On Wednesday 18 October 2023, Academy President Professor Richard Holden FASSA addressed to the National Press Club, asking ‘Is Australian Economic Exceptionalism Over?’.
Thank you to the Club for this opportunity, and to Misha for that generous introduction. Let me begin by acknowledging the traditional owners of the lands on which we meet, the Ngunnawal and Ngambri People, pay my respects to elders past and present, and extend that respect to other First Nations People present today.
Beginning in 1991, Australia went three decades without a recession. And that streak was only broken by a once-in-a-century pandemic. Can we do it again?
This taming of the business cycle was remarkable by historical and international standards. For instance, the United States had 2 recessions while Australia kept a clean sheet. One of those US recessions, triggered by the 2008 financial crisis, was deep and long-lasting. Historically, in OECD economies the average length of an economic expansion is five and a half years.
Australia’s economic performance from 1991 to the pandemic was exceptional. Sure, there was an element of luck involved. The remarkable rise of China’s economy drove a huge export boom for Australia. But there was a lot more good design than there was good luck.
The modernisation of Australia’s economy that began in 1983 made the economy more open, dynamic, and resilient. The advent of inflation targeting by the Reserve Bank in 1993 allowed for more effective monetary policy. And the introduction of the GST in 2000 improved the efficiency of our tax system.
But, as has been pointed out by numerous commentators, it’s been two decades since our last major economic reform. Good economic management isn’t just set-and-forget. The reform process doesn’t have to be constant, but it can’t be absent.
Since our last major reforms, our tax system has become dated, bordering on obsolete. Our company tax rate has gone from among the lowest in the OECD to among the highest. Our comparatively low GST rate and coverage puts more pressure on personal income tax to deliver revenues—yet this acts as handbrake on work and workers.
At the same time, our political processes and culture make major reforms challenging to pull off. Several governments have dipped their toe in the water with significant ideas, only to find that political water pretty icy.
Our inability to make major reforms is a significant risk. Every year that we are unable to enact important reforms increases the chance of a recession if we are hit by a global or domestic shock.
Now, one of the great lessons of economics in recent decades has been to understand the relationship between politics and economics. The late, great Harvard professor Alberto Alesina showed how important that relationship is—and that it runs two ways: from politics to economics and from economics to politics. Despite that fact, and despite Alberto’s influence on me personally, I will refrain from speaking about politics and the political process today. Instead, I will focus on our economic opportunities and challenges.
We face formidable challenges, but we have significant opportunities.
We may need to become a green energy superpower to replace the large economic contribution of our fossil-fuel industries as the world decarbonises.
The decline of student performance relative to other countries, and in absolute terms, will need to be reversed.
Productivity growth will need to be significantly enhanced.
We will need to adapt to an aging population.
And we will need to reconfigure our global supply chains.
Yet Australia possesses an extraordinary endowment of natural resources required for a decarbonised global economy.
We have a long history of stable and high-functioning institutions.
And we remain one of the most attractive places in the world to live—at least if you can actually afford to live here.
In the remainder of this address I’ll outline what I see as a path to continued Australian economic exceptionalism, and I will focus on 5 main areas: productivity, education, decarbonisation, an aging society, and global supply chains.
I began by noting our incredible run of economic success, and asked “can we do it again?”
I’m an optimistic person by nature, so my answer is going to be yes. But I’m a skeptical person by training, so I’m also not going to pretend it’s going to be easy.
Australia’s labor productivity has averaged just 1.2% since 2005. That’s about half the rate we achieved in the 1990s. But it’s important to realise that we’re not alone. Over the last 10 years labor productivity has been even lower than Australia in Canada, Germany, France, Italy, Japan, New Zealand, and the UK.
So whatever is going on here probably bears some similarity to what is going on in all advanced economies. Things like the rise of the services economy and technological shifts.
The reason this matters is because, as Paul Krugman said long ago: “A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”
And seemingly small differences in annual rates have big medium-run effects. If we grow productivity at 2.5% a year, living standards will double every 28 years. If we grow productivity at 1% a year, our living standards will increase only by a third over the same period.
If that isn’t enough to grab your attention, former Reserve Bank governor Philip Lowe has pointed out that if productivity doesn’t pick up then inflation is likely to be higher than it otherwise would, necessitating higher interest rates.
So what can we do? The Productivity Commission has carefully and consistently documented several important things we should do. Increasing business dynamism, encouraging better matches between workers and firms, and improving human capital through education and training are all important ideas. We should embrace them properly and in earnest.
