Australia is enjoying its 17th consecutive year of growth. Living standards are rising faster than in the rest of the OECD, the unemployment rate is around its lowest for 33 years and the government’s balance sheet has swung into a net asset position. These results have been underpinned by structural reforms, the proximity to dynamic Asian markets and hefty terms of trade gains. However, the long period of uninterrupted growth has pushed the economy towards capacity limits at a time when it is faced with a fresh surge in commodity prices. The external environment should remain favourable over the medium term, with the continuation of rapid growth by the Chinese and Indian economies prompting strong demand for Australia’s mineral resources. In the short term, the priority should be to curb inflationary pressures. In the longer term, the main challenge is to raise capacity faster. Current and prospective favourable conditions should be seized to adopt reforms that would allow Australia to catch up with the best performing OECD countries.

The economy has expanded for sixteen consecutive years and the economic picture is, overall, very favourable. However, inflationary pressures have mounted and macroeconomic policy will need to stay relatively tight to ease demand pressure until a significant easing in inflation is in prospect. The new government has launched a vast reform programme to sustain strong growth over the medium term. Against this backdrop, this chapter will assess the recent performance of the economy, the short-term outlook and monetary and fiscal policy requirements. The chapter will then highlight the main structural policy challenges. These include reforming the education system, raising labour supply, reforming industrial relations and product markets, the latter including critical areas such as infrastructure and water management.

Australia faces the challenge of increasing labour supply to sustain growth in view of rising skill shortages and population ageing. Priority should be given to improving incentives to work for groups with the greatest scope to raise supply, such as women with families and lone parents, disability benefit recipients and older workers over 55. Immigration remains an important contributor to labour supply, helping to alleviate skill shortages. Given the high skill level of Australia’s immigration intake, the adequate use made of immigrants’ human capital is a matter of key importance. A significant challenge lying ahead is to remove potential barriers to increased immigration.

The Australian education system fares well in international comparison with regards to PISA test scores and the higher education system attracts an increasing number of foreign students. Vocational education and training (VET) is an important part of the post-secondary education system, equipping individuals with the skills to enter or re-enter the labour force and offering a pathway to further education. However, a number of challenges need to be addressed. Reducing complexity and fragmentation and tackling issues of under-supply and under-representation of children from disadvantaged groups in the early childhood education and care system is of major importance, given the beneficial impact of early education on outcomes later in life. A key challenge for the school sector is to reduce the achievement gaps of the lowest performing students, while improving overall literacy and numeracy outcomes. Greater autonomy at the school level and improvements in teaching quality would help in this regard. Enhancing the capacity of the VET system to address skill shortages is another key priority. The low rate of completion of training courses is an additional policy issue facing the sector. Finally, moving towards a less rigid policy framework for higher education would enhance flexibility and diversity, making the system more responsive to labour market needs and globalisation challenges. The promotion of a high-quality education system that responds swiftly to changing skill needs is a top priority of the new government. The “Education Revolution”, backed by the Council of Australian Governments (COAG), pursues reforms across all sectors of the education system, an important objective being the closing of the gap for the indigenous population.

The product and labour market reforms since the early 1990s have played a pivotal role in enhancing employment and productivity, and ultimately growth performance. Despite this progress, important margins still exist for improving the functioning of product markets and a new reform wave was launched with the National Reform Agenda (NRA), and more recently, the COAG reform agenda. It is also necessary to cut red tape and to reduce the geographical segmentation of markets, which hampers efficiency. In the case of the labour market, the main challenge is to preserve flexibility following the phasing out of some aspects of the WorkChoices reform, which led to equity concerns. This chapter reviews the government’s reform projects that aim at enhancing product markets and revising the industrial relations system and provides an assessment of ways to further improve them.

Over the past 15 years, water management issues have come to the fore in economic policy discussions. Over-exploitation of water and harmful environmental effects have become major concerns, while water is not used efficiently, particularly in rural areas. Water extraction levels that are ecologically sustainable have been breached in a number of regions. Guaranteeing water security and diversifying supply for the major urban areas has become a major policy challenge. Difficulties are likely to grow because demand will rise further, while climate change is likely to further reduce available water resources. The authorities have recently stepped up reforms aimed at remedying over-exploitation, stopping wastage caused by deficient water delivery systems and directing water use towards the most productive activities. This chapter reviews the challenges posed by water management, assesses the policies to meet them and suggests ways to make them more effective.