a year in retrospect, a decade in prospect - dr martin parkinson

8/3/2019 A Year in Retrospect, A Decade in Prospect - Dr Martin Parkinson

1/14

Close Window

A Year in Retrospect, A Decade in Prospect

Address to the Sdne Institute

13 December 2011

Dr Martin Parkinson PSMSecretar to the Treasur

I would like to acknowledge the assistance of Leigh Soding in preparing this address.

A Year in Retrospect, A Decade in Prospect

Introduction

Thank you for the opportunity to be here with you tonight.

With 2011 rapidly coming to an end, I thought I might take stock of what has happened over the year,

both globally and domestically, and muse a little about what lies in store for the year, and years,

ahead.

A ear in retrospect

2011 has been a tumultuous year.

Were I to have been standing here this time last year, I would have said something like:

The Australian economy is in a strong position real GDP is now growing at around its

trend rate The global economy has recovered from recession faster than expected, but

at different speeds across regions Financial market conditions have improved since

the sharp increase in market volatility and stress experienced in mid-2010 when the

European sovereign debt crisis reached its peak.1


2/14

In fact, a barrage of events, either unanticipated or occurring more rapidly than expected, has battered

both the global and Australian economies.

Who would have thought standing here last December that we were shortly to see a series oftremendous and devastating natural disasters. Floods and cyclones in Australia; the triple calamity of

an earthquake, tsunami and nuclear accident in Japan; and a second devastating earthquake in New

Zealand.

These natural disasters have wreaked immense damage on people and communities in all these

regions.

And they have also had significant implications for the Australian economy.

The deadly floods in Queensland saw the tragic loss of 35 of our fellow Australians and, along with

Cyclone Yasi, disrupted countless other lives, with the loss of houses, jobs and community

infrastructure. They disrupted coal exports, while agricultural production was also hit hard, with the

resulting supply shortages leading to temporary, but significant, increases in some product prices andto headline inflation.

The events in Japan, a key export market for our commodities, impacted on the closely integrated

global supply chains of vehicles and high-end manufactures. Indeed, the loss of production in Japan

was a key factor in the12 per cent plunge in US light vehicle sales over April to June, with similarimpacts being seen in Australia clearly evidence of globalisation at work.

Combined these natural disasters subtracted around of a percentage point from Australias

economic growth in 2010-11.

These events also meant that the Australian economy, and to some extent the global economy,

entered 2011 on a less stable footing than anticipated, although the global and domestic outlooks stillseemed broadly positive.

This stability has been questioned a number of times this year, including in part by the major geo-

political event of the year the Arab Spring. This reawakening of the Arab peoples has seen the

overthrow of governments in Tunisia, Egypt, Libya, a transition of power in Yemen, serious challenges


3/14

to the authority of others in the region, and what looks to be virtual civil war in Syria.

It is too early to tell how this will all turn out, but these are events that I suspect will have long-term

geo-political and, possibly, economic implications.

But what of the global recovery?

Well, it was dramatically undermined by a series of events emanating in the North Atlantic.

To be frank, Europe spent 2011 lurching between economic catastrophe and mere disaster. The world

watched morbidly fascinated as a fundamental mismatch between underlying competiveness and fiscalpolicies dragged one Euro-zone country after another into crisis, recognising that the integration of

global banking systems increasingly risked turning Europes slow-motion train wreck into a global

problem.

And while we all knew that the US faced considerable medium-term fiscal challenges, how many of us

expected a decision around raising the debt cap for the US Government would reach the brink of

pushing the US into default?

Or that this would result in the unprecedented loss of its AAA credit rating?

