Emeritus Professor Fred Hilmer AO delivered the Alf Rattigan Lecture on Restarting Micro Economic Reform on Wednesday, 6 December.
See below for the full transcript of the lecture given at the ANU’s Australian Academy of Science’s Shine Theatre.
Thank you for the honour of delivering the 2017 Alf Rattigan Lecture.
Rattigan was a pioneer whose ideas and advocacy punched a hole in the then prevailing economic fabric of high tariffs, regulated wages and heavy government involvement in industry.
A year ago the distinguished journalist Dr Paul Kelly concluded his Alf Rattigan Lecture with these words
“The community is increasingly anxious about the future, but uncertain about the path to follow”.
The sources of anxiety he listed included an unsustainable budget situation, the faltering transition to a high-tech economy, increasing gaps between regions as well as income groups; and the erosion of living standards for the middle class.
These issues remain with us today and if anything are becoming more acute. Moreover, new challenges are emerging, in particular an almost global backdown on free trade, increasing tension internationally; and what is often referred to as “toxic” domestic politics where the noise of populism and special interests drowns out any argument for continuing reform.
In the light of this background, tonight’s Alf Rattigan Lecture will discuss how Australia might be able to restart micro-economic reform. Even in this environment reform is possible, as the examples of New Zealand and many of our Asian neighbours show. The views expressed reflect my experience with National Competition Policy from the early 1990’s to the present, as well as lessons from Alf Rattigan’s successes in tariff reform.
Restarting micro-economic reform is, in my view, vital. The benefit of the strong and steady economic growth that Australia has enjoyed has not been the result of distinctive macro-economic policies. Australian macro-economic policy, with its emphasis on managing budget deficits and holding to stimulatory monetary policy is unexceptional.
What is different about the Australian experience is a long period of major micro-economic reforms starting in the late 1980’s, including tariff cuts, floating the dollar, enterprise bargaining, competition policy and introduction of the GST. Together these and related micro reforms changed the incentives for managers and bureaucrats. Lifting productivity and adapting to competitive challenges and opportunities replaced rent seeking. However, there have been no new major micro-economic reforms or advances in past reform areas over the last 10 - 15 years and none appear imminent.
There are 4 parts to the case I seek to make tonight.
I begin by arguing that the need to restart micro-economic reform is vital. Micro-economic reform has now taken a back seat to macro-economic policies.
A fresh approach to micro reform is needed because what worked in the 1990’s and early 2000 is unlikely to work in the current political environment. We need to cut through or work around the many obstacles to micro reform.
The approach over the next decade should focus on the one or two areas of reform with the greatest potential for improvement, and with the best prospects for political success. Two areas are suggested:
Further competition policy reform, particularly with respect to
energy and utilities.Improved processes and decisions on infrastructure investment.
Leadership of this approach, both formal and informal, is critical.
Recall Paul Kelly’s list of economic concerns. They start with an unsustainable budget situation, with debt and deficits heading in the wrong direction. He also mentions the faltering transition to a high-tech economy, increasing gaps between income groups and regions and the erosion of middle class living standards.
The main remedies being followed to cure these ills are macro-economic. Bringing the budget into balance via tax increases and spending cuts and holding to a stimulatory monetary policy are the main elements. However, the results of these policies which are being widely followed in most developed economies are at best marginal. Growth of GDP, productivity and wages appears to be settling on a lower trend line than was the case 10 – 15 years ago, a point highlighted by the Productivity Commission in its “Shifting the Dial Report of August 2017. We are learning that tight fiscal and monetary policies can stop economic growth, but that restoring growth is not as simple as loosening macro policies.
Over the last decade, with most policy attention on macro-economics, little has been done in terms of micro-economic reform. The 1993 National Competition Policy was reviewed by the Harper Committee in 2015, but it is hard to see any major new reforms flowing from this review, a point I will come back to later. There are proposals to change tax rates to provide greater incentives both for companies and individuals. However, the incentive effect of what are at best moderate changes, is not very significant.
