Flat economy will continue to challenge the Victorian government

External economic pressures, including a high Australian dollar, will pose challenges for the Napthine government. AAP

The last two years for Victorians and the Baillieu government have been challenging, with a flat economy and tight budget constraints. The next few years for the Napthine government are likely to involve similar challenges.

Using the broad macroeconomic indicators, the Victorian economy was close to stationary over 2011 and 2012. Aggregate employment was almost constant, the unemployment rate rose from just over 5% to over 6%, and state final demand was little changed with falls in the last two quarters of 2012. The manufacturing and home construction industries experienced declines, but most other sectors of the economy have benefited from higher sales and investment.

Some (but not all) of the external pressures on the Victorian economy to change and adapt to new global and Australian economic conditions over the past two years are likely to affect the opportunities and challenges for the next few years. Completion of the investment stage of the mining boom, and then the resulting increased production stage in coming years, is likely to maintain the high value of the Australian dollar well into the future. Continuation of a high dollar will continue to squeeze returns of the non-mining export sector and the import competing sector, especially those parts which are relatively labour intensive and using low-level technology.

At the same time, the rapid growth of China, India and other developing countries that lie behind the mining boom has benefited the Victorian economy and opens new opportunities. First, expansion of mining in other states generates new market opportunities for manufacturing, business services and construction in Victoria and other states to service the mining investment. Second, some of the benefits of the higher national income generated by the mining boom are spread via taxation and higher personal incomes to an expanded demand for the non-traded sector, including services. Third, households and businesses have benefited from lower prices for imported goods and services driven by the higher exchange rate. Fourth, the rapid development of economies in Asia and the increased number of higher income middle class consumers opens new and expanding markets for Australian agriculture, services and high technology manufactured products. Many of these new opportunities will be grasped via joint ventures.

A major challenge facing the Australian economy — particularly the Victorian economy — has been the stagnation of productivity growth this century. The increase in the terms of trade to record high levels over the last decade largely drove higher living standards over this period rather than productivity growth, but this is likely to be eroded in the coming years.

Restarting productivity growth is vital if Victorians’ increasing expectations of higher income are to be realised. There is a major challenge for the government, businesses and individuals to better respond to changing markets and buyer needs, to adopt new technology, to change management and work practices, and to allow the transfer of resources and industries from less productive to more productive uses.

On a more cheerful note, the household saving rate, which increased from zero or less at the turn of the century to over 10% of household disposable income last year and now is close to historical high levels, is likely to stabilise. Household expenditure can be expected to expand along with national income. The increase in household expenditure should be good news for retailers, the home construction industry, and for GST revenue for the government.

The Victorian state budget has been challenged by static revenue, ever increasing Commonwealth intervention on spending initiatives via commonwealth special purpose payments, and higher expenditure demands in education, health, policing and transport. With a determination to run a budget surplus and not increase its own taxation, the government responded by tightening expenditure programs, including tough bargaining on wages for public servants. More of the same tough government spending decisions are to be expected in the future.