Assessment and recommendations1
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Macroeconomic developments and near-term prospects: post-boom adjustment continues
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Monetary and financial-market policy: coping with low interest rates
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Encouraging business productivity and innovation through framework conditions
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Addressing inequality, enhancing inclusiveness and deepening skills
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Tackling environmental challenges: progress in greenhouse-gas emission policy
Following an impressive 25 consecutive years of output growth, Australia’s gross domestic product per capita is high and the country generally ranks favourably in well-being (Figure 1). Despite the end of the global commodity super-cycle, the economy continues to perform well. The rebalancing of economic activity from commodity investment to other activities is well advanced, facilitated by monetary and fiscal policies, currency depreciation, and flexible labour and product markets.
However, Australia’s economy shares the global risk of a “low-growth trap”. Along with many OECD countries, productivity growth has slowed since its peak in the 1990s (Figure 2) but remains in line with its longer term average. Despite encouraging recent productivity growth, population aging (the number of Australians over 65 years of age will more than double by 2055) means the country’s growth prospects depend crucially on strong productivity growth which, in turn, requires greater capacity for absorbing and generating new innovations. This is the subject of this Survey’s in-depth examination of innovation and related policies and the focus of a recent government initiative (the National Innovation and Science Agenda; Australian Government, 2015a).
Furthermore, inclusiveness has been eroded. The Gini coefficient has been drifting up and households in upper income brackets have benefited disproportionally from Australia’s long period of economic growth. Real incomes for the top quintile of households grew by more than 40% between 2004 and 2014 while those for the lowest quintile only grew by about 25% (Figure 3). Strong growth has pulled the incomes of households with wage earners further ahead of households reliant on transfers or pensions, which dominate the lower end of the income distribution. Furthermore, recent economic development has been strongly skill biased – partly because scale effects have amplified returns to some already high-paid segments of the labour market – widening the wage distribution. This partly explains the increasing share of income going to the very top end of the income distribution. In addition, large socioeconomic gaps between Australia’s indigenous population (Box 1) and the rest of the population remain and there is room to reduce gender imbalance (Figures 3 and 4).
Indigenous Australians account for around 3% of the total population, but around 45% of the population in rural and remote areas. Addressing indigenous disadvantage is a priority across all levels of government in Australia, with targets agreed and set by the Council of Australian Governments to improve outcomes. The policy function at the Federal level sits within the Prime Minister’s department and the Prime Minister delivers an annual update to Parliament on the extent of progress made, in the Closing the Gap report. Progress is generally reported based on the extent to which the difference in outcomes for indigenous compared to non-indigenous Australians has been reduced.
The 2016 Closing the Gap report indicated:
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targets on track: halving the gap in child mortality by 2018; and halving the gap in Year 12 attainment by 2020
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targets not on track: closing the gap on life expectancy; halving the gap in employment by 2018; closing the gap between indigenous and non-indigenous school attendance; and halving the gap for indigenous children in reading, writing and numeracy (although four of the eight measures are on track)
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it is too early to gauge whether the target will be met for 95% of all indigenous four year olds to be enrolled in early childhood education by 2025.
The Productivity Commission's annual report on indigenous disadvantage (Productivity Commission, 2016) also highlights that progress towards better socio-economic outcomes remains mixed. The report also draws attention to the lack of rigorously evaluated programmes in the area of indigenous policy.
Against this background the main messages of this Survey are:
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Strong macroeconomic and financial-sector institutions and policies have supported strong economic growth and high living standards.
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Merely maintaining long-run average productivity growth jeopardises this success; a renewed emphasis on structural reforms in particular those that help boost Australia’s capacity to absorb and generate innovation is required.
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Widening income inequalities and longstanding issues of inclusion (notably Australia’s indigenous population) call for an ongoing emphasis on policies to ensure equitable opportunities for engaging in the labour market through skills acquisition and active labour market policies, especially policies that address these concerns while also enhancing productivity.
Macroeconomic developments and near-term prospects: post-boom adjustment continues
Australia’s output growth remained resilient during the global financial crisis thanks to a prompt macroeconomic policy response, high commodity prices and a resilient financial system (Figure 5). The significant economic adjustment to the commodity super cycle, which has dominated cyclical development over the past decade or so, has proceeded relatively smoothly (Figure 5). There have been large falls in resource-sector investment, from 9% of GDP towards 4.5%, and falls in resource-sector employment, partly because several large multi-year construction projects have reached, or are close to, completion. In addition, declines in global commodity prices from their peak in 2011, notably for iron ore and coal, have curtailed plans for new investment and prompted cost-cutting by producers, although commodity prices have increased in recent times. As in many other developed economies, Australia now faces the risk of low growth and lacklustre private-sector investment due to pessimistic expectations and weakening global trade.
Markets have been redeploying resources and reducing macroeconomic tensions reasonably effectively so far, helped by flexibility-oriented policy settings for labour and capital, and by supportive macroeconomic policy. Exchange-rate depreciation has proven a key channel, spurring non-resource-sector exports, such as inbound tourism (Figure 6). The reallocation of labour resources is echoed in state-level employment trends, with strong employment growth in New South Wales and Victoria countering low growth in the resource-rich states of Queensland and Western Australia. Net international migration has proved a shock absorber in Australia, as the influx of labour during the commodity boom has been reversing (Figure 6).
Consumer-price inflation and wage growth remain subdued. Consumer-price inflation has been below the Reserve Bank of Australia’s (RBA’s) medium-term target range of 2-3% for several quarters. Also, inflation expectations and nominal-wage growth have trended down (Figure 7). Wage growth has been at record lows partly because of ongoing slack in the labour market, including in part-time employment where many employees wish to work longer hours. In addition, the share of part-time employment continues to rise.
