Lewis: Chapter 1 An Overview of the Australian Economy

STRUCTURE
Size of the Economy
Economists use the gross domestic product (GDP) as a measure of the size of the economy. GDP is the total value of all the goods and services provided in the economy, with a caveat that only those goods and services that have a market value are counted. Many people have questioned the use of GDP as a reliable indicator of economic activity or, as it is sometimes used, as a measure of welfare. One of the major problems with measured GDP is that it ignores the non-market activities in the economy. The Australian Bureau of Statistics (ABS) carries out occasional surveys of the number of hours people work in paid employment and at home. More noticeably but perhaps not unexpectedly women perform twice as much unpaid work as men. These data show clearly one of the dangers of measuring economic activity in terms of GDP. One of the characteristics of Australia and most other countries in the world is that there has been a huge shift away from people doing unpaid household work towards doing paid work. This would have exaggerated the apparent growth in GDP. Another item not considered in measuring GDP is leisure. Leisure obviously contributes a great deal to peoples wellbeing. It could be argued that Australias standard of living is high because there is an abundance of leisure and complements to leisure such as surf and sun. Another important feature is the environment. It is obvious to s obvious to anyone who has travelled to cities in Asia, Europe and America that Australia has one of the cleanest environments in the world. The balance between environmental considerations and production is a very important issue in Australia. Using GDP as a measure of the standard of living is also deficient because it does not account for things such as the availability and quality of education or health-care facilities, which directly contribute to the standard of living in a country. Although the market can and does provide some of these services, in Australia the government takes prime responsibility for them. The relatively easy access to quality education and health care that all Australian enjoy is an important factor in determining the standard of living. Perhaps just as important as the total size of GDP is the distribution of GDP among the nations population. Much of economics is concerned with economic efficiency that is, how to allocate resources to obtain the maximum income or welfare of the whole community. Nevertheless, equity issues in other words, how to distribute this income among the members of the economy need also to be addressed. Although it is hard to be more tangible, there seems little doubt, however, that Australians do have the characteristics that have important influences on the economy.

Industry Composition
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Another important consideration is the composition of the economy. By far the highest proportion (nearly 80 per cent) of output produced in the economy is in the service sector, followed by manufacturing with about 10 per cent. The primary sectors, agriculture and mining, are relatively small, comprising about 4 and 8 per cent respectively of GDP. Interesting changes have occurred in the composition of Australias output over time, the most significant is the huge increase in the importance of services to the Australian economy. Although manufacturing has grown in absolute terms, in percentage terms it has declined in importance. The rural sector, which at one time was by far the longest non-service sector of the economy, is now the smallest component of GDP. Mining has always made only a small contribution to GDP. Care must be taken, however, in interpreting these data. For instance, structural change has occurred in agriculture whereby may of the tasks that used to be performed on-farm are now performed off-farm; hence, such tasks are no longer included in agriculture but instead are included in manufacturing or services.

Openness
Another way that economists define an economy is according to the degree of openness. Open economies are ones that have a high proportion of their output devoted to trade. Closed economies, on the other hand, are economies that have a relatively low proportion of their GDP devoted to trade. It is convenient to divide the Australian economy into those industries which produce mainly tradeable goods and services and those which produce mainly non-tradeable goods and services. Tradeables are produced in competition with overseas producers and are usually taken to be agriculture, mining and manufacturing. Australias tradeable sector share has been declining over time, from 26.3 per cent in 1981 to 19.7 per cent in 2009. The above dichotomy into tradeables and non-tradeables is, however, also open to question, given that Australias trade increasingly also includes services. Clearly, Australia has a relatively small proportion of its economy devoted to trade. By contrast, Korea, Canada and Germany have large percentages of GDP traded and, therefore, are definitely in the league of open economies. In terms of international trade, Australia is a relatively closed economy, but is more open than the United States or Japan. A very important and persistent policy issue in Australia has been its trade with the rest of the world. Until the 1950a Australia was a very highly protected economy. Protection may take the form of tariffs on imported goods that compete with locally produced goods, or subsides given to local industries. Protection has the effect of reducing imports into the economy, but it also has the effect of reducing Australias exports. Since the early 1980s, much government policy has been directed at making the Australian economy more able to match international competition.

Market Economy

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Another way of defining an economy is the extent to which it is a market economy that is, to what extent goods and services are produced by the private sector. Alternatively, an economy can be defined by the size of the public sector. Measuring the extent of government involvement in the economy is not as straightforward as it may seem. As a proportion of GDP, Australias government sector is smaller than that of the United Kingdom and the United States, which are often considered very capitalist countries. It is much smaller than the government sectors of the relatively socialist countries of Scandinavia, such as Sweden and Denmark. Governments have an extremely important role in any economy. They are involved in maintaining law and order, enforcing contracts and providing public goods such as defence and street lighting. Governments may also be responsible of redistributing income in the economy, largely through taxation and the social security system. However, not all countries see governments as having this obligation.

