Flexibility will keep us afloat in economic storm
Committing to a floating currency was one of the most important reforms of the Hawke-Keating era. Since that time a flexible currency has largely shielded the economy from various adverse international events.
Now the dollar is high and somewhat volatile. It is being blamed for various economic ills; some believe that Australia suffers from Dutch disease. Yesterday we heard that 1000 jobs had been lost. Last week it was 400. There will be more to come. It appears that manufacturing is being hollowed out while mining is prospering.
Although the emphasis is on manufacturing, job losses could occur across several sectors. Tourism and tertiary education, for example, are exposed to the dollar. This should be particularly troubling for the government. Treasury modelling showing the benign impact of the carbon tax is predicated on those industries expanding even in the face of a high dollar.
The fact of the matter is Australia faces several economic challenges. Not all of these are related to the dollar.
Western Europe is locked into a sovereign debt crisis exacerbated by the single currency, while the US largely faces a political crisis over the future of fiscal policy. It certainly looks as if the US will fall back into recession and the fallout will affect Australia to some extent.
All industries and business models that have high overheads are particularly challenged by the internet. This creative destruction would occur anyway but has come at a particularly bad time.
Australia itself faces a very different set of macro-economic challenges. Low growth combined with high inflation and rising unemployment means that Australia has a stagflation problem. This is more or less a direct consequence of the Keynesian fiscal policies that have been pursued since the financial crisis.
With bad news on the international and domestic fronts, there is good reason for business and consumer confidence to be low. In this environment, the high Aussie dollar makes pre-existing problems worse. Australian real interest rates are high relative to the rest of the world, which means our dollar is going to be high too. This is an additional burden on business; it is not the only burden or even the primary burden.
The government should avoid those policies that are likely to provide short-term relief from exchange rate volatility at the expense of long-term economic prosperity. Schemes to prop up dying industries will simply postpone the pain associated with economic change.
The notion that mining firms should invest in manufacturing to provide employment would result in long-term economic losses that would undermine the mining industry. It is really just an additional form of taxation.
Other proposals usually include building up sovereign wealth funds. The best sovereign wealth fund the nation could have is a budget in surplus.
The best defence against economic turmoil is a flexible and prosperous economy. A generation of economic reform and a budget surplus worked to shield Australia against the effects of the GFC. The economy survived despite the massive fiscal stimulus, not because of it. We are not as well-placed to survive another economic crisis.
It is well-recognised that productivity growth has been disappointing during the past decade. It turns out those policies to address poor productivity will also assist business dealing with the high dollar.
Those businesses that are flexible, innovative and entrepreneurial will better handle a period of high and volatile exchange rates. The impediments to entrepreneurship are well known. Excessive government intervention and too much spending financed by too much taxation act as a drag on the economy.
Kevin Rudd used "This irresponsible spending must stop" as a slogan, yet it is now an economic imperative.
Debt and deficits crowd out private economic enterprise. This is always true, even if an economy is not at full employment.
Excessive labour market regulation makes it difficult to employ workers at a value-adding wage. Although Work Choices was a massive over-reach, the present government has swung the pendulum too far in the other direction. Not nearly enough has been done to reduce red tape. Corporate tax rates remain far too high while payroll tax is a tax on employment.
Schemes to introduce new mining taxes and complex derivative instruments on greenhouse gases driving up energy prices are exactly wrong given our economic circumstances.
The events in Europe and the US are beyond our control. Excessive government intervention, too much spending and taxes that are too high, however, are within our control. Maximising the flexibility of our economy and economic institutions will ensure that the economy is able to weather storms beyond our control while dealing with an exchange that is likely to be high and volatile during the next decade or so.