costs paid for imports by local ﬁrms and prices paid for imports by house- 10 holds, and making Australia a more attractive destination for $ billions overseas investment. 5

0 DEREGULATION AND OTHER REFORMS OF THE LABOUR MARKET 2000–01 1971–72 1989–90 2006–07 1996–97 The labour market is an institution dealing with matters affecting Figure 7.2 Estimated gross federal government all workers such as wages, incomes and other conditions of industry subsidies, 1971–72 to 2006–07 ($ billion) employment including work hours. During the 1990s and, Sources: Data calculated using information derived from especially, between 1996 and 2007, the federal government intro- Industry Commission, Productivity commission reports, 2006–07 budget overview and other sources. duced major microeconomic reforms in this area. These changes were based on the belief that the quality, efficiency, training, Again, this reform is consistent with the government’s belief in health and skill of a nation’s labour force are vital in determining the benefits of strong competition and trade liberalisation. Australia’s productive capacity, sustainable rate of economic growth, adaptability to changing circumstances and our inter- Abolition of import quotas national competitiveness. Most importantly, labour market Import quotas are designed to restrict the quantity of specific reform has involved a gradual shift from the centralised types of imports permitted into the country. In order to achieve minimum wage (prior to November 2006 this was called the a stated volume target, prospective importers must obtain a minimum award wage), to a system involving greater deregulation licence that gives them permission to import a certain of wages based on enterprise or workplace agreements. Although maximum number of articles of a particular description. Quotas both these wage systems are still used today, by late 2006, only were commonplace in the 1970s and early 1980s, especially on about 10 per cent of all workers were covered by the minimum cars, textiles, footwear and clothing. However, these were pro- wage, with the remaining 90 per cent on workplace agreements. gressively abolished. The last of these quotas, applying to Let us now consider the details of these two wage systems. cheese, was terminated in 2000–01. Again, this reform is part of Australian Fair Pay Commission and the belief in the long-term efficiency benefits of freer trade and stronger competition. the centralised system of minimum wages Increased number of free trade Traditionally, Australia has relied very heavily on a centralised agreements (FTAs) wage fixing system which, since November 2006, is under the con- Australia has membership of various multinational (i.e. involving trol of the Australian Fair Pay Commission (AFPC) (previously many countries) trading groups like the World Trade Organiza- controlled by the Australian Industrial Relations Commission tion (WTO). Through the Doha rounds of trade negotiations with (AIRC) the main role of which is to settle industrial disputes). the WTO (called the Doha rounds because negotiations took The AFPC is responsible for determining the federal place in Doha, the capital of Qatar), Australia has been pushing minimum wage for low paid workers not covered by various hard for general reductions in global tariffs and the abolition of enterprise or workplace agreements. In particular, the com- subsidies, along with increased international access to agricul- mission is guided by a new set of criteria to those used previ- tural, manufacturing and services markets. Indeed, Australia was ously by the AIRC. In particular, the AFPC sets its minimum instrumental in setting up the Cairns group of fair agricultural wage taking into account: traders bent on eliminating agricultural subsidies. Despite these I the promotion of the economic prosperity of the people of efforts, progress has been slow due to significant opposition from Australia groups in the US, Japan and Europe. I the capacity for the unemployed and low paid to obtain and Given this slow pace of multilateral trade reform, Australia remain in employment has increasingly tried to negotiate bilateral free trade agree- I employment and competitiveness across the economy ments (FTAs) with two or more individual countries. For I providing a safety net for the low paid example, by early 2007, we had four FTAs in place: I providing minimum wages for junior employees to whom I Australia–New Zealand FTA (also known as ‘Closer economic training arrangements apply and employees with disabilities relations’) in 1983 that ensure those employees are competitive in the labour I Australia–Singapore FTA in 2005 market. I Australia–Thailand FTA in 2005 In addition, under Australia’s Corporations Act (recently I Australia–United States FTA in 2005. tested in an appeal to the High Court), the federal government

CHAPTER 7 Economic management using microeconomic policy 241 has successfully overridden much of the various state govern- agreements match or exceed, minimum conditions or standards ments’ wages system, thereby increasing its power to determine including those relating to wage rates, long service leave entitle- wages. This means that now the minimum wage is applied fairly ments, unpaid parental leave and four weeks annual leave. uniformly to particular workers across Australia, who are not covered by enterprise or workplace agreements. In its first Importance of productivity for wage rises decision in November 2006 (to apply from 1 December 2006 to An important and common feature of most enterprise or work- about 1.4 million workers), the AFPC announced: place agreements is that wage rises are based on actual improve- I an increase of $27–36 per week in the standard federal ments in worker efficiency or productivity (i.e. increases in output minimum wage taking it up to nearly $512 per week per worker per hour). Pay rises are usually performance-based. I an increase of $27–36 per week in all Australian Pay and Agreements are renegotiated regularly Classification (pay) scales up to $700 per week At fairly regular intervals (i.e. up to 3 years), workers and their I an increase of $22.04 per week in all pay scales above $700 particular boss, renegotiate wages and conditions so that the per week. workplace agreements can be updated to reflect changing cir- The next annual wage review for these workers will occur in cumstances, both inside and outside the firm. mid-2007. Two types of enterprise agreements Today there are two possible types of enterprise agreement: Certi- Increased reliance on workplace fied agreements and Australian workplace agreements. Certified agreements agreements (CAs) can only occur between unions and employers. Australian workplace agreements (AWAs) provide an In Australia nowadays, decentralised or firm-by-firm workplace alternative to CAs. An AWA can exist between an employee and agreements (also called employment contracts and enterprise agree- his or her employer. These are individual employment contracts ments), are a far more popular alternative to the traditional that can apply even to salaried employees such as executives and centralised wage system. The main features of enterprise agree- professionals. ments are as follows. Wage agreements are negotiated on a firm-by-firm basis Recent industrial relations reforms Under workplace agreements, wages and conditions are usually set on a firm-by-firm basis and more closely reflect the freer oper- In 1996 and 2005, the federal government passed two important ation of the forces of demand and supply in the labour market. reforms in the area of industrial relations: This allows businesses to have greater flexibility in setting wages, 1. the Workplace Relations Act 1996 so they better mirror worker performance, local market trends, 2. the Workplace Relations Amendment (Work Choices) Act 2005 the firm’s profitability and other unique circumstances for the (effective March 2006). business, thus helping to improve competitiveness. However, a Table 7.1 sets out the details of these two important reforms no disadvantage test is applied. This requires that enterprise designed to further deregulate Australia’s labour market:

242 Economics Down Under Book 2 Table 7.1 Recent changes to Australia’s industrial relations laws

WORKPLACE RELATIONS ACT (1996)

1. The role of The Act scaled back the responsibilities of the AIRC (whose wage-setting role was later taken the AIRC over in 2005 by the AFPC). Its most important duty was presiding over the annual National wage case that determines the minimum or safety net wage (i.e. the idea of a living wage where workers earn enough to live and not just survive). For example, from 1997–98 to 2005–06, the AIRC’s annual safety net award wages were increased by between $8 and $18 a week, so that its last minimum weekly award wage was set around $484. However, these days the key role is settling industrial disputes. Another current responsibility of the AIRC is the enforcement of awards. 2. Simplification The traditional system of minimum award wages was complex, expensive and clumsy. Under of the award this Act, award simplification occurred so that any award decision could only cover twenty system allowable matters (e.g. classification of skills of employees, hours of work, pay rates, incentives, long-service leave, holidays, pay loading for overtime, redundancy pay, dispute settlement procedures, stand-down provisions and superannuation). 3. The no The Act requires that all enterprise or workplace agreements meet the minimum standards disadvantage set out in relevant awards. This is called the no disadvantage test so that workers could not test be worse off than they would be under an award. 4. Role of trade The Act reduces the direct role of trade unions in some wage negotiations. It restated the unions principles of voluntary unionism and illegality of compulsory unionism. It also confirmed that a worker could not be discriminated against on the basis of union membership and established the general right to strike (72 hours notice is needed for lockouts and strikes that are only allowed during the negotiation period for a new agreement). In addition, the legislation covers the illegality of secondary boycotts (e.g. ‘sympathy strikes’ where other unions go out on strike to support a cause not directly their own) as well as strike pay (when workers receive payment while undertaking industrial action). 5. Unfair The Act changed the unfair dismissal laws to instances where dismissal was seen as harsh, dismissal unjust or unreasonable. However, adequate notice had to be given or pay offered in lieu of provisions notice. 6. The The Employment advocate was set up to enforce AWEs and to protect vulnerable groups (e.g. Employment the young, females, apprentices, non-English speaking migrants). advocate

WORKPLACE RELATIONS AMENDMENT (WORK CHOICES) ACT (2005)

1. Setting up the After nearly 100 years, the AIRC’s minimum wage setting role was handed over to the newly Australian set up, Australian Fair Pay Commission (AFPC). Depending on the results of the federal Fair Pay election scheduled for late in 2007, this situation may change. Commission 2. The reduced The old AIRC was to concentrate on industrial relations dispute resolution, the simpliﬁcation role of the and rationalisation of awards (i.e. reducing the number of awards and the allowable matters) Australian and dealing with applications about industrial action (e.g. strikes). Industrial Relations Commission 3. Creating a The Corporations Act is used to give the WorkChoices legislation its national power to more national override the state government industrial relations system (but unincorporated employers wage system and their employees will remain within the state industrial relations system in WA, NSW, SA, Queensland and Tasmania). The challenge to the constitutional legality of this power failed to get support in a landmark decision in late 2006, thereby increasing the power of the Commonwealth in this and perhaps other areas (e.g. water, nuclear power). 4. Creating the The Act establishes certain minimum, statutory, standard working conditions. For example, Australian fair the 38-hour week, four weeks annual leave, and sickness, parental, personal and carers pay and leave. In addition, individual can cash in up to two weeks of annual leave. These conditions conditions form the universal Australian fair pay and conditions standard. standard (continued)

CHAPTER 7 Economic management using microeconomic policy 243 Table 7.1 (continued)

WORKPLACE RELATIONS AMENDMENT (WORK CHOICES) ACT (2005)

5. Allowable Award wage agreements struck prior to 2006 will continue to apply but the list of allowable matters matters (e.g. incentive-based payments, hours of work, leave loadings, public holidays) has been reduced to 13, and non-allowable matters (e.g. union picnic and training days) are now no longer legally enforceable.

6. Types of Work Choices distinguishes four main types of Australian workplace agreements (AWAs) or Australian individual contracts: workplace 1. non-union negotiated collective agreements agreements 2. union negotiated collective agreements 3. employer negotiated greenﬁeld agreement (where the employer makes a wage agreement with themselves before any person is hired, that employees will become subject to the agreement, thus giving the employer total control over staff wages and conditions) 4. union negotiated greenﬁeld agreements. Under these arrangements, it is possible that particular staff might be singled out, one at a time, and pushed onto AWAs with reduced conditions of work (e.g. relating to weekends, shift work, and special pay rates for overtime rates, public holidays and shifts).

7. Exemptions There have been changes to some of the provisions of the unfair dismissal laws. These have from unfair increased the power of employers with fewer than 100 staff to sack workers. This further dismissal erodes the rights of employees. The claim in support of this change is that it will help lower laws unemployment since ﬁrms are more likely to hire extra staff if they know that they can more easily dismiss them if they prove to be unsatisfactory or even if they are unnecessary, given operational developments. Contested claims for unfair dismissal are still possible, but they are expensive.

8. The Minister The Minister for Industrial Relations has the power to terminate agreement negotiations, for Industrial even if there is only the possibility of a strike (it does not even have to be an actual strike). Relations

244 Economics Down Under Book 2 Other labour market reforms Retraining of workers Over the past 10 years or so, there have been many schemes intro- Apart from changing the nature of Australia’s wages system duced by the government to improve the skills and training of through the Workplace Relations Act, there have also been other workers. For instance, there was the 1994 Working nation scheme, important labour market reforms. the 1997–98 Modern apprenticeship and traineeship scheme, the cre- Multiskilling and multitasking ation of the Green corp, expansions of the Work for the dole scheme Multiskilling of workers has become more common and wage (1998–99 to 2005–06), and the 2001–02 Australians Working awards have been simplified and combined to cover those Together package. The Australians Working Together scheme, for workers with broadly similar skill levels. Competency based example, included new requirements for recipients of parenting vocational education and training, where people demonstrate payments to undertake job searching, education, or training to skills, knowledge and understanding against set standards, has develop their work skills and prepare them for a return to work. also encouraged multitasking by employees. These changes have These activities need to involve 150 hours in each six-month helped to improve labour efficiency and make workers more period (or approximately six hours on average per week). In employable. addition to these government schemes, 24 new Australian technical colleges were established between 2005 and 2007. Job demarcation Job placement agencies replaced the Commonwealth Employ- During the late 1980s and 1990s, job demarcation boundaries ment Service (CES) (where workers have set tasks they perform that cannot be trans- Until 1998, the CES was responsible for finding jobs for the ferred to other areas) were radically reduced, creating wider, unemployed. Since then, Private employment placement enterprises less traditional employment areas. This shift was believed neces- (PEPE) have been responsible for connecting the unemployed sary to help reduce strikes, lower production costs and improve with prospective employers. Centrelink facilitates this process employment flexibility. and the government pays these job broking agencies, only when Union amalgamation they find real employment for an unemployed individual. Thanks to changed guidelines developed in the early 1990s, there has been a significant level of union amalgamation (i.e. Some strengths and weaknesses of combining smaller unions to form larger unions). In addition, recent labour market reforms union amalgamation partly reflected the huge decline of unionism, the advance of multiskilling and reduced job demar- Labour market deregulation and other reforms have been under- cation. One benefit of encouraging fewer unions is that it sim- taken to help improve Australia’s economic performance. Some plifies industrial bargaining and reduces delays caused by of the strengths and weaknesses of these changes are listed in demarcation or inter-union disputes. table 7.2.

Table 7.2 Some strengths and weaknesses of recent labour market reforms in Australia

SOME STRENGTHS OF LABOUR MARKET SOME WEAKNESSES OF LABOUR MARKET REFORMS REFORMS

Reforms help to reduce inflation Reforms have increased income inequality in the Under workplace or enterprise agreements (i.e. since short term and reduced the power of workers 1991) and other labour market reforms, pay rises The growth of enterprise agreements has contributed to increasingly reflect improved performance or worker the rise in inequality in the initial distribution of market productivity, thereby keeping down RULCs. In turn, incomes (i.e. income before government tax and better efficiency and lower costs reduce inflation (e.g. outlays). This is partly because increasingly, workers in as occurred generally during 1992–2007). This was not different firms in various parts of Australia get paid usually the case under the old system of award wages different wages. Another worry is that some workers where pay rises occurred irrespective of worker are relatively disadvantaged in workplace negotiations efficiency or the ability of particular firms to pay. (e.g. the inarticulate, non-English speaking, unskilled, unproductive, young people, non-unionised, rural workers, part-timers) as compared with, say, senior executives in profitable firms. Additionally, those workers remaining on the old centralised wage system, have not generally gained such rapid pay rises as those using the new system of workplace enterprise agreements, and increasingly, trade union scrutiny of pay rises is disappearing due to falling membership. (continued)

CHAPTER 7 Economic management using microeconomic policy 245 Table 7.2 (continued)

SOME STRENGTHS OF LABOUR MARKET SOME WEAKNESSES OF LABOUR MARKET REFORMS REFORMS

Reforms help to accelerate productivity and the Reforms may have increased unemployment in sustainable rate of economic growth the short-term Workplace or enterprise agreements (used since 1991) The growing popularity of performance-based, firm-by- offer pay rises in exchange for improved efficiency by firm enterprise agreements dramatically accelerated workers. With increased efficiency of labour resources, worker productivity against 1980s levels. This meant more output can be gained from the same or fewer that many local businesses have been able to produce inputs, thereby accelerating economic growth and more output with the same or fewer staff. As a short- raising average incomes (e.g. generally between 1992– term result, this may have tended to slow employment 2007). Additionally, locally made goods and services growth and add to structural unemployment. become more competitive, raising sales and production levels. Reforms help to create fuller employment in the Incomplete reforms long term Some claim that the government has not gone far In the long term, labour market reforms have increased enough with labour market reforms to ensure that worker efficiency, improved worker competitiveness, Australian firms and their employees are sufficiently lowered business costs and reduced business closures competitive against even more deregulated labour that cause structural unemployment. Additionally, the markets abroad in Asia, the United States and New traditional minimum wage system sets pay rates at Zealand. For instance: levels above the free equilibrium in the labour market, – Some people (even discussed by the Opposition) thereby contributing to a glut of workers (supply argue that safety net wages should be replaced with exceeds demand) or structural unemployment. By a tax credit scheme for low-income employees. Here, reducing emphasis on this system, structural tax cuts would replace the need for rises in the unemployment should be cut. Furthermore, estimates minimum wage. This proposal would protect suggest that the recent changes to the unfair dismissal workers’ purchasing power, keep real wage costs for laws may help create between 40 000 and 50 000 extra firms stable and reduce the structural unemployment jobs by making employers more willing to hire full-time rate. workers, knowing that they can be dismissed more – Unfair dismissal laws may need to be relaxed further easily if they prove to be unsatisfactory. so that firms employing more than 100 staff are more Reforms help to improve external stability likely to hire extra full-time employees. By reducing labour costs, reforms have helped to make – The income gap between having a part-time job and Australian workers and firms operating in local and being on government welfare is too small and overseas markets more competitive, thereby helping to distorts the efficient operation of the labour market. increase exports relative to imports, thereby tending to – Real wages (especially for youths) are perhaps still reduce the CAD. too high, causing higher unemployment. Estimates Reforms help to promote equity in the long term suggest that a 10 per cent fall in real wages could lift Equity may be protected by the retention of safety net employment by possibly 4–7 per cent. wages and initially, the no disadvantage test. Additionally, in the long term, labour market reforms have helped to accelerate economic growth, lift average per capita incomes (including those from exports), slow inflation so necessities are cheaper and more affordable, reduce unemployment by improving local business competitiveness and lift tax revenues to pay for the expensive welfare system. These developments help equity. Reforms help to encourage cooperation and Lack of coverage by agreements limits the impact reduce strikes Workplace or enterprise agreements were formally Labour market reforms involving workplace and endorsed in 1991. However, even by 2006, around enterprise agreements have promoted cooperation and 10 per cent of all workers (higher for women) were still discussion between workers and their management. not covered by this system. Instead, these employees Employees are encouraged to be more accountable, and continued to rely on an inflexible and inefficient to show greater initiative and self-management. This centralised approach to wage determination. approach is believed to have dramatically reduced industrial unrest including strikes (e.g. as seen during 1992–2007), absenteeism and poor product quality.

