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					 ECONOMIC PROSPECTS AND POLICY
         CHALLENGES




ADDRESS TO THE AUSTRALIAN BUSINESS ECONOMISTS

                   SYDNEY

                 20 MAY 2003




                 KEN HENRY

         SECRETARY TO THE TREASURY
                                                  2

ECONOMIC PROSPECTS AND POLICY CHALLENGES

This year, I want to address four topics. As usual, I will say a little about our short-term economic
performance and prospects. I will then share with you some reflections on the CGS review. In my
third topic I will return to some of the longer-term economic developments that I referred to briefly
twelve months ago. Finally, I will say something about the policy challenges posed by those
longer-term developments.

Short-term performance and prospects

We put last year‟s Budget together against a backdrop of a strongly growing domestic economy and
a world economy that was showing tentative signs of recovery. The Australian economy was
growing by over 4 per cent and the worst of the global downturn looked to be over: the United
States had recorded a couple of strong quarters of growth, Europe and Japan had started to grow
again and the Asian economies were growing strongly. We flagged a number of risks – both upside
and downside – but we were cautiously optimistic that the world was going to pick up,
underpinning solid domestic growth.

How the outlook has changed (Chart 1).

We have seen the major economies lose momentum. Growth has slowed to a crawl in the United
States, Japan‟s economy has stalled, again, and Germany has just recorded a negative quarter.
Since last Budget we have shaved off around 1 percentage point from our world growth forecast for
2003; 1¼ per cent for the United States; ½ per cent for Japan; and 2 per cent for the Euro Area.

Not only have our central forecasts been pared back, but the downside risks to those forecasts have
also increased, significantly.

     The major economies seem to have lost traction.

     Even if the major economies do pick up in the short term, they face major structural
      impediments that could prove to be a drag on growth for some time: in the United States, an
      historic current account deficit; in Japan a debt overhang; and in Europe widespread structural
      rigidity and emerging financial system stress. Some of these risks have been around for some
      time – as usually happens, they come to the fore when cyclical conditions are less benign.

     And there are geopolitical risks. How will developments in the Middle East play out? What
      will happen on the Korean peninsula? How will the prospect of ongoing security concerns
      affect global travel and trade? How will SARS affect regional growth?

These international developments have had an impact on the domestic economy, and the risks have
implications for our thinking about domestic prospects (Chart 2).

Other factors affecting current and prospective domestic performance include:

     The drought. This wasn‟t on anyone‟s radar screen at the time of the last Budget, but has
      turned out to be the most extensive in our recorded history. It has wiped around 1 percentage
      point from GDP growth this year. If the drought breaks, as now seems likely, we should see
      some recovery next financial year. But there are risks: large parts of the country are still
      drought declared, there is limited availability of stored water and the timing and distribution
      of future rainfall is uncertain.
                                                         3

     Security and health concerns. These have made us re-examine the prospects for tourism, and
      the contribution it might make to growth next year.

     The exchange rate. Last year our Budget assumption was an exchange rate of US53c and a
      TWI of around 52. In this year‟s Budget we used an exchange rate of US60c and a TWI of
      around 55 – the average of the past couple of months. Today, the exchange rate is in the mid-
      60s against the $US.

     A surge in investment in medium-density dwelling. The surge continues even as vacancy
      rates increase and yields fall. A correction at some point is in prospect.

The risks are substantial, but I don‟t want to sound too negative. Underlining the benefits of many
years of economic reform, we came through the Asian financial crisis with flying colours; we came
through a global slowdown in 2001 in good shape; and we recorded solid growth this year despite a
weak world economy and one of the worst droughts on record. Investment has been strong,
unemployment is low and inflation is moderate. Even with a difficult external environment we look
set to record solid growth again next year. Solid, but not spectacular. Note, especially, as Ross
Gittins did yesterday1, what our forecasts are saying about non-farm GDP growth: falling from 4
per cent in 2002-03 to 2¾ per cent in 2003-04. This is only one half of a percentage point higher
than what was achieved in 2000-01.

CGS review

You would, by now, be familiar with the Government‟s decision to maintain a substantial stock of
CGS to support the Treasury bond futures market. Rather than go through the details of that
announcement, I thought I might say something about what we have learned from the consultation
process.

In excess of 90 organisations participated in the review. Our assessment is that the process worked
well – due, overwhelmingly, to the quality of the working relationships that developed between the
review team and stakeholders. To all of those who were involved in the consultations, I would like
to offer my thanks.

