AUSTRALIAN ECONOMY: by John BallantyneNews Weekly
The economy that will confront the next generation
, March 12, 2005
Australia's economy is ill-prepared to compete with the emerging economic superpowers of India and China, a leading Australian economist has warned. Australia's high levels of household indebtedness could lead to a financial meltdown and cause economic hardship for future generations.
One of Australia's best-known and most highly regarded economic forecasters, Melbourne's Dr Peter Brain, delivered a keynote address to the National Civic Council's annual national conference at Melbourne University, on Saturday, February 5.
He spoke of Australia's unique geostrategic position and how, "in the next 20 years, the world's two most populous countries, India and China, will become the world's biggest economies". If, however, Australia does not radically change its economic course and embrace innovation-driven competitiveness, Australia's wage levels could fall dramatically.Unsustainable debt
Australia's high level of debt-driven consumption is ultimately unsustainable, warned Dr Brain. Overseas investors could decide one day that the risk premium on the Australian dollar was far too high. This would trigger a capital flight and a collapse in the dollar's value. This would force the Reserve Bank to raise interest rates and, given the Australian economy's internal weakness, could plunge the country into a deep recession.
Dr Brain is executive director of the National Institute of Economic and Industry Research, a body which he co-founded 20 years ago. He has had 30 years' experience in applied economics and economic modelling. In 1996 he was almost alone in his profession in forecasting the then imminent Asian financial meltdown. In his 1999 book, Beyond Meltdown: the Global Battle for Sustained Growth
, he explained why the Asian crisis occurred and what it signified for the world economy.
Australia could suffer a similar catastrophe, he warned, if it does not radically change its economic course.
To date, Australia's underlying economic weakness has been disguised by two things: First, the steady decline in Australian manufacturing has been masked by the recent boom in housing construction activity.Wealth illusion
Second, Australia suffers from a "wealth illusion", whereby a high level of investment - a large part of it financed by borrowing from overseas - has inflated established asset prices (dwellings, shares, etc) far beyond their real value.
Australia, said Dr Brain, is in the curious situation where it has a healthy public-sector balance-sheet (the federal government's large budget surplus), but seriously deteriorating private-sector balance-sheets (ever-shrinking savings levels, with firms and households going ever deeper into debt).
During this time, private businesses have increased their debt ratios, not necessarily to increase their productive capacity, but often to finance speculative investment in property and shares. This has inflated asset values - improving dividend pay-outs in the short-term - and contributed to the property price spiral, but has done little to strengthen the economy.
Dr Brain said that these days a small suburban manufacturing firm can often stand to make more money by closing its operations and turning its property into shops, offices or residential housing.
The federal government's compulsory superannuation levy was designed to improve the private savings pool and expand Australia's capital base. This would help finance a sustainable increase in investment, lift future output and improve living standards for both the employed and the retired.
But quite the reverse has occurred, according to Dr Brain. Since the introduction of the superannuation levy, Australia's savings ratio has shrunk. Increases in wealth have mainly been consumed rather than invested.
In addition, households have dis-saved and borrowed heavily to maintain high levels of consumption expenditure. Australia's household-debt-to-income ratio is now among the highest among OECD countries.
The household sector has absorbed most of the increase in Australia's foreign debt, which now exceeds $400 billion.
A few years back, Dr Brain established the link between the high levels of Australian households' indebtedness and Australia's chronic current account deficit - a link which has recently been acknowledged by Access Economics, a free-market think-tank close to the Liberal Party (News Weekly
, February 12, 2005).
Australia's debt-ridden economy is now acutely vulnerable to changes in overseas interest rates and investor confidence.
Dr Brain pointed out that, paradoxically, the huge amounts accumulated by superannuation funds will not necessarily result in more Australians being able to fund their own retirements.
Instead, such is the level of household indebtedness that, when large numbers of the baby-boomer generation start retiring in five years' time, they will be obliged to hand over their retirement pay-outs to the banks just to clear their debts.