246 Economics Down Under Book 2 SOME STRENGTHS OF LABOUR MARKET SOME WEAKNESSES OF LABOUR MARKET REFORMS REFORMS

Change was essential and there was little choice Productivity is hard to measure under enterprise Whether we like it or not, Australia was forced into agreements labour market deregulation by similar developments The system of workplace or enterprise agreements abroad. Given the need to be competitive because of bases pay rises on productivity gains. However, it is globalisation, there was little choice if we wanted local very difficult to accurately measure efficiency firms to survive and workers to have jobs in the future. improvements attributable only to workers (i.e. as opposed to capital equipment). Moreover, the encouragement of productivity may even worsen structural unemployment in the short term.

I efficiency in resource allocation (by affecting savings, consumption and investment levels) I the size of the CAD, NFD and our external competitiveness I equity in the distribution of personal income. However, of all these, most of the recent tax reforms that emphasised reductions in rates, were driven by the government’s push to improve efficiency in resource allocation by encouraging savings, lifting investment, increasing the motivation to work hard, rewarding personal effort, and extending international competition. In turn, greater efficiency also promotes economic and employment growth, lower inflation, external stability, rising incomes and the potential for greater equity in income distribution.

TAX REFORMS To assess the quality of a tax system, economists often apply four criteria. A tax should be: 1. Simple Is it easily understood and simple to administer? 2. Fair Does it promote an equitable income distribution? 3. Efficient Does it promote an efficient use of resources? 4. Adequate Can it raise the necessary revenue so that governments can pay for their budget outlays without going REFORMS TO PROMOTE into debt? Given changing circumstances and, with these four guidelines in NATIONAL SAVINGS mind, by the late 1990s it became especially clear that Australia’s In 1993, the National savings strategy was first released. It tax system was in need of a good overhaul. Table 7.3 (p. 248) attempted to address the problems of relatively high domestic sums up some of the key tax reforms introduced in the years to interest rates (which disadvantage local firms that borrow for July 2007. expansion) and the large national savings–investment gap cur- Tax reform will have many impacts on the economy. For rently filled by heavy foreign borrowing (which worsens the example, the changes will affect: CAD through interest payments abroad). Between 1993 and I the sustainable rate of economic growth by altering both AD early 2007, a number of microeconomic reforms were used to and AS (including the levels of employment, production try and encourage national savings, often involving initiatives costs, business profitability and prices) announced in the annual budget.

CHAPTER 7 Economic management using microeconomic policy 247 Table 7.3 Key federal government tax reforms

TOP RATE HISTORICAL REFORM OF TAXATION (2006) TOP RATE

PAYG income tax Between 2000 and mid 2007, the tax-free threshold 45 per cent 75 per cent for personal incomes was increased, the entry points (Plus 1.5 per (<1951–52) into higher marginal tax brackets were moved up cent Medicare considerably (e.g. until July 2008 the 45 per cent tax levy) rate cuts in at $150 000 per year but this will rise to $180 000), and the top marginal rate was cut from 47 to 45 per cent. CGT In 1986, the tax rate on capital gains (other than the 22.5 per cent NA family home that is exempt) was effectively halved. (Plus Medicare (Before 1986) Only 50 per cent (not 100 per cent as previously) of levy) the capital gain was to be taxed. The family home is normally exempt. Superannuation For many years, the government has made zero 30 per cent superannuation contributions very attractive (as a way (For end- (1983 on lump to save for retirement) by offering tax concessions on benefits sum payments both contributions and end benefits. These withdrawn after above a arrangements were frequently altered, with the most aged 60 years threshold) significant changes announced in the 2006 budget from July 2007) that allows a tax-free withdrawal of end benefits from aged 60 years from July 2007. Company tax Between 2000 and 2002, the tax rate on company 30 per cent 49 per cent profits was lowered from 36 to 34 per cent and finally (1986–88) to 30 per cent. Changes in some As an anti-inflationary measure, the automatic NA NA excise taxes indexation of the fuel excise tax ceased in 2001–02. Previously, as the price of fuel increased, the amount of tax collected increased without discretionary decisions being made by the Treasurer. This policy added to inflation and grew government revenues. Additionally, there were modifications made to other excise taxes (e.g. on light beer). Tariffs By 1996, the general tariff rate on most manufactured zero 38 per cent imports had been reduced from nearly 40 per cent in (General tariff (General tariff 1968–69 to only 5 per cent. In 2005, the 3 per cent rate effectively) rate, 1968–69) tariff on business inputs was abolished where there is no local substitute (business inputs, for example, are natural resources, labour and capital purchased by firms to allow them to make final goods and services or output production). Today most imports are tariff free, except for motor vehicles, and textiles, clothing and footwear. Indirect taxes In July 2000, the 10 per cent GST replaced the 10 per cent 45 per cent WST Wholesale Sales Tax (that had rates between 12 to 45 GST (Before July per cent). Unlike the WST, the GST is a broad-based tax 2000) applied to most (non-essential) goods and services and was levied on behalf of the states.

Source: Data derived from the Treasury Economic roundup, Winter 2006.

Acceptance of ‘fiscal balance’ as a guiding principle for budgets turn, overseas borrowing to finance government budget defi- Between 1991–92 and 1996–97, the federal government ran up cits, also led directly to a structural rise in the CAD and NFD. many budget deficits totalling nearly $60 billion. Unfortunately, In contrast to this, recent budgets have been based on the these deficits required financing. Local borrowing by the principle of fiscal balance over the medium term, so that budget government pushed up domestic interest rates relative to those surpluses in some years pay for deficits in others. Here, there is overseas. This encouraged the private sector to borrow even no need for federal government borrowing. Indeed, between more from overseas and attracted foreign capital inflow. In 1996–97 and 2007–08, budgets were mostly surpluses (only two

248 Economics Down Under Book 2 out of 11 were deficits) totally over $80 billion. This is shown annuation contributions by offering very generous tax in figure 7.3. concessions. For instance, marginal tax rates on income might In addition, by 2005, the government’s previous debt was be as high as 45 per cent (plus the Medicare levy) but for those completely repaid. Fiscal consolidation like this abolished one of involved with salary sacrificing (i.e. using some of your pre-tax the structural problems causing Australia’s NFD. It can also be earnings to pay for benefits such as a car), there is only a argued that the many budget surpluses (i.e. government 15 per cent tax on contributions. Also from July 2007, savings) helped to keep down domestic interest rates, making individuals can withdraw their superannuation tax free once overseas borrowing by the private sector relatively less attractive. they reach the age of 60 years. Again this provides further This too, helped to reduce income payments abroad, thus incentive to save. tending to lower our CAD. I Superannuation co-contributions scheme. The Superannuation co-contributions scheme commenced in 2002–03. Basically, the Establishment of the Future Fund government matches low income after-tax superannuation In 2005, the Future Fund was created to lift national savings, contributions at the rate of up to $1.50 for every $1 (up to a improve the government’s long term financial position and its limit) put into an approved superannuation account by an ability to meet unfunded public sector superannuation liabilities individual. For 2007–08, this will rise to $3 for every $1 of around $100 billion. It was started using seed capital (as dis- contribution. This increases the incentive to save. cussed in chapter 5) of around $18 billion, contributed by the – Reductions in tax rates. Between 1999 and 2007, there were sig- government. The money has been used to create a giant invest- nificant tax reforms involving cuts in tax rates. Many of these ment portfolio that should grow over time through the gener- changes should help to increase national savings. For ation of income, topped up with extra capital from further asset example, the 50 per cent reduction in the rate of capital gains sales (e.g. Telstra 2006) and future budget surpluses. tax (1999) effectively lowered the maximum current rate to Promotion of household savings only 23.25 per cent. Reforms in 2000 and 2002 also cut the Microeconomic reforms (implemented through the federal rate of company tax from 36 to 30 per cent. This should help budget), have also tried to encourage private sector savings. For to boost business savings via increases in retained profits. In example: addition, lower PAYG tax rates should provide temporary I Superannuation guarantee charge (SGC). Starting in 1991, super- relief from the effects of bracket creep (where individuals find annuation was made compulsory for all employees through that over time, they end up moving into higher tax brackets the introduction of the Superannuation guarantee charge. This is with a heavier tax burden). In turn, this may help to lift a compulsory levy on a company’s payroll and was originally household savings. Similarly, the 10 per cent GST (intro- equal to an extra 3 per cent of wages paid into a worker’s duced in 2000) is a tax that discourages consumption and superannuation account. However, as from 2002, it was indirectly encourages savings. It also broadened the tax base increased to 9 per cent. to include both goods and services (relative to the old and I Generous tax advantages for voluntary contributions to super- narrow WST on goods only), perhaps adding further to annuation. The government encourages private super- public sector savings.

–5 ($ billions) –10

–15 Underlying budget outcome –20 2000–01

2004–05 2002–03 1992–93 1994–95 2001–02 2005–06 2007–08* 2008–09* 1993–94 1995–96 1996–97 1997–98 1998–99 2003–04 2006–07 2009–10 1999–2000 Figure 7.3 Federal underlying budget outcome 1992–93 to 2006–07 and 2007–08 ($ billions) Sources: Data derived from RBA Bulletin, various editions; 2006–07 budget overview. Note: *represents latest estimate

CHAPTER 7 Economic management using microeconomic policy 249 By encouraging higher levels of national saving (i.e. an Corporatisation of some remaining government operations increase in the supply of savings relative to the demand for sav- Corporatisation involves full government ownership of the busi- ings), these reforms should tend to lower domestic interest ness enterprise. However, the GBE is run more like a private rates, slow cost inflation, improve long-term economic and enterprise (e.g. Australia Post, Australian Airlines in the 1980s, employment growth, raise dynamic and intertemporal and the Port of Melbourne Authority). Providing there is no ser- efficiency, reduce the NFD and CAD, and possibly help improve vice obligation (e.g. Telstra has an obligation to provide some equity in the distribution of personal income. public telephone access in the community even though it may not be profitable), the main goal is usually to make a profit by REFORM OF THE PUBLIC SECTOR minimising costs and by applying the user pays principle. There is also independence of management and corporatised govern- Reforms of government businesses and the public sector have ment businesses are not given special commercial favours (i.e. involved eight key aspects. there is competitive neutrality). Sometimes this can bring benefits Privatisation of selected government business and cost savings to the users of government services and, in par- enterprises (GBEs) ticular, reduce the financial burden of these GBEs for govern- Many claims have been made about the supposed inefficiency of ments and taxpayers. government businesses. One response to this was to partially or Commercialisation of some government activities fully privatise selected GBEs. Figure 7.4 shows that there was Commercialism also involves government ownership of businesses much privatisation between 1995–96 and 2005–06, especially in but, unlike corporatisation, the enterprise is not expected to the earlier years (although the sale of Telstra in late 2006 should actually make a profit. Often this feature reflects the existence see a jump when the 2006–07 final figures are released). of community service obligations. Instead, the enterprise is 20 000 expected to help cover its running costs by generating at least some revenue. It also seeks to reduce losses, lower the tax 16 000 burden and raise efficiency (e.g. some rail operations, aspects of the ABC and some water boards). 12 000 Public-private partnerships in infrastructure Between 2000 and 2007, some state governments tried the idea 8 000 of private funding of public infrastructure (e.g. schools, roads, tunnels, water treatment, public housing and hospitals). These 4 000 are often called, public–private partnerships. Here, private money Value ($ millions) Value would build, maintain and operate the facility but the govern- 0 ment would lease these facilities back for periods up to 30 years. The questionable success of these ventures in Europe has not stopped over $9 billion worth of projects being ear-

2000–01 marked by Victoria and New South Wales for the period 2003 2002–03 2001–02 2004–05 1998–99 1996–97 1997–98 2003–04 2005–06 2007–08 2006–07* to 2007. 1999–2000 Figure 7.4 Estimated value of federal government Public sector staff cuts privatisation ($ million) Structural change (1987–2007) initially involved dramatic Sources: Derived from budget papers and other sources. Note: public sector staff cuts of around 35 per cent designed to reduce data represent estimates only based on asset sales and other costs and raise worker efficiency. In part, staff downsizing smaller items. Note for 2006–07: this figure should be very large given the success of the Telstra 3 share sales. reflects the impacts of fiscal balance, as well as privatisation and corporatisation. Although there has recently been a 25 per cent The justification for privatisation as an efficiency measure, is rise in public sector staff numbers in the six years to 2005–06 often based on three main arguments: due to national security concerns and government reforms, 1. Private owners and shareholders demand greater efficiency staffing levels are still well below the peak of 1987–88. and cost cutting in order to maximise their profits or returns. Reform of Commonwealth–state relations 2. Private owners often have better access to the huge amounts During the period 1992 to 2007, the Council of Australian Govern- of capital needed for investment in new equipment and tech- ments continued reforms in Commonwealth–state relations. It nology. This helps them to grow their efficiency more quickly. aimed to reduce the degree of inefficiency caused by service 3. Private owners may be able to recruit and appoint manage- duplication. Problems in this area are not only costly to tax- ment and staff of superior quality, ambition and creativity, payers and business, but they represent a misallocation of the than would be the case if the business remained in the nation’s resources. As a consequence of these changes, by 2007 public sector. there was good progress on reducing railway duplication, the Examples of partial or full privatisation include the complete creation of a single eastern electricity grid, centralisation of sale of the Commonwealth Bank (1996), Aussat (which became TAFE education, water trading, and uniform product and road Optus with 49 per cent foreign ownership), the NSW Govern- laws applying to all states. ment Insurance Office (GIO), Qantas, TABCORP, some roads (e.g. Melbourne’s City Link), many ports (e.g. Geelong, National Competition Council (NCC) Portland), some airports (e.g. Melbourne, Brisbane), parts of The NCC is an organisation providing advice, conducting Sydney’s water supply, PowerCor and Telstra. research, making recommendations and evaluating state

