chapter 7 · chapter 7economic management using microeconomic policy241 figure 7.2 estimated gross...

CHAPTER 7 Economic management using microeconomic policy

chapter

7Economic

management usingmicroeconomic policy

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7.1 Definition of microeconomic policy

Microeconomic policy has to do with a wide range of supply-side, costcutting, efficiency measures designed to improve the way in which par-ticular enterprises, industries and sectors within the Australian economyundertake and organise production.

In essence, microeconomic policy includes reforms designedto increase output from available resources. Reforms may

include structural change, better productivity, cost cutting inproduction and the application of the best international prac-tices by business managers and workers. In turn, thesereforms should collectively improve profits, bolster nationalproductive capacity and increase aggregate supply.

Economics Down Under Book 2238

7.2 Aims of microeconomic policyAlthough microeconomic policy can be used to pursue all thegovernment’s economic objectives, its main aim is increasedefficiency in resource allocation. Indeed, microeconomic reform isalmost entirely about lifting productivity by cutting costs, pro-moting competition and restructuring the way production isorganised in both the private and government sectors. Thesemeasures involve allocating resources to get more output fromthe same quantity of inputs, in order to raise real incomes andraising material living standards.

Microeconomic reform aims to improve four aspects ofefficiency in resource allocation:1. Microeconomic reform tries to increase allocative efficiency by

ensuring that resources are directed into areas where theybest help to satisfy society’s needs and wants. Often allocativeefficiency may be improved if there is strong competitionbetween producers and sellers in the market. This ensuresthat resources are directed into areas of comparative costadvantage. However, on some occasions, government inter-vention may be needed to ensure there is allocativeefficiency.

2. Microeconomic reform may aim to increase productive (tech-nical) efficiency by encouraging businesses to use the least costmethod of production. Firms need to cut costs and purchasefewer resources. This entails employing the best internationalpractices available along with savings reforms to lower thecost of firms purchasing new equipment.

3. Microeconomic reform seeks to increase dynamic efficiency byencouraging firms to be adaptive and creative in responseto changing economic circumstances. Policy needs toencourage firms to use the latest technology, upgradeemployee skills and incentives for efficient work, promotemarket research and product development, and encourageinnovation among firms so that they better meet thechanging tastes of consumers.

4. Microeconomic reform aims to improve intertemporal efficiencyby ensuring there is a suitable balance between resources

being allocated towards current consumption on the onehand and, on the other, adequate saving for financing futureinvestment.

By improving efficiency in resource allocation, ultimatelymicroeconomic reform promotes all other government econ-omic objectives. For instance:

� Domestic economic stability is helped by increased efficiency.This is because greater efficiency raises the economy’s speedlimit or sustainable rate of economic growth. More outputcan be gained from the same inputs. Increased efficiency alsohelps to cut costs and slow inflation. This leads to increasedprofits, improved competitiveness and better sales. As a result,over the medium to long term, the total level of employmentshould grow more quickly and structural unemploymentshould be reduced by fewer business closures.

� External stability should be improved through increased inter-national competitiveness that follows better structuralefficiency and lower production costs. Efficiency should liftour exports relative to imports, help slow the rise in the CADand rein in the foreign debt.

� Increased equity in the distribution of personal income may occurin the long-term, when greater efficiency leads to higherlevels of real incomes and production available for distri-bution among the population. Here, efficiency boosts thevalue of government tax revenues collected, thereby makingthe welfare system and the provision of community servicesfor the poor much more affordable. Greater efficiency alsoleads to the creation of more jobs and helps eventually tolower structural unemployment caused by a lack of competi-tiveness and business profitability. This improves equity too.Moreover, increased efficiency helps to slow inflation thatwould otherwise undermine the purchasing power of lowerincome earners. Overall, material living standards arepromoted through increased efficiency in the allocation ofresources.

CHAPTER 7 Economic management using microeconomic policy 239

THE REASONS FOR USING MICROECONOMIC POLICYThe 1950s and 1960s represent the golden age for Australianproductivity. However, during the 1970s, 1980s and early 1990s,our economic performance lagged behind that of many coun-tries:� Our sustainable growth rate was often slower� The inflation rate was generally higher� Unemployment levels were excessive� The CAD:GDP ratio mostly was large (limiting our sustain-

able rate of economic growth) and overall, our dollar depre-ciated badly

� Efficiency grew very slowly� Australia’s material living standards fell from first place in

1901, to fourth in 1950 to around fifteenth in the early 1990s.

Because government macroeconomic measures on their ownhad failed to provide the necessary solutions to this economicdecline, there was renewed interest in the possibilities offeredby effective microeconomic reform.

7.3 Specific instruments of microeconomic policy

During the 1980s, 1990s and 2000s, federal governments werekeen to pursue microeconomic reform. Let us now take a look atsome of the most important ones.

TRADE LIBERALISATIONUntil the 1970s, Australian governments strongly protected localindustry from competition. They did this mainly by using hightariffs (taxes on imports to make them dearer than the localitem), generous subsidies (cash payments to exporters orimport competing firms to help them cover their productioncosts to allow them to sell more cheaply), and restrictive importquotas (legal restrictions on the quantity and type of importspermitted). Assistance like this sought to help local firms (ofteninfant industries) survive foreign competition and, supposedly,to create more jobs for workers.

However, starting in the early 1970s, the Australian Govern-ment signalled the start of a change in its policy of protectinglocal industry from foreign competition. Increasingly, it liberal-ised international trade. This involved the progressive reductionof tariffs, subsidies and import quotas, and a shift towards theidea of free trade. Increasingly, national borders no longer restrictthe movement of goods, services and money capital betweencountries. With freer trade (associated with globalisation), we areforced to allocate resources into areas of production where Aus-tralia has a comparative cost advantage (or least disadvantage). Inother words, resources will flow into areas where we are mostefficient. It will mean that more national output (or GDP) canbe gained from the same inputs of resources. This leads tohigher incomes and material living standards. In addition, inthe long-term, greater efficiency also leads to lower inflation,improved international competitiveness and increased employ-ment.

Our investigation here will focus on the four key aspects oftrade liberalisation policies:1. tariff cuts2. reduced subsidies and other assistance

3. abolition of import quotas4. increased number of free trade agreements with other coun-

tries.

Tariff cuts

Especially during the past thirty-five years, a debate has ragedabout the appropriate level of tariff protection for Australianindustry. Tariffs or import duties represent an indirect tax leviedon selected imported goods. In general, tariffs are added on tothe price of imports to make them dearer, or less attractive, tolocal consumers. Because this limits foreign competition in localmarkets, economists agree that high tariffs cause resources to beallocated inefficiently into industries where we have a compara-tive cost disadvantage. The existence of high tariff rates meansthat local households and businesses consuming Australian-made goods and services must pay higher prices or costs forthese items. This offsets any possible increase in income andemployment in the short term arising from having tariffs. Addi-tionally, when one country raises its tariffs, this becomes a justi-fication for other nations to retaliate. As a result, world tradevolumes and domestic economic activity contract.

Figure 7.1 (p. 240) shows that there was a huge reduction inthe general tariff rate on most manufactured items from 36 percent in 1968–69, to effectively zero by 2005–06. It all started witha 25 per cent overnight tariff cut in 1973. However, reductionscontinued in different industries, at different rates. Effectivelyby 2007, most goods were tariff free. Of the few remainingimports still protected, around 90 per cent were at a rate of lessthan 5 per cent. Even so, tariffs are still applied to local indus-tries making passenger motor vehicles, textiles, clothing andfootwear. Traditionally, these areas were starting off from muchhigher levels of protection and to suddenly remove tariffs wouldhave meant certain collapse. However, for these special indus-tries, scheduled tariff reductions are continuing so firms knowthat efficiency must continue to rise, if they are to survive.

TRY SHORT ANSWER EXERCISE 1, p. 276


Figure 7.1 Changes in estimated effective rates of tariff protection of selected Australian industries, 1968–69 to 2005–06

Sources: Data derived from the Industry Commission, Productivity commission reports, ‘Trade policy review, Australia, 2002’, AGPS and other sources.

Reduced subsidies and other

assistance to local producers

Subsidies are government cash payments made to local pro-ducers to help them cover some of their production costs. Theycan enable Australian firms to export at a more competitiveprice. Some even involve special assistance to accelerateindustry restructuring. For example, there is the one billiondollar ‘Automotive competitiveness and investment scheme’ for2000–05 to help car firms upgrade plant, equipment and tech-nology, and an $800 million grant to help textile firms restruc-ture, with tax rebates as high as 45 per cent offered for

companies with significant export orientation. However, thereare problems with giving government subsidies. For example,they tend to increase inefficiency in resource allocation amongfirms that come to depend on their continuation. There is alsothe extra cost of subsidies to taxpayers who have to foot the bill.As part of its trade liberalisation measures, the AustralianGovernment has increasingly reduced subsidies or used them tohelp restructure the industry more efficiently.

Figure 7.2 shows us that in the period between 1971–72 and2006–07, there was a general reduction in gross subsidies, fromaround $25 billion in 1971–72, down to an estimated$4.3 billion or less by 2006–07.

20

0

40

60

80

120

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Eff

ecti

ve t

arif

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(%

)

1985–86

1980–81

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1990–91

1995–96

2000–01

2005–06

2010–11

180

200General ma

Passenger motor

vehicles (PMV)

Clothing apparel

White goods

Agriculture

INDUSTRY AREA

1968–69

1970–71

1980–81

1985–86

1990–91

1995–96

2000–01

2005–06

2010–11

General manufacturing

36 35 23 20 16 5 4.2 0

Passenger motor vehicles (PMV)

50 50 96 125 60 25 15 10

Clothing apparel

97 91 140 148 176 35 25 17.5

White goods 55 55 30 19 8 5 2.5 2.5

Agriculture 32 28 12 12 13 10 6 0


Figure 7.2 Estimated gross federal government industry subsidies, 1971–72 to 2006–07 ($ billion)

Sources: Data calculated using information derived from Industry Commission, Productivity commission reports, 2006–07 budget overview and other sources.

Again, this reform is consistent with the government’s belief inthe benefits of strong competition and trade liberalisation.

Abolition of import quotas

Import quotas are designed to restrict the quantity of specifictypes of imports permitted into the country. In order to achievea stated volume target, prospective importers must obtain alicence that gives them permission to import a certainmaximum number of articles of a particular description. Quotaswere commonplace in the 1970s and early 1980s, especially oncars, textiles, footwear and clothing. However, these were pro-gressively abolished. The last of these quotas, applying tocheese, was terminated in 2000–01. Again, this reform is part ofthe belief in the long-term efficiency benefits of freer trade andstronger competition.

Increased number of free trade

agreements (FTAs)

Australia has membership of various multinational (i.e. involvingmany countries) trading groups like the World Trade Organiza-tion (WTO). Through the Doha rounds of trade negotiations withthe WTO (called the Doha rounds because negotiations tookplace in Doha, the capital of Qatar), Australia has been pushinghard for general reductions in global tariffs and the abolition ofsubsidies, along with increased international access to agricul-tural, manufacturing and services markets. Indeed, Australia wasinstrumental in setting up the Cairns group of fair agriculturaltraders bent on eliminating agricultural subsidies. Despite theseefforts, progress has been slow due to significant opposition fromgroups in the US, Japan and Europe.

Given this slow pace of multilateral trade reform, Australiahas increasingly tried to negotiate bilateral free trade agree-ments (FTAs) with two or more individual countries. Forexample, by early 2007, we had four FTAs in place:� Australia–New Zealand FTA (also known as ‘Closer economic

relations’) in 1983 � Australia–Singapore FTA in 2005� Australia–Thailand FTA in 2005� Australia–United States FTA in 2005.

In addition, by 2006–07, negotiations were underway forstriking FTAs with China, Malaysia, ASEAN and Japan. The aimsof this type of trade reform include lifting the competitivenessof our exporters, establishing a business presence abroad,expanding Australia’s market share in overseas countries, deliv-ering stronger economic growth, reducing costs paid forimports by local firms and prices paid for imports by house-holds, and making Australia a more attractive destination foroverseas investment.

DEREGULATION AND OTHER REFORMS OF THE LABOUR MARKET The labour market is an institution dealing with matters affectingall workers such as wages, incomes and other conditions ofemployment including work hours. During the 1990s and,especially, between 1996 and 2007, the federal government intro-duced major microeconomic reforms in this area. These changeswere based on the belief that the quality, efficiency, training,health and skill of a nation’s labour force are vital in determiningAustralia’s productive capacity, sustainable rate of economicgrowth, adaptability to changing circumstances and our inter-national competitiveness. Most importantly, labour marketreform has involved a gradual shift from the centralisedminimum wage (prior to November 2006 this was called theminimum award wage), to a system involving greater deregulationof wages based on enterprise or workplace agreements. Althoughboth these wage systems are still used today, by late 2006, onlyabout 10 per cent of all workers were covered by the minimumwage, with the remaining 90 per cent on workplace agreements.Let us now consider the details of these two wage systems.

Australian Fair Pay Commission and

the centralised system of minimum

wages

Traditionally, Australia has relied very heavily on a centralisedwage fixing system which, since November 2006, is under the con-trol of the Australian Fair Pay Commission (AFPC) (previouslycontrolled by the Australian Industrial Relations Commission(AIRC) the main role of which is to settle industrial disputes).

The AFPC is responsible for determining the federalminimum wage for low paid workers not covered by variousenterprise or workplace agreements. In particular, the com-mission is guided by a new set of criteria to those used previ-ously by the AIRC. In particular, the AFPC sets its minimumwage taking into account:� the promotion of the economic prosperity of the people of

Australia� the capacity for the unemployed and low paid to obtain and

remain in employment� employment and competitiveness across the economy� providing a safety net for the low paid� providing minimum wages for junior employees to whom

training arrangements apply and employees with disabilitiesthat ensure those employees are competitive in the labourmarket.In addition, under Australia’s Corporations Act (recently

tested in an appeal to the High Court), the federal government

2006–07

2000–01

1996–97

1971–72

1989–90

0

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$ b

illi

ons

10

15

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25

30


has successfully overridden much of the various state govern-ments’ wages system, thereby increasing its power to determinewages. This means that now the minimum wage is applied fairlyuniformly to particular workers across Australia, who are notcovered by enterprise or workplace agreements. In its firstdecision in November 2006 (to apply from 1 December 2006 toabout 1.4 million workers), the AFPC announced:� an increase of $27–36 per week in the standard federal

minimum wage taking it up to nearly $512 per week� an increase of $27–36 per week in all Australian Pay and

Classification (pay) scales up to $700 per week� an increase of $22.04 per week in all pay scales above $700

per week.The next annual wage review for these workers will occur inmid-2007.

Increased reliance on workplace

agreements

In Australia nowadays, decentralised or firm-by-firm workplaceagreements (also called employment contracts and enterprise agree-ments), are a far more popular alternative to the traditionalcentralised wage system. The main features of enterprise agree-ments are as follows.

Wage agreements are negotiated on a firm-by-firm basis

Under workplace agreements, wages and conditions are usuallyset on a firm-by-firm basis and more closely reflect the freer oper-ation of the forces of demand and supply in the labour market.This allows businesses to have greater flexibility in setting wages,so they better mirror worker performance, local market trends,the firm’s profitability and other unique circumstances for thebusiness, thus helping to improve competitiveness. However, ano disadvantage test is applied. This requires that enterprise

agreements match or exceed, minimum conditions or standardsincluding those relating to wage rates, long service leave entitle-ments, unpaid parental leave and four weeks annual leave.

Importance of productivity for wage rises

An important and common feature of most enterprise or work-place agreements is that wage rises are based on actual improve-ments in worker efficiency or productivity (i.e. increases in outputper worker per hour). Pay rises are usually performance-based.

Agreements are renegotiated regularly

At fairly regular intervals (i.e. up to 3 years), workers and theirparticular boss, renegotiate wages and conditions so that theworkplace agreements can be updated to reflect changing cir-cumstances, both inside and outside the firm.

Two types of enterprise agreements

Today there are two possible types of enterprise agreement: Certi-fied agreements and Australian workplace agreements. Certifiedagreements (CAs) can only occur between unions andemployers. Australian workplace agreements (AWAs) provide analternative to CAs. An AWA can exist between an employee andhis or her employer. These are individual employment contractsthat can apply even to salaried employees such as executives andprofessionals.

Recent industrial relations reforms

In 1996 and 2005, the federal government passed two importantreforms in the area of industrial relations: 1. the Workplace Relations Act 19962. the Workplace Relations Amendment (Work Choices) Act 2005

(effective March 2006).Table 7.1 sets out the details of these two important reformsdesigned to further deregulate Australia’s labour market:


Recent changes to Australia’s industrial relations laws

WORKPLACE RELATIONS ACT (1996)

1. The role of the AIRC

The Act scaled back the responsibilities of the AIRC (whose wage-setting role was later taken over in 2005 by the AFPC). Its most important duty was presiding over the annual National wage case that determines the minimum or safety net wage (i.e. the idea of a living wage where workers earn enough to live and not just survive). For example, from 1997–98 to 2005–06, the AIRC’s annual safety net award wages were increased by between $8 and $18 a week, so that its last minimum weekly award wage was set around $484. However, these days the key role is settling industrial disputes. Another current responsibility of the AIRC is the enforcement of awards.

2. Simplification of the award system

The traditional system of minimum award wages was complex, expensive and clumsy. Under this Act, award simplification occurred so that any award decision could only cover twenty allowable matters (e.g. classification of skills of employees, hours of work, pay rates, incentives, long-service leave, holidays, pay loading for overtime, redundancy pay, dispute settlement procedures, stand-down provisions and superannuation).

3. The no disadvantage test

The Act requires that all enterprise or workplace agreements meet the minimum standards set out in relevant awards. This is called the no disadvantage test so that workers could not be worse off than they would be under an award.

4. Role of trade unions

The Act reduces the direct role of trade unions in some wage negotiations. It restated the principles of voluntary unionism and illegality of compulsory unionism. It also confirmed that a worker could not be discriminated against on the basis of union membership and established the general right to strike (72 hours notice is needed for lockouts and strikes that are only allowed during the negotiation period for a new agreement).In addition, the legislation covers the illegality of secondary boycotts (e.g. ‘sympathy strikes’ where other unions go out on strike to support a cause not directly their own) as well as strike pay (when workers receive payment while undertaking industrial action).