As a result of these factors, and the inability or unwillingness of political institutions in the affected

countries to craft effective responses, at the end of 2012 the Mid Year Economic and Fiscal Outlook(MYEFO) describes the short term global outlook as follows:

International growth prospects have weakened markedly since Budget and the risks to

global stability from the European sovereign debt crisis have intensified The

deterioration in global conditions has contributed to a weaker near-term outlook for the

Australian economy than at Budget, with forecast gross domestic product (GDP) and

employment growth both revised lower. Conditions are also expected to remain uneven,

with the weaker global economy, the high Australian dollar and cautious household

spending behaviour creating significant challenges for some sectors.2

Despite this, Australia remains among the best placed of all the worlds advanced economies to


4/14

weather the fallout from these global developments. But we have been significantly affected and wecannot expect to be immune if things deteriorate further.

MYEFO saw our forecasts downgraded from Budget, with economic growth lowered by of apercentage point in 2011-12 and by of a percentage point in 2012-13. We have seen forecastrevenue fall by some $20 billion over the forward estimates, meaning that in 2012-13 alone our revenueforecasts are some $10 billion lower than we anticipated prior to the GFC.

At the same time, our economic growth is still likely to be around trend, underlying inflation is firmly in

the middle of the RBAs target band, and unemployment remains close to the NAIRU.3

Australian banks remain well placed to handle the ongoing funding market pressures emanating fromEurope. Our four major banks remain among the most profitable and well capitalised in the world.Indeed, according to Standard and Poors, Australias four major banks remain amongst the safest inthe world, with only one bank globally rated higher.

A decade in popec

In describing the start of the next decade, most attention is devoted to the continuing fallout from theNorth Atlantic. So, what does 2012 and beyond hold?

Lets start with Europe.

In early 2011, ongoing concerns about Greeces debt led to fears of a disorderly Greek debt default andadversely impacted confidence in the region. Coupled with slippage in the Greek IMF/EU program inMay 2011, this resulted in markets once again becoming highly stressed. These developmentsweighed on confidence and economic growth in the region.

In Greece, the need to meet agreed targets under the IMF/EU program despite dramatic falls inforecast GDP, led to even more dramatic fiscal tightening. This vicious cycle was widely seen asunsustainable without further intervention.

And the fate of Ireland and Greece was increasingly being projected onto other Eurozone countries asthe year progressed.

In mid-2011, EU leaders agreed to increase the effective size of the regions emergency bailout fund,the European Financial Stability Facility (EFSF), to combat the crisis. However, delays in itsimplementation, together with a lack of detail, on top of deteriorating growth prospects and fears ofcontagion through interlinked banking systems, resulted in significant market scepticism and led to thecredit ratings of the sovereigns underwriting the guarantees being threatened adding to greateruncertainty, and a further escalation in the crisis.

As the year progressed, economic prospects in Europe continued to worsen and market confidence inpolitical institutions capacity to develop credible responses continued to decline. This manifested indifferent ways in different countries. For example the previous Italian governments perceived footdragging when it came to implementing credible reforms, saw Italian bond yields climb to around

7 per cent. Given Italys sizable debt (gross debt is 120 per cent of GDP) and deteriorating outlook,this led to concerns that it would be difficult for Italy to service its debt, should yields remain at theseelevated levels.


5/14

The 26 October Leaders Summit attempted to achieve three key objectives place Greek sovereign

debt on a sustainable footing, minimise contagion to other euro area sovereigns by increasing the

firepower of the EFSF, and restore confidence in Europes banking sector by increasing banks capital

requirements.

However, markets remained sceptical over the measures. In particular, questions remained over the

details, implementation and whether the commitment existed to deal with underlying problems

associated with both high sovereign debt and weak growth.

The recent announcement (9 December) of moves towards more fiscal integration is to be welcomed,

but repeats the same process, with little detail feeding even more heightened market scepticism.

Moreover, while the measures announced may be a good step forward in addressing medium to longer

term issues, they are not perceived by markets as dealing with the immediate problems facing the

region4.

Before leaving Europe, let me return to again to Greece and the vicious circle referred to earlier.Historically what has tended to occur is that in response to the crisis, the troubled sovereign

implements even harsher austerity measures. Greece is a case in point.