250 Economics Down Under Book 2 government microeconomic reforms. This forms the basis of Deregulation of agricultural markets the National competition policy. In particular, the NCC scrutinises During the past 10 to 15 years to 2007, there have been signifi- the changes with regard to road transport, power generation cant reforms involving deregulation of markets for primary and the creation of a national electricity grid, gas and water products, along with other measures to accelerate structural supply, standardisation of regulations and laws between states, change. For instance: the promotion of interstate trade and competition, and pricing – Wool pricing. Some years ago, the minimum or reserve price reforms undertaken by government monopolies. scheme for wool was abandoned. – Egg marketing. Victoria, New South Wales, South Australia and Contracting out and competitive tendering Queensland, have deregulated egg marketing. Contracting out (also called outsourcing) is where agreements are – Milk marketing. Between 2001 and 2005, milk marketing was made for the supply of goods and services, between the govern- deregulated, along with dairy farm-gate prices. In addition, ment and private business. In order to cut costs, firms are there has been compensation to dairy farmers for the loss of invited to respond to government advertisements by submitting milk quotas designed to encourage structural change in the quotes or tenders. This approach has been widely used in industry. garbage collection, cleaning and maintenance of government – Grains. There has been extensive deregulation of grain sales buildings, fleet management, information technology, legal and especially following the scandal surrounding the Aus- services and public works. Sometimes this can be more cost tralian Wheat Board’s (AWB) behaviour in its wheat dealings efficient than having these goods and services provided by full- with Iraq. The single desk, international marketing system is time government employees and departments. to be reviewed during 2007. All up, reforms of the public sector will affect unemployment, – Sugar industry restructuring. In late 2002, the government was inflation, economic growth, external competitiveness, allocative, forced to announce a levy of between 16 and 18 cents a kilo- productive and dynamic efficiency, and the distribution of per- gram on sugar consumers to raise money to promote struc- sonal income. tural change and help farmers to leave the industry. This was aimed at relieving the problems of over supply and low prices. – Cheese quotas. During 2000–01, import quotas on cheese were WELFARE REFORMS finally abolished. Between 1996–97 and 2006–07, reforms (again announced through the budget) made welfare less accessible to some Deregulation of transport markets people. For example, measures included: In the past two decades there have been numerous examples of I working for the dole changes in the Australian transport system. I Airline deregulation. In 1990 the government’s two airline or I maintaining a jobs interview diary duopoly policy for domestic flights (i.e. Ansett Airlines and I forcing the unemployed to turn up to job interviews by sus- Australian Airlines) was ended. In addition, Qantas was pending the payment of benefits allowed into the domestic market and was privatised. This I tightening the work test cleared the way for new competitors like Virgin Airlines, Jet- I requiring some on disability benefits and single parents star and foreign carriers, to compete on both domestic and (whose children have reached school age) to do at least 15 international routes. hours of work a week I Unifying state railways. Some years ago, the National Rail I encouraging the aged to defer retirement and build up their Corporation was set up, owned jointly by the Victorian, New superannuation South Wales, Western Australian and federal governments. I setting up a hot line to report welfare fraud This reform was designed to improve efficiency and cut waste I allowing welfare recipients to earn more income before ben- and duplication. efits are lost (so as the reduce the welfare trap as recipients I Waterfront and shipping reform. These included the privatisation start work). of some ports (e.g. Geelong), allowing competitors into freight Welfare reform has been seen as an opportunity to increase handling to help improve worker productivity on the water- efficiency in resource allocation. Some people felt the original front (helped by the extension of workplace agreements) and system was over generous. Claims were made that it encouraged an end to the closed or union shop for waterfront workers. welfare dependence, and discouraged work and financial inde- I Road reforms. Much money has been spent on upgrading pendence. It was also seen as a burden on taxpayers, a limitation national highways. In addition, the level of motor registration on high rates of labour force participation and a constraint on charges more closely reflect the damage to roads caused by the rate of economic growth. various types of users. Financial sector deregulation GENERAL DEREGULATION OF The main microeconomic financial reforms have already been MARKETS covered in chapter 6 (p. 206). You may recall that these focused on reducing government controls. It exposed the banking Economists generally believe that resources are most efficiently sector to more competition so that efficiency improved and allocated where there is strong competition. Sometimes, this interest rates on loans became cheaper. can only occur if governments reduce regulations that restrict competition. During the 1980s, 1990s and 2000s, market Deregulation of telecommunications deregulation has been a focus of many of the government’s Between 1990 and 2007, there were some significant changes in microeconomic reforms. telecommunications to allow more competition in the industry.

CHAPTER 7 Economic management using microeconomic policy 251 Optus and Telstra, for example, were locked in a battle for imposed, along with possible jail sentences for company direc- customers and the cost of some telephone services has come tors. The ACCC also performs other functions. For example, it down. Telstra downsized its staff to cut costs and was progres- supervises company mergers and takeovers to ensure that they sively privatised between 1997 and 2006, after the Coalition do not reduce competition and that they are in the public government gained a majority in the Upper House that allowed interest. In addition, it monitors pricing (prices surveillance) it to pass the necessary legislation. and other arrangements (e.g. false advertising claims) in industries where competition is weak including the utilities, aviation REFORMS TO STRENGTHEN and airports, insurance, petrol, postal, rail, waterfront and communications. COMPETITION Recently, between 2000 and 2007, the ACCC has adopted a Strong competition usually results in greater efficiency, lower high profile and aggressive stance to promote competition. It costs of production, cheaper prices, and better quality of service took legal action against Coles which owns Liquorland. There and product. Unfortunately, in some markets, competition were allegations that Coles had engaged in anti-competitive between rival firms is weak due to the existence of monopolies, behaviour in New South Wales by entering into contracts with oligopolies, takeovers, mergers, and price collusion. For these outlets licensed to sell liquor. One of the terms of the contract reasons, the government undertook reforms to strengthen com- prevented these licensed operators from supplying packaged petition. In 1995, the Australian Competition and Consumer Commis- takeaway liquor to consumers and, therefore, restricting compe- sion (ACCC) was set up to take over the roles previously covered tition. The ACCC also considered cases involving the companies by the Trade Practices Commission (TPC) and the Prices Surveillance and industries listed below (but it should be noted that not all of Authority (PSA). As such, the ACCC now enforces the TPA, which these firms have been found guilty of breaching the Act). is designed to help prevent powerful companies (i.e. price makers) from artificially raising prices to exploit consumers. Under the Act, a number of practices are illegal such as: I Price fixing, for example, where firms collaborate to set prices. I Exclusive dealing, for example, where companies refuse to supply their products or services to one or more firms. I Collusive bidding, for example, in submitting a tender or quote for the completion of works or to supply goods or services, supposedly competing firms meet secretly beforehand to agree whose tender should be most attractive, cheapest and likely to win the contract. I Price leadership, for example, where the dominant or leading firm takes a lead in setting prices that others follow. I Predatory pricing, for example, where the dominant firms conduct a price war involving big cuts in prices with the intention of driving rival firms bankrupt, and then later enjoying the market without competition. I Market zoning, for example, where competing firms in a region divide up the market into zones, areas or regions within which they agree not to compete with each other over prices. I Interlocking directorships, for example, where a person acting as a member of the board of directors for one company, is also on the board as a director of a supposed rival company. If a company is found guilty of these offences, fines of up $500 000 for individuals or $10 000 000 for companies may be

Qantas Major banks Archem Australia

Telstra Seven Network Hutchison Australia

Foxtel Berri Fruit Juice Advanced Medical Institute

Optus ABB Power Transmission Australian Gaslight Limited

Mobil, BP, Shell and Caltex Darwin Radio Taxis Chubb Security

Coles–Myer, Liquorland, Woolworths Coopers & Lybrand and Nissen Price Waterhouse (Price WaterhouseCoopers)

Source: Data derived from the ACCC.

252 Economics Down Under Book 2 ENVIRONMENTAL REFORMS Public–private partnerships Public–private partnerships involving the private financing of Environmental reforms cover issues related to environmental social infrastructure (e.g. schools, welfare housing and hospi- change, energy and water use. tals) have expanded, where the government leases these facil- Energy ities back from private-sector owners. For some years now, concern has been expressed about the Health insurance rebate impact of burning fossil fuels (e.g. by cars, trucks, power gener- There has been the introduction of the 30 per cent rebate to ators, industry and waste disposal) on greenhouse gas emissions help offset some of the cost of private health insurance (to and global climate change. This gave rise to a summit that pro- relieve the pressure on Medicare), along with the use of casemix posed the Kyoto protocol or convention that commenced in funding in public hospitals. 2003. The aim was to limit carbon emissions by industrialised nations to specific target levels. Emissions by firms would need Education to be offset by firms purchasing carbon credits in the market- A review of education has taken place. This has included federal place. This scheme gives pollution emissions by a firm a cost, funding of public and private schools and the application of or money value, that affects company profits and hence their national literacy standards. resource allocation. For Australia, the target for the 2008–12 commitment period, was to slow the emissions rise to only 108 per cent of the 1990 benchmark level. Clearly, if Australia MICROECONOMIC POLICY had signed up to this agreement, it would have had significant effects on the structure and operations of some local industries RESULTED IN PRIVATE–SECTOR and firms, relative to others (e.g. brown coal power generation, REFORM road transport, the smelting of aluminium and other metals). The government did not sign this protocol, but did set Government microeconomic reform, especially market deregu- renewable energy targets. More recently, the rise in oil prices lation and trade liberalisation, have a knock-on effect. They (2004–06) and growing concern about climate change (in the force the private sector to restructure the way it goes about pro- context of the current drought) caused by greenhouse gases, ducing goods and services. No longer can local firms coast has led to the federal government’s renewed interest in the along if they want to survive foreign competition. In their battle problem. Reports were commissioned in 2006 into nuclear to increase efficiency, privately operated firms must keep on energy and a possible system for trading carbon credits reviewing their business practices. Often this has involved the (i.e. licences to pollute, the market price of which would place following changes. a cost on firms that pollute). Rationalisation of operations Water trading Local firms must rationalise their operations, closing down unprofitable or less viable branches. For example, BHP closed There is growing concern also about water. The current its Newcastle plant, Email ceased its dishwasher and other oper- drought and, for farmers, the string of dry seasons that stretches ations in Victoria, Mitsubishi closed its engine plant in South back to 2003–04, have prompted this. Many of our largest cities Australia, banks including the ANZ, the Commonwealth, NAB are on stage 4 (or higher) water restrictions and our productive and Westpac have reduced branches and shed over nearly capacity has been reduced. The matter has also raised debate 20 per cent of their staff. about using irrigation for growing crops like rice in almost desert conditions and how to maintain environmental river Benchmarking against best practice flows. In late 2006 and again in 2007, the Prime Minister called Benchmarking has been widely introduced and involves setting a summit of state premiers to discuss the matter and to com- time targets for particular processes and work tasks, using the mence work on reforms including a water trading scheme. standards set by leading international plants. Costs SOCIAL INFRASTRUCTURE There has been an increased focus on recycling, reducing pro- The social infrastructure includes the government’s provision of duction times, operating with fewer staff, and cutting costs, adequate health, education and housing. This task is made waste and delivery delays. more difficult because of financial constraints in the budget, an Technology already high direct tax burden, tax avoidance, growing welfare Technology has been applied more widely and is updated more dependency, a drop in the growth rate for the labour force, and frequently. an ageing population that is expecting higher standards of welfare and health care (as highlighted in the Treasurer’s 2002–03, Management Intergenerational report). These developments have forced Many firms have used a flatter management structure. This efficiency improvements in the government’s delivery of ser- involves fewer levels of middle management and increased vices. Additionally, other reforms have involved the following. responsibilities and performance targets for ordinary workers. Funding cuts and user pays Training During the past 10 years, there have been cuts in the govern- There has been the promotion of continuous learning, ment staffing and funding of departments, and in some cases, multiskilling, teamwork and encouragement of adaptability by increased application of the user-pays principle. staff.

CHAPTER 7 Economic management using microeconomic policy 253 Stocks Marketing Keeping large stocks of components or finished product is expen- During the 1990s and 2000s, there has been a broadening in the sive so, increasingly, firms employ the idea of ‘just in time’ (JIT) approach to product marketing from having a local orientation, (when new stock is only ordered when stocks are running low). to greater emphasis on e-commerce and global markets. Wage system Some of the results of reform have been nothing short of stag- Most firms use a performance-based pay system from CEOs gering. For example, at Rio Tinto’s Hamersley mining oper- down. This involves workplace agreements that link wage rises ations, wage, industrial relations and other changes reduced the to the achievement of productivity and other targets. number of hours lost to industrial disputes by around 98 per cent over a recent 10-year period, and at the same time, grew Communication productivity by nearly 90 per cent in terms of tonnes of ore Businesses have sought to improve communication between mined per employee a year. These outcomes meant a huge cost staff, since this helps to lift efficiency. Increasingly, the top-down saving that translated into increased output, higher profits, busi- command system of management has been replaced by a two- ness expansion, increased employment and rises in real way system of communication. This gives employees greater incomes. responsibility for their performance and may improve the level of cooperation between workers and management, leading to lower rates of strikes and industrial conflict. TRY SHORT ANSWER EXERCISE 2, pp. 276–77

7.4 Using microeconomic policy to improve domestic economic stability

Remember that internal or domestic economic stability entails the side conditions aimed at encouraging an increase in AS, all three government simultaneously achieving the objectives of: aspects of economic stability should eventually improve. Econ- I price stability (an average annual inflation rate over the cycle omic growth should be stronger, inflation slower and unemploy- of 2–3 per cent) ment lower than would otherwise occur. Let us see why these I sustainable economic growth (average annual GDP growth of improved outcomes should occur. around 4 per cent) I full employment (an unemployment rate of around 5–6 per AS1 = AS2 = increased cent of the labour force). original supply-side productive During the past two decades, microeconomic reform has become conditions capacity an increasingly important part of the overall policy mix or combi- following nation. While monetary and budgetary policies act as shorter- macroeconomic, term stabilisers of the level of AD, microeconomic policies help supply-side Cost inflation efficiency to improve stability in the longer term by growing Australia’s P 1 reforms productive capacity and boosting our AS. Supply-side microeconomic reforms like labour market or wage deregulation, trade liberalisation, cuts in tax rates, improved public-sector P2 efficiency, growing the level of national savings and competition General level price reforms, all help us to produce a greater level of national output AD1 = ideal from fewer inputs, and at a lower cost or general price level. levels of These beneficial impacts of reforms are illustrated on the AD–AS spending diagram shown in figure 7.5. = increased GDP1 = GDP2 Notice that, as a result of microeconomic efficiency policies, original sustainable sustainable rate of the economy’s productive capacity has grown from AS1 to AS2 rate of economic growth economic growth (i.e. the AS line has shifted outwards). As a result, the equi- and employment librium level of national output has grown from GDP1 to GDP2, Real GDP (national output) and the general level of costs and prices has fallen from P1 to P2. This is more or less what has happened in Australia following Figure 7.5 How microeconomic supply-side microeconomic reforms, especially during the past 20 years to reforms can help improve domestic economic 2007. Because microeconomic policies try to promote better supply- stability

254 Economics Down Under Book 2 Microeconomic reforms have helped cost less to produce, businesses can keep their prices down and ‘price stability’ still make good profits. This slows cost inflation and greatly improves price stability. In the long term, improved price stab- Through various efficiency reforms (i.e. productive, allocative, ility and international competitiveness also help GDP and dynamic and intertemporal efficiency) involving structural employment growth and, hence, general economic stability. change, the use of positive incentives, and stronger competition, Six of the most significant microeconomic reforms designed firms have lowered their production costs. If goods and services to slow cost inflation pressures are reviewed in table 7.4.

Table 7.4 The top six microeconomic reforms that ﬁght inﬂation

1. Tariff cuts and There were progressive cuts in general tariff rates from around 40 per cent in 1968–69, trade to zero for most items by 2005–06, along with ongoing reductions in those for cars, liberalisation textiles, clothing and footwear. Additionally, subsidies were reduced, import quotas abolished and four FTAs were in operation by early 2007 (with four more in the pipeline). Tariff cuts helped to keep inflation down. This happened in several ways. I Reduced tariffs increased the level of competition forcing local firms to slash their costs and prices. I Lower tariffs and freer trade made imports cheaper. This meant a significant reduction in production costs for firms using imported equipment. Goods were also less expensive for households purchasing imports such as cars, footwear, clothing and electrical goods. I Cheaper imports helped to siphon off excess AD, thereby slowing demand inflation. I Lower tariffs forced businesses to allocate resources more efficiently to areas where our comparative cost advantage was greatest. This too helped to keep inflation down.

2. Labour market The past decade and a half has seen the extension of efficiency or performance-based deregulation workplace wage agreements. These and other labour market reforms helped to actually reduce RULCs during the 10 years to 2005–06. Being the main cost of production for many firms, lower RULCs in turn slowed cost inflation. In addition, these reforms also contributed greatly to reducing costly industrial strikes.

3. Competition Changes were made to improve the level of competition between sellers of goods and reforms services. These included the creation of the ACCC, the strengthening of the TPA, widened surveillance of prices, and closer scrutiny of mergers and takeovers. Economists believe that strong competition between rival firms is a precondition needed for efficiency and lower inflation rates.

4. Public sector Public sector efficiency reforms helped to reduce production costs and hence inflation. efficiency These included privatisation, corporatisation, contracting out and competitive tendering, reforms and public service staff cuts. As a result of reforms, the cost to users of many government services actually fell in real terms.

5. Tax reforms The reductions in most tax rates (e.g. on personal incomes and company profits) between 2000 and early 2007, helped to slow inflation. Companies had higher after-tax profits allowing them to absorb some of the cost rises without putting up their prices. This helped to accelerate investment in more efficient new equipment. Individuals were also encouraged to work harder, knowing they would get to keep more of their income. This helped productivity and lowered inflation.

6. Promoting Measures (e.g. encouragement of superannuation, budget surpluses, the Future Fund) national savings were put in place to try and promote national savings. With more savings available for lending, the cost to firms of borrowing credit used to finance investment in new equipment and technology tended to become cheaper than otherwise. Indeed, current interest rates are at a 30-year low. This helps to reduce cost pressures on firms and slow inflation.

