I think as a society we've lost the drive to kind of expand the pie. There was a time when there was a strong sense of shared prosperity in the country that by making the pie bigger we could all be better off. That was the kind of dominant narrative kind of in political and economic discourse. That narrative now has gone away and we're more now unfortunately arguing over shares and that's a path to unhappiness. No one wins out of that. The way people win is having a bigger pie and then we have a discussion about how we distribute that pie.
Welcome to the first edition of a brand new podcast called the Prosperity Question which will be hosted monthly by me and I am very grateful to Dr. Philip Lowe for joining me as my first guest for this first issue. Now his name of course precedes itself for many of you but let me just briefly outline some of his career. He was deputy governor of the Reserve Bank of Australia from 2012 to 2016 and governor from 2016 to 2023. I think he has a PhD from MIT if I recall correctly which is believe me in the economics world very impressive. And he's been at the forefront of Australian policymaking of course for many many years in his capacity at the Reserve Bank. Phil thank you so much for joining me.
Thanks Adam. It's great to be with you.
So I should say firstly Phil and I do go back a bit. I joined the RBA as a grad in 2003 and you were already very senior by that point. In fact I think you'd already been at the RBA for 23 years. You joined in 1980 I believe it's right and that was actually my birth year actually. Give that away. And you joined straight out of school at age 17.
From which school? From where?
From Trinity Senior High School in Wauchope in New South Wales.
Okay. And you joined not as an economist I imagine but as some sort of assistant clerical staff.
I was doing clerical work and I went to university at nighttime for the first two years.
So what did clerical work entail back then when you started?
Adding up numbers on a calculator. It was pre-computer and the calculator had a paper roll so you could check your work. So I spent the days punching numbers into a calculator.
Okay. And was that fairly common back then? People joining that way.
A number of people did. Hard to believe now, but in those days it was hard for the Reserve Bank to attract people who are interested in economics.
So they kind of had a program of attracting people straight from high school. Seeing to university at nighttime, if you did well enough then they'd support you to do the rest of the degree.
Yes. Now I ended up leaving the Reserve Bank in about 2009 for me to go off and be a journalist and be a staffer and all sorts of things like that. You're actually very prescient when I was a grad in 2004. I think you were assistant governor of the financial system group as it was called then and you said that I should be a journalist or I should maybe think about being a journalist. What made you say that?
Well, it was one of my good forecasts wasn't it?
Well, I saw you're kind of incredibly industrious and interested in issues and you were prepared to go straight to the source when you're hunting down questions. So, you had all the attributes of a first-grade journalist and so it turned out to be.
Well, thanks very much. I was thinking that you might put me in. I was a little bit naughty and went on and presented my currency union thesis in New Zealand without asking permission which didn't impress you very much at the time and I also rang up the financial services minister to get to the source as you suggested. So we got to know each other from very early on and then when I was a journalist we'd regularly catch up. I remember during the Brexit vote I was in your office actually. You probably don't remember but you said well I think it's time to leave now Adam because the financial markets were going all over the place at the time. So anyway enough of the preliminaries. Let's get on to the major economic topics of the day. So it's a pretty sad state of affairs I'd say in Australia at the moment if you look at the economic statistics whether it's household income, GDP per capita which I think has shrunk in 10 of the last 16 quarters as the IPA keeps track of. So we've had this marked stagnation after an extraordinary 30 years. You know what's the primary cause for that in your view?
Well I think it's important we keep things in perspective. I mean, Australians enjoy one of the highest standards of living in the world. We're often told we're in a crisis of one form or another, but objectively, we enjoy one of the highest standards of living in the world. The problem, as I see it, is living standards have stagnated. For seven years now, there's been no net growth in per capita income. So, average real incomes today in Australia are the same as they were seven years ago. And that's staggering. As you said, we'd had 30 years of very good economic growth before that. That growth was built on advances in technology, on good public policy reforms that focused on expanding the size of the pie. It was built on the China boom which increased commodity prices so that a ton of iron ore bought more imports and it was brought on through demographics. We had an increase in the share of the population that was working age people found jobs. We had 30 years of tremendous progress in average living standards, but the last seven years have been very different. The China boom is still boosting national income, but it's not boosting growth. The demographic dividend's over. The population is now aging. So I think over time there'll be a smaller share of the population that is available and willing to work. And public policy reform has gone into reverse. Public policy is no longer focused on expanding the size of the pie. It's more about the distribution of income and wealth.