5. Unfair dismissal provisions

The Act changed the unfair dismissal laws to instances where dismissal was seen as harsh, unjust or unreasonable. However, adequate notice had to be given or pay offered in lieu of notice.

6. The Employment advocate

The Employment advocate was set up to enforce AWEs and to protect vulnerable groups (e.g. the young, females, apprentices, non-English speaking migrants).

WORKPLACE RELATIONS AMENDMENT (WORK CHOICES) ACT (2005)

1. Setting up the Australian Fair Pay Commission

After nearly 100 years, the AIRC’s minimum wage setting role was handed over to the newly set up, Australian Fair Pay Commission (AFPC). Depending on the results of the federal election scheduled for late in 2007, this situation may change.

2. The reduced role of the Australian Industrial Relations Commission

The old AIRC was to concentrate on industrial relations dispute resolution, the simplification and rationalisation of awards (i.e. reducing the number of awards and the allowable matters) and dealing with applications about industrial action (e.g. strikes).

3. Creating a more national wage system

The Corporations Act is used to give the WorkChoices legislation its national power to override the state government industrial relations system (but unincorporated employers and their employees will remain within the state industrial relations system in WA, NSW, SA, Queensland and Tasmania). The challenge to the constitutional legality of this power failed to get support in a landmark decision in late 2006, thereby increasing the power of the Commonwealth in this and perhaps other areas (e.g. water, nuclear power).

4. Creating the Australian fair pay and conditions standard

The Act establishes certain minimum, statutory, standard working conditions. For example, the 38-hour week, four weeks annual leave, and sickness, parental, personal and carers leave. In addition, individual can cash in up to two weeks of annual leave. These conditions form the universal Australian fair pay and conditions standard.

(continued)

Table 7.1


(continued)

WORKPLACE RELATIONS AMENDMENT (WORK CHOICES) ACT (2005)

5. Allowable matters

Award wage agreements struck prior to 2006 will continue to apply but the list of allowable matters (e.g. incentive-based payments, hours of work, leave loadings, public holidays) has been reduced to 13, and non-allowable matters (e.g. union picnic and training days) are now no longer legally enforceable.

6. Types of Australian workplace agreements

Work Choices distinguishes four main types of Australian workplace agreements (AWAs) or individual contracts:1. non-union negotiated collective agreements2. union negotiated collective agreements3. employer negotiated greenfield agreement (where the employer makes a wage agreement

with themselves before any person is hired, that employees will become subject to the agreement, thus giving the employer total control over staff wages and conditions)

4. union negotiated greenfield agreements.Under these arrangements, it is possible that particular staff might be singled out, one at a time, and pushed onto AWAs with reduced conditions of work (e.g. relating to weekends, shift work, and special pay rates for overtime rates, public holidays and shifts).

7. Exemptions from unfair dismissal laws

There have been changes to some of the provisions of the unfair dismissal laws. These have increased the power of employers with fewer than 100 staff to sack workers. This further erodes the rights of employees. The claim in support of this change is that it will help lower unemployment since firms are more likely to hire extra staff if they know that they can more easily dismiss them if they prove to be unsatisfactory or even if they are unnecessary, given operational developments. Contested claims for unfair dismissal are still possible, but they are expensive.

8. The Minister for Industrial Relations

The Minister for Industrial Relations has the power to terminate agreement negotiations, even if there is only the possibility of a strike (it does not even have to be an actual strike).

Table 7.1


Other labour market reforms

Apart from changing the nature of Australia’s wages systemthrough the Workplace Relations Act, there have also been otherimportant labour market reforms.

Multiskilling and multitasking

Multiskilling of workers has become more common and wageawards have been simplified and combined to cover thoseworkers with broadly similar skill levels. Competency basedvocational education and training, where people demonstrateskills, knowledge and understanding against set standards, hasalso encouraged multitasking by employees. These changes havehelped to improve labour efficiency and make workers moreemployable.

Job demarcation

During the late 1980s and 1990s, job demarcation boundaries(where workers have set tasks they perform that cannot be trans-ferred to other areas) were radically reduced, creating wider,less traditional employment areas. This shift was believed neces-sary to help reduce strikes, lower production costs and improveemployment flexibility.

Union amalgamation

Thanks to changed guidelines developed in the early 1990s,there has been a significant level of union amalgamation (i.e.combining smaller unions to form larger unions). In addition,union amalgamation partly reflected the huge decline ofunionism, the advance of multiskilling and reduced job demar-cation. One benefit of encouraging fewer unions is that it sim-plifies industrial bargaining and reduces delays caused bydemarcation or inter-union disputes.

Retraining of workersOver the past 10 years or so, there have been many schemes intro-duced by the government to improve the skills and training ofworkers. For instance, there was the 1994 Working nation scheme,the 1997–98 Modern apprenticeship and traineeship scheme, the cre-ation of the Green corp, expansions of the Work for the dole scheme(1998–99 to 2005–06), and the 2001–02 Australians WorkingTogether package. The Australians Working Together scheme, forexample, included new requirements for recipients of parentingpayments to undertake job searching, education, or training todevelop their work skills and prepare them for a return to work.These activities need to involve 150 hours in each six-monthperiod (or approximately six hours on average per week). Inaddition to these government schemes, 24 new Australian tech-nical colleges were established between 2005 and 2007.

Job placement agencies replaced the Commonwealth Employ-ment Service (CES)Until 1998, the CES was responsible for finding jobs for theunemployed. Since then, Private employment placement enterprises(PEPE) have been responsible for connecting the unemployedwith prospective employers. Centrelink facilitates this processand the government pays these job broking agencies, only whenthey find real employment for an unemployed individual.

Some strengths and weaknesses of

recent labour market reforms

Labour market deregulation and other reforms have been under-taken to help improve Australia’s economic performance. Someof the strengths and weaknesses of these changes are listed intable 7.2.

Some strengths and weaknesses of recent labour market reforms in Australia

SOME STRENGTHS OF LABOUR MARKET REFORMS

SOME WEAKNESSES OF LABOUR MARKET REFORMS

Reforms help to reduce inflationUnder workplace or enterprise agreements (i.e. since 1991) and other labour market reforms, pay rises increasingly reflect improved performance or worker productivity, thereby keeping down RULCs. In turn, better efficiency and lower costs reduce inflation (e.g. as occurred generally during 1992–2007). This was not usually the case under the old system of award wages where pay rises occurred irrespective of worker efficiency or the ability of particular firms to pay.

Reforms have increased income inequality in the short term and reduced the power of workersThe growth of enterprise agreements has contributed to the rise in inequality in the initial distribution of market incomes (i.e. income before government tax and outlays). This is partly because increasingly, workers in different firms in various parts of Australia get paid different wages. Another worry is that some workers are relatively disadvantaged in workplace negotiations (e.g. the inarticulate, non-English speaking, unskilled, unproductive, young people, non-unionised, rural workers, part-timers) as compared with, say, senior executives in profitable firms. Additionally, those workers remaining on the old centralised wage system, have not generally gained such rapid pay rises as those using the new system of workplace enterprise agreements, and increasingly, trade union scrutiny of pay rises is disappearing due to falling membership.

(continued)

Table 7.2


(continued)



Reforms help to accelerate productivity and the sustainable rate of economic growthWorkplace or enterprise agreements (used since 1991) offer pay rises in exchange for improved efficiency by workers. With increased efficiency of labour resources, more output can be gained from the same or fewer inputs, thereby accelerating economic growth and raising average incomes (e.g. generally between 1992–2007). Additionally, locally made goods and services become more competitive, raising sales and production levels.

Reforms may have increased unemployment in the short-termThe growing popularity of performance-based, firm-by-firm enterprise agreements dramatically accelerated worker productivity against 1980s levels. This meant that many local businesses have been able to produce more output with the same or fewer staff. As a short-term result, this may have tended to slow employment growth and add to structural unemployment.

Reforms help to create fuller employment in the long termIn the long term, labour market reforms have increased worker efficiency, improved worker competitiveness, lowered business costs and reduced business closures that cause structural unemployment. Additionally, the traditional minimum wage system sets pay rates at levels above the free equilibrium in the labour market, thereby contributing to a glut of workers (supply exceeds demand) or structural unemployment. By reducing emphasis on this system, structural unemployment should be cut. Furthermore, estimates suggest that the recent changes to the unfair dismissal laws may help create between 40 000 and 50 000 extra jobs by making employers more willing to hire full-time workers, knowing that they can be dismissed more easily if they prove to be unsatisfactory.

Incomplete reformsSome claim that the government has not gone far enough with labour market reforms to ensure that Australian firms and their employees are sufficiently competitive against even more deregulated labour markets abroad in Asia, the United States and New Zealand. For instance:

– Some people (even discussed by the Opposition) argue that safety net wages should be replaced with a tax credit scheme for low-income employees. Here, tax cuts would replace the need for rises in the minimum wage. This proposal would protect workers’ purchasing power, keep real wage costs for firms stable and reduce the structural unemployment rate.

– Unfair dismissal laws may need to be relaxed further so that firms employing more than 100 staff are more likely to hire extra full-time employees.

– The income gap between having a part-time job and being on government welfare is too small and distorts the efficient operation of the labour market.

– Real wages (especially for youths) are perhaps still too high, causing higher unemployment. Estimates suggest that a 10 per cent fall in real wages could lift employment by possibly 4–7 per cent.

Reforms help to improve external stabilityBy reducing labour costs, reforms have helped to make Australian workers and firms operating in local and overseas markets more competitive, thereby helping to increase exports relative to imports, thereby tending to reduce the CAD.

Reforms help to promote equity in the long termEquity may be protected by the retention of safety net wages and initially, the no disadvantage test. Additionally, in the long term, labour market reforms have helped to accelerate economic growth, lift average per capita incomes (including those from exports), slow inflation so necessities are cheaper and more affordable, reduce unemployment by improving local business competitiveness and lift tax revenues to pay for the expensive welfare system. These developments help equity.

Reforms help to encourage cooperation and reduce strikesLabour market reforms involving workplace and enterprise agreements have promoted cooperation and discussion between workers and their management. Employees are encouraged to be more accountable, and to show greater initiative and self-management. This approach is believed to have dramatically reduced industrial unrest including strikes (e.g. as seen during 1992–2007), absenteeism and poor product quality.

Lack of coverage by agreements limits the impactWorkplace or enterprise agreements were formally endorsed in 1991. However, even by 2006, around 10 per cent of all workers (higher for women) were still not covered by this system. Instead, these employees continued to rely on an inflexible and inefficient centralised approach to wage determination.

Table 7.2


TAX REFORMSTo assess the quality of a tax system, economists often apply fourcriteria. A tax should be:1. Simple Is it easily understood and simple to administer?2. Fair Does it promote an equitable income distribution?3. Efficient Does it promote an efficient use of resources?4. Adequate Can it raise the necessary revenue so that govern-

ments can pay for their budget outlays without goinginto debt?

Given changing circumstances and, with these four guidelines inmind, by the late 1990s it became especially clear that Australia’stax system was in need of a good overhaul. Table 7.3 (p. 248)sums up some of the key tax reforms introduced in the years toJuly 2007.

Tax reform will have many impacts on the economy. Forexample, the changes will affect:� the sustainable rate of economic growth by altering both AD

and AS (including the levels of employment, productioncosts, business profitability and prices)

� efficiency in resource allocation (by affecting savings, con-sumption and investment levels)

� the size of the CAD, NFD and our external competitiveness� equity in the distribution of personal income.

However, of all these, most of the recent tax reforms thatemphasised reductions in rates, were driven by the govern-ment’s push to improve efficiency in resource allocation byencouraging savings, lifting investment, increasing the motiv-ation to work hard, rewarding personal effort, and extendinginternational competition. In turn, greater efficiency also pro-motes economic and employment growth, lower inflation,external stability, rising incomes and the potential for greaterequity in income distribution.

REFORMS TO PROMOTE NATIONAL SAVINGSIn 1993, the National savings strategy was first released. Itattempted to address the problems of relatively high domesticinterest rates (which disadvantage local firms that borrow forexpansion) and the large national savings–investment gap cur-rently filled by heavy foreign borrowing (which worsens theCAD through interest payments abroad). Between 1993 andearly 2007, a number of microeconomic reforms were used totry and encourage national savings, often involving initiativesannounced in the annual budget.



Change was essential and there was little choiceWhether we like it or not, Australia was forced into labour market deregulation by similar developments abroad. Given the need to be competitive because of globalisation, there was little choice if we wanted local firms to survive and workers to have jobs in the future.

Productivity is hard to measure under enterprise agreementsThe system of workplace or enterprise agreements bases pay rises on productivity gains. However, it is very difficult to accurately measure efficiency improvements attributable only to workers (i.e. as opposed to capital equipment). Moreover, the encouragement of productivity may even worsen structural unemployment in the short term.


Key federal government tax reforms

Source: Data derived from the Treasury Economic roundup, Winter 2006.

Acceptance of ‘fiscal balance’ as a guiding principle for budgetsBetween 1991–92 and 1996–97, the federal government ran upmany budget deficits totalling nearly $60 billion. Unfortunately,these deficits required financing. Local borrowing by thegovernment pushed up domestic interest rates relative to thoseoverseas. This encouraged the private sector to borrow evenmore from overseas and attracted foreign capital inflow. In

turn, overseas borrowing to finance government budget defi-cits, also led directly to a structural rise in the CAD and NFD.In contrast to this, recent budgets have been based on theprinciple of fiscal balance over the medium term, so that budgetsurpluses in some years pay for deficits in others. Here, there isno need for federal government borrowing. Indeed, between1996–97 and 2007–08, budgets were mostly surpluses (only two

REFORM OF TAXATION TOP RATE

(2006)HISTORICAL TOP RATE

PAYG income tax Between 2000 and mid 2007, the tax-free threshold for personal incomes was increased, the entry points into higher marginal tax brackets were moved up considerably (e.g. until July 2008 the 45 per cent tax rate cuts in at $150 000 per year but this will rise to $180 000), and the top marginal rate was cut from 47 to 45 per cent.

45 per cent (Plus 1.5 per cent Medicare

levy)

75 per cent(<1951–52)

CGT In 1986, the tax rate on capital gains (other than the family home that is exempt) was effectively halved. Only 50 per cent (not 100 per cent as previously) of the capital gain was to be taxed. The family home is normally exempt.

22.5 per cent(Plus Medicare

levy)

NA (Before 1986)

Superannuation For many years, the government has made superannuation contributions very attractive (as a way to save for retirement) by offering tax concessions on both contributions and end benefits. These arrangements were frequently altered, with the most significant changes announced in the 2006 budget that allows a tax-free withdrawal of end benefits from aged 60 years from July 2007.

zero(For end-benefits

withdrawn after aged 60 years

from July 2007)

30 per cent(1983 on lump sum payments

above a threshold)

Company tax Between 2000 and 2002, the tax rate on company profits was lowered from 36 to 34 per cent and finally to 30 per cent.

30 per cent 49 per cent (1986–88)

Changes in some excise taxes

As an anti-inflationary measure, the automatic indexation of the fuel excise tax ceased in 2001–02. Previously, as the price of fuel increased, the amount of tax collected increased without discretionary decisions being made by the Treasurer. This policy added to inflation and grew government revenues.Additionally, there were modifications made to other excise taxes (e.g. on light beer).

NA NA

Tariffs By 1996, the general tariff rate on most manufactured imports had been reduced from nearly 40 per cent in 1968–69 to only 5 per cent. In 2005, the 3 per cent tariff on business inputs was abolished where there is no local substitute (business inputs, for example, are natural resources, labour and capital purchased by firms to allow them to make final goods and services or output production).Today most imports are tariff free, except for motor vehicles, and textiles, clothing and footwear.

zero (General tariff

rate effectively)

38 per cent (General tariff rate, 1968–69)

Indirect taxes In July 2000, the 10 per cent GST replaced the Wholesale Sales Tax (that had rates between 12 to 45 per cent). Unlike the WST, the GST is a broad-based tax applied to most (non-essential) goods and services and was levied on behalf of the states.

10 per cent GST

45 per cent WST(Before July

2000)

Table 7.3


out of 11 were deficits) totally over $80 billion. This is shownin figure 7.3.

In addition, by 2005, the government’s previous debt wascompletely repaid. Fiscal consolidation like this abolished one ofthe structural problems causing Australia’s NFD. It can also beargued that the many budget surpluses (i.e. governmentsavings) helped to keep down domestic interest rates, makingoverseas borrowing by the private sector relatively less attractive.This too, helped to reduce income payments abroad, thustending to lower our CAD.

Establishment of the Future FundIn 2005, the Future Fund was created to lift national savings,improve the government’s long term financial position and itsability to meet unfunded public sector superannuation liabilitiesof around $100 billion. It was started using seed capital (as dis-cussed in chapter 5) of around $18 billion, contributed by thegovernment. The money has been used to create a giant invest-ment portfolio that should grow over time through the gener-ation of income, topped up with extra capital from further assetsales (e.g. Telstra 2006) and future budget surpluses.

Promotion of household savingsMicroeconomic reforms (implemented through the federalbudget), have also tried to encourage private sector savings. Forexample:� Superannuation guarantee charge (SGC). Starting in 1991, super-

annuation was made compulsory for all employees throughthe introduction of the Superannuation guarantee charge. This isa compulsory levy on a company’s payroll and was originallyequal to an extra 3 per cent of wages paid into a worker’ssuperannuation account. However, as from 2002, it wasincreased to 9 per cent.

� Generous tax advantages for voluntary contributions to super-annuation. The government encourages private super-

annuation contributions by offering very generous taxconcessions. For instance, marginal tax rates on income mightbe as high as 45 per cent (plus the Medicare levy) but for thoseinvolved with salary sacrificing (i.e. using some of your pre-taxearnings to pay for benefits such as a car), there is only a15 per cent tax on contributions. Also from July 2007,individuals can withdraw their superannuation tax free oncethey reach the age of 60 years. Again this provides furtherincentive to save.

� Superannuation co-contributions scheme. The Superannuationco-contributions scheme commenced in 2002–03. Basically, thegovernment matches low income after-tax superannuationcontributions at the rate of up to $1.50 for every $1 (up to alimit) put into an approved superannuation account by anindividual. For 2007–08, this will rise to $3 for every $1contribution. This increases the incentive to save.