Subdued nominal GDP growth has been weighing on revenues, making it harder to reach the government’s fiscal goals (see below). Australia has a sizeable current account deficit though this is expected to narrow in the coming years. Economic risk from the persistent current account deficit is not considered large because a large proportion of foreign-held debt is either denominated in Australian dollars or is hedged against exchange-rate fluctuations (Figure 8). Australia’s total debt burden has been steadily increasing, however it remains middle ranking in international comparison (Figure 9). Also, the Australian government only issues in Australian dollars. Household debt, while relatively high, is concentrated in high income households, and matched with rising asset values and low interest rates. Debt servicing to income ratios remain low (see discussion on macroprudential measures below).
Looking forward, OECD projections anticipate a slow pick-up in activity in the medium-term. The OECD Economic Outlook of autumn 2016 projected output growth for 2016 and 2017 of a little over 2½ %, rising to 3% for 2018 (Table 1). Since the projection was finalised, data releases showed that the economy shrank by 0.5% in Q3 of 2016. However, this outcome is expected to mean annual growth will only be slightly slower than in the projection given the largely temporary factors, including unseasonal factors behind the Q3 result. Sectoral shifts in investment will continue. The projections incorporate further shrinkage in mining investment, though at a slower pace, and a continued rise in non-commodity investment. Record low interest rates, currency depreciation and favourable business conditions on other fronts will support the investment. New liquefied-natural-gas (LNG) production following the completion of new facilities will continue to boost exports. Employment growth in non-mining activities will bring further declines in the rate of unemployment and support aggregate household income, and boost consumption. The pick-up in activity is not expected to generate significant inflationary pressure due to remaining economic slack.
There are several risks to this central scenario with implications for potential output and productivity:
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Trade-related uncertainties are a key element in Australia’s risk profile. Developments in global demand and prices for iron ore and coal will be critical, particularly demand for these commodities in China (Figure 10). Aggregate demand in China is also of growing importance for Australia’s trade in services, notably in tourism as China’s middle class grows.
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Non-commodity investment growth may not pick up as expected. Capital-expenditure and non-residential building-approval data have yet to show a clear positive trend (Figure 11). However, business-credit growth has been picking up, potentially signalling stronger investment ahead (see discussion below).
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Shifts in US monetary policy, uncertainties about Brexit, rising protectionism and revisions to China’s exchange rate policy, may catalyse global exchange-rate volatility that could affect Australia’s trade.
Indicators suggest there is some risk of downturn (Box 2), with several potentially destabilising events possible (Table 2). Threats to stability from overheating in terms of output or inflation has lessened in recent years (Figure 12, Panel A). However, macro-financial indicators underline the threat from the housing market, with house prices and related indicators (house indebtedness, bank size, Figure 12, Panel B) pointing to continued vulnerability. Any impact will most likely be through aggregate demand than financial instability. Although there are a number of factors likely to mitigate the systemic impact of these vulnerabilities, including large aggregate mortgage prepayment buffers and recently tightened macro-prudential measures, a fall in house prices and or demand could have significant macroeconomic implications. Specifically, the market may not ease gently but develop into a rout on prices and demand with significant macroeconomic implications. Externally, Australia, as always, is exposed to the vagaries of global commodity markets and this might include a renewed plunge in prices (or, positively, a strong resurgence). Australia’s iron ore production is among the lowest cost in the world and therefore comparatively insulated from such developments, however its coal sector is relatively more exposed as its production is distributed across the cost curve. Interaction of downside scenarios is likely to exacerbate the negative macroeconomic outcomes. For instance, a negative external shock could lift unemployment sharply which would result in significant fall in consumption and rising mortgage stress and falling house prices.
The OECD’s database of vulnerability indicators (Hermansen and Röhn 2015; Röhn et al., 2015) can be used to assess the risk of downturn. The database comprises over 70 indicators across six categories of vulnerability (five domestic, one international). Echoing a number of recent Surveys (e.g. 2016 Economic Survey of the United States), statistical methods can be used to develop leading indicators of past downturns and recessions.
Four downturns (not all are recessions as they do not fulfil the usual definition of at least two consecutive quarters of falling output) were identified for Australia in the period spanned by the resilience data (which begin in the mid-1970s). Principal components analysis was used to develop a single-number leading indicator. The most powerful elements proved to be those in the category of “spillovers, contagion and global risks”, such as global asset market prices and global credit growth. This fits in with Australia’s strong linkage to global markets. The leading indicator was then used to estimate the downturn probability at different time horizons (Figure 13).
As similar exercises for other countries have found, the indicator developed from the resilience database is not very accurate. It predicts two of Australia’s four previous downturn events quite well (in Figure 13, the indicators are performing well if they peak around the beginning of a downturn). However it does not predict the second downturn and flags problems in the run up to the global financial crisis but is inaccurate on the timing.
Bearing in mind the limited accuracy, the emergence of peaks in the most recent data suggests there is a non-negligible risk of downturn.
The economy is well positioned to handle shocks such as those described in Table 2. The speed and strength of the rebalancing processes in response to the end of the commodity boom auger well for the economy’s shock-absorbing capacity. In addition, Australia has more reserve capacity for monetary and fiscal stimulus than many other OECD economies (see discussion below).
Monetary and financial-market policy: coping with low interest rates
As in many other economies, monetary policy has been the principal tool for supporting aggregate demand in recent years. This partly reflects that fiscal policy has focused on curbing deficits following the large fiscal expansion during the global financial crisis and consequent rise in public debt (Figure 14). Monetary stimulus has been consistent with the RBA’s medium-term inflation target band of 2% to 3% (Figure 7), as inflation has been low, and interest rates are higher in Australia than in the United States or the euro area (Figure 14).