So, three of the four drivers of growth have gone away and so we've stagnated in terms of real incomes. I think that's the main economic social problem that's facing the country. My view is that unless we change things, this stagnation is going to continue and we can go more than a decade without any advance in our real living standards which after three decades is a huge disappointment and I can understand why people aren't happy.
Yeah, you say stagnate but we are going backwards aren't we? Technically shrinking more or less.
Well per capita, I mean you can look at the data one quarter to the next but you take it over time, for six or seven years now broadly per capita incomes are unchanged that's how I would characterize it. So there's no growth, the economy is growing so that's good but it's growing because of population growth not because we're getting better at doing stuff.
And that getting better at doing stuff is the way we increase our real incomes per person.
Yeah. Certainly we'll come to possible solutions. You mentioned seven years ago. Did something really happen seven years ago or was there a policy change or an event that you think changed the trajectory?
There wasn't a single event but the combination of the China boom topping out, the demographic dividend gradually changing, and I think the cessation of really fundamental economic reforms that try and drive economic growth. You know, when was the last big public policy reform that set out to make the pie bigger? It's a long time ago. And we need to make the economy more dynamic, more efficient, more productive because that's the basis of growth in our living standards and our political class for whatever reasons have stopped doing that and there wasn't a day that it turned off but it's a gradual process combined with the gradual process of aging and it catches up with you and it's caught up with us and it's going to kind of continue unless we change.
Yeah. So I think Australia was more or less kind of part of the G20 pack or the western world pack if you like in terms of living standards but we have deviated since then and then in 2017 there was that famous paper by Raj Chetty that certainly got tongues wagging in the US that suggested that there could be a generation of children for the first time in many many decades, generations that would actually be poorer than their parents. I think 50% was the threshold or something like that. But I mean, is there a risk that that's going to happen here if we just continue on our current way?
Well, we're already kind of, as I said, stagnated and I don't see that stagnation continuing. I think as a society, we've lost the drive to kind of expand the pie. There was a time when there was a strong sense of shared prosperity. We were striving for shared prosperity in the country that by making the pie bigger, we could all be better off. That was the kind of dominant narrative kind of in political and economic discourse. That narrative for reasons I don't fully understand now has gone away and we're more now unfortunately arguing over shares.
And that's a path to unhappiness. No one wins out of that. The way people win is having a bigger pie and then we have a discussion about how we distribute that pie.
Partly it's a result I think of our own success. You know, as I said before, we're one of the wealthiest, most prosperous countries in the world with the highest standard of living. That was kind of around 2010, we could say 2015, we could probably say that. And we become complacent.
Become complacent. We've become risk averse and we've been worried about our shares rather than growing the pie.
Yeah. Just off hand, what was the last kind of sensible reform at state or federal level that was about growing the pie that you can think of? I'm just kind of racking my brain.
Let me think of one. We moved into a world where policy reforms are like shifting the dial a notch or two and then we argue endlessly over whether we shift it one or two notches and what we need to do is to step back and say how do we make Australia a great place for business to invest, expand, innovate and hire people. That's what we've got to do. And shifting the dial, like twiddling with it and spending all our energy arguing over small shifts of the dial. It's pointless. It just leads to animosity and it doesn't get you anything. So, we've got to have some big shifts to make Australia a great place to invest, expand, innovate and hire people.
Well, certainly one dial that has been turned up is spending growth, which on some economist calculations in the last few years anyway. I mean, it's been drifting up for some time, but we've had the biggest growth since Whitlam at the federal level. States are obviously spending huge, taking on huge debts and growing as well. I mean I remember John Maynard Keynes wrote somewhere and I could never find the book but he definitely wrote it that no economy could withstand more than 25% taxation kind of by government. Well I think if you combine state and federal we're well above that and certainly spending even more. I mean is that a problem as well that government's just grown so large and inherently it's not as efficient in most cases as the private sector?
Yeah, I think the issue for me here is the lack of a fiscal framework. You can argue about what the right size of government is. I don't have a particularly strong view on that, but I know we need to have a fiscal framework. And I say that because I've seen the benefit of a framework in the monetary policy sphere because in public policy, there are a lot of kind of what the economists call intertemporal trade-offs. You do things that make you feel good today, but they have a cost tomorrow. So, we've got a central bank that knows that, that has a long-term horizon, that has a framework that constrains its decisions. And I think while people criticize the Reserve Bank, it's done a pretty good job over a long period of time based on that framework. In the fiscal area, we had frameworks for a while. We had a budget balance over the cycle. We had a spending cap, a share of GDP. So you know those fiscal frameworks weren't perfect but they were frameworks and during COVID the government suspended those and they haven't replaced it with anything. So now we find ourselves running sizable budget deficits at a time where we're at full employment and commodity prices are very high. We should be running sizable surpluses. So we don't have a framework and we're not solving the intertemporal problem. So what we're doing now is spending today and leaving the debt for our kids.