– Reductions in tax rates. Between 1999 and 2007, there were sig-nificant tax reforms involving cuts in tax rates. Many of thesechanges should help to increase national savings. Forexample, the 50 per cent reduction in the rate of capital gainstax (1999) effectively lowered the maximum current rate toonly 23.25 per cent. Reforms in 2000 and 2002 also cut therate of company tax from 36 to 30 per cent. This should helpto boost business savings via increases in retained profits. Inaddition, lower PAYG tax rates should provide temporaryrelief from the effects of bracket creep (where individuals findthat over time, they end up moving into higher tax bracketswith a heavier tax burden). In turn, this may help to lifthousehold savings. Similarly, the 10 per cent GST (intro-duced in 2000) is a tax that discourages consumption andindirectly encourages savings. It also broadened the tax baseto include both goods and services (relative to the old andnarrow WST on goods only), perhaps adding further topublic sector savings.

Figure 7.3 Federal underlying budget outcome 1992–93 to 2006–07 and 2007–08 ($ billions)

Sources: Data derived from RBA Bulletin, various editions; 2006–07 budget overview.

Note: *represents latest estimate

–20

–15

–10

–5

0

5

10

15

Un

derly

ing

bu

dg

et

ou

tcom

e($

bil

lion

s)

1999–2000

1998–99

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1996–97

1995–96

1994–95

1993–94

1992–93

2000–01

2001–02

2002–03

2003–04

2004–05

2005–06

2006–07

2007–08*

2008–09*

2009–10


By encouraging higher levels of national saving (i.e. anincrease in the supply of savings relative to the demand for sav-ings), these reforms should tend to lower domestic interestrates, slow cost inflation, improve long-term economic andemployment growth, raise dynamic and intertemporalefficiency, reduce the NFD and CAD, and possibly help improveequity in the distribution of personal income.

REFORM OF THE PUBLIC SECTORReforms of government businesses and the public sector haveinvolved eight key aspects.

Privatisation of selected government business enterprises (GBEs)Many claims have been made about the supposed inefficiency ofgovernment businesses. One response to this was to partially orfully privatise selected GBEs. Figure 7.4 shows that there wasmuch privatisation between 1995–96 and 2005–06, especially inthe earlier years (although the sale of Telstra in late 2006 shouldsee a jump when the 2006–07 final figures are released).

Figure 7.4 Estimated value of federal government privatisation ($ million)

Sources: Derived from budget papers and other sources. Note: data represent estimates only based on asset sales and other smaller items. Note for 2006–07: this figure should be very large given the success of the Telstra 3 share sales.

The justification for privatisation as an efficiency measure, isoften based on three main arguments:1. Private owners and shareholders demand greater efficiency

and cost cutting in order to maximise their profits or returns. 2. Private owners often have better access to the huge amounts

of capital needed for investment in new equipment and tech-nology. This helps them to grow their efficiency more quickly.

3. Private owners may be able to recruit and appoint manage-ment and staff of superior quality, ambition and creativity,than would be the case if the business remained in thepublic sector.

Examples of partial or full privatisation include the completesale of the Commonwealth Bank (1996), Aussat (which becameOptus with 49 per cent foreign ownership), the NSW Govern-ment Insurance Office (GIO), Qantas, TABCORP, some roads(e.g. Melbourne’s City Link), many ports (e.g. Geelong,Portland), some airports (e.g. Melbourne, Brisbane), parts ofSydney’s water supply, PowerCor and Telstra.

Corporatisation of some remaining government operationsCorporatisation involves full government ownership of the busi-ness enterprise. However, the GBE is run more like a privateenterprise (e.g. Australia Post, Australian Airlines in the 1980s,and the Port of Melbourne Authority). Providing there is no ser-vice obligation (e.g. Telstra has an obligation to provide somepublic telephone access in the community even though it maynot be profitable), the main goal is usually to make a profit byminimising costs and by applying the user pays principle. There isalso independence of management and corporatised govern-ment businesses are not given special commercial favours (i.e.there is competitive neutrality). Sometimes this can bring benefitsand cost savings to the users of government services and, in par-ticular, reduce the financial burden of these GBEs for govern-ments and taxpayers.

Commercialisation of some government activitiesCommercialism also involves government ownership of businessesbut, unlike corporatisation, the enterprise is not expected toactually make a profit. Often this feature reflects the existenceof community service obligations. Instead, the enterprise isexpected to help cover its running costs by generating at leastsome revenue. It also seeks to reduce losses, lower the taxburden and raise efficiency (e.g. some rail operations, aspects ofthe ABC and some water boards).

Public-private partnerships in infrastructureBetween 2000 and 2007, some state governments tried the ideaof private funding of public infrastructure (e.g. schools, roads,tunnels, water treatment, public housing and hospitals). Theseare often called, public–private partnerships. Here, private moneywould build, maintain and operate the facility but the govern-ment would lease these facilities back for periods up to 30years. The questionable success of these ventures in Europehas not stopped over $9 billion worth of projects being ear-marked by Victoria and New South Wales for the period 2003to 2007.

Public sector staff cutsStructural change (1987–2007) initially involved dramaticpublic sector staff cuts of around 35 per cent designed to reducecosts and raise worker efficiency. In part, staff downsizingreflects the impacts of fiscal balance, as well as privatisation andcorporatisation. Although there has recently been a 25 per centrise in public sector staff numbers in the six years to 2005–06due to national security concerns and government reforms,staffing levels are still well below the peak of 1987–88.

Reform of Commonwealth–state relationsDuring the period 1992 to 2007, the Council of Australian Govern-ments continued reforms in Commonwealth–state relations. Itaimed to reduce the degree of inefficiency caused by serviceduplication. Problems in this area are not only costly to tax-payers and business, but they represent a misallocation of thenation’s resources. As a consequence of these changes, by 2007there was good progress on reducing railway duplication, thecreation of a single eastern electricity grid, centralisation ofTAFE education, water trading, and uniform product and roadlaws applying to all states.

National Competition Council (NCC)The NCC is an organisation providing advice, conductingresearch, making recommendations and evaluating state

0

4 000

8 000

12 000

16 000

20 000

Valu

e (

$ m

illi

on

s)

1999–2000

2000–01

1998–99

1997–98

1996–97

2001–02

2002–03

2003–04

2004–05

2005–06

2006–07*

2007–08


government microeconomic reforms. This forms the basis ofthe National competition policy. In particular, the NCC scrutinisesthe changes with regard to road transport, power generationand the creation of a national electricity grid, gas and watersupply, standardisation of regulations and laws between states,the promotion of interstate trade and competition, and pricingreforms undertaken by government monopolies.

Contracting out and competitive tendering

Contracting out (also called outsourcing) is where agreements aremade for the supply of goods and services, between the govern-ment and private business. In order to cut costs, firms areinvited to respond to government advertisements by submittingquotes or tenders. This approach has been widely used ingarbage collection, cleaning and maintenance of governmentbuildings, fleet management, information technology, legalservices and public works. Sometimes this can be more costefficient than having these goods and services provided by full-time government employees and departments.

All up, reforms of the public sector will affect unemployment,inflation, economic growth, external competitiveness, allocative,productive and dynamic efficiency, and the distribution of per-sonal income.

WELFARE REFORMSBetween 1996–97 and 2006–07, reforms (again announcedthrough the budget) made welfare less accessible to somepeople. For example, measures included:� working for the dole� maintaining a jobs interview diary� forcing the unemployed to turn up to job interviews by sus-

pending the payment of benefits� tightening the work test� requiring some on disability benefits and single parents

(whose children have reached school age) to do at least 15hours of work a week

� encouraging the aged to defer retirement and build up theirsuperannuation

� setting up a hot line to report welfare fraud� allowing welfare recipients to earn more income before ben-

efits are lost (so as the reduce the welfare trap as recipientsstart work).

Welfare reform has been seen as an opportunity to increaseefficiency in resource allocation. Some people felt the originalsystem was over generous. Claims were made that it encouragedwelfare dependence, and discouraged work and financial inde-pendence. It was also seen as a burden on taxpayers, a limitationon high rates of labour force participation and a constraint onthe rate of economic growth.

GENERAL DEREGULATION OF MARKETSEconomists generally believe that resources are most efficientlyallocated where there is strong competition. Sometimes, thiscan only occur if governments reduce regulations that restrictcompetition. During the 1980s, 1990s and 2000s, marketderegulation has been a focus of many of the government’smicroeconomic reforms.

Deregulation of agricultural marketsDuring the past 10 to 15 years to 2007, there have been signifi-cant reforms involving deregulation of markets for primaryproducts, along with other measures to accelerate structuralchange. For instance:– Wool pricing. Some years ago, the minimum or reserve price

scheme for wool was abandoned.– Egg marketing. Victoria, New South Wales, South Australia and

Queensland, have deregulated egg marketing.– Milk marketing. Between 2001 and 2005, milk marketing was

deregulated, along with dairy farm-gate prices. In addition,there has been compensation to dairy farmers for the loss ofmilk quotas designed to encourage structural change in theindustry.

– Grains. There has been extensive deregulation of grain salesand especially following the scandal surrounding the Aus-tralian Wheat Board’s (AWB) behaviour in its wheat dealingswith Iraq. The single desk, international marketing system isto be reviewed during 2007.

– Sugar industry restructuring. In late 2002, the government wasforced to announce a levy of between 16 and 18 cents a kilo-gram on sugar consumers to raise money to promote struc-tural change and help farmers to leave the industry. This wasaimed at relieving the problems of over supply and low prices.

– Cheese quotas. During 2000–01, import quotas on cheese werefinally abolished.

Deregulation of transport marketsIn the past two decades there have been numerous examples ofchanges in the Australian transport system.� Airline deregulation. In 1990 the government’s two airline or

duopoly policy for domestic flights (i.e. Ansett Airlines andAustralian Airlines) was ended. In addition, Qantas wasallowed into the domestic market and was privatised. Thiscleared the way for new competitors like Virgin Airlines, Jet-star and foreign carriers, to compete on both domestic andinternational routes.

� Unifying state railways. Some years ago, the National RailCorporation was set up, owned jointly by the Victorian, NewSouth Wales, Western Australian and federal governments.This reform was designed to improve efficiency and cut wasteand duplication.

� Waterfront and shipping reform. These included the privatisationof some ports (e.g. Geelong), allowing competitors into freighthandling to help improve worker productivity on the water-front (helped by the extension of workplace agreements) andan end to the closed or union shop for waterfront workers.

� Road reforms. Much money has been spent on upgradingnational highways. In addition, the level of motor registrationcharges more closely reflect the damage to roads caused byvarious types of users.

Financial sector deregulationThe main microeconomic financial reforms have already beencovered in chapter 6 (p. 206). You may recall that these focusedon reducing government controls. It exposed the bankingsector to more competition so that efficiency improved andinterest rates on loans became cheaper.

Deregulation of telecommunicationsBetween 1990 and 2007, there were some significant changes intelecommunications to allow more competition in the industry.


Optus and Telstra, for example, were locked in a battle forcustomers and the cost of some telephone services has comedown. Telstra downsized its staff to cut costs and was progres-sively privatised between 1997 and 2006, after the Coalitiongovernment gained a majority in the Upper House that allowedit to pass the necessary legislation.

REFORMS TO STRENGTHEN COMPETITIONStrong competition usually results in greater efficiency, lowercosts of production, cheaper prices, and better quality of serviceand product. Unfortunately, in some markets, competitionbetween rival firms is weak due to the existence of monopolies,oligopolies, takeovers, mergers, and price collusion. For thesereasons, the government undertook reforms to strengthen com-petition. In 1995, the Australian Competition and Consumer Commis-sion (ACCC) was set up to take over the roles previously coveredby the Trade Practices Commission (TPC) and the Prices SurveillanceAuthority (PSA). As such, the ACCC now enforces the TPA, whichis designed to help prevent powerful companies (i.e. pricemakers) from artificially raising prices to exploit consumers.

Under the Act, a number of practices are illegal such as:� Price fixing, for example, where firms collaborate to set prices.� Exclusive dealing, for example, where companies refuse to

supply their products or services to one or more firms.� Collusive bidding, for example, in submitting a tender or quote

for the completion of works or to supply goods or services,supposedly competing firms meet secretly beforehand toagree whose tender should be most attractive, cheapest andlikely to win the contract.

� Price leadership, for example, where the dominant or leadingfirm takes a lead in setting prices that others follow.

� Predatory pricing, for example, where the dominant firms con-duct a price war involving big cuts in prices with the intentionof driving rival firms bankrupt, and then later enjoying themarket without competition.

� Market zoning, for example, where competing firms in aregion divide up the market into zones, areas or regionswithin which they agree not to compete with each other overprices.

� Interlocking directorships, for example, where a person acting asa member of the board of directors for one company, is alsoon the board as a director of a supposed rival company.

If a company is found guilty of these offences, fines of up$500 000 for individuals or $10 000 000 for companies may be

imposed, along with possible jail sentences for company direc-tors. The ACCC also performs other functions. For example, itsupervises company mergers and takeovers to ensure that theydo not reduce competition and that they are in the publicinterest. In addition, it monitors pricing (prices surveillance)and other arrangements (e.g. false advertising claims) in indus-tries where competition is weak including the utilities, aviationand airports, insurance, petrol, postal, rail, waterfront and com-munications.

Recently, between 2000 and 2007, the ACCC has adopted ahigh profile and aggressive stance to promote competition. Ittook legal action against Coles which owns Liquorland. Therewere allegations that Coles had engaged in anti-competitivebehaviour in New South Wales by entering into contracts withoutlets licensed to sell liquor. One of the terms of the contractprevented these licensed operators from supplying packagedtakeaway liquor to consumers and, therefore, restricting compe-tition. The ACCC also considered cases involving the companiesand industries listed below (but it should be noted that not all ofthese firms have been found guilty of breaching the Act).

Source: Data derived from the ACCC.

Qantas Major banks Archem Australia

Telstra Seven Network Hutchison Australia

Foxtel Berri Fruit Juice Advanced Medical Institute

Optus ABB Power Transmission Australian Gaslight Limited

Mobil, BP, Shell and Caltex Darwin Radio Taxis Chubb Security

Coles–Myer, Liquorland, Woolworths Coopers & Lybrand and Price Waterhouse (Price WaterhouseCoopers)

Nissen


ENVIRONMENTAL REFORMSEnvironmental reforms cover issues related to environmentalchange, energy and water use.

Energy

For some years now, concern has been expressed about theimpact of burning fossil fuels (e.g. by cars, trucks, power gener-ators, industry and waste disposal) on greenhouse gas emissionsand global climate change. This gave rise to a summit that pro-posed the Kyoto protocol or convention that commenced in2003. The aim was to limit carbon emissions by industrialisednations to specific target levels. Emissions by firms would needto be offset by firms purchasing carbon credits in the market-place. This scheme gives pollution emissions by a firm a cost,or money value, that affects company profits and hence theirresource allocation. For Australia, the target for the 2008–12commitment period, was to slow the emissions rise to only108 per cent of the 1990 benchmark level. Clearly, if Australiahad signed up to this agreement, it would have had significanteffects on the structure and operations of some local industriesand firms, relative to others (e.g. brown coal power generation,road transport, the smelting of aluminium and other metals).The government did not sign this protocol, but did setrenewable energy targets. More recently, the rise in oil prices(2004–06) and growing concern about climate change (in thecontext of the current drought) caused by greenhouse gases,has led to the federal government’s renewed interest in theproblem. Reports were commissioned in 2006 into nuclearenergy and a possible system for trading carbon credits(i.e. licences to pollute, the market price of which would placea cost on firms that pollute).

Water trading

There is growing concern also about water. The currentdrought and, for farmers, the string of dry seasons that stretchesback to 2003–04, have prompted this. Many of our largest citiesare on stage 4 (or higher) water restrictions and our productivecapacity has been reduced. The matter has also raised debateabout using irrigation for growing crops like rice in almostdesert conditions and how to maintain environmental riverflows. In late 2006 and again in 2007, the Prime Minister calleda summit of state premiers to discuss the matter and to com-mence work on reforms including a water trading scheme.

SOCIAL INFRASTRUCTUREThe social infrastructure includes the government’s provision ofadequate health, education and housing. This task is mademore difficult because of financial constraints in the budget, analready high direct tax burden, tax avoidance, growing welfaredependency, a drop in the growth rate for the labour force, andan ageing population that is expecting higher standards of wel-fare and health care (as highlighted in the Treasurer’s 2002–03,Intergenerational report). These developments have forcedefficiency improvements in the government’s delivery of ser-vices. Additionally, other reforms have involved the following.

Funding cuts and user pays

During the past 10 years, there have been cuts in the govern-ment staffing and funding of departments, and in some cases,increased application of the user-pays principle.

Public–private partnerships

Public–private partnerships involving the private financing ofsocial infrastructure (e.g. schools, welfare housing and hospi-tals) have expanded, where the government leases these facil-ities back from private-sector owners.

Health insurance rebate

There has been the introduction of the 30 per cent rebate tohelp offset some of the cost of private health insurance (torelieve the pressure on Medicare), along with the use of casemixfunding in public hospitals.

Education

A review of education has taken place. This has included federalfunding of public and private schools and the application ofnational literacy standards.

MICROECONOMIC POLICY RESULTED IN PRIVATE–SECTOR REFORMGovernment microeconomic reform, especially market deregu-lation and trade liberalisation, have a knock-on effect. Theyforce the private sector to restructure the way it goes about pro-ducing goods and services. No longer can local firms coastalong if they want to survive foreign competition. In their battleto increase efficiency, privately operated firms must keep onreviewing their business practices. Often this has involved thefollowing changes.

Rationalisation of operations

Local firms must rationalise their operations, closing downunprofitable or less viable branches. For example, BHP closedits Newcastle plant, Email ceased its dishwasher and other oper-ations in Victoria, Mitsubishi closed its engine plant in SouthAustralia, banks including the ANZ, the Commonwealth, NABand Westpac have reduced branches and shed over nearly20 per cent of their staff.

Benchmarking against best practice

Benchmarking has been widely introduced and involves settingtime targets for particular processes and work tasks, using thestandards set by leading international plants.

Costs

There has been an increased focus on recycling, reducing pro-duction times, operating with fewer staff, and cutting costs,waste and delivery delays.

Technology

Technology has been applied more widely and is updated morefrequently.

Management

Many firms have used a flatter management structure. Thisinvolves fewer levels of middle management and increasedresponsibilities and performance targets for ordinary workers.

Training

There has been the promotion of continuous learning,multiskilling, teamwork and encouragement of adaptability bystaff.