This current agenda with the main emphasis on macro policies is quite different to that of the 1980’s and 90’s. The main focus then was on building an incentive structure that caused firms and individuals to change behaviour in ways that lifted productivity. The first wave of reform, compliments of Alf Rattigan, was tariff cuts. These were intended to apply competitive pressure from imports to the traded economy, and thus lower inflation.
Floating of the dollar in 1983 made it possible for the stimulus to compete with imports to be strengthened or moderated as circumstances changed. Financial deregulation in the 1980’s brought new entrants and further competitive pressure to what was then a highly protected segment.In 1991 enterprise bargaining was adopted. Enterprise bargaining, in contrast to industry-wide craft based bargaining provided strong incentives to firms to streamline work practices. The 1993 National Competition Policy reinforced competitive pressure across the economy with particular focus on the non-traded sector and government monopolies. The GST in 2000 was also an important micro reform.
By early 2000 one could say that for most firms, the incentive had changed from looking to Canberra or State capitals for help to looking over one’s shoulders at competitors and looking ahead at the opportunities that were emerging. The adage “when the going gets tough the tough get going … to Canberra” had not disappeared, but had less potency.
Macro-economic policies are and will continue to be important. Getting these policies wrong can wreak havoc on an economy. But if the macro is not supported by ongoing micro reforms, it is unlikely that an economy will perform to its potential. It was the mix of sound macro and comprehensive micro policies that has underpinned Australia’s 26 plus years of solid economic performance. The recent slippage in our relative performance comes at a time when micro reforms are running out of steam.
Fresh Approach Needed
A fresh approach to micro-economic reform is needed because what worked in the past is unlikely to work in the current environment. In the case of National Competition Policy development in the 1990’s, 6 factors underpinned its success.
First - the drive for change and ongoing leadership came from Prime Ministers Hawke and Keating and their most senior colleagues. This continued under John Howard, though direct responsibility for competition policy was assigned to the Treasurer. Similarly, in Rattigan’s time, when tariff cuts were being considered, Rattigan argued successfully that Prime Minister Whitlam take responsibility for the reform.
Second - support for Competition Policy was bipartisan. Before I agreed to take on Chair of the Inquiry, I called Nick Greiner, the then Premier of N.S.W. He assured me that he and Jeff Kennett, then the Victorian Premier, were strongly supportive. Support from both sides of politics continued through the successful COAG process.
Third - all the States and Territories signed up – the reform was “whole of Governments” in the best sense.
Fourth - the competition policy was consistent with and reinforced other reforms. All of these reforms created incentives in the same direction, towards an open economy where improving efficiency and effectiveness lead to lower prices, more choice and greater prosperity and employment.
Fifth - and of particular importance, the reforms were supported by an implementation process driven by COAG and backed up by competition payments to States and Territories of $5.7 billion over 9 years for implementing the policy.
Finally - the goals of reform were clear – lower costs, lower prices and more choice.
Of the six factors that underpinned competition policy reform, not one is in place today.
First - neither the Prime Minister, Opposition Leader, Treasurer or Shadow Treasurer have responsibility for competition policy and for micro-economic reform more generally. The Harper Review, an initiative of the Coalition to provide a 20-year update on the policy, was driven by the Minister for Small Business. In my view this was clearly inappropriate, a view strengthened by the lack of focus in what were impossibly wide terms of reference. Important areas such as mechanisms and new ways to control monopoly pricing, and how in practical terms to extend the reach of policy to human services, were either not dealt with in sufficient depth and/or were dropped. Recall what happened with “Mediscare”, and tuition fees for higher education. Reforms in these areas quickly fell victim to populist attacks. Monopoly pricing, especially its interaction with privatisation remains a thorny issue. The Section 46 proposals on misuse of market power consumed time and attention way out of proportion to their importance.