The consultation environment allowed for frank and open discussions. It encouraged understanding
of the views of the different parties. And it exploited their comparative skill and knowledge
advantages.

A useful measure of the effectiveness of the consultations is the way in which the focus of the
review was refined over time. Initially, there were some eight potential roles identified for the CGS
market. As the arguments were examined and tested in consultations, the number of core issues was
reduced to three – managing interest rate risk, financial sector stability during times of uncertainty
and, to a lesser extent, the pricing of other financial products.

I have noted that good working relationships were established in the review process. Nevertheless,
it would be worth remarking that when the consultations began some stakeholders appeared
unfamiliar with the role of policy advisers. Policy advisers do not make policy. Rather, they have a
responsibility for ensuring that government is fully informed of the range of policy options and the
benefits, costs and risks associated with these options. Governments make the policy decisions.


1
      Ross Gittins, “A tough, risky fiscal year lies ahead”, Sydney Morning Herald, 19 May 2003, p.31.
                                                   4

So when you work with us in consultations on public policy issues, there are a few things that will
be worth keeping in mind.

First, while we will be interested in knowing your desired outcomes, we will be even more
interested in the quality of your argument. Statements such as „this has never been done before‟ are
not persuasive. They do, however, suggest a case for analytical effort. And that is what we will be
looking for from you. Early in the review proponents of the case for keeping the CGS market were
challenged to support their case with sound analysis. The challenge was issued both by the
Treasurer and in the discussion paper. A number of you rose to the challenge. In this regard, I can
refer positively to work such as that of the CGS Market Industry Working Group, whose analytical
input assisted us greatly.

Second, there is little point in trying to convince us of something by sheer force of will.

Third, you might want to think about the implications for other people of public policy decisions,
and factor into your argument some consideration of the handling of those implications. For
example, in the initial stages of the debt review it was clear that few people had given any
consideration to the risks for the taxpayer of government accumulating a large portfolio of financial
assets to support the CGS market. Yet, as we saw the issues, this was a key one that needed to be
addressed in our policy advice.

The core lessons from the recent experience, then, are these: (1) understanding our role will
improve your effectiveness in public policy consultations; and (2) when we consult with you, we
will be looking not just to harvest your views, but to harness your skills and experience.

Longer-term economic developments

I want to turn now to longer-term economic developments.

In my address to this function last year, I provided a „supply-side‟ decomposition of the contributors
to GDP growth; summarised in the „3Ps‟ of population, participation and productivity. Twelve
months on, the „3Ps‟ framework has been integrated into the mainstream of policy thinking in
Canberra, and in a lot of interesting work now coming out of the OECD. The framework is
particularly useful for considering the causes of divergent growth in living standards among
countries. Today, I want to use the framework to draw comparisons among three countries –
Australia, the United States and Japan. These comparisons are useful for framing consideration of
the various factors impacting our growth prospects and of appropriate policy responses. Today‟s
exercise will draw on some of the commentary provided in this year‟s Budget Statement 4.

First, some revision (Chart 3).

GDP decomposes into a number of familiar concepts: P, the number of people in the population; ,
the proportion of the population that is of working age (which I will take to be 15 years and above);
, the proportion of the working age population that wants to work (that is, the participation rate);
(1-u), the complement of the unemployment rate; h, the average hours worked by an employed
person; and , the GDP produced by an average hour of work (that is, labour productivity).

These six variables may be grouped into three convenient categories – the „3Ps‟.

 Population: The number of people in the population who are of working age.

 Participation: The number of hours actually worked by an average person of working age.
                                                       5

 Productivity: The GDP generated by an hour‟s work.

A similar decomposition is available for GDP per capita (Chart 4) – with the only difference being
that the population factor concerns only the proportion (and not the number) of the population that
is of working age. GDP per capita is driven by the 3Ps.

Whenever economists talk about GDP or GDP per capita they risk being accused of capture by the
material, to the exclusion of the „things that really matter‟. Let me deal with that risk immediately.
I will, indeed, be focussing my remarks on the factors that drive GDP per capita. But this does not
mean that I consider that measure to capture all of the things that affect wellbeing. Because it
excludes non-market transactions, and fails to account directly for environmental degradation and
other factors affecting the real store of wealth, it doesn‟t tell us everything we might want to know
about even the average level of consumption, properly defined. Nor does it tell us much about the
other factors that impact wellbeing: the distribution of income (in a spatial or temporal sense);
levels of risk and uncertainty; levels of complexity; and freedom and opportunity.

