Microeconomic-policy- Essay PDF

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Analyse the impact of Australia’s recent microeconomic reforms on economic growth, inflation, and the distribution of income. Introduction Australia has implemented several microeconomic reforms in both product and factor markets in recent decades. These reforms have included the removal of protective barriers for Australian industry, labour market reforms, and the implementation of the National Competition Policy. These reforms have been instrumental in ensuring continued economic growth and in controlling inflation by promoting structural changes in the economy which have improved productivity and efficiency. However, some of these policies may have had negative impacts on the distribution of income in Australia. Microeconomic reforms act to increase economic activity and reduce inflation over the longer term by increasing the economy’s level of aggregate supply. This can be seen in the below AD/AS diagram, where reforms have increased AS from S1 to S2. This has resulted in economic growth increasing GDP from Y1 to Y2, while reducing the price level from P1 to P2. Impact of reduction in protection on economic growth and inflation The gradual but sustained reduction in protective barriers for Australian industry has had a significant impact on the level of economic growth and the inflation. Protective barriers in the form of tariffs were first reduced in the 1970s in order to improve the productivity and allocative efficiency of Australian industries. This saw the effective rate of protection in the Australian industries fall from 60% in the 1960s, to only 15% by 1989 for the manufacturing industry and 25% for the agricultural industry by the 1980s. In the short term, this helped to reduce imported inflation by reducing the cost of imported goods. This can be shown in the below tariff diagram. By removing the tariff PWPT on the imported good, the price of the good falls from PT to the world price, PW. As a result, a fall in the price level across a wide range of imported goods will help to reduce imported inflation, and improve price stability in the Australian economy. In the long run, reducing tariffs will continue to improve Australia’s price stability. This is because domestic industries will be forced to become internationally competitive, resulting in increasing productivity and efficiency. As a result, the cost of producing goods or services domestically will fall, resulting in lower costpush inflation. Thus reducing protection reduces inflation in both the short and long run. However, in the short term, reductions in protection will worsen economic growth. This is because the removal of protection means that industries unable to compete with international competitors will downsize or shutdown. This reduces Australia’s economic activity as production shrinks, as shown in the below AD/AS diagram, where aggregate supply falls from S2 to S1, resulting in economic activity falling as GDP contracts from Y2 to Y1. In addition, increases in imports replacing domestically produced goods, as well as falling exports will reduce aggregate demand, resulting in a fall in economic growth. In contrast, reducing protection improves economic growth in the long term. This is because internationally competitive industries will increase exports, increasing aggregate demand and economic activity. This can be seen in the rapidly growing tertiary sector, particularly Australia’s education export industry. In addition, the removal of protection means that the cost of inputs for certain industries, particularly the services sector, will fall, reducing cost-push inflation and increasing real GDP growth. This contributes to an increase

in aggregate supply, as shown in the first diagram. Thus, reducing protection will increase economic growth in the long run, but may reduce it in the short term. Impact of labour market reforms on inflation and the distribution of income Australia’s labour market reforms have resulted in large increases in labour productivity, and the efficiency in which labour is allocated in the economy. This has contributed to the maintenance of price stability, but may have contributed to a worsening in the inequality of the distribution of income. Australia’s labour market reforms have involved a shift from a strongly regulated, centralised labour market system, to a more deregulated, decentralised labour market. This has increased the flexibility and efficiency of the labour market, by discouraging the use of industry-wide Awards, and encouraging the use of firm-level enterprise agreements as well as individual contracts. This has been successful, with the proportion of employees on Awards falling from 23% in 2000 to 16% in 2012, and the use of enterprise agreements rising from 37% to 42% over the same time period. By increasing the responsiveness of the labour market to changes in the economy and derived demand for labour, this has reduced the cost of labour, thus reducing the price of goods and services. As a result, labour market reforms have reduced cost-push inflation. However, the decentralisation of the labour market has resulted in an increase in inequality. This is because the current labour system under the Fair Work Act 2009 encourages the use of enterprise agreements to vary the wages and conditions of employees at different firms to encourage the efficient allocation of resources. This has resulted in increased wage differentials both within an industry, but also between different occupations. However, the current situation is an improvement from the former Howard government’s Workchoices, which prioritised individual agreements (AWAs), which resulted in an even larger wage differentials. As a result, Australia’s Gini coefficient increased from 0.3 in 1996-97 to 0.33 in 2007-08. Thus, labour market reforms have resulted in an increase in inequality of the distribution of income. Impact of competition policy on economic growth and inflation The implementation of Australia’s National Competition Policy in 1995 aimed to use competitive pressures to drive innovation in the economy, increasing economic activity, and to force firms to compete with each other and lower prices, thus reducing inflation. The government has promoted competition in several markets through deregulation, and the corporatisation or privatisation of government-owned enterprises in formerly monopolised markets. This includes the privatisation of Telstra from 1997-2006, and the subsequent opening of the telecommunications industry to competition. Reforms such as these help to improve economic growth by allowing private firms to develop new innovative products that would otherwise not come to fruition within inefficient government bodies. Corporatisation of other government enterprises such as electricity generators, and Australia Post also increases efficiency in these markets, helping lower costs for consumers of these products, and lowering cost-push inflation. The government also promotes competition through legislation such as the Competition and Consumer Act 2010, which empowers to ACCC to prevent anti-competitive behaviour such as price fixing and abuse of market power. By prohibiting these activities, the government is able to force firms to compete against one another, thereby placing downward pressure on prices, and increasing the quality and range of goods and services available to consumers. As a result, firms will seek to cut costs in order to lower prices while protecting their profitability, thus increasing productivity and efficiency, and reducing cost-push inflation. Hence, the National Competition Policy promotes non-inflationary economic growth. Conclusion Australia’s microeconomic reforms to product and factor markets, including reductions in protection, labour market reforms, and the National Competition Policy have increased Australia’s economic growth, while reducing inflation by increasing the productivity and efficiency of the Australian economy. However, some of these policies may have increased the inequality of the distribution of income....