Myth and Reality in the Economic Reform Debate

The Federalism Project
Issues Paper No. 2

EXECUTIVE SUMMARY

• Contrary to received wisdom, the States are currently setting the pace in most, if not all, areas of economic reform.
• The Commonwealth, which did spearhead the reform process in the 1980s, is no longer doing so.  It is lagging behind the States, and in some areas has lost the plot altogether.
• The Keating Government in the 1990s is not living up to the standards set by the Hawke Government in the 1980s;  while the State governments are very different from the State governments of the 1980s.
• The belief that leadership naturally emanates from Canberra, and that the States are not to be trusted with money and serious reform, is, despite its widespread acceptance, without foundation.
• This should surprise no one.  Mr Keating won the 1993 election on a platform designed to woo those frightened by the explicit reformist agenda of Fightback!.  In contrast, the winners of recent State elections all ran on clear, far-ranging reformist tickets.
• Even so, the Commonwealth's rhetoric still lays claim to the moral high ground on reform.  Objective assessment of relevant indicators reveals how little substance there is now to the rhetoric.
• The Commonwealth, which is primarily responsible for Australia's record low level of national savings (measured as a share of GDP), will not even endorse, let alone implement, the fiscal goals set out in the National Savings Report.  In contrast, the States have, without exception, adopted and implemented the goals recommended by Dr FitzGerald's Report (see Figure 1).
• State own-purpose outlays are declining, and are expected to reach 10.4 per cent of GDP in 1996-97, the lowest level in at least 30 years.  Conversely, Commonwealth own-purpose outlays reached a record high of 20.7 per cent of GDP in 1993-94 and are expected to continue to expand through 1995-96 and up to the next federal election (see Figure 4).
• The States have accounted for over 60 per cent of all assets sold by the public sector during the 1990s, and will continue to do so, despite the Commonwealth's expanded privatisation plans, through the 1990s (see Figure 5).
• The indebtedness of the State sector is declining as a percentage of GDP, as is its debt-servicing cost;  while the indebtedness of the Commonwealth is expected to double as a share of GDP between June 1993 and June 1997, and its interest bill is expected to grow in real terms by over 100 per cent over the same period (see Figure 7).
• The States have cut their budget-sector workforce by 40,000 fulltime positions (or 5.4 per cent) so far in the 1990s;  while the Commonwealth's budget-sector workforce has grown by 3.4 per cent or 5,200 full-time positions over the same period (see Table 1).
• The States have, and will maintain, much tighter control over social expenditure, including health, education, public safety and welfare, than the Commonwealth (see Table 3).
• The Commonwealth has undertaken many useful tax reforms, but is failing in two important areas:  reform of the indirect tax base, and reform of tax-sharing arrangements.  The States have failed to reform their existing taxes, but are prevented by the Commonwealth from undertaking the big reforms.
• The States, without exception, are currently accelerating the pace and breadth of microeconomic reform.  Victoria, yesterday's laggard, now has the most thorough reform programme of any Australian Government, as thorough as that in any part of the world.  The pace of reform at the Commonwealth level has slowed, and is now faltering seriously, despite its tasks being at best half-started.
• The Commonwealth's new Industrial Relations legislation is a retrograde step.  It fails to meet even the objectives set out for it by the Prime Minister;  it provides a platform to undermine the State reforms;  and it strengthens union control over industrial relations and other areas of economic management.  The States are attempting reform, but they are being thwarted by the Commonwealth.
• The States continue to push for reform of State-Federal relations and for co-operation on a range of "national" reforms, including a national competition policy.  The Commonwealth has, since early 1992, obstructed all changes except those that give it more power.  It has indeed presided over the largest expansion of its own powers and responsibilities at the expense of the States since the Whitlam era.
• The States are now doing more than enough to be awarded the moral high ground on reform.
• The Commonwealth is not doing enough to retain its reformist reputation.  Indeed the media's continuing acclaim of Mr Keating's reformist zeal is increasingly looking like a case of the Emperor's new clothes.
• As in sport, reform is best achieved through relying on the best performers of the day, who are now the States, rather than relying on yesterday's hero -- the Commonwealth.  Unfortunately, this rule is not being applied in Australia:  the best performers are steadily being held back and relegated to the bench, while the non-performer carries the flag.

INTRODUCTION

Which level of Government in Australia is performing the better in terms of economic reform:  the Commonwealth or the States?

Judging from the national media, ⁽¹⁾ the Keating Government is the clear winner.  It is portrayed as leading in most areas of reform, while the States (defined as including the ACT and the NT) either lag behind or drag their feet.  A similar view is frequently expressed, less effusively, by peak industry groups, ⁽²⁾ but more strongly by the union movement, welfare lobby groups and other members of the corporatist club.

It is certainly the view which the Keating Government itself aggressively pushes, using it to justify its tight control over the functions and finances of the States.

Is such a view justified?

Or, as the States argue, is it a myth purveyed by the Commonwealth, self-servingly fostered by the corporatist club, uncritically repeated by the national media, and designed to hide the Commonwealth's increasing failure to reform and to rationalise the distribution of federal powers?

This question featured significantly when the Prime Minister, Premiers and Chief Ministers met in August 1994 at the Council of Australian Governments (COAG) to discuss the implementation of the Hilmer Report.  Each level of government strove to occupy the moral high ground on economic reform so as to justify its claim to functions, taxes and regulatory powers.

The weight of evidence supports the States' case:  that the States are leading in most areas of reform;  that the Commonwealth is lagging or going backwards in many areas;  and that the Commonwealth is using its extensive powers over the States to undermine the States' ability to implement reform.

In other words, the view from Canberra is back-to-front.

This should surprise no one.  After all, Mr Keating won the 1993 election on a platform designed to woo those frightened by the explicitly reformist agenda of Fightback!.  In contrast, the winners of recent State elections -- in Victoria, Western Australia and South Australia -- all ran on clear and far-ranging reformist tickets.  Even though the Keating Government has ditched some of its election promises, and has been slightly more reformist than implied during the election, its performance over a wide range of reform falls well short of what it should be, and far short of what the States are achieving.

The logical response is to reduce Commonwealth controls over the States;  to let the States get on with their tasks;  and for the Commonwealth to concentrate more on its own functions and activities, including leadership.  Its obsessive quest for control over State policies and finances not only erodes its ability to provide effective leadership but also wastes huge sums of money, and undermines the ability and willingness of the States to perform.

DEFINING THE REFORM AGENDA

What benchmark should we use to judge the performance of the governments?  There are many different agendas to choose from:  each government and political party has its own, as do quite a few lobby groups, and an increasing number of business and research organisations, most notably the BCA, CEDA, and EPAC.  Indeed the "vision thing" seems to be back in vogue.

The Business Council of Australia, in its Australia 2010 Agenda, ⁽³⁾ the key elements of which are shown in Box 1, offers a good and useful reform agenda.  It is comprehensive, well-researched, and non-political.  It correctly makes the case for a high-income objective, and outlines a detailed strategy designed to return Australia to the ranks of the highest per-capita income countries by 2010.

The Australia 2010 Agenda will be used here to assess the comparative performance of the Commonwealth and State Governments on economic reform.  For brevity, only six of the elements of the agenda will be examined here:  stability, limited government, taxation, savings, labour market and microeconomic reform.  Inclusion of the other six would not greatly change the balance of the conclusions.

In overall terms, this agenda is reasonably close to the Government's own -- at least in rhetoric.

MACROECONOMIC STABILITY

The Australian economy is a tough one to manage, and was particularly so during the turbulent 1980s.  It is a small, open economy, heavily dependent on resources, and has one of the most heavily traded currency, bond and stock markets in the world.  The inherent volatility of the Australia economy is accentuated by its heavy dependence on overseas savings and by its large level of foreign liabilities ($232b or 55 per cent of GDP). ⁽⁴⁾

Even considering the difficulty of their task, the macroeconomic record of Australian governments was poor during the 1980s.  Macroeconomic instruments (interest rates, wages and fiscal policy) were changed frequently, often in conflicting directions, relying excessively on monetary policy to smooth out the business cycle.  Policy decisions were overly influenced by politics and the political cycle.

The policy environment amplified the inherent volatility of the Australian economy and contributed to an inflation rate higher than our trading partners' for most of the decade.  Government policy -- particularly excessive reliance on monetary policy -- also contributed to the decade's culminating in the worst recession in 60 years, and a collapse in private investment.

The policy failure of the late 1980s did have one positive, unintended, result:  a sharp fall in inflation.  The recession, here and abroad, was so severe that it all but wiped out inflation.  Since Australia went into the recession with an inflation rate above that of most countries, its rate fell during the recession more than most countries'.  The question is, as recovery unfolds, will inflation re-emerge?  The truthful answer is that we do not know.  It will depend to a large extent on the individual and collective policies of governments across a broad range of policy fronts, including macroeconomic management.

Two points are known.  First, Australia's current low rate of inflation was not achieved as an intended result of macroeconomic policy.  Australian governments have not yet earned a reputation for being "tough on inflation".  Second, low inflation is not unique to Australia.  Most countries are now experiencing low inflation, and many countries have done more in terms of explicit policy decisions to earn it than has Australia.  This means that the benchmarks against which Australia's inflationary policies will be judged by the markets are significantly tougher than before.

Has the government's approach to macroeconomic management changed during the 1990s?  Has government learned the lessons of the 1980s?

MONETARY POLICY

In terms of monetary policy which is, through the Reserve Bank of Australia (RBA), the responsibility of the Commonwealth Government, there has been no enduring reform.

There has been no change to the objectives or independence of the RBA.  It retains its multiple objectives, specified so as to allow extensive flexibility in interpretation and in setting priorities.  Price stability is only one of the RBA's objectives and the priority given to price stability is left to the bank.  There have been no changes, statutory or otherwise, to strengthen RBA independence from the government:  it continues to exercise what it calls "independence with consultation".

The RBA's and the Government's commitments to low inflation remain in question.  Both have frequently stated that they are committed to locking in low inflation now that it has been achieved.  The RBA has made it understood that it has a target of a 2-3 per cent inflation rate.  The truth is, however, that neither the RBA nor the Government has any choice but to make these commitments;  they are doing no more than making a virtue out of necessity.  The markets, unlike the press gallery, know this, and remain sceptical.  The recent increase in interest rates (by 75 points, on 17 August) should have improved the RBA's anti-inflation credentials.  But a credibility gap -- smaller, now, perhaps -- remains:  not surprisingly, given the long delay in deciding on the move, the belief that the RBA's decision was forced by the US Federal Reserve's decision on US rates, and the background concern about the RBA's lack of independence from the Government.  The Commonwealth's commitment to low inflation still looks fragile and fickle.  Despite releasing a very expansive budget against the dictates of economic and political cycles, accusing the markets of madness for forecasting a rise in inflation and arguing for changes in fiscal or monetary settings, the Commonwealth now attempts to portray itself as an inflation "hawk".

The Commonwealth and the RBA still have some proving to do to show the market that they have learned the lessons of the 1980s.

WAGES POLICY

The Commonwealth's new Industrial Relations Reform Act of 1993 is seriously astray in terms of macroeconomic management.  It reduces control over nominal wages without offsetting benefits, and will retard the process of labour market decentralisation and the tying of wages to productivity growth.  It also significantly increases the union movement's control over wages policy and, through it, its control over other areas of policy.  The new Act is without doubt a major aberration.

The Commonwealth Government did, reluctantly, learn one major lesson during the 1980s:  a centralised wage-fixing system is a certain route to a low-productivity, low-wages society.  In response, it very gradually moved toward decentralisation;  refusing, however, to go all the way to full deregulation.  A major problem with the initial experiments with partial decentralisation of the labour market was that "... 'comparative wage justice' considerations resulted in considerable leap-frogging or wage-wage spirals". ⁽⁵⁾  During the 1980s the Commonwealth attempted to achieve some control over nominal wage movements through the " ... [Industrial Relations] Commission promulgating wage-fixing principles governing award variations and using the devices of a 'public interest' test and the extraction of 'no extra claims' commitments from the unions".  Although the Commission's rulings were a second or third best, they did limit upward bias in wage movements.  The new Act scuttled the previous controls on nominal wages, removed the Commission's discretion to replace them with other kinds, including insistence on productivity trade-offs, and left the responsibility for wage moderation in the hands of the union movement. ⁽⁶⁾

Although the ACTU has so far co-operated with the Government to restrain wage growth (with unemployment at 10 per cent this has required little real effort), it has been less restrained in other areas of macroeconomic policy.  The ACTU has used its increased influence and its promise of wage restraint to achieve both a more expansive fiscal policy and a softer line on monetary policy from the Government.  This was illustrated when Mr Kelty, President of the ACTU and member of the RBA Board, warned, in June, of the potential for a wages explosion if monetary policy were tightened;  and when the Government offered new parental leave in exchange for a lower across-the-board wage increase.

Although the States do not have a direct role in setting aggregate wages, they can play an indirect role by facilitating decentralisation of the wages system.  As discussed below, in this area they have clearly out-performed the Commonwealth.

FISCAL POLICY

The gap between the rhetoric and the performance of the Commonwealth Government is biggest in fiscal policy.

This is one area of macroeconomic management in which the States do have a minor role, and where their commitment to reform exceeds the Commonwealth's by a wide and growing margin.  Indeed the States have played a larger and more constructive role in fiscal policy than they have been given credit for.

The fiscal lessons of the 1980s are clear.  First, "Keynesian" countercyclical theory does not work in practice.  Such policies tend to accentuate the instability of the economy, and push too much of the burden of adjustment onto monetary policy.  Second, in a volatile economy such as Australia's, flexibility is the key.  Particularly if Keynesian policies were pursued, tax increases would not be ruled out.  Countercyclical spending should be restricted to programmes with a strictly limited life.  Third, fiscal policy should be administered within a credible medium-term plan.  Fourth, performance, particularly early in the recovery, is what counts, not promises and resting on unearned laurels.