So GDP per capita has its limitations as a measure of wellbeing. But here‟s the important bit:
While I will be identifying a number of factors that are likely to have adverse implications for our
future levels of GDP per capita, it would be a mistake to assume that those factors will have
compensating impacts on the other components of wellbeing. Indeed, some of them will have
equally deleterious impacts on those other components. For example, employment is at the core of
the determinants of GDP per capita, but it is also important for distributional reasons. Moreover,
the experience of having a job provides an important degree of protection from economic
uncertainty, welfare dependency, social exclusion and poverty.

A particularly useful concept here is the employment ratio, which is a subset of the participation
category. Specifically, the employment ratio shows the proportion of the working age population
that actually has a job. This is, obviously enough, dependent upon both the participation rate and
the unemployment rate: Our participation rate is currently about 64 per cent. With an
unemployment rate of about 6 per cent, we have an employment ratio of about 60 per cent (.64(1-
.06)). That is, some 60 per cent of working age Australians (people aged 15 or more years) actually
have a job.

I have explained elsewhere2 why there is not a lot that can be done to affect population dynamics
over the next 40 years. But the areas of participation and productivity are of considerable policy
interest.

Chart 5 compares the participation rate performances of Australia, the United States and Japan from
1960 to 2002. In this chart and a number of those following I have drawn vertical dashed lines at
1973, 1990 and 2001. These years have been used to take snap-shots reported in Budget
Statement 4.

No one can prescribe the optimal participation rate for Australia. The welfare-maximising
participation performance would, presumably, emerge in undistorted markets from the preferences
of individuals and families. Yet in my comments today, I venture that the Australian participation
rate is „too low‟, a claim that I will illustrate by comparison over time with the performance of the
United States. This is not to erect the US numbers as a benchmark that Australia ought equal or
exceed: Australians might reasonably have different work-leisure preferences from Americans, and

2
     See, for example, “The demographic challenge to our economic potential”, Chris Higgins Memorial Lecture, 13
November 2002 and Address to the Conference of Economists Business Symposium, 4 October 2002.
                                                   6

different social values about the provision of government services, and the welfare and taxation
policies that strongly influence participation.

But I want to argue that our prospective participation rate, consequent on ageing and the recent
weak participation rate for mature-age male workers, is likely not only to detract from future
increases in living standards, but also to be inconsistent with equitable, flexible access to
employment over longer, healthier lifespans.

Australia‟s participation rate has improved, on average, over the last 42 years. There have,
however, been periods of pronounced weakness: most notably in the second half of the 1970s and
the recessions of the early 1980s and early 1990s. There have been two periods of strong growth –
the decade covering the second half of the 1960s and the first half of the 1970s, and the second half
of the 1980s – both associated with rapidly rising female participation.

But the US participation performance has been much more impressive. The US participation rate
did not deteriorate in the second half of the 1970s, nor in the early 1980s recession, and fell only
marginally in the early 1990s recession.

The Japanese story is interesting: A very large decline through to the mid 1970s from the high
levels of the immediate post-war period, followed by little change until the 1990s when the
participation rate again fell substantially – especially in the second half of that decade.
Significantly, the Japanese participation rate is now noticeably less than ours – a point that I will
return to in a moment.

Let‟s now compare the behaviour of each country‟s unemployment rate (Chart 6). Australia‟s
unemployment rate moved up sharply from 1973, and climbed to about 10 per cent in the early
1980s recession. It fell back some 4 percentage points during the second half of the 1980s before
climbing to around 11 per cent in the early 1990s recession. Over the 1990s the unemployment rate
again fell to a level of around 6 per cent.

The United States performance is rather different: starting the 1960s with a considerably higher
unemployment rate than ours, they went through all of the 1990s with a significantly lower rate for
the apparent reason that their more flexible labour markets facilitated a much less pronounced
unemployment impact from the early 1990s recession. However, since 2001 the United States
unemployment rate has climbed sharply, with very rapid labour shedding associated with the
recession in that country.

And, again, the Japanese story is interesting, with a very low rate of unemployment right through
until the early 1990s, and a steady increase in the rate since then.

It is tempting to conclude that our three rates are converging. But, of course, unemployment rates
are affected considerably by cyclical performance, as the chart illustrates – and the three economies
are not synchronised in that respect.