Unless downside risks materialise, the current supportive stance of monetary policy remains appropriate at present, particularly in the absence of inflationary pressures. However, a side effect is a risk that accommodative policy may be increasingly distorting financial markets and, especially, house prices (which have risen to very high levels). Eventually, rates will need to be normalised, but the timing and pace will depend on developments in growth, employment, inflation, and the housing market.
Macro-prudential measures are helping contain housing-loan growth
House prices and household debt have reached unprecedented highs (Figure 15), in part because policy-rate cuts have lowered debt servicing costs (most housing loans are set at variable interest rates). In real terms, house prices have increased by 250% since the mid-1990s. Furthermore, the ratio of house prices to incomes has undergone further increase in recent years, straining affordability, especially for first-time buyers in Sydney. Foreign demand for housing, while a contributing factor, does not appear to have had a substantial impact on price growth. There are signs that the housing market is cooling. Recent data indicate price growth has eased in most urban centres, reflecting in part a substantial supply response – dwelling approvals and investments have increased substantially in recent years (Figure 15). However, the significant increase in Australia’s house prices and price to income ratios remains. A continued rise of the market, fuelled by both investor and owner-occupier demand, may end in a significant downward correction that spreads to the rest of the economy.
As recommended in the previous Survey (OECD, 2014a), the authorities have deployed “macro-prudential” measures to cool mortgage lending and reduce risks (Box 3). Measures include pressure on banks to limit growth of mortgage lending to those purchasing for investment purposes (see Table 3 and Annex, below). These augment institution-by-institution scrutiny of mortgage lending (“micro-prudential” policy), which in the Australian context is an effective approach because the four major banks account for a large share of mortgage lending (around 80% in the first quarter of 2016 according to data published by the banking regulator, APRA). Demand-side measures, such as macro-prudential tools, should continue to play a role with careful attention to distributional consequences for households. As recommended in past Surveys (Table 3), supply-side measures, including planning-regulation reform, can also help ease market pressure over the longer term.
In response to concerns about the level of risk being taken on by banks and households, the Australian Prudential Regulation Authority (APRA) announced measures in December 2014 to reinforce sound housing lending practices (APRA, 2014). These measures focus on:
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the extent of higher-risk mortgage lending – for example, high loan-to-income loans, high loan-to-valuation (LVR) loans, interest-only loans to owner occupiers, and loans with very long terms
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the pace of growth in investor housing lending – in particular portfolio growth materially above a threshold of 10 %
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interest rate buffers and floors used in loan serviceability assessments – in APRA’s view, these should incorporate an interest rate buffer of at least 2 % above the loan product rate, and a floor lending rate of at least 7 %, when assessing borrowers’ ability to service their loans.
These measures, coupled with increased mortgage risk weights for Internal Rating Based (IRB) banks (i.e used by major banks), have seen investor credit growth slow and an improvement in the quality of credit being extended in the mortgage market (Figure 16).
Resilience and competition issues in banking
The global financial crisis did not lead to systemic bank failures in Australia but, as elsewhere, prompted tighter regulation and alteration in banking practices. Banks have shifted their funding composition away from short-term debt and towards deposits (Figure 17). Furthermore, a recent report by the banking regulator (APRA, 2016) indicates that capital ratios have reached the thresholds recommended by the Financial System Inquiry (“Murray Inquiry”) (Australian Government, 2014). However, APRA’s report notes that banks must continue increasing their capital ratios to at least maintain, if not improve, their relative positioning. The Murray Inquiry underscored that strengthening bank resilience should also include new measures to limit the costs to the public in the event of bank failure. Specifically, it recommended the establishment of a loss absorbing and recapitalisation framework in line with international developments to allow effective resolution with limited risk to taxpayer funds. This approach has been endorsed by the government and APRA is developing detailed implementation.
The Murray Inquiry’s call for stronger resilience also reflects concerns that four major banks have substantial market share in many financial services (especially retail services), an issue that has been raised in previous Surveys. Bolstering resilience can reduce the banks’ implicit guarantees, which put them in an advantageous position in providing financial services. Concern about the strength of banking regulation has prompted efforts to identify and eliminate advantages for banks in regulatory technicalities. On this front, there has been welcome progress with the reduction in major banks’ advantages over other lenders that use the standardised model of risk assessment in the mortgage market arising from differences in mortgage risk weights (see Table 3).
Fiscal consolidation, tax and spending reform
Compared with other OECD countries, Australia’s tax burden, public spending and public debt are low (Figure 18). Following the global financial crisis, the authorities provided timely fiscal support that helped Australia avoid a recession (one of the few OECD countries to do so). Since then the fiscal deficit has been unwinding, though somewhat slowly (Table 4 and Figure 19). The federal deficit in financial year 2015-16 was 2.4% of GDP, which is below its peak of 4.2% but not low enough to bring a fall in the debt-GDP ratio.
Australian fiscal policy is guided by a broad rule of achieving a balanced budget (or surpluses) in the federal budget “over the cycle”. State governments do not substantially affect the overall fiscal stance because their balances are comparatively small. The current government has adopted an operational goal of reaching a federal budget surplus of 1% of GDP “as soon as possible” (Australian Government, 2016a), which is more than sufficient to put the debt-GDP ratio on a downward track. Simulations suggest that a budget surplus of 1% after 2021-22 would bring the ratio to 25% of GDP by 2025-26 and close to zero by 2040 (Figure 20). Australia’s balanced-budget/surplus guidance reflects a longstanding preference for achieving low debt burdens.