With few financial assets left, they will then qualify for the government pension, thus adding to the burden borne by working taxpayers.Reverse mortgages
The baby-boomer generation will have little to bequeath to their children. Even the family home will be in jeopardy. Already, the elderly are increasingly turning to "reverse mortgages", whereby they pawn the home to fund their retirement.
According to Dr Brain, much of Australia's household debt has been provided by foreigners investing in the banking system.
So what will happen, he predicted, is that "an increasing proportion of generations X and Y's inheritance will disappear offshore when the baby-boomers start dying. Then you really have a banana republic type society."
Australia's high indebtedness risks plunging the country into a severe recession. When more and more retirees cash in their financial assets to discharge their debts, an "asset price meltdown" will occur, Dr Brain warned.
With a smaller wealth pool to draw upon, future governments will find it increasingly difficult to fund all the retirees relying on the government pension.
Who will foot the bill for all this? The burden, said Dr Brain, will ultimately fall on the so-called generations X and Y, who have already had to pay for much of their education and start their careers loaded with debt.
Their parents were more fortunate. The inflation of the 1960s and '70s reduced the real value of their mortgage burden by their late 30s. Today, however, thanks to low inflation, servicing a debt is a much heavier burden, absorbing some 40 per cent of a household's income, even when the couple are in their 40s.
Soon there will come a time, Dr Brain predicted, when generations X and Y "will discover that their expected inheritance has been sold to foreign banks". Then they will wake up to the fact that they have no future.
Even today, said Dr Brain, some 50,000 well-educated Australians leave the country every year in search of better opportunities - "We're losing our best and brightest."
Australia's low levels of public sector investment - thanks to the reigning orthodoxy of economic rationalism - has greatly harmed the country's prospects. Dr Brain warned that, because of a lack of provision of proper public infrastructure, Australian private firms have become risk- and innovation-averse. They have increasingly tended to invest in safe, low-risk industries, such as shops and offices, rather than in research and development or in emerging industries.
The result is a deeply unenterprising society, with few quality job opportunities available.
Dr Brain argued that well-administered public investment can yield a high economic return, because it can provide an environment more conducive to private investment.
He cited Japan, South Korea, Taiwan and Singapore as places where private enterprise has benefitted greatly from government involvement in the economy.
In addition, he quoted European and North American studies which have shown that the economic return on public sector investment can range between 30 and 70 per cent per annum.
Australia, in the not-so-distant future, is likely to face stiff competition from massive factory plants constructed in China and India, he warned.
Whereas developing countries have endeavoured to modernise their economies by moving from the sale of commodities to value-adding and manufacturing, Australia has done precisely the opposite: it has let manufacturing decline over the last two decades.
To create a more sustainable future, Australia needs to provide the necessary infrastructure, subsidies and capital grants to enable private firms to flourish and innovate more.
If we don't take this course, Dr Brain warned, Australia's wage levels will converge towards those of India and China.
Australia should promote regional economic development, especially where regions have the types of competitive advantages and institutional support that can lead to the emergence of a strong knowledge-based economy.
This regional development approach would be in keeping with a current global trend which favours devolution of government to regional structures.
Dr Brain observed that the federal Coalition Government, despite its traditions, is becoming increasingly centralist.
To help develop economic regions, government should not neglect the important task of making them attractive areas in which to live. As high-income regions will inevitably attract the young, it is important for the government to prevent older people concentrating in poorer areas, thereby creating a regional ageing crisis as well as exacerbating inequality.
All this, as Dr Brain readily admitted, will cost money, although, as he stressed, the economic returns from public investment can be substantial.
He reminded his audience that Australia is not taxed particularly highly in comparison to other advanced economies. Government spends about 28 per cent of the Gross National Product - approximately the same as in the US.
If Australia's income tax seems abnormally high by international standards, this is because many other countries use payroll tax to a greater extent to finance such things as social security.