And the Australian Government has a stated intention to champion R&D, with a target of doubling national investment to 3% of GDP, to keep Australia at the cutting edge of innovation.
But the scary thing is that might not be enough.
In a provocative paper last year NYU economist Thomas Phillippon suggested that productivity growth might be linear, not exponential. So the compounding one gets from the standard model might just be wrong. Now there are some caveats around that paper, but it makes one think. If its basic point holds up then we have historically relied on big innovations like electrification of homes and industries, or the personal computer revolution, to get historical levels of productivity growth. Absent big innovations we actually get very modest growth.
So what might be our next, big step-change innovation? Arguably it’s artificial intelligence, but not in the way you might think.
Economists Ajay Agrawal, Joshua Gans and Avi Goldfarb argue that large language models, like GPT-4, are best thought of as “prediction machines”. What AI does is reduce the cost of prediction – often dramatically. That’s very useful, but by itself probably doesn’t get us a big leap in productivity. But if organisations (businesses, schools, hospitals, government departments) can use the better predictions to reorganise their processes then the leap in productivity might be dramatic.
Agrawal, Gans, and Goldfarb illustrate this with two examples. The first is electrification. Electric power was developed in the 1890s. Now, electricity is better than steam power because it loses less energy. So factories gained from removing steam power and plugging in electric power.
But the big productivity gains came because electric power allowed factories to be completely redesigned. They could be moved away from water sources. They could be laid out in one big floor rather than on multiple floors to keep production processes close to the single steam power source. Suddenly the modern assembly line and mass production became possible.
Their second example comes from the 2021 New Zealand America’s Cup team. Team New Zealand used AI to run 24-hour a day simulations of optimal racing tactics. The crew learnt a lot from this. But the big payoff came when they realised that boat design could be improved by understanding the feedback loops between design and tactics.
The lesson here is that to turbocharge the benefits of AI we need to connect better prediction with improved design (of boats, of factories, of organisations) and create a virtuous feedback loop.
This will take policies that don’t place too many regulatory burdens on the use of AI, that empower organisations to redesign their operations, and help cushion the blow on those that lose out from the redesign.
First, the bad news. Educational outcomes—at least as measured by standardised tests—have been declining. Since international PISA tests began in 2000, Australia’s educational standing has been in constant decline relative to our peers. In 2000 there were 35 countries with lower PISA math scores than Australia. Since then 16 of them have overtaken us.
We’re also doing worse in absolute terms. From a starting point of a little over 500, our math scores have fallen by 33 points, reading scores by 26 points, and science scores by 24. The proportion of low performers has increased by between 6 and 8 percentage points. The proportion of high performers has fallen by between 4 and 9 percentage points. The proportion of students attaining the National Proficiency Standard has fallen by between 9 and 13 percentage points.
The news is better when it comes to NAPLAN scores. For year 9 students, who are basically the same age as PISA students, average scores have been flat since 2008 when testing began. Why have NAPLAN scores remained constant while PISA scores have declined so much? The answer lies in what they test. NAPLAN is a basic skills test, while PISA tests higher-order thinking skills and the ability to apply knowledge. PISA is designed to test how well students can extract information from what they’ve learned and apply that knowledge in unfamiliar settings.
Basic skills are, of course, important. But they are a platform for the higher-order thinking skills that provide the basis for further study or training, and are essential to developing the human capital required for better, higher-paying jobs.
Anyone who runs a business knows the importance of higher-order thinking skills in their employees. Anyone who teaches in a university knows the importance of higher-order thinking skills in their students. As President of the Academy of the Social Sciences in Australia, I regularly speak about critical and contextual thinking, communication and problem-solving skills as hallmarks of training in the social science disciplines.
And I submit that over recent decades, people in both those sectors have seen exactly the kind of changes in their employees and their students that our PISA scores suggest.
The good news is there’s excellent evidence from overseas about what works in education. As with any policy question, to know what educational interventions work we need to understand the causal effect of the intervention on outcomes.
The best way to do that is through a randomised controlled trial (or RCT). To understand the causal effect of heart medication on cardiac outcomes researchers assemble, say, 200 people and randomly assign 100 to a treatment group that get the heart medication and 100 to a control group who get a sugar pill. The average number of cardiac events in the treatment group minus that average in the control group is the causal effect of the heart medication.