Stocks

Keeping large stocks of components or finished product is expen-sive so, increasingly, firms employ the idea of ‘just in time’ (JIT)(when new stock is only ordered when stocks are running low).

Wage system

Most firms use a performance-based pay system from CEOsdown. This involves workplace agreements that link wage risesto the achievement of productivity and other targets.

Communication

Businesses have sought to improve communication betweenstaff, since this helps to lift efficiency. Increasingly, the top-downcommand system of management has been replaced by a two-way system of communication. This gives employees greaterresponsibility for their performance and may improve the levelof cooperation between workers and management, leading tolower rates of strikes and industrial conflict.

Marketing

During the 1990s and 2000s, there has been a broadening in theapproach to product marketing from having a local orientation,to greater emphasis on e-commerce and global markets.

Some of the results of reform have been nothing short of stag-gering. For example, at Rio Tinto’s Hamersley mining oper-ations, wage, industrial relations and other changes reduced thenumber of hours lost to industrial disputes by around 98 percent over a recent 10-year period, and at the same time, grewproductivity by nearly 90 per cent in terms of tonnes of oremined per employee a year. These outcomes meant a huge costsaving that translated into increased output, higher profits, busi-ness expansion, increased employment and rises in realincomes.

7.4 Using microeconomic policy to improve domestic economic stability

Remember that internal or domestic economic stability entails thegovernment simultaneously achieving the objectives of:� price stability (an average annual inflation rate over the cycle

of 2–3 per cent)� sustainable economic growth (average annual GDP growth of

around 4 per cent)� full employment (an unemployment rate of around 5–6 per

cent of the labour force).During the past two decades, microeconomic reform has become

an increasingly important part of the overall policy mix or combi-nation. While monetary and budgetary policies act as shorter-term stabilisers of the level of AD, microeconomic policies helpto improve stability in the longer term by growing Australia’sproductive capacity and boosting our AS. Supply-side micro-economic reforms like labour market or wage deregulation,trade liberalisation, cuts in tax rates, improved public-sectorefficiency, growing the level of national savings and competitionreforms, all help us to produce a greater level of national outputfrom fewer inputs, and at a lower cost or general price level.These beneficial impacts of reforms are illustrated on the AD–ASdiagram shown in figure 7.5.

Notice that, as a result of microeconomic efficiency policies,the economy’s productive capacity has grown from AS1 to AS2

(i.e. the AS line has shifted outwards). As a result, the equi-librium level of national output has grown from GDP1 to GDP2,and the general level of costs and prices has fallen from P1 to P2.

This is more or less what has happened in Australia followingmicroeconomic reforms, especially during the past 20 years to2007. Because microeconomic policies try to promote better supply-

side conditions aimed at encouraging an increase in AS, all threeaspects of economic stability should eventually improve. Econ-omic growth should be stronger, inflation slower and unemploy-ment lower than would otherwise occur. Let us see why theseimproved outcomes should occur.

Figure 7.5 How microeconomic supply-side reforms can help improve domestic economic stability

TRY SHORT ANSWER EXERCISE 2, pp. 276–77

Cost inflation

Gen

eral

pric

e l

evel

GDP2 = increased

sustainable rate of

economic growth

AS2 = increasedproductivecapacityfollowingmacroeconomic,

supply-sideefficiencyreforms

AS1 =original supply-side

conditions

GDP1 =

original sustainablerate of economic growth

and employment

AD1 = ideallevels ofspending

P1

P2

Real GDP (national output)


Microeconomic reforms have helped

‘price stability’

Through various efficiency reforms (i.e. productive, allocative,dynamic and intertemporal efficiency) involving structuralchange, the use of positive incentives, and stronger competition,firms have lowered their production costs. If goods and services

cost less to produce, businesses can keep their prices down andstill make good profits. This slows cost inflation and greatlyimproves price stability. In the long term, improved price stab-ility and international competitiveness also help GDP andemployment growth and, hence, general economic stability.

Six of the most significant microeconomic reforms designedto slow cost inflation pressures are reviewed in table 7.4.

The top six microeconomic reforms that fight inflation

1. Tariff cuts and trade liberalisation

There were progressive cuts in general tariff rates from around 40 per cent in 1968–69, to zero for most items by 2005–06, along with ongoing reductions in those for cars, textiles, clothing and footwear. Additionally, subsidies were reduced, import quotas abolished and four FTAs were in operation by early 2007 (with four more in the pipeline). Tariff cuts helped to keep inflation down. This happened in several ways.

� Reduced tariffs increased the level of competition forcing local firms to slash their costs and prices.

� Lower tariffs and freer trade made imports cheaper. This meant a significant reduction in production costs for firms using imported equipment. Goods were also less expensive for households purchasing imports such as cars, footwear, clothing and electrical goods.

� Cheaper imports helped to siphon off excess AD, thereby slowing demand inflation.

� Lower tariffs forced businesses to allocate resources more efficiently to areas where our comparative cost advantage was greatest. This too helped to keep inflation down.

2. Labour market deregulation

The past decade and a half has seen the extension of efficiency or performance-based workplace wage agreements. These and other labour market reforms helped to actually reduce RULCs during the 10 years to 2005–06. Being the main cost of production for many firms, lower RULCs in turn slowed cost inflation. In addition, these reforms also contributed greatly to reducing costly industrial strikes.

3. Competition reforms

Changes were made to improve the level of competition between sellers of goods and services. These included the creation of the ACCC, the strengthening of the TPA, widened surveillance of prices, and closer scrutiny of mergers and takeovers. Economists believe that strong competition between rival firms is a precondition needed for efficiency and lower inflation rates.

4. Public sector efficiency reforms

Public sector efficiency reforms helped to reduce production costs and hence inflation. These included privatisation, corporatisation, contracting out and competitive tendering, and public service staff cuts. As a result of reforms, the cost to users of many government services actually fell in real terms.

5. Tax reforms The reductions in most tax rates (e.g. on personal incomes and company profits) between 2000 and early 2007, helped to slow inflation. Companies had higher after-tax profits allowing them to absorb some of the cost rises without putting up their prices. This helped to accelerate investment in more efficient new equipment. Individuals were also encouraged to work harder, knowing they would get to keep more of their income. This helped productivity and lowered inflation.

6. Promoting national savings

Measures (e.g. encouragement of superannuation, budget surpluses, the Future Fund) were put in place to try and promote national savings. With more savings available for lending, the cost to firms of borrowing credit used to finance investment in new equipment and technology tended to become cheaper than otherwise. Indeed, current interest rates are at a 30-year low. This helps to reduce cost pressures on firms and slow inflation.

Table 7.4


Microeconomic reforms have

promoted higher sustainable

economic growth

There are two ways supply-side microeconomic reform canhelp accelerate the rate of economic growth that aneconomy can sustain, without jeopardising price stability:1. Microeconomic policy can increase Australia’s sustain-

able rate of economic growth by expanding our pro-ductive capacity. This occurs because greater efficiencyallows businesses to produce a bigger output from thesame inputs, simply by cutting costs or using the avail-able resources more efficiently.

2. Cost-cutting efficiency reforms (e.g. industry assistance,cuts in tax rates, labour and capital market deregulation,modifications to welfare access and R&D schemes) liftthe sustainable rate of GDP growth by boosting businessprofits and creating incentives for individuals to workharder. This improves worker motivation and makesfirms more willing to expand their output.

Table 7.5 shows some of the more important microeco-nomic reforms used to help increase Australia’s sustain-able rate of economic growth during the past 10–20 yearsto 2007.

The top four microeconomic reforms that promote sustainable economic growth

1. Tax reforms In general, lower tax rates (as in Australia, 1999–2007) help to boost economic growth and productive capacity. From the supply-side point of view, reduced rates of company and capital gains taxes help to grow the after-tax profits of investors and firms. This motivates business expansion through increased investment spending on new equipment and technology. Capital deepening (i.e. more investment or capital per worker) leads to better efficiency. Similarly, lower rates of PAYG help to encourage hard work since individuals can retain a larger percentage of their income. This may also lead to higher rates of saving and investment.


Australia’s labour market reforms have mainly been about boosting worker productivity and using resources more efficiently. For instance, workplace agreements represent a performance-based wage system. Typically, these agreements only pay higher wages when there is increased worker efficiency. In addition, the relaxation of the unfair dismissal laws (see Work Choices, 2005) might mean that more workers are employed than previously, contributing to increased national production.

3. Public sector reforms

Australia’s public sector produces almost 20 per cent of GDP. As a result of efficiency reforms including cost cutting, contracting out, privatisation and corporatisation, our productive capacity and sustainable rate of economic growth should tend to increase.

4. Reforms to promote national savings

Australians save too little to finance national investment. Among other things, this leads to higher interest rates that discourage business expansion in plant and equipment. In turn, this slows our sustainable rate of economic growth. However, the savings reforms between 1991 and 2007 including many surplus budgets, the creation of the Future Fund, the introduction of compulsory superannuation and other incentives to encourage private superannuation, should help to correct this problem.

Table 7.5


Microeconomic reforms have helped

encourage fuller employment

There is little doubt that microeconomic reform increased struc-tural unemployment over the short and medium terms. Often,cost reductions by firms, the promotion of efficiency and therationalisation of production by the private and public sectors,resulted in the downsizing of staffing levels. Although this is verydistressing for those involved, theoretically, if there is improvedefficiency, product quality, price competitiveness and businessprofitability, in the longer term, fewer firms should close down.Structural unemployment should drop. Indeed, reforms shouldeventually help to grow employment opportunities more than wouldbe the case if industries were inefficient. In addition, localefficiency reforms help to grow domestic and international salesof goods and services, generating even more jobs.

Table 7.6 summarises some stand out microeconomic reformsaffecting employment.

Some other advantages of

microeconomic policy

Microeconomic reforms have other advantages.

Microeconomic policy is more effective than macroeconomic policy in some situationsUnlike macroeconomic policy in general, and especiallymonetary policy in particular, microeconomic reforms are very

effective in dealing with supply-side structural causes of economicinstability. � While contractionary monetary and budgetary measures

work well to slow demand inflation, they often worsen costinflation. This is not a problem with microeconomic reforms.These actually reduce costs and do not depend on stoppingthe economy to check inflation.

� Similarly, expansionary budgetary and monetary policieswork quite well by boosting AD to counteract a cyclical slow-down economic activity and employment. However, micro-economic measures are far more effective thanmacroeconomic strategies in actually lifting the sustainablerate at which the economy can grow.

Microeconomic policies are consistent with achieving most other government economic objectivesIn promoting domestic stability through greater efficiency, thishelps the government achieve its other economic objectives. Forinstance, external stability should be improved as firms becomemore internationally competitive and we are less dependent onfinancing national investment through overseas borrowing anddebt. Certainly there will be greater efficiency in resource allo-cation and, in the long term, this may even lead to improvedequity in income distribution.

The top five microeconomic reforms that can lower unemployment in the long term

1. Tax reforms Tax rates were cut (especially during the years 1999 and 2007) partly because lower rates help to create more jobs and less unemployment. Reduced company and capital gains taxes encourage higher levels of business investment and expansion because after-tax profits are higher and firms are more internationally competitive. This generates jobs whereas low or falling company profits destroy employment.

2. Welfare reforms Reforms (especially 1996–2007) have made it more difficult to access welfare and have removed some of the disincentives to work. The welfare trap has been reduced. New policies have also aimed to increase labour force participation rates and get more individuals to accept responsibility for their personal financial situation.

3. Trade liberalisation

Over 20 per cent of Australian jobs result from international trade. Trade reforms in the years to 2007 focused on cutting the level of tariff and other protection, and expanding FTAs. In the short term, it is likely that the move towards freer trade caused structural unemployment to rise as local firms closed down due to import penetration of the domestic market. However, some research confirms that employment grows fastest in more globalised industries where, due to lower tariffs, resources are allocated efficiently into areas of comparative cost advantage.

4. Labour market reforms

Employment grows and unemployment shrinks if Australian firms are profitable due to lower production costs. One of the key costs is wages for labour. Over the past 15 years to 2007, there has been extensive deregulation of our labour market and wages, with the extension of workplace agreements to cover around 90 per cent of workers. This has been the main reason for the actual fall in RULCs (by around 0.44 per cent per year during 1996–2006), and record levels of business profitability experienced in recent years.

5. Reforms to lift national savings

Business can only expand if it has access to cheap finance and low interest rates. Recent reforms have tried to grow the pool of national savings via surplus budgets, the Future Fund and inducements for superannuation. As a result, interest rates are lower than would have otherwise been the case.

Table 7.6


HAS MICROECONOMIC POLICY PROMOTED DOMESTIC STABILITY?Conclusive evidence of the success (or otherwise) of thesemicroeconomic reforms is difficult to find. This is becausethere are so many local and international factors other thanmicroeconomic policy, that affect how well the economy per-forms. Even so, it is interesting to compare data for twoperiods of time — first, for the years 1980–1992 (prior to theacceleration of reform), and second, for the period from1992–93 to 2005–06 (when changes in microeconomic policywere much faster). Table 7.7 attempts to do this using ascorecard.

Notice for example:� Productivity is growing much more strongly.� RULCs for firms have actually decreased.� Strike rates are greatly reduced.� The cost of overdraft interest rates is much cheaper for firms

borrowing credit.� Tax rates on companies are significantly lower.� The labour force participation rate has increased.� Tariff protection of local manufacturing industry is now

almost non-existent.� Many goods and services (e.g. electrical appliances and air

travel) are now cheaper for households and firms.These trends have implications for the achievement of domesticeconomic stability.

A scorecard for government microeconomic policy for domestic economic stability

Sources: Data derived from ABS 1350.0; RBA Bulletin; RBA Occasional Paper, No. 8A.

INDICATOR OF THE SUCCESS OF MICROECONOMIC POLICY REFORMS

AVERAGE 1980–

92

AVERAGE 1992–2006

NOTES ABOUT THE CHANGE IN AVERAGES

(1992–06 COMPARED WITH 1980–92 AND OTHER YEARS)

Price stability: Inflation (average annual percentage change in CPI)

8.1 2.6 Inflation down by 67.9 per cent

Sustained economic growth: GDP growth (average annual percentage change)

3.4 3.7 Sustainable rate of economic growth faster by 8.8 per cent

Full employment: Unemployment rate (average percentage of labour force)

7.7 7.1 Unemployment down by 7.8 per cent (October 2006, a 30-year low figure of 40.3 per cent down on 1980–92)

1. Productivity (average percentage change in GDP per hour worked)

1.2 2.1 Average labour efficiency increased by 75 per cent

2. RULCs (average annual percentage change)

–0.3 –0.4 Average RULCs for firms are falling and cheaper by 33 per cent

3. Strikes level (average working days lost per 1000 employees)

352 65 Estimate down by 81.5 per cent (2005–06 figure down an estimated 97 per cent on 1970s average)

4. Gross profit growth (average annual percentage change)

11.2 8.5 Down by 24.1 per cent

5. Rate of company tax (average percentage of profits)

44 33 Down by 25 per cent (2005–06 rate 39.9 per cent down on 1980 rate)

6. Interest rates on overdrafts (average percentage a year)

16 9.1 Down by 43.1 per cent (2005–06 rate down 54 per cent on 1989 rate)

7. Labour force participation rate (average percentage of total persons)

61 63.4 Average is up by 3.9 per cent (October 2006 figure down 6.7 per cent)

8. General manufacturing tariff rate (average annual effective percentage)

19 2 A fall in the average annual level of tariff protection by 89.5 per cent

Table 7.7


Some possible successes of reforms

Based on table 7.7 and other data for the past 25 or more yearsto 2005–06, many commentators believe that recent microeco-nomic policies generally have been very effective in promotingdomestic stability in three ways.

1. A faster sustainable rate of economic growth

Economic activity rose in all years at an annual average ofaround 3.6 per cent. This higher sustainable rate of econ-omic growth was the result of good profits, greater prod-uctivity, increased labour force participation rates, fewerstrikes, lower tax rates and cheaper credit. Although theaverage rate was just short of the government’s 4 per centtarget, it was held back in the past 3–4 years to 2007, becausethe economy had little unused productive capacity.

2. Better price stability

Overall, inflation was within the government’s 2–3 per centtarget (unlike the years 1980–92), thanks partly to strongerproductivity of over 2 per cent a year, falling RULCs, lowertariffs and cheaper credit for firms. The price of some goodsand services actually went down. Even so, there were twospikes in Australia’s inflation rate in 2000–01 and 2006–07.These were partly provoked by once-off events, and morerecently, by the fact that the economy was close to its pro-ductive capacity.

3. Fuller employment

This period eventually saw the achievement of the fullemployment target (i.e. 5–6 per cent unemployment).Except for a slight rise during the slowdown of 2000–01,unemployment fell fairly steadily from 8.3 per cent in 1996,to a 30-year low of only 4.6 per cent in late 2006. This may bepartly attributed to the increased competitiveness of localfirms following effective microeconomic reforms (e.g. labourmarket deregulation, tax cuts and savings reforms).

Some areas of weakness in reforms

Despite this apparent success, critics of recent microeconomicpolicy draw attention to some areas of weaknesses.

The pace of microeconomic reform slowed down between 2001 and 2005

Microeconomic reform appears to have moved in waves withpeaks in the early 1990s, 1996, 2000 and perhaps 2005. Despitesome renewed interest in 2005, the pace of change did seem toslow and the federal opposition believed that the governmenthad run out of new ideas.

Possible conflict with other government objectives in the short term

Perhaps the most severe weakness of many microeconomic poli-cies in Australia is that, in the short term, they are likely toweaken the achievement of full employment and equity. Forexample, in the 1990s and 2000s, structural change has meantthat most firms have produced more output with fewer workers.Indeed, ABS data shows that while manufacturing output rose36 per cent between 1996–97 and 2005–06, this sector providednearly 7 per cent fewer jobs. This was only possible becausethere has been a 19 per cent rise in labour productivity (i.e.GDP per hour worked). In addition, when unemployment rises,

for whatever reason, equity in income distribution also tends tosuffer in the short term. This is because unemployment causesincomes, purchasing and access to basic goods and services tobe reduced. When assessing the short-term effects of micro-economic policy on the level of structural unemployment andequity, the following reforms have proved to be the mostdamaging.� Reduced tariffs and protection. Import duties have been progres-

sively reduced. The general tariff rate was cut from 15 percent in 1992 to zero by 2005–06. In addition, in the 14 yearsto 2005, tariffs on cars fell from 35 to 10 per cent, and, for thetextiles, clothing and footwear industries, from 47.5 to amaximum of 15 per cent. This caused business closures andstructural unemployment in the manufacturing sector.

