Let’s not be complacent – Australia faces three great challenges: Kohler

Australia is facing a flood of economic issues in 2010. If you thought everything was okay, think again.

Australia’s going beautifully, right? We survived the GFC in better shape than almost everyone else and now we can look forward to an easy ride in the slipstream of the world’s new economic powerhouse, China.

Wrong, or at least only half right. Our success through the crisis of 2007-2009 has masked a series of problems, not least of which is actually our reliance on China – a decidedly unreliable patron.

Australia’s productivity has been declining for 10 years, the tax base has been eroded by a decade of political populism, health costs are soaring as the baby-boomers enter their high-maintenance years, the nation’s infrastructure is in disrepair, water has been shockingly over-allocated, we’re the worst carbon polluters on the planet and the fiscal cupboard is now bare when there is still so much to spend money on. But at least Australia isn’t broke, like some we could mention.

Don’t get us wrong: we’re not saying Australia is on the brink of some kind of existential crisis, as we were 1986 when the terms of trade collapsed or in the early 1970s when the mining boom unravelled at the same time as an energy crisis struck.

But we are definitely saying that complacency is not a good idea. We need to wake up from post-GFC smugness, from any self-satisfied schadenfreude in which we might be tempted to indulge. In this we endorse the Prime Minister Kevin Rudd, who has been warning against complacency in his series of Australia Day speeches around the country.

The PM’s main purpose, and that of Treasury chief Ken Henry, appears to be to soften us up for tax increases to deal with the ageing of the population, but that’s just one of the challenges ahead, albeit a big one. Apart from anything else the main plan, up to now, to deal with that is lots of immigration, but that brings with it costs of its own, such as housing shortages and over-stretched infrastructure.

There are a range of major challenges facing this country as we begin the second decade of the 21st century, with three in particular:

– Fiscal policy

– Climate change

– China

In some ways each of these things is outside our control. The budget surplus has been spent offsetting the GFC; the planet is warming – perhaps catastrophically; and China will do what it does, with us along for the ride. For Australia it’s all about managing the risks.

How, exactly, does the government introduce important tax reforms resulting from Ken Henry’s review of the tax system when there’s nothing in the pot to compensate the losers, as there was when GST was introduced a decade ago?

And how do we reduce carbon emissions without damaging a lifestyle that depends so critically on cheap electricity from coal? And as global temperatures rise anyway, how do we prepare for the collapse of Murray Darling irrigation as well as sharply higher prices for urban water, not to mention energy?

And last, but by means least, how do we insure ourselves against economic and political volatility in China when our own manufacturing sector has been, and is being, devastated?

A dangerous bubble seems to be developing in the Chinese property market that seems likely to disrupt its economic miracle before long, but in any case, even if its economic growth continues at 9-10 per cent, China is a difficult and capricious customer that requires more than a few phone calls in Mandarin to keep diplomatic relations on an even keel – or even afloat at all.

Let’s face it, the warm relationship between Australia and China that was supposed to follow the election of a Mandarin-speaking Australian Prime Minister has not eventuated. Perhaps, as Alexander Downer argues in this series, this is our fault – caused by the government’s attack on China’s Tibet policies, granting a visa to Uighar leader, Rebiya Kadeer, the Defence White Paper and kicking up a fuss over Stern Hu.

Maybe, but underlying these scuffles is the uncomfortable truth that economic success and prosperity has not, as expected, resulted in greater political freedoms and openness in China.

If anything, this Leninist one-party state is becoming more repressive, not less, as evidenced recently by Google’s decision to pull out of China after the systematic hacking of the email accounts of human rights activists.

Western political leaders, especially a succession of optimistic American presidents, have long believed that free trade and the internet would lead inevitably to political liberalisation within China.

But rather inconveniently, it hasn’t happened. What’s more, as Financial Times columnist Gideon Rachman says, Google’s decision to confront China may be an early sign that the Americans are getting fed up with dealing with Chinese authoritarianism.

Rachman believes the traditional US approach towards China of welcoming its rise and seeking greater engagement will come under pressure in both the White House and Congress: “The US has been almost wilfully naive about the connections between free trade and democracy. The Chinese have been provocative over currency and human rights.”