The Commonwealth has failed to learn these lessons.

During the recession the Commonwealth reverted to Keynesian policies with a vengeance.  The bottom line of the general government sector went from a surplus of $7.7b in 1989-90 to a deficit of $15.7b in 1992-93;  a fiscal expansion of over $23b, ⁽⁷⁾ which was one of the largest expansions in the OECD during the period.  The fiscal expansion of the 1990s was large by the standards of the 1980s, with the Commonwealth deficit reaching 4.6 per cent of GDP in 1992-93 compared with a peak of 4.2 per cent in 1983-84 (see Figure 1).  Importantly, the fiscal expansion in the early 1990s was in the main (60 per cent according to the OECD) ⁽⁸⁾ structural rather than cyclical:  the deficit was caused mainly by policy decisions to increase spending and cut taxes rather than the effects of the recession.

The Commonwealth has significantly constrained its flexibility in fiscal policy.  By ruling out reform of the indirect tax base and promising additional tax cuts, it has greatly limited its revenue options.  A large proportion of new spending has been directed to ongoing politically-sensitive programmes;  specifically, a large increase in welfare payments.  As shown in Figure 2, welfare payments increased dramatically during the 1990s and -- despite the recovery, and the transfer of unemployment benefits from the welfare to the employment vote -- are expected to remain high to 1997.

Shortly after the 1993 election the Commonwealth grudgingly confirmed that it would reduce its deficit to around 1 per cent of GDP by 1996-97.  The target is better than none, but falls short of what is required.  As argued in the FitzGerald Report on National Savings, ⁽⁹⁾ the Commonwealth should aim not for a reduced deficit but for a surplus.  It did this in the past when growth was as high as is currently forecast, achieving quite large budget surpluses during the mid-to-late 1980s (see Figure 1).  Even if the Government target is achieved, it will leave a deficit of around $5b which will be $12b larger than the budget position at the beginning of the decade.

Performance on the deficit reduction plan has so far been less than credible.  The structural deficit has increased in each of its first two years.  In the 1993 Budget, the Commonwealth eased fiscal policy by $2.5b (see Figure 3).  This budget did include a range of revenue measures to cut back the deficit for 1994-95 to 1996-97.  In the 1994 Budget, the Commonwealth undid many of these cuts.  It added $2.2b annually to the structural deficit up to the end of 1996-97.  This more than offset the cuts put in place for the 1994-95 fiscal year in the previous budget, and resulted in the structural deficit for 1994-95 being $1.3b higher than before the deficit reduction plan was announced.  The cuts put in place in the 1993-94 budget for 1995-96 and 1996-97 were also significantly eroded -- indeed the cuts for 1995-96 were reduced by over 60 per cent.

Although under the deficit reduction plan, the structural deficit projected for 1995-96 and 1996-97 has been reduced, these cuts could well be eroded in the next budgets.  A federal election must be held by mid-1996.  Given the Commonwealth's apparent spending proclivities, one must assume that further spending initiatives will be announced during the run-up to that election.  The process has already started with the recent commitment to funding parental leave, the Aboriginal land fund, the proposed "Aboriginal Social Justice" policy, the proposed "arts and culture" statement, and so on.  Given its restrictive commitment on taxes, the Commonwealth has few revenue options, except the sale of assets, to fund any additional spending commitments.  The Government is relying on higher economic growth to expand its tax base and meet its deficit reduction target.  The sale of assets does not, of course, add to national savings.

The Government has said that, if needed, it can tighten policy as it did during the 1980s.  But on the evidence so far, the markets are right to doubt the Government's word.  This is is not the same Government that tightened fiscal policy in the 1980s.  This is a Keating-led Government whose leader is committed to not reducing outlays, with a record of continuously expanding structural deficits.  If this Government were indeed serious about avoiding excessive reliance on monetary policy, it would have tightened fiscal policy in 1993-94 and would not have loosened it in 1994-95.

The States, on the other hand, have on the whole learned and applied the fiscal lessons of the 1980s.

As shown in Figure 1, the deficit of the State and Local sector did increase as a share of GDP during the recession, from 0.5 per cent in 1988-89 to 1.5 per cent in 1991-92.  This expansion arose, however, not from countercyclical policies, but rather from the realisation of losses on dud investments, and from underwriting of financial institutions, as well as large redundancy payments made to reduce the size and cost of previously swollen public services.

During the 1990s, the States have in general concentrated on increasing their fiscal flexibility and reducing their structural deficits.  They have cut back dramatically on their workforces, spending over $4b on special redundancy programmes, with a reduction of around 70,000 full-time positions in State public services.  They have increased taxes and have in general not ruled out further increases, and have advocated tax reform.  They have reduced subsidies to their trading enterprises by 10 per cent, and have massively increased "dividends" from their trading enterprises by 356 per cent, from $561m in 1989-90 to around $2,000m in 1993-94. ⁽¹⁰⁾

These policies have allowed the States to reduce their deficits sharply.  Figure 1 shows the deficit of the State and Local sector declining steadily from 1.5 per cent of GDP in 1992-93 to 0.3 per cent in 1993-94.  This trend will continue:  Commonwealth Treasury expects a surplus of around 0.2 per cent of GDP for the sector in 1994-95. ⁽¹¹⁾

All States have in place credible deficit reduction plans.  All aim to achieve or maintain AAA credit ratings, by various dates.  This is a target far superior to the Commonwealth's.  Credit ratings are based on a wide range of indicators, including the deficit, taxing effort, debt, contingent liabilities, and the composition of spending.  They distinguish between cyclical and structural aspects of fiscal policy.  Importantly they provide a neutral assessment of governments' fiscal policy and performance.  All States have fiscal plans consistent with eventually achieving AAA ratings, and at least in the last couple of years they have performed to plan.

Of course the States have, relative to the Commonwealth, a limited role, and even less discretion, in fiscal policy.  Canberra controls most of the cyclically volatile areas of expenditure, such as welfare, and taxation, such as income tax.  The Commonwealth controls a large proportion of States' revenue through grants, and a large share of their spending through specific purpose grants.  Moreover, some of the States ended the 1980s with no option but to cut back on their deficits and debt.  Nonetheless, within their limited role, the States have out-performed the Commonwealth on fiscal policy, and seem certain to continue to do so.

NATIONAL SAVINGS

Australia has a chronic national savings problem, as amply demonstrated in the FitzGerald Report, submitted to the Commonwealth Treasurer in June 1993 -- a few months before the new Keating Government's first budget.  FitzGerald found that

Australia's national saving ... is at its lowest level in two generations.  Apart from "national emergencies", the two World Wars and the Great Depression, it is the lowest level of saving this century.

We cannot, on a sustainable basis, continue to finance the investment we need to grow over the 1990s, and into the next century, by going progressively further into foreign debt.  We are already paying a significant premium on our borrowings and are becoming gradually more exposed to external shocks.

The main contributor to our long term decline in national saving is a decline in public sector savings ...

There is considerable scope to strengthen overall public saving as part of an effort to raise national savings -- balanced against the immediate need to maintain the momentum of the recovery.

... the Commonwealth should seek to return its overall general government budget to its "natural position" of surplus, while the States should seek to return to the historical long term trend decline in their overall general government deficit.

Substantial savings in outlays, in the order of $3 billion annually for the States alone, appear to be feasible over the medium term without cutting back on the existing range and quality of services, simply by providing these more efficiently ... ⁽¹²⁾

How well have the Commonwealth and the States performed against these goals, bearing in mind that others might argue for better, higher goals?

The States have performed excellently.  Their Underlying Net Borrowing Requirement (UNBR -- Figure 1) has declined significantly since the recovery began in 1992-93 and will decline further over the medium term.  As discussed below, the States have already achieved the recommended $3b in annual savings and will do even better over the medium term.

The Commonwealth's performance has been pathetic:  it is indeed primarily responsible for the decline in public, and therefore national, savings.  The deterioration in Commonwealth savings during the early 1990s was (see Figure 1) simply huge -- one of the largest on record.  Canberra rationalised this increase in dissavings by the need to counteract the recession, an explanation to which FitzGerald was sympathetic.  But contrary to FitzGerald's recommendation, the Commonwealth has not yet wound back this stimulus with the onset of recovery.  FitzGerald recommended that the Commonwealth return to budget surplus and not just, as planned, a reduction in the deficit.  Importantly, as explained, the Commonwealth has increased expenditure significantly to date and up to at least 1997;  and there are few signs of efficiency savings being pursued. ⁽¹³⁾

The Commonwealth's failure to meet national savings goals not only puts into jeopardy the sustainability of the recovery, but means that foreign ownership and control will necessarily increase.

LIMITED GOVERNMENT

A major task of all governments is to restrain the growth of spending.  This is necessary not just for fiscal policy or national savings, but as a means of improving the efficiency and effectiveness of government activities and of the economy as a whole.  Governments are involved in too many activities, and perform too many functions poorly compared with the private sector.  The task is to reduce the size of the public sector by focusing on the essential "core" activities of government.

During the 1980s the States earned a reputation as fiscal reprobates.  Conversely, the Hawke Governments earned a reputation for being committed to containing the size of government.  As with most reputations, both were based on a mixture of fact and fiction and were at best imprecise.

Some States, particularly Victoria, were fiscally irresponsible and committed to ever-expanding government.  But some States, particularly Queensland, were models of fiscal restraint and small government.

The Commonwealth Government did get serious about limiting and refocusing the public sector in the mid-to-late 1980s.  Before that, its record was no better than Victoria's.  More importantly, its record on containing the growth of own-purpose outlays, even during the mid-to-late 1980s, was not as impressive as has been claimed.  The Commonwealth was more committed to limited government for the States than for itself.

Despite the Commonwealth's reputation, spending still grew.  Recurrent outlays in the general government (or budget) sector grew by 2.1 per cent of GDP over the 1980s -- from 27.8 per cent in 1979-80 to 29.9 per cent in 1989-90.  Contrary to reputation, Commonwealth spending expanded more than the States sector, with Commonwealth own-purpose spending increasing by 1.4 per cent of GDP and State own-purpose outlays by 0.8 per cent.

Are these reputations any more or less accurate during the 1990s?  Judging from the available data, the answer is no.  Indeed the evidence suggests a reversal of reputations, with the States firmly committed to smaller government, and the Commonwealth committed to an expanded public sector -- that is, as long as it can control it.

OWN-PURPOSE OUTLAYS

The most important indicator of a government's commitment to limiting and reforming government is the trend in its own-purpose, general government, outlays.  The trend in total outlays is less useful, because governments, particularly the Commonwealth, can restrain total outlays simply by cutting grants to other governments.

As shown in Figure 4, the Commonwealth Government has been, and will remain, in a big-spending mode during the 1990s.  In contrast, the States are contracting sharply.  In fact the reduction in State sector outlays is the most dramatic contraction in government spending since World War II.

Commonwealth own-purpose outlays grew to a record level of GDP during the recession in the early 1990s.  However, and despite robust economic growth, spending will continue to expand as a share of GDP up to 1995-96 before declining very slightly in 1996-97.  In other words, Commonwealth spending will remain at record levels even after four years of high growth.

Own-purpose outlays of the State sector grew slightly as a share of GDP during the early part of the 1990s.  Since 1992-93, however, these outlays have declined;  still declining, they will reach a record low share of GDP (10.4 per cent) in 1996-97.

The divergence between the Commonwealth and State sectors should not come as a surprise:  it is fully consistent with the commitments of the respective governments.  The Keating Government -- before, during and after the 1993 election -- made it perfectly clear that it does not intend to reduce its own spending.

The States are all committed to restraining the growth of their own spending, even the Labor Governments in Queensland and the ACT.  And the Kennett Government in Victoria has put in place the most far-reaching and radical reshaping of government spending since the War.

ASSET SALES

Another indicator of a government's commitment to limiting government is its asset sales programme.

All Australian governments have over the decades acquired assets and activities which are no longer "core" activities.  They were, largely for ideological reasons, slow to join the world-wide privatisation trend in the 1980s.  The pace did pick up in the late 1980s, and most governments are now committed to sizeable asset sales programmes during the 1990s.

Although the Commonwealth's privatisation and asset disposal programme gets the most public attention, the States have actually had a larger programme so far in the 1990s, and will continue to lead in this area through the remainder of the decade.  The States have sold more assets on a yearly basis since 1988-89, and between 1989-90 and 1993-94 they accounted for slightly over 60 per cent of all assets sold by the public sector -- see Figure 5.  Although the States have not released detailed estimates of future asset sales, they are committed to substantial expansions in their programmes over the rest of the decade.  South Australia is committed to selling $3b in assets over the rest of the decade.  Victoria has a long privatisation list:  it includes the TAB (recently floated for around $595m (net)), more passenger trains, and possibly even crematoriums;  it expects the privatisation of its electricity utilities to yield some $8b.  Western Australia and New South Wales are pledged to expanded assets divestment programmes, including State banks, hospitals, buses, and gas pipelines.  The Commonwealth plans, subject to party constraints, a sizeable asset sales programme of $4.4b over 1994-95 to 1997-98.  But if the States are true to their commitments, and there is no reason to expect them not to be, they will continue to lead the privatisation process through the 1990s.

Of course, a government's efforts to relinquish unnecessary activity can be achieved other than by selling assets.  It can, for example, allow the private sector to build, own and operate new utilities which in the past would have been in the public sector;  it can contract-out new or existing services to the private sector;  and it can develop public-private joint ventures.

All Australian governments, State and Commonwealth, have slowly begun using these "alternative" types of privatisation.  There are, however, virtually no hard data indicating the extent or success of such activities.  It is thus impossible to quantify differences between the States and the Commonwealth.  Nonetheless, it has been the States that have led in the use of these techniques.  New South Wales under Nick Greiner was the first Australian government to adopt them as a matter of public policy, and undertook the intellectual spadework necessary for their introduction.  Since 1993, Victoria has taken over the policy leadership, but most States have increased their commitment to all forms of privatisation.