When we combine the participation and unemployment rates to produce the employment ratio – the
proportion of the working age population that actually has a job – a rather interesting story emerges
(Chart 7).

The line corresponding to Australia is volatile, but doesn‟t reveal much of a trend over the last 42
years. The peaks and troughs do, however, illustrate rather graphically the costs of poor labour
market performance. For example, the plunge in the employment ratio from 1973 through to 1983
                                                   7

took 6 per cent of the working age population out of a job and reduced GDP per capita by
something of the order of 10 per cent relative to what it would have been.

It is on this measure that superiority of the United States performance appears most obvious. In
1973 their employment ratio was 2.6 percentage points worse than ours. By 1990 it was 3.3
percentage points better. For all of the 1990s the employment ratio of the United States exceeded
ours by a considerable margin – as much as 5.8 percentage point, and is still some 3 percentage
points higher despite the 2001 US recession. In the case of the United States there has been a clear
trend improvement in the employment ratio over the last 42 years.

So what about Japan? Well here we can see a clear trend decline in performance – a performance
that should be of considerable concern to policy makers in that country. But Japanese policy
makers are not the only people who should be thinking about appropriate policy responses.

Recall our comparison of participation rates. If you agree with me that Japan has reason to be
concerned about the performance of its participation rate, then you must also agree that they are not
alone.

Chart 8 shows what will happen to the Australian participation rate over the next 40 years simply
because of the ageing of the Australian workforce. Indeed the projection is optimistic since it
assumes that the trend improvement in age-specific participation rates of the last 42 years will
continue, albeit at a slower rate. Despite those age-specific improvements, the overall participation
rate will fall dramatically as workers age.

And why does Japan look so bad relative to us today? Primarily because they have already
experienced much of the ageing impact that is about to hit us. To see this more clearly, consider
Chart 9. Here we have a chart that looks at the participation rates in various age cohorts: 25-34,
35-44, 45-54, 55-59, 60 –64 and 65+. Australia‟s total participation rate is higher than Japan‟s. But
if you look at the age-specific participation rates you can see that in every age cohort, the Japanese
participation rate is higher than ours. And at ages 55 and over the gaps are very large.

In fact, among industrialised economies it is not only Japan that has higher mature age participation
rates than us. Charts 10 to 13 present OECD country participation rates for males aged 55 to 59,
males aged 60 to 64, females aged 55 to 59 and females aged 60 to 64.

In terms of mature age participation rates, we are about middle of the OECD pack. Mature age
female participation rates are very similar in Japan and the United States, while male rates in the
United States lie between the relatively high Japanese, and relatively low Australian, rates.

But these charts tell us nothing about the age structure of the population. What happens to the
overall participation rate is a product of both age-specific rates and the age structure. In the case of
Japan, relatively high age-specific participation rates are nevertheless delivering a declining overall
participation rate – to a level already below ours, driven by population ageing. The entire reduction
in the Japanese participation rate between 1990 and 2002 can be explained by population ageing. It
is not a product of declining age-specific participation rates. The Japanese story, overwhelmingly,
is one of an ageing population. And that is about to become our story.

Back to the employment ratio. Chart 14 shows what is implied for the next 40 years by the earlier
participation performance, on the basis of the Intergerational Report assumption that the
unemployment rate converges on 5 per cent.
                                                           8

In all of the post-War period we have never experienced an employment ratio this low – not even in
recession. Indeed the prospective 2042 level is nearly 3 per cent lower than the low point of the
early 1980s recession. And unlike that low point, it is not a cyclical prospect. It will not go away
with a return to trend growth. Rather, it will be a key factor producing lower trend growth.

Other things equal, this trend deterioration in the employment ratio – due exclusively to population
ageing – will lower GDP per capita by some 12 per cent relative to what would be achieved with
today‟s employment ratio. Of course, other things never are equal.

Recall the components of GDP per capita, and the relationship to the employment ratio (Chart 4).
The three other contributors to GDP per capita are: , the proportion of the population that is of
working age; h, average hours worked; and , labour productivity. The first of these will continue
to increase over coming decades, as the population ages, but will make only a very small
contribution to GDP per capita. Moreover, as noted earlier, it is not susceptible to policy
intervention. Average hours worked is not expected to contribute anything. This leaves
productivity. How have we done relative to other countries in that area?