PERFORMANCE
GDP per Head
By world standards, Australia is quite a rich economy in terms of GDP per head of population. However, as shown earlier in the chapter, care has to be taken in using GDP per head as a measure of the standard of living. Even greater care must be taken when making international comparisons, since the GDP estimates are all in US dollars. It is necessary to do this because it makes little sense to compare, say, Japanese yen with Australian dollars. Therefore, the value of each currency relative to another, the exchange rate, is important in determining GDP per head in US dollars. In addition, adjustment has to be made for the cost of living in each country. When the respective countries GDPs are adjusted in the way they are said to be measured at purchasing power parity (PPP).

Economic Growth
Perhaps more significant than GDP at a particular point in time is the increase in GDP over time that is, economic growth. Economic growth is defined as the percentage change in real GDP over time, where real GDP is measured by the quantity of output rather than the dollar value, called the chain volume measure of GDP. Since 1992 Australia has experienced one of its longest periods of economic growth. Particularly interesting is the pattern of positive growth in recent years. The huge downturn in real GDP in the early 1990s was a result of Commonwealth Government policy and is generally regarded, in retrospect, as due to poor economic management. Australia was virtually alone in the world in experiencing a recession during this time. The downturn in 2008 is attributed to the global financial crisis (GFC).

Productivity
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Productivity is a key measure of an economys performance. One way in which a country can increase its standard of living is by obtaining more resources. This has occurred throughout Australias history as new discoveries of commodities, such as gold, iron, ore, gas and oil, have been made. In addition, Australia has traditionally been a major host country for migrants, who have brought in skills and assets. However, in the long run, the capacity of a country to increase its standard of living depends on its ability to produce more output with the same or a lesser amount of resources that is, by increasing its productivity. The biggest growth in productivity has occurred in communications, due to rapid technological change and microeconomic reform. Agriculture faces fierce international competition and has always had to increase productivity to maintain competitiveness. Productivity increases in these industries are largely due to pressure on the public sector to produce more efficiently and the transfer of public assets to the private sector. Productivity growth was lower over the period in the major service industries, which are wholesale and retail trade, restraints, hotels, finance and insurance. This is of some concern, since these industries make up a large proportion of GDP, while many of the industries with the higher productivity growth rates, such as agriculture, make up only a small proportion of GDP> The poor productivity performance in the service sector is not well researched. However, the lack of competition from overseas and government regulation readily come to mind as possible factors restricting productivity growth. Experiences up to the early 1990s suggest that a lack of competition created over-employment in the finance and airline industries. AS these industries have been opened up to competition they have shed a considerable proportion of their workforce while maintaining or increasing output. This has led to considerable increases in productivity over the last few years. Up to 1994 the growth of productivity in Australia has been declining overall. Many other developed countries experienced similar declines in productivity growth rates. However, Australia, together with many other OECD (Organisation for Economic Co-operation and Development) countries such as the United States, experienced significant increases in productivity during the 1990s and 2000s. This period was characterised by significant technological change associated with the New Economy. The New Economy is associated with the growth and diffusion of information technology and globalisation Developments in the New Economy have important implications for Australia.

Competitiveness
Competitiveness is a somewhat difficult concept to measure. One measure of the competitiveness of the open economy is the real exchange rate; this is, simply, the nominal exchange rate adjusted for differences in the price level between Australia and overseas. Intuitively, if the nominal exchange rate rises, Australian goods are more expensive overseas and imports are cheaper. Australian industries are thus less competitive. Similarly, if inflation is greater in Australia than overseas, again competitiveness falls. In general, competitiveness can be measured by the reciprocal of the real exchange rate.
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Competitiveness can also be measured by how a country rates according to the factors necessary for competitiveness. Various surveys of countries, including Australia, have been carried out to measure such characteristics as expenditures on research, education, natural resources, productivity and business performance. Overall, Australia scores well on the role of government, infrastructure and human resources. In the past it has rated poorly with respect to outward orientation and domestic economic strength. It is these areas of the economy that successive governments have been trying to address.

Inflation and Unemployment

So far in this introduction to the Australian economy, the emphasis has been on the component parts that make up the whole economy. This is the microeconomics of the economy. While this has received much more attention recently, it is still the case that much of the economic policy debate centres on macroeconomics. Politicians and the media often focus on aggregate or macroeconomic measures such as the inflation rate, the unemployment rate, the balance of payments and interest rate. Macroeconomic factors have very important impacts on individual consumers, firms and industries, particularly those in the open economy. In addition, the financial sector us an essential element in macroeconomic policy. Economic growth, inflation and unemployment have traditionally been the major indicators of macroeconomic performance. It is not only the overall rate of unemployment, but its persistence, the growth in long-term unemployment and the concentration of unemployment among certain groups, such as young people, that is of concern.