SUBSIDIES TO GBEs

No area of expenditure, particularly in the State sector, is more wasteful than the subsidies paid to trading enterprises.  These subsidies are high by OECD standards and to a large extent are used to support inefficient and ineffective activities particularly in public transport.  Substantial reductions in such expenditure are indispensable to expenditure restraint and reform.

The subsidies provided by the States to their Government Business Enterprises – GBEs -- have been large, and remain so (see Fig. 6).  The data also show, however, that the States have, since 1986-87, cut subsidies each year in real terms.  Importantly, further large cuts are expected over the next few years.

Canberra has made few real inroads into the level of subsidies paid to its own GBEs.  Even though it does not have anywhere near the problem that the States have, it is not trying as hard.

DEBT AND INTEREST COSTS

One good indicator of whether a government is serious about the size and quality of public spending is its policy on debt.  During the 1980s, Victoria, Western Australia, and (for part of the decade) Tasmania operated a "no worries, mate" debt policy.  They argued that debt and other liabilities were no serious problem, even when used for consumption purposes and when servicing costs were high and rising.  In contrast, the more fiscally responsible governments, such as Queensland and New South Wales, maintained policies explicitly targeted at limiting the accumulation of debt.

Now all States are committed to reducing debt and interest costs, as well as other financial liabilities and employee entitlements.  The Commonwealth has, in contrast, picked up the "no worries, mate" debt policy.

As Figure 7 shows, the net debt of the State sector is declining as a share of GDP and is expected to do so up to 1997.  In fact net debt is declining as a share of Gross State Product in every State, except the ACT.  Many State governments, including New South Wales, Victoria, South Australia and Western Australia, have also introduced reforms to reduce the rate of accumulation of unfunded employee entitlements;  Queensland continues full funding of public sector superannuation.  Most States, including Victoria, Western Australia and South Australia, have also put in place policies to reduce existing, and avoid future, non-debt funding liabilities.

In contrast, Commonwealth net debt grew sharply as a share of GDP in the early 1990s and is expected to grow up to 1997.  The Commonwealth, which has the most generous superannuation arrangements of all governments (see Table 2), has done little in the 1990s to reduce growth in unfunded super liabilities (which, if left unchecked, will consume 24 per cent of total labour costs by the year 2032).  The Commonwealth has done little to address non-debt liabilities;  in fact it does not even publish data on them.

The Commonwealth justifies its lax debt policy by reference to the relatively higher debt levels in other OECD countries.  These are hardly appropriate benchmarks.  Those countries have serious debt problems;  some are even experiencing difficulty in borrowing.  By its own standards, Commonwealth net debt is high;  it is growing quickly, and by 1997 will be at the highest level (as a share of GDP) in over 30 years. ⁽¹⁴⁾  More importantly, most of the debt accumulated in the 1990s will have been used for consumption purposes and will act as a dead weight on future taxpayers.

OVERLAP AND DUPLICATION

Although federal systems have a lot going for them, they can tend to waste resources through excessive overlap and duplication between levels of government.  Australia's federal system, compared with other federal countries', and assessed against accepted principles for allocating functions in a federal system -- as well as commonsense -- has a grossly excessive level of overlap and duplication.  Moreover, it grew steadily through the 1980s.

The problem lies overwhelmingly with the Commonwealth.  It has, particularly since World War II, greatly expanded its involvement in functions that were and should have remained the sole domain of State or Local government.  It achieved this by directly competing with the States in the provision of activities and, more commonly, by controlling State activities through tied or specific purpose grants.  The States have not been entirely innocent.  They have also expanded into functions which were adequately covered by the Commonwealth or Local government.  A good example is the provision of trade services by the States, which is naturally the responsibility of the Commonwealth.

During the 1990s, despite vigorous complaints by the States, the Commonwealth steadily expanded its involvement in State functions.  Tied grants (excluding grants for on-passing) grew as a proportion of total grants to the States from 38 per cent in 1989-90 to 41 per cent in 1994-95 (see Figure 8).  This growth occurred despite the shifting of $350m in tied road funding, commencing in 1993-94 but agreed to by the Hawke Government, to general purpose funding, and the channelling, from January 1994, of all Commonwealth funding for State TAFE agencies through the Australian National Training Authority (ANTA) rather than directly to the States via tied grants.  If Commonwealth funding for TAFE in 1994-95 and the so-called Better Cities Programme are treated as tied grants, then such grants will have increased steadily from 38 per cent to 45 per cent of all grants between 1989-90 and 1994-95.  This represents a substantial growth in tied funding.

Significantly, there have been few attempts to reform the way tied grants are allocated and monitored.  The strings attached by the Commonwealth to such funds relate almost exclusively to how they are to be spent by the States rather than what they achieve.  This input focus not only increases the administrative costs of both the State and Commonwealth governments, but also sits uneasily with the outcome focus being aimed at in Commonwealth own-purpose outlays.

The Commonwealth has also increased wasteful overlap by developing its own parallel agencies and by forcing the States to agree to new "national" (that is, Canberra-dominated) arrangements.  One of the most unnecessary recent Commonwealth initiatives is its regional development initiative, announced in the Working Nation statement in March 1993. ⁽¹⁵⁾  The Commonwealth plans to spend $150m over four years creating a series of regional development councils and "strategic" regional infrastructure projects.  This is pure, wasteful duplication:  all States already have established networks of regional development councils and already provide infrastructure on a "strategic" basis to their regions.

In contrast, the States have in recent years tried, with no real success, to convince the Commonwealth of the need to reduce the extent of overlap and duplication and to reduce the associated waste by shifting the focus of the Commonwealth from inputs to outputs.  They have not, in general, taken a parochial "State's rights" approach;  they have been willing to discuss the sharing of functions, even the transfer of functions to Canberra.  They have agreed to a nationally-coordinated approach to trade assistance.  Unfortunately the Commonwealth has failed to approach the issue in like manner.  It has continued to use its financial, constitutional and political powers to grasp even more power for itself, thus wasting money and resources, and swelling the government sector in the process.

STAFFING LEVELS

Governments are primarily in the business of providing services;  labour costs therefore make up most of their operating costs.  The key indicator of a government's approach to labour costs is the trend in staff numbers.  In this area the States have been significantly better-disciplined than the Commonwealth in the last four years.

Table 1 shows that the States have cut staffing levels in their general government agencies by 40,000 full-time positions since 1989-90.  This represents a reduction of 5.4 per cent of their total workforce and is in addition to the 30,000-plus cut from their trading enterprises over the same period.  The Commonwealth, during the same period, has actually increased its budget sector workforce by 5,200 full-time positions or by 3.4 per cent.

Table 1:  Growth in General Government Workforce
1989-90 to 1993-94 (full-time equivalent)

	No.	%
States	-40,000	-5.4
Commonwealth	5,200	+3.4

Source:  State and Commonwealth Budget Papers, 1990-91 through 1993-94.

The size of the workforce is not the whole story.  Wage rates, on-costs and particularly the cost of superannuation are also crucial.  Although limited and dated, the comparative data on wage and non-wage costs indicate that, at least in the early 1990s, the Commonwealth had very high labour costs relative to both the States and the private sector (see Table 2).  In 1991-92, Commonwealth public servants received salary packages, including superannuation and other benefits, which were on average 19 per cent higher than those in the State public sector and a massive 41 per cent greater than those of the total private sector.  The Commonwealth's costs were particularly high for superannuation (125 per cent higher than in the State sector) and other on-costs (18 per cent higher than the State sector).  Given that superannuation and other on-costs receive preferential tax treatment, the effective after-tax benefits of being a Commonwealth public servant are obviously very high.  Of course, high labour costs are less of a concern if offset by higher productivity.  But there are no data to indicate that the Commonwealth public sector is more or less productive than the State sector.

Table 2:  Comparative Labour Costs Commonwealth, State and Private 1991-92
(Average earnings per employee)

Commonwealth Relative to: (% difference)	State 1 %	Private 2 %
Salary	9	18
Superannuation	125	452
Other	18	88
Total earnings	19	41

Source:  Labour Costs Australia 1991-93, ABS Cat. No. 6348.0

Notes:
⁽¹⁾ Includes monetary value of annual leave, sick leave, other leave, public holidays, annual leave loading, infrequent bonus termination payments, and fringe benefits.  Does not include employee-based taxes paid by employer such as payroll tax, worker's compensation and fringe benefit tax.
⁽²⁾ Total private sector average.

GROWTH IN "BIG-TICKET" ITEMS

Public-sector spending is highly concentrated on a few, so-called big ticket items;  a government can only be successful in controlling the size of government spending if it controls spending in these areas.

As shown in Table 3, the States have so far, in the 1990s, been quite successful in controlling spending in all their big ticket areas except for welfare.  Moreover they expect to be even more frugal over the next three years, with real reductions forecast in big ticket areas, as well as in total outlays.

Table 3:  Growth in Own Purpose ¹ Outlays
(Cumulative Growth in 1989-90 Prices)

	1989-90 to 1993-94 (Actual)		1993-94 to 1996-97 (Forecast)
	States	Commonwealth	States 2	Commonwealth
Health	-3	25	-4	10
Education	8	34	-1	2
Welfare	39	45	-7	-1
Public safety and order	9	44	-3	-7
Defence	-	10	-	-3
Total	16	29	-4	7

Sources:  ABS 5501.0, ABS 5204.0, Commonwealth Budget Paper No. 1, 1994-95, WA Budget Paper No. 4, 1994-95, 1994 August Economic Statement of Victoria, NSW Budget Paper No 2, 1993-94.  The 1994-95 Tasmanian Budget, Queensland State Budget 1994-95 Budget Paper No. 2.

Notes:
⁽¹⁾ Own purpose outlays except estimates of State spending on health, education, welfare, public safety and defence listed in column 4 (States 1993-94 to 1996-97).
⁽²⁾ Does not include data from Northern Territory or South Australia.
⁽³⁾ Table 3 overstates the growth in State outlays over the period 1993-94/1996-97, as it includes Commonwealth grants which are expected to grow more rapidly than State own-purpose outlays.

Unsurprisingly, the Commonwealth has over the same time presided over a blow-out in spending in all its big ticket areas.  Worse, it does not plan to cut back on its expenditures to any significant degree over the next three years.  In other words, it has fallen for the usual Keynesian trick:  using a recession as an excuse to crank up spending, channelling this growth into politically-sensitive areas and thereby locking this spending in during the recovery.

The Keating Government's spending propensities are best explained by its approach to welfare spending.  During the mid-to-late 1980s, the Hawke Government did undertake a series of fundamental reforms designed to improve the targeting of welfare programmes.  These reforms generated significant savings and were one of the main reasons the Government was able to reduce the growth of its own-purpose outlays during the period.  During the 1990s, the Keating Government has steadily undone the reforms of the 1980s.  New programmes have been introduced which are poorly targeted and not means-tested;  the targeting of existing programmes has been weakened.  The level of benefits has grown significantly, faster than the cost of living and wages.  The result is shown by Figure 2 and Table 3.  Welfare spending grew at an exponential rate during the recession;  but despite rapid economic growth and a reduction in underlying need, welfare payments are not expected to decline from their recession peak over the next four years.  Clearly the Keating Government has used the recession to expand the welfare state and dependency.  The States, which also undertook a large expansion in their welfare services during the recession (see Table 3), are also planning only slight reductions in their welfare programmes over the next three years, albeit a larger cutback than planned by the Commonwealth. ⁽¹⁶⁾

During the 1980s, to the extent that the States did restrain expenditure, this was, in large part, due to cuts in Commonwealth grants -- a result of the Commonwealth's transferring the pain of fiscal adjustment to the States.  During the 1990s, the States have been more thoroughgoing in their restraint, without the discipline of Commonwealth parsimony.

TAXATION

The Commonwealth Government deservedly earned a reputation for tax reform during the 1980s.  It introduced a large range of reforms to the tax system:  the fringe benefits and capital gains taxes;  changes to depreciation and withholding tax arrangements;  dividend imputation;  R & D tax concessions;  the removal of a large number of exemptions;  lowering the rate for personal and company tax.  The Hawke Government did fail in a number of key areas of tax reform.  Even though it came close, it failed to introduce a broad-based indirect tax or to achieve other satisfactory reform of its indirect tax base.

But in respect of reform of State-Federal tax-sharing, the Hawke Government did not just fail to reform but actively thwarted useful reforms -- at least for most of its term.  It blocked the States' access to a broad-based tax;  it steadily encroached on the existing tax bases of the States;  and it refused to reform the process by which States' grants are allocated.  The Hawke Government, to its credit, did begin to get serious about reform of State-Federal fiscal relations in 1989, through the "New Federalism" process.

During the 1980s, the States achieved no substantive tax reform and, if anything, the quality of their tax systems deteriorated over the decade.  Most States undertook more-or-less comprehensive reviews of their tax systems;  all these reviews argued for major reform of State tax systems, in particular the need for the States to have access to a broader tax base to enable them to eliminate a range of taxes and to reduce their dependence on the Commonwealth's tax collections and grants.  But the States, individually and collectively, failed to pursue these reforms and instead introduced a range of measures which made the tax system even more narrowly-based and inefficient.  This failure was compounded over the later 1980s by large increases in tax effort designed to offset cuts in grants from the Commonwealth.

The failure to reform State taxes was not, however, the fault only of the States.  The Commonwealth must bear a good part of the responsibility.  The Hawke Government prevented the States from gaining access to the income-tax surcharge made available to them by the Fraser Government. ⁽¹⁷⁾  It also refused to co-operate with the States in allowing them access to a broad-based indirect tax.  And the Commonwealth refused to provide the States with a guaranteed share of one of its own major tax bases.  Indeed, federal fiscal relations is an area in which the record of the Hawke Labor Government is far worse than that of its predecessor -- the Fraser Government.

