Date created: August 12, 1997

Last modified:18 December 2002

Maintained by: John Quiggin

Micro benefits of reform

June 18 1997

When America's armed forces were deeply mired in Vietnam an elder statesman, approach for his advice was said to have suggested 'declare victory and get out'. A similar solution is looking increasingly attractive for Australian governments dealing with the problems of microeconomic reform. A decade or more after microeconomic reform began in earnest, the 'battlers' are more discontented than ever with the results of financial deregulation, tariff reform and privatisation.

The Hilmer reforms, imposed from the top down through the National Competition Policy Act, have spread the discontent further, directly affecting opinion leaders in local government, community and professional organisations. Particularly in regional Australia, the Hilmer reforms have appeared as edicts from central government, replacing democratic and accountable local processes with ruthless market forces. Bank and post office closures, compulsory contracting out of council road work, corporatisation and the associated loss of rights of Freedom of Information; all are seen as part of the Hilmer process. For many in regional Australia, 'Hilmer' has replaced 'economic rationalism' as a favourite swear word.

The Howard government is showing signs of responding to the reform fatigue evident in the community. The recent round of bank-bashing saw both the Prime Minister and the Treasurer repudiate the claim, central to the case for microeconomic reform, that financial deregulation has finally produced a competitive retail banking system. It also looks likely that the government will freeze tariffs on motor vehicles, preferring political realism to ideological purism.

If the government shows signs of getting out, its declaration of victory may be found in Budget Statement 3, entitled Structural Change,: Recent Developments, Benefits and th Role of Policy. Victory is claimed on four counts. First, on the basis of a slight upward movement in productivity growth rates over the last two years, the Treasury claims that microeconomic reform has halted a downward trend in productivity growth over the 1970s and 1980s. The evidence offered is a broken trend line fitted to a graph. This analysis would not stand up to serious statistical testing. Indeed, when estimates showing a decline in total factor productivity growth over the 1980s were first produced, supporters of the microeconomic reforms that began in the early 1980s dismissed them as statistically unsound. Now Treasury wants to claim that the stabilisation of productivity growth at the low rate experienced in the 1980s is evidence of the benefits of microeconomic reform.

Second, Treasury quotes a number of official estimates of the benefits of reform, including predictions published by the Bureau of Industry Economics in 1990, the Economic Planning Advisory Commission in 1994 and the Industry Commission in 1995. The first two papers reported modelling simulations for the period from 1990 to 2000, claiming that microeconomic reform would raise GDP by 10 per cent, relative to a baseline of no policy change. The predicted gains in GDP have failed to materialise so far, and Treasury's own forecasts for the next three years do not suggest that growth will accelerate. The Industry Commission predicted a more modest 5 per cent gain in GDP over a period of five to ten years. However, as I have shown in an article to be published in the Australian Economic Review, even this model greatly overestimates the welfare benefits of the reforms under consideration. A more reasonable analysis of the same reforms suggests that the net benefit will be no more than 2 per cent of GDP and may be less than 1 per cent. This benefit must be set against losses from failed reform policies in areas like the financial sector and cable TV/telephony.

Third, Treasury quotes estimates published by the Australian Competition and Consumer Council (ACCC) to suggest that, on average, airfares have been reduced by deregulation by around 20 per cent. The ACCC's predecessor, the Prices Surveillance Authority has already acknowledged that its estimates do not represent an index of prices paid by passengers, but a measure of revenue per passenger kilometre received by the airlines. The increase the proportion of travellers buying discount fares under restrictive conditions, rather than full economy or business class fares, means that revenue per passenger kilometre has declined independently of changes in prices. A true price index, which measures the cost of a given basket of services, is presented in my article Evaluating Airline Deregulation in Australia (Australian Economic Review 30(1)). It shows that although some fares have risen and others have fallen, on average prices have barely changed since deregulation.

Finally, the relatively low unemployment rates of the United States, the United Kingdom and New Zealand are quoted to show the benefits of labor market reform. Australia's own experience, where the move to enterprise bargaining appears to have raised the 'natural' rate of unemployment by at least 1 per cent, is not discussed. What the overseas models really show is that official unemployment rates can be cut by reducing or eliminating unemployment benefits. The unemployed do not necessarily get jobs as a result. Many leave the labour force, and live on other welfare benefits or, as in the United States, on the proceeds of crime and begging. For New Zealanders, migration to Australia provides an attractive option. The Treasury acknowledges that New Zealand's reduction in unemployment has been achieved despite the fact that growth in GDP and employment have been weaker than in Australia; over the last decade New Zealand's performance has been worse on both an absolute and a per capita basis.

In Australia and overseas, there is very little to show for a decade or more of microeconomic reform. The signs that the government may be prepared to declrae victory and abandon the struggle would be welcome if the focus on microeconomic reform was replaced by a serious commitment to full employment. Unfortunately, there is little likelihood of that.

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