Slow progress in reducing the federal deficit reflects the tendency for federal budget outcomes to fall short of targets. This is despite active measures and consolidation due to bracket creep. Personal income tax thresholds are not automatically indexed in Australia; which provides leeway for discretionary adjustment of the tax schedule as part of structural reforms. Discretion on threshold updating may also serve, at times questionably, to help resolve budget imbalances. The weak pace of consolidation in large part reflects disappointing nominal GDP growth. Also, some policy initiatives have involved sizeable multi-year spending commitments, including a lift in the base-rate of the pension and increased commitments on hospitals and schools funding. Such commitments have meant spending as a share of GDP has remained above pre-crisis levels (Figure 21). Over the next few years, spending commitments will be boosted by the ongoing implementation of a reform of support systems for the disabled (the National Disability Insurance Scheme, NDIS, see below) and higher defence spending.
Australia’s fiscal position is strong and the current fiscal stance is appropriate given the outlook. According to a recent cross-country study (Fall and Fournier, 2015), debt could begin reducing output growth between 70-90% of GDP. This implies Australia, with gross debt at 44%, still has a significant margin to absorb shocks and actively stimulate growth. Indeed, the government could run a substantially larger deficit for some time without coming close to the limits suggested above (Figure 20). In this context, should the downside risks materialise, the authorities should actively use fiscal policy to support the economy, as they did in 2008-09. The more financial and global the shock, and the closer monetary policy is to the zero-lower bound, the stronger the case for using fiscal policy, particularly if the exchange-rate does not respond. Though fiscal stimulus would delay the return to a balanced budget and raise public debt, it would be unlikely to jeopardise fiscal sustainability or generate financial market turmoil. Moreover, it would take some pressure off expansionary monetary policy and thereby reduce the risk of financial market distortions. Automatic stabilisers should be allowed to operate. Additional stimulus, if required, should look as far as possible to investments that can be quickly dispersed and also lift aggregate supply and growth potential.
The ramping up of spending commitments during the commodity boom suggests that medium-term fiscal discipline could benefit from a spending ceiling or a longer-term debt anchor (as suggested in recent IMF analysis). This could help guide the use of fiscal space and provide a guard against Australia’s longstanding vulnerability to excessive fiscal expansion during commodity booms. An alternative, or additional, approach would be to institute federal- and state-level stabilisation funds (or make greater use of existing funds, such as the Future Fund), as recommended in previous Surveys (see Table 5, below), and following the approach of some other commodity producers (such as Alberta (Canada), Chile, and Norway).
Improving the tax system
Taxation has been receiving welcome policy attention. The tax mix remains tilted towards direct taxes, especially on corporates, that can hurt growth. Measures addressing this issue form part of the tax reforms that are a central theme of the current government’s economic policy. Detailed measures were outlined in the 2016-17 Budget proposals (Table 6), the elements of most structural significance are:
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Corporate income tax rate cuts (as part of the “Ten Year Enterprise Tax Plan”), initially for small businesses with eventual extension to all businesses. Australia’s standard rate of corporate tax is 30%, which is high in international comparison. Proposals also include an increased tax discount for unincorporated small business.
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Further measures to combat corporate tax avoidance, including the establishment of a tax avoidance taskforce.
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A superannuation reform package, comprising reduced tax concessions for high-income earners and more generous tax treatment for low income earners.
However, the tax system could be improved in some respects:
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There has been no progress on a major tax reform that makes greater use of value added tax (the Goods and Services Tax, GST) and little progress in land-tax reform, both moves long recommended in OECD Surveys and discussed widely in Australia (Figure 22). As GST revenues are currently passed to the states, such reform would require some reshaping of federal-state financial arrangements. To the extent the Australian GST is less progressive compared to the personal-income taxes, reform would also need to address poverty and income distribution issues, perhaps by adjusting welfare policies.
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State level taxation still involves a number of inefficiencies and distortions, particularly heavy use of transactions taxes in real estate (greater use of recurrent taxes on residential property would be preferable), substantial exemptions in payroll taxes and a multitude of small-scale charges and fees. Replacing these inefficient taxes with a higher GST and greater use of land tax, for example, would improve economic performance. In Australian Capital Territory a substantial shift away from inefficient taxes towards land tax is underway but progress in other jurisdictions is limited (see Table 5 and Annex).
Efficiency enhancing reforms in public expenditure
Continued efforts to innovate economies and to find efficiency gains in public spending could strengthen public finances, raise the quality of public services and increase the effectiveness of welfare and transfer payments. Government spending should, in addition, be redirected towards additional public investments with substantial long-term returns, particularly economic infrastructure that is partnered with the private-sector (Figure 23). To ensure long-term returns, cost-benefit analysis should play a prominent role in project selection.
As detailed in Chapter 1 of this Survey, alterations to the public procurement system are planned that widen the field of prospective bidders to bring more innovative solutions to public service provision. Additional steps could, for instance, include further shifts to outcome rather than output criteria, thus providing greater leeway on how services are delivered. Further development of digital government services could also help. In addition, making public data more widely available for commercial and research use could support more general research and development.
Support for small and medium enterprises (SMEs) should also be scrutinised (Chapter 1). Australia has around 340 innovation-related schemes, most aimed at SMEs. Strong review and reform mechanisms are important, as is making firms aware of the available support. Size-based policies, by definition, involve cut-off points that can dissuade firms from transitioning to larger scales of operation. With the current government adding more size-based support (in tax as well as subsidies), the risk of distortions and inefficiencies may become substantial. In addition, Australia has a track record of prolonged subsidies for “sunset” industries or for new production facilities in economically deprived areas. The termination of subsidies on car production plants in Australia removed one of the most prominent and longstanding examples. However, the authorities continue to resort to industry subsidy.
Encouraging business productivity and innovation through framework conditions
Progress in structural reform in recent decades has significantly improved policy settings for the business environment on many fronts. However, as other countries have been improving their settings, Australia’s advantage has been eroded (Figure 24). This Survey’s in-depth chapters highlight the importance of more intensive generation and adoption of innovation for future productivity growth, issues which are also prominent in the government’s National Innovation and Science Agenda (NISA, see Box 4). The Agenda endeavours to make a number of incremental changes which, together, can make a significant change.