During the 1990s the Commonwealth has remained active on the tax front.  It has, inter alia, cut personal and company tax rates, provided investment allowances, changed and accelerated rates of depreciation, and streamlined the wholesale tax system.  It has also undertaken a number of measures to extract more tax revenue, including higher rates of excise and wholesale tax for some goods, broadening the FBT base, tightening tax compliance, and changing company tax payment arrangements.

Although some of these changes have been appropriate, the Commonwealth's approach to tax policy during the 1990s has been flawed.  First, the cuts have not been fully funded and thus are not sustainable.  Tax cuts that are not fully funded -- or are funded by recourse to borrowing -- are not tax cuts but rather tax postponements.  Second, two key areas have been quarantined from the reform process.  The Commonwealth has ruled out the introduction of a broad-based consumption tax and thus fundamental reform of its indirect tax base.  The Commonwealth, under Mr Hawke's New Federalism, was in 1991 actively considering changes to tax-sharing arrangements between States and Commonwealth.  (In fact, it was considering something much like the arrangements in place when it took office in 1983.)  But the New Federalism process was effectively aborted by Mr Keating during his successful run for the Lodge.  Mr Keating later clearly ruled out either any substantive changes to tax-sharing or the States' acquiring access to a broadly-based tax base such as income tax or a goods and services tax. ⁽¹⁸⁾

The States began the 1990s committed to fundamental tax reform, not just of their own systems but also of the Commonwealth's.  But tax reform at the State level was effectively killed off by Mr Keating's scuttling of the New Federalism, by the demise of the GST and Fightback!, and by Mr Keating's subsequent confirmation that under his leadership the Commonwealth would not allow the States access to greater tax powers.

There are undoubted economic gains to be had from reform of existing State taxes.  Such gains are dwarfed by what could be achieved by wholesale reform.  Given the huge political cost involved in any tax reform, refining the existing flawed and debauched State tax system is probably not worth the effort.  The system badly needs fixing.  The best option would be to get rid of a large range of existing State taxes -- including franchise fees, stamp duties, and payroll tax -- and replace them with an income tax surcharge or, better, a broad-based indirect tax, such as a retail sales tax.  Any first-best option tax reform requires Commonwealth co-operation, not point-blank refusal;  and if the Commonwealth does not have the will for tax reform, it should get out of the way and let the States do the job.

The Commonwealth and the States have, with some impetus from the New Federalism process, introduced a number of useful changes to State-Federal fiscal relations during the 1990s:  Commonwealth grants to States have been provided in a rather more predictable manner, and the National Fiscal Outlook or "Federation Budget" process was adopted.  Nonetheless, the really important reforms have been sabotaged by the Commonwealth.

While all governments have actively pursued non-tax sources of revenue during the 1990s, the States have been more aggressive on all fronts.  As discussed above, the States have led in asset sales (see Fig. 5), and should continue to do so over the medium term.  Although the Commonwealth increased its take in user charges, the States have led the way, having experienced more consistent and rapid growth of user charges than the Commonwealth over the 1990s (see Fig. 9).

The States have also led the push for higher dividends from trading enterprises.  Figure 10 shows that dividends from State GBEs rose dramatically during the 1990s (by over 300 per cent), and in 1993-94 generated nearly $2.0b in revenue for State budgets.  The Commonwealth has also increased its dividend take from its GBEs, though inconsistently so.  In 1993-94, dividends of Commonwealth GBEs jumped dramatically from $300m to $1100m.  Although they are expected to decline in 1994-95 to $800 million, they will remain substantially above the pre-1993-94 level.

The increase in user charges and assets sales are reforms worthy of support, at least by those interested in improving the efficiency of the public sector;  reforms which owe much of their currency to State initiative.

The increase in dividends from GBEs is much more controversial.  There is a legitimate concern that governments are extracting dividends to capture an inappropriately large proportion of the gains from reform, and conversely are failing to pass on an appropriate share of the gains to the private sector.  The major focus of concern has been the State electricity industry, which provides the bulk of dividends to the States and has accounted for the bulk of the growth in GBE dividends to the States over the 1990s.  Few if any complaints have been made about the Commonwealth's GBE dividend and pricing policies.  In short, the concern is that the State electricity authorities, particularly in NSW, are being used to collect monopoly rents. ⁽¹⁹⁾

Is this a valid concern?  The available evidence does seem to indicate that the State Governments have captured for themselves the lion's share of the financial benefits flowing from reform of their electricity authorities during the 1990s.  Although on average electricity prices declined significantly across the States during the latter part of the 1980s, the average price remained basically unchanged between 1989-90 and 1992-93. ⁽²⁰⁾  During this period, however, the electricity industry achieved substantial improvements in productivity and reductions in debt and employment.  The obvious conclusion is, therefore, that cost savings have been used to finance dividends to the general government sector rather than lower prices.

This conclusion does not apply to all, or even most, State electricity authorities.  It does not apply to Victoria, Queensland, Tasmania or the Northern Territory, as those authorities either have very low dividends or show prices decreasing more rapidly than costs.  Indeed, it really only applies to New South Wales.

Is the New South Wales Government's decision to allocate the lion's share of the benefits from electricity reform to itself as the shareholder, rather than to the consumer, inappropriate?  Is it using its electricity authorities to reap monopoly profits?  From the available evidence, which is admittedly incomplete, the answer is no.  The dividends are correctly structured, set against appropriate benchmarks, and are in line with the payments made by other Commonwealth and State GBEs.

Dividends paid by New South Wales electricity authorities are in two parts:  a return on equity and a tax-equivalent payment.  Conceptually both these payments are appropriate, ensuring competitive neutrality with the private sector, and ensuring that managers properly cost capital decisions.  The equity payment is appropriately determined as a share (based on private sector performance) of earnings before interest and tax.  The tax-equivalent payment is determined appropriately in relation to Commonwealth taxes.

The return on investment to the New South Wales Government and taxpayers is not out of line with that achieved by other GBEs.  The dividend payout ratio (dividends paid as percentage of assets) of the combined New South Wales electricity authorities was 6.7 per cent in 1992-93.  That is below the ratio achieved by the Victorian electricity authority (SECV) (8.6 per cent), and not significantly different from the ratio achieved by Telecom (6.5 per cent) and Australia Post (6.3 per cent).  Given the large increase in dividends by Australia Post and Telecom after 1992-93, their dividend payout ratios are now probably larger than that of the New South Wales electricity authorities. ⁽²¹⁾  The same basic picture is provided by examining the ratio of dividends to earnings after interest and tax (see Table 4).

Table 4:  Financial Ratios, Select GBEs, 1992-93

	Dividend to Equity Ratio 5	Dividend Payout Ratio 5
Electricity   NSW 1   Victoria 2   Queensland 3   Other States 4	6.7 8.6 1.9 11.4	69.3 92.0 20.4 60.2
Telecom	6.5	74.5
Australia Post	6.3	49.5

Source:  Government Trading Enterprises, Performance Indicators, 1987-88 to 1992-93, Industry Commission, June 1994.

Notes:
⁽¹⁾ Combined Pacific Power, Prospect Electricity, Sydney Electricity, Shortland Electricity and Illawarra Electricity.
⁽²⁾ State Electricity Commission of Victoria.
⁽³⁾ Combined Queensland Electricity Commission, South East Queensland Electricity Board and Capricornia Electricity Board.
⁽⁴⁾ Combined Electricity Trust of South Australia, State Energy Commission of Western Australia, Hydro-Electric Commission of Tasmania, Power and Water Authority of the Northern Territory, ACT Electricity and Water.
⁽⁵⁾ Dividends including tax equivalent payments divided by average total equity.
⁽⁶⁾ Dividends including tax equivalent payments divided by operating profit.

The conclusion is that during the first part of the 1990s New South Wales gave priority to implementing appropriate pricing of capital over cutting prices in its electricity GBEs.  The available data do not support the argument that it is collecting monopoly profits, at least any more than Telecom or Australia Post.

The New South Wales Government has also set up a Pricing Tribunal, explicitly charged with reviewing the pricing of all GBE and other government charges.  The Tribunal is not only the first such institution, but provides a far superior overview of government pricing and guard against monopoly pricing than those available in other States and, importantly, than those provided by the Commonwealth.

Electricity prices in New South Wales declined by 21 per cent in 1993-94, and are expected to decline to the level of Queensland (the lowest prices in the country) by June 1995.  Thus the New South Wales Government is now passing on a greater proportion of the productivity gains to electricity consumers in the form of lower prices.

MICROECONOMIC REFORM

During the 1980s and into the early 1990s, the Commonwealth, under the leadership of Mr Hawke, did undertake a number of fundamental microeconomic reforms.  It floated the dollar;  deregulated the banking sector;  reduced tariffs;  deregulated some agricultural marketing arrangements;  and opened up (though gradually and partially) a range of its GBEs to competition.

During the same period, the States also began a process of reform, focused primarily on their GBEs, but including review of regulations, deregulation of agricultural marketing boards, opening up intra-state aviation, and deregulating land transport.

Which level of government did the most during the 1980s and early 1990s?  In general, the honours must go to the Hawke Government.  The big private sector reforms, the deregulation of the financial sector, floating the dollar and reduction of tariffs, were not just significant in and of themselves, but forced the pace of reform of the public sector.  The deregulation of the agricultural sector did likewise:  once farmers were fully exposed to international competition, the desire and ability to continue to subsidise inefficient public enterprise evaporated.  The reformist credentials of the Hawke Government were proven most emphatically in March 1991, when -- during a deep recession, correctly perceived to be partially of its own making, and during the early stages of a leadership tussle -- it announced another large reduction in tariffs.  This took courage and leadership.

Commonwealth reform of the telecommunications and aviation industries has also yielded significant gains.  Telecom improved its labour productivity by 100 per cent and cut its prices in real terms by 20 per cent over the 6 years to 1992-93. ⁽²²⁾  The end of the two-airline policy in 1990 and subsequent reforms, partially privatising Qantas and allowing Qantas to carry domestic passengers, combined to produce a 25 per cent reduction in average air fares, a 23 per cent increase in domestic passengers and total benefits of $100m per year to the economy. ⁽²³⁾

The States also achieved substantial reform, particularly of their GBEs.  According to some estimates, the overall (capital plus labour) productivity of State-owned electricity utilities improved by 32 per cent in the nine years to 1990-91; ⁽²⁴⁾  while labour productivity in the industry improved by 100 per cent over the 6 years to 1992-93. ⁽²⁵⁾  Labour productivity in water, sewerage, drainage and irrigation utilities increased 75 per cent, underpinned by a 25 per cent reduction in aggregate employment during the 6 years to 1992-93. ⁽²⁶⁾  A similar picture is presented by reforms to rail freight, with a labour force reduction of around 39 per cent and an improvement in labour productivity of around 65 per cent over the six years to 1992-93. ⁽²⁷⁾

The New Federalism process -- a Commonwealth-State joint venture -- also generated a host of effective microeconomic reforms.  Between 1989-90 and 1992-93, State port authorities collectively increased their labour productivity by 140 per cent, cut their staff levels by 50 per cent and cut turn-around times for containerised cargo by 25 per cent. ⁽²⁸⁾  The National Rail Authority was established to improve the efficiency and competitiveness of interstate rail.  State and Commonwealth Governments agreed to work toward integrating State electricity markets into a single east-coast market via the National Electricity Grid.  The New Federalism process also spawned mutual recognition by the States of each other's regulations in such areas as labelling, health and professional qualification.

The reform agendas of both States and Commonwealth have had their weak spots.  For example, despite numerous reviews and promises to cut red tape, neither level of government has achieved much by way of reducing the regulatory burden on business.  The States have failed to improve the operation of their public (passenger) transport sector, ⁽²⁹⁾ and the Commonwealth has failed to improve the performance of Australia Post. ⁽³⁰⁾

Notwithstanding the reform achievement of bath levels of government, there is no justification for relaxing or resting on one's laurels.  Indeed, the main lesson from the 1980s and early 1990s is that all Australian governments at all levels must increase the pace and breadth of reform.

Neither the Commonwealth nor the States have done enough.  Recent research undertaken by EPAC found that although considerable progress has been made in Australia over the last decade, the microeconomic task (even including reform committed to but not yet completed) is at best only half-done -- and that is on the very unreal assumption that the rest of the world will stand still. ⁽³¹⁾

Although the microeconomic reform achievements were substantial by the standards of Australia's past, they were inadequate by the standards of our major trading partners.  Relative to Australia's major trading partners, reform in Australia during the 1980s was slow and incomplete.  Indeed, Australia's overall ranking in international competitiveness (compared with OECD countries rather than major trading partners), declined through the 1980s and continued to decline through to 1992. ⁽³²⁾  Australia's overall competitiveness did improve in 1993, though from an unsatisfactory level and only slightly.  As shown in Table 5, Australia's ranking among the 22 OECD countries improved from 16 in 1991 to 14 in 1993.  In contrast, New Zealand's international ranking began to rise in the late 1980s, as a result of its faster reform effort, and continued to rise through the 1990s. ⁽³³⁾  New Zealand's ranking among the OECD countries improved from 17 in 1991 to 8 in 1993.

Table 5:  International Competitiveness:  Australia 1991 and 1993

Indicators of Competitiveness 1	1993 Ranking 2	1991 Ranking 2
Agricultural policies	2	3
Govt subsidies to industry	6	3
Price controls	6	14
Govt direction of investment	8	18
Telecommunications	9	14
Air transport	10	9
Protectionism	12	21
Adaptability of govt policy	13	14
Bank deregulation	14	3
Roads	14	19
Trade policies	15	22
Govt control of enterprises	16	15
Regulatory environment	16	14
Power supply	17	14
Railroads	19	20
Port access	19	19
Environmental policy	22	9
Overall	14	16

Source:  IMD World Economic Forum, The World Competitiveness Report,
June 1991 and June 1993.