6/14

As this chart shows, each subsequent review of its program has meant even greater fiscal

consolidation and corresponding lower rates of economic growth. To achieve agreed targets under the

IMF/EU program requires even greater austerity. That is, fiscal policy is pro-cyclical without any other

actions to boost growth.

Given the delays in crafting a Euro-wide credible policy response, and the fiscal contractions now

underway in many Euro-zone members, Europe will almost certainly return to recession next year,

with the potential for it to be deep and drawn out.

On a more positive note, lets now turn to the US.

Compared to only 6 months ago, the US economic recovery is looking in far better shape.

The first half of 2011 saw a US economy hit by a confluence of events that acted to seriously impede

the growth of the worlds largest economy.

Poor weather in early 2011 depressed tentative growth in the construction sector, which was followedby ongoing supply-chain effects of the Japanese tsunami that seriously affected the US manufacturing

sector, and US exports.

Together, this culminated in combined GDP growth of only 0.4 per cent in the first half of 2011. In

addition, downward revisions to US GDP meant that at even by the June quarter 2011, the US

economy had still not completely recovered from the 2008-09 recession.

Confidence in the recovery was not assisted by the Congressional debt ceiling debate, which took the

US to the brink of default.

Since then, however, the fortunes of the US economy appear to have turned, with consumer confidence

rising and domestic demand contributing to a relatively robust September quarter GDP growth of0.5 per cent. That said, this remains a very unusual recovery, with GDP only now back to pre-GFC

levels.


7/14

And the US labour market remains anaemic, ith emploment still nearl 5 per cent belo its peak.

The US housing market remains equall depressed, ith an estimated ecess suppl of housing to


8/14

that would take around 8 months to clear, at current sales rates, and with persistently low houseprices acting to weigh down new home construction.

That said, the US economy is now on the path to a recovery albeit a slow, and tentative one.However, the US public balance sheet remains in a work in progress. The failure of the CongressionalSupercommittee, tasked with finding US$1.2 trillion in budget savings has now triggered automaticspending cuts. These could reduce GDP growth by up to of a percentage point in financial year2013, a potentially significant shock to what is likely to be a still modest recovery.

Back o Aalia

Developments in 2011 in the North Atlantic have emphasised the importance of good public finances.They also highlight how critical is a focus on underlying competitiveness to generate sustainablegrowth and that this requires credible medium-term macroeconomic policy frameworks and

structural flexibility.

As I noted earlier, developments globally have, and will continue to have, impacts on Australia.Perhaps the most marked impact has been on the budget, particularly through the write down in theCommonwealths revenue estimates.

In total, revenue over 2008-09 to 2012-13 is expected to be $141 billion less than we expected at the2008-09 Budget, as a result of the GFC, natural disasters and now the growth effects of the Europeancrisis.


9/14

While the impact was less than was initially feared, around $110 billion of the revenue downgrade canbe directly explained by the GFC.

Over the past 18 months, natural disasters and the ongoing problems in Europe have caused revenueto be revised down again, by around $30 billion over the years to 2012-13. While the economy willrecover in time, the revenue is permanently lost, meaning our debt levels are higher than otherwise.

The weaker domestic growth outlook also means that setting fiscal policy to be consistent with theGovernments medium-term fiscal strategy will continually involve tough decisions. Recall that theGovernments fiscal strategy includes achieving budget surpluses, on average, over the medium termand keeping taxation as a share of GDP, on average, below the level for 2007-08.

The weak outlook for revenue is expected to continue beyond the forward estimates; as a result taxreceipts are expected to stay below 2007-08 levels as a share of GDP for much of this decade.

The Government has also committed to restrain annual real growth in spending growth to 2 per cent on

average until a surplus of over 1 per cent of GDP is achieved. As Chart 7 illustrates, to achieve theprojected surpluses, spending as a share of the economy will have to be slightly lower on average,than the average between 2000-01 and the start of the GFC.


