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December 17,1976 Ups and Downs, Down Under So now it's Australia's turn. After several years of weak economic performance, the government de valued the Australian dollar by W i percent in late November, and backtracked only slightly with two modest up-valuations during the past week. This situation of a weak ening currency—and a weakening economy—contrasts strikingly with the nation's strong growth perform ance of the several preceding dec ades. A formula of moderately expansive fiscal and monetary policies, cou pled with an open-door approach toward foreign investment, proved highly successful in the 1950's and 1960's, as the nation's real gross product expanded at close to a 5percent annual average rate, while the inflation rate averaged just over 3 percent a year. But the internal and external shocks of the 1970's led to entirely different results— slow growth, high unemployment, double-digit inflation, declining foreign investment, and dwindling foreign-exchange reserves. Curbing government spending The problem could be traced in part to an upsurge in public-sector spending. Federal (Common wealth) government spending quadrupled in real terms over the last quarter-century, and its share of gross domestic product increased from 23 to 32 percent over that period. In the 1973-75 period alone, Federal spending rose almost 15 percent annually in real terms, with the largest increases concentrated in education, health, and social welfare. Meanwhile, the govern ment deficit rose from $A0.7 billion in fiscal 1973 to $A3.6 billion in fiscal 1976, and the money supply ex panded rapidly. The Liberal-Country Party coalition government, immediately after tak ing office in December 1975, at tacked the problem by introducing ceilings on government spending and employment. Later, in an Au gust budget presentation, Treasurer Phillip Lynch announced a $A1.0 billion reduction in the Federal deficit for fiscal 1977, along with a slowdown in the target moneysupply (M3) growth to the 10-12 percent range, compared with the 14-15 percent growth of the several preceding years. To date, no one can tell how well these measures will work. At the end of the third quarter, the con sumer price index still stood about 14 percent higher than a year earli er, only slightly behind 1975's infla tion rate. In the present quarter, however, the inflation rate is ex pected to slow to about a 5-6 per cent rate. Curbing protectionism Part of Australia's problems could also be traced to a long-standing policy of protectionism, followed (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. by both the present coalition and the predecessor Labor Party gov ernment. Australia traditionally has relied on relatively high tariff barri ers to protect domestic industries from foreign competition. Yet no matter how successful the policy has been as a means of nurturing infant industries, it has also tended to weaken the efficiency of the nation's manufacturing sector. Dur ing the past two decades, labor productivity in Australian manufac turing has grown at a slower pace than in practically every other ma jor industrial country. In addition, Australian industries have encoun tered difficulty competing in for eign markets. While manufacturing is Australia's largest sector in output and employment terms, it ranks behind both agriculture and mining in total exports. Recognizing these problems, the Labor government reduced tariff rates by 25 percent in 1973, but soon thereafter reversed itself and imposed new quotas and tariffs when unemployment rose and the foreign-trade account deteriorated. This turnaround enabled Australia to register trade surpluses in both 1974 and 1975, despite falling world2 demand and falling prices for its major exports. But the new import restrictions also aggravated long term structural problems in manu facturing. Most of the restrictions remain in effect today, although the increasing flexibility in exchangerate policy could ultimately pave the way for trade liberalization. Reversing investment curbs In the area of foreign investment, several sharp policy reversals have occurred in recent years. Up until 1965, Australia had pursued a pre dominantly open-door strategy, with restrictions in certain sectors but with the welcome mat out for investors in manufacturing and mining. Policy began to shift over the next several years, and then a major change occurred in late 1972 when the Labor Party came to pow er on a platform of "start