Notes:
⁽¹⁾ Select categories only.
⁽²⁾ Ranked in ascending order with 1 the highest and 22 the lowest.  Ranked against 22 OECD countries.

In terms of specific policy-related indicators, Australia's ranking remains generally low.  As shown in Table 5, Australia does rank well in some areas -- such as agricultural policies, government subsidies, government price controls, government control over investment flows, telecommunications and air transport -- but its policy rating was mediocre in other areas -- such as protectionism, adaptability of government policy to changing economic circumstances, bank deregulation and roads.  And in some crucial areas Australia's ranking remains dismal:  in trade policies, government control over state-owned enterprises, regulatory environment, power supply, railroads, port access and environmental policy Australia is still ranked in the bottom 30 per cent of the OECD.

Another lesson from the recent past is that competition, defined broadly, is the key to achieving and sustaining microeconomic reform.  As the Prime Minister recently stated, "... the engine which drives efficiency is free and open competition." ⁽³⁴⁾  Since microeconomic reform is all about improving efficiency, competition provides the rationale for, and means of, reform.

Another lesson of the 1980s is that Commonwealth-State co-operation is essential to reform -- and so is reform of State-Federal fiscal relations, a fact less widely understood.

How well have the States and the Commonwealth learned these lessons?

PACE OF REFORM

Since 1991 the pace of reform has slowed in areas in which the Commonwealth has sole responsibility.  Although there is still a lot of activity taking place at the moment, most is concerned with implementing reforms adopted under Mr Hawke's leadership.  The only new initiatives announced since 1992 have been the jobs compact (and associated welfare reforms and training programmes) and the privatisation of the Federal airports announced in the Working Nation statement. ⁽³⁵⁾  The airport privatisation will, if achieved, be a significant piece of microeconomic reform.  Although the job creation programmes and associated reforms may have a beneficial impact on the efficiency of the labour market, the impact will probably be slight. ⁽³⁶⁾

There is still much to do in telecommunications, Australia Post, coastal shipping, liner shipping, and aviation, all of which are not currently on the Commonwealth agenda.  The Commonwealth is continuing with reforms to public service delivery, but again most of these have their origin and impetus in the past.  The clearest example of "reform fatigue" is the announcement in Working Nation that tariffs would not be reduced beyond the cuts announced in 1991.  The gain from additional cuts in tariffs is substantial;  there is, as there has been over the last decade, bipartisan support for tariff reduction;  the gains from past cuts are now apparent to all who care to look;  and the economy is on the move.  The only explanation is that the will to push for hard reform is waning at the Commonwealth level, at least in the Commonwealth's own bailiwick.

The State sector has, since 1992, accelerated the pace of reform significantly.  Although there is still wide variation across States and policy areas, all States are doing more, and faster.  Importantly, Victoria, yesterday's laggard, now has the most thorough reform programme of any Australian government, as thorough as that in any part of the world.  Western Australia and South Australia have begun implementing broad-based programmes of microeconomic reforms.  New South Wales is, like the Commonwealth, showing signs of reform fatigue.  Queensland -- despite having the most efficient public services, both in the general government and GBE sector, across the Australian public sector -- has increased the pace of reform, albeit slightly.

The recent reform initiatives of the States are too many to list, let alone discuss.  Some were highlighted earlier in reference to limiting the size of government and privatisation.  All States are increasing the rate of reform in their GBEs, including rail, road, electricity, gas, water and sewerage.  One good example is public transport.  This is one area where the pace has been slow.  It is also one where reform is difficult, because of the extent of monopoly power (including trade union monopoly power) and political sensitivity.  It is also an area where the Commonwealth has been uncharacteristically quiet.  Victoria and, now, Western Australia have recently introduced reforms designed to reduce the extent of public subsidies and improve the quality of service through reducing manning levels, raising fees, opening public systems to limited competition from the private sector, and the contracting-out of services to the private sector.  The Victorian reforms are expected to achieve a 20 to 24 per cent increase in labour productivity by 1997. ⁽³⁷⁾  Western Australia expects to reduce the operating costs of its bus system by around 33 per cent. ⁽³⁸⁾  Although these initiatives will leave substantial scope for further reform, they do represent fundamental advances in a tough area, one where the Commonwealth has feared to tread.

In terms of accelerating the pace of reform, the States are now clearly ahead.

COMMITMENT TO COMPETITION

A major weakness of the reform agenda so far, particularly in respect of State utilities, has been an excessive concentration on efficiency drives rather than on exposing enterprises to competition.  Forsyth is correct when he argues that "These types of reforms are not likely to be long lasting, as there is no continuing pressure on the firm to keep performing well." ⁽³⁹⁾  Although the Commonwealth has placed greater emphasis to date on structural reform and competition, it has not gone far enough:  Australia Post, for example, is still excessively protected, as are many other Commonwealth agencies.

There are signs that the States are placing greater emphasis on structural reform and competition. ⁽⁴⁰⁾  Victoria's reforms to its electricity industry will produce one of the most open and competitive industries in the world. ⁽⁴¹⁾  New South Wales has introduced a wholesale market for electricity in the State. ⁽⁴²⁾  Western Australia is also in the process of opening up its gas and electricity industries to competition. ⁽⁴³⁾  Victoria's "case mix" reforms to the public hospital system, which force hospitals to compete for the right to provide services, are as as important, innovative and difficult to implement as any reform undertaken to date in Australia. ⁽⁴⁴⁾

All States have agreed to implement a national competition policy along the lines of the recommendations of the Hilmer Report, subject to the caveats discussed below. ⁽⁴⁵⁾  This will, if achieved, place greater emphasis on structure and competition.

The States are also increasingly committed to "competitive federalism".

The main driving force for economic reform at the State level is, and will remain, competition from other States.  The fact that electricity prices, taxes, debt, and the cost of government services are lower in Queensland, and that these lower costs have attracted people, investment and jobs from other States, has been the main impetus for reform in all States and hence in Australia.  Competition between the States is intensifying as a result of greater mobility of capital and labour, better information about the comparative performance of the States (for which the Commonwealth deserves a good deal of credit) and the desire by the States to compete with each other as well as with overseas jurisdictions.

The Commonwealth has also increased its commitment to structural reform and competition:  in particular, it is committed to the implementation of a national competition policy consistent with the recommendations of the Hilmer report.  But its approach and that of the Hilmer report itself are fundamentally flawed.  The flaw stems from the Commonwealth's pursuit of power, and the Commonwealth's and the Hilmer Report's disdain for the federal system.

FEDERAL-STATE RELATIONS

Since 1992, the Commonwealth Government has poisoned Federal-State relations, thus greatly weakening the microeconomic reform agenda.  Since 1992, the Keating Government has, inter alia:

• deliberately aborted the New Federalism process;
• ruled out reform of tax sharing arrangements;
• increased its control over State spending through the use of tied grants;
• taken over functions properly undertaken by the States;
• used the external affairs power to override the constitutional powers of the States in industrial relations and land management;
• actively encouraged workers -- particularly State public sector employees -- to shift from State to Federal awards;
• reduced the compensation paid to the States for their loss of tax revenue to the Commonwealth as a result of privatisation of GBEs;  and
• imposed its own payroll tax, in the form of the superannuation levy, and thereby encroached on the States' sole "growth tax".

All of these have had the effect of increasing the powers of the Commonwealth at the expense of the States, undermining the ability and incentive of the States to push for reform, and diminishing the willingness of the States to "co-operate" with the Commonwealth on issues that need a joint effort.  The fact that the States are, despite the actions of the Commonwealth, accelerating the pace of reform and are still willing to co-operate with the Commonwealth on some issues, is a credit to the States and the reforms put in place through the New Federalism process.  These actions also indicate that the reluctance of the States to "co-operate" with the Commonwealth on some issues is not, as usually portrayed by the media and the Commonwealth, the result of parochial, "States' rights" paranoia, but a rational assessment of the Commonwealth's motive, which is greater centralisation of power to itself.

The Commonwealth's approach to competition policy is similarly flawed.  The Commonwealth wants the recommendations of the Hilmer Report to be implemented in full, without any major changes and without any side-deals on funding or other reforms.  On the surface this sounds reasonable and makes the States' call for changes and compensation sound like the bleating of laggards.  But a glance at the detail indicates that the States have reason to be concerned, that the Commonwealth's position betrays once again its quest for power.  Under the Hilmer recommendations, national competition policy is Commonwealth policy, not joint Commonwealth and State.  The controlling legislation will reside solely with the Commonwealth Parliament.  The sole power to provide exemptions will reside with the Commonwealth.  The Commonwealth will appoint the various regulatory agencies.  The Commonwealth will have the power to override or regulate State operations, but the States will not have reciprocal powers.  The Commonwealth will have the power to dictate the pace and pattern of reform.  Importantly, the Commonwealth will receive the bulk of the financial and political benefits flowing to the public sector from the reform, while the States will be forced to carry the lion's share of the financial and political costs.

The most critical and controversial aspect of the Commonwealth's approach to competition policy is, not surprisingly, its denial of the need to compensate the States for reform or to change tax-sharing arrangements.  Unfortunately, the Hilmer Report did not address these issues.

The facts, as I understand them, are:

• reforms will impose significant, direct and indirect, costs on governments in the form of redundancy payments, rights to compensation from loss of property rights, financing of non-performing debt, and, for the States, revenue capacity lost to the Commonwealth;
• most reforms and therefore most costs will fall to the States to implement;
• since the Commonwealth controls almost all growth-related taxes, it, and not the States, will receive the lion's share of the revenue flowing to the public sector from the faster economic growth generated by reform;  and
• given the nature of, and constraints on, their existing taxing powers, the States do not have the capacity to fund the cost of reform without detracting from their debt- and deficit-reduction targets.

Given these facts, it seems not just reasonable but necessary that the States receive either compensation from the Commonwealth or access to a growth tax.  This should not be seen as a bribe, but as a legitimate recompense for the costs incurred by the States and their taxpayers to achieve reform.  Failure to honour the obligation will not only undermine the capacity of the States to reform, but eventually undermine their willingness to do so.

The States' other concerns about the Commonwealth's and the Hilmer approach to competition policy are also reasonable. ⁽⁴⁶⁾  In addition to their proper concern about the sharing of financial benefits, the States believe that:

• the Hilmer recommendations should apply to all Commonwealth, as well as all State, GBEs;
• the States, collectively, should have the capacity (as will the Commonwealth) to authorise exemptions from the Trade Practices Act;  and
• the proposed National Competition Council should be dispensed with, as existing arrangements are adequate.

The basic argument of the States is that, collectively, they should be treated as equals with the Commonwealth;  as the recommendations currently stand, they are not.

Another serious and related flaw of the Commonwealth's and the Hilmer approach to competition policy is that it fails even to consider the most powerful mechanism for competition in the public sector -- competitive federalism.  The Hilmer Report does not even mention the role of the federal system or the existence of inter-state competition.  Its recommendations -- in seeking uniformity of objectives, laws, institutions, and decision-makers -- will undermine further the ability of the States to be different and to compete.  The Commonwealth's whole-hearted acceptance of the Hilmer recommendations is consistent with its centralist vision.

Centralisation, streamlining and imposed homogeneity are antithetical to competition.  The Commonwealth's "competition" policy is fundamentally anti-competitive because it will not allow competition in policy, in regulation, in institutions.  It is fundamentally about managed outcomes.  This will reduce, rather than increase, the scope for diversity and on-going change.

At the August 1994 COAG meeting, the Commonwealth agreed, reluctantly and with reservations, to the States' receiving an unspecified proportion of the yet-to-be identified gains.  The States in turn agreed to the formation of the National Competition Council, the application of the Trade Practices Act to their GBEs, and to most other (but not all) aspects of the Hilmer recommendations.  But relations remain strained, progress on reform has slowed, a great deal of negotiation lies ahead, and the crucial issues -- reform of tax-sharing and overlap and duplication -- were not even addressed.  Nor was the need to integrate competitive federalism into the national competition policy.

LABOUR MARKET

Australian governments in the 1980s failed dismally in the most important area of microeconomic reform -- the labour market.  Although there was almost continuous change in labour market policies over the last decade, the change was concentrated on the cosmetic end of policy;  change to structure and philosophy has been glacially slow, ad hoc, and often retrograde.  For the most part, governments acted as defenders of the status quo, resisting change and trying to hide it with fancy foot-work and disinformation.

The reform that was achieved was in the main forced on governments by the changing political agenda, by business groups and, most importantly, by international competition.  Although governments may try, the labour market cannot be sheltered from the competitive pressures confronting the product and service markets.  Demand for labour is, after all, derived from the demand for goods and services.  Government reforms designed to enhance the level of competition in goods and services inevitably lead to the need for faster and broader reform of the labour market.  Indeed, reform of the labour market should have been the first reform off the rank.  If goods and services are exposed to greater competition but operate in a protected labour market, as was increasingly the case in Australia, ⁽⁴⁷⁾ the inevitable result will be higher levels of unemployment.  Firms will be forced to shed labour, substitute capital for labour, or even worse, go out of business or move offshore.

As a result of the slow pace of reform, Australia's industrial relations (IR) system was considered in 1993 to be the most fragile in terms of employer/employee relations in the OECD, except for Turkey, Greece and Spain, and even worse than the majority of the 15 non-OECD countries examined in the World Competitiveness Report (see Figure 11).