� Labour market reforms. Labour market reforms (especially theextension of enterprise agreements) have increased workerproductivity. In many cases, more work is now completedusing fewer staff, temporarily causing a slower growth inemployment.

� Reforms to the government sector. Initially between 1987 and1999, there was a 35 per cent reduction in public sector stafflevels due to the effects of privatisation, corporatisation, com-mercialisation, contracting out and the government’s fiscalconsolidation. However, between 1999 and 2006, numbershave again grown, although not to previous levels.

� Structural change by businesses. There has been massive restruc-turing, especially in the car, textiles, aviation, transport,farming, telecommunications and banking industries. This hasoften been associated with the accelerated use of new tech-nology (e.g. robots, computers and the Internet, and R&D),the rationalisation of company branches (i.e. sometimescaused by integration, mergers, takeovers), and the introduc-tion of new worker–management systems designed to cut costs.

Political constraints slow or weaken reform

As we saw between 1996 and 2007, many microeconomic reforms(e.g. the Workplace Relations Act, the privatisation of Telstra, andthe introduction of the GST) initially failed to gain approval inthe Upper House where federal governments lacked a majorityuntil 2005. In addition, WorkChoices (2005–06) the proposedsale of Medibank Private (perhaps 2007) and the Snowy Moun-tains Hydro Scheme (the idea was scrapped in 2006), proved


unpopular with some sections of the community. Political con-straints like these, slow the speed of reform and may sometimesresult in them being watered down and made less effective.

Implementation lags are often long Microeconomic policy can involve enormous time lags or delaysin policy implementation. Reform of the car industry, for instance,commenced in 1983 but the tariff cuts associated with it, will stillnot be complete until some time after 2010. Another exampleof implementation delays is labour market deregulation. Thiswas designed to slow the growth in wages, reduce cost inflationand improve external competitiveness. Workplace agreementswere first approved in 1991, but even by 2006, over 10 per centof the labour force was still regulated by the old minimum wagesystem. This long implementation lag also reduced the ability ofreform to improve domestic stability.

Inability to use microeconomic reforms as a short-term stabiliserUnlike macroeconomic policies that can help reduce the severityof booms and recessions, microeconomic reform cannot be used as

a short-term stabiliser to iron out fluctuations in the businesscycle. Instead, microeconomic measures are more aimed at thelonger term where they are limited mainly to raising efficiencyand the sustainable rate of economic growth, cutting businesscosts and inflation, and improving the international competi-tiveness and profitability of Australian firms.

Institutional constraints slow the pace of reformWhile some people are critical of change, others believe thatour pace of reform has been too slow. One reason for this is theinstitutional constraints that limit progress. There does seem tohave been a lack of real commitment to reform across a widerange of institutions from unions, to business and to govern-ment at all levels. In addition, greater determination toimplement reform overseas has meant that relatively, Australiamay still be losing ground.

7.5 Using microeconomic policy to improve external stability

For Australia, the government’s objective of external stabilitymeans that we should be able to pay our way in international trans-actions, without undue downward pressures on the A$ or anexcessively large CAD or NFD. Figure 7.6 shows, hypothetically,that there are two sets of factors currently causing Australia’sexternal problems. 1. From time to time, excessively strong AD and economic

activity can cause a cyclical rise in our CAD.2. There are ongoing or long-term structural problems that

cause the CAD to seldom fall below 3 per cent of GDP.

As supply-side efficiency measures, microeconomic reforms arevery well suited in the long term, for dealing with Australia’sexternal structural problems, namely: � the large saving–investment gap that is currently filled by bor-

rowing overseas� our relatively high production costs that reduce our inter-

national competitiveness. Let us now consider each of these two areas to see what macro-economic policy is doing to correct the problem.

Figure 7.6 The causes of external instability and its reduction using microeconomic policies

TRY SHORT ANSWER EXERCISE 3, pp. 277–78

6

3

0

CA

D:G

DP r

ati

o (

%)

Years

2. A large CAD:GDP ratio of around 6% shows that there is excessively strong AD and economic activity. National expenditure is running ahead of our productive capacity. Contractionary macroeconomic measures might help to reduce this problem.

1. This area represents ongoing structural causes of external instability including our poor competitiveness and our big NFD due to a lack of domestic savings to fill the S–I gap.This problem can be reduced by microeconomic reforms that improve our competitiveness and close our national S–I gap.

A figure of around 3–4% for the CAD:GDP ratio is the government’s target for the objective of external stability. This is most likely to be achieved when there is domestic economic stability (rather than a boom).


Reducing the large ‘gap’ in national

savings and investment

Australians do not save enough to finance their high level ofinvestment in new plant and equipment. We have come todepend very heavily on overseas borrowing and debt, in orderto make up the difference. This problem then adds to Aus-tralia’s CAD (especially the huge net income deficit) and hascontributed to the long-term decline in the A$. In addition,poor savings mean that domestic interest rates paid by busi-nesses borrowing credit, are often higher than those facedabroad. This further encourages overseas borrowing. It also rep-resents a cost disadvantage by discouraging local firms from pur-chasing the latest technology needed to lift efficiency, and itlowers the competitiveness of our exports relative to imports.Table 7.8 reviews some of the key microeconomic reforms usedto try to increase domestic savings.

Lowering our high costs and

improving our international

competitiveness

Often due to low efficiency and our particular endowments ofresources, Australian firms often face higher production costsrelative to those overseas. Costs here include wages, interest rateson borrowed credit, utilities (i.e. energy, water, telecommuni-cations), transport, imported materials and equipment, and highfixed costs caused by the local market being comparatively smallin size (this reduces economies gained from large-scale pro-duction where costs can be spread more thinly). In addition,

companies have to contend with relatively high tax rates. Becauseit often costs more to produce goods and services here, it is dif-ficult for local firms to keep prices down and still make reason-able profits. Regrettably, high domestic costs and pricesundermine export sales and encourage imports. They also pre-vent our firms from adding greater value to exports through fur-ther processing or manufacture. Together, these problemscontribute directly to Australia’s ongoing structural CAD, risingNFD and overall declining value of the A$.

Microeconomic policy has tried hard to improve Australia’sinternational competitiveness through the cost-cuttingefficiency measures shown in table 7.9 (p. 262). Coverage herewill be brief because these measures have been mentionedalready in connection with slowing inflation.

Five microeconomic reforms that may help increase national savings

1. Surplus budgets and pursuit of fiscal balance

Since 1996, the Treasurer has accepted the idea of fiscal balance in the medium term, where budget surpluses pay for deficits. This means that there is no Federal public sector borrowing requirement and, by 2005, all Commonwealth debt had been repaid. This helped to reduce the size of the NFD and CAD. It also meant that interest rates were lower than otherwise, stimulating private sector investment in new technology and helping to improve our international competitiveness.

2. The Future Fund In 2005, the Future Fund was created. It used proceeds from asset sales and surplus budgets to try to grow national savings and capital through wise investments.

3. Tax concessions for private superannuation contributions

The government encourages private superannuation contributions by offering very generous income tax concessions for those sacrificing their salary and, from July 2007, individuals can withdraw their superannuation tax-free, once they reach the age of 60 years.

4. Introduce the compulsory national superannuation guarantee charge

Starting in 1991, national superannuation was made compulsory for all employees through the introduction of the Superannuation guarantee charge (SGC). This levy on business originally started at 3 per cent, but in 2002, was increased to 9 per cent of an employee’s pay.

5. The co-contributions superannuation

The Superannuation co-contributions scheme commenced in 2002–03. Basically, the government matches low-income after-tax superannuation contributions at the rate of up to $1.50 for every $1 (higher for 2007–08) put into an approved superannuation account.

6. Tax reform involving lower tax rates

Between 1999 and 2007, there were significant reforms involving cuts in tax rates. Many of these changes should help to increase disposable incomes and national savings by individuals and companies.

Table 7.8


Six microeconomic reforms that help increase our international competitiveness

HAS MICROECONOMIC POLICY PROMOTED EXTERNAL STABILITY?It is hard to prove the success or otherwise of microeconomicpolicies. This is because there are so many local and inter-national factors affecting Australia’s ability to ‘pay its way’, and

in turn, influencing the CAD, NFD and exchange rate for theA$. Isolating cause and effect accurately, is almost impossible.Even so, the data in table 7.10 helps to cast light on the situ-ation. It compares statistics for the years spanning 1996–97 to2005–06 (when microeconomic policies were at their peak),with those for 1980–1992 (before microeconomic reformsgained popularity).

1. Tariff cuts and trade liberalisation

In the 30 or more years, to 2007, local industry has been exposed progressively to much stronger competition from imports following reductions in tariffs and subsidies, the abolition of import quotas and the growing number of FTAs. This has forced Australian firms to cut costs by restructuring their production, improve product quality and service, and to allocate resources more efficiently into areas where our comparative cost advantage is greatest.


Under workplace agreements, wage rates paid by firms now, more closely reflect market conditions of demand and supply than was the case when the traditional centralised minimum wage system was more dominant. Reforming the wage system, changing legislation about unfair dismissal, and encouraging union amalgamation and multiskilling, have all helped to lower RULCs. This has made local exporters more competitive.

3. Deregulation of other markets

The government also has deregulated many other markets (e.g. including aviation, power, communications, primary products, and financial markets) to stimulate competition, improve efficiency and strengthen the international competitiveness of local firms. The floating of the A$ in particular has helped to ensure that the A$ trades at an appropriate level that reflects global demand and supply conditions. This acts as an automatic device to help correct the size of our CAD.

4. Competition reforms The promotion of stronger competition through the Trade Practices Act and its enforcement by the ACCC has helped to keep business costs and prices down. This makes local firms more competitive.

5. Public sector efficiency reforms

There has been significant privatisation of government business enterprises during the past 20 years to 2007. Supporters claim that this lifts efficiency, cuts production costs for firms using these services, and allows them to sell profitably at lower prices. In addition, corporatisation of some government businesses and overall reductions in the size of the public sector have contributed to lower costs of government and a more competitive economy.

6. Tax reforms Reforms here have especially focused on lowering tax rates on individuals and firms. For example, reductions in taxes on company profits and capital gains, allow firms to enjoy better after-tax profits. Local exporters can also sell at a lower more competitive price, encouraging better sales.

Table 7.9


A government microeconomic policy scorecard for external stability

Sources: Data derived from ABS 1350.0; RBA Bulletin; RBA Occasional Paper, No. 8A.

Some strengths of microeconomic

policies

Supporters of Australia’s microeconomic policies point out thatthere are limits to what the government can do to strengthenexternal stability. As we have seen, a host of reforms certainlytried to improve national savings and our international compet-itiveness, without which, it could be argued, the results wouldhave been much worse. Microeconomic policies have helpedexternal stability by:� increasing worker productivity � lowering RULCs for export firms� reducing strike rates that are costly to firms and disrupt

export trade

� pushing down interest rates on business overdrafts to a30-year low, thus cutting production costs and improvingcompetitiveness

� improving after-tax company profits thereby allowing firms toabsorb rising costs and sell exports more cheaply.

Some weaknesses of microeconomic

policies

However, despite these claims, on the face of it, microeconomicreforms appear to have failed to deliver external stability. Table7.10 supports this. For instance, it can be seen that, for 1996–2006, the CAD:GDP ratio averaged 4.6 per cent. This exceedsthe government’s 3–4 per cent target and, overall, it looks like

INDICATOR OF THE SUCCESS OF MICROECONOMIC POLICY REFORMS

ANNUAL AVERAGE

1980–92

ANNUAL AVERAGE

1992–2006

NOTES ABOUT THE CHANGE IN AVERAGES

(1992–06 COMPARED WITH 1980–92 AND OTHER YEARS)

CAD:GDP ratio (percentage) 4.8 4.6 There was a slight reduction in the average size of the CAD:GDP ratio by about 4 per cent

NFD:GDP ratio (percentage) 25.7 38.5 The average size of the NFD:GDP ratio ballooned by nearly 50 per cent

TWI (1970 = base year = 100 points) 67.1 55.8 The average value of the A$ on a TWI basis fell by nearly 17 per cent

1. Productivity (percentage change in GDP per hour worked)

1.2 2.1 The average annual rate of growth in labour efficiency increased by 75 per cent

2. Household savings ratio (percentage of GDP)

7.8 1.6 Household savings as a percentage of GDP collapsed by nearly 80 per cent

3. RULCs (annual percentage change) –0.3 –0.4 The average annual level of RULCs fell by 33 per cent

4. Strike levels (estimated working days lost per 1000 employees)

1878 65 Estimates of the strike rate are down by over 80 per cent (with the 2005–06 figure down 97 per cent on the 1970s average)

5. Gross profit growth (percentage) 11.2 8.5 Annual rate of profit growth slowed by about 24 per cent

6. Rate of company tax (percentage of profits)

44 33 The company tax rate is down by 25 per cent (with the 2005–06 rate down about 40 per cent on that for 1980)

7. Interest rates on overdrafts (percentage) 16 9.1 The average cost of business overdrafts was down by about 43 per cent (with the 2005–06 rate down 54 per cent on that for 1989)

8. General manufacturing tariff rate (estimated percentage)

19 2 A fall in the average annual rate of tariff protection by nearly 90 per cent

Table 7.10


efficiency and savings measures to reduce the CAD have not yetworked. It is also clear that the average size of the NFD as a per-centage of GDP has ballooned by nearly 50 per cent. This is des-pite reforms to close the savings–investment gap. In fact,household savings as a percentage of GDP have actually fallenand are now negative. In addition, despite a much stronger A$,recently, since the low of 2000–01, overall the currency has lost alot of ground against where it was in 1970, or during the period1980–92. The picture is even worse taking an even longer-termview. In 1901, for example, A$1 would buy over 70 per centmore in terms of the US$ than at present.

Although most commentators acknowledge the usefulness ofthe government’s microeconomic policies in helping Australiacontrol its external problem, there are several reasons why suc-cess appears to be rather limited.

Some negative effects of trade liberalisation on external stabilityOn the one hand, tariff cuts can help reduce the cost ofimported equipment for local firms and make our exportersmore competitive. However, it is also true that lower tariffs canworsen the CAD and weaken the A$. This is because importsbecome cheaper, thereby encouraging Australians to buy moreitems made abroad.

Conflicts with some other government goalsImproving efficiency and international competitiveness throughmicroeconomic policy can conflict with the achievement ofother goals. For instance, in the short term it appears thatefficiency reforms (e.g. tariff cuts, privatisation, deregulation)often cause structural unemployment. In turn, unemploymentusually results in a lower level of disposable income for an indi-vidual that limits his or her access to basic goods and services.Typically, living standards are reduced.

Policy time lags are usually longThe fact that microeconomic policies often have large time lagsfor implementation and impact, is one reason why the gains maynot be all that apparent in the short term. For instance: � tariffs cuts commenced in 1973 are still going

� labour market deregulation involving performance-basedworkplace agreements started in 1991 yet some workers arestill covered by this system.

� the privatisation of Telstra began in 1998, but all shares willnot be sold until at least 2007

� the Superannuation guarantee charge commenced in 1992,but savings still only represents 9 per cent of payroll and isinsufficient for retirees to have reasonable living standards

� despite significant changes in 2000 and 2007, tax reformshave a significant way to go to make local firms more inter-nationally competitive.

Political constraints

One reason for Australia’s cautious approach to reform is theadverse political impact on voters at election time. Tariff cuts,workplace relations and privatisation for instance, have hardlybeen popular in some electorates with manufacturing indus-tries. This is because some of these microeconomic policiescause structural unemployment in the short term. There is alsothe added problem for the federal government if it does nothave a majority in the Upper House that allows it to ram legis-lation through parliament.

Institutional constraints

Microeconomic measures such as tariff cuts and labour marketderegulation have sought to create an export culture and sharpenour focus on the need to be more internationally competitive.Business and union organisations were initially slow inresponding. This reduced the success of reforms.

Overseas constraints

Effective microeconomic policy can be undone by overseasfactors. For instance, protectionist measures adopted by someforeign governments (e.g. EU, Japan and the US) have under-mined our improved competitiveness resulting from domesticreforms. Clearly, not all countries believe in the level playing fieldas a basis for international trade.

7.6 Using microeconomic policy to improve efficiency in resource allocation

Nations that use resources efficiently enjoy better material livingstandards. These productivity improvements can arise frommany sources including allocative, technical, dynamic and inter-temporal efficiency. As we have seen on previous occasions, allo-cating resources more efficiently mostly involves cost-cuttingpolicies designed to improve structural or supply-side conditions,rather than measures to regulate the demand-side of theeconomy. With this in mind, let us briefly review the top fivemicroeconomic reforms that have perhaps made the largest con-tribution to improving efficiency in resource allocation.

Labour market reforms to lift

allocative efficiency

Microeconomic reforms have increasingly deregulated thelabour market. Between 1991 and 2007, this involved mainly theextension of workplace agreements and the reduced influenceof the minimum wage system. It means that rather than mostwages being set by government regulation, workers are increas-ingly paid according to the market value of their services(reflecting demand for staff relative to their supply). Also,workers are increasingly rewarded according to their perfor-



mance or productivity, and the profitability of the particularbusiness. This means that allocative efficiency is increased andthere is more incentive for staff to work hard. Also, other labourmarket reforms involving the encouragement of union amal-gamation, the extension of multiskilling, and the easing ofunfair dismissal laws, may have helped to significantly reduceindustrial strikes, again improving worker efficiency (i.e. moreGDP per hour worked).

Public sector reforms to lift efficiency

In Australia, the public sector produces about 20 per cent ofGDP. It is, therefore, important that governments are efficientusers of resources. In this area, there have been numerousmicroeconomic reforms.

Privatisation

Some government businesses enterprises (GBEs) have been par-tially or fully privatised (e.g. the Commonwealth Bank, Qantas,Telstra, some shipping ports like Geelong and airports). Variousarguments have been used to justify privatisation. For example,it is often claimed that: � the private sector is a more efficient user of resources than

the public sector because it tries to maximise profits by mini-mising costs

� private firms have superior management and more com-mitted staff

� private shareholders demand increased efficiency to raisetheir share price and dividends or returns

� private firms put more emphasis on R&D and marketing � private firms have better access to capital and technology � private firms are exposed to greater competition.