The National Innovation and Science Agenda (NISA) was announced on the 7th of December, 2015. The Agenda is built on four pillars:
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Culture and capital: focuses on rewarding entrepreneurialism and supporting innovative start-ups by improving the availability of finance. Initiatives include tax treatments to encourage small businesses to take risks and innovate. Working in partnership with the private sector, the government has established the CSIRO Innovation Fund and the Biomedical Translation Fund to back high potential ideas.
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Collaboration: seeks to incentivise greater collaboration through changes to university funding formulas, providing investment in research infrastructure and an introduction of a national impact and engagement assessment framework.
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Talent and skills: aims to support young Australians to create and use digital technologies, expanding opportunities for women in the field of Science, Technology, Engineering and Mathematics and encouraging more entrepreneurial and research talent from overseas.
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Government as an exemplar: commits the public sector to lead by example in becoming more innovative in how services are delivered and how public data should be shared. Also part of this, the government has established Innovation and Science Australia as an independent advisory board responsible for researching planning and advising the Government on all science, research, and innovation matters.
The authorities have implemented, or are on track to implement, all measures in the first wave of NISA. Also, the second and third waves of NISA have been outlined, which will focus on new ways of attracting private sector investment and infrastructure for science and simplify the way businesses interact with government by removing unnecessary regulatory measures.
More information can be found at http://innovation.gov.au.
Improving framework conditions to boost innovative capacity
Rapid and widespread assimilation of advances in the global frontiers of know-how and technologies are key to sustaining high productivity. This process can be substantially bolstered by efficient resource allocation and competitive markets as this boosts the number of businesses operating at, or close to, these frontiers. Chapter 1 underscores the importance of the following:
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Continued follow up on the Competition Policy Review (the “Harper Review”, Australian Government, 2015b).
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Reducing barriers to labour mobility. Large distances between major urban centres make labour mobility more costly and aggravate skill mismatch. Further reduction in labour-market frictions generated by interstate differences in education and vocational qualifications would help, as would measures that assist household mobility. Reduced skill mismatch can also improve job opportunities and reducing unemployment; a “win-win” measure in inclusiveness and productivity.
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Encouraging a positive process of “creative destruction” through firm entry and exit, as this keeps more businesses closer to knowledge frontiers. Past reforms have reduced the regulatory burdens for establishing a business. Regarding firm exit, proposals to lighten insolvency regulation as part of the NISA reform are encouraging. Barriers to firm growth may also be an issue; SME support policies can inadvertently create disincentives to growth beyond a certain size, for instance.
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Working towards intellectual property (IP) arrangements that provide incentives to innovate and allow access to knowledge and technology. As Australia both creates intellectual property and is a net importer of innovation, interest lies in balanced protection of intellectual property policy. Meanwhile attention should be paid to the efficiency of domestic IP arrangements (a special regime for SMEs has not proven very effective, for instance).
Expanding access to low-cost, high-speed information and communication technology (ICT)
Widespread access to low cost, high-quality mobile telephony and broadband internet is important for the development and diffusion of many of today’s innovations and for narrowing the digital divides within society. As in many other countries, a multiple-operator system has been operating for some time, but nevertheless requires continued attention by regulators to keep up to speed with technological and market developments. Australia faces particular challenges in extending provision to rural and remote areas. While expensive, ensuring good ICT access in these areas, potentially brings wide benefits including improvements in public health, social engagement and education. In fixed-line technology, the wholesaler (National Broadband Network) needs to address concerns that it is not lowering its prices sufficiently quickly as the market develops. In mobile telephony, stronger encouragement of new entrants to retail markets, for instance via policy on the sale of mobile spectrum, would be welcome. Australia currently has only three mobile telephony operators and there is a growing view among international experts that the presence of a fourth operator raises competition significantly (OECD, 2014b). Allowing mobile operators access to the towers being installed for broadband in rural areas would be one practical step to improve choice and make the mobile market more attractive for new entrants.
The regulatory response to disruptors has so far been broadly positive
Echoing global developments, Australia is experiencing a surge in “disruptive” innovations, particularly business-model innovations based on internet platforms. So far the authorities’ response has been broadly positive, endeavouring to reshape regulation to accommodate new players while ensuring neutrality of treatment. State-level governments are establishing “cohabitation” arrangements between ride-sharing and taxi services. However, ideally the regulation ought eventually to converge to a common framework both ride-sharing and taxi services. Local governments’ regulatory response to new accommodation services via companies such as Airbnb has varied widely. As experience deepens with issues such as anti-social behaviour by short-term renters, efforts should be made to identify the most effective regulatory approaches and encourage convergence to them. More generally, barriers to disruption in general framework conditions should be addressed. In particular, competition policy should counter undesirable defence strategies by incumbents. Where tax issues arise from disruption, fair treatment should be sought for incoming enterprises firm and incumbents. The considerations are not always straightforward, as illustrated in the different tax position of those renting out short-term accommodation and hoteliers.
Encouraging productivity and innovation through R&D policy
Strengthening collaboration between business and the research sector
Collaborative research is an important channel for the commercialisation of publicly funded research and knowledge transfer, helping to ensure public returns to support for domestic research. Australia performs poorly on this front (Figure 25). This reflects little priority to collaboration in performance metrics of academics; weak mobility between research and business sectors (including industry placement programmes); and issues in university management of IP. Australia could learn further from international examples of research hubs, such as the Waterloo “triangle” of education, research and innovation in Canada (OECD, 2016a).