Although governments at all levels were culpable, the Commonwealth bears most of the responsibility for the slow pace of IR reform over the last decade.  The Commonwealth has considerable potential power over most aspects of the labour market;  power continuously exercised since 1983.  Indeed, the high degree of centralisation in IR is one of the main characteristics of the Australian system.  This was accentuated during the 1980s with the establishment of the Accord between the ACTU and the Commonwealth Government.  The Commonwealth resisted any countervailing action by the States.  In the mid 1980s, for example, the Queensland Government introduced individual employment contracts between firms and employees.  These were used extensively by SEQEB (the state-owned electricity utility in South-East Queensland) and resulted in huge improvements in productivity and costs.  The Commonwealth Government vigorously resisted the Queensland initiatives and took SEQEB and the Queensland Government to the High Court in an attempt to prevent the use of such contracts and to assert its control over IR.  The Commonwealth also maintained a steady campaign of low-level intimidation against the reforms introduced by New South Wales in the early 1990s.  Except for Queensland (where, in 1990, the earlier reforms were in any case largely reversed by the Goss Government) and New South Wales, the States did not attempt until recently to challenge the Commonwealth's dominance or to push for thoroughgoing reform;  as a result they are partly responsible for the national IR fiasco over the last decade.

The Prime Minister, in a speech to the Institute of Company Directors on 21 April 1993, laid out his Government's post-election vision for reform to the IR system.  This vision is ample proof that the Government is aware of the need for faster and more comprehensive reform, and offers a very friendly set of benchmarks for assessing the outcome in the form of the Industrial Relations Reform Act 1993.

In this speech, the Prime Minister argued that:

• wages and conditions of work, for most employees and businesses, should be determined by agreements between employers, employees and their unions at the enterprise level, and these agreements should fully substitute for awards;
• awards should serve only as a safety net for the minority of employees unable to make workplace agreements;
• compulsory arbitration should be used rarely by the Industrial Relations Commission;
• unions should not have to be party to workplace agreements;  and
• there should be clear, substantial and easily enforceable penalties for breaches of agreements.

Brendan McCarthy ⁽⁴⁸⁾ has evaluated the Industrial Relations Reform Act 1993 against the principles enunciated by Mr Keating.  He found that the Act in the main failed to meet the Prime Minister's principles, that it did not diminish the role of awards, of union monopoly, of compulsory arbitration, or of barriers to enterprise bargaining.  Indeed, he found that the Act "... does not have one redeeming feature".  Judith Sloan reaches a similar assessment. ⁽⁴⁹⁾  Even by its own criteria, the Commonwealth Government is still failing adequately to reform IR.

The States, after a long period of subservience to the Commonwealth, have now taken the lead in IR reform.  The Kennett Government has led the way, followed soon after by the Court Government and the Brown Government.  These State Governments have all introduced new IR legislation which is in general more consistent with the reform principles spelled out by the Prime Minister in April 1993, than is the Commonwealth Act.  All the States differ from each other and some States, particularly Victoria, go further than was envisaged by the Prime Minister.  But all of them envisage or at least facilitate a reduced role for awards, the elimination of union monopoly, a greatly diminished role for compulsory arbitration, and a significant reduction in the barriers to enterprise bargaining.

The Commonwealth is now resisting the States' initiative in reform even more vigorously than in the past.  In other words, despite having botched its own attempt at reform, it is again attempting to stop the States from doing their and its job.  This, more than any other single action, proves that the current Commonwealth Government has lost the will and the courage to reform, and worse, is holding back the States from doing the job.

In the new Act, the Commonwealth is relying on the external affairs Constitutional power, via a couple of specious ILO conventions, to increase its dominance of the labour market and stop State reforms.  It has had some success to date:  a significant number of unions, particularly those representing State public-sector workers, have been enticed from State to Commonwealth jurisdiction by the lure of better conditions and less reform.  The Victorian Government, along with Western Australia, has launched a High Court challenge, but in the meantime State reform is being steadily undermined.

CONCLUSION

Although much economic reform was achieved during the 1980s, more remains to be done.  Indeed, in many areas of reform, little ground was gained during the 1980s.

The task of the 1990s is to speed up the pace and breadth of economic reform on all fronts by all governments.

Contrary to received wisdom, the States are currently setting the pace in most areas of economic reform.  They are, incidentally, displaying in full the benefits which well-executed federalism can offer.

The Commonwealth, which did spearhead the process of reform in the 1980s, is no longer doing so.  It is lagging behind the States, and in some areas has lost the plot altogether.

The Keating Government of the 1990s is not living up to the standards of the Hawke Government of the 1980s, and the State Governments are different -- radically so -- from the State Governments of the 1980s.

The belief that leadership naturally emanates from Canberra, and that the States are not to be trusted with money and serious reform, is, despite widespread acceptance, without foundation.

The essential fact of Australian politics now is that good Federal-State relations are essential to most of the reforms which count:  competition, tax, IR, health, education, training, and most of the accepted microeconomic reform agenda.

Reform of Federal-State fiscal relations is a vital, indeed central, element of the economic reform agenda.  The current system, by resting too much control with the Commonwealth, is restraining the current performers -- the States -- and slowing the pace of reform.  It wastes scarce time and resources in fights between the States and Commonwealth over powers and responsibilities.

The tasks are clear:  the New Federalism process should be resuscitated as a matter of priority;  the States should be given access to greater tax powers;  and the functions and responsibilities of all levels of government should be made clear, with minimal overlap.

Given these changes, even if the Commonwealth continues to perform poorly, at least the States can get on with the job of accelerating economic reform.

---

ENDNOTES

1.  Of the many daily examples, one might cite Glen Milne, "Lack of Challenge Sends Keating off on Walkabout", Australian Financial Review, 20 June 1994.  The media coverage of the Darwin COAG meeting was entirely typical.

2.  See, for example, Don Greenlees, "Business Goes into Top Gear", The Australian, 20 June 1994.

3.  Business Council of Australia, Australia 2010:  Creating the Future Australia, Melbourne, 1993, pages 35-36.

4.  ABS Cat. No. 1350.0, August 1994.

5.  Commonwealth Treasury, Economic Round-Up, Winter 1994, pages 56-57.

6.  Judith Sloan, An Economist's Guide to the Industrial Relations Reform Act, Working Paper No. 1/94, The Full Employment Project, Institute of Public Affairs, Melbourne, 1994, page 10.

7.  ABS Cat. No. 5501.0, 1993-94.  During the 1990s, the Commonwealth budget deficit figures became increasingly distorted, understating the bottom line.  The two main sources of distortion were the inclusion of the proceeds of major asset sales, and repayment of debt by the States.  These funds are temporary in nature and relate to existing liabilities which are not included in the budget.  They have both been excluded in the data displayed in Figure 1.

8.  OECD, "OECD Economic Outlook", No. 54, December 1993, page 86.

9.  V.W. FitzGerald, National Saving:  A Report to the Treasurer, Canberra, AGPS, 1993.

10.  ABS Cat. No. 5501.0, 1993-94 and 1994-95.

11.  Commonwealth Budget Paper No. 2, 1994-95, page 6.33.

12.  FitzGerald, op. cit., pages 1 and 73.

13.  The modest improvement in national savings evident over the last four months has been solely attributable to the private sector and the low level of investment.  When investment picks up, we will once again see national dissavings (a negative level of national savings).  (See ANZ Bank, ANZ Savings Report, March Quarter, 1994.)

14.  National Fiscal Outlook, Report to the Premiers' Conference, 25 March 1994, Commonwealth Treasury, Canberra, 1994, page 41, Chart 17.

15.  P.J. Keating, Working Nation:  Policies and Programmes, AGPS, May 1994.

16.  Table 3 overstates the growth in State outlays over the period 1993-94/1996-97, as it includes Commonwealth grants which are expected to grow more rapidly than State own-purpose outlays.

17.  Although access to the income-tax surcharge was technically available to the States during the late 1970s and most of the 1980s, the high income-tax rate levied by the Commonwealth, and the refusal of the Commonwealth to make room for the States, effectively prevented the exercise of this option.

18.  P.J. Keating, "Reshaping Australian Institutions", Speech at the Australian National University, 22 February 1994.

19.  W Haynes, "Will Electricity Reforms Deliver Lower Prices?", Business Council Bulletin, No. 103, November 1993, pages 31-35.

20.  Steering Committee on National Performance Monitoring of Government Trading Enterprises, Government Trading Enterprises, Performance Indicators, 1987-88 to 1992-93, Melbourne, Industry Commission, 1994, page 19.

21.  There are differences in the measurement of assets across the GBEs which may seriously distort the dividend payout ratios.  All GBEs do not use the same approach to measurement of assets;  some, if not all, include non-performing assets.

22.  Steering Committee ..., op. cit., page 408.

23.  Richard Filmer and Dan Dao, Economic Effects of Microeconomic Reform, EPAC Background Paper No. 38, February 1994, page 21.

24.  Ibid., page viii.

25.  Steering Committee ..., op. cit., page 18.

26.  Ibid., page 152.

27.  Ibid., page 294.

28.  Ibid., page 326.

29.  Ibid., page 242.

30.  Ibid., page 398.

31.  Filmer and Dao, op. cit., page xii.

32.  IMD World Economic Forum, World Competitiveness Report 1991, Lausanne, 1992, pages 26 ff.

33.  Ibid., pages 80 ff.

34.  PJ Keating, One Nation, Prime Ministerial Statement, 26 February 1992, page 15.

35.  P.J. Keating, Working Nation:  Policies and Programmes, AGPS, May 1994.

36.  See Mark Wooden, "The Green Paper on Employment Opportunities, or Don't You Worry About That", and Peter Kenyon, "Restoring Full Employment:  Backing an Outsider", both in Australian Economic Review, January-March, 1994.

37.  Alan Stockdale, Autumn Economic Statement, Government Printer, Melbourne, page 2/25.

38.  Government of Western Australia, 1994-95 Economic and Financial Overview, Budget Paper No. 5, June 1994, page 83.

39.  Peter Forsyth, "Microeconomic Reform:  Where to from Here?", Policy, Winter 1994, page 20.

40.  Ibid., page 21.

41.  Stockdale, op. cit., pages 3/9-3/14.

42.  Bureau of Industry Economics, International Performance Indicators:  Overview, Research Report No. 23, February 1994, page 33.

43.  Loc. cit.

44.  Stockdale, op. cit., page 2/20.

45.  Commonwealth of Australia, National Competition Policy, Report by the Independent Committee of Inquiry, August 1993.

46.  See the Communiqué issued by Meeting of Premiers and Chief Ministers, 29 July 1994, Sydney (signed by all Premiers and Chief Ministers), page 3.

47.  The same was also true of New Zealand before the passage of that country's Employment Contracts Act in 1991.  It is no accident that, since that time, unemployment has begun to fall faster, and private investment to rise sooner (and faster), than in Australia.

48.  Brendan McCarthy, "Reform Retreat:  The Industrial Relations Reform Act 1993", Policy, Winter 1994, pages 13-17.

49.  Judith Sloan, op. cit.

The External Affairs Power

The Federalism Project
Issues Paper No. 1

INTRODUCTION

The Australian Federation will have its centenary on 1 January 2001, but it is already one hundred years since its Founding Fathers began their deliberations which led to the passage of the Act of the British Parliament we know as the Australian Constitution.  Enormous changes, social, economic and political, have occurred through the twentieth century and it would be surprising, indeed alarming, if our Constitution had not been flexible enough to accommodate its operation to the demands of such a challenging century.  The "external affairs power", assigned to the Commonwealth under that Constitution, has been the focal point of some of these most difficult demands.

In the long list of powers given to the Commonwealth (39 in all), it is sandwiched between powers concerning "the influx of criminals" and "the relations of the Commonwealth with the islands of the Pacific".  The power is couched in very wide terms -- just the two words -- but that is not unusual in a Constitution.  To confuse the nature of this power even more, the addition of the words "and treaties" to that of "external affairs" was removed during the Convention debates, on the ground that these matters would be outside Commonwealth power -- the negotiation and ratification of treaties then being seen as the responsibility of the United Kingdom.  It cannot be said that the Founding Fathers had very clear ideas about the nature of the power.  That is not surprising;  the States were self-governing colonies within the British Empire and the new Commonwealth of Australia would not have any higher status until the idea of dominionhood evolved some decades later.

The development of Australian nationhood has clearly been one of the most notable changes which the Federation has had to accommodate.  The existence of the external affairs power has been of vital importance in that process.  Indeed, if it had not been there it would have to have been invented.  Although the power to make a treaty arises under the executive power, ⁽¹⁾ that in itself would have been insufficient.  Australia had to develop the trappings of nationhood, such as the creation of a diplomatic corps and the reception of diplomats.  It even itself became a colonial power in Papua, and received a mandate from the League of Nations to govern the former German colony of New Guinea.

The external affairs power is much wider than a power with respect to treaties.  "Treaties" cover a range of international agreements, some of which are called by other names;  for instance, conventions, covenants, protocols and declarations.  Even an "exchange of notes" may be included.  Laws relating to diplomatic relations, extradition, war crimes (overseas) and sovereignty over the continental shelf do not require a treaty to give them validity.  The problem only arises when the provisions of a treaty have to be implemented within Australia.  Of course, if a treaty deals only with subjects which are already included in the list of powers assigned to the Commonwealth, there is no problem.  A problem arises when it is desired to implement the provisions of a treaty within Australia when there is no other specific power to do so under the Constitution.

The first test of the ambit of the treaty-making power occurred in the High Court in 1936, in Burgess's Case. ⁽²⁾  The Commonwealth had entered into an international civil aviation convention which laid down rules for the safety of aviation between and within the nations which were parties to it.  Not unnaturally, air travellers are concerned about their safety and not about any nice distinctions between interstate and intra-state travel within Australia.  The Commonwealth legislation therefore raised the nub of the problem.  Unfortunately, the legislation set out its own rules about the safety of air travel in Australia and did not specifically implement the rules of the convention.