Economics of education researchers began applying these techniques more than 20 years ago. Rather than rely on observational data—or worse still, anecdote, they began running RCTs in education. And they have demonstrated how effective some educational interventions can be. Among the most effective are high-dose tutoring, managed professional development for teachers, frequent feedback for students, the use of data to guide instruction, and reduced class size.
The last one—class size—might surprise you as the conventional wisdom in Australia is that class size has no effect on student outcomes. This was also the conventional wisdom in the United States at one point. But high-quality RCTs show that reducing class size by about 25% has a big impact on student outcomes.
That’s instructive because it points to how misleading conventional statistical analyses can be. And it highlights the need for evidence from randomised trials in education in Australia.
There’s no doubt that the world is decarbonising. And we need to. The debate about whether global warming is “a thing” is over. That’s good. What’s not so good is that we have waited so long to take serious action that we have a very large challenge in front of us and a very short time in which to complete it.
To achieve net zero emissions by 2050 and to get our grid to 82% renewables by 2030 is a scientific, engineering, economic, and logistical challenge of staggering proportions. Although when I look around Australia—indeed when I look around the UNSW campus—I’m amazed by our scientific accomplishments and progress. Yet we should not underestimate the scientific challenge.
But even setting that aside—and assuming success—we will be faced with one of two economic scenarios. Scenario 1 is that the world also moves to net zero and our fossil fuel industries will have essentially no export destinations. Now, there’s a difference between gross zero and net zero. But basically we would then have to fill a whole in our economy that is about 15% of GDP.
Critical minerals are an exciting opportunity that has already been recognised. And Australia will likely be some part of the global electric-vehicle battery supply chain. But it seems rather unlikely that we will be a major battery manufacturer.
Then there is the prospect of Australia becoming a “green energy superpower”. True, we have some natural advantages like sun, wind, and cheap land. But it takes more than those natural advantages to pull off a technical revolution.
It takes a visionary who can coordinate all manner of different actors. Steve Jobs did that for personal computers. But let’s not forget that there were plenty of hobbyists and enthusiasts in Silicon Valley in the 1970s. Yet it wasn’t random enthusiasts at the Homebrew Computer Club, but Steve Jobs that changed the world. And Jobs was not an enthusiast, he was a revolutionary. Who will be our Steve Jobs?
Scenario 2 is that a meaningful portion of the rest of the world doesn’t decarbonise and our mining exports are still viable. But given that we don’t know which scenario will occur—and we can’t wait to find out—we will have to have green energy superpower capability on hand just in case. Assuming that’s possible.
You can see that I think decarbonisation is completely crucial. But it’s here that the execution challenges of decarbonisation and then replacing all the lost GDP that will be perhaps the largest we face in coming decades.
An aging society
Like many countries, Australia’s population is aging. In 1996 12% of the Australian population was over 65. Today that number is 16%. A generation from now, in 2060, it’s projected to be 20%. The population over 85 was 1% in 1996, is now double that at 2%, and by 2060 is projected to be around 4%. And, of course, because the total population is rising, there will be a lot more elderly Australians. We have fewer than 600,000 Australians over 85 today. In 2060 that is projected to be more than 1.5 million.
We will have a lot more older Australians to care for in the coming decades.
The starting point in any discussion about this must be that every Australian deserves to age with dignity. We have seen, sadly, that we are not doing an adequate job of this at present. Yet the task is only going to get more challenging. This is going to cost a lot of money. And there’s really no getting away from that basic fact.
Now, if we can deal with the other challenges I have outlined and keep our economy moving, then some of these costs can be paid for out of the prosperity generated.
But if that’s not enough then we are going to be faced with some harder questions. One is whether it’s right for people to die with significant superannuation balances while younger Australians fund their aged care. This is an intergenerational equity issue. It’s also an efficiency issue because of the additional tax burden on younger Australians.
There is, though, a broader point here. The relative prices of the things that government buys have increased a lot. Former U.S. Treasury Secretary Larry Summers has a nice way of illustrating this.
In the U.S. the quality-adjusted price of a television has fallen 25-fold since 1983. The price of a day in hospital has increased six-fold. So there’s been a 150-fold change in the relative price of TVs and a day in hospital.
Another way to see this is to note that if the price of cars had fallen as rapidly as the price of computing power over the last 4 decades, then a nice car would now cost 5 cents. This is, of course, due to Gordon Moore’s famous observation that the number of transistors that can be etched onto a microchip tends to double every 2 years.