CHAPTER 7 Economic management using microeconomic policy 255 Microeconomic reforms have promoted higher sustainable economic growth There are two ways supply-side microeconomic reform can help accelerate the rate of economic growth that an economy can sustain, without jeopardising price stability: 1. Microeconomic policy can increase Australia’s sustainable rate of economic growth by expanding our productive capacity. This occurs because greater efficiency allows businesses to produce a bigger output from the same inputs, simply by cutting costs or using the available resources more efficiently. 2. Cost-cutting efficiency reforms (e.g. industry assistance, cuts in tax rates, labour and capital market deregulation, modifications to welfare access and R&D schemes) lift the sustainable rate of GDP growth by boosting business profits and creating incentives for individuals to work harder. This improves worker motivation and makes firms more willing to expand their output. Table 7.5 shows some of the more important microeconomic reforms used to help increase Australia’s sustainable rate of economic growth during the past 10–20 years to 2007.

Table 7.5 The top four microeconomic reforms that promote sustainable economic growth

1. Tax reforms In general, lower tax rates (as in Australia, 1999–2007) help to boost economic growth and productive capacity. From the supply-side point of view, reduced rates of company and capital gains taxes help to grow the after-tax profits of investors and firms. This motivates business expansion through increased investment spending on new equipment and technology. Capital deepening (i.e. more investment or capital per worker) leads to better efficiency. Similarly, lower rates of PAYG help to encourage hard work since individuals can retain a larger percentage of their income. This may also lead to higher rates of saving and investment.

2. Labour market Australia’s labour market reforms have mainly been about boosting worker productivity deregulation and using resources more efﬁciently. For instance, workplace agreements represent a performance-based wage system. Typically, these agreements only pay higher wages when there is increased worker efﬁciency. In addition, the relaxation of the unfair dismissal laws (see Work Choices, 2005) might mean that more workers are employed than previously, contributing to increased national production.

3. Public sector Australia’s public sector produces almost 20 per cent of GDP. As a result of efﬁciency reforms reforms including cost cutting, contracting out, privatisation and corporatisation, our productive capacity and sustainable rate of economic growth should tend to increase.

4. Reforms to Australians save too little to ﬁnance national investment. Among other things, this leads promote to higher interest rates that discourage business expansion in plant and equipment. In national savings turn, this slows our sustainable rate of economic growth. However, the savings reforms between 1991 and 2007 including many surplus budgets, the creation of the Future Fund, the introduction of compulsory superannuation and other incentives to encourage private superannuation, should help to correct this problem.

256 Economics Down Under Book 2 Microeconomic reforms have helped effective in dealing with supply-side structural causes of economic encourage fuller employment instability. I While contractionary monetary and budgetary measures There is little doubt that microeconomic reform increased struc- work well to slow demand inflation, they often worsen cost tural unemployment over the short and medium terms. Often, inflation. This is not a problem with microeconomic reforms. cost reductions by firms, the promotion of efficiency and the These actually reduce costs and do not depend on stopping rationalisation of production by the private and public sectors, the economy to check inflation. resulted in the downsizing of staffing levels. Although this is very I Similarly, expansionary budgetary and monetary policies distressing for those involved, theoretically, if there is improved work quite well by boosting AD to counteract a cyclical slow- efficiency, product quality, price competitiveness and business down economic activity and employment. However, micro- profitability, in the longer term, fewer firms should close down. economic measures are far more effective than Structural unemployment should drop. Indeed, reforms should macroeconomic strategies in actually lifting the sustainable eventually help to grow employment opportunities more than would rate at which the economy can grow. be the case if industries were inefficient. In addition, local Microeconomic policies are consistent with achieving efficiency reforms help to grow domestic and international sales most other government economic objectives of goods and services, generating even more jobs. Table 7.6 summarises some stand out microeconomic reforms In promoting domestic stability through greater efficiency, this affecting employment. helps the government achieve its other economic objectives. For instance, external stability should be improved as firms become more internationally competitive and we are less dependent on Some other advantages of financing national investment through overseas borrowing and microeconomic policy debt. Certainly there will be greater efficiency in resource allocation and, in the long term, this may even lead to improved Microeconomic reforms have other advantages. equity in income distribution. Microeconomic policy is more effective than macroeconomic policy in some situations Unlike macroeconomic policy in general, and especially monetary policy in particular, microeconomic reforms are very

Table 7.6 The top ﬁve microeconomic reforms that can lower unemployment in the long term

1. Tax reforms Tax rates were cut (especially during the years 1999 and 2007) partly because lower rates help to create more jobs and less unemployment. Reduced company and capital gains taxes encourage higher levels of business investment and expansion because after-tax profits are higher and firms are more internationally competitive. This generates jobs whereas low or falling company profits destroy employment. 2. Welfare reforms Reforms (especially 1996–2007) have made it more difficult to access welfare and have removed some of the disincentives to work. The welfare trap has been reduced. New policies have also aimed to increase labour force participation rates and get more individuals to accept responsibility for their personal financial situation. 3. Trade Over 20 per cent of Australian jobs result from international trade. Trade reforms in the liberalisation years to 2007 focused on cutting the level of tariff and other protection, and expanding FTAs. In the short term, it is likely that the move towards freer trade caused structural unemployment to rise as local firms closed down due to import penetration of the domestic market. However, some research confirms that employment grows fastest in more globalised industries where, due to lower tariffs, resources are allocated efficiently into areas of comparative cost advantage. 4. Labour market Employment grows and unemployment shrinks if Australian firms are profitable due to reforms lower production costs. One of the key costs is wages for labour. Over the past 15 years to 2007, there has been extensive deregulation of our labour market and wages, with the extension of workplace agreements to cover around 90 per cent of workers. This has been the main reason for the actual fall in RULCs (by around 0.44 per cent per year during 1996–2006), and record levels of business profitability experienced in recent years. 5. Reforms to lift Business can only expand if it has access to cheap finance and low interest rates. Recent national savings reforms have tried to grow the pool of national savings via surplus budgets, the Future Fund and inducements for superannuation. As a result, interest rates are lower than would have otherwise been the case.

CHAPTER 7 Economic management using microeconomic policy 257 HAS MICROECONOMIC POLICY Notice for example: I Productivity is growing much more strongly. PROMOTED DOMESTIC I RULCs for firms have actually decreased. STABILITY? I Strike rates are greatly reduced. I The cost of overdraft interest rates is much cheaper for firms Conclusive evidence of the success (or otherwise) of these borrowing credit. microeconomic reforms is difficult to find. This is because I Tax rates on companies are significantly lower. there are so many local and international factors other than I The labour force participation rate has increased. microeconomic policy, that affect how well the economy per- I Tariff protection of local manufacturing industry is now forms. Even so, it is interesting to compare data for two almost non-existent. periods of time — first, for the years 1980–1992 (prior to the I Many goods and services (e.g. electrical appliances and air acceleration of reform), and second, for the period from travel) are now cheaper for households and firms. 1992–93 to 2005–06 (when changes in microeconomic policy These trends have implications for the achievement of domestic were much faster). Table 7.7 attempts to do this using a economic stability. scorecard.

Table 7.7 A scorecard for government microeconomic policy for domestic economic stability

NOTES ABOUT THE INDICATOR OF THE SUCCESS OF AVERAGE AVERAGE CHANGE IN AVERAGES MICROECONOMIC POLICY 1980– 1992– (1992–06 COMPARED WITH REFORMS 92 2006 1980–92 AND OTHER YEARS)

Price stability: Inﬂation (average annual 8.1 2.6 Inﬂation down by 67.9 per cent percentage change in CPI)

Sustained economic growth: GDP growth 3.4 3.7 Sustainable rate of economic growth (average annual percentage change) faster by 8.8 per cent

Full employment: Unemployment rate 7.7 7.1 Unemployment down by 7.8 per cent (average percentage of labour force) (October 2006, a 30-year low ﬁgure of 40.3 per cent down on 1980–92)

1. Productivity (average percentage change 1.2 2.1 Average labour efﬁciency increased in GDP per hour worked) by 75 per cent

2. RULCs (average annual percentage –0.3 –0.4 Average RULCs for ﬁrms are falling change) and cheaper by 33 per cent

3. Strikes level (average working days lost 352 65 Estimate down by 81.5 per cent per 1000 employees) (2005–06 ﬁgure down an estimated 97 per cent on 1970s average)

4. Gross proﬁt growth (average annual 11.2 8.5 Down by 24.1 per cent percentage change)

5. Rate of company tax (average 44 33 Down by 25 per cent (2005–06 rate percentage of proﬁts) 39.9 per cent down on 1980 rate)

6. Interest rates on overdrafts (average 16 9.1 Down by 43.1 per cent (2005–06 rate percentage a year) down 54 per cent on 1989 rate)

7. Labour force participation rate (average 61 63.4 Average is up by 3.9 per cent percentage of total persons) (October 2006 ﬁgure down 6.7 per cent)

8. General manufacturing tariff rate 19 2 A fall in the average annual level of (average annual effective percentage) tariff protection by 89.5 per cent

Sources: Data derived from ABS 1350.0; RBA Bulletin; RBA Occasional Paper, No. 8A.

258 Economics Down Under Book 2 Some possible successes of reforms for whatever reason, equity in income distribution also tends to suffer in the short term. This is because unemployment causes Based on table 7.7 and other data for the past 25 or more years incomes, purchasing and access to basic goods and services to to 2005–06, many commentators believe that recent microeco- be reduced. When assessing the short-term effects of micro- nomic policies generally have been very effective in promoting economic policy on the level of structural unemployment and domestic stability in three ways. equity, the following reforms have proved to be the most 1. A faster sustainable rate of economic growth damaging. Economic activity rose in all years at an annual average of I Reduced tariffs and protection. Import duties have been progres- around 3.6 per cent. This higher sustainable rate of econ- sively reduced. The general tariff rate was cut from 15 per omic growth was the result of good profits, greater prod- cent in 1992 to zero by 2005–06. In addition, in the 14 years uctivity, increased labour force participation rates, fewer to 2005, tariffs on cars fell from 35 to 10 per cent, and, for the strikes, lower tax rates and cheaper credit. Although the textiles, clothing and footwear industries, from 47.5 to a average rate was just short of the government’s 4 per cent maximum of 15 per cent. This caused business closures and target, it was held back in the past 3–4 years to 2007, because structural unemployment in the manufacturing sector. the economy had little unused productive capacity. I Labour market reforms. Labour market reforms (especially the extension of enterprise agreements) have increased worker 2. Better price stability productivity. In many cases, more work is now completed Overall, inflation was within the government’s 2–3 per cent using fewer staff, temporarily causing a slower growth in target (unlike the years 1980–92), thanks partly to stronger employment. productivity of over 2 per cent a year, falling RULCs, lower I Reforms to the government sector. Initially between 1987 and tariffs and cheaper credit for firms. The price of some goods 1999, there was a 35 per cent reduction in public sector staff and services actually went down. Even so, there were two levels due to the effects of privatisation, corporatisation, com- spikes in Australia’s inflation rate in 2000–01 and 2006–07. mercialisation, contracting out and the government’s fiscal These were partly provoked by once-off events, and more consolidation. However, between 1999 and 2006, numbers recently, by the fact that the economy was close to its pro- have again grown, although not to previous levels. ductive capacity. 3. Fuller employment This period eventually saw the achievement of the full employment target (i.e. 5–6 per cent unemployment). Except for a slight rise during the slowdown of 2000–01, unemployment fell fairly steadily from 8.3 per cent in 1996, to a 30-year low of only 4.6 per cent in late 2006. This may be partly attributed to the increased competitiveness of local firms following effective microeconomic reforms (e.g. labour market deregulation, tax cuts and savings reforms).

Some areas of weakness in reforms Despite this apparent success, critics of recent microeconomic policy draw attention to some areas of weaknesses. The pace of microeconomic reform slowed down between 2001 and 2005 Microeconomic reform appears to have moved in waves with peaks in the early 1990s, 1996, 2000 and perhaps 2005. Despite I Structural change by businesses. There has been massive restruc- some renewed interest in 2005, the pace of change did seem to turing, especially in the car, textiles, aviation, transport, slow and the federal opposition believed that the government farming, telecommunications and banking industries. This has had run out of new ideas. often been associated with the accelerated use of new technology (e.g. robots, computers and the Internet, and R&D), Possible conﬂict with other government objectives the rationalisation of company branches (i.e. sometimes in the short term caused by integration, mergers, takeovers), and the introduc- Perhaps the most severe weakness of many microeconomic poli- tion of new worker–management systems designed to cut costs. cies in Australia is that, in the short term, they are likely to weaken the achievement of full employment and equity. For Political constraints slow or weaken reform example, in the 1990s and 2000s, structural change has meant As we saw between 1996 and 2007, many microeconomic reforms that most ﬁrms have produced more output with fewer workers. (e.g. the Workplace Relations Act, the privatisation of Telstra, and Indeed, ABS data shows that while manufacturing output rose the introduction of the GST) initially failed to gain approval in 36 per cent between 1996–97 and 2005–06, this sector provided the Upper House where federal governments lacked a majority nearly 7 per cent fewer jobs. This was only possible because until 2005. In addition, WorkChoices (2005–06) the proposed there has been a 19 per cent rise in labour productivity (i.e. sale of Medibank Private (perhaps 2007) and the Snowy Moun- GDP per hour worked). In addition, when unemployment rises, tains Hydro Scheme (the idea was scrapped in 2006), proved

CHAPTER 7 Economic management using microeconomic policy 259 unpopular with some sections of the community. Political con- a short-term stabiliser to iron out fluctuations in the business straints like these, slow the speed of reform and may sometimes cycle. Instead, microeconomic measures are more aimed at the result in them being watered down and made less effective. longer term where they are limited mainly to raising efficiency and the sustainable rate of economic growth, cutting business Implementation lags are often long costs and inflation, and improving the international competi- Microeconomic policy can involve enormous time lags or delays tiveness and profitability of Australian firms. in policy implementation. Reform of the car industry, for instance, commenced in 1983 but the tariff cuts associated with it, will still Institutional constraints slow the pace of reform not be complete until some time after 2010. Another example While some people are critical of change, others believe that of implementation delays is labour market deregulation. This our pace of reform has been too slow. One reason for this is the was designed to slow the growth in wages, reduce cost inflation institutional constraints that limit progress. There does seem to and improve external competitiveness. Workplace agreements have been a lack of real commitment to reform across a wide were first approved in 1991, but even by 2006, over 10 per cent range of institutions from unions, to business and to govern- of the labour force was still regulated by the old minimum wage ment at all levels. In addition, greater determination to system. This long implementation lag also reduced the ability of implement reform overseas has meant that relatively, Australia reform to improve domestic stability. may still be losing ground. Inability to use microeconomic reforms as a short-term stabiliser Unlike macroeconomic policies that can help reduce the severity of booms and recessions, microeconomic reform cannot be used as TRY SHORT ANSWER EXERCISE 3, pp. 277–78

7.5 Using microeconomic policy to improve external stability

For Australia, the government’s objective of external stability As supply-side efﬁciency measures, microeconomic reforms are means that we should be able to pay our way in international trans- very well suited in the long term, for dealing with Australia’s actions, without undue downward pressures on the A$ or an external structural problems, namely: excessively large CAD or NFD. Figure 7.6 shows, hypothetically, I the large saving–investment gap that is currently ﬁlled by bor- that there are two sets of factors currently causing Australia’s rowing overseas external problems. I our relatively high production costs that reduce our inter- 1. From time to time, excessively strong AD and economic national competitiveness. activity can cause a cyclical rise in our CAD. Let us now consider each of these two areas to see what macro- 2. There are ongoing or long-term structural problems that economic policy is doing to correct the problem. cause the CAD to seldom fall below 3 per cent of GDP.

6 2. A large CAD:GDP ratio of around 6% shows that there is excessively strong AD and economic activity. National expenditure is running ahead of our productive capacity. Contractionary macroeconomic measures might help to reduce this problem.