The High Court held that the treaty-making power did not permit the Commonwealth to make its own laws on the subject matter of the treaty.  It said, however, that if the legislation had followed the provisions of the convention, then it would have been a valid exercise of the external affairs power, notwithstanding the fact that it applied to travel within a State and was not otherwise within the Commonwealth's heads of power.  Only one of the five Judges (Dixon) was seemingly troubled by this conclusion, and as events have turned out his misgivings were fully justified.  To allay his concern, Mr Justice Dixon expressed the view that this effect of a treaty could only occur if the subject matter of the treaty was "indisputably international" in character.  Another decision of the High Court, in 1965, on the implementation within Australia of another civil aviation convention regarding safety, upheld the local regulations, but it is not clear whether the decision was based on the external affairs power or the "trade and commerce" power.  It did not take the arguments beyond what we found in Burgess's Case.

In 1973, the Federal Parliament implemented two international treaties concerning the continental shelf and the territorial sea.  All the States challenged the validity of the legislation.  At the end of 1975, the High Court, in a decision known as the Seas and Submerged Lands Case, ⁽³⁾ upheld the Commonwealth legislation in its entirety.  A number of the Judges did so on the basis of the treaties.  A majority of the Court, however, held that sovereignty over the territorial sea had never belonged to the States because of their status as colonies.  With regard to the continental shelf, its ownership was itself an external affair and the Commonwealth did not require a treaty to give it the power to acquire it.  Although the various reasons for their decision in this case included these other issues, there remained solid support by the Court for the ambit of the external affairs power extending to the implementation of a treaty.  This was again, however, a case where the matters at issue could be said to be indisputably international in character.

This case was decided within a week of the 1975 election which returned the Fraser Government.  At that stage, there was wide support in legal and political circles for an interpretation of the external affairs power which went beyond the limitations which had been prescribed by Sir Owen Dixon as far back as 1936.  The view was that the treaty itself attracted the power, and that no other "external" element was necessary.  There was, however, no clear-cut High Court decision which took the ambit of the power as far as that.

The Fraser Government, meanwhile, embarked upon a policy of cooperative federalism, and deliberately sought to avoid a confrontation with the States over this issue.  Had the Whitlam or any Labor Government continued in power, I feel sure that this question would have been brought to a head earlier than it was.  This political observation is an important one.  It shows that the resolution of the problem of the external affairs power lies perhaps more at the political level than at the legal level.  I will be returning to this theme at a later stage of this paper.

Despite the best policy efforts of the Fraser Government and at least two most notable achievements of cooperative federalism, namely the National Companies and Securities Scheme and the Offshore Constitutional Settlement, another test of the ambit of the external affairs power arose in the High Court in 1982, in Koowarta v. Bjelke-Petersen. ⁽⁴⁾  The case concerned the validity of a key section of the Racial Discrimination Act, which had been passed by the Federal Parliament in 1975 and had survived any challenge for seven years.  The Act was based on a treaty seeking to outlaw racial discrimination throughout the world.  It was a clear test of the ambit of the power because the case concerned the treatment of an Australian in Australia by an Australian.  On the authorities as they stood, the only way the Act could be upheld would be through the Dixon doctrine or some variation of it.  It was, of course, important for the credibility of the Fraser Government's policy on cooperative federalism that its argument in support of the legislation was consistent with existing decisions and reasoning.  It would have been most provocative for the Commonwealth to argue for the full ambit of the power which fashionable legal and political opinion clearly desired.

The Commonwealth was not directly a party to the dispute, because it arose under a complaint by Mr Koowarta against the Queensland Government.  It was necessary, however, for the Commonwealth to intervene and endeavour to uphold the validity of the Racial Discrimination Act.  It did so on the basis of the Dixon view.  The Act was upheld because one Judge (Stephen J) was prepared to follow that limitation on the power.  The other three Judges of the majority supported a wider interpretation of it, while the three dissenting Judges, led by the Chief Justice Sir Harry Gibbs, took the view that the power could not extend to provisions of a treaty unless there was a relationship between conduct overseas and within Australia.  The civil aviation cases, of course, were a classic example of that.  In Koowarta, that was clearly absent;  but Mr Justice Stephen was able to identify an international concern on the subject of racial discrimination which in his view was sufficient to uphold the implementation of the treaty solely within Australia.

THE LEGAL POSITION

I come now to the last of the great cases on the ambit of the treaty-making power:  the Tasmanian Dam Case of 1983. ⁽⁵⁾  The Tasmanian Government proposed to build a dam on the Franklin River in the south-west corner of the State.  This wilderness area of the State had been placed on the "World Heritage List".  The Fraser Government had tried to dissuade the Tasmanian Government from going ahead with its plans, but -- in accordance with its own policy -- refused to use the external affairs power.  Following the election of the Hawke Government in March 1983, legislation was speedily introduced and passed by the Federal Parliament, relying on the power (among others).  The Tasmanian Government challenged the validity of the legislation in the High Court.  The Court's decision was unambiguous and it seems unlikely that the present High Court will change its view of the ambit of the power as it was laid down in that case.  The law as it stands today can therefore be summarised as follows:

1. The Federal Parliament can implement the obligations of any treaty which the Commonwealth has ratified.  The Parliament can disregard any questions such as degrees of international concern, mutuality of obligations or whether it is purely international in character.  It is, of course, likely that there will be disputes about whether, or what sort of, obligations have been created by a treaty.  Many treaties are couched in very general terms and the nature of the obligation could be obscure.
2. The treaty must be bona fide.  This means that it must not have been entered into as a means of attracting the power.
3. The law must actually implement the treaty obligation and it must do so in a proportionate and reasonable way.  The Parliament cannot simply make a law with respect to the subject matter of the treaty.
4. The power to implement a treaty is subject to the various constitutional restrictions on Federal power such as section 92 (free trade), 116 (freedom of religion) or section 80 (trial by jury).
5. The power is controlled by certain implied limitations on Commonwealth power, no matter how acquired, which prevent the Commonwealth from discriminating against the States or any State or which interfere with their capacity to function as such. ⁽⁶⁾

The High Court has already made some further expansion of its decision in the Tasmanian Dam Case.  It has approved the establishment by the Commonwealth of a commission of inquiry to ascertain the facts relating to the possible exercise of the Commonwealth's power under a treaty:  namely, whether or not certain forests in Tasmania come within consideration for World Heritage listing. ⁽⁷⁾  It has also held -- in a challenge by the Queensland Government to the nomination of the wet tropical forests of north east Australia for inclusion on the World Heritage list -- that there was no legal ground available for Queensland to challenge the claim that such forests are of sufficient environmental importance to warrant this action. ⁽⁸⁾  This, of course, leaves the Commonwealth's Executive in even greater control of its own power and, in my opinion, is quite unacceptable.  The High Court may further expand the power to extend it to any provision of a treaty regardless of whether there is a clear obligation.

Not surprisingly, the Tasmanian Dam Case has led to an enormous amount of concern and controversy which has continued and will continue until some more satisfactory resolution of the problem can be achieved.  Indeed, one might say that only the Mabo Case has displaced it from its place at the top of the charts of famous or, depending on the point of view, infamous High Court decisions.

The Labor Government which initiated the legislation on which the decision was based has not made great use of its new power.  This policy, however, seems to be changing, and we are likely to see an acceleration of its use.  The most recent example is the Commonwealth's Industrial Relations Reform Act (1993) which draws on International Labour Organization Conventions for some of its major provisions.  There is also the proposed legislation aimed at overcoming Tasmania's laws on homosexual conduct, arising out of a finding by the United Nations Human Rights Committee that they are in breach of the International Covenant on Civil and Political Rights.  This interpretation of the Covenant is, incidentally, itself highly contentious.  Even the threat of using the power, also, could force the States to act as the Commonwealth desires.  The concern so far, however, is more about its potential than its actual impact.

It is interesting to contrast the impact of the external affairs power on the operation of the federal structure in Australia with the impact on it of the financial powers of the Commonwealth.  Since the uniform taxation scheme in 1942 at least, the Commonwealth has been slowly widening its influence on a whole range of State responsibilities such as health, education, housing and roads by the power of the purse.  The combined effect of its taxation power and its power to make grants to the States on any terms it thinks fit (section 96) has totally changed the way our federal system operates.  No such claim can yet be made about the external affairs power.  How seriously, then, should its potential be rated?

On its face, it would appear that the power could be used to destroy the federal nature of our Constitution.  This assumes that sufficient material could be found in the treaties which have been entered into over the life of the Commonwealth to extract a basis for Commonwealth legislation on virtually all the areas which still remain within State powers.  Although there seems to be great doubt about the actual number of treaties that the Commonwealth has entered into or which are still current, there are at least hundreds of such treaties which could be ransacked to assist the Commonwealth if it adopted the policy of totally destroying the federal system.  Of course, federalism could be effectively destroyed without any specific such intention by a government in pursuit of other ends.  This, together with even the current use of the power by a Federal Government, would seem to justify an effort to achieve some modification of the existing power.

The most up-to-date official statement about the number of treaties which Australia has entered into or is bound by comes from the Minister for Foreign Affairs, Senator Gareth Evans, in a letter dated 21 July 1994 and published in the Sydney Morning Herald on 1 August 1994.  Senator Evans states that "... there are currently only about 920 treaties which apply to Australia." (emphasis added).  He goes on to say that this is "about average for an OECD country".  He fails to spell out what exactly he means by a treaty "applying" to Australia.  For someone with his legal and political experience this is rather odd.  I assume that he means that those treaties have been ratified by Australia.  In the context, however, of the present debate about the external affairs power, in which Senator Evans was participating in his letter, it is more important, surely, to know how many of those treaties create obligations for Australia.  He extols the benefits of those treaties but ignores the price Australia pays.

THE FAILED SOLUTIONS

It certainly can't be said that the question has been ignored these last eleven years, or that no genuine effort in fact has been made to find a solution to the problem.  On the contrary a great deal of thought and action has been given to it, and a number of proposals have been debated and some partial modifications of Federal policy have been agreed.  Nevertheless, no substantial agreement has been reached on any amendment to the Constitution itself.  This means that no change to the Constitution is in sight.

This conclusion must be very disappointing for those who do feel not only a sense of concern but a real sense of betrayal by Australian politicians (and not just Federal politicians) of the federal principle.  To ease these feelings, if for no other reason, it behoves those who believe in the federal principle to keep searching for and promoting a solution to this most intractable problem.

The Australian Constitutional Convention sat periodically from 1973 through to 1985, when it was disbanded by the Hawke Government and replaced by a Constitutional Commission which was set up to report on changes to the Constitution to mark the national Bicentenary in 1988.  At the Adelaide session of the Australian Constitutional Convention in 1983, a motion was passed about the external affairs power which expressed "... concern that the traditional balance of legislative, executive and judicial powers between the Commonwealth and the States may be destroyed by an expansionary interpretation of section 51(29)".  The motion also requested that a sub-committee be established to consider the effect of this power on the division of powers "... which has traditionally existed in the Australian Federation". ⁽⁹⁾  The External Affairs Sub-Committee, duly established, reported back to the next session of the Convention which was held in Brisbane in 1985.  The Brisbane session accepted a number of recommendations which were designed to improve the role played by State officials in the negotiation of treaties, including also the establishment of a Treaties Council.  The members of this council were to have expertise in international law and inter-governmental relations and the council was to report to and advise both Commonwealth and State Governments on proposed treaties and on the implementation of treaties.  It was to report regularly to all Australian Parliaments.  No recommendation, however, could be achieved through the Convention process for any constitutional change to the ambit of the external affairs power.

In 1984, a bill was developed for an amendment to the external affairs power.  This bill was drafted by a former Commonwealth Parliamentary Counsel, and it was hoped that it would have been considered by the External Affairs Sub-Committee of the Convention.  For some reason, however, that committee finished its deliberations before the bill was introduced.  Accordingly, it was referred to the Brisbane session of the Convention seeking its further consideration by the External Affairs Sub-Committee.  That proposal was narrowly defeated.  Had it been supported by the delegation of the then Queensland Government, it would have been passed.

The bill was designed to confine the power in the way which had been proposed in broad terms by Sir Harry Gibbs in his dissenting judgment in the Koowarta Case to which I have already referred.  It proposed that a new section should be inserted in section 51(29) of the Constitution following the phrase "external affairs", to provide that the power did not authorise laws operating with respect to persons, matters or things in the Commonwealth except to the extent that

1. Those persons, matters or things have a substantial relationship to other countries or to persons, matters or things outside the Commonwealth and the enactment deals with, or with all matters affecting or arising out of, that relationship;  or
2. The operation of the enactment is related to the movement of persons, matters or things into or out of the Commonwealth.

It also proposed to declare that this sub-section was to operate notwithstanding any treaty or international agreement.

The Constitutional Commission was set up in 1986 with a view to major changes to the Constitution being considered for the Bicentenary in 1988.  Unlike the Constitutional Convention -- which comprised delegates from all Australian Parliaments together with delegates from Local Government -- this Commission was hand-picked by the Federal Government.  All the members of the Commission itself were lawyers, although two of them (Mr Gough Whitlam and Sir Rupert Hamer) had had long political experience.  It was chaired by a former Solicitor-General of the Commonwealth, Sir Maurice Byers QC, and its other two members were distinguished Law Professors, Zines and Campbell.

The Commission was also assisted by four advisory committees, which widened considerably the number of people who gave it their experience and views on all the issues which the Commission had to consider.  Nevertheless, the Commission could not be described as representative of Australian opinion.  All the Commissioners came from Sydney, Melbourne and Canberra.  Both the Commission and its advisory committees did, however, carry out a very thoughtful and extensive examination of most aspects of the Constitution -- including the external affairs power.  They considered the history of the power, and the principal proposals which had been made to change or modify it.  Having done this, however, they came to the conclusion that no change to the Constitution was desirable, and they merely adopted the suggestions which had been put forward by the Australian Constitutional Convention.

Sir Rupert Hamer dissented strongly from this conclusion;  while Professor Zines made a valuable suggestion about parliamentary involvement in the ratification of treaties.  As with the Australian Constitutional Convention, however, the bottom line was again that no agreement could be reached about any change to the constitutional power itself.