buying back Australia." Under the new policy, foreign capital was barred from a number of areas (such as banking, domestic airlines, and television) while tight screening procedures and 50-percent domestic-ownership requirements were applied to other areas (such as mineral exploration). The consequences were dramatic for the capital sector. Foreign direct investment declined nearly twothirds in 1973 alone, and capital 2 inflows even today remain well be low those of the early 1970's. Final ly, responding to the depressed state of domestic capital formation, the Labor government completely revamped its guidelines in Septem ber 1975, primarily by easing restric tions for mineral-resource develop ment. After it took office, the LiberalCountry Party government an nounced similar liberalized guide lines. Foreign investors are now encouraged to seek Australian par ticipation in those “ key areas” where guidelines call for 50percent Australian equity and con trol, but projects will be allowed to proceed even in those cases where local participation is not readily available. Although somewhat tat tered, the welcome mat is out once again. Abounding problems Australia may still have some diffi cult times ahead. Like most other developed countries, it is faced with the trade-off between severe inflation on the one hand, and slow growth and serious unemployment on the other. Although inflation now appears to be decelerating, the price level in early fall was still 14 percent higher than a year ago. At the same time, the economy is growing at only a 3y2-percent rate,3 3 while the jobless rate approaches 5 percent—a very high figure for Australia. Also, one-third of the nation’s foreign reserves have dis appeared within a year’s time, set ting the stage for the recent devalu ation. (Actually, the exchange rate had not been rigid, having been set as a trade-weighted average of the rates of Australia’s trading partners.) Now an export-led recovery can be expected, especially in the impor tant mining and agricultural sectors, provided that Australia keeps infla tion under control. In addition, devaluation might spur a resur gence of capital inflows. Yet structural as well as cyclical problems still abound, as our ac count suggests. The government to date has relied mainly on fiscalmonetary policies to restore a situa tion of non-inflationary growth. Should the economy not respond as expected to these macro economic policy changes, more effort might be directed at areas of structural weakness in the econo my. Further pressures might then arise to liberalize foreign-trade and foreign-investment policies in or der to spur economic growth. Nicholas Sargen uoj8u!i|seyv\ • M^in * uo8aJO • epBASN • oijepi mbmbh • e|UJOp|B3 • cu o zu y • B>jSB|V •ji|* 3 'o is p u u j u«s ZSL 'ON llW H d aivd BDV-LSOd nvw ssvid sti isaid BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Amount Outstanding 12/01/76 Change from 11/24/76 Change from year ago Dollar Percent Loans (gross, adjusted) and investments* Loans (gross, adjusted)—total Security loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities O ther securities Deposits (less cash items)—total* Demand deposits (adjusted) U.S. Government deposits Time deposits—total* States and political subdivisions Savings deposits O ther time deposits:): Large negotiable C D ’s 92,726 70,369 1,572 22,615 21,325 11,906 9,437 12,920 91,058 26,828 296 62,328 4,674 29,499 25,988 9,968 + 1,908 + 1,300 + 96 34 + 95 + 38 + 685 77 + 1,631 + 1,474 + 6 + 290 67 + 368 172 + 42 + 5,045 + 4,722 30 579 + 1,698 + 1,465 + 164 + 159 + 2,787 + 2,562 196 + 744 1,316 + 7,609 4,173 - 6,085 Weekly Averages of Daily Figures W eek ended 12/01/76 Selected Assets and Liabilities Large Commercial Banks Member Bank Reserve Position Excess Reserves (+)/Deficiency (-) Borrowings Net free(+)/Net borrowed (-) Federal Funds—Seven Large Banks Interbank Federal fund transactions Net purchases (+)/Net sales (-) Transactions of U.S. security dealers Net loans (+)/Net borrowings (-) + W eek ended 11/24/76 - + 54 0 54 - 3 0 3 + 582 + 643 + 275 - 10 + + + + + + + + + + - 5.75 7.19 1.87 2.50 8.65 14.03 1.77 1.25 3.16 10.56 39.84 1.21 21.97 34.76 13.84 37.91 Comparable year-ago period + + + 67 1 66 + 1,767 + 707 ■"Includes items not shown separately. ^Individuals, partnerships and corporations. Editorial comments may be addressed to the editor (William Burke) or to the author. . . . Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184.
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