Chart 15 presents productivity level data obtained from the OECD. The data are normalised so that
the productivity level for the United States in 1995 is 100.3 The gap between Australian and US
productivity levels has consistently been of the order of a quarter. But if you look a little closer at
the chart some interesting pictures emerge. Up to 1973, US productivity growth exceeded ours by a
considerable margin. But since then we have outperformed the United States. In Budget
Statement 4 we present a comparison of productivity levels and growth rates on an „hours‟ basis –
that is, GDP per hour worked. We find that in the period 1950 to 1973, our productivity growth rate
averaged 2.6 per cent a year as against the US growth rate of 3 per cent. Over that 23-year period,
our productivity level fell from 81 per cent of the US level to 73 per cent. But from 1973 to 1990
we outperformed the US with an average annual growth rate of 1.5 as against 1.3, and continued to
outperform in the 1990s with a growth rate of 2.2 as against 1.4 per cent a year. By 2001 our
productivity level had come back to 82 per cent of the US level.

The productivity gap to the United States remains significant. As one illustration of this, suppose
we were able to continue to outperform the United States by the same amount as in the 1990s – that
is, by 2.2 per cent as against 1.4 per cent a year. Then the productivity gap would take 25 years to
close.

The Japanese productivity story is one of rapid growth up until 1990, with a pronounced slowing
over the 1990s. But we will see in a moment that the 1990s performance looks rather different
when we measure productivity on the basis of GDP per hour worked – the measure that matches the
3Ps framework.

When we put the 3Ps together we have a comparison of GDP per capita performance. Chart 16
presents the data contained in Table 1 of Budget Statement 4. The data have been normalised so
that the level of US GDP per capita is 100 in each of the years 1950, 1973, 1990 and 2001.



3
        Labour productivity, as defined by the OECD, is real output per employed person in the business sector.
Business sector employment is derived as total employment less public sector employment. Business output is defined
as real GDP less the government‟s real wage bill less net real indirect taxes less real consumption of fixed capital.
Business output is thus valued at factor cost. This concept of productivity is different from that employed elsewhere in
this paper, and in Budget Statement 4. The latter concept corresponds to real GDP per hour of work, and is therefore a
total economy measure.
                                                  9

In 1950 Japan‟s GDP per capita was only 20 per cent of that of the US. By 1990 it had lifted to 82
per cent, but by 2001 had fallen back to 75 per cent.

Australia‟s GDP per capita was 78 per cent of that of the US in 1950 and, after falling to 73 per cent
in 1990, had returned to 78 per cent in 2001.

Everybody knows that the 1990s were difficult years for Japan in macroeconomic terms. Equally
well known is that the 1990s were very good years for the United States. Nobody, therefore, would
be surprised to observe Japanese GDP per capita declining relative to the US over that decade. But
they might be interested to learn what really lies behind that decline.

Chart 17 compares productivity levels on an hours basis – that is, GDP per hour worked. While the
growth rate of Japanese productivity fell in the 1990s, it nevertheless continued to exceed that of the
US – 1.9 per cent a year as against 1.4 per cent. So the decline over the 1990s in Japanese GDP per
capita relative to the United States is not a story of relatively poor productivity performance.
Rather, it is a story of the other 2Ps: Population and participation; the two factors that, combined,
provide hours worked per capita. In these areas Chart 18 reveals a 30-year trend decline in
Japanese relative performance.

Chart 19 allows us to look at the effect of the 3Ps taken together. The numbers at the bottom of the
chart show Japanese GDP per capita as a percentage of US GDP per capita in each of the snap-shot
years: rising from 20 per cent to 69 per cent between 1950 and 1973; reaching 82 per cent by 1990;
then falling back to 75 per cent over the 1990s. The chart shows that between 1950 and 1973 the
population and participation factors – hours worked per capita – and productivity factors – GDP per
hour – worked in the same direction to lift Japanese GDP per capita relative to that of the United
States. Between 1973 and 1990 continued strong productivity growth more than compensated for
the deteriorating relative performance of hours worked per capita to produce further growth in
relative GDP per capita. But from 1990 through 2001 higher Japanese productivity growth was not
enough to offset the continued deterioration in hours worked per capita – relative GDP per capita
declined.

Now for a comparison of Australian and US productivity levels (Chart 20). Between 1950 and
1973 our productivity level – GDP per hour worked – declined relative to that of the US. But since
1973 we have had a superior growth performance.

But what about the other 2Ps? Well, Chart 21 is pretty much a mirror image of the productivity
story, with a much better Australian performance between 1950 and 1973, and a significantly worse
performance subsequently.