So the kids are going to have to pay the debt and the interest. And unless we change the stagnation, then they're not going to have a bigger pie to pay it back from. So this is the big intergenerational inequity issue as I see it much bigger than any other ones that we're kind of giving sugar hits to mum and dad today paid with borrowing from their kids and the kids have to pay interest. And that's the problem. If you had a strong fiscal framework either a budget balance over the cycle or something like that and strong cost-benefit analysis to guide public investment decisions we wouldn't be in this position and then we could argue over what the right size of the government is and people legitimately have different views on that but we need a fiscal framework to guide the overall level of spending and the investment decisions by government. We have neither of those and we make ourselves poorer as a result and we're leaving our kids more debt and more interest and a lower standard. It's just not right.
Yes. Look, I know you mentioned offline talking about the $75 household energy rebate that I know your family got. Every family got of course it was paid with borrowed money. The government just increases its, you know, is that a classic example?
Well, I was, I thought every quarter like you, I'd get a $75 credit on my electricity bill. I thought, why am I getting this? I do not need the money. And it's not like this money is coming from government coffers. They've got money in a bank account. They were in deficit. And they had to go to the financial markets and borrow so they could give me $75. And who's going to pay that back? My kids. And they're going to pay it back with interest.
Well, just my kids don't want the debt. My kids don't want the interest. I just think it was kind of bad public policy. But it came from a place of good intention, didn't it? The government saw a need on behalf of the community. They thought this was an administratively easy way of doing it. And from that perspective, I can understand why they did it. But if you had a proper framework to make these decisions, you would I don't think you would have done that. You would have said no.
You would have found something more targeted or you would have found something more temporary or you would have said no or this is just not going to help over time. It might help for a year, but you know, we've got a bigger problem.
Yeah. Look, do you think there needs to be some sort of, you know, I'm of course loathe to suggest more bureaucracy, but does there need to be some sort of independent arbiter that assesses certain policies that can say this is bad or good? You know, and that basically in a parliamentary democracy, the arbiter is the people. You know the government goes to the election every three years put in place ways that you a new bureaucracy but bureaucracies come with value systems and you know what's good or bad is going to you know from some perspectives the electricity rebates were actually good you know they did help people in need but I was not in need to say you weren't in need either and we were getting people getting them on their holiday houses it was ridiculous.
Well the COVID stimulus was arguably I mean I know barristers that bought works of art with their... But anyhow, it came from a good place but without a framework for decision making other than what's going to help me get elected and what's going to help me right now.
We need to kind of refocus on the intertemporal aspect of these things. Governments go on, people's lives go on and they have to solve a problem over their whole lifetime. And this is why I kind of want a framework and I want us to focus on the long term for the sake of our kids. And we need to make some sacrifices and take some hard decisions for the sake of our kids. Otherwise, we're leaving them more debt, higher housing prices, and a great environment. It's just not right.
Just to briefly pin you down on the fiscal framework. I mean, we've had, you know, in Australian history, there's been loans councils to try to discipline the states, which of course, as you know, recently have just gone crazy with borrowing. You mentioned some of the rules on taxation the 23.9% a rather bizarre figure I don't know how who came up with that sure you would have just rounded it up but anyway and you know Switzerland has debt breaks and some states do even things some US states can't grow at all what what sort of you know kind of limits do you see as reasonable even in a broader sense?
Yeah, I mean I like the kind of concept of, you know it's hard to operationalize, is the balanced budget over the cycle. It's kind of providing this concept that kind of over a run of years you should have roughly a balanced budget but you can go into surplus and deficit depending upon the cycle with a separate budget for public investment decisions but with that separate budget being guided by strong cost-benefit analysis. So, you know, I think it would be beneficial having a stronger public institution that looked over the cost-benefit analysis on large public sector investment projects.
And then the operating budget in principle should balance over a run of years.
Bit like, you know, we used to talk about inflation being two to 3% over the cycle. It got to provide a medium-term anchor and let some flexibility. So an operating balance on average over a cycle with pluses and minuses and a capital spending budget guided by strong cost-benefit analysis.