Commercialisation and corporatisationMany of the remaining GBEs have been corporatised so that theyoperate more along the lines of a private company. Some areexpected to contribute to their own operating costs by the com-mercialisation of their services (e.g. the ABC, ABS).

Other measures to reform government efficiencyOther measures to reform government efficiency include con-tracting out, competitive tendering, changes to Commonwealth–state relations and the establishment of the National CompetitionCouncil to oversee the National competition policy.

Trade liberalisation to lift allocative

and technical efficiency

During the 1970s, 1980s, 1990s and 2000s, significant tariff cutsand trade liberalisation forced local firms to use resources moreefficiently. During the 40 years between 1967 and 2007, generaltariff rates have come down from around 40 per cent, and arenow effectively zero for most items. What this has done is causenatural, labour and capital resources to be allocated into areasof comparative cost advantage. Clearly, this would strengthen allo-cative and dynamic efficiency. Moreover, not only do tariff cutsforce local firms to reduce costs to remain competitive, but alsothey make imported capital equipment relatively cheaper. Thispromotes technical efficiency by improving local access to new,more efficient technology that may reduce time and waste inproduction. There are also the efficiency benefits associatedwith the development of an export culture or orientation amongfirms exposed to international competition. Businesses, whichsucceed in breaking into overseas markets, can also gain fromimprovements in economies of larger-scale operation (i.e. theirfixed costs per unit produced are lower because these arespread over a bigger volume of output).

National savings reforms to promote

intertemporal and technical efficiency

Without adequate national savings, Australian firms would lackaccess to cheap credit or finance. Interest rates would be higherthan those overseas, discouraging vital investment spending onnew plant and equipment incorporating the latest technology.With this problem in mind, the federal government initiated sav-ings reforms, including the pursuit of fiscal balance, creating theFuture Fund, lowering tax rates and encouraging superannuationusing a range of strategies. This should tend to increase intertem-poral efficiency. In addition, local businesses are currently enjoyingsome of the lowest interest rates since the early 1970s allowingthem to more readily purchase new equipment, bringing aboutcapital deepening, and improving productive efficiency.

Financial sector reforms to improve

allocative efficiency

Since 1982, there has been considerable deregulation ofAustralia’s financial system. This reform involved removingunnecessary government restrictions and other impediments toallocative efficiency by creating a more competitive financial system.For example, deregulation has meant floating the A$, removingcontrols on interest rates, and encouraging the entry of morelocal and foreign banks to stiffen competition between lending


institutions. There is some evidence that these reforms have nar-rowed bank profit-lending margins by 1–2 per cent, making localcredit more affordable to firms needing to borrow funds forinvestment.

Tax reforms to improve efficiency

Lower rates of personal, company and capital gains taxes havebeen introduced as part of government reforms. The idea is thatcuts in PAYG rates create greater personal motivation and incen-tive to work hard. In addition, lower rates of capital gains andcompany taxes, for example, mean higher returns and biggerafter-tax profits. This should mean there is a greater willingnessand ability to increase investment in new plant and equipment.This could lead to capital deepening (i.e. a rise in the value ofequipment per worker) and better labour productivity.

HAS MICROECONOMIC POLICY PROMOTED EFFICIENCY IN RESOURCE ALLOCATION?An obvious question to ask is, how effective has microeconomicreform been in improving Australia’s efficiency in resource allo-cation during the past 10 to 15 years to 2006–07? Unfortunately,we cannot be absolutely certain. There are statistical limitationsto our data, and there are so many local and internationalfactors affecting efficiency, other than government policy. Evenso, let us start by looking at figure 7.7 that compares statisticaldata for two periods of time: one before the pace of micro-economic reform accelerated (i.e. 1982–92), and one after(i.e. 1996–2006).

Figure 7.7 Comparisons of labour and multifactor productivity in Australia, 1982–92 (before accelerated microeconomic reforms) and 1992–2006 (after acceleration of microeconomic reforms)

Source: Data derived from ABS 5204.0 for multifactor (national accounts), 2004–05 (November 2005), p. 37.


policies

Exponents of microeconomic policy are quick to seize on theupward productivity trends shown in figure 7.7. Notice that bothlabour and multifactor efficiency grew faster in the more recentyears between 1996 and 2006 (i.e. during and after the fullimpact of accelerated microeconomic reforms), than in theearlier period, 1982–92 (i.e. before reforms gathered pace). Inaddition, commentators note:� there was greater allocative efficiency across many specific

markets (e.g. labour, capital, raw materials)� a dramatic cut in the level of disruption to production caused

by industrial strikes (as shown in figure 7.8) after labourmarket reforms.

Figure 7.8 Average annual strike levels in

Australia (working days lost per 1000 employees)

Sources: Data derived from ABS 1350.0; RBA Occasional Paper, No. 8A.

� much lower inflation rates due to greater efficiency andreduced cost pressures

� the 32-year low in unemployment or idle resources� quite strong rises in company profits� lower production costs including interest rates and RULCs� a rise in the sustainable rate of economic growth� near record rises in material living standards (i.e. GDP per

head).In addition, microeconomic reform is the government’s pre-

ferred policy when it comes to measures to increase efficiency. Itcertainly has the edge over budgetary and, especially, monetarypolicies for its directness in tackling the structural supply-side ofthe economy.


policies

Despite its apparent success in improving efficiency, microeco-nomic policy has its limitations. Critics note that some of theclaimed benefits of reforms have been exaggerated, while othershave failed to appear.

Australian productivity peaked and is slowing

Data show that, after the cyclical peak between 1994 and 1999,average productivity slowed towards 2006 and is now only mar-ginally above our long-term average. Perhaps this reflects:� the reduced pace of microeconomic reform between 2001

and 2004� the limits to microeconomic policies and the fact that the eas-

iest and most obvious reforms were completed some years ago� the effects of previous reforms are now wearing off

0

Annual %

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(before

microeconomic

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1996–2006

(after

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1

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Multifactor productivity

1000 200

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300 400

1992–2006 — during andafter labour market reforms

1980–1992 — before

labour market reforms


� the fact that large improvements in efficiency require far moreinvestment in new technology than has occurred to date

� that domestic and international factors, other than govern-ment reforms, are now slowing efficiency.

Overseas productivity is much stronger

Perhaps one of the main criticisms of recent microeconomicpolicy from an efficiency standpoint is that it has been far tooslow by comparison with developments overseas. This meansthat, today, we find that most sectors of the Australian industryhave inferior productivity to levels abroad and, in some specificindustries, efficiency has actually decreased. Figure 7.9 showsthat in terms of GDP per hour worked (i.e. which has beenadjusted in terms of purchasing power parity to reflect differ-ences in the cost of living in different countries), Australiaranked only fifteenth amongst 24 OECD nations in 2004. Thiswas well behind countries like Norway, Ireland, France, Ger-many, the United States and the United Kingdom.

While recent policies may have helped to improve resourceallocation, they have not made up for the decades of neglect,nor are they stimulating structural change as rapidly as in somecountries. This is causing us to fall even further behind.

Figure 7.9 International comparisons of labour

productivity (Index number, US = 100 points)

Source: OECD Productivity Database, January 2006.

The conflict with other government objectives in the

short term

Especially in the short term, the pursuit of greater efficiencythrough government microeconomic policies like tariff cuts, pri-vatisation and market deregulation, has been in conflict withthe achievement of some other government economic objec-tives like full employment and equity in income distribution.For instance, tariff cuts certainly decimated some areas of manu-facturing industry and caused some firms to close down or scaleback Australian operations. This added to structural unemploy-ment. Likewise, performance-based workplace agreements haveenabled some firms to produce more output with fewer staff,again swelling structural unemployment in the short term. Theknock-on effect is that unemployment typically lowers theincome and purchasing power of individuals, making somegoods and services less affordable. However, hopefully in thelong term, greater efficiency and competitiveness should lowerunemployment and even improve equity.

The other conflict issue is that the non-economic well-beingof some workers has been undermined by the pursuit ofgreater efficiency. It has come at a cost. The downside is thataverage hours of work have increased and leisure time withfamilies has diminished. Furthermore, it is likely that staffstress levels have increased and unions no longer act to coun-terbalance the increased power of employers. So, althoughworkers may now be richer, they may not necessarily have abetter quality of daily life.

Time lags caused by resource immobility

It is unrealistic to believe that resources can be moved or rede-ployed from one use to another, more efficient one, in a shortspace of time. Some resources are immobile, such as special-ised machinery. In order to respond to microeconomic policy,time (perhaps five, 10 or even 20 years) may need to beallowed. The gains from reform may take years to emerge fully.A related problem is that of the reluctance by some institutions(e.g. business, unions, governments) to move with the times. Insome ways, Australian production methods and work practiceshave changed only slowly relative to the pace overseas.

Political restraints

Many things could be done to reform the production process.However, adverse voter reaction and the short time betweenelections, prevents some of the harder reforms from being tried.This was especially the case when a government lacked amajority in both Houses of Parliament. For example, theHoward Government initially found it very difficult getting theWorkplace Relations Acts passed. Well over 160 amendments wererequired in 1996 to get Democrat support in the Upper House.Another obstacle to the privatisation of Telstra, which wasdesigned to further lift efficiency, was the lack of Senatenumbers between 1996 and 2005. Similarly, the introduction ofa GST and other tax reforms in 1999–2000 proved difficult atthe time because of the Coalition’s absence of an Upper Housemajority.

The limitations of specific policies

Some specific policies have limitations and have not fullyachieved their aims.

200 40

Index (US base = 100 points)

60 80 100 120 140

24 — Korea

23 — Portugal

22 — New Zealand

21 — Greece

20 — Japan

19 — Iceland

18 — Canada

17 — Italy

16 — Spain

15 — Australia (80% of US)

14 — Switzerland

13 — Finland

12 — United Kingdom

11 — Austria

10 — Sweden

9 — Denmark

8 — Germany

7 — United States Index base

6 — Netherlands

5 — France

4 — Ireland

3 — Belgium

2 — Luxembourg

1 — Norway


� Reforms to increase national savings. Although the governmenthas done what it can to increase national savings (to helpkeep domestic interest rates and foreign borrowing lowerthan otherwise), the measures do not appear to have pre-vented the continued slide in the household savings ratio tonegative 2.9 per cent of GDP (2005–06). While this may havebeen worse without savings policies, success has been limited.

� Labour market reforms. Labour market reforms have probablyhelped to lift worker efficiency by extracting greater personaleffort and motivation from employees. However, there arephysical limits to how much further this can go and howmuch more leisure time staff are prepared to sacrifice, giventhe substantial rise already, in average hours worked duringthe past 10 years. Ultimately, greater staff efficiency nowdepends on higher levels of investment in new equipment,along with greater emphasis on education, skills and training.These, rather than the labour market reforms we have seenrecently, would help to bring about capital deepening andeven larger rises in labour efficiency.

� Deregulation of other markets. Up to a point, free and deregu-lated labour and other markets can bring about greaterefficiency in the allocation of resources. Sometimes, however,market failure occurs and this can only be corrected bygovernment regulation or intervention. For instance, someaspects of the operation of the financial market involving pru-dential supervision of non-bank financial institutions havebeen reregulated to help ensure stability and efficiency. Inaddition, the government attempts to regulate the level ofeconomic activity because improved stability also helps toincrease efficiency. Adopting a non-interventionist approach

in this area was shown to be dangerous during the GreatDepression of 1929–33.

� Tariff cuts and trade liberalisation. For most industries, cuts havereduced tariffs to zero. They have gone as far as they can topromote greater efficiency. In addition, trade liberalisation byour government is partly frustrated or made less effective bythe failure of other countries to do likewise. Some claim thatwhile reduced protection may make surviving Australianindustry more efficient, the continued use of tariffs and sub-sidies by some overseas nations (e.g. Japan and somemembers in the European Union) has not opened up thenew markets we expected, nor delivered such huge benefits.

� Reform of the public sector. Privatisation of some governmentbusiness enterprises is seen as an efficiency measure. Duringthe 1990s and 2000s, this has been extensive but, by 2007, fewpossibilities remain for the government.

� Competition policies. Promoting competition generally helps to liftefficiency among rival firms. However, preventing price collu-sion and other tactics is very difficult and there are some whofeel that preventing company mergers and takeovers in par-ticular circumstances might actually reduce efficiency by pre-venting firms from gaining economies of large scale where fixedcosts can be spread more thinly over bigger output volumes.

� Tax reform. Cutting personal, capital gains and company taxrates can help lift the incentive to work hard and expandinvestment. However, given the acceptance of fiscal balanceas a medium-term aim of budgetary policy, further reductionsare limited by financial constraints.



7.7 Using microeconomic policy to improve equity in income distribution

The Australian Government’s objective of an equitable distributionof income means that everyone should have access to basic goodsand services (e.g. food, housing, clothing, health and edu-cation) and enjoy reasonable living standards. Normally, wethink of budgetary policies as the main instrument to promoteequity. This is because fiscal measures like progressive taxes,direct welfare benefits and indirect benefits or services (e.g. freeor cheap public health and education), redistribute finalincome from the rich to the poor very efficiently, directly andprecisely. However, it is still important not to underestimate thevital role played by microeconomic reform in helping indi-viduals enjoy improved access to goods and services, and bettermaterial living standards. In the long term, there are at least fourmain ways that this can happen (even though in the short tomedium terms, structural unemployment caused by these poli-cies can reduce purchasing power and equity).

1. Reforms can lift GDP and average incomes per headCost-cutting efficiency reforms should mean that the Aus-tralian economy can produce a bigger level of nationaloutput from the same resources. Put another way, these strat-egies grow Australia’s capacity to produce goods and servicesand, hence, grow our production possibility frontier. Pro-viding that our GDP expands at a faster rate than the growthin population, Australians should enjoy higher average mat-erial living standards (i.e. indicated by the average value ofGDP per person a year) and improved access to goods andservices, of which previous generations could only dream.

2. Reforms improve competitiveness, lift profits and create more jobsBy lifting efficiency and cutting production costs for localfirms, business profits grow faster than otherwise. Strongprofit growth is vital for business expansion and survival. Inthe long term, fewer firms close down, resulting in a reduc-tion in structural unemployment. With more individuals

working, incomes are higher than on welfare, and goods andservices are more affordable. For example, in late 2006,average full-time weekly earnings were around $1050 and theminimum weekly wage was $511, compared with, perhaps,$200–250 per week for a single person on governmentincome support.

3. Reforms can lower production costs and slow inflation

Greater efficiency in our use of resources means lower unitproduction costs. This helps to keep inflation down and thereal purchasing power of incomes up. This improves generalaccess to basic goods and services, along with equity in thedistribution of income.

4. Reforms help grow the government’s income and the affordability of welfare and government services

As explained already, improved efficiency helps to grow GDPand real incomes per head. In turn, this causes governmenttax revenues in the annual budget to grow faster. As a result,government outlays on direct welfare benefits (e.g. for theaged, sick, unemployed and families) and indirect services(e.g. public health and education) are much more afford-able than otherwise.

By contrast to these long-term benefits for equity, if efficiencyfails to grow strongly because of the absence of effective micro-economic reforms, average per capita incomes fall, goods andservices are dearer and less affordable, unemployment rises dueto poor business profitability and the closure of firms, andfalling budget revenues force the government to cut back evenmore on welfare and services for the poor. Clearly, income dis-tribution in this case would become less equitable.

During the past 10–15 years to 2007, table 7.11 shows some ofthe most important microeconomic reforms that have beenespecially important in improving equity and raising materialliving standards.

Six microeconomic reforms that help increase equity in income distribution

1. Labour market reforms

Australia’s labour market reforms have included the extension of the decentralised, productivity-based wage system, the reduced importance of the centralised minimum wage system that failed to encourage efficiency, the promotion of union amalgamation to reduce strike levels, and the exemption of small firms from unfair dismissal laws. These changes may have helped equity in several ways:

� stronger productivity has meant that RULCs have fallen making goods and services cheaper and more affordable

� employees on workplace agreements, have generally enjoyed bigger increases in their take-home pay than workers on the minimum wage, again making goods and services more affordable.

Table 7.11

(continued)


(continued)

2. Trade liberalisation

The past 15 years, to 2007 in particular, have seen most tariffs abolished and free trade extended. These changes have been important for equity in several ways:

� freer trade has forced Australians to allocate resources more efficiently to areas of comparative cost advantage and away from industries where we have a cost disadvantage. This means that the same inputs can produce a bigger GDP leading to higher real incomes per person.

� freer trade has meant much lower inflation for the period 1992 to 2007, than for the 1970s and 1980s. Many goods and services (e.g. clothing, appliances, cars) are now far cheaper and more affordable for ordinary households. It also means lower costs for local firms importing inputs and equipment, allowing them to enjoy better profits, improved competitiveness and stronger sales. Firms have expanded rather than closed down, again helping to lower structural unemployment that would otherwise undermine equity.

3. Tax reforms In general, the period 1999–2007 saw the introduction of significant reform involving lower tax rates on personal incomes, capital gains and company profits. This helped equity in several ways:

� households are encouraged to work harder and end up with more disposable income. This increases their purchasing power and access to goods and services.

� firms have larger after-tax profits. This encourages business expansion and investment, that creates even more jobs for the unemployed and higher incomes. Again, equity should benefit.

4. Competition reforms

Competition reforms have involved the ACCC, tightening of the Trade Practices Act, increased prices surveillance, and the supervision of mergers and takeovers. This should help promote equity:

� basic goods and services should be cheaper and more affordable if there is no price fixing and competition is fierce

� businesses, buying inputs from other firms, find that their costs are lower if there is competition rather than if there is price collusion. This means better profits, the expansion of firms, reduced unemployment and, hence, higher real incomes.

5. Reforms to promote national savings

Savings reforms introduced between 1991 and 2007 have included the creation of many surplus budgets, the launch of the Future Fund, the introduction and expansion of a compulsory superannuation scheme for employees and other incentives to encourage private superannuation. By promoting national savings and tending to increase the supply of credit in financial markets, interest rates (i.e. the cost of credit) have tended to be lower. This helps cut costs, increase profits and bring about business investment and expansion. If firms grow (and cause our GDP to expand) rather than close down, incomes will be higher and unemployment lower. This helps to improve equity.