Balance of Payments
The maintenance of low inflation and low unemployment is often referred to as internal balance. Another measure of macroeconomic performance is the extent to which an economy does not incur persistent balance-of-payments deficits or surpluses on the current account, which could eventually result in the economy having to undergo costly adjustment. Another element to external balance is the degree of foreign indebtedness. The issue of whether Australia has a problem with its external debt is controversial. The controversy regarding the nature and extent of the balance of payments and foreign debt problem makes these fairly poor measures of economic performance.

POLICY
Microeconomic Reform
Since the 1980s, there have been many government policies and programs introduced by both Labor and Coalition governments. These were designed to improve Australias competitiveness and productivity through what is known as microeconomic reform. Microeconomic reform includes policies such as reduction in protection to manufacturing industries, increasing competition,
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regulatory reforms in the transport and communications industries, restructuring the taxation system, reforming industrial relations, improving and increasing education and training, and reforming public-sector operations and ownership. These policies have removed the elements of government control that are impediments to efficiency and competition. To be competitive means to be able to produce the goods and services that customers both in Australia and overseas want, at a price and quality at least as good as producers in other countries. In addition, producers must be reliable and deliver on time. Producers in the export and import competing sectors must be producing as efficiently as they can, or they will lose out to overseas competition. However, the competitiveness of Australian firms also depends on the performance of the other sectors of the economy. Firms in the open sectors of the economy employ inputs from the rest of the economy that may not be open to competition. The most important input is labour (human resources). Hiring of labour is subject to restrictions. The quality of the labour employed depends on investment in education and training. Labour is an area of great policy debate in Australia. The other major input is capital. The growth of capital, or investment, depends crucially on an efficient financial sector. From the 1980s and into the early 2000s the financial sector experienced significant change. Simultaneously, the sector became more open to world financial markets, most notably through the floating of the exchange rate. The international financial sector has been subject to crises, most notably in 1997 and 2008, which have had less impact on Australia than on most other countries.

Trade Policy

Making the economy more open will increase competitiveness. This has been recognised by successive governments, which have introduced policies to make the Australian economy more open. Of equal importance to protection at home for Australia are the protection policies of other countries in the world. Of primary importance to Australia is the freeing up of agricultural trade. The protectionist policies of the European Union (EU), in particular, as well as the countervailing policies of the United States, have serious implications for Australias exports. Partly because of its frustration with the EU, Australia has gone to great lengths to encourage free trade. Not all Australians, however, have welcomed the increased competitiveness, globalisation and deregulation that have occurred in Australia and most of the rest of the world. For instance, demonstrations at world trade meetings are common.

Taxation Policy
Taxes are an important element of policy making. They provide the major revenue source for government programs, they are a major tool of fiscal policy, they can be used to even out the distribution of income, and they can change patterns of consumption and production.
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Macroeconomic Policy
Although issues such as health, education and the environment also receive attention, the unemployment rate, inflation rate and the balance of payments always grab the headlines. The Commonwealth Government can influence macroeconomic variables through fiscal policy. Fiscal policy refers to variations in taxation and public expenditure to influence total production and consumption of goods and services. The major component of GDP of made up of private consumption and investment. It follows that, for efficient macroeconomic management, it is necessary to understand what determines consumption. Another important aspect of privatesector spending is savings that part of income that is not consumed. Savings are the major means by which the economy can build up its capacity to produce in the future that is, the means that make investment possible. Indeed, the imbalance between savings and investment in Australia is seen as a policy problem, as is the reluctance of Australian households to save. Monetary policy refers to variations in liquidity and interest rates. Changes in monetary policy can have real effects, in that variables such as consumption and investment are affected. However, monetary policy is more often associated with nominal outcomes, most importantly the containment of inflation. Indeed, the Reserve Bank of Australia (RBA) usually conducts monetary policy in order to maintain an inflation target within the range of 2 to 3 per cent on average. Contractionary monetary policy to reduce inflation by raising interest rates may increase unemployment or increase the value of the Australian dollar and adversely affect exports. In summary,, macroeconomic policy is plagued by conflicts between objectives that make it extremely difficult to achieve several targets at the same time. In part because of disillusionment with the ability of macroeconomic policy to deliver full employment, low inflation and strong economic growth, there has been a growing emphasis on microeconomic policy. With this has come a change in attitude away from the view that governments can solve a countrys economic problems without addressing the fundamentals of markets. Indeed, there is a further view that governments should remove themselves from previously traditional areas of ownership and regulation.

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