10/14

While it is our own performance that ultimately matters, Australias fiscal indicators also suggest we

are well placed compared to other advanced economies. The Government is planning on returning the

budget to surplus ahead of the major advanced economies.

Further, the average net debt position of the major advanced economies (G7) is projected to reach in

excess of 90 per cent of GDP in 2016, more than 10 times higher than the expected peak in

Australias net debt of 8.9 per cent of GDP.

While our actual position is healthy, and markedly so in comparison to other advanced economies,

this is not a cause for complacency we will need continued focus on hard decisions to deliver these

outcomes and to maintain fiscal credibility and sustainable public finances.

And while fiscal consolidation remains a priority, Australia also needs to continue pursuing an

economic reform agenda which will assist the Australian economy adjust to global shocks, and

generate a sustainable base from which to create and boost wealth and living standards over the next

decade.

This means tackling the decline in our productivity performance in order to expand our growth potential,

offset the impacts of ageing and allow us to respond to the global economic transformation from west

to east that is underway.

The decade in popec: he conined ie of Aia

While 2011 saw multiple shocks to the global economy, we also continued to witness a more longer-

term transformation in the global economy with the rise of the emerging market economies -

particularly of China and India. There has been considerable attention this year on the impacts of

structural change arising from this global transformation on the Australian economy, typically relating

to the impacts of the higher exchange rate threatening the viability of business models, particularly inthe manufacturing sector.

But the exchange rate story is only one part of the broader structural adjustment process unfolding in

the economy. While it may appear to some that this story of structural adjustment has only begun in

2011, these changes are in part an acceleration of underlying shifts in the makeup of the economy that


11/14

hae been ndea fo ome ime.

In 2006, m pedeceo, Ken Hen, poke pblicl on eeal occaion abo he impac of he e-

emegence of China ino he global econom old hae on he ce of he Aalian econom. A

banial demand fo mineal commodiie b China and ohe emeging economie lead o a em

of ade boom, poiding a pice ignal, e-allocaing eoce oad he mining eco and aa

fom impo-compeing eco, ih he olme of ade epanding fo boh eoce epo and

impo of manface. A a noed a he ime, hee ee epeced o be long-n end,

ehaping he Aalian econom fo man decade.5

A e all kno, hee faco hae plaed o in j hi manne oe ecen ea.

Thee deelopmen led o mch hinking abo he appopiae polic fameok and eing

needed o epond o boh he aociaed challenge and opponiie.6 Theme of a fleible

econom, pomoing ainable goh and booing podcii ae fiml a pa of hi.

A fleible echange ae i impoan fo macoeconomic abili and alo in peading he benefi

fom he boom.

Moe boadl, a moe fleible econom help allocae eoce moe effeciel and can lead o bee

oeall macoeconomic ocome. Take he pefomance of he labo make fo eample. We hae

een eidence ha depie he geogaphic concenaion of he mining eco, and he emegence ofhe mli-peed econom, he dipeion of nemplomen aco egion ha acall naoed in

ecen ea. We pec hi ocome oe mch o effo o impoe labo make fleibili oe

man ea.


12/14

While the first stage of China and Indias development manifests itself in Australias eyes as demand

for our natural resources, the story is richer and the opportunities to come are greater still but so

too are the challenges for Australia.

As they seek to shift millions of their citizens out of poverty, becoming more urbanised and build the

cities, infrastructure and amenities that we in advanced economies take for granted, emerging

economy living standards will rise and the size of the middle class will grow significantly.

In 2009 there were around half a billion middle class consumers in the Asia-Pacific region. By 2020 it

is expected that this figure will increase by an astonishing 1.7 billion people. If this scenario

eventuates, this region will have more middle class consumers than the rest of the world combined,

and China will have the worlds single largest middle class market in dollar terms.