Reforms underway, mainly as a part of NISA, attempt to address these issues. A new simplified funding system for university research began operating in early 2017, in which federal block grants for research are determined solely by income from two categories, competitive grants and other sources (including business); these two categories are now given equal weight. One consequence of the reform is that publications will no longer feature in the funding formula (Watt, 2015). The change is intended to increase universities’ incentives to collaborate. The reform also aims to make government competitive grants to universities more responsive to applicants’ needs. Notably, it moves the Australian Research Council Linkage Projects to a continuous application and assessment process, rather than one round per year, and introduces a fast-track decision-making process (Australian Government, 2015, 2016). Moreover, additional steps are envisaged towards making IP arrangements more effective. These include changes in the funding arrangements for universities from 2017, requiring universities to list their patents generated by publicly funded research on a central information platform (Source IP) and to use simplified contracting arrangements, if requested by collaborative partners.
Regular assessment of funding programmes can help ensure that increased collaboration on research does not come at the expense of quality. The government should also proceed with the development of the new “impact assessment” framework, which facilitates assessment of university research performance in terms of non-academic impact and “engagement” with end-users of research. This will complement the national evaluation framework for the quality of university research. Overall, these reforms go in the right direction in helping create a more collaborative culture between researchers and business and help Australia better translate research knowledge into commercial outcomes. However, there is still scope for improvement, in particular:
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Estimates suggest that only 13% of the firms registered under the R&D Tax Incentive (discussed below) are involved in business-focussed collaboration programmes funded by the government (Watt, 2015). Take-up could be increased by implementing simple and flexible governance arrangements, which would reduce unnecessary delays in the negotiation and formalisation of agreements for collaborative research. Greater stability in the menu of programmes and closer monitoring of outcomes would also support higher take-up.
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More effective management of IP created by the universities through the further development and wider use of simplified IP contracts is critical for knowledge exchange and collaboration on the exploitation of IP.
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The mobility between research and business sectors is low (Figure 25). There is room to increase the scope and scale of industry placement programmes for higher degree research students through the introduction of a nationally consistent approach, as recommended by a recent review by the Australian Council of Learned Academies (McGagh, 2016). Plans to revise appointments and promotions in universities, in particular so that individuals who spent time in business are not disadvantaged in the selection processes go in the right direction.
Achieving greater commercial impact from research in public research institutions
The leading public-sector research agency, the Commonwealth Scientific and Industrial Research Organisation (CSIRO), performs well in many respects, but lags behind in terms of commercial impact according to some measures (Figure 26). CSIRO has moved to a more comprehensive and consistent impact evaluation approach in recent years, which is welcome. However, impact evaluations conducted so far have been retrospective. Progress is also required for future impact planning. This is particularly important in view of the larger focus given, compared to the past, on the commercial outcomes under CSIRO’s new long-term strategy (CSIRO 2015; The Senate, 2015). It is important that planning and evaluation processes assess the wider impact of commercialisation, including the effect on research excellence and the societal impact.
A new fund (the CSIRO Innovation Fund), announced as part of NISA, was launched at end-2016 by the government to support co-investment in new spin-off and start-up companies created by CSIRO and other research institutions and universities (Australian Government, 2015a). This is a positive initiative in view of the critical role of capital for start-ups. It should also foster greater research-industry collaboration. Investments to be made by the CSIRO Innovation Fund however need to favour projects with large commercialisation and productivity-enhancing potential. The government is also transitioning to a common approach for assessing the outcomes and impacts of funded research. This should increase the effectiveness and efficiency of the public-sector research agencies.
Fine-tuning the R&D Tax Incentive
Analysis of the R&D Tax Incentive (Incentive) in Chapter 2 of this Survey uncovers the challenges in achieving good returns to this form of support. Australia relies heavily on tax incentives, as distinct from grants (Figure 27). Since the introduction of the Incentive in 2011 (which replaced another scheme), participation has increased rapidly, with fiscal costs exceeding forecasts (Australian Government, 2016c). Business R&D intensity data have not so far echoed this development, possibly because of other influences, especially the end of the mining boom. This trend has to be watched, however. The government has initiated a welcome review of the Incentive, with a first assessment (Ferris et al., 2016) circulated for public consultation. This review sensibly proposes fine-tuning the system rather than wholesale change. Areas for improvement include:
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Evidence suggests that only around 10-20% of the total R&D registered under the Incentive is additional (Australian Government, 2016c). Ferris et al. (2016) conclude that the Incentive “falls short of its stated objectives of additionality and spillovers”. Measuring and strengthening additionality is difficult and can increase complexity, and compliance and administrative costs. One reform option, suggested by Ferris et al., is the introduction of an intensity threshold (i.e. a minimum amount of R&D expenditure as a proportion of business expenses for eligibility to the Incentive) for recipients of the non-refundable component of the Incentive (larger firms), complemented by an increase in the existing expenditure threshold. Comprehensive analyses are required to assess additionality, as well as the trade-off between increasing additionality and complexity (Appelt et al., 2016).
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The efficiency and effectiveness of the Incentive hinge on careful monitoring of integrity risks and the introduction, if necessary, of tighter, well-targeted compliance measures.
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The Incentive’s eligibility criteria are principle-based rather than highly specific. This approach can adapt to changes in the nature of R&D activity, but can also be open to misinterpretation, highlighting the need for clear and consistent interpretation of the eligibility criteria by the authorities. The recent review of the Incentive recommends the development of new guidance (including plain-language summaries and case studies) to increase clarity about the scope of eligible activities and expenses (Ferris et al., 2016).
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The upward risks to the Incentive’s costs could be further managed by strengthening provisions for the existing expenditure threshold, so that it also applies to “connected entities”, and/or by introducing additional caps (BDO, 2016). For instance, a cap on the refundable tax credit could be considered, while assessing carefully its potential trade-off with additionality.
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Compliance costs could be reduced by adopting a single application process for accessing the R&D tax credit. Currently, companies first register the R&D activities and then make the claim for tax return.
