Recent macroeconomic performance continues to be impressive: gross domestic product (GDP) growth since the turn of the millennium has averaged above 3% per annum and, including the terms-of-trade gains, growth in real gross domestic income has averaged over 4%, among the handful of OECD countries achieving such rapid growth; the unemployment rate has fallen to around 5%, its lowest level since the 1970s; inflation has remained within the target range; and, following a long stretch of fiscal surpluses, Australia is now one of the few OECD countries where general government net debt has been eliminated.

The major short-term challenge is to maintain macroeconomic stability in the face of a commodities price boom that has boosted the terms of trade by around 30% over the last three years. Recent monetary tightening in the face of relatively weak output growth needs to be seen in the context of strong income gains due to the surge in the terms of trade and the prospective effect this is likely to have on spending. Unusually buoyant tax revenues related to the commodities boom also raise the question as to how ambitious short-term fiscal objectives should be. Recent budget tax cuts are also considered in the context of previous Survey recommendations and a recent study comparing Australia’s tax system with that in other OECD countries.

Judged in terms of GDP per capita, Australia’s ranking among the OECD countries has steadily improved since the beginning of the 1990s. It has now surpassed all G7 countries except the United States. This chapter reviews the main challenges that policy-makers need to address to sustain this strong performance. In framing policy responses it is important to recognise the over-arching framework of fiscal federalism which is of key importance in many areas which are crucial in determining long-run performance. In common with most other OECD countries, population ageing threatens to slow the growth in living standards over coming decades.

Key areas of public service provision are subject to complex patterns of joint government involvement that can lead to inefficiencies. Clarifying government roles and responsibilities is likely to have a significant potential for improving public sector efficiency. Fragmentation of decision making and funding arrangements, particularly in the areas of hospital services and old-age care, creates incentives for cost and blame-shifting between government levels. A collaborative approach between government levels to overcome some of these problems, as recently initiated by the Council of Australian Governments, would help to develop better governance arrangements and improve spending assignments. A less complex system of inter-governmental transfers would also contribute to a more effective specification of spending responsibilities. Stronger revenue-raising capacity of the states, through a further improvement in the efficiency of the state tax system, would raise the ability of sub-national governments to meet expenditure responsibilities and be better prepared for coping with demographic change.

Australia’s National Competition Policy (NCP) has set out competition principles which extended the reach of competition law to previously exempt activities and provided a coherent framework for reforms in essential infrastructure industries. Among the major achievements are the establishment of an overarching national access regime – together with sector-specific regimes – which introduced thirdparty access arrangements for infrastructure services such as gas pipelines and rail track networks. Independent authorities were established in all jurisdictions to monitor and set prices for monopoly services. However, there remains unfinished business and the NCP infrastructure reform agenda was not exhaustive, leaving room for additional measures to improve the efficiency in essential areas such as electricity, water, road and rail transport.

The industrial relations system has evolved gradually from a very prescriptive set of rules set by judicial bodies to a much more flexible system, with many enterprise and individual agreements. However, the judicial rulings have remained important in setting a floor on what can be agreed upon. Many attempts have been made in recent years to instil greater flexibility, while maintaining a social safety net. The latest is the WorkChoices legislation, which took effect in March 2006. This chapter reviews WorkChoices and assesses the room and options for further reforms.

Raising labour force participation is of major importance for sustaining vigorous growth, especially in the face of population ageing. The major challenge is to increase participation among women with families and lone parents, disability benefit recipients and older workers over 55. While participation decisions reflect personal choices, these are influenced by policy settings. Despite improvements in “inactivity traps”, Australia ranks high internationally in terms of “low wage traps” for lone parents and one earner households. Tackling such “low wage traps” either by addressing allowance and parenting payment income tests or by reducing the lowest income tax rate or raising the threshold at which income tax is first paid, should be a priority.