This article was first published in Business Spectator on 29 November 2012:
It was 22 years ago today that Treasurer Paul Keating said Australia is in recession and that “this is a recession that Australia had to have”. He was commenting on the national accounts data that had been released earlier that day, which showed a thumping 1.6 per cent fall in GDP in the September quarter of 1990.
Keating was right.
One only has to look at the economic performance of Australia that has followed the nasty recession of the early 1990s to see how it cleansed the economy of inflation, high interest rates, stagnant real wages and asset price bubbles. It is unlikely that this would have happened without the recession.
Singapore’s President Lee Kuan Yew had made waves about a decade before the recession when he said that Australia was on track to become “the poor white trash of Asia”. Among the reasons Lee could have cited were industry featherbedding, automatic wage indexation, high tariffs, a lack of competition, tax inefficiencies and a slothful business culture in what was a harsh but probably fair assessment.
To move from trash to treasure, Australia not only needed to implement a raft of policy reforms, the economy needed to have a final purge of the structural rigidness and inefficiencies that had held Australia back during the 1960s, 1970s and early 1980s.
The recession fostered that purge.
The early 1990s recession saw inflation fall sharply. After a couple of years of low inflation, RBA Governor Bernie Fraser saw an opportunity for Australia to join the low-inflation countries and in 1993, he started to articulate an inflation target of 2 to 3 per cent. That target is still the prime focus for the RBA today.
In terms of policy success, annual inflation has averaged 2.5 per cent over the last 20 years – slap bang in the middle of the target range. In the 20 years up to the early 1990s, the average annual inflation rate was a corrosive 9.2 per cent.
The low inflation environment was a vital legacy of the recession as it altered investment incentives, saw a structural lowering in interest rates and underscored real wage increases.
In terms of interest rates, the cash rate set by the RBA has not been above 7.5 per cent since 1992 and has averaged 5.3 per cent over those two decades. In the period from 1980 to 1991, the interbank interest rate averaged a bruising 13.8 per cent and spent many years above 15 per cent.
It is arguable that the early 1990 recession-induced smashing of inflation lowered average interest rates by 8.5 percentage points. We should all be grateful for that.
The destructive power of high inflation meant that real wages fell in every year from 1985 to the start of the 1990 recession. To be sure, the structural change in the labour market, brought about by the policy consensus that came with the ground breaking prices and incomes accord, was a critical factor holding back wage gains, but somewhat perversely, in the near two decades after the recession, real wages have risen strongly in all but three and a half years.
Perversely because the recession drove the unemployment rate to 11 per cent, which might normally be a factor dampening wage claims. Rather than that, it furthered enterprise bargaining, wage rises were increasingly linked to productivity and there was some long overdue flexibility given to the labour market.
In the decade prior to the recession, the unemployment rate had only three months below 6 per cent and it in fact averaged 8.1 per cent, not counting three years during and immediately after the recession where the unemployment was above 10 per cent.
In the aftermath of that recession, the unemployment rate ratcheted down. The fact that the last time the unemployment rate reached 8 per cent was in January 1998 is clear evidence of this; it has not been above 7 per cent since 1999 and for every month since July 2003, the unemployment rate has been below 6 per cent. In the last decade, the unemployment rate has averaged a world beating 5.1 per cent.
The decade prior to the early 1990s recession was truly a miserable economic picture of high inflation, high unemployment and falling wages. Asset prices were surging, distorting investment away from productive uses and while many structurally important policy changes had been made in the prior few years, an active ingredient was needed to make them work.
This was the recession.
And the last word on the consequences of the recession should probably go to Lee. During a visit to Australia in 2007, in reference to his “poor white trash” comments a quarter of a century earlier, he said: “There are some words sometimes thrown in the heat of the argument which perhaps at that time was warranted. You have changed.”
Indeed Australia has changed. Its economy is the envy of the world, Australians have never been richer in absolute terms and relative to the rest of the world. These are the legacies of the recession that Australia had to have.