Second - bipartisanship is at the lowest level in living memory. Ken Henry, NAB Chair and former Treasury Secretary from 2001 – 2011, has spoken eloquently on this point. (CEDA Feb 23, 2017)
“Our politicians have dug themselves into deep trenches
from which they fire insults designed purely to causeembarrassment …. The country that Australians want
cannot even be imagined from those trenches.”
Third - animosity between States and the Commonwealth has replaced intergovernmental cooperation. Examples include a multiplicity of renewable energy targets, changing decisions on infrastructure, and a failure to progress tax reform.Fourth - there is little consistency between current reform proposals. Electricity is best described as a mess. Are we trying to improve a market mechanism, and adapt it to handle carbon emissions, or have we reverted to government ownership of significant generation, and how will this be operated and priced? Privatising natural monopolies without proper and effective price controls is another instance of inconsistent policies.
Fifth - there is no longer an implementation mechanism similar to the Competition Payments process. COAG is seen as less effective and cluttered.
Finally - reform increasingly suffers from the curse of multiple objectives that need to be traded off. In 1993, while policy still had to be developed, the objectives of competition policy were clear. Energy is a case in point. Lower costs and high reliability, reflected in lower prices were the goals. When the issue of limiting carbon emissions emerged around the turn of the century, there was no agreement on the carbon reduction goal and no mechanism for how this was to be achieved without impacting cost and reliability more than necessary. A market mechanism could not be agreed upon and confusing and conflicting versions of renewable energy targets were added. The modelling of how the various targets for carbon reduction might affect cost & reliability was either missing, or not disclosed. Similar issues arise from multiple, conflicting objectives in health and education. Even in road use pricing, how is road usage as a determinant of spending on roads traded-off against road safety?
I share the view that the issues in energy reflect failures by governments, not a failure of competition policy or of markets per se. Recently, some politicians and commentators are challenging the effectiveness of market mechanisms because of perceived reform failures, such as the blowout in energy prices. The issue however is not that the market mechanism has failed, rather the market mechanism has been poorly designed and implemented, in particular in failing to recognise the need to accommodate multiple and potentially conflicting goals.
In summary, Australia was able to implement a range of reforms through a focussed bipartisan approach with clear objectives. However, the approach that worked in the 1980’s and 1990’s will not work today without a major change in the political environment. While we can hope for a better political environment, we need an approach that will cut through, or work around the current obstacles to micro reform.
Over the last 30 or so years, governments have used 8 different policy instruments to further micro-economic reform. The first wave of reform covered tariff-cuts, floating of the dollar, financial deregulation and corporatisation and privatisation. As Table 1 shows, these reforms are “mainly done”. Moreover, this set of reforms is quite difficult to undo, though there is continued political conflict over privatisations and the effect of tariff cuts can be diminished by trade restrictions and anti-dumping actions. From an economic perspective, the issue with privatisations is about selling off monopolies without proper price regulation; and creating new government monopolies such as the NBN.
The current agenda where most remains to be done is in the bottom 4 areas in Table 1. These include:
Completing competition policy reform. The Harper Review provided a contemporary assessment of what still needed to be done. The review, reflecting its wide terms of reference, called for completing reforms in energy and water, adopting user pays road pricing and extending competition to health and education. These are seriously non-trivial challenges that the review did not have the focus and time or high level support to tackle in sufficient detail. The Minister of Small Business is hardly likely to be the driver of reform in health, education and utilities. My preference would be to focus on creating effective national markets for energy and transport, and developing a new mechanism and approaches for potential monopoly pricing. Education and health reforms need more than a competition policy approach, and require traversing political minefields.
Completing deregulation of the employment market. Adoption of enterprise bargaining in 1991 was a great step forward. In 2015 the Productivity Commission reviewed the workplace relations system as it evolved since 1991. They concluded that the system was not dysfunctional, and that repair rather than replacement was needed. The Commission recommended making the system less bureaucratic by streamlining processes and clarifying the roles of the administering institutions. Business leaders strongly supported further reform. However, none of these ideas (which are hardly radical) has seen the light of day, further testament to our current anti-reform political environment.
