Economic Reform-Policy Mix Essay, Research Paper
Question:
What role do governments have in modern mixed economies such as Australia? Using appropriate indicators (macro economic aggregates) outline the present state of the economy. In what ways is the Commonwealth government using fiscal and monetary policies to influence the Australian economy? What are the main features of the government’s micro economic policy? Why is the government concerned about microeconomic reform?
Synopsis:
The role of government in Australia today has less influence on the market than they did a decade ago. It function now is to provide a stable internal and external balance under which the market can function. This is achieved through the use of fiscal, monetary and microeconomic reform.
Australia currently operates under a mixed economic system. This means that the government has partial control over the economy and has the ability to influence the markets. Recent moves by the government that shows the government’s role in the economy to be shrinking includes the privatisation of government business enterprises (GBE) and deregulation of the financial market. The main roles that the Australian government plays today are to ensure:
1) The efficient and even distribution of income (though CSSB, tax)
2) Provide a limited range of goods and services (Aust post)
3) General economic management through macro and micro economic policies.
In 96/97 the CAD fell to $20.9bn from the $27bn blowout during 95/96. This was largely due to a fall in domestic spending which lead to a slight rise in national savings. Inflation remained low and fell between the RBA’s 2-3% target. This gave way to the RBA’s 3 consecutive drops in interest rates to stimulate the economy. Economic growth has stabilised between 3-4%. Although this is a reasonable figure, a higher growth rate is required if unemployment is to fall from the 8.6% is has averaged for the past year. Overall economic performance has been reasonable but current figures show the problems with our external balance and unemployment will not be solved any time soon.
Fiscal policy is the government’s use of the Budget to achieve its economic management goals. This is done through revenue collection and government spending. In recent years there has been a shift away from the Keynesian view that fiscal policy is used to stabilise short-term fluctuations in demand. This refers to a contractionary stance during a boom period to dampen economy and an expansionary stance during a bust period to stimulate the economy. Current fiscal policies are aimed at the medium and long-term goals of resource allocation, income distribution and external balance. This is because fiscal policy is relatively inflexible and is adjusted on an annual basis.
One of the government’s objectives in using fiscal policy is to reduce the Public Sector Borrowing Requirement (PSBR). To do this the government has had a $3.9bn cut in discretionary spending during the 96/97 budget. This cut may be the first of several in a bid to achieve a budget surplus. One reason behind this goal is to maintain external stability. For the past decade (except for the late 80’s boom) the public debt has been on a continual rise. This was largely due to a succession of budget deficits. The result of this was a large increase in net income as a component of the current account, which in turn became a burden on the next budget. A surplus budget can be used to pay of the public debt thereby easing interest obligations.
At the same time a reduction in the deficit will increase national savings. By reducing the deficit, the government does not need as much national savings in order to finance the budget. This will leave a larger pool of savings to fund investment. Although a contractionary fiscal stance will increase public saving, they may decrease private savings. Cuts in government spending to programs aimed at increasing private savings (such as Austudy) have meant that the private sector must cover the costs, forgoing saving opportunities. This will mean a lower level of private savings but not enough to offset the increase in public saving. On the whole national saving increases.
Due to the multiplier effect, a reduction in government spending will impact the level of economic activity. The recent cut in government spending has dampened aggregate demand. This in turn produced low levels of inflation and economic growth.
By reducing the amount of government participation in the market, it hopes to achieve the ‘crowding in’ effect. This means that the private sector will invest in functions that the government once provided (CES facilities).
Monetary policy is the raising or lowering of interest rates to dampen or stimulate the economy. It is concerned with internal balance (ie. economic activity, employment and price stability). Unlike fiscal policy, monetary policies influence the economy indirectly through changes in financial conditions. This follows the belief that the level of financial activity plays a major role in determining the level of economic activity. The main indicator of monetary policy stance is the level of short-term interest rates.
The government is currently using monetary policy to boost the level of economic activity. By easing interest rates the private sector will be more inclined to borrow money for investment. Small businesses will expand and this should lead to an increase in employment opportunities and a decreasing unemployment rate. A fall in interest rates will also increase the level of spending in the economy. This is due to the increase in the availability of credit. A boost in spending increases aggregate demand followed by an increase in retail sales but will also fuel inflation.
