Flexibility needed from policy makers

THERE are four long-term trends facing the Australian economy that will have a significant effect on its future shape. These are:

• continued globalisation and the development of emerging market economies – particularly the rise of China and India as global economic superpowers;

• continuing rapid technological innovation;

• demographic change – the ageing of the population; and

• environmental pressures – including climate change and water.

This mix of long-term trends will have significant impacts, both positive and negative, on Australia’s productive base and, therefore, the wellbeing of future generations.

Globalisation

The first of these four long-term trends is continued globalisation. The global economy is in the midst of a radical transformation, unprecedented in the last 100 years.

The speed of globalisation has accelerated through the advancement of new technologies, falling transport costs, and as tariffs and other barriers to trade have been removed.

Continued globalisation has also led to significant growth in developing economies. Thirteen countries have grown by more than 7 per cent per year on average for 25 years or more, and this list of countries will only grow – it will not be too long before India may also join this club.

China is now the second largest economy in the world, and is expected to surpass the US in size by 2020, while India is on track to surpass the US by mid century. 

The continuing transformation of the economies and societies of China and India has far-reaching implications. For example, by 2020, the Asia Pacific region could have more people in their middle class than the rest of the world combined. China could have a middle-class market that surpasses the US in dollar terms. The continued rise of the Asian middle class presents Australia with huge opportunities – a potentially very large market for our goods and services. 

But it is not pre-ordained that this will benefit us; we need to take the decisions that will allow us to succeed in this new world, one where there will be a premium on a flexible, adaptable and innovative Australian business culture.

For now, the mining boom is the most obvious early manifestation for Australia of the shift in the world‘s economic geography from west to east.

With the rise of China and India, the global demand for resources and energy has outstripped the rise in global supply, resulting in a sharp rise in global resource and energy prices.

In addition, growth in the manufacturing sectors of China has led to increased global supply of low-cost products.

Together, this has resulted in Australia‘s terms of trade reaching their highest sustained level in 140 years.

Improved terms of trade increase real national income – the rise in global commodity prices increases the value of Australia‘s mineral and energy endowment. We can now purchase more imports for each unit of exports; or, put another way, we can afford to purchase more without doing anything else different.

Is this sustainable? Eventually no, but when this is likely to be the case remains unknown. At some point, growth in the global supply of commodities will start to outweigh the continued strong growth in demand, which will first stop the rise in prices and, eventually lead to them falling.

Given the implications for the economy as a result of globalisation, and the rise of China and India in particular, it will be important that we adapt in a sustainable way. Whether we do this, however, will depend on whether policy makers and businesses make the right decisions for the long term. 

A flexible, responsive economy will be crucial. 

It will be important that we facilitate structural adjustment, not oppose it. 

It will be important to build new comparative advantages through investments in infrastructure, education, skills and innovation and that we take advantage of the opportunities presented by the continued development of the emerging market economies.

Technology

The second long-term trend is continued technological advancement.

Rapid technological advancement will have significant implications for sustainability; improvements in ICT in particular have the prospect of improving productivity, service delivery and networking. Technological advances have already transformed businesses and trade and played an important role in reducing the ‘tyranny of distance’.

ICT enables innovative tools to be developed, allows new business models to arise, facilitates the emergence of new products, industries and production processes, as well as increasing competition and greater specialisation. This will have a profound impact on the Australian economy.

The ICT revolution will also have implications for the way in which government services are provided to a growing and ageing population and, more generally, for the way in which citizens of all ages interact with their governments. 

In particular, continued ICT advancement will improve the delivery of education and health services, improving human capital.

Demographic change 

The third long-term trend is demographic change.

As with all other advanced economies – and many emerging economies – Australia has an ageing population, reflecting the combined effects of the decline in fertility since the 1960s, the shift of the baby boomer population bulge into ever older age cohorts and a general increase in life expectancy.

The proportion of the population aged 65 and over has increased from just over 8 per cent in 1969 to around 13 per cent today. The 2010 Intergenerational Report (IGR) projected that by 2050 the proportion of the population aged 65 and over would rise to around 23 per cent.

Furthermore, it projected that by 2050, around 5 per cent of the population will be aged 85 and over; this compares to about 1.8 per cent today.

The ageing of the population will create substantial pressures around fiscal sustainability.

Rising dependency ratios and slower economic growth will reduce the capacity of Australia to fund its spending commitments. At the same time, increased demand for age-related payments and services, including through technological advancements in health and demand, for higher quality health services will drive up expenditure.

Environment 

The fourth long-term trend is environmental sustainability. 

Environmental issues, particularly climate change, are probably those most commonly associated with the term  – sustainability. 

With the expected rapid growth of the global economy over coming decades, significant pressures will be placed on global resources, particularly the natural environment. 

This presents a serious challenge, for Australia and for the world. 

The Australian economy will need to become more energy, resource and environmentally efficient. 

In fact, energy, resource and environmental efficiency will be key drivers of productivity.

The resulting structural adjustments will generate concerns.

A common thread across all these longer-term trends is that they all involve structural adjustment.

This structural adjustment can be managed or it can be opposed; the critical point is that it cannot be avoided. Moreover, history shows that opposing adjustment rarely succeeds, and the negative consequences are significant. The challenge for policy makers is to facilitate as smooth an adjustment as possible for all affected.

The most effective and credible policy responses will be those that encourage structural adjustment while at the same time protecting those individuals most vulnerable.

• This is an edited extract of Treasury Secretary Martin Parkinson’s Shann Memorial Lecture, delivered at the University of WA on August 23.