3 A figure of around 3–4% for the CAD:GDP 1. This area represents ongoing structural causes of ratio is the government’s target for the external instability including our poor objective of external stability. This is most competitiveness and our big NFD due to a lack of likely to be achieved when there is domestic domestic savings to fill the S–I gap. economic stability (rather than a boom). This problem can be reduced by microeconomic reforms that improve our competitiveness and close our national S–I gap. CAD:GDP ratio (%) 0 Years Figure 7.6 The causes of external instability and its reduction using microeconomic policies

260 Economics Down Under Book 2 Reducing the large ‘gap’ in national companies have to contend with relatively high tax rates. Because savings and investment it often costs more to produce goods and services here, it is difficult for local firms to keep prices down and still make reason- Australians do not save enough to finance their high level of able profits. Regrettably, high domestic costs and prices investment in new plant and equipment. We have come to undermine export sales and encourage imports. They also pre- depend very heavily on overseas borrowing and debt, in order vent our firms from adding greater value to exports through fur- to make up the difference. This problem then adds to Aus- ther processing or manufacture. Together, these problems tralia’s CAD (especially the huge net income deficit) and has contribute directly to Australia’s ongoing structural CAD, rising contributed to the long-term decline in the A$. In addition, NFD and overall declining value of the A$. poor savings mean that domestic interest rates paid by busi- Microeconomic policy has tried hard to improve Australia’s nesses borrowing credit, are often higher than those faced international competitiveness through the cost-cutting abroad. This further encourages overseas borrowing. It also rep- efficiency measures shown in table 7.9 (p. 262). Coverage here resents a cost disadvantage by discouraging local firms from pur- will be brief because these measures have been mentioned chasing the latest technology needed to lift efficiency, and it already in connection with slowing inflation. lowers the competitiveness of our exports relative to imports. Table 7.8 reviews some of the key microeconomic reforms used to try to increase domestic savings. Lowering our high costs and improving our international competitiveness Often due to low efficiency and our particular endowments of resources, Australian firms often face higher production costs relative to those overseas. Costs here include wages, interest rates on borrowed credit, utilities (i.e. energy, water, telecommunications), transport, imported materials and equipment, and high fixed costs caused by the local market being comparatively small in size (this reduces economies gained from large-scale production where costs can be spread more thinly). In addition,

Table 7.8 Five microeconomic reforms that may help increase national savings

1. Surplus budgets and Since 1996, the Treasurer has accepted the idea of fiscal balance in the medium pursuit of fiscal term, where budget surpluses pay for deficits. This means that there is no Federal balance public sector borrowing requirement and, by 2005, all Commonwealth debt had been repaid. This helped to reduce the size of the NFD and CAD. It also meant that interest rates were lower than otherwise, stimulating private sector investment in new technology and helping to improve our international competitiveness.

2. The Future Fund In 2005, the Future Fund was created. It used proceeds from asset sales and surplus budgets to try to grow national savings and capital through wise investments.

3. Tax concessions The government encourages private superannuation contributions by offering very for private generous income tax concessions for those sacriﬁcing their salary and, from July superannuation 2007, individuals can withdraw their superannuation tax-free, once they reach the contributions age of 60 years.

4. Introduce the Starting in 1991, national superannuation was made compulsory for all employees compulsory national through the introduction of the Superannuation guarantee charge (SGC). This levy superannuation on business originally started at 3 per cent, but in 2002, was increased to 9 per cent guarantee charge of an employee’s pay.

5. The co-contributions The Superannuation co-contributions scheme commenced in 2002–03. Basically, the superannuation government matches low-income after-tax superannuation contributions at the rate of up to $1.50 for every $1 (higher for 2007–08) put into an approved superannuation account.

6. Tax reform involving Between 1999 and 2007, there were signiﬁcant reforms involving cuts in tax rates. lower tax rates Many of these changes should help to increase disposable incomes and national savings by individuals and companies.

CHAPTER 7 Economic management using microeconomic policy 261 Table 7.9 Six microeconomic reforms that help increase our international competitiveness

1. Tariff cuts and trade In the 30 or more years, to 2007, local industry has been exposed progressively to liberalisation much stronger competition from imports following reductions in tariffs and subsidies, the abolition of import quotas and the growing number of FTAs. This has forced Australian ﬁrms to cut costs by restructuring their production, improve product quality and service, and to allocate resources more efﬁciently into areas where our comparative cost advantage is greatest.

2. Labour market Under workplace agreements, wage rates paid by ﬁrms now, more closely reﬂect deregulation market conditions of demand and supply than was the case when the traditional centralised minimum wage system was more dominant. Reforming the wage system, changing legislation about unfair dismissal, and encouraging union amalgamation and multiskilling, have all helped to lower RULCs. This has made local exporters more competitive.

3. Deregulation of other The government also has deregulated many other markets (e.g. including aviation, markets power, communications, primary products, and financial markets) to stimulate competition, improve efficiency and strengthen the international competitiveness of local firms. The floating of the A$ in particular has helped to ensure that the A$ trades at an appropriate level that reflects global demand and supply conditions. This acts as an automatic device to help correct the size of our CAD.

4. Competition reforms The promotion of stronger competition through the Trade Practices Act and its enforcement by the ACCC has helped to keep business costs and prices down. This makes local ﬁrms more competitive.

5. Public sector There has been significant privatisation of government business enterprises during efficiency reforms the past 20 years to 2007. Supporters claim that this lifts efficiency, cuts production costs for firms using these services, and allows them to sell profitably at lower prices. In addition, corporatisation of some government businesses and overall reductions in the size of the public sector have contributed to lower costs of government and a more competitive economy.

6. Tax reforms Reforms here have especially focused on lowering tax rates on individuals and firms. For example, reductions in taxes on company profits and capital gains, allow firms to enjoy better after-tax profits. Local exporters can also sell at a lower more competitive price, encouraging better sales.

HAS MICROECONOMIC POLICY in turn, inﬂuencing the CAD, NFD and exchange rate for the A$. Isolating cause and effect accurately, is almost impossible. PROMOTED EXTERNAL Even so, the data in table 7.10 helps to cast light on the situ- STABILITY? ation. It compares statistics for the years spanning 1996–97 to 2005–06 (when microeconomic policies were at their peak), It is hard to prove the success or otherwise of microeconomic with those for 1980–1992 (before microeconomic reforms policies. This is because there are so many local and inter- gained popularity). national factors affecting Australia’s ability to ‘pay its way’, and

262 Economics Down Under Book 2 Table 7.10 A government microeconomic policy scorecard for external stability

ANNUAL ANNUAL NOTES ABOUT THE INDICATOR OF THE SUCCESS OF AVERAGE AVERAGE CHANGE IN AVERAGES MICROECONOMIC POLICY 1980– 1992– (1992–06 COMPARED WITH REFORMS 92 2006 1980–92 AND OTHER YEARS)

CAD:GDP ratio (percentage) 4.8 4.6 There was a slight reduction in the average size of the CAD:GDP ratio by about 4 per cent

NFD:GDP ratio (percentage) 25.7 38.5 The average size of the NFD:GDP ratio ballooned by nearly 50 per cent

TWI (1970 = base year = 100 points) 67.1 55.8 The average value of the A$ on a TWI basis fell by nearly 17 per cent

1. Productivity (percentage change in GDP 1.2 2.1 The average annual rate of growth in per hour worked) labour efﬁciency increased by 75 per cent

2. Household savings ratio (percentage of 7.8 1.6 Household savings as a percentage of GDP) GDP collapsed by nearly 80 per cent

3. RULCs (annual percentage change) –0.3 –0.4 The average annual level of RULCs fell by 33 per cent

4. Strike levels (estimated working days 1878 65 Estimates of the strike rate are down lost per 1000 employees) by over 80 per cent (with the 2005– 06 ﬁgure down 97 per cent on the 1970s average)

5. Gross proﬁt growth (percentage) 11.2 8.5 Annual rate of proﬁt growth slowed by about 24 per cent

6. Rate of company tax (percentage of 44 33 The company tax rate is down by proﬁts) 25 per cent (with the 2005–06 rate down about 40 per cent on that for 1980)

7. Interest rates on overdrafts (percentage) 16 9.1 The average cost of business overdrafts was down by about 43 per cent (with the 2005–06 rate down 54 per cent on that for 1989)

8. General manufacturing tariff rate 19 2 A fall in the average annual rate of (estimated percentage) tariff protection by nearly 90 per cent

Sources: Data derived from ABS 1350.0; RBA Bulletin; RBA Occasional Paper, No. 8A.

Some strengths of microeconomic I pushing down interest rates on business overdrafts to a policies 30-year low, thus cutting production costs and improving competitiveness Supporters of Australia’s microeconomic policies point out that I improving after-tax company profits thereby allowing firms to there are limits to what the government can do to strengthen absorb rising costs and sell exports more cheaply. external stability. As we have seen, a host of reforms certainly tried to improve national savings and our international compet- Some weaknesses of microeconomic itiveness, without which, it could be argued, the results would policies have been much worse. Microeconomic policies have helped external stability by: However, despite these claims, on the face of it, microeconomic I increasing worker productivity reforms appear to have failed to deliver external stability. Table I lowering RULCs for export firms 7.10 supports this. For instance, it can be seen that, for 1996– I reducing strike rates that are costly to firms and disrupt 2006, the CAD:GDP ratio averaged 4.6 per cent. This exceeds export trade the government’s 3–4 per cent target and, overall, it looks like

CHAPTER 7 Economic management using microeconomic policy 263 efficiency and savings measures to reduce the CAD have not yet I labour market deregulation involving performance-based worked. It is also clear that the average size of the NFD as a per- workplace agreements started in 1991 yet some workers are centage of GDP has ballooned by nearly 50 per cent. This is des- still covered by this system. pite reforms to close the savings–investment gap. In fact, I the privatisation of Telstra began in 1998, but all shares will household savings as a percentage of GDP have actually fallen not be sold until at least 2007 and are now negative. In addition, despite a much stronger A$, I the Superannuation guarantee charge commenced in 1992, recently, since the low of 2000–01, overall the currency has lost a but savings still only represents 9 per cent of payroll and is lot of ground against where it was in 1970, or during the period insufficient for retirees to have reasonable living standards 1980–92. The picture is even worse taking an even longer-term I despite significant changes in 2000 and 2007, tax reforms view. In 1901, for example, A$1 would buy over 70 per cent have a significant way to go to make local firms more inter- more in terms of the US$ than at present. nationally competitive. Although most commentators acknowledge the usefulness of the government’s microeconomic policies in helping Australia Political constraints control its external problem, there are several reasons why suc- One reason for Australia’s cautious approach to reform is the cess appears to be rather limited. adverse political impact on voters at election time. Tariff cuts, workplace relations and privatisation for instance, have hardly Some negative effects of trade liberalisation on been popular in some electorates with manufacturing indus- external stability tries. This is because some of these microeconomic policies On the one hand, tariff cuts can help reduce the cost of cause structural unemployment in the short term. There is also imported equipment for local firms and make our exporters the added problem for the federal government if it does not more competitive. However, it is also true that lower tariffs can have a majority in the Upper House that allows it to ram legis- worsen the CAD and weaken the A$. This is because imports lation through parliament. become cheaper, thereby encouraging Australians to buy more items made abroad. Institutional constraints Microeconomic measures such as tariff cuts and labour market Conflicts with some other government goals deregulation have sought to create an export culture and sharpen Improving efficiency and international competitiveness through our focus on the need to be more internationally competitive. microeconomic policy can conflict with the achievement of Business and union organisations were initially slow in other goals. For instance, in the short term it appears that responding. This reduced the success of reforms. efficiency reforms (e.g. tariff cuts, privatisation, deregulation) often cause structural unemployment. In turn, unemployment Overseas constraints usually results in a lower level of disposable income for an indi- Effective microeconomic policy can be undone by overseas vidual that limits his or her access to basic goods and services. factors. For instance, protectionist measures adopted by some Typically, living standards are reduced. foreign governments (e.g. EU, Japan and the US) have undermined our improved competitiveness resulting from domestic Policy time lags are usually long reforms. Clearly, not all countries believe in the level playing field The fact that microeconomic policies often have large time lags as a basis for international trade. for implementation and impact, is one reason why the gains may not be all that apparent in the short term. For instance: I tariffs cuts commenced in 1973 are still going TRY SHORT ANSWER EXERCISE 4, p. 278 7.6 Using microeconomic policy to improve efficiency in resource allocation

Nations that use resources efficiently enjoy better material living Labour market reforms to lift standards. These productivity improvements can arise from allocative efficiency many sources including allocative, technical, dynamic and intertemporal efficiency. As we have seen on previous occasions, allo- Microeconomic reforms have increasingly deregulated the cating resources more efficiently mostly involves cost-cutting labour market. Between 1991 and 2007, this involved mainly the policies designed to improve structural or supply-side conditions, extension of workplace agreements and the reduced influence rather than measures to regulate the demand-side of the of the minimum wage system. It means that rather than most economy. With this in mind, let us briefly review the top five wages being set by government regulation, workers are increas- microeconomic reforms that have perhaps made the largest con- ingly paid according to the market value of their services tribution to improving efficiency in resource allocation. (reflecting demand for staff relative to their supply). Also, workers are increasingly rewarded according to their perfor-

264 Economics Down Under Book 2 mance or productivity, and the profitability of the particular Commercialisation and corporatisation business. This means that allocative efficiency is increased and Many of the remaining GBEs have been corporatised so that they there is more incentive for staff to work hard. Also, other labour operate more along the lines of a private company. Some are market reforms involving the encouragement of union amal- expected to contribute to their own operating costs by the com- gamation, the extension of multiskilling, and the easing of mercialisation of their services (e.g. the ABC, ABS). unfair dismissal laws, may have helped to significantly reduce Other measures to reform government efficiency industrial strikes, again improving worker efficiency (i.e. more Other measures to reform government efficiency include con- GDP per hour worked). tracting out, competitive tendering, changes to Commonwealth– state relations and the establishment of the National Competition Council to oversee the National competition policy.

Trade liberalisation to lift allocative and technical efficiency During the 1970s, 1980s, 1990s and 2000s, significant tariff cuts and trade liberalisation forced local firms to use resources more efficiently. During the 40 years between 1967 and 2007, general tariff rates have come down from around 40 per cent, and are now effectively zero for most items. What this has done is cause natural, labour and capital resources to be allocated into areas of comparative cost advantage. Clearly, this would strengthen allocative and dynamic efficiency. Moreover, not only do tariff cuts force local firms to reduce costs to remain competitive, but also they make imported capital equipment relatively cheaper. This promotes technical efficiency by improving local access to new, more efficient technology that may reduce time and waste in production. There are also the efficiency benefits associated with the development of an export culture or orientation among firms exposed to international competition. Businesses, which succeed in breaking into overseas markets, can also gain from improvements in economies of larger-scale operation (i.e. their fixed costs per unit produced are lower because these are spread over a bigger volume of output).

National savings reforms to promote intertemporal and technical efficiency Public sector reforms to lift efficiency Without adequate national savings, Australian firms would lack access to cheap credit or finance. Interest rates would be higher In Australia, the public sector produces about 20 per cent of than those overseas, discouraging vital investment spending on GDP. It is, therefore, important that governments are efficient new plant and equipment incorporating the latest technology. users of resources. In this area, there have been numerous With this problem in mind, the federal government initiated sav- microeconomic reforms. ings reforms, including the pursuit of fiscal balance, creating the Privatisation Future Fund, lowering tax rates and encouraging superannuation using a range of strategies. This should tend to increase intertem- Some government businesses enterprises (GBEs) have been par- poral efficiency. In addition, local businesses are currently enjoying tially or fully privatised (e.g. the Commonwealth Bank, Qantas, some of the lowest interest rates since the early 1970s allowing Telstra, some shipping ports like Geelong and airports). Various them to more readily purchase new equipment, bringing about arguments have been used to justify privatisation. For example, capital deepening, and improving productive efficiency. it is often claimed that: I the private sector is a more efficient user of resources than Financial sector reforms to improve the public sector because it tries to maximise profits by minimising costs allocative efficiency I private firms have superior management and more com- Since 1982, there has been considerable deregulation of mitted staff Australia’s financial system. This reform involved removing I private shareholders demand increased efficiency to raise unnecessary government restrictions and other impediments to their share price and dividends or returns allocative efficiency by creating a more competitive financial system. I private firms put more emphasis on R&D and marketing For example, deregulation has meant floating the A$, removing I private firms have better access to capital and technology controls on interest rates, and encouraging the entry of more I private firms are exposed to greater competition. local and foreign banks to stiffen competition between lending