It means that for the first time ever, Australia’s political interests are beginning to diverge from its economic interests.

Of course there’s no sign at this stage that we may be forced to choose between China and the US, but some sort of trade war between them is not unthinkable.

Negotiations are continuing over the current hot spot – Google – but China’s leaders say they are determined to control the flow of information into the country, and Google says it will not put up with censored search results and hacking into its Gmail accounts.

More importantly, China has refused to change its policy of keeping its currency pegged, and low, to the US dollar. But America has double-digit unemployment and is facing a jobless economic recovery – to the extent that it gets a recovery at all.

Australia’s political interests have always been in complete alignment with its economic ones – going way back to our political and trade ties with Britain in the nation’s first century, then the close economic and political relationship with the United States (“all the way with LBJ”), followed by the close ties with Japan through that country’s industrialisation in the 60s and 70s.

Japan never wavered in its close alliance with the United States following World War II, which meant that Australia’s trade and economic ties with Japan were never a problem in our own relationship with the US.

That is certainly not the case with China. As we become more and more dependant on China for our economic well-being, so does China’s relationship with the United States deteriorate and become more and more fractious. This is already our central foreign policy challenge and is likely to become an increasingly difficult one in future.

Meanwhile, in the short term, there’s the more urgent question of whether China can keep its economic miracle going. Opinion is divided: there are as many predicting a disastrous collapse of its property and sharemarkets as are predicting 10 per cent economic growth as far as the eye can see.

The government is now trying to restrain bank lending and, given the control it exerts over the economy, it might succeed before the bubble inflates far enough to pop. But at the same time Chinese banks are looking to raise capital, led by the Bank of China which is in the process of raising $US30 billion. This new capital will presumably be geared and lent, creating even more liquidity and even higher asset prices.

Moreover it is easy to be skeptical about the Chinese economy. The national accounting is highly suspicious, with national GDP coming out two weeks after the end of each quarter.

Also, China allocates capital very inefficiently – there are many anecdotes of empty skyscrapers and undriven freeways. There’s no doubt its investment-driven export growth model has served the nation well up to now, but in 2010 the authorities are facing unprecedented challenges to sustained it.

Meanwhile, within Australia one of a few key challenges, as both the Prime Minister and the head of Treasury have reminded us lately, is the ageing of the population.

As Kevin Rudd reminded us in the first of his Australia Day speeches, in 1970 there were 7.5 people of working age supporting every person over 65. Today it’s 5. By 2050, it will be 2.7.

In his speech last week, Ken Henry identified two implications of this for tax policy: revenue will have to grow strongly and marginal rates will have to change to encourage those who are more productive, at the expense of those who are less likely to participate fully in the workforce.

But unlike the last major episode of tax reform – the introduction of the GST in 2000 – this one won’t be supported by compensation for the losers: the money’s all gone. The Henry Review of the tax system was commissioned in May 2008, well before Treasury unzipped its purse to the tune of $79 billion between September 2008 and March 2009.

Tax system reviews have a history of going straight from the hands of the Treasurer to whom they are presented to the Too Hard Basket to gather dust. This one can’t, and the fact that it’s being leaked like summer rain suggests that Treasurer Wayne Swan is trying to prepare us for some tough news.

At the same time as reforming the tax system and rebuilding the budget to prepare for the ageing of the population, and dealing with a possible economic downturn in China, we must also reform Australian energy supply.

Our reliance on coal for electricity generation has gone from being a benefit to be clung onto at all costs, to being a big problem. A way must be found to convert Victoria’s base load power generation from brown coal to gas, and then NSW’s and Queensland’s black coal power stations as well.

The CPRS, currently stalled in the Senate, will probably do it, but with too much pain and loss; a better, more direct, method needs to be found.

The ‘good news’, if it can be called that, is that there appears to be little stomach elsewhere in the world for a serious attack on climate change, so that if the effort in Australia continues to stall we won’t be left high and dry and facing trade sanctions. Then we’ll just have to worry about the worse prospect of actual global warming.

None of these challenges facing Australia are theoretical or somewhere in the distant future. Our reliance on the uncertain future of China, the need for fiscal consolidation simultaneous with tax reform and decision time on climate change are all here in 2010.

This article first appeared on Business Spectator