When we put the 3Ps together (Chart 22) we find that between 1950 and 1973 the superior
performance in hours worked per capita was not enough to offset the weaker productivity
performance. Between 1973 and 1990 the stronger productivity performance was not sufficient to
offset the weaker performance in hours worked per capita. But in the 1990s productivity growth
was strong enough to more than compensate for a weaker hours per capita performance.

Policy challenges

In Budget Statement 4 we note that Australia‟s strong productivity performance in the 1990s seems
to be attributable to our partial catch-up on an expanding international productivity frontier.
                                                        10

Yet, as the productivity gap between the United States and us illustrates, we continue to lie well
below that frontier. There is good reason to expect the frontier to continue to expand. But will we
continue to move with it? And would that be enough to satisfy societal aspirations?

Before addressing those questions, note also that we have a gap in hours worked per capita relative
to the United States. And this gap is most certainly set to widen over coming decades in the
absence of substantial policy and behavioural change. The fact is that, as a consequence of rising
fertility trends since the early1980s, the US population structure is getting younger as ours ages.
After 2035, the US dependency ratio will actually start to fall as the current bulge of children turns
into a bulge of adults.4

As the Economist magazine noted in a recent essay on America‟s demographic exceptionalism,

“ … anyone who assumes the United States is now at the zenith of its economic or political power
is making a big mistake. There are plenty of other ways in which America could weaken itself
economically or politically, but demography will offer a fine basis for future growth, and strength.” 5

Given the very different demographic trends in prospect for Australia and the United States, I
consider it very unlikely that Australians would find their aspirations satisfied by maintenance of
the present relative productivity position. There is a strong case, on economic and social grounds,
for striving to bridge the productivity gap. There is an equally strong case for lifting our
prospective participation performance.

I have heard it argued that the prospect of falling participation and slower productivity growth
ought not be of much, if any concern; after all, even the Intergenerational Report baseline
projection showed we would still be some 85 per cent richer 40 years hence than today.

That seems to me dangerously complacent, for four reasons. First is the reason emphasised in the
Intergenerational Report: lower future GDP growth means that tax rates will have to increase to
fund projected budget outlays. Second, Budget Statement 4 reminds us that we became about 190
percent richer in GDP per capita terms from 1950 to 2001; but as we look back over that period
from today‟s vantage point, few would argue more than half that progress could (or ought)
comfortably have been forgone. Third, it ignores how strongly others‟ living standards are likely to
continue to grow in the future – the United States in particular – and the impact on Australian
wellbeing of substantial relative decline in material wealth. And fourth is a reason given by Sol
Encel in his report to the ACTU and the Business Council of Australia on the case for older
Australians staying in the workforce. He notes that what we now somewhat euphemistically call
„early retirement‟ should more correctly be called „early exit‟.6 OECD reports of longitudinal
studies in 13 EU members emphasise that the withdrawal from participation among older workers
often follows job loss, usually afflicts the poorer, less educated and less skilled, is seldom reversed
and is associated with persistent poverty. Although Australian longitudinal data is not yet well
enough developed to permit direct comparison with these findings, what we hear from case workers
and observe ourselves leads me to suspect that much the same applies here.7 Improving
4
      I owe these estimates to American demographer Bill Frey, cited in “Half a Billion Americans?”, The Economist,
22 August 2002.
5
      Ibid.
6
      Age Can Work: The Case for Older Australian Staying in the Workforce, A Report to the ACTU and the
Business Council of Australia, April 2003, p 7.
7
      OECD Employment Outlook 2003, Chapter 2, forthcoming.
                                                  11

participation outcomes is worth pursuing for its own sake – for the (constitutive) contribution it
might make directly to wellbeing – and not just because of its (instrumental) contribution to GDP
per capita.

In Budget Statement 4 we report findings of recent OECD research into the linkages between policy
settings and participation and productivity performance. The research confirms the importance of a
policy environment that supports competition, enhances flexibility in lightly regulated product and
labour markets, and encourages productive human and physical capital formation. Specifically, it
finds that:

 Anti-competitive product market regulation worsens labour market performance.

 Labour market regulation affects product market performance. In particular, the deployment of
  new technologies is likely to occur fastest where working conditions and wages are the most
  flexible.

 Job security cannot be bought with anti-competitive product market regulation.

 Product market deregulation does not lead to permanent increases in earnings inequality.