CHAPTER 7 Economic management using microeconomic policy 265 institutions. There is some evidence that these reforms have nar- Some strengths of microeconomic rowed bank profit-lending margins by 1–2 per cent, making local policies credit more affordable to firms needing to borrow funds for investment. Exponents of microeconomic policy are quick to seize on the upward productivity trends shown in figure 7.7. Notice that both Tax reforms to improve efficiency labour and multifactor efficiency grew faster in the more recent years between 1996 and 2006 (i.e. during and after the full Lower rates of personal, company and capital gains taxes have impact of accelerated microeconomic reforms), than in the been introduced as part of government reforms. The idea is that earlier period, 1982–92 (i.e. before reforms gathered pace). In cuts in PAYG rates create greater personal motivation and incen- addition, commentators note: tive to work hard. In addition, lower rates of capital gains and I there was greater allocative efficiency across many specific company taxes, for example, mean higher returns and bigger markets (e.g. labour, capital, raw materials) after-tax profits. This should mean there is a greater willingness I a dramatic cut in the level of disruption to production caused and ability to increase investment in new plant and equipment. by industrial strikes (as shown in figure 7.8) after labour This could lead to capital deepening (i.e. a rise in the value of market reforms. equipment per worker) and better labour productivity. 1980–1992 — before HAS MICROECONOMIC POLICY labour market reforms PROMOTED EFFICIENCY IN 1992–2006 — during and RESOURCE ALLOCATION? after labour market reforms 0 100 200 300 400 An obvious question to ask is, how effective has microeconomic Number of working days reform been in improving Australia’s efficiency in resource allo- lost per 1000 employees cation during the past 10 to 15 years to 2006–07? Unfortunately, we cannot be absolutely certain. There are statistical limitations Figure 7.8 Average annual strike levels in to our data, and there are so many local and international Australia (working days lost per 1000 employees) factors affecting efficiency, other than government policy. Even Sources: Data derived from ABS 1350.0; RBA Occasional Paper, so, let us start by looking at figure 7.7 that compares statistical No. 8A. data for two periods of time: one before the pace of micro- I much lower inflation rates due to greater efficiency and economic reform accelerated (i.e. 1982–92), and one after reduced cost pressures (i.e. 1996–2006). I the 32-year low in unemployment or idle resources I quite strong rises in company profits Labour productivity I lower production costs including interest rates and RULCs (GDP per hour worked) I a rise in the sustainable rate of economic growth Multifactor productivity I near record rises in material living standards (i.e. GDP per head). 3.5 In addition, microeconomic reform is the government’s pre- 3 ferred policy when it comes to measures to increase efficiency. It certainly has the edge over budgetary and, especially, monetary 2.5 policies for its directness in tackling the structural supply-side of the economy. 2 Some weaknesses of microeconomic 1.5 policies 1 Despite its apparent success in improving efficiency, microeco- Annual % change 0.5 nomic policy has its limitations. Critics note that some of the claimed benefits of reforms have been exaggerated, while others 0 have failed to appear. 1982–92 1996–2006 (before (after Australian productivity peaked and is slowing microeconomic microeconomic Data show that, after the cyclical peak between 1994 and 1999, reforms accelerated) reforms accelerated) average productivity slowed towards 2006 and is now only mar- Figure 7.7 Comparisons of labour and multifactor ginally above our long-term average. Perhaps this reflects: productivity in Australia, 1982–92 (before I the reduced pace of microeconomic reform between 2001 accelerated microeconomic reforms) and 1992– and 2004 2006 (after acceleration of microeconomic reforms) I the limits to microeconomic policies and the fact that the eas- Source: Data derived from ABS 5204.0 for multifactor (national iest and most obvious reforms were completed some years ago accounts), 2004–05 (November 2005), p. 37. I the effects of previous reforms are now wearing off

266 Economics Down Under Book 2 I the fact that large improvements in efficiency require far more The conflict with other government objectives in the investment in new technology than has occurred to date short term I that domestic and international factors, other than govern- Especially in the short term, the pursuit of greater efficiency ment reforms, are now slowing efficiency. through government microeconomic policies like tariff cuts, privatisation and market deregulation, has been in conflict with Overseas productivity is much stronger the achievement of some other government economic objec- Perhaps one of the main criticisms of recent microeconomic tives like full employment and equity in income distribution. policy from an efficiency standpoint is that it has been far too For instance, tariff cuts certainly decimated some areas of manu- slow by comparison with developments overseas. This means facturing industry and caused some firms to close down or scale that, today, we find that most sectors of the Australian industry back Australian operations. This added to structural unemploy- have inferior productivity to levels abroad and, in some specific ment. Likewise, performance-based workplace agreements have industries, efficiency has actually decreased. Figure 7.9 shows enabled some firms to produce more output with fewer staff, that in terms of GDP per hour worked (i.e. which has been again swelling structural unemployment in the short term. The adjusted in terms of purchasing power parity to reflect differ- knock-on effect is that unemployment typically lowers the ences in the cost of living in different countries), Australia income and purchasing power of individuals, making some ranked only fifteenth amongst 24 OECD nations in 2004. This goods and services less affordable. However, hopefully in the was well behind countries like Norway, Ireland, France, Ger- long term, greater efficiency and competitiveness should lower many, the United States and the United Kingdom. unemployment and even improve equity. While recent policies may have helped to improve resource The other conflict issue is that the non-economic well-being allocation, they have not made up for the decades of neglect, of some workers has been undermined by the pursuit of nor are they stimulating structural change as rapidly as in some greater efficiency. It has come at a cost. The downside is that countries. This is causing us to fall even further behind. average hours of work have increased and leisure time with families has diminished. Furthermore, it is likely that staff 1 — Norway stress levels have increased and unions no longer act to coun- 2 — Luxembourg terbalance the increased power of employers. So, although 3 — Belgium workers may now be richer, they may not necessarily have a better quality of daily life. 4 — Ireland 5 — France Time lags caused by resource immobility 6 — Netherlands It is unrealistic to believe that resources can be moved or rede- ployed from one use to another, more efficient one, in a short 7 — United States Index base space of time. Some resources are immobile, such as special- 8 — Germany ised machinery. In order to respond to microeconomic policy, 9 — Denmark time (perhaps five, 10 or even 20 years) may need to be 10 — Sweden allowed. The gains from reform may take years to emerge fully. A related problem is that of the reluctance by some institutions 11 — Austria (e.g. business, unions, governments) to move with the times. In 12 — United Kingdom some ways, Australian production methods and work practices 13 — Finland have changed only slowly relative to the pace overseas.

14 — Switzerland Political restraints 15 — Australia (80% of US) Many things could be done to reform the production process. 16 — Spain However, adverse voter reaction and the short time between 17 — It aly elections, prevents some of the harder reforms from being tried. This was especially the case when a government lacked a 18 — Canada majority in both Houses of Parliament. For example, the 19 — Iceland Howard Government initially found it very difficult getting the 20 — Japan Workplace Relations Acts passed. Well over 160 amendments were 21 — Greece required in 1996 to get Democrat support in the Upper House. Another obstacle to the privatisation of Telstra, which was 22 — New Zealand designed to further lift efficiency, was the lack of Senate 23 — Portugal numbers between 1996 and 2005. Similarly, the introduction of 24 — Korea a GST and other tax reforms in 1999–2000 proved difficult at 0 20 40 60 80 100 120 140 the time because of the Coalition’s absence of an Upper House Index (US base = 100 points) majority. Figure 7.9 International comparisons of labour The limitations of specific policies productivity (Index number, US = 100 points) Some specific policies have limitations and have not fully Source: OECD Productivity Database, January 2006. achieved their aims.

CHAPTER 7 Economic management using microeconomic policy 267 I Reforms to increase national savings. Although the government in this area was shown to be dangerous during the Great has done what it can to increase national savings (to help Depression of 1929–33. keep domestic interest rates and foreign borrowing lower I Tariff cuts and trade liberalisation. For most industries, cuts have than otherwise), the measures do not appear to have pre- reduced tariffs to zero. They have gone as far as they can to vented the continued slide in the household savings ratio to promote greater efficiency. In addition, trade liberalisation by negative 2.9 per cent of GDP (2005–06). While this may have our government is partly frustrated or made less effective by been worse without savings policies, success has been limited. the failure of other countries to do likewise. Some claim that I Labour market reforms. Labour market reforms have probably while reduced protection may make surviving Australian helped to lift worker efficiency by extracting greater personal industry more efficient, the continued use of tariffs and sub- effort and motivation from employees. However, there are sidies by some overseas nations (e.g. Japan and some physical limits to how much further this can go and how members in the European Union) has not opened up the much more leisure time staff are prepared to sacrifice, given new markets we expected, nor delivered such huge benefits. the substantial rise already, in average hours worked during I Reform of the public sector. Privatisation of some government the past 10 years. Ultimately, greater staff efficiency now business enterprises is seen as an efficiency measure. During depends on higher levels of investment in new equipment, the 1990s and 2000s, this has been extensive but, by 2007, few along with greater emphasis on education, skills and training. possibilities remain for the government. I These, rather than the labour market reforms we have seen Competition policies. Promoting competition generally helps to lift recently, would help to bring about capital deepening and efficiency among rival firms. However, preventing price collu- even larger rises in labour efficiency. sion and other tactics is very difficult and there are some who I Deregulation of other markets. Up to a point, free and deregu- feel that preventing company mergers and takeovers in par- lated labour and other markets can bring about greater ticular circumstances might actually reduce efficiency by preventing firms from gaining economies of large scale where fixed efficiency in the allocation of resources. Sometimes, however, costs can be spread more thinly over bigger output volumes. market failure occurs and this can only be corrected by I Tax reform. Cutting personal, capital gains and company tax government regulation or intervention. For instance, some rates can help lift the incentive to work hard and expand aspects of the operation of the financial market involving pru- investment. However, given the acceptance of fiscal balance dential supervision of non-bank financial institutions have as a medium-term aim of budgetary policy, further reductions been reregulated to help ensure stability and efficiency. In are limited by financial constraints. addition, the government attempts to regulate the level of economic activity because improved stability also helps to increase efficiency. Adopting a non-interventionist approach TRY SHORT ANSWER EXERCISE 5, p. 278

268 Economics Down Under Book 2 7.7 Using microeconomic policy to improve equity in income distribution

The Australian Government’s objective of an equitable distribution working, incomes are higher than on welfare, and goods and of income means that everyone should have access to basic goods services are more affordable. For example, in late 2006, and services (e.g. food, housing, clothing, health and edu- average full-time weekly earnings were around $1050 and the cation) and enjoy reasonable living standards. Normally, we minimum weekly wage was $511, compared with, perhaps, think of budgetary policies as the main instrument to promote $200–250 per week for a single person on government equity. This is because fiscal measures like progressive taxes, income support. direct welfare benefits and indirect benefits or services (e.g. free or cheap public health and education), redistribute final 3. Reforms can lower production costs and slow inflation income from the rich to the poor very efficiently, directly and Greater efficiency in our use of resources means lower unit precisely. However, it is still important not to underestimate the production costs. This helps to keep inflation down and the vital role played by microeconomic reform in helping indi- real purchasing power of incomes up. This improves general viduals enjoy improved access to goods and services, and better access to basic goods and services, along with equity in the material living standards. In the long term, there are at least four distribution of income. main ways that this can happen (even though in the short to 4. Reforms help grow the government’s income and the medium terms, structural unemployment caused by these poli- affordability of welfare and government services cies can reduce purchasing power and equity). As explained already, improved efficiency helps to grow GDP 1. Reforms can lift GDP and average incomes per head and real incomes per head. In turn, this causes government Cost-cutting efficiency reforms should mean that the Aus- tax revenues in the annual budget to grow faster. As a result, tralian economy can produce a bigger level of national government outlays on direct welfare benefits (e.g. for the output from the same resources. Put another way, these strat- aged, sick, unemployed and families) and indirect services egies grow Australia’s capacity to produce goods and services (e.g. public health and education) are much more afford- and, hence, grow our production possibility frontier. Pro- able than otherwise. viding that our GDP expands at a faster rate than the growth By contrast to these long-term benefits for equity, if efficiency in population, Australians should enjoy higher average mat- fails to grow strongly because of the absence of effective micro- erial living standards (i.e. indicated by the average value of economic reforms, average per capita incomes fall, goods and GDP per person a year) and improved access to goods and services are dearer and less affordable, unemployment rises due services, of which previous generations could only dream. to poor business profitability and the closure of firms, and 2. Reforms improve competitiveness, lift profits and falling budget revenues force the government to cut back even create more jobs more on welfare and services for the poor. Clearly, income dis- By lifting efficiency and cutting production costs for local tribution in this case would become less equitable. firms, business profits grow faster than otherwise. Strong During the past 10–15 years to 2007, table 7.11 shows some of profit growth is vital for business expansion and survival. In the most important microeconomic reforms that have been the long term, fewer firms close down, resulting in a reduc- especially important in improving equity and raising material tion in structural unemployment. With more individuals living standards.

Table 7.11 Six microeconomic reforms that help increase equity in income distribution

1. Labour Australia’s labour market reforms have included the extension of the decentralised, market productivity-based wage system, the reduced importance of the centralised minimum wage reforms system that failed to encourage efﬁciency, the promotion of union amalgamation to reduce strike levels, and the exemption of small ﬁrms from unfair dismissal laws. These changes may have helped equity in several ways: I stronger productivity has meant that RULCs have fallen making goods and services cheaper and more affordable I employees on workplace agreements, have generally enjoyed bigger increases in their take-home pay than workers on the minimum wage, again making goods and services more affordable. (continued)

CHAPTER 7 Economic management using microeconomic policy 269 Table 7.11 (continued)

2. Trade The past 15 years, to 2007 in particular, have seen most tariffs abolished and free trade liberalisation extended. These changes have been important for equity in several ways: I freer trade has forced Australians to allocate resources more efficiently to areas of comparative cost advantage and away from industries where we have a cost disadvantage. This means that the same inputs can produce a bigger GDP leading to higher real incomes per person. I freer trade has meant much lower inflation for the period 1992 to 2007, than for the 1970s and 1980s. Many goods and services (e.g. clothing, appliances, cars) are now far cheaper and more affordable for ordinary households. It also means lower costs for local firms importing inputs and equipment, allowing them to enjoy better profits, improved competitiveness and stronger sales. Firms have expanded rather than closed down, again helping to lower structural unemployment that would otherwise undermine equity.

3. Tax reforms In general, the period 1999–2007 saw the introduction of significant reform involving lower tax rates on personal incomes, capital gains and company profits. This helped equity in several ways: I households are encouraged to work harder and end up with more disposable income. This increases their purchasing power and access to goods and services. I firms have larger after-tax profits. This encourages business expansion and investment, that creates even more jobs for the unemployed and higher incomes. Again, equity should benefit.

4. Competition Competition reforms have involved the ACCC, tightening of the Trade Practices Act, reforms increased prices surveillance, and the supervision of mergers and takeovers. This should help promote equity: I basic goods and services should be cheaper and more affordable if there is no price fixing and competition is fierce I businesses, buying inputs from other firms, find that their costs are lower if there is competition rather than if there is price collusion. This means better profits, the expansion of firms, reduced unemployment and, hence, higher real incomes.

5. Reforms to Savings reforms introduced between 1991 and 2007 have included the creation of many promote surplus budgets, the launch of the Future Fund, the introduction and expansion of a national compulsory superannuation scheme for employees and other incentives to encourage savings private superannuation. By promoting national savings and tending to increase the supply of credit in financial markets, interest rates (i.e. the cost of credit) have tended to be lower. This helps cut costs, increase profits and bring about business investment and expansion. If firms grow (and cause our GDP to expand) rather than close down, incomes will be higher and unemployment lower. This helps to improve equity.

6. Welfare Although welfare reforms have had some negative effects, the tightening of access to reforms government benefits and the extension of the idea that individuals must try very hard to be financially independent, may indirectly improve equity. For example: I unemployment benefits are only paid on condition that individuals are ‘actively looking for work’, working for the dole, or alternatively, are enrolled in education or training programs. Improving the skills of the unemployed should make them more employable and allow them, in the future, to gain better incomes. In addition, it helps to reduce welfare dependency that can sometimes lock them permanently into lower incomes. I the relaxation of rules relating to the amount of income that can be earned before welfare benefits are lost has allowed recipients to enjoy higher incomes. Again, it has also reduced the welfare trap that keeps some people on low incomes.

270 Economics Down Under Book 2 HAS MICROECONOMIC POLICY I Interestingly, part B of figure 7.10 shows that after taking inflation and rising costs of living into account over the eight PROMOTED EQUITY IN INCOME years to 2002–03 when microeconomic reform was in full swing, even the poorest quintile gained a greater than 10 per DISTRIBUTION? cent increase in their real purchasing power (relative to the You may recall that, although there is evidence of growing richest quintile with around 16 per cent). This should have income inequality between 1996 and 2005–06, it seems that the allowed low-income earners to access more goods and ser- poor (and rich) have never been richer, and general living stan- vices than previously and enjoy better material living dards have increased. However, it would be interesting to know standards. the extent to which microeconomic reform has brought about Of course, these observations may just be a coincidence, but this trend. Unfortunately, this is not easy to judge because there supporters of reform dismiss the suggestion. In addition, rela- are so many local and international events that could have tively recent microeconomic policies have been associated with played a role, other than government policies. All we can do significantly lower unemployment and inflation rates than previ- here is to look at a few of the possibilities. ously. Again these improved conditions are beneficial for equity.