Now we can quibble about differences between Australia and the U.S. in terms of hospital and TV prices, but there is no escaping the following basic truth. There is no Moore’s Law for most of what government buys. So not only are the demands on government going to increase substantially, so is the relative price of those demands.
This all brings us back to the importance of productivity growth. And, in particular, the importance of productivity growth in the services sector. Achieving productivity growth in the services sector is not an easy task, but it is possible.
What it will almost surely require is more automation in sectors like aged care. That won’t be a job killer because the demand for aged care will rise so dramatically. Government services, in general, will need more capital and more labor. Sometimes that will involve technology that substitutes for labor. An example of this is pill-dispensing robots in Japanese healthcare, freeing up the time of medical personnel to perform other tasks.
And in other instances labor and capital can be complements, not substitutes.
A good example of this is DaVinci surgical robots. Rather than replace surgeons they allow surgeons to work with greater steadiness and precision, leading to improved accuracy, shorter recovery times, and less pain.
This also brings me back to artificial intelligence. If we can get dramatically better prediction then we could see large efficiency gains in the services sector. If that allows for processes and organisations to be redesigned then we can turbocharge those efficiency gains.
In short, I’m pretty optimistic about the prospects of increasing productivity in the services sector.
We’re all familiar with how the coronavirus pandemic disrupted global supply chains. In the pre-pandemic era of seemingly unfettered globalisation, and armed with sophisticated IT systems, companies had fine-tuned “just-in-time” supply chains. This cut down on inventory, thus reducing working capital requirements. It was one of the unexpected upsides of globalisation. But, as we discovered, in a world where a major pandemic can occur, this is cutting things too fine. Supply chains need to be a little less just-in-time and a little more just-in-case.
Firms have done or are doing this, and they have every incentive to do so. This is how things are supposed to work: get an update on the possible risks, and re-optimise.
But a bigger issue looms. International trade has now been—or is in the process of being—weaponised. It now seems almost inexplicable that Germany became dependent on Russia for 55% of its natural gas. Equally inexplicable is how the United States became dependent on Taiwan for 95% of its advanced semiconductors. Of course, Taiwan is a friend of the United States—but I think you get the point. Geopolitics can have dramatic consequences for trade.
Of course, these decisions were made at a time when the prevailing wisdom was that trade prevents war. Perhaps now we’re in a world where war prevents trade.
And in such a world there will be—and there already is—a desire to ensure continuity of supply. One way to do this is though so-called “reshoring”—making certain that there’s adequate domestic manufacturing capability. Another is through what has become known as “friendshoring”. One doesn’t have to have domestic capability—just a stable trading relationship with a country that does.
As an economist, the retreat from globalisation makes me, well, a little bit sad. But as a realist, one simply can’t ignore the need to diversify our global supply chains.
The crucial thing is to do this in a smart way. We should not reshore something that we can safely friendshore. For instance, there is simply no sound case for a domestic Australian semiconductor fabrication capability.
In other industries, we will probably end up manufacturing things that we used to trade internationally.
This is like buying an insurance policy. It’s smart. But it’s not something to celebrate. I don’t know anyone who celebrates paying their car insurance.
Now, in a narrow sense it might look like it creates some jobs. But it also means we’re not doing other things at which we’re relatively better—at which we have a comparative advantage. We lose from de-globalisation. It’s something to be managed, rather than letting it manage us.
Beginning in 1983 Australia opened up to the world. We became a dynamic and vibrant economy. We cut tariffs and increased exports. We benefited enormously from globalisation. And the economic prosperity that flowed helped build one of the world’s great social safety nets. There’s no doubt that safety net needs to be improved in various important ways. But we won’t be able to do that without economic prosperity.
During this period we had governments from both sides of politics that embraced markets, but knew that sometimes markets fail and need correction. These governments both had extraordinary prime minister-treasurer teams. And they passed crucial economic reforms.
But they weren’t neoliberal. When Ronald Reagan said “government is not the solution to our problems; government is the problem”, that was neoliberal. When Margaret Thatcher said “there’s no such thing as society”, that was neoliberal.
I began by asking whether Australia can replicate our economic success of the past 30 (or really 40) years. Can we go another 30 years without a recession? Yes, we can. But not if we turn our backs on what made those years possible.
We need to update our economic approach, but not uproot it. We need to adapt to the present, but not abandon the successes of the past. But if we do that then Australian economic exceptionalism is definitely not over.
Feature image by @hil_clix_pix.