Budget Statement 4 provides a set of policy directions to improve participation and productivity
outcomes, supported by stable macroeconomic policy settings.

First, policies directed at improving education and training outcomes; developing systems that have
the flexibility and responsiveness to adapt to changes in the ages of key clients and in the skills
demanded by employers.

Second, policies to enhance labour market flexibility; permitting the evolution of markets that
facilitate the deployment of new technologies, the engagement of older workers and the upgrading
of skills.

Third, taxation policies that recognise the disincentive effects of high marginal rates; developing a
tax system that encourages participation rather than early retirement, and that encourages
participation in the Australian labour market, recognising the increasing international mobility of
skilled workers – of teachers, nurses, lawyers and accountants in particular.

Fourth, health and welfare policies – including in the interaction of the tax and social security
systems – that encourage labour market participation.

And fifth, a pro-competition reform agenda, encompassing the areas of energy, water and transport,
and the few remaining areas of significant border protection.

The Government has singled out each of these areas for future reform. Some initiatives have
already been announced – including in this year‟s Budget. The challenges to our future living
standards posed by demographic change will call for many reform initiatives over many years.
Indeed, the future economic reform agenda is stacking up every bit as important, and just as
extensive, as what has been achieved over the last couple of decades.
12
                                                                 13

Chart 1



                  International growth
                        forecasts
                                                 2003                              2004
                                 2002-03          2002-03          2003-04
                                 Budget           MYEFO            Budget

        World                       4                3½                3               3½
        United States              3½                2½               2¼               3¼
        Japan                      1¼                 1                ¾                ¾
        Euro Area (a)               3                 2                1                2
 TH E       (a) Figures for the 2002-03 Budget and 2002-03 MYEFO are for the European Union.
 TREASURY




Chart 2




                      Domestic forecasts

                                         2002-03                               2003-04
                                 2002-03 2002-03               2003-04
                                 Budget MYEFO                  Budget

        GDP                        3¾             3               3                  3¼
         Farm                      3¾           -17              -27                 25
         Non-farm                  3¾            3¾               4                  2¾
        CAD                         4            4½              5½                 5¼
 TH E
 TREASURY
                                                    14




Chart 3



                           3Ps of GDP

            GDP  P (1  u )h 
            P: Number of people in the population
                                                         Population
            : Proportion of population of working age
            : Participation rate
            u: Unemployment rate                         Participation
            h: Average hours worked
            : GDP per hour of work                      Productivity


 TH E
 TREASURY
                                                             15

Chart 4



                          GDP per capita
        GDP/P   (1  u )h 
                                    Population                         Productivity

                                                     Participation


                        Employment ratio
                           e   (1  u)
 TH E
 TREASURY




Chart 5



                        Participation rate [
             Per cent                                                      Per cent
        70                                                                            70



        68                                                                            68



        66                                                                            66



        64                                                                            64



        62                                                                            62



        60                                                                            60



        58                                                                            58
 TH E    1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002
 TREASURY
                                   Australia   US      Japan
                                                                   16

Chart 6




Chart 7



               Employment ratio [(1-u)]
              Per cent                                                         Per cent
        70                                                                                70




        65                                                                                65




        60                                                                                60




        55                                                                                55


                                          Australia   US   Japan

        50                                                                                50
             1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002
 TH E
 TREASURY
                                                         17

Chart 8



                        Participation rate [
             Per cent                                         Per cent
        70                                                                70



        68                                                                68



        66                                                                66



        64                                                                64



        62                                                                62



        60                                                                60



        58                                                                58
 TH E    1960                             2002                     2042
 TREASURY
                              Australia     US   Japan




Chart 9
           TH E
                                                                                                                                                                  TH E
                                                                                                                                                                                                                                   Participation rate
                                                                 Participation rate




TREASURY
                                                                                                                                                       TREASURY




                                                                                                                                            Chart 11
                                                                                                                                                                                                                                                                                                                      Chart 10




                                                                                                                                                                                                                                                                         100.0
                                                                                                                                                                                                                                                                                 110.0




                                                                                                                                                                                                       10.0
                                                                                                                                                                                                              20.0
                                                                                                                                                                                                                     30.0
                                                                                                                                                                                                                            40.0
                                                                                                                                                                                                                                      50.0
                                                                                                                                                                                                                                             60.0
                                                                                                                                                                                                                                                    70.0
                                                                                                                                                                                                                                                           80.0
                                                                                                                                                                                                                                                                  90.0