Rebalancing the mix of taxes, not to raise more revenue, but to increase incentives to work, save and invest. The last major tax reform, the GST, has been largely unchanged since introduced in 2000.
Adopting a non-political properly resourced process for determining infrastructure investment, with the emphasis on maximising returns – making every infrastructure dollar work to provide real tangible benefits that fully justify the expenditure.
Table 1Micro Reform Status
Putting these 4 reform areas together in a comprehensive reform package, as was the case in the 1990’s, would not work today. But giving up on reform is clearly not in the national interest. A way through may be to pick one or two areas where reform is politically most likely and focus on implementing constructive changes that can be “sold” to the public.
The idea of a limited, focussed micro-reform agenda is not entirely new. One of the lessons from Australia’s success that Gary Banks pointed out was that we “hastened slowly”. We focussed on one or two areas for 5 to 10 years; and stayed with reforms for a decade or so. A similar focus on a few high impact areas at any one time also characterises successful large-scale corporate changes. What then are the one or two top priority reforms?
I pose this question with some trepidation, as all 4 areas where micro reform is incomplete are important, and focusing on any one or two would be beneficial. Because we had a reform hiatus for the last 15 years, there is a backlog of pressing reforms, all of which would contribute to a stronger economy. However, proceeding on all 4 fronts is unimaginable in the current environment, so the question “where to focus” must be addressed.
If the 4 areas where reform is still needed were ranked according to political difficulty, a ranking as set out in Table 2 emerges:
Infrastructure investment comes out as a top area, but only if the selected investments will really generate strong, positive returns. The processes to ensure this happens are not yet in place; and our track record is worrying. We have built two desalination plants that so far aren’t used, a number of tunnels and toll roads where traffic is well below projections, an NBN that is unlikely to generate commercial returns; and gold-plated investments in poles and wires that drives up power prices. While there is a stimulus from the building of infrastructure, unless there are sound real returns the investment becomes a drag on growth.
To avoid the risk of poor projects being undertaken and supported by government, processes need to be significantly strengthened. Granting Infrastructure Australia (IA) statutory independence is a start.
But IA can be by-passed by political leaders’ announcements. And, politicians have form in by-passing bodies they do not directly control. Recall what happened to competition impact regulation reviews for the NBN and for higher education. In addition, the resources available to IA, about $10–12M p.a. seem tiny in relation to the range and complexity of projects to be evaluated. Assessing returns from infrastructure where benefits cannot be sold into a market (e.g. a toll road) is extremely complex, and made more so by the long timeframes involved. Moreover, there is a temptation to justify investment by using monopoly pricing, as with the NBN. Monopoly pricing is a tax on consumers, not an infrastructure benefit to the community.Good infrastructure spending decisions require a process of high integrity and independence, supported by strong analytic skills. We are not there yet. On the positive side, the politics of infrastructure investment are generally less negative than other reforms, as new spending, even if not justified economically, is generally popular.
Further competition policy reforms are needed in energy, transport and utilities, as is stronger price regulation of monopolies and non-competitive oligopolies (whether public or private.) These reforms need to go further than restating the 1993 approach. In particular, they need to accommodate the conflicting objectives as discussed earlier. Nor should we shy away from “man on the moon” goals, such as regaining Australia’s competitive advantage in energy costs.
Business leaders see further employment market deregulation as a high priority reform according to the World Economic Forum Global Competitiveness Report 2017-8 (The Australian, September 27, 2017 p.4). Major productivity gains followed from the 1991 reforms of enterprise bargaining. However, the politics of further reform are not encouraging. Recall what happened to the Productivity Commission Report of 2015.
Tax structure, as opposed to the tax burden, has been shown
to have positive incentive effects. The main case in point
is reduction in marginal income tax rates, off-set by an increase in other taxes, usually on consumption and on ownership of land. Removing
“bad taxes” such as stamp duty and payroll tax; and imposing
taxes on activities seen as harmful (smoking, gambling, alcohol,
pollution) is also seen as a positive area of reform. However, the political difficulties in tax reform are daunting.