Well I think the Reserve Bank has kept inflation between two and three over the cycle if you take a long enough... I'm a huge believer in frameworks in solving the intertemporal problem and providing discipline on decision makers. In the case of the Reserve Bank, it provides discipline on the board. And if we had a fiscal framework, it would provide discipline on the politicians. And it's actually harder for the politicians to be disciplined because at the central bank, I had a seven-year term. I had a long-term perspective. I knew I had to do the right thing. I didn't have to be elected. Whereas, you have to go to the people every 3 years. It's hard.
Yeah. Is three years, you know, kind of part of the problem. I mean, personally, I kind of like short terms. You can make good or bad decisions in three years, and if you get a bad government, you want them out before four years. So.
Yeah. Exactly. I don't think people often blame that as the problem. I don't think that's the problem here.
But briefly, you want to touch on Australia's inflation problem at the moment, which we've had for a few years. It seemed as though it was trending down like the rest of the world. And now it's not. Core inflation's too high and it's a problem. Everyone recognizes that. And there's this huge debate about what causes inflation. I mean, there's so much economic ignorance out there in the public. I think it's one of the big reasons why it's hard to get sensible political decisions. But I mean, you mentioned deficits earlier. You know the underlying cash balance deficit is very large. The headline balance is about twice that 60 billion or so a year. I mean these sorts of deficits you mentioned earlier it should be a surplus but these sorts of deficits they do contribute to inflation right that's a fair comment to make.
Well government spending contributes to inflation because inflation comes when demand is greater than supply. That's you know first year economics you learn this in high school prices determined by the balance of supply and demand. If demand is growing stronger than supply then prices go up. Our supply is driven by in the broad terms by population growth and productivity and I said productivity growth has been zero. So the supply side of the economy is growing very very weakly. That means unfortunately demand has to grow weakly. It's very unsatisfactory but that's the reality and it's the government spending has been adding to demand progressively over time and that's putting upward pressure on inflation. I think the other downside of weak productivity growth is we can't afford to pay ourselves big wage increases.
Now the government and many others want to see wage increases three and a half, four.
Well Victorian teachers are getting 7% a year I think over the next few years. We used to be able to do 4% wage increase. That was we had 1 and a half% productivity growth, 4% wages growth, and that delivered 2 and a half% average inflation. That was a really good outcome. But the reality, you know, it pains me to say this, but it's true. If you have zero productivity growth and you're going to have 2 and a half% inflation, then wages going to grow at two and a half, not three and a half, four or seven. And as a society, we haven't yet made that adjustment. So we've got wages growth, nominal wages growth not being consistent with 2 and a half% inflation and zero productivity growth. So we've got too much demand in the economy for supply and unit labor costs. This is kind of the difference between nominal wages growth and productivity being too fast. And that's where the inflation is coming from. On top of that, we've got the higher oil prices.
So does the public sector have a responsibility to, you know because they can arbitrarily set the incomes of their workers obviously by fiat I mean they've been very high as I understand it certainly in some states is there a responsibility amongst the public sector to accept lower rates of increase so that the private sector can also be lower?
There's responsibility. I used to be on the other side of this because when governments had wage caps of 2% I used to say I didn't think that was sensible it wasn't consistent with 2 and a half% inflation and it wasn't consistent with shared prosperity so it used to be that I was arguing for larger pay rises which felt... and now we've switched the other way. Yeah. We switched the other way. We need to come back, I think, to the sensible middle. And the sensible middle is we get 2% for inflation and whatever we can deliver on productivity growth. And if we can't deliver on productivity growth, then we have to accept that everything just grows more slowly and we can complain about it and feel bad about it, but we need to address the underlying problem and that's weak productivity growth.
Well, look, I mean, what are some of the, you know, structural levers? We haven't had any big bang reform in Australia for quite some time. We have massive reliance on income tax as you know and we have a top marginal rate of 47% at now 190,000. You know if it had been indexed it would be in the high 200s by now. I mean there's a lot of emphasis on that rate as being a real impediment to attracting talented workers from overseas and also incentives for effort and saving and so forth. I mean do you see that top rate as a real problem in Australia now or income tax reliance in general?
Well, it's one of the problems to, you know, to get productivity increasing again, a living standard rising, we need Australia to be a great place for firms to invest, expand, innovate, and hire people. So, we need to have a pro-growth, pro-investment culture. So, when people ask how you do that, the first thing I think is taxation. Every study that's been done of the Australian taxation system makes the observation that we tax income and wealth generation too highly and consumption too lightly.