13/14

As the size of this Asian middle class expands and incomes rise, they will exhibit consumption

patterns akin to advanced economies this creates a massive potential market for our key

knowledge-based exports like education and high-end manufacturing, as well as tourism. As living

standards improve, purchasing power rises and food consumption patterns change, so we can alsoexpect to see growing demand for agricultural and soft commodities as new members of the middle

class have greater opportunities for a more protein-rich diet.

No one should be under the illusion that the growth paths of emerging economies, whether China or

any other country, will be smooth and uninterrupted there will be cycles of growth, but we anticipate

these will be around a strong rising trend when looked at in decadal terms.

In the case of China, a key test will be how the government manages the need for greater reliance on

more market-like policy instruments and how it further integrates with the existing global economic

architecture (or in fact re-shapes it).

With the economic centre of gravity shifting with the re-emergence of Asia, there are consequential,

and profound, implications for international geopolitical relationships, the result of which is a more

multi-polar distribution of influence.

This means Australia will operate in a global and regional environment where leading powers have very

different political systems and operating assumptions, with few current signs of convergence, and

differing views on the provision of public goods (such as economic stability and environmental

commons). Moreover, Australia will be operating in the historically unique environment where its

primary economic and security relationships do not coincide.

While the growth of China, India and other emerging economies will continue the diffusion of global

influence, the major developed economies, including the US, Japan and parts of Europe, will continue

to have a strong influence on the global economy through their technological leadership, contribution to

world growth, accumulated wealth and prominence in world financial markets. However, structural

weakness in these economies, in the form of significant financial and fiscal imbalances and, in parts of

Europe, weak international competitiveness, will take many years to play out. Much of the next decade

is therefore, likely to be characterised by slow rates of growth in the key developed economies, with

additional macroeconomic volatility arising from what has traditionally been thought of as a more stable


14/14

part of the world economy.

In this world of weaker growth in advanced economies, the importance of the emerging economies

rises even further, and faster.

But because China has grown so quickly, it has not yet really found its feet as the worlds second

largest economy and is not really sure what sort of leader it should be.

The rise of Asia in particular the China story brings with it a number of complexities which are

equally as important to comprehend as the opportunities I have discussed.

Highlighting this point, the Prime Minister recently commissioned a White Paper onAustralia in the

Asian Centur, led by Dr Henry. Understanding that the growth and change in Asia will have immense

global as well as regional implications, it will be important to take a broad perspective on what this all

means for Australia and how we can prepare ourselves to reap the benefits and manage any risks.

Conclsion

To conclude, we have seen a number of significant events, some still unfolding, which were largely

inconceivable this time last year. And other long-lived transformations have, if anything, accelerated.

Given the near-term global economic outlook remains uncertain, we may find ourselves saying the

same thing this time next year though at least we could say we predicted that!

The Australian economy has not been immune from these events.

However, Australia can take some comfort from its starting position. We are located in the fastest

growing region in the global economy with a number of opportunities likely to present themselves over

the next decade. Equally, the flexibility of our economy and our medium-term oriented policy

frameworks have assisted Australia manage the impacts from external volatility.

The policies that have stood us in good stead in the current volatility will also provide a good foundation

for the policies we need to pursue to reap the opportunities in prospect over the next decade and

beyond.

Thank you.

1 Part 1, 2010-11 Mid-Year Economic and Fiscal Outlook.

2 Part 1, 2011-12 Mid-Year Economic and Fiscal Outlook.

3 The NAIRU, or non-accelerating inflation rate of unemployment, refers to the level of unemployment

below which generally results in increases in the rate of inflation.

4 Note also that the 9 December moves are not a step toward full fiscal union but are a tightening of

the rules of how individual countries should respond to rising fiscal deficits. As such, on the detail

available they seem to encourage pro-cyclical fiscal policies.

5 Henry, K. (2006), The Fiscal and Economic Outlook, Address to the Australian Business

Economists.

6 For instance, see Statement 4 in Budget Paper No.1 in both 2010-11 and 2011-12 Budgets.

a year in retrospect, a decade in prospect - dr martin parkinson

Documents