Managing External Problems

As stated by Gruen and Grattan (1993:101), “during early 1985 increasing economic and political problems emerged, including a growing awareness that Australia faced deep external problems. After June 1985 Australia's terms of trade declined quite sharply - by about 10 per cent, compared with a long term average decline of about 1 per cent per annum”. The Australian dollar plummeted in value by about 30 per cent in the first half of that year. By early 1986 it was obvious the crisis was more serious than had been foreseen. In 1986, the current account deficit blew

out to 6 per cent of GDP as compared with 4.5 per cent in 1985 (Kelly 1992: 197). In mid-May 1986, the Hawke government came face-to-face with its fundamental political dilemma of the 1980s. This engendered a sense of economic crisis. On a talk-back radio program, Keating warned the nation that if the situation were not addressed, then Australia faced the risk of becoming a “banana republic” (cited from Singleton 1990: 166).

Kelly (1992:200) states that “there were three factors responsible for the rapid deterioration in the current account deficit - the resources boom, excessive domestic spending, and the terms of trade decline - [but they] merely reflected deeper structural issues. In the first place, many commentators saw the existing current account deficit to be the result of [Australia’s] failure to move towards a more diversified export base with more raw materials processing. Australia was forced to face the realities of international trends in 1986, when the terms of trade for raw materials, including petroleum, fell to the lowest levels in recorded history. The two further underlying issues for Australia at the core of its current account deficit crisis were its lack of international competitiveness and its inability to generate higher national savings to reduce its call upon overseas saving”. The problem was that strong domestic growth was spilling into a level of imports which Australia was unable to finance through its exports.

Kelly also states that “the 1986 crisis was quite different from the expectations of 1983, when Hawke came to office to end Australia’s recession through a new compact with the unions. The crisis generated awareness within the government that the recovery it had made contained a nasty shock. The crisis, to some extent, revealed the structural and competitive deterioration of the economy namely poor productivity, reliance upon raw materials exports, and inadequate national savings to fund investment. This legacy of decades confronted Labor with electoral and philosophical challenges as severe as any in its history” (Kelly 1992: 219). On the one hand, the crisis represented a “confluence of short-term economic policy and long-term cultural traditions” (Kelly, 1992:196). Once again, the crisis was a

warning and an admission that Australia’s underlying institutions and ideas (protection, regulation, introspection, arbitration and commodity reliance) drastically required drastic (Kelly 1992: 197). The crisis required an assumption of responsibility in government if the Hawke administration was to sustain the claims to sound economic management that was the basis of its electoral strategy (Singleton

1990: 166).

Confronting ways of addressing the current account deficit crisis while avoiding a recession, forced the Hawke government to change Labor’s traditional policies dramatically. As a result, the Hawke government moved decisively towards a free market economic rationalist agenda which flew in the face of ALP policy tradition. Further, the government moved from public sector expansion to contraction (Kelly

1992:211).

This inaugurated a new era in Australian economics and politics which was to endure far into the 1990s (Kelly 1992: 196). Firstly, government, through the framework of the Accord, persuaded the ACTU and the then Arbitration Commission to reduce the rate of money wage growth below the rate of the growth of prices. Under the terms of the original Accord, the increase of 2 per cent in inflation would have meant a corresponding increase in award wages. But the government recognised that such an increase would in turn increase labour costs (costs of production), which would undermine the international competitive advantage of Australian products. This, in turn, would increase the balance of payments deficit. Therefore, the government needed to offset the rising costs of production. As a result, after a considerable period of negotiation, the Accord was renewed to become the Accord Mark II. Under this new formula, the ACTU agreed with the government proposal to a 2 per cent discounted wage indexation in order to prevent a debilitating upward spiral of costs and prices as the effect of the dollar’s depreciation took hold. In addition, a national productivity-based pay rise was deferred. This was subsequently awarded as a 3 per cent employer contribution to superannuation (though the Arbitration Commission disallowed this in 1987).

Promised tax cuts were also deferred until later in the year. Thus, the Accord Mark II was designed to cut real wages in order to hold the competitive gains from depreciation (Kelly 1992: 206). This first re-negotiation of the Accord was highly important. It broke down the previous commitment to full wage indexation and showed how much the government was concerned to accommodate employers' and the nation’s interests (Stilwell 1993: 72).

Later on, Accord Mark II was re-negotiated, in response to the continuing deterioration in Australia's balance of payments during 1986. It was already clear that the dramatic fall in Australia's terms of trade was swamping the effects of the two per cent previous wage discounting (Stilwell 1993: 73). It also become apparent that wage indexation was inappropriate in the present economic climate and that the problem of restrictive work practices had to be addressed. Further, there was a recognition that full wage indexation was incompatible with redressing the balance of payments slump. Put simply, the depreciation would make or break the Accord as wages policy. Therefore, while the government slowed the economy moderately by tightening both monetary and fiscal policy, a further discounting of wage indexation was important to reduce real wages so that Australia's international trade competitiveness would be increased while at the same time it acted as a 'circuit breaker' on the domestic wage-prices spiral. The result was Accord Mark III. Under this new formula, the ACTU and government agreed to implement a two-tier wage system to replace wage indexation. The arrangements established in the National Wage Case of March 1987 involved a first-tier increase of $ 10 per week in award wages and salaries, while giving agreement to a further wage increase of up to four per cent of existing wages and salaries. But to achieve this four per cent, there would be guidelines involving the elimination of restrictive work practices. Therefore, this Accord Mark III, as many employers recognised, involved a further shift away from a cost-of living criterion towards a productivity-based criterion for the determination of wages.

slowdown the budget deficit was further reduced, by more than $ 2 billion in 1987- 88. Although unemployment increased marginally (from 7.6 per cent in June 1986 to 8.5 per cent in March 1987), as the result of the economic slowdown and a commodity price recovery driven by an unexpected rebound in international economic activity, the current account deficit was reduced from over 6 per cent of GDP in 1985-86 to 3.7 per cent two years later (Gruen and Grattan 1993: 102). The government reined in its budget deficit and ran budget surpluses for three years after

1986-87; the size of the government was reduced, and so was inflation.

The improving economy from 1986 to 1987, enhanced the perceptions of the competence of government, in particular of Treasurer, Paul Keating. The Hawke government proved its claim to be a sound economic manager. It showed it could handle a the “banana republic” crisis with both discipline and competence. This success provided the opportunity for the government to call an early election in July 1987. “Capitalising on politically debilitating feuding within the Opposition Liberal and National Parties, the government was returned to office only a year after the trough of the balance of payments” (Stutchbury 1990: 66).