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The main challenge for policy is managing a sustained recovery by promoting important structural changes. Australia has continued to weather the global economic crisis well reflecting sound macroeconomic policies and strong demand from China. Although non-mining tradable sectors have struggled with the strong exchange rate driven by the mining boom, fundamentals remain solid with the unemployment rate close to its structural rate and inflation and public debt low. Growth strengthened in 2012, and the outlook is positive, even though there are mainly negative external risks, to which Australia is however less vulnerable than many other OECD countries.

The current monetary and fiscal policy mix is appropriate to sustain recovery, and Australia is in a good position to respond to risks. Monetary easing in the context of low inflation is supporting activity while the budget is being rapidly returned to surplus to restore fiscal space. In case of a sharper-than-expected cyclical weakening, the first line of defence has to be monetary policy. But in case of a large negative shock, budget consolidation could be slowed.

Stronger medium-term fiscal institutions would be better able to cope with volatility in natural resource revenues. The medium-term objective of reducing net debt is welcome. The authorities should consider creating a stabilisation fund to accumulate mining-related revenues when they are unusually high to insulate budget and spending, thereby reducing the risk of pro-cyclical fiscal policy. 

The structural changes stemming from the mining boom can be facilitated by maintaining flexible markets and introducing tax reforms. Australia should promote smooth reallocation of resources by taking advantage of new opportunities prompted by growth in Asia, and should minimise adjustment costs by preserving a decentralised and flexible labour market. In particular, public subsidies should not be used to retain resources in sectors where Australia’s comparative advantage is declining. Tax reforms, including a lower corporate tax rate, a broader resource rent tax and more efficient state taxes would facilitate ongoing structural adjustments. At the same time, a fair sharing of the burden and gains of adjustment would facilitate acceptance of change.

Continued good performance will require lifting productivity growth. Part of the slowdown in multifactor productivity growth is temporary. Nevertheless, sustaining broad-based increases in living standards calls for policies to improve vocational and higher education outcomes to meet future skill needs, enhanced innovation performance through closer collaboration of key players, resolving infrastructure bottlenecks through better planning and more efficient financing and use of infrastructure, as well as stronger competition.

Recent progress to promote more sustainable growth based on efficient environmental policy is welcome and should continue. The introduction of a carbon price, together with accompanying measures, should encourage investment in clean energy technologies, and help enhance competitiveness in a carbon-constrained world. More efficient allocation in the use of water resources may be achieved by better water pricing and suppression of barriers to water trade through swift implementation of the National Water Initiative.

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