The view on: Australia’s economic future, with Dr Ken Henry (part 2)

AAP

Welcome to part two of our interview with Dr Ken Henry, the latest in our series of video collaborations with SBS.

In the first part of his interview with SBS business business journalist Ricardo Gonsalves, Dr Henry discussed how Australia’s economic future should be connected to the rise of the Chinese middle class.

In part two, he says the Reserve Bank has room for further interest rate cuts; that “it is inevitable” the GST will have to be broadened; and it is “extremely unlikely” Australia will fall into recession.

Dr Henry: recession in Australia is “extremely unlikely”.

Full video transcript

Q: Ken, we’ve seen a weakening Australian dollar, just recently St. George became the latest to revise down its forecast to 92 US cents by the end of the year. At what level will the Aussie (dollar) need to be to help business become more productive internationally?

A: Businesses need to restructure. Businesses need to find a business model that is likely to be successful if the Australian dollar remains elevated relative to the average of the 1990s. Whether it’s 92 cents or whether it 102 cents against the US dollar. Many businesses are going to need a business strategy that is different from the one they found successful in the first decade of this century.

Those that are likely to be successful, as I said earlier, are those that understand what is going on in Asia, but let me just say a little more about that. The trick for business success, and I’ve seen this with Australian businesses operating in Asia as recently as last week when I was talking to some business people in Hong Kong, well indeed in Shanghai and then in Hong Kong. What they are doing is, they are developing strategies that will see them become integral parts of regional, and in some cases, global supply chains.

They’re identifying niche market opportunities in which Australian expertise is acknowledged and Australian expertise is highly valued. The level of the currency is a consideration, but you know in the list of things that really matter in executing that strategy, the level of the dollar might be number five, it’s certainly not number one.

Q: Do you see the need for further interest rate cuts locally?

A: I think what I’d say about that is the Reserve Bank of Australia retains the ability to cut, if necessary, and perhaps unlike some countries in the world, monetary policy retains effectiveness in Australia. That is to say, if there were to be a further cut in interest rates in Australia, you could expect it so see a positive, have a positive impact on economic performance. As you know, many countries around the world have been in the position for quite some time now where cutting the official cash rate of interest just doesn’t do anything and they’ve engaged in quantitative easing and other mechanisms in order to try and stimulate those economies.

Q: An interesting note I saw recently, Goldman-Sachs predicting a 20% chance Australia will fall into recession. What do you think?

A: Does that mean an 80% chance we won’t fall into recession?

Q: But are people actually saying that Australia could fall into recession?

A: Well, people are talking about it. I mean, I read it in the newspapers almost every day, the possibility the Australian economy will go into recession. Of course, you can never say that it’s simply impossible, of course it’s possible but look, it’s extremely unlikely. It is extremely unlikely.

I think the reason why it has resonance though, and this is a very serious point, that the reason it has resonance is that people understand, or at least they are beginning to understand, that in order for the mining sector and mining-related construction activity, those sectors of the economy to expand … in order for them to expand in an economy that was already pretty close to full capacity - you go back to late 2003, 2004 and 2005 (and) this economy was already at a pretty full capacity and some sectors of the economy were then expanding - how does that work?

It only works if other sectors of the economy are contracting. So then people ask themselves the question, suppose the other parts of the economy are contracting, what happens if mining and mining-related construction activity stops expanding? Doesn’t that mean then that the economy overall is contracting? And actually, yes. If that were to happen, then yes indeed.

If those contracting parts of the economy were not to start growing again and if the resources sector and the mining related construction sectors of the economy were to stop expanding, to stall, then you would see a recession. But it would take a particularly peculiar [laughs] set of circumstances to produce that outcome. More likely we will see the other sectors of the economy pick up growth, grow more quickly even as the resources sector slows down.

Q: Well share markets and investors are on tenterhooks waiting for the federal reserve to decide what it’s going to be doing with quantitative easing later this week. Do you expect there to be a tapering?

A: This is a very difficult judgement call, and again, I’m not trying to duck this question, I genuinely think this is a very, very difficult judgement call. The United States still has a very high rate of unemployment and with present rates of labour force growth, it is difficult to see the United States making substantial in-roads to that unemployment rate.

The US economy went into recession in 2007, it’s six years after the recession and the unemployment rate is about three percentage points above where it was before the United States economy went into recession, and that’s the unemployment rate. There are also a lot of labour that’s been discouraged from the labour market, that’s left the labour market. So if you were to look at the true increase in unemployed population, it’s a much larger impact than that, and it’s six years after the recession hit in the United States.

It’s going to take the US economy a long time to work through this particular problem. One can understand, particularly with the state of the US Congress frankly, one would understand why someone with Ben Bernanke’s responsibilities would use any instrument at his disposal in order to try and keep this growth going because the economic and indeed social implications for the United States of not being able to get that unemployment rate down more quickly, they could be truly worrying. Is it time for him to taper? I reckon he would want to be tapering as quickly as he could, I don’t think there’s any central banker anywhere in the world who actually enjoys quantitative easing.

Q: And just finally, in terms of the tax system, do you think there should be any more changes to the GST?

A: Let me say it‘s inevitable. The base of consumption tax does need to be broader in this country, it will have to be broadened in this country over time and the rate of taxation applied to consumption will have to be raised over time.

Q: To what level?

A: I don’t know. Let me try and answer that question this way. You recall when the first inter-generational report was published in 2002 and then another was published in 2007 and another published in 2010.

Every one of those intergenerational reports pointed to the impact on budget, well it was the commonwealth budget but the state budgets are effected as well, the impact of population aging. And what those reports identified was an emerging funding gap over a 40-year period of close to more than five percentage points of gross domestic product. At the moment I think we’ve got a revenue to GDP share at the commonwealth level in Australia, I think it’s 22.5%, something of that order.

Just in order to address the budgetary impacts of an aging population, unless we can find some other way of supporting the aging population, for example, a way of growing the economy faster so we don’t have to increase tax rates in order to get more revenue, we’ve just got a bigger tax base because the economy is growing faster due to productivity reforms and through reforms to participation.

If we can do that, great, but if we can’t do that then we know and these intergenerational reports have been saying it for more than 10 years now, we’re going to have to find another five percentage points of GDP in the form of government revenue. We’re going to have to lift average tax rates by five percentage points, now which tax bases would you be targeting if that was your job? If your job was to find a way of increasing that tax to GDP ratio in Australia in a way that does least economic damage which taxes would you target? Would you be increasing personal marginal rates of tax? I don’t think so.

Would you be increasing the company tax rate? I don’t think so. There’s only two things left: land and natural resources and in the tax review published in 2010 we spent quite a lot of time talking about the need for a heavier taxation on land and natural resources. It hasn’t gone terribly well, I have to say, not politically it hasn’t. And the only one left is consumption. You can call them all sorts of weird and wonderful names, you can even call them levies, but at the end of the day there’s only four things you can tax.

Q: So is there an urgent need for that to be changed?

A: Urgent need? Well that’s a question … the urgency relates to the time period over which the budget should be brought back into surplus. I’m not uncomfortable with what is in the budget papers. I would feel more comfortable I guess, had the surplus already been delivered, but I understand why it hasn’t.

That is, I understand the economics of why it’s been rather difficult to deliver a surplus. But the surplus is in prospect and the pace of return to surplus is something one can be broadly comfortable with. I don’t identify an urgent need to lift the taxation burden but there is an increasingly urgent need, let me put it that way. Particularly because although this problem was identified more than 10 years ago back in 2002, one has to say there has been very, very little action to address the problem. So we’re 10 years in, another 30 to go.

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