Some strengths of microeconomic Some weaknesses of microeconomic policies policies To establish the success of microeconomic reforms in pro- It is difficult to hide from the observation that, especially in the moting equity, we would expect to see a rise in the sustainable short term, some aspects of microeconomic policy have not rate of economic growth leading to faster increases in average helped to promote equity. real GDP per head per year since the introduction of micro- The conflict with full employment and equity in the short term economic reforms. In addition, individuals should now have In the short to medium term, structural unemployment rose higher incomes (purchasing power) and the benefits shared following some microeconomic reforms. This tended to erode equitably so that all people can be better off materially (not just equity. For instance: the rich). These outcomes can be seen in parts A and B of I tariff cuts in the years up to 2005–06 caused business closures, figure 7.10. especially in manufacturing (e.g. in the textiles, clothing, auto- I As indicated in part A of figure 7.10, it is clear that real motive industries and footwear — Blundstone Boots, 2007) annual incomes and GDP per capita have grown much faster I there were staff cuts in the federal public sector designed to in the 14-year period since government microeconomic lift efficiency following corporatisation, privatisation and reforms accelerated, than in the 14 years prior to reforms. contracting out

Part A — Total % rise in real GDP or income per capita (% over the two, 14-year periods) before and after government microeconomic reforms

Total % rise 1992–93 to 2005–06 (at the peak of reforms) Total % rise 1979–80 to 1992–93 (largely before reforms) 0 20 40 60 80 100 120 Total % rise over the period

Part B — Comparison of rise in annual real equivalised disposable income by quintile — Australia, 1994–95 to 2002–03

Total real % rise in equivalise median disposable household income for the ‘highest’ quintile

Total real % rise in equivalise median disposable household income for the ‘lowest’ quintile 0 5 10 15 20 Total % rise in income over the period Figure 7.10 Indicators of improving equity in income distribution — Australia. Sources: Data derived from RBA Occasional Paper No. 8A; ABS, 1350.0 and 6523.0 for 2002–03.

CHAPTER 7 Economic management using microeconomic policy 271 I productivity-based workplace agreements (i.e. where higher items may now be cheaper due to microeconomic reforms. wages were traded for improved worker efficiency) allowed Unemployment also causes households to run down their stock some firms to downsize their staff numbers of assets or wealth (e.g. sell their house or car, run up debts), fur- I industry restructuring was undertaken by most firms to cut ther cutting living standards for the unemployed relative to costs (e.g. in banking, there was the closure of less efficient those with jobs. The main hope in the long run is that micro- branches and cuts to staff levels) economic reforms will create more jobs in Australian industry I many markets were deregulated to strengthen competition through increased international competitiveness. and reduce production costs, including labour. This caused some firms (e.g. Ansett Airlines, 2002) to close, leading to Increasing wage differences in society unemployment and reduced incomes. A number of microeconomic policies tended to increase income inequality: I The extension of workplace agreements has meant that some workers are now in a relatively weaker position when negoti- ating pay rises. For example, wage rates among females, the unskilled and poorly educated, part-time workers, some non- English speaking workers, employees in firms where productivity is low and the wages of workers where union membership is low, have often fallen behind those received by skilled, unionised, articulate, efficient, full-time workers in profitable businesses. I Tariff cuts and stronger competition have squeezed profits and wages in some manufacturing industries, relative to others. I For some families, the restructuring of private firms and the public sector has meant cutting staff, increasing structural unemployment and diminishing incomes. I In recent years, general pay rates for staff on workplace agreements have risen faster than those on minimum wages. This has increased inequality in the distribution of income. I The tax system has become less steeply progressive due to cuts in rates of capital gains, company and PAYG taxes. These When there is a rise in structural unemployment, there is usually a changes have benefited the rich more than the poor. dramatic cut in incomes for workers who are forced to survive on meagre welfare benefits. In turn, basic goods and services become even less affordable, despite the fact that some of these TRY SHORT ANSWER EXERCISE 6, p. 279

272 Economics Down Under Book 2 school assessment tasks

7.8 School Assessed Coursework

As mentioned previously, there are two SACs to be completed To help prepare you for the end-of-the-year examination and for VCE Economics Unit 4, one for each of the two outcomes. to provide some guidance for SAC 2, several sample tasks have

You will recall that SAC 1 covered macroeconomic policy. been included in this section of your text. For instance, chapter 7 and learning activities However, SAC 2 will cover microeconomic policy (chapter 7) (about microeconomic reform policy) contains: and the government’s current policy mix (chapter 8). With I multiple-choice test items this in mind, you are advised to wait until you have covered I short-answer test questions the ﬁnal chapter of this text (chapter 8) before tackling this I an essay question last SAC for the year. This ﬁnal task could involve one of the I some possible questions relevant for completing a written following: report I an essay I a problem-solving exercise. I a written report Finally, this section of your text also contains a wide range of I a problem-solving exercise other learning activities (e.g. web quests, debates, concept maps, I a test with multiple-choice and short-answer questions quiz, etc.), to help make learning more effective, interesting I an evaluation of print and/or electronic media. and relevant.

MULTIPLE-CHOICE test questions

Instructions: You may like to complete the following questions. (A, B, C, D) that represents the most appropriate answer for Using the multiple-choice answer grid below, select the letter each question by marking this with a tick ().

Answer grid

QUESTION 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

A B C D

QUESTION 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Question 1 A Australia’s material living standards were falling relative to The immediate and main priority of microeconomic policy is those of many other comparable countries and there was a most probably: severe problem with the CAD A full employment B Australia had a slower rate of economic growth than some B increased equity countries caused by severe supply-side constraints on rises in C efﬁciency in resource allocation and more rapid and sustain- productive capacity able rates of economic growth C Australia’s productivity was very poor and cost inﬂation was D external stability and equity. common D all of the above were applicable. Question 2 In the 1980s and early 1990s, microeconomic reform was des- Question 3 perately needed because: Concerning recent changes in tariffs, which statement is correct?

CHAPTER 7 Economic management using microeconomic policy 273 A Australia’s general rate of tariffs is lower than most com- Question 9 parable Western nations but higher than most in Asia. Microeconomic reform is believed to encourage more rapid, B By 1996, Australia’s general tariff rate was only 5 per cent long-term economic and employment growth by: and has since been further reduced. A stimulating sales of Australian-made goods and services by C Tariffs on imported cars into Australia fell to zero by 2006. making them more competitively priced in domestic and D Australia is yet to create a free trade zone with New Zealand. foreign markets B boosting the productive capacity of our resources through Question 4 allocating them more effectively and using them to produce Which statement about microeconomic policy in Australia is more output with fewer inputs incorrect? C enabling firms to access cheaper inputs, thereby raising busi- A Import quotas still exist for the TCF and car industries. ness profitability and supply B Reforms of the public sector to increase efficiency in govern- D all of the above. ment include council amalgamation, contracting out and competitive tendering. Question 10 C The operations of the ACCC help to increase price compe- The most likely way that recent microeconomic reform should tition in various markets. help to promote improved external stability in Australia is D The National Competition Policy seeks to accelerate the through: pace and degree of microeconomic reform by state govern- A restrictions on imports ments. B controls on foreign borrowing C cuts in production costs which improve domestic and Question 5 external competitiveness of local firms In order to promote greater efficiency in the government’s D all of the above. delivery of goods and services to the community, federal microeconomic reform has not involved: Question 11 A the introduction of a scheme to boost and revitalise govern- Microeconomic policy designed to improve efficiency in resource ment business enterprises by massive capital spending to allocation is unlikely to include the following constraint. upgrade productive capacity A Increases in unemployment, especially in the short term B subjecting government business enterprises to prices surveil- B Reduced equity in the short term lance and the payment of taxation like private corporations C An adverse impact on the rate of economic growth (competitive neutrality) D Unpopularity among the voting public in some electorates C collaboration with state governments to reduce service duplication and to encourage the creation of national Question 12 markets for some services such as power Especially between 1994 and 1999, Australian statistics show that: D the commercialisation and corporatisation of many A labour, capital and multi-factor productivity were stronger remaining government businesses that have not been priva- than in the 1980s or early 1990s tised. B industrial unrest has increased, slowing productivity C labour productivity has generally fallen but capital prod- Question 6 uctivity has risen Which statement is false? The federal government has moved to D productivity levels have remained fairly constant since the increase national savings by: early 1980s. A the delivery of a ‘fiscal balance’ over the economic cycle B the establishment of the Future Fund Question 13 C the abolition of all taxes on superannuation contributions The reasons for believing that microeconomic reforms may D the progressive extension of compulsory superannuation have been effective since the early 1990s include: contributions by employers on behalf of their employees. A fairly low inflation and even falling costs for some goods and services Question 7 B the attainment of fairly rapid economic growth without an Currently, which Australian market is probably the least competi- inflationary breakout tive and least deregulated market in Australia? C an increase in GDP per head per year A The labour market D all of the above. and learning activities B The market for TCF C The capital market Question 14 D Primary industry markets The main constraint of recent microeconomic policy in Australia is: Question 8 A large time lags in implementation and impact of policy Microeconomic reform mostly slows inflation by: B rising cyclical unemployment generated by the reforms A slowing AD and the pressures created by expenditure C short-term inflationary consequences arising out of struc- B reducing imported inflation tural change C easing cost pressures on prices through greater efficiency D the financial constraints for government arising out of D reducing inflationary expectations. privatisation.

274 Economics Down Under Book 2 school assessment tasks school assessment tasks

Question 15 Question 20 Reform of Australia’s labour market during the 1990s and 2000s In general, the spread of enterprise agreements until 2007 as has involved which combination of the following? part of labour market reforms, may be expected to lead to (i) A reduction in the number of allowable matters covered increased income inequality because of: in federal awards covering pay and conditions of work A the reduced role of trade unions in representing otherwise (ii) The splitting up of large unions into smaller ones with less fairly powerless individual workers power B the unequal bargaining strength of different types of (iii) Making the AFPC (previously AIRC) less important in the workers in different ﬁrms, combined with unemployment regulation and supervision of wages and working con- rates in excess of 7 per cent ditions C both (A) and (B) above

(iv) The encouragement of workplace or enterprise agree- D the removal of minimum legal wages and protection offered and learning activities ments on a firm-by-firm basis against unfair dismissal. (v) Retention of minimum wages as a ‘safety net’ A Answers (i), (ii), (iii), (iv) and (v) Question 21 B Answers (i), (iii) and (v) A constraint in using higher tariffs is: C Answers (i), (iii), (iv) and (v) A they are politically difficult to remove D Answer (v) B they are a handicap for other import-competing and export businesses which use foreign goods in their production Question 16 process The main aim of labour market reform has been the promotion C they weaken competition and domestic efficiency, misallo- of: cate resources into areas of non-comparative cost advantage A external stability and efficiency in resource allocation and cause higher demand and cost inflation B price stability and improved equity D all of the above. C full employment in the short term D political popularity for the federal government. Question 22 Which of the following is not a constraint of tariff cuts and Question 17 reduced industry protection? Which of the following is not normally seen as an advantage of A Adverse political consequences are likely in some regions of workplace or enterprise agreements? the country. A Uniformity in wages and conditions B Increased bankruptcy levels are likely, due to import pen- B Improved flexibility in staffing and cost cutting by firms etration. C The maintenance of minimum safety net wages for low C Other nations will retaliate and raise their tariffs on our income earners exports. D An emphasis on productivity-based pay rises to help avoid D Income inequality will probably worsen for some individuals. inflation Question 23 Question 18 Which of the following is not a general constraint of reducing The extension of workplace agreements during the 1990s and tariffs? 2000s is expected to improve price stability and external stability A Cyclical unemployment rises. by: B Long time lags are needed to implement the cuts and to see A lifting worker productivity by offering more incentive for the resulting benefits. hard work C The CAD generally gets worse before it improves. B promoting greater competition among workers in the labour D Government revenue falls, creating a financial limitation. market so that wages more closely reflect the market value of what is being produced by each employee Question 24 C reducing the central role previously taken by unions in wage Reforms promoting freer international trade will tend to direct negotiations more resources into areas of comparative cost advantage. This D all of the above. necessarily means that: A surviving industries can produce more cheaply than any Question 19 other producer in the world Which of the following has not been a significant constraint of B resources should move into areas where, relatively, there is recent labour market deregulation? the least cost disadvantage in production A The limited coverage of firms and workers in Australia by C there will be full employment enterprise agreements D there will be price and external stability. B The time taken to successfully complete wage negotiations on a firm-by-firm basis Question 25 C The political constraint until 2005, due to a lack of numbers Which of the following reforms is likely to help promote fuller in the Upper House to pass federal legislation employment in the long term? D Opposition to reform caused by the strong growth in union- A The signing of bilateral and multilateral trade agreements isation of Australia’s labour force which raise exports

CHAPTER 7 Economic management using microeconomic policy 275 B The increased discouragement of foreign investment and A Microeconomic policy seeks to lift efficiency, cut costs and takeovers of local companies expand AS, while macroeconomic policy is about regulating C Cutting R&D grants and tax concessions the growth in AD. D Abolishing import quotas and subsidies B Microeconomic policy helps affect the long-term capacity or speed limit for economic growth whereas macroeconomic Question 26 policy helps affect the extent to which a nation’s productive Regarding the impact of microeconomic reforms involving the capacity is utilised. external sector, which statement is false ? C Both (A) and (B) are correct. A Reduced tariffs tend to redistribute incomes away from D Neither (A) nor (B) are correct. importers. B Trade agreements may lift the income share of exporters. Question 29 C The existence of tariffs can cause some basic goods and ser- In relation to financial reforms, which statement is false ? vices to be less affordable for low income families. A The supervision of financial sector liquidity needed for cus- D Bounties paid to local producers redistribute income in tomer confidence and stability is now the responsibility of their favour, typically at the expense of taxpaying individuals APRA. and companies. B The Wallis Inquiry recommended a substantial deregulation Question 27 of the financial sector. C Licences were extended to allow some building societies to Which of the following statements about the Workplace Relations Act is generally false ? become banks in an attempt to increase competition. A It makes some strikes illegal, along with secondary boycotts. D Reforms have not meant efficiency rises and lower real B It makes all employee dismissals fair, no matter what the interest rates. circumstances. C It reduces the roles of the AFPC and unions and establishes Question 30 an Employment Advocate to help improve fairness and settle A microeconomic policy solution to the worry of high structural disputes. unemployment which is currently running at perhaps 5–6 per D It restates the principle of voluntary unionism and makes cent of Australia’s labour force is: closed shops illegal. A expansionary monetary measures B budgetary tax cuts and increased government outlays Question 28 C government strategies that increase AD Concerning microeconomic as compared with macroeconomic D cost-cutting, productivity-promoting measures that increase policy, which statement is correct? Australia’s competitiveness.

STRUCTURED SHORT-ANSWER test questions

Instructions: You may like to try a selection of the following Question 2 structured short-answer questions. These questions may enable A Concerning the policy of trade liberalisation: students to practise in readiness for the end-of-year examin- (a) Explain what is meant by the policy of free trade, outlining ation. the extent to which it has currently been adopted by the Australian Government. (6 marks) Question 1 (b) Identify and explain one strength and one weakness of A What is meant by microeconomic reform or policy? (2 marks) pursuing this policy. (2 + 2 = 4 marks) B Distinguish between the following types of efficiency: B Concerning deregulation and other reforms of the labour market: (a) Allocative efficiency and technical (productive) (a) Define what is meant by labour market deregulation, giving efficiency. (2 marks) specific examples of reforms. (4 marks) (b) Intertemporal efficiency and dynamic efficiency. (b) In what ways are enterprise or workplace agreements dif- (2 marks) ferent from the traditional minimum wage system? and learning activities C What do you consider to be the three most important objec- (6 marks) tives of microeconomic policy? (3 marks) (c) List and outline two important strengths and two weaknesses D In general terms, explain how microeconomic policy might of labour market deregulation in Australia during the affect any three of the following: 1990s and 2000s. (4 marks) (a) economic growth C Concerning reforms to promote national savings: (b) inflation (a) Explain what national savings means. (2 marks) (c) unemployment (b) Outline two reasons why is it important to lift the level of (d) the CAD saving in Australia. (4 marks) (e) efficiency in resource allocation (c) Suggest three specific ways this has been encouraged by (f) the distribution of income. (2 + 2 + 2 = 6 marks) government microeconomic reform. (3 marks)

276 Economics Down Under Book 2 school assessment tasks school assessment tasks

D Concerning reforms to the public sector: (d) the abolition of tariffs. (4 + 4 = 8 marks) (a) What is the difference between privatisation and corpora- F Outline one weakness of microeconomic reforms aimed at tisation? (2 marks) increasing the sustainable rate of economic growth. (b) Why can privatisation lead to greater efficiency in the (4 marks) operation of a business? (3 marks) G In general terms, how might the creation of a more efficient and competitive economy using microeconomic reform, Question 3 eventually help to lower unemployment? A In general terms, how does microeconomic reform help to H Explain how any two of the following microeconomic lower inflation? (4 marks) reforms might affect the rate of unemployment: B Explain how any three of the following microeconomic reforms (a) the exemption of small firms employing fewer than 100

introduced during the 1990s and 2000s, may help to lower staff from unfair dismissal laws and learning activities Australia’s inflation and promote price stability: (b) trade liberalisation including the signing of FTAs with (a) the move towards free trade with lower subsidies and China and Japan tariffs (c) the future privatisation of Medibank Private, the ABC (b) labour market reform including the encouragement of and the Snowy Mountains Hydro Scheme enterprise or workplace bargaining (d) a reduction in the rate of company tax from 30 to 20 per (c) reform of the public sector cent (d) tightening of the TPA and broadening of prices surveil- (e) the abolition of the minimum wage system lance by the ACCC (f) a reduction in welfare assistance paid to the unemployed (e) tax reform (g) a rise in the minimum age for receiving the pension to (f) the promotion of national savings 70 years (g) deregulation of the financial sector and transport (h) welfare and other reforms to increase the participation reform. (2 + 2 + 2 = 6 marks) rate. (4 + 4 = 8 marks) C Giving an example, identify one important constraint on the I Apart from microeconomic reform, suggest one other effectiveness of microeconomic policy, when it is used to slow category of government policy used to help lower Australia’s inflation. (4 marks) unemployment rate. (4 marks) D ‘Between 1992 and 2006, Australia enjoyed more rapid econ- Examine figure 7.11 showing trends in Australia’s unemploy- omic growth than during the 1970s and 1980s. There were ment rate between 1992–93 and 2005–06. also much lower rates of inflation and unemployment.’ In In April 2007, the unemployment rate reached a 32 year low general terms, explain how microeconomic reform can help of only 4.4 per cent. Suggest and explain two important to achieve all three aspects of domestic stability simul- microeconomic reforms that could help to lower this rate taneously. Illustrate this on a fully labelled AD–AS diagram, even more. (4 marks) showing the ‘before’ and ‘after’ effects of microeconomic J Examine figure 7.12 (p. 278) showing trends in Australia’s reforms. (6 marks) employment by industry. E Selecting two reforms from the list below, explain how each (a) Identify and explain two important government micro- microeconomic policy can be used to help increase Aus- economic policies that could account for the trend in tralia’s sustainable rate of economic growth? ‘manufacturing’ employment between 1997 and 2006. (a) tax reform (4 marks) (b) workplace agreements (b) How would you expect these employment trends to alter (c) competition reforms Australia’s distribution of income? (2 marks)

4 % unemployed 2

0 2000–01 1992–93 1993–94 1994–95 1995–96 1996–97 1997–98 1998–99 2001–02 2002–03 2003–04 2004–05 2005–06 2006–07 2007–08 2008–09 1999–2000 Figure 7.11 Australia’s unemployment rate (percentage of labour force) Source: Data derived from ABS 1350.0.