                                                                                                                                                                                                 0.0




                                                                                                            100.0




                                           10.0
                                                  20.0
                                                         30.0
                                                                40.0
                                                                        50.0
                                                                                60.0
                                                                                       70.0
                                                                                              80.0
                                                                                                     90.0




                                     0.0
                                                                                                                                                                                Ic
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                                                                                                                                                                                                                                                                                                                                 18




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                                                                                                                                                                                                                                                                                               aged 55 to 59




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                                                                                                                    males aged 60 to 64
                            ur
                                g




                                                                                                                    Participation rates -
                                                                                                                                                                               Tu
                     Fr                                                                                                                                                             rk
                         an                                                                                                                                                              e
                             ce                                                                                                                                              Be y
                                                                                                                                                                                   lg
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                    R ary
                                                                                                                                                                                                                                                                                         Participation rates: males




                      ep                                                                                                                                                       Po
                         ub                                                                                                                                                         la
                              lic                                                                                                                                                       nd
           TH E
                                                                                                                                                                    TH E
                                                                                                                                                                                                                          Participation rate
                                                                 Participation rate




                                                                                                                                                                                                     10.0
                                                                                                                                                                                                            20.0
                                                                                                                                                                                                                   30.0
                                                                                                                                                                                                                            40.0
                                                                                                                                                                                                                                     50.0
                                                                                                                                                                                                                                               60.0
                                                                                                                                                                                                                                                      70.0
                                                                                                                                                                                                                                                             80.0
                                                                                                                                                                                                                                                                    90.0




                                                                                                                                                                                               0.0




                                            10.0
                                                   20.0
                                                          30.0
                                                                       40.0
                                                                                  50.0
                                                                                         60.0
                                                                                                70.0
                                                                                                       80.0




                                      0.0




TREASURY
                                                                                                                                                         TREASURY
                                                                                                                                                                               Ic




                                                                                                                                              Chart 13
                                                                                                                                                                                                                                                                                                           Chart 12
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                                                                                                                                                                                                                                                                                                                      19




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                                                                                                                      aged 60 to 64
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                                                                                                                                                                                                                                                                           Participation rates - females




                           lic




                                                                                                              Participation rates - females
                                                                               20

Chart 14



              Employment ratio [(1-u)]
               Per cent                                                               Per cent
        70                                                                                        70




        65                                                                                        65




        60                                                                                        60




        55                                                                                        55




        50                                                                                        50
             1960                                    2002                                  2042
 TH E
 TREASURY                                 Australia         US        Japan




Chart 15



                          Labour productivity
              Per cent                                                                   Per cent


        115                                                                                       115



         95                                                                                       95



         75                                                                                       75



         55                                                                                       55



         35                                                                                       35



         15                                                                                       15
 TH E         1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002
 TREASURY
                                         Australia               US           Japan
                                                           21

Chart 16



                    GDP per capita
            120


            100


            80


            60


            40


            20


             0
                  1950               1973           1990        2001



                         Australia          US   Japan
 TH E
 TREASURY




Chart 17



                         Productivity
            120


            100


            80


            60


            40


            20


             0
                  1950               1973           1990        2001


                                            US   Japan
 TH E
 TREASURY
                                               22

Chart 18


                       Population and
                        participation
            130

            125

            120

            115

            110

            105

            100

            95

            90
                  1950      1973        1990        2001


                                US   Japan
 TH E
 TREASURY




Chart 19



                         Productivity
            120
            100
            80
            60
            40
            20
             0    1950      1973        1990        2001

            Population and participation
            130
            125
            120
            115
            110
            105
            100
             95
             90   1950      1973        1990        2001


 TH E             20       69           82          75
 TREASURY
                                US   Japan
                                                        23

Chart 20



                         Productivity
            105


            100


            95


            90


            85


            80


            75


            70
                  1950               1973        1990        2001


                         Australia          US
 TH E
 TREASURY




Chart 21


                     Population and
                      participation
            106

            104

            102

            100

            98

            96

            94

            92

            90
                  1950               1973        1990        2001


                         Australia          US
 TH E
 TREASURY
                                                        24

Chart 22



                          Productivity
            105
            100
            95
            90
            85
            80
            75
            70    1950               1973        1990        2001


            Population and participation
            106
            104
            102
            100
            98
            96
            94
            92
            90
                  1950               1973        1990        2001


 TH E             78                 76          73          78
 TREASURY
                         Australia          US

				
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