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Industry-research collaboration could be encouraged more, perhaps through an R&D tax premium or by adding criteria relating to collaboration in the current programme.
Improving the governance framework for innovation policy
Australia’s science, research and innovation system is complex, with the involvement of several federal government departments and numerous councils, committees and boards. State governments are also involved in policy development and programme design. Federal government investment in research and innovation is spread across 15 portfolios, with their own research and innovation programmes and multiple agencies delivering such programmes (Cutler, 2008). In a welcome step, a new independent board, Innovation and Science Australia (ISA), was established in 2016 to provide “strategic, whole-of-government advice on all science, research and innovation matters” (Australian Government, 2015a). ISA could also promote collaboration, as it will be working directly with the industry and community sectors. Its achievements in delivering such outcomes should be closely monitored and evaluated; greater coordination should not come at the expense of the diversity of innovation activities, which would constrain the responsiveness of the innovation system to evolving needs. Some consolidation of the numerous (around 150) small research funding programmes and agreements would also help focus innovation policy.
Strengthening the monitoring and evaluation of innovation programmes
High quality evaluation and performance measurement of innovation programmes is important for efficient and effective policy, facilitating adjustment in the menu of measures towards better outcomes. Good practice principles underscore that evaluations should be based on independent and transparent assessment; their findings are made public; and that they are accompanied by effective mechanisms for policy learning to ensure that the findings of evaluation are guiding future decision-making (OECD, 2015). The system should incorporate both ex-post and ex-ante evaluations (Appelt et al., 2016; OECD, 2014c).
There have been some welcome initiatives, including the Evaluation Strategy for 2015-19 of the Department of Industry, Innovation and Science, which provides a framework to guide evaluation and performance measurement (Australian Government, 2015c). The strategy incorporates evaluation across a programme’s lifecycle and envisages both prospective and retrospective evaluations. A core goal of the framework is to improve the data available to assess the impacts and outcomes of all programmes.
Addressing inequality, enhancing inclusiveness and deepening skills
Innovation policy can play an important role in tackling social issues
Innovation policy in Australia already incorporates considerations of the “wider good” by backing research with potential for significant social return, such as research in many areas of health care and innovations in education. Additional measures could be taken, for instance re-evaluation of innovation support programmes and greater recognition of low-tech or low-cost innovation that bolsters inclusivity. Incorporating innovation-based schemes in the support system for Australia’s indigenous communities may yield particularly significant returns, given the very wide socioeconomic gaps with the rest of the population. In addition, ensuring that policy measures regarding broadband and mobile services improve services in areas with indigenous communities in particular would lessen disadvantage arising from digital divides. This would also open more avenues for ICT-based support, for instance in online education and training.
Some progress in welfare policy is being made
As emphasised in previous Surveys, the overall architecture of Australia’s welfare system is sound. The fiscal demands of the welfare system are comparatively light, which helps keep tax wedges on labour low, supporting employment and competitiveness. The strong emphasis on encouraging transition from welfare to work incentives and activation schemes (run through the Australian Government funded network of private employment service providers) helps limit the number of non-working households dependent on transfers (OECD, 2014a). A renewed emphasis on programmes of support for indigenous job seekers should be a focus to address the gap in employment participation by indigenous and non-indigenous Australians.
Progress is being made on a number of fronts in welfare policy (Table 8). A plan for significant increase in paid parental leave was re-evaluated. Also, as recommended in the previous Survey, the government has prioritised child care by announcing a new child care package. In addition, a new programme will offer unemployed youth intensive pre-employment training and short internships (4 to 12 weeks), providing wage subsidies for employers. Moreover, the government will cease the carbon tax compensation for the new recipients of welfare benefits, given the abolition of this tax in 2014, and direct the freed-up resources to the National Disability Insurance Scheme (NDIS). Consideration should be given to also end the compensation for existing welfare recipients. The government will further review over the next 3 years around 90 000 (out of a total more than 800 000) Disability Support Pension (DSP) recipients to assess their capacity to work, with a third of the reviews to include a medical assessment (Australian Government, 2016a). The focus on beneficiaries with a high risk of ineligibility for DSP payments is welcome.
In addition, a new “investment approach” to long-term welfare dependency has begun, illustrating an openness to innovative solutions by the government. Welfare data have been used to identify three groups at risk: young parents, young carers, and young students. Targeted measures will be used to support these groups to transition to employment. Actuarial evaluations will be used to evaluate the effectiveness of interventions and to determine whether an intervention should be scaled up, continued or concluded.
As welfare spending represents a significant share of outlays, particularly at the federal level, it is frequently a target for budgetary measures. While efforts to seek efficiency gains are welcome, the authorities should avoid measures, such as freezes on indexing welfare payouts, so as not to compromise inclusiveness.
General improvement in Australia’s education system continues
Education indicators point to an above-average, though not top-ranking, performance. Australian 15 year-olds perform comparatively well in the OECD’s PISA tests of reading, mathematics and scientific proficiency and the share of students lacking basic skills is well below that in many other advanced countries (Figure 28). However, performance in PISA tests has declined and differences by socioeconomic background are large (Figure 28). The 2016-17 budget devotes additional funding (of around AUD 1.2 billion between 2018 and 2020) to schools, which is needs-based and contingent on reform to improve student outcomes, including through improving literacy and numeracy, and teaching quality (Australian Government, 2016a). Additional needs-based funding is provided for students with a disability. Early childhood education and training is being boosted through the implementation of in the Jobs for Families initiative, which, for instance, is piloting schemes for families where accessing mainstream childcare is not practicable.