CHAPTER 7 Economic management using microeconomic policy 277 Property and (b) reduced industry subsidies business services (c) tax reform involving further reductions in personal, Construction capital gains and company tax rates (d) further privatisation and corporatisation of government Retail trade business enterprises Health and (e) banking deregulation community services (f) the extension of enterprise or workplace agreements Education and other labour market reforms Government (g) further reforms to increase national savings administration and defence C Giving an Australian example, outline one constraint or weakness of using microeconomic reforms to improve Transport and storage external stability. (2 marks) Accommodation and cafes etc. Question 5 Finance and insurance A Define clearly what is meant by an efficient allocation of resources. (2 marks) Personal and other B Identify the two types of statistical evidence that you would Mining use to confirm whether or not there has been an improve- ment in Australia’s efficiency in resource allocation in recent Cultural and recreation times. (2 marks) C From the following list, select and explain one important Communication services microeconomic reform that has helped to improve allocative efficiency and one reform that has helped to improve inter- Electricity, gas and water temporal efficiency: Manufacturing (a) relaxation of unfair dismissal laws (b) tariff cuts and trade liberalisation Wholesale trade (c) welfare reforms Agriculture, forestry (d) deregulation of the financial market and fishing (e) deregulation of domestic and international aviation –100 0 100 200 300 400 carriers Figure 7.12 Change in Australia’s employment (f) savings reforms numbers by industry — 1997–2006 (g) tax reforms. (4 + 4 = 8 marks) Source: Data derived from ABS 1350.0. D Explain how the Workplace Relations Act (1996) and or the more recent Work Choices Act (2005) might help to increase Question 4 labour efficiency. (3 marks) A Outline how two structural problems currently help to cause E Explain two constraints of microeconomic policy that is Australia’s large CAD:GDP ratio and NFD. (4 marks) designed to increase efficiency in resource allocation. B By 2005–06, Australia’s CAD equalled $54.4 billion, while the (4 marks) NFD had grown to $494 billion. Faced with this sort of F Examine table 7.12 showing annual average changes in external problem, select any three of the following govern- productivity across selected Australian industries, 1998–2004. ment microeconomic reforms and outline how each might (a) How is productivity generally measured? (2 marks) improve Australia’s external stability. (2 + 2 = 4 marks) (b) Suggest two likely reasons why productivity grew strongly, (a) tariff cuts and the signing of additional FTAs with China especially in areas like manufacturing, and agriculture, and Japan forestry and fishing. (4 marks)

Table 7.12 Annual rates of productivity change in selected Australian industries

PRODUCTIVITY, PRODUCTIVITY, 1998–99 TO 1998–99 TO

and learning activities INDUSTRY 2003–04 INDUSTRY 2003–04

Agriculture, forestry and ﬁshing 4.8 Health and community services 1.7 Manufacturing 4.1 Cultural and recreational services 1.6 Wholesale 3.9 Accommodation, cafes and restaurants 1.3 Transport and storage 3.4 Construction 0.6 Finance and insurance 3.0 Mining –0.6 Total change overall 2.0 Electricity, gas and water –2.4

Source: Data estimated from ABS, 5204.0.

278 Economics Down Under Book 2 school assessment tasks school assessment tasks

Question 6 (f) the further encouragement of enterprise or workplace A In general terms, outline three important ways whereby bargaining microeconomic reform can promote a more equitable distri- (g) further tightening of welfare eligibility bution of income. (6 marks) (h) an extension of superannuation by a rise in the levy on B Explain how any three of the following microeconomic poli- employers, from 9 to 15 per cent of a worker’s wage. cies may affect the degree of equity in the distribution of (2 + 2 + 2 = 6 marks) income: C ‘Microeconomic reform may increase economic efﬁciency, (a) the move towards a user-pays principle in the provision but this is at the expense of equity.’ Discuss this statement. of government services and social infrastructure (4 marks) (b) complete privatisation of Telstra (2006) D Explain how budgetary policy can compliment or support

(c) toughening of the Trade Practices Act microeconomic reform in increasing equity in the distri- and learning activities (d) further tariff cuts in the TCF and car industries bution of goods, services and incomes. (6 marks) (e) reducing rates of personal, company and capital gains E Quoting speciﬁc policy examples, explain how microeco- taxes nomic reforms may help to achieve better material living standards for Australian citizens. (4 marks) A PROBLEM-SOLVING exercise

A possible task for Unit 4, SAC 2 is a problem-solving exercise. B In general terms, how could microeconomic policy help to The following may provide you with practice for this type of correct the economic problems experienced by Atlantis, question. 2000–2009? Imagine that you have been appointed to the position of C Select any three of the following microeconomic reforms. For Head of the Economic Task Force set up to advise the govern- each policy, outline the changes that should be made to help ment of Atlantis about microeconomic reform. This action was correct Atlantis’s economic problems. prompted by the fact that economic conditions had deteri- (a) Labour market reform orated seriously over the ten years to 2009. Table 7.13 summar- (b) Promotion of national saving ises the dire economic problems faced by Atlantis. (c) Promoting stiffer competition A Using the following headings, briefly outline the economic (d) Shift away from industry protection towards freer conditions that had developed in Atlantis between 2000 and trade 2009. (e) Reform of the public sector (a) Domestic conditions (f) Reforms implemented by firms in the private sector (b) External conditions following the government’s move towards freer trade (c) Efficiency levels in resource allocation (g) Tax reform (d) Equity conditions D Outline two constraints or weaknesses of applying the policies you selected for your answer to part C above. Table 7.13 Economic indicators for Atlantis — 1990–99 to 2000–2009

ECONOMIC INDICATOR FOR ATLANTIS 1990–1999 2000–2009

(1) Annual average growth in GDP per capita (%) 3.1 0.2 (2) International ranking for GDP per capita ($ per year) 3rd 15th (3) Unemployment rate (% labour force) 5.8 7.1 (4) Productivity growth (% GDP per hour worked) 2.4 −0.5 (5) Inflation (%) 2.2 5.7 (6) RULCs (% per year) 0.2 4.8 (7) CAD:GDP ratio (%) 2.9 5.5 (8) Domestic interest rates (% on business overdrafts) 4.5 8.4 (9) NFD:GDP ratio (%) 20 55 (10) Gini coefficient for final income distribution 0.3 0.4 (11) General tariff rate (%) 3 9 (12) Company tax rate (% profits) 30 40 (13) Number of working days lost per year per 100 employees through 10 190 strikes (14) Household savings (% of income) 10 1 (15) Level of business concentration in ownership by industry low high (16) Size of government sector 20 30 (percentage of GDP)

CHAPTER 7 Economic management using microeconomic policy 279 OTHER learning activities

Have you tried the following learning activities in your class I the car industry recently? I the TCF industry I the power industry 1. Web Quest I social welfare reform Visit the website for this book and click on the Weblinks for I tax reform this chapter (see Weblinks, page 310). I tariff cuts Use the Internet for researching some of the following: I reform of government – projects of the Productivity Commission I banking deregulation – the AFPC decisions about rises in award wages I labour market reform. – the ACTU’s campaigns over pay and conditions – the ACCC’s investigations into companies 4. Newspaper reports – the Ofﬁce of Employment Advocate, and Workplace Rela- Photocopy a newspaper report about a recent change in tions and Small Business microeconomic policy or use the Internet for research. Stu- – government tax reform dents could then summarise the report, possibly identify – current debates in federal parliament or statements by the bias, or expand on what has been said in the article. Prime Minister – wider aspects of microeconomic reform in Australia 5. Role play reported in Australian newspapers (e.g. magazines using The government announced that it would again review various search engines. tariffs applying to some areas of Australian manufacturing. As always, teachers are strongly advised to check all website Set up a mock meeting between the government and rep- addresses listed in this text for suitability, appropriateness of resentatives from the ACTU, the Industry Commission, the content, operation and accuracy, before asking students to Employer’s Federation and a consumer group lobby. Each conduct research. group is given a chance to put their case about future tariff cuts for the TCF and automotive industries. 2. Class debate Select one of the following topics or create your own: 6. Crosswords I ‘That in the 1990s and 2000s, Australia’s microeconomic Construct a crossword using terminology and knowledge policy has brought more pain than gain.’ about recent microeconomic policy. Use the Internet for I ‘That microeconomic reform faces so many constraints as access to software that makes this task easy. to make it ineffective.’ I ‘That labour market reforms are exactly what the doctor 7. Team quiz ordered for improving our economic performance.’ Divide the class into teams. When it is their turn to answer questions about microeconomic policy (that the teacher and 3. Data show or video or students have previously written), team members can act Students could be asked to use either a video camera to as a brains trust before the ﬁnal answer is given. Perhaps the make a 3–4 minute documentary OR a computer to create a winning team could be awarded a prize. A variation of this is PowerPoint presentation about one of the following aspects the Economics Wheel of Fortune using numbered questions and of recent microeconomic reform: token prizes. and learning activities

280 Economics Down Under Book 2 school assessment tasks summary

Summary chapter 7

What is microeconomic policy? Using microeconomic policy to promote external stability Microeconomic policy involves a range of supply-side efficiency Theoretically, microeconomic policy (e.g. the promotion of reforms designed to improve the way particular firms, industries, national savings, competition reforms, reform of the govern- markets and sectors of the Australian economy are structured ment sector, tax reform, labour market reforms, competition and operate. Specific measures include tariff cuts and trade lib- policy) can make an important contribution to external stability and a eralisation, competition-promoting strategies, labour market lower structural CAD. The main approach is by strengthening a reforms including the encouragement of workplace agreements, nation’s international competitiveness in domestic and external banking reform, transport reform, telecommunication reform, markets for goods, services and money capital through cost- reform of government businesses and operations, welfare cutting and efficiency reforms. Recent policy has probably changes, tax reform and promoting national savings. helped to do this, but the high CAD:GDP ratio is still a periodic or cyclical worry. Constraints have limited its effectiveness The aims of microeconomic policy including time lags in implementation, unfavourable external The key aims of microeconomic policy are probably domestic econ- events, the conflict that exists between some government omic stability (i.e. especially stronger economic growth and objectives, the adverse short-term impact of trade liberalisation, price stability), external competitiveness and stability and political obstacles and institutional constraints. increased efficiency in the allocation of resources. Unfortu- nately, equity in the distribution of income and wealth often Using microeconomic policy to promote efficiency in suffers in the short term following the implementation of resource allocation microeconomic policy. However, in the long term, rising pro- Theoretically, microeconomic policy (e.g. industry reforms, duction and real incomes resulting from reform, are beneficial, labour market deregulation, deregulation of the financial providing that these gains are redistributed equitably using sector, and the promotion of fiercer competition through lower budgetary policy (e.g. provision of welfare benefits and afford- tariffs and the ACCC) is extremely well suited to increasing allocative, able community services, paid for out of progressive taxes). dynamic, intertemporal and productive efficiency in resource allocation. Certainly, recent productivity has been at high levels (especially Using microeconomic policy to promote domestic economic in the 1995–2004 cycle), well above those in the 1980s and early stability 1990s. However, there are factors limiting policy effectiveness Theoretically, microeconomic policy can promote improved domestic including institutional constraints, time lags, overseas events stability by means of efficiency measures designed to slow cost and adverse political considerations. inflation and increase national output from the same inputs, Using microeconomic policy to promote equity in improve competitiveness and, in the long term, increase income distribution employment. Measures here could include: Theoretically, microeconomic reform is likely to weaken equity in the dis- – labour market reforms tribution of income and wealth, in the short term, although there are con- – promoting national savings siderable longer-term gains for equity arising from the impact of greater – trade liberalisation efficiency on real production and national income. This extra pro- – tax reforms duction and income then become available (through taxation) – deregulation of financial and other markets for redistribution and support of the needy (perhaps using – reform of the public sector. various budgetary policies like progressive taxes, welfare and Unfortunately, in the short term, there may be an increase cheap services). In addition, equity is promoted through lower in structural unemployment following microeconomic inflation, cheaper and more affordable goods and services and reform. Between 1992 and 2007, recent policy has contrib- increased employment resulting from increased industry uted to better price stability, economic growth and, perhaps competitiveness. nowadays, to falling unemployment. However, there are However, constraints operate to limit the effectiveness of micr- constraints including long implementation lags, conflict oeconomic reform. These constraints include conflict between between the objectives of policy, political obstacles and some government objectives, political constraints, long time lags institutional constraints. in implementation and impact and financial considerations.

CHAPTER 7 Economic management using microeconomic policy 281 using microeconomic policy

Microeconomic policy Government reforms that increase structural efficiency and lower production costs so that more output can be gained from the same inputs of resources. These supply-side structural reforms increase AS and productive capacity.

1. Aims of microeconomic policy: Recent measures have emphasised the following objectives — Domestic stability by promoting greater output (GDP) from the same inputs and by cutting cost inflation — External stability (by promoting greater international competitiveness among local firms) — Efficiency in resource allocation by promoting greater technical, allocative, dynamic and inter-temporal efficiency — Better equity by reducing costs and prices, increasing GDP and incomes per head per year, government tax revenues and provision of welfare and services.

2. Instruments/aspects of microeconomic policy: Efficiency reforms include — Deregulation of the labour, capital and other markets by reducing government controls and increasing competition — Tax reforms that cut tax rates — Reform of the public sector (e.g. privatisation, corporatisation) — Promotion of stiffer competition — Encouragement of higher savings — Trade liberalisation.

3. Using microeconomic policy to promote internal/domestic economic stability: — Microeconomic reforms (e.g. deregulation of the labour market) are very effective in increasing economic growth by lifting the economy’s productive capacity (more output from the same inputs) and AS — Reforms (e.g. tax cuts, lower tariffs, promotion of competition) also help lower cost inflation by increases in efficiency and by strengthening the level of competition in the market.

4. Using microeconomic policy to promote external stability: — Microeconomic reforms (e.g. tariff cuts, tax reforms, government deregulation of various markets) are very effective in increasing the international competitiveness of local producers (in terms of price and quality) of goods and services relative to overseas firms. This helps increase exports relative to imports — Reforms that increase national savings (e.g. encouragement of superannuation by tax incentives, acceptance of fiscal balance) can help lower our reliance on foreign borrowing that adds to our CAD/NFD and weakens the exchange rate.

5. Using microeconomic policy to promote efficiency in resource allocation: — Microeconomic reform policies are most effective in lifting efficiency in resource allocation (i.e. they strengthen allocative, technical, inter-temporal and dynamic efficiency) — Here we think of the effects of tariff cuts, lowering of rates of personal, capital gains and company tax, tighter welfare access, stiffening of competition-promoting measures, reform of the public sector measures to promote savings and labour market reforms.

6. Using microeconomic policy to promote a more equitable distribution of personal income: — Microeconomic reforms are less effective and direct in the short-term in promoting greater equity in income distribution than, say, budgetary policy — Even so, microeconomic reforms are very effective in the long-term in lifting the volume of goods and services produced and general income levels. They also lower the cost or price of basic goods and make welfare and government services more affordable thus promoting equity.

282 Economics Down Under Book 2