In summary, the first part of a fresh approach is to recognize the need for micro-economic reform and to pick 1 – 2 key areas where, reform would be and could be progressed. My suggestions are the adoption of tough, high integrity, properly resourced processes for infrastructure spending, and a further look at competition policy, particularly in energy, transport and utility markets.
Table 2Political Difficulty
No discussion of reform is complete without addressing the topic of leadership. Where will leadership of a new reform push come from, and how does one deal in a partisan, toxic and populist environment.
My starting point is that reforms occur because there are many leaders whose efforts coalesce around big ideas. The notion that all leadership requires is a charismatic powerful person is, if true at all, only part of the story. All successful reforms had the strong, visible support not only of the then Prime Minister, but also senior colleagues, and many others.
Leadership starts with thought leadership. Recall Keynes’ dictum
“Practical men who believe themselves to be
quite exempt from any intellectual influenceare usually the slaves of some defunct economist”I would have preferred the quote if the word “defunct” was replaced by “far-sighted”, but the basic idea remains valid. Thought leadership is an essential starting point.
Reform ideas come to life via vivid stories. The Competition Policy reforms of the 1990’s could be readily explained by the impact on prices and choice. Examples such as free-range eggs, potatoes for McDonald’s fries, conveyancers lowering home acquisition costs all helped. Today’s stories about high energy costs, potential blackouts and gas shortages, as well as the benefits of new infrastructure, all need to be woven into a narrative that makes reform tangible and worthwhile.
Thought leadership also needs to be strongly supported. The reforms of the 1980’s and 1990’s were supported by the PM as well as senior public servants, academics and journalists. Alf Rattigan is a case in point. Rattigan held a statutory position as Chair of the Tariff Board. While his Minister, John McEwan believed the high tariff regime was essential, Rattigan persisted with providing data and arguments against the tariffs that finally won over Prime Minister Whitlam, who declared himself “a Rattigan man”.
I recognize independence of the Public Service has diminished since Rattigan’s time. However, there are independent civil servants who can and do argue reform cases. Examples include the Reserve Bank Governor, Chair of the ACCC and Chair of the Productivity Commission. There are also recently retired civil servants such as Ken Henry, Alan Fels and Gary Banks whose views are given prominence in the media. International groups such as OECD also add to the debate.
Informal leadership of ideas and public debate also comes from academics, think-tanks and peak business organisations. The Business Council of Australia (BCA) played a significant role in “Making Hilmer Happen”, the title of a BCA conference on competition policy in 1995. The BCA also drove the change to enterprise bargaining in 1991. ANZSOG itself could play a more significant role both in research and advocacy.
In summary, leadership of a micro-economic reform agenda needs to come from a variety of sources. While strong political leadership is vital, political leadership can and actually does, follow thought leadership and advocacy both from those in formal positions and from independent, knowledgeable people. My concern is that there are too few champions, and too few well researched and well argued, ideas for restarting micro-reform.
In concluding, recall Paul Kelly’s list of issues – the budget situation, the faltering transition to the high-tech economy, increasing gaps between regions as well as income groups and the erosion of middle class living standards. A fair question is “how will restarting micro-economic reform help?”.
The answer is that if historic levels of productivity can be achieved, incomes rise and tax revenues rise, there is then increased capacity for business to invest and for governments to help regions and groups adjust and to provide needed services and policies, such as to better protect the environment.Airline deregulation is a good case in point. When deregulation is implemented, jobs are lost, but as efficiency rises, ticket prices drop, traffic increases, and tourism booms. As a result, far more jobs are created than lost. Similar stories can be told of extending shopping hours, deregulating pharmacies, newsagents and the supply of communications services.
Despite the enormity of the challenge of restarting micro reform in the current environment, I remain an optimist, particularly when I recall Alf Rattigan’s achievements, a powerful example of what one person with a big, good but initially unpopular idea can do.