6. Welfare reforms

Although welfare reforms have had some negative effects, the tightening of access to government benefits and the extension of the idea that individuals must try very hard to be financially independent, may indirectly improve equity. For example:

� unemployment benefits are only paid on condition that individuals are ‘actively looking for work’, working for the dole, or alternatively, are enrolled in education or training programs. Improving the skills of the unemployed should make them more employable and allow them, in the future, to gain better incomes. In addition, it helps to reduce welfare dependency that can sometimes lock them permanently into lower incomes.

� the relaxation of rules relating to the amount of income that can be earned before welfare benefits are lost has allowed recipients to enjoy higher incomes. Again, it has also reduced the welfare trap that keeps some people on low incomes.

Table 7.11


HAS MICROECONOMIC POLICY PROMOTED EQUITY IN INCOME DISTRIBUTION?You may recall that, although there is evidence of growingincome inequality between 1996 and 2005–06, it seems that thepoor (and rich) have never been richer, and general living stan-dards have increased. However, it would be interesting to knowthe extent to which microeconomic reform has brought aboutthis trend. Unfortunately, this is not easy to judge because thereare so many local and international events that could haveplayed a role, other than government policies. All we can dohere is to look at a few of the possibilities.


policies

To establish the success of microeconomic reforms in pro-moting equity, we would expect to see a rise in the sustainablerate of economic growth leading to faster increases in averagereal GDP per head per year since the introduction of micro-economic reforms. In addition, individuals should now havehigher incomes (purchasing power) and the benefits sharedequitably so that all people can be better off materially (not justthe rich). These outcomes can be seen in parts A and B offigure 7.10.� As indicated in part A of figure 7.10, it is clear that real

annual incomes and GDP per capita have grown much fasterin the 14-year period since government microeconomicreforms accelerated, than in the 14 years prior to reforms.

� Interestingly, part B of figure 7.10 shows that after takinginflation and rising costs of living into account over the eightyears to 2002–03 when microeconomic reform was in fullswing, even the poorest quintile gained a greater than 10 percent increase in their real purchasing power (relative to therichest quintile with around 16 per cent). This should haveallowed low-income earners to access more goods and ser-vices than previously and enjoy better material livingstandards.

Of course, these observations may just be a coincidence, butsupporters of reform dismiss the suggestion. In addition, rela-tively recent microeconomic policies have been associated withsignificantly lower unemployment and inflation rates than previ-ously. Again these improved conditions are beneficial for equity.


policies

It is difficult to hide from the observation that, especially in theshort term, some aspects of microeconomic policy have not

helped to promote equity.

The conflict with full employment and equity in the short termIn the short to medium term, structural unemployment rosefollowing some microeconomic reforms. This tended to erodeequity. For instance:� tariff cuts in the years up to 2005–06 caused business closures,

especially in manufacturing (e.g. in the textiles, clothing, auto-motive industries and footwear — Blundstone Boots, 2007)

� there were staff cuts in the federal public sector designed tolift efficiency following corporatisation, privatisation andcontracting out

Figure 7.10 Indicators of improving equity in income distribution — Australia.

Sources: Data derived from RBA Occasional Paper No. 8A; ABS, 1350.0 and 6523.0 for 2002–03.

200 40

Total % rise over the period

Part A — Total % rise in real GDP or income per capita(% over the two, 14-year periods)

before and after government microeconomic reforms

60 80 100 120

Total % rise 1979–80 to 1992–93

(largely before reforms)

Total % rise 1992–93 to 2005–06

(at the peak of reforms)

50 10

Total % rise inincome over the period

Part B — Comparison of rise in annual realequivalised disposable income by quintile — Australia,

1994–95 to 2002–03

15 20

Total real % rise in equivalise median disposablehousehold income for the ‘lowest’ quintile

Total real % rise in equivalise median disposablehousehold income for the ‘highest’ quintile


� productivity-based workplace agreements (i.e. where higherwages were traded for improved worker efficiency) allowedsome firms to downsize their staff numbers

� industry restructuring was undertaken by most firms to cutcosts (e.g. in banking, there was the closure of less efficientbranches and cuts to staff levels)

� many markets were deregulated to strengthen competitionand reduce production costs, including labour. This causedsome firms (e.g. Ansett Airlines, 2002) to close, leading tounemployment and reduced incomes.

When there is a rise in structural unemployment, there is usually adramatic cut in incomes for workers who are forced to surviveon meagre welfare benefits. In turn, basic goods and servicesbecome even less affordable, despite the fact that some of these

items may now be cheaper due to microeconomic reforms.Unemployment also causes households to run down their stockof assets or wealth (e.g. sell their house or car, run up debts), fur-ther cutting living standards for the unemployed relative tothose with jobs. The main hope in the long run is that micro-economic reforms will create more jobs in Australian industrythrough increased international competitiveness.

Increasing wage differences in society

A number of microeconomic policies tended to increase incomeinequality:

� The extension of workplace agreements has meant that someworkers are now in a relatively weaker position when negoti-ating pay rises. For example, wage rates among females, theunskilled and poorly educated, part-time workers, some non-English speaking workers, employees in firms whereproductivity is low and the wages of workers where unionmembership is low, have often fallen behind those receivedby skilled, unionised, articulate, efficient, full-time workers inprofitable businesses.

� Tariff cuts and stronger competition have squeezed profitsand wages in some manufacturing industries, relative toothers.

� For some families, the restructuring of private firms and thepublic sector has meant cutting staff, increasing structuralunemployment and diminishing incomes.

� In recent years, general pay rates for staff on workplace agree-ments have risen faster than those on minimum wages. Thishas increased inequality in the distribution of income.

� The tax system has become less steeply progressive due tocuts in rates of capital gains, company and PAYG taxes. Thesechanges have benefited the rich more than the poor.


Coursework


7.8 School Assessed

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As mentioned previously, there are two SACs to be completedfor VCE Economics Unit 4, one for each of the two outcomes.You will recall that SAC 1 covered macroeconomic policy.However, SAC 2 will cover microeconomic policy (chapter 7)and the government’s current policy mix (chapter 8). Withthis in mind, you are advised to wait until you have coveredthe final chapter of this text (chapter 8) before tackling thislast SAC for the year. This final task could involve one of thefollowing:� an essay� a written report� a problem-solving exercise� a test with multiple-choice and short-answer questions� an evaluation of print and/or electronic media.

To help prepare you for the end-of-the-year examination andto provide some guidance for SAC 2, several sample tasks havebeen included in this section of your text. For instance, chapter 7(about microeconomic reform policy) contains:� multiple-choice test items� short-answer test questions� an essay question� some possible questions relevant for completing a written

report� a problem-solving exercise.Finally, this section of your text also contains a wide range ofother learning activities (e.g. web quests, debates, concept maps,quiz, etc.), to help make learning more effective, interestingand relevant.

MULTIPLE-CHOICE test questions

Instructions: You may like to complete the following questions.Using the multiple-choice answer grid below, select the letter

(A, B, C, D) that represents the most appropriate answer foreach question by marking this with a tick (�).

Answer grid

Question 1The immediate and main priority of microeconomic policy ismost probably:A full employmentB increased equityC efficiency in resource allocation and more rapid and sustain-

able rates of economic growthD external stability and equity.

Question 2In the 1980s and early 1990s, microeconomic reform was des-perately needed because:

A Australia’s material living standards were falling relative tothose of many other comparable countries and there was asevere problem with the CAD

B Australia had a slower rate of economic growth than somecountries caused by severe supply-side constraints on rises inproductive capacity

C Australia’s productivity was very poor and cost inflation wascommon

D all of the above were applicable.

Question 3Concerning recent changes in tariffs, which statement is correct?

QUESTION 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

A

B

C

D

QUESTION 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

A

B

C

D


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A Australia’s general rate of tariffs is lower than most com-parable Western nations but higher than most in Asia.

B By 1996, Australia’s general tariff rate was only 5 per centand has since been further reduced.

C Tariffs on imported cars into Australia fell to zero by 2006.D Australia is yet to create a free trade zone with New Zealand.

Question 4Which statement about microeconomic policy in Australia isincorrect?A Import quotas still exist for the TCF and car industries.B Reforms of the public sector to increase efficiency in govern-

ment include council amalgamation, contracting out andcompetitive tendering.

C The operations of the ACCC help to increase price compe-tition in various markets.

D The National Competition Policy seeks to accelerate thepace and degree of microeconomic reform by state govern-ments.

Question 5In order to promote greater efficiency in the government’sdelivery of goods and services to the community, federal micro-economic reform has not involved:A the introduction of a scheme to boost and revitalise govern-

ment business enterprises by massive capital spending toupgrade productive capacity

B subjecting government business enterprises to prices surveil-lance and the payment of taxation like private corporations(competitive neutrality)

C collaboration with state governments to reduce serviceduplication and to encourage the creation of nationalmarkets for some services such as power

D the commercialisation and corporatisation of manyremaining government businesses that have not been priva-tised.

Question 6Which statement is false? The federal government has moved toincrease national savings by:A the delivery of a ‘fiscal balance’ over the economic cycleB the establishment of the Future FundC the abolition of all taxes on superannuation contributionsD the progressive extension of compulsory superannuation

contributions by employers on behalf of their employees.

Question 7Currently, which Australian market is probably the least competi-tive and least deregulated market in Australia?A The labour marketB The market for TCFC The capital marketD Primary industry markets

Question 8Microeconomic reform mostly slows inflation by:A slowing AD and the pressures created by expenditureB reducing imported inflationC easing cost pressures on prices through greater efficiencyD reducing inflationary expectations.

Question 9Microeconomic reform is believed to encourage more rapid,long-term economic and employment growth by:A stimulating sales of Australian-made goods and services by

making them more competitively priced in domestic andforeign markets

B boosting the productive capacity of our resources throughallocating them more effectively and using them to producemore output with fewer inputs

C enabling firms to access cheaper inputs, thereby raising busi-ness profitability and supply

D all of the above.

Question 10The most likely way that recent microeconomic reform shouldhelp to promote improved external stability in Australia isthrough:A restrictions on importsB controls on foreign borrowingC cuts in production costs which improve domestic and

external competitiveness of local firmsD all of the above.

Question 11Microeconomic policy designed to improve efficiency in resourceallocation is unlikely to include the following constraint.A Increases in unemployment, especially in the short termB Reduced equity in the short termC An adverse impact on the rate of economic growthD Unpopularity among the voting public in some electorates

Question 12Especially between 1994 and 1999, Australian statistics show that:A labour, capital and multi-factor productivity were stronger

than in the 1980s or early 1990sB industrial unrest has increased, slowing productivityC labour productivity has generally fallen but capital prod-

uctivity has risenD productivity levels have remained fairly constant since the

early 1980s.

Question 13The reasons for believing that microeconomic reforms mayhave been effective since the early 1990s include:A fairly low inflation and even falling costs for some goods and

servicesB the attainment of fairly rapid economic growth without an

inflationary breakoutC an increase in GDP per head per yearD all of the above.

Question 14The main constraint of recent microeconomic policy inAustralia is:A large time lags in implementation and impact of policyB rising cyclical unemployment generated by the reformsC short-term inflationary consequences arising out of struc-

tural changeD the financial constraints for government arising out of

privatisation.


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Question 15Reform of Australia’s labour market during the 1990s and 2000shas involved which combination of the following?

(i) A reduction in the number of allowable matters coveredin federal awards covering pay and conditions of work

(ii) The splitting up of large unions into smaller ones with lesspower

(iii) Making the AFPC (previously AIRC) less important in theregulation and supervision of wages and working con-ditions

(iv) The encouragement of workplace or enterprise agree-ments on a firm-by-firm basis

(v) Retention of minimum wages as a ‘safety net’A Answers (i), (ii), (iii), (iv) and (v)B Answers (i), (iii) and (v)C Answers (i), (iii), (iv) and (v)D Answer (v)

Question 16The main aim of labour market reform has been the promotionof:A external stability and efficiency in resource allocationB price stability and improved equityC full employment in the short termD political popularity for the federal government.

Question 17Which of the following is not normally seen as an advantage ofworkplace or enterprise agreements?A Uniformity in wages and conditionsB Improved flexibility in staffing and cost cutting by firmsC The maintenance of minimum safety net wages for low

income earnersD An emphasis on productivity-based pay rises to help avoid

inflation

Question 18The extension of workplace agreements during the 1990s and2000s is expected to improve price stability and external stabilityby:A lifting worker productivity by offering more incentive for

hard workB promoting greater competition among workers in the labour

market so that wages more closely reflect the market value ofwhat is being produced by each employee

C reducing the central role previously taken by unions in wagenegotiations

D all of the above.

Question 19Which of the following has not been a significant constraint ofrecent labour market deregulation?A The limited coverage of firms and workers in Australia by

enterprise agreementsB The time taken to successfully complete wage negotiations

on a firm-by-firm basisC The political constraint until 2005, due to a lack of numbers

in the Upper House to pass federal legislationD Opposition to reform caused by the strong growth in union-

isation of Australia’s labour force

Question 20In general, the spread of enterprise agreements until 2007 aspart of labour market reforms, may be expected to lead toincreased income inequality because of:A the reduced role of trade unions in representing otherwise

fairly powerless individual workersB the unequal bargaining strength of different types of

workers in different firms, combined with unemploymentrates in excess of 7 per cent

C both (A) and (B) aboveD the removal of minimum legal wages and protection offered

against unfair dismissal.

Question 21A constraint in using higher tariffs is:A they are politically difficult to removeB they are a handicap for other import-competing and export

businesses which use foreign goods in their productionprocess

C they weaken competition and domestic efficiency, misallo-cate resources into areas of non-comparative cost advantageand cause higher demand and cost inflation

D all of the above.

Question 22Which of the following is not a constraint of tariff cuts andreduced industry protection?A Adverse political consequences are likely in some regions of

the country.B Increased bankruptcy levels are likely, due to import pen-

etration.C Other nations will retaliate and raise their tariffs on our

exports.D Income inequality will probably worsen for some individuals.

Question 23Which of the following is not a general constraint of reducingtariffs?A Cyclical unemployment rises.B Long time lags are needed to implement the cuts and to see

the resulting benefits.C The CAD generally gets worse before it improves.D Government revenue falls, creating a financial limitation.

Question 24Reforms promoting freer international trade will tend to directmore resources into areas of comparative cost advantage. Thisnecessarily means that:A surviving industries can produce more cheaply than any

other producer in the worldB resources should move into areas where, relatively, there is

the least cost disadvantage in productionC there will be full employmentD there will be price and external stability.

Question 25Which of the following reforms is likely to help promote fulleremployment in the long term?A The signing of bilateral and multilateral trade agreements

which raise exports


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B The increased discouragement of foreign investment andtakeovers of local companies

C Cutting R&D grants and tax concessionsD Abolishing import quotas and subsidies

Question 26Regarding the impact of microeconomic reforms involving theexternal sector, which statement is false ?A Reduced tariffs tend to redistribute incomes away from

importers.B Trade agreements may lift the income share of exporters.C The existence of tariffs can cause some basic goods and ser-

vices to be less affordable for low income families.D Bounties paid to local producers redistribute income in

their favour, typically at the expense of taxpaying individualsand companies.

Question 27Which of the following statements about the Workplace RelationsAct is generally false ?A It makes some strikes illegal, along with secondary boycotts.B It makes all employee dismissals fair, no matter what the

circumstances.C It reduces the roles of the AFPC and unions and establishes

an Employment Advocate to help improve fairness and settledisputes.

D It restates the principle of voluntary unionism and makesclosed shops illegal.

Question 28Concerning microeconomic as compared with macroeconomicpolicy, which statement is correct?

A Microeconomic policy seeks to lift efficiency, cut costs andexpand AS, while macroeconomic policy is about regulatingthe growth in AD.

B Microeconomic policy helps affect the long-term capacity orspeed limit for economic growth whereas macroeconomicpolicy helps affect the extent to which a nation’s productivecapacity is utilised.

C Both (A) and (B) are correct.D Neither (A) nor (B) are correct.

Question 29

In relation to financial reforms, which statement is false ?A The supervision of financial sector liquidity needed for cus-

tomer confidence and stability is now the responsibility ofAPRA.

B The Wallis Inquiry recommended a substantial deregulationof the financial sector.

C Licences were extended to allow some building societies tobecome banks in an attempt to increase competition.

D Reforms have not meant efficiency rises and lower realinterest rates.

Question 30

A microeconomic policy solution to the worry of high structuralunemployment which is currently running at perhaps 5–6 percent of Australia’s labour force is:A expansionary monetary measuresB budgetary tax cuts and increased government outlaysC government strategies that increase ADD cost-cutting, productivity-promoting measures that increase

Australia’s competitiveness.

STRUCTURED SHORT-ANSWER test questions

Instructions: You may like to try a selection of the followingstructured short-answer questions. These questions may enablestudents to practise in readiness for the end-of-year examin-ation.

Question 1

A What is meant by microeconomic reform or policy? (2 marks)B Distinguish between the following types of efficiency:

(a) Allocative efficiency and technical (productive)efficiency. (2 marks)

(b) Intertemporal efficiency and dynamic efficiency. (2 marks)

C What do you consider to be the three most important objec-tives of microeconomic policy? (3 marks)

D In general terms, explain how microeconomic policy mightaffect any three of the following:(a) economic growth(b) inflation(c) unemployment(d) the CAD(e) efficiency in resource allocation(f) the distribution of income. (2 + 2 + 2 = 6 marks)

Question 2

A Concerning the policy of trade liberalisation:(a) Explain what is meant by the policy of free trade, outlining

the extent to which it has currently been adopted by theAustralian Government. (6 marks)

(b) Identify and explain one strength and one weakness ofpursuing this policy. (2 + 2 = 4 marks)

B Concerning deregulation and other reforms of the labour market:(a) Define what is meant by labour market deregulation, giving

specific examples of reforms. (4 marks)(b) In what ways are enterprise or workplace agreements dif-

ferent from the traditional minimum wage system?(6 marks)

(c) List and outline two important strengths and two weaknessesof labour market deregulation in Australia during the1990s and 2000s. (4 marks)

C Concerning reforms to promote national savings:

(a) Explain what national savings means. (2 marks)(b) Outline two reasons why is it important to lift the level of

saving in Australia. (4 marks)(c) Suggest three specific ways this has been encouraged by

government microeconomic reform. (3 marks)


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D Concerning reforms to the public sector:(a) What is the difference between privatisation and corpora-

tisation? (2 marks)(b) Why can privatisation lead to greater efficiency in the

operation of a business? (3 marks)

Question 3A In general terms, how does microeconomic reform help to

lower inflation? (4 marks)B Explain how any three of the following microeconomic reforms

introduced during the 1990s and 2000s, may help to lowerAustralia’s inflation and promote price stability:(a) the move towards free trade with lower subsidies and

tariffs(b) labour market reform including the encouragement of

enterprise or workplace bargaining(c) reform of the public sector(d) tightening of the TPA and broadening of prices surveil-

lance by the ACCC(e) tax reform(f) the promotion of national savings(g) deregulation of the financial sector and transport

reform. (2 + 2 + 2 = 6 marks)C Giving an example, identify one important constraint on the

effectiveness of microeconomic policy, when it is used to slowinflation. (4 marks)

D ‘Between 1992 and 2006, Australia enjoyed more rapid econ-omic growth than during the 1970s and 1980s. There werealso much lower rates of inflation and unemployment.’ Ingeneral terms, explain how microeconomic reform can helpto achieve all three aspects of domestic stability simul-taneously. Illustrate this on a fully labelled AD–AS diagram,showing the ‘before’ and ‘after’ effects of microeconomicreforms. (6 marks)

E Selecting two reforms from the list below, explain how eachmicroeconomic policy can be used to help increase Aus-tralia’s sustainable rate of economic growth?(a) tax reform(b) workplace agreements(c) competition reforms

(d) the abolition of tariffs. (4 + 4 = 8 marks)F Outline one weakness of microeconomic reforms aimed at

increasing the sustainable rate of economic growth. (4 marks)

G In general terms, how might the creation of a more efficientand competitive economy using microeconomic reform,eventually help to lower unemployment?