Interest rate drops in the latter half of the year has not had much effect on the economy. Economic growth slowed to 3%, investment dell from 17% to 10% between 94/95 and 95/96, profit growth fell from 16% to 3%, unemployment rose from 8.4% to 8.8%, the growth of retail sales has slowed and both business sentiment and consumer confidence has fallen. This poor performance may be attributed to the reduction of government spending during the 96/97 budget. Only inflation managed to drop to the RBA’s target of 2-3% underlying inflation. New figures released in early March 97 show an increase in retail sales and economic activity. This may be a response to the drop in interest rates from the previous year.
Microeconomic reforms (MER) are initiatives taken by the government to improve resource allocation and efficiency. By doing so they improve productivity, international competitiveness, economic efficiency and long-run economic growth. A growing economy provides an environment in which the success of MER is high. The government uses macroeconomic policies to provide this type of environment. There are three main objectives to MER, they are:
1) To raise the supply potential of the economy. This will lead to higher economic growth, domestic demand and living standards.
2) Reduction in interference with price signals in the labour and product markets to enhance economic efficiency, competition and lower inflationary pressures.
3) To facilitate the stabilisation of external debt and to reduce the demand for domestic savings without lowering living standards.
The government currently aims to internationalise the domestic economy. Their aim is to promote greater competition by exposing businesses to the international market and to encourage innovation and flexibility.
Tariff reforms are a part of this process. These programs are to reduce protection to industries that are deemed inefficient and to allocate funds to other causes. The Garnaut Report released in 1989 proposed that all tariffs should be gradually eliminated. This will allow enterprises to take advantage of economies of scale.
There have been plans to provide long term solutions to the trade imbalance. The government now place emphases on producing manufactured tradeable that provide a more stable export base to replace the volatile commodity markets. Greater diversification of products and more productive rather than speculative capital inflow have also been emphasised.
Before internationalising the economy, there must first be an efficient domestic market structure in Australia. MER has been introduced to the domestic economy to increase the international competitiveness of our industries and its workers.
Fiscal reform seeks to reduce the budget deficit to 1 percent of GDP. To do this, tax reforms were introduced. These were aimed at increasing economic incentives and creating a better environment for business investment. GBEs were also targeted for their inefficiencies. The aim was to ensure cost effective production of goods and services and that prices charged reflected the cost of supply. It is estimated that a $9bn increase in GDP would occur if GBE inefficiencies were eliminated.
Part of the Hilmer Report is based on reforming GBEs at a national level. The proposals included:
- Placing GBEs under the Trade Practice Act.
- Structural reform of public monopolies.
- Regulation of pricing.
- Competition neutrality between GBEs and the private sector pricing structure.
These reforms are paying off with lowered costs, improved productivity, and improved returns but the reform process has been slow.
Problems such as a low level of labour productivity and high domestic cost structure have seen labour market reform to be focusing on enterprise bargaining. This process allows for individual workplace agreements and wage increases are more in line with economic circumstances and productivity improvements. Enterprise bargaining is seen by the government as the key to labour productivity improvements.
MER has had significant achievements in the economy. Significant improvements have been made in particular areas such as maintaining a highly skilled future workforce, and productivity improvements in the waterfront and shipping industry. There is a down side to MER. Job loss has risen as reforms are implemented; displaced workers usually lack the skills required for employment in other industries. This leads to a growth in the rate of structurally unemployed. Reforms will also increase inequalities in income distribution; workers relying on safety net wage rises will be disadvantaged to those who have formal agreements. The government is concerned about these factors but believe that MER was not designed to fix social issues. They believe its function is to improve productivity in key industries that will benefit the economy as a whole.
In the 90’s, the government’s role in the economy is shrinking. Its main function is to provide a stable environment in which the market can function. To achieve this, the government uses a policy mix containing fiscal, monetary and MER which implemented in conjunction with one another will provide a platform where Australian firms can compete successfully in the international market.
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