In higher education, subsidised student loans (repayment of the loans is income contingent) have been available (since 2009) for courses providing vocational educational and training qualifications; the loans were previously only available for bachelor-level degrees (OECD, 2014a). In principle, this measure has given a welcome boost to vocational education and training, which helps provide skills to innovative sectors. However, in recent years significant problems with the fee system (VET FEE-HELP) have emerged. In particular, inadequate checks on the quality of providers have prompted the emergence of operators selling poor quality courses to students.
Similar to other OECD countries, Australia’s education policy favours science, technology, engineering and maths (STEM) skills on the basis that these are key for productive and innovative sectors. NISA continues this approach with programmes to increase primary and secondary students’ interest in ICT, to promote STEM skills (for instance by expanding prizes for science) and to encourage women in science. However this approach downplays the importance of other subjects in providing skills in innovative and productive sectors, such as innovation-related arts disciplines. It also overplays the returns to taking STEM subjects, given the career prospects for tertiary-level graduates in some STEM some sub-categories are not strong. Improving the depth and timeliness of information on employment outcomes across different subjects and across providers would help fine-tune policy and student choices. Innovation-relevant skills and university-business linkages can be boosted through encouraging students to take “entrepreneurship” courses as part of their degrees.
Tackling environmental challenges: progress in greenhouse-gas emission policy
Australia’s carbon intensity of production is around one-third greater than the OECD average, and per capita emissions are 50% higher – though in other respects air quality is generally good (Figure 29). These high emissions relate more to the energy mix than to energy intensity, which is somewhat above the OECD average but improving. Renewables, currently mostly from hydroelectric generation, have picked up but still account for only a small share of energy production compared with the OECD average. Australia’s new greenhouse-gas (GHG) reduction target, in accordance with the Paris Agreement 2015, includes reducing GHG emissions by 26-28% below 2005 levels by 2030, which according to official estimates translates to an emission level of about 440 million tonnes of CO2-equivalent (CO2-eq) by 2030 (Australian Government, 2015d; Figure 30).
Greenhouse-gas reduction centres on the Direct Action Plan, which was initiated in 2014 following the repeal of the Emissions Trading Scheme, a carbon-credit and purchase system. Under the centrepiece Emissions Reduction Fund, emitters receive payment for emission reductions, rather than paying to emit. Using a reverse auction, the authorities select emission-reduction projects from a pool of proposals submitted by emitters (such as energy producers). The authorities then contract with emitters to buy the selected projects’ emission reductions on delivery. The three auctions conducted up to April 2016 have resulted in a commitment to purchase a total of 143 million tonnes CO2-eq with a value of AUD 1.7 billion, implying an average emission-reduction cost of AUD 11.9 per tonne. The government aims for a total commitment of AUD 2.6 billion, which, if the same average price results from the remaining auctions, will represent a commitment to purchase about 210 million tonnes CO2-eq.
The Emission Reduction Fund, in principle, can achieve the same emission-reduction outcomes as alternative economic mechanisms, such as a carbon tax or a cap-and-trade system. However, it entails fiscal expense rather than increased revenue. Also, as the Fund focuses on specific emission-reduction projects, rather than total emissions, it does not strongly guarantee achievement of Australia’s commitments. To tackle this, a “safeguard mechanism” has been operating since July 2016, as supported by the 2014 Survey (Table 9). The mechanism discourages large industrial facilities from exceeding a historical emission baseline, to counter the risk that emission reductions paid for under the Emission Reduction Fund are “undone” by emissions elsewhere. Should emitters exceed baseline emissions, they can purchase carbon credits from other facilities. The safeguard therefore has an element of a cap-and-trade system and in future it could play a more active role in emission reduction. This may prove an attractive option in the event that emission reductions beyond those brought about by the Direct Action Plan are needed to achieve Australia’s commitments. More generally the price of carbon emissions in Australia is low, with large shares of emissions in industry, electricity, agriculture and fisheries are not priced at all. This weakens the incentives to cut carbon in a cost-effective manner (OECD, 2016b).
Changes are underway to reduce grant-based support and increase equity and debt support for green innovation. These involve a new fund, the Clean Energy Innovation Fund, which will make loans or take equity stakes in companies engaged in commercialising emerging technologies. The authorities envisage that this fund will take over much of the role currently played by the Australian Renewable Energy Agency, which provides grants to companies. The Clean Energy Finance Corporation which provides loans for the installation of established clean-energy technologies will continue with its current role. The shift away from grants towards loan and equity support means more fiscal “return” to support but might mean there is less early stage support.
Road-based transport is dominant in Australia and so incorporating environmental considerations in regulation and taxation that relate to vehicle use is particularly important. Inflation indexing on retail-fuel excise has been re-introduced, a welcome move that will end erosion of the real value of fuel taxation and help boost the level of environmental taxation (Figure 29). Room for further improvement in fuel taxation remains. Currently, Australia charges the same excise per litre on diesel and gasoline, which is a superior approach to that of those countries where excise on diesel is less than that on gasoline. However, as argued in an OECD working paper (Harding, 2014), in light of diesel’s additional disadvantages, notably in terms of local air pollution, the optimal excise on diesel ought to be above that for petroleum. As underscored in the 2014 Survey, charges for car use rather than car ownership should be the central pillar of policy, and would provide further justification to reform the various state-level taxes relating to car ownership. In a welcome development, the authorities are pressing on with plans to reform road-user charges, beginning with heavy trucks.
Water resources (the subject of in-depth review in the 2008 Survey) are a key constraint for agriculture. Drought conditions have, in the past, threatened the supply of water to Sydney, which now has a wind-powered desalination plant as reserve supply (WaterNSW, 2016). Groundwater depletion and salinity are problems in the Murray-Darling basin, the principal river system, but since basin management techniques have been introduced groundwater levels have recovered in some areas since the 1990s (Smerdon et al., 2012).
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← 1. The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law.