H Explain how any two of the following microeconomicreforms might affect the rate of unemployment:(a) the exemption of small firms employing fewer than 100

staff from unfair dismissal laws(b) trade liberalisation including the signing of FTAs with

China and Japan(c) the future privatisation of Medibank Private, the ABC

and the Snowy Mountains Hydro Scheme(d) a reduction in the rate of company tax from 30 to 20 per

cent(e) the abolition of the minimum wage system(f) a reduction in welfare assistance paid to the unemployed(g) a rise in the minimum age for receiving the pension to

70 years(h) welfare and other reforms to increase the participation

rate. (4 + 4 = 8 marks)I Apart from microeconomic reform, suggest one other

category of government policy used to help lower Australia’sunemployment rate. (4 marks)Examine figure 7.11 showing trends in Australia’s unemploy-ment rate between 1992–93 and 2005–06.In April 2007, the unemployment rate reached a 32 year lowof only 4.4 per cent. Suggest and explain two importantmicroeconomic reforms that could help to lower this rateeven more. (4 marks)

J Examine figure 7.12 (p. 278) showing trends in Australia’semployment by industry. (a) Identify and explain two important government micro-

economic policies that could account for the trend in‘manufacturing’ employment between 1997 and 2006.(4 marks)

(b) How would you expect these employment trends to alterAustralia’s distribution of income? (2 marks)

Figure 7.11 Australia’s unemployment rate (percentage of labour force)

Source: Data derived from ABS 1350.0.

0

2

4

6

8

10

12

% u

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1999–2000

1998–99

1997–98

1996–97

1995–96

1994–95

1993–94

1992–93

2000–01

2001–02

2002–03

2003–04

2004–05

2005–06

2006–07

2007–08

2008–09


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Figure 7.12 Change in Australia’s employment numbers by industry — 1997–2006

Source: Data derived from ABS 1350.0.

Question 4A Outline how two structural problems currently help to cause

Australia’s large CAD:GDP ratio and NFD. (4 marks)B By 2005–06, Australia’s CAD equalled $54.4 billion, while the

NFD had grown to $494 billion. Faced with this sort ofexternal problem, select any three of the following govern-ment microeconomic reforms and outline how each mightimprove Australia’s external stability. (2 + 2 = 4 marks)(a) tariff cuts and the signing of additional FTAs with China

and Japan

(b) reduced industry subsidies(c) tax reform involving further reductions in personal,

capital gains and company tax rates(d) further privatisation and corporatisation of government

business enterprises(e) banking deregulation(f) the extension of enterprise or workplace agreements

and other labour market reforms(g) further reforms to increase national savings

C Giving an Australian example, outline one constraint orweakness of using microeconomic reforms to improveexternal stability. (2 marks)

Question 5

A Define clearly what is meant by an efficient allocation ofresources. (2 marks)

B Identify the two types of statistical evidence that you woulduse to confirm whether or not there has been an improve-ment in Australia’s efficiency in resource allocation in recenttimes. (2 marks)

C From the following list, select and explain one importantmicroeconomic reform that has helped to improve allocativeefficiency and one reform that has helped to improve inter-temporal efficiency:(a) relaxation of unfair dismissal laws(b) tariff cuts and trade liberalisation(c) welfare reforms(d) deregulation of the financial market(e) deregulation of domestic and international aviation

carriers(f) savings reforms(g) tax reforms. (4 + 4 = 8 marks)

D Explain how the Workplace Relations Act (1996) and or themore recent Work Choices Act (2005) might help to increaselabour efficiency. (3 marks)

E Explain two constraints of microeconomic policy that isdesigned to increase efficiency in resource allocation. (4 marks)

F Examine table 7.12 showing annual average changes inproductivity across selected Australian industries, 1998–2004.(a) How is productivity generally measured? (2 marks)(b) Suggest two likely reasons why productivity grew strongly,

especially in areas like manufacturing, and agriculture,forestry and fishing. (4 marks)

Annual rates of productivity change in selected Australian industries

Source: Data estimated from ABS, 5204.0.

0–100 100 200 300 400

Manufacturing

Wholesale trade

Agriculture, forestryand fishing

Electricity, gas and water

Communication services

Cultural and recreation

Mining

Finance and insurance

Personal and other

Government

administration and defence

Transport and storage

Accommodation andcafes etc.

Education

Health andcommunity services

Retail trade

Construction

Property andbusiness services

INDUSTRY

PRODUCTIVITY, 1998–99 TO

2003–04 INDUSTRY

PRODUCTIVITY, 1998–99 TO

2003–04

Agriculture, forestry and fishing 4.8 Health and community services 1.7

Manufacturing 4.1 Cultural and recreational services 1.6

Wholesale 3.9 Accommodation, cafes and restaurants 1.3

Transport and storage 3.4 Construction 0.6

Finance and insurance 3.0 Mining –0.6

Total change overall 2.0 Electricity, gas and water –2.4

Table 7.12


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Question 6A In general terms, outline three important ways whereby

microeconomic reform can promote a more equitable distri-bution of income. (6 marks)

B Explain how any three of the following microeconomic poli-cies may affect the degree of equity in the distribution ofincome:(a) the move towards a user-pays principle in the provision

of government services and social infrastructure(b) complete privatisation of Telstra (2006)(c) toughening of the Trade Practices Act(d) further tariff cuts in the TCF and car industries(e) reducing rates of personal, company and capital gains

taxes

(f) the further encouragement of enterprise or workplacebargaining

(g) further tightening of welfare eligibility(h) an extension of superannuation by a rise in the levy on

employers, from 9 to 15 per cent of a worker’s wage. (2 + 2 + 2 = 6 marks)

C ‘Microeconomic reform may increase economic efficiency,but this is at the expense of equity.’ Discuss this statement.(4 marks)

D Explain how budgetary policy can compliment or supportmicroeconomic reform in increasing equity in the distri-bution of goods, services and incomes. (6 marks)

E Quoting specific policy examples, explain how microeco-nomic reforms may help to achieve better material livingstandards for Australian citizens. (4 marks)

A PROBLEM-SOLVING exercise

A possible task for Unit 4, SAC 2 is a problem-solving exercise.The following may provide you with practice for this type ofquestion.

Imagine that you have been appointed to the position ofHead of the Economic Task Force set up to advise the govern-ment of Atlantis about microeconomic reform. This action wasprompted by the fact that economic conditions had deteri-orated seriously over the ten years to 2009. Table 7.13 summar-ises the dire economic problems faced by Atlantis.A Using the following headings, briefly outline the economic

conditions that had developed in Atlantis between 2000 and2009.(a) Domestic conditions(b) External conditions(c) Efficiency levels in resource allocation(d) Equity conditions

B In general terms, how could microeconomic policy help tocorrect the economic problems experienced by Atlantis,2000–2009?

C Select any three of the following microeconomic reforms. Foreach policy, outline the changes that should be made to helpcorrect Atlantis’s economic problems.(a) Labour market reform(b) Promotion of national saving(c) Promoting stiffer competition(d) Shift away from industry protection towards freer

trade(e) Reform of the public sector(f) Reforms implemented by firms in the private sector

following the government’s move towards freer trade(g) Tax reform

D Outline two constraints or weaknesses of applying the poli-cies you selected for your answer to part C above.

Economic indicators for Atlantis — 1990–99 to 2000–2009

ECONOMIC INDICATOR FOR ATLANTIS 1990–1999 2000–2009

(1) Annual average growth in GDP per capita (%) 3.1 0.2

(2) International ranking for GDP per capita ($ per year) 3rd 15th

(3) Unemployment rate (% labour force) 5.8 7.1

(4) Productivity growth (% GDP per hour worked) 2.4 −0.5

(5) Inflation (%) 2.2 5.7

(6) RULCs (% per year) 0.2 4.8

(7) CAD:GDP ratio (%) 2.9 5.5

(8) Domestic interest rates (% on business overdrafts) 4.5 8.4

(9) NFD:GDP ratio (%) 20 55

(10) Gini coefficient for final income distribution 0.3 0.4

(11) General tariff rate (%) 3 9

(12) Company tax rate (% profits) 30 40

(13) Number of working days lost per year per 100 employees through strikes

10 190

(14) Household savings (% of income) 10 1

(15) Level of business concentration in ownership by industry low high

(16) Size of government sector (percentage of GDP)

20 30

Table 7.13


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OTHER learning activities

Have you tried the following learning activities in your classrecently?

1. Web QuestVisit the website for this book and click on the Weblinks forthis chapter (see Weblinks, page 310).

Use the Internet for researching some of the following:– projects of the Productivity Commission– the AFPC decisions about rises in award wages– the ACTU’s campaigns over pay and conditions– the ACCC’s investigations into companies – the Office of Employment Advocate, and Workplace Rela-

tions and Small Business– government tax reform– current debates in federal parliament or statements by the

Prime Minister– wider aspects of microeconomic reform in Australia

reported in Australian newspapers (e.g. magazines usingvarious search engines.

As always, teachers are strongly advised to check all websiteaddresses listed in this text for suitability, appropriateness ofcontent, operation and accuracy, before asking students toconduct research.

2. Class debateSelect one of the following topics or create your own:� ‘That in the 1990s and 2000s, Australia’s microeconomic

policy has brought more pain than gain.’� ‘That microeconomic reform faces so many constraints as

to make it ineffective.’� ‘That labour market reforms are exactly what the doctor

ordered for improving our economic performance.’

3. Data show or videoStudents could be asked to use either a video camera tomake a 3–4 minute documentary OR a computer to create aPowerPoint presentation about one of the following aspectsof recent microeconomic reform:

� the car industry� the TCF industry� the power industry� social welfare reform� tax reform� tariff cuts� reform of government� banking deregulation� labour market reform.

4. Newspaper reportsPhotocopy a newspaper report about a recent change inmicroeconomic policy or use the Internet for research. Stu-dents could then summarise the report, possibly identifybias, or expand on what has been said in the article.

5. Role playThe government announced that it would again reviewtariffs applying to some areas of Australian manufacturing.Set up a mock meeting between the government and rep-resentatives from the ACTU, the Industry Commission, theEmployer’s Federation and a consumer group lobby. Eachgroup is given a chance to put their case about future tariffcuts for the TCF and automotive industries.

6. CrosswordsConstruct a crossword using terminology and knowledgeabout recent microeconomic policy. Use the Internet foraccess to software that makes this task easy.

7. Team quizDivide the class into teams. When it is their turn to answerquestions about microeconomic policy (that the teacher andor students have previously written), team members can actas a brains trust before the final answer is given. Perhaps thewinning team could be awarded a prize. A variation of this isthe Economics Wheel of Fortune using numbered questions andtoken prizes.

chapter 7


Summary

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What is microeconomic policy?

Microeconomic policy involves a range of supply-side efficiencyreforms designed to improve the way particular firms, industries,markets and sectors of the Australian economy are structuredand operate. Specific measures include tariff cuts and trade lib-eralisation, competition-promoting strategies, labour marketreforms including the encouragement of workplace agreements,banking reform, transport reform, telecommunication reform,reform of government businesses and operations, welfarechanges, tax reform and promoting national savings.

The aims of microeconomic policy

The key aims of microeconomic policy are probably domestic econ-omic stability (i.e. especially stronger economic growth andprice stability), external competitiveness and stability andincreased efficiency in the allocation of resources. Unfortu-nately, equity in the distribution of income and wealth oftensuffers in the short term following the implementation ofmicroeconomic policy. However, in the long term, rising pro-duction and real incomes resulting from reform, are beneficial,providing that these gains are redistributed equitably usingbudgetary policy (e.g. provision of welfare benefits and afford-able community services, paid for out of progressive taxes).

Using microeconomic policy to promote domestic economic stability

Theoretically, microeconomic policy can promote improved domesticstability by means of efficiency measures designed to slow costinflation and increase national output from the same inputs,improve competitiveness and, in the long term, increaseemployment. Measures here could include:– labour market reforms– promoting national savings– trade liberalisation– tax reforms– deregulation of financial and other markets– reform of the public sector.

Unfortunately, in the short term, there may be an increasein structural unemployment following microeconomicreform. Between 1992 and 2007, recent policy has contrib-uted to better price stability, economic growth and, perhapsnowadays, to falling unemployment. However, there areconstraints including long implementation lags, conflictbetween the objectives of policy, political obstacles andinstitutional constraints.

Using microeconomic policy to promote external stabilityTheoretically, microeconomic policy (e.g. the promotion ofnational savings, competition reforms, reform of the govern-ment sector, tax reform, labour market reforms, competitionpolicy) can make an important contribution to external stability and alower structural CAD. The main approach is by strengthening anation’s international competitiveness in domestic and externalmarkets for goods, services and money capital through cost-cutting and efficiency reforms. Recent policy has probablyhelped to do this, but the high CAD:GDP ratio is still a periodicor cyclical worry. Constraints have limited its effectivenessincluding time lags in implementation, unfavourable externalevents, the conflict that exists between some governmentobjectives, the adverse short-term impact of trade liberalisation,political obstacles and institutional constraints.

Using microeconomic policy to promote efficiency in resource allocationTheoretically, microeconomic policy (e.g. industry reforms,labour market deregulation, deregulation of the financialsector, and the promotion of fiercer competition through lowertariffs and the ACCC) is extremely well suited to increasing allocative,dynamic, intertemporal and productive efficiency in resource allocation.Certainly, recent productivity has been at high levels (especiallyin the 1995–2004 cycle), well above those in the 1980s and early1990s. However, there are factors limiting policy effectivenessincluding institutional constraints, time lags, overseas eventsand adverse political considerations.

Using microeconomic policy to promote equity in income distributionTheoretically, microeconomic reform is likely to weaken equity in the dis-tribution of income and wealth, in the short term, although there are con-siderable longer-term gains for equity arising from the impact of greaterefficiency on real production and national income. This extra pro-duction and income then become available (through taxation)for redistribution and support of the needy (perhaps usingvarious budgetary policies like progressive taxes, welfare andcheap services). In addition, equity is promoted through lowerinflation, cheaper and more affordable goods and services andincreased employment resulting from increased industrycompetitiveness.

However, constraints operate to limit the effectiveness of micr-oeconomic reform. These constraints include conflict betweensome government objectives, political constraints, long time lagsin implementation and impact and financial considerations.


2. Instruments/aspects of microeconomic policy: Efficiency reforms include — Deregulation of the labour, capital and other markets by reducing government controls and increasing competition — Tax reforms that cut tax rates

— Reform of the public sector (e.g. privatisation, corporatisation) — Promotion of stiffer competition — Encouragement of higher savings — Trade liberalisation.

3. Using microeconomic policy to promote internal/domestic economic stability: — Microeconomic reforms (e.g. deregulation of the labour market) are very effective in increasing economic growth by lifting the economy’s productive capacity (more output from the same inputs) and AS — Reforms (e.g. tax cuts, lower tariffs, promotion of competition) also help lower cost inflation by increases in efficiency and by strengthening the level of competition in the market.

4. Using microeconomic policy to promote external stability: — Microeconomic reforms (e.g. tariff cuts, tax reforms, government deregulation of various markets) are very effective in increasing the international competitiveness of local producers (in terms of price and quality) of goods and services relative to overseas firms. This helps increase exports relative to imports — Reforms that increase national savings (e.g. encouragement of superannuation by tax incentives,

acceptance of fiscal balance) can help lower our reliance on foreign borrowing that adds to our CAD/NFD and weakens the exchange rate.

1. Aims of microeconomic policy: Recent measures have emphasised the following objectives — Domestic stability by promoting greater output (GDP) from the same inputs and by cutting cost inflation — External stability (by promoting greater international competitiveness among local firms) — Efficiency in resource allocation by promoting greater technical, allocative, dynamic and inter-temporal efficiency — Better equity by reducing costs and prices, increasing GDP and incomes per head per year, government

tax revenues and provision of welfare and services.

5. Using microeconomic policy to promote efficiency in resource allocation: — Microeconomic reform policies are most effective in lifting efficiency in resource allocation (i.e. they strengthen allocative, technical, inter-temporal and dynamic efficiency) — Here we think of the effects of tariff cuts, lowering of rates of personal, capital gains and company tax, tighter welfare access, stiffening of competition-promoting measures, reform of the public sector measures to promote savings and labour market reforms.

6. Using microeconomic policy to promote a more equitable distribution of personal income: — Microeconomic reforms are less effective and direct in the short-term in promoting greater equity in

income distribution than, say, budgetary policy — Even so, microeconomic reforms are very effective in the long-term in lifting the volume of goods and services produced and general income levels. They also lower the cost or price of basic goods and make welfare and government services more affordable thus promoting equity.

Microeconomic policyGovernment reforms that increase structural efficiency and lower production costs so that more output can be

gained from the same inputs of resources. These supply-side structural reforms increase AS and productive capacity.

using microeconomic policy

chapter 7 · chapter 7economic management using microeconomic policy241 figure 7.2 estimated gross...

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