The reason advanced by the majority of the Commission for preserving the power as it now stands was as follows:

Unless Australia was to withdraw from active participation in many fields of international negotiation and agreement it would be necessary in many circumstances (if the external affairs power was not available) to seek the agreement of the States to the ratification and implementation of treaties.  This would prove in many cases to be slow and cumbersome and in many other cases to be wholly impracticable.  It could in some circumstances permit one or more States to determine in effect the policy for Australia. ⁽¹⁰⁾

This argument overlooks a number of most important considerations.

First, the statement ignores the fact that there are a number of other notable Federations which are also active participants in international affairs -- not least the United States, Germany and Canada.  It is ridiculous to claim that these countries, along with Australia, cannot fully participate in international affairs.  The facts totally refute such a proposition.  It may, of course, be said that some Australian governments have been over-anxious to prove their virility as participants in international affairs, to the extent that considerations of other countries' attitudes and reactions are more important than those of Australia itself.

In the United States, the government may enter into treaties but they have to be ratified by the United States Senate.  That requirement has not stopped the United States from being a party to treaties.  The mere fact of the US government's signing a treaty does not mean it will or can be implemented in that country.  Germany is in much the same situation as Australia.  As far as Canada is concerned, its Constitution assigns some exclusive powers to the Provinces, as their States are known. ⁽¹¹⁾  This gives the Provinces much greater power than the States in the US or Australia and the Laender in the Germany, but Canada has been a most notable participant in the post-war international community.  Even in Australia and Germany, the government alone cannot guarantee the domestic implementation of a treaty.  That requires parliamentary approval.

Second, in 1982, an agreement was reached at the Premiers' Conference setting out rules for co-operation between the Commonwealth and State in regard to the making of treaties.  The agreement was as follows:

1. Information would be given to the States by the Commonwealth at an early stage in the negotiation of a treaty.
2. There would be consultation during the negotiations with the relevant State ministers and officials.
3. In appropriate cases, State representatives would be included in the delegations at international conferences -- at least when State matters were being considered.
4. "Federal clauses" would be sought in treaties which involved matters within State powers.
5. The States would be given the first opportunity of implementing treaty provisions that affected their areas of responsibility.

This agreement was the result of the policy of cooperative federalism which was pursued by the Fraser Government.  It was largely based upon the experience that the Federal and State Governments and their officials had had in operating that process.  The last provision -- whereby States were given the first opportunity of implementing those parts of a treaty which were within their traditional responsibility -- had already been put into practice in some cases.  This was working perfectly well.  It can be highlighted by the nature of the Offshore Constitutional Settlement, which was negotiated as a result of the High Court decision in the Seas and Submerged Lands Case.  There was some reluctance, and indeed resistance, by Federal officials at times, but the States were very alert to complain.  It was the Federal ministers' duty to make such an agreement work.

Unfortunately, when the Hawke Government came into power, it made substantial qualifications to this agreement, to the effect that:

1. The procedures under it should not be allowed to result in unreasonable delay in negotiating a treaty.  (This is really quite absurd when one considers the delays that already occur in the international process of negotiating a treaty.)
2. The Government did not favour the inclusion of federal clauses in treaties.  (It is very difficult to see what possible objection there can be to that, unless it is based upon the notion that Australia would be an international cripple if it didn't commit itself to every word or wish of the international community.  It is true that it is difficult to achieve the acceptance of federal clauses by the unitary states which predominate in these discussions;  but in the event that such a clause could not be agreed, the appropriate course would be for Australia simply to make a reservation about matter within the States' powers.)
3. The Federal Government would not accept any limitation on its power to enact legislation which is "constitutionally subject to Commonwealth power".  (This obviously includes the external affairs power as interpreted in the Tasmanian Dam Case.  This particular qualification therefore totally destroys the objects of the agreement, and simply affirms the aggressively centralist attitude of the Federal Government.)

As stated earlier, Sir Rupert Hamer vigorously and at length dissented from the majority recommendations of the Constitutional Commission.  He emphasised the widely-held view that the High Court, by its interpretation of the external affairs powers, had totally changed the nature of the Constitution from that envisaged by its Framers.  They, indeed, went to great trouble to detail the list of powers assigned to the Commonwealth;  and in his view "... it is inconceivable that they intended to give power to the Parliament to make a law on any other matter merely because it happened to be the subject of a treaty." ⁽¹²⁾  He found it even more remarkable that this could be achieved merely by a decision of the Executive Government without even the requirement to inform, much less consult, the Parliament or be governed by the Parliament on the matter.  I totally agree with these views.

Before I proceed to discuss what could and should be done to overcome this grave failure in the operation of our Constitution, I should refer to two other proposals which have been put on the table, both of which have come from academic lawyers.

One was made by Dr Finnis of Oxford University, who was then an adviser to the Bjelke-Petersen Government of Queensland.  He proposed that the phrase "external affairs" should be expanded with the following words:

but notwithstanding the executive power of the Commonwealth with respect to external affairs nothing ... shall be taken to authorise laws regulating matters within Australia ... other than laws giving effect to Australia's international obligations in relation to fugitive offenders, diplomatic relations with other countries and international organisations, air traffic (or matters otherwise within the power of the Commonwealth).

This represents a small expansion of Sir Rupert Hamer's view, which is that the external affairs power should not allow the Commonwealth to expand its powers using a treaty.  It is interesting to note that Dr Finnis has included laws with respect to fugitive offenders and air traffic as well as diplomatic relations.  In all these cases there is a relationship between people in one country and those in Australia.  These are but particular examples of the matters which are covered in broader terms by my proposal based on the dissenting judgment of Sir Harry Gibbs in the Koowarta Case.

The other proposal has come from Professor Crommelin of Melbourne University.  It is based upon the Canadian scheme of federation, which assigns some exclusive powers to the provinces.  He suggests allocating to the States a rather limited number of such powers, largely to ensure their continuing functioning.  Other exclusive powers are given to the Commonwealth, such as defence, foreign affairs, citizenship, currency and coinage.  All other powers would be concurrent, with paramountcy for the Federal Parliament.  This proposal has not found much favour and it does seem to me that the exclusive powers to be given to the States are too restrictive to be of much value. ⁽¹³⁾

WHAT SHOULD BE DONE

I have dealt with the nature of the problem, and attempted to assess its magnitude and significance for the future of the Australian federal system.  I have discussed the present ambit of the power, and the likelihood that it will be extended rather than reduced by the High Court for the time being at least.  There must undoubtedly be a real question as to whether anything can in fact be done about the situation, however strongly one may feel that something should be done about it.  I must emphasise again that it is not a new problem.  Its roots can be seen in some of the early decisions of the Court.  It is instructive to recall some observations of the then Chief Justice, Sir John Latham, in Burgess's Case.  He wrote:

The Department of External Affairs of the Commonwealth published on 15 August 1935, a "List of International Agreements" (treaties, conventions, etc) to which Australia is a party or which affect Australia, together with prefatory notes.  The list of bilateral international agreements extends over eighteen pages and the list of general and multi-national international agreements extends over eleven pages.  The subjects are so various that it is impossible to classify them.  They include matters affecting extradition, trade and commerce, navigation, legal proceedings, joint stock companies, war graves, commercial arbitration, international arbitration, tariffs, trademarks and other industrial property, friendship and amity, postal matters, medical practitioners, lunatics, submarine telegraph cables, maritime and land warfare, sanitation, white slave traffic, use of white phosphorus in manufacturing matches, copyright, obscene publications, peace after the Great War, labour matters, contagious diseases, dangerous drugs, economic statistics, limitation and reduction of armaments and other subjects.  It will be seen therefore that the possible subjects of international agreement are infinitely various.  [Emphasis added.]

It is interesting to note that very few of these treaties have given rise to any constitutional problem.  It is also interesting to note that the vast majority of these treaties dealt with subjects which involved a relationship between people and matters in Australia, and those overseas.  It is also striking that none of them, except "labour matters", relates to the subjects which have caused the recent problems with the power -- human rights and the environment.  It seems fairly clear, therefore, that it is largely the frenetic activity of treaty-making over the past forty years which is at the root of the problem.  It is important to realise that the High Court has been faced with a significantly different problem from the one which it faced in the period before the Second World War:  treaties now are likely to mandate solutions to social and economic issues on a world-wide scale.

THE HIGH COURT

Until the Engineers' Case, in 1920, the High Court had interpreted the Constitution by reference to two implied limitations on its actual wording. ⁽¹⁴⁾  The Engineers' Case held that full effect should be given to the words of any Commonwealth power without regard to limitations of these kinds.  The High Court, however, never lost sight of the view that it was interpreting a document which set up a federal system.  In 1947 in the Melbourne Corporation Case, the High Court held that, despite the specific banking power (section 5l.xiii), the Commonwealth had no power to force State and Local Authorities to bank with the Commonwealth Bank.  It has also developed a doctrine, of somewhat limited application, which places some restraints on Commonwealth power no matter how clear it may otherwise be.  The most recent case which has given effect to this doctrine is Queensland Electricity Commission v. The Commonwealth, of 1985.  I quote from Sir Harry Gibbs, Chief Justice:

... it is now clear in principle and established by authority that the powers granted by Section 51 of the Constitution are subject to certain limitations derived from the Federal nature of the constitution.  The fundamental purpose of the Constitution and its very frame reveal an intention that the power of the Commonwealth to affect the States by its legislation must be subject to some limitation.  It is clear that there are two distinct rules each based on the same principle but dealing separately with general and discriminatory laws.  A general law will be invalid if it would prevent a State from continuing to exist and function as such.  A Commonwealth law will also be invalid if it discriminates against the States in the sense that it imposes some special burden or disability on them.  [Emphasis added.]

The implied limitation also extends to such a discrimination against one State only, as had occurred in the Queensland Electricity Case.

It may be said that this implied limitation does no more than recognise the fact that a Federal Constitution by its very nature guarantees the existence of its constituent bodies -- which in Australia we call States.  In a unitary state, the central government can do what it likes about local systems of government;  but in a Federation their continued existence is part and parcel of the federal principle.  In the Tasmanian Dam case, the present Chief Justice of the High Court, Sir Anthony Mason (then Mason J) did express the view that this implied limitation might have invalidated the Commonwealth legislation under challenge in that case, if large areas of the State of Tasmania had been brought under its prohibitions.

There can also be some encouragement from the fact that the High Court Justices in the most notable recent cases of Koowarta and Tasmanian Dam have been divided four to three;  although it does seem most unlikely that the present Court will overturn its approach.  There must, however, be a real possibility that a differently-constituted Court may take a different view;  without totally rejecting the existing doctrine, it could at least develop some means of modifying it.  I have shown that there are a number of precedents over the history of the High Court's interpretation of the power, which would enable the Court to develop some greater limits to the power.  I have already mentioned the dissenting judgment of Sir Harry Gibbs in the Koowarta case, and the fact that I had adopted his formula for my bill to amend the external affairs power.  I have no doubt that State governments will keep challenging the Commonwealth's use of the power.  They have done so in the case of the Commonwealth's recent Industrial Relations Reform Act, which has relied on International Labour Organization Conventions to widen the impact of Commonwealth industrial laws.  If the Commonwealth Parliament seeks to overturn Tasmania's laws relating to homosexual conduct, I am sure there will be another High Court battle about that.

Over time, therefore, if the Commonwealth Government follows a policy of putting this power to greater use, there will be many more opportunities for the High Court to consider how far it will allow the Commonwealth to go.  A great deal will depend upon the people who are appointed to it.  But even without a wholesale change in the membership of the Court, the process of public debate, academic discussion, State protests and all those subtle pressures in a democratic community, may convince the Judges of the Court -- or at least a majority of them -- that there are dangers to the federal system in the present interpretation of the Commonwealth's powers. ⁽¹⁵⁾

There is one other ground for hoping that the High Court may be persuaded to review the ambit of its decision in the Tasmanian Dam Case.  Until that case, the Court's best-known decision was the Bank Nationalisation case which held that Section 92 of the Constitution prevented the Commonwealth Government from nationalising the Australian private banks. ⁽¹⁶⁾  After well over one hundred decisions on the interpretation of Section 92, it was by the 1980s a complete shambles.  In 1988, the High Court was persuaded to make a fundamental review of its various interpretations of the section;  and in the subsequent decision (Cole v. Whitfield), it overruled a number of previous approaches and cases and laid down a new principle for the interpretation of the section.  There is no need here to go into to the details of this decision, other than to point out that in this judgment the current High Court has itself made a major reversal of previous decisions.  Cole v. Whitfeld is a powerful precedent for arguing that an interpretation of a section in the Constitution by the High Court which is proving overly controversial or virtually unworkable should be reviewed and may well be reversed.

A POLITICAL SOLUTION

The most promising means of limiting the ambit of the external affairs power lies, in my view, within the political arena.  As I have already pointed out, there have been a number of initiatives in the political sphere which would enable Australia adequately to perform its role as an active member of the international community, but at the same time to observe the federal principle in the exercise of the external affairs power.  The political road does not usually lead to hard and fast solutions, and is certainly not an easy option.  Nevertheless, there is enough experience and evidence to conclude that it is a viable option and more likely to succeed substantially in achieving limits on the external affairs power than by seeking change through the High Court or through amendment to the Constitution itself.

The obvious drawback with the political solution is the major difference between the political parties in Australia about the desirability of limiting the external affairs power.  The Fraser Government followed a consistent policy of restraint in its use of the power and did put in place a framework of cooperative arrangements about its use.  The Labor Party has opposed in principle a policy of restraint in the use of Commonwealth powers, whether of external affairs or corporations or any other.  When the legislation giving effect to the Offshore Constitutional Settlement was being debated in the Parliament, the official Labor view was that in government they would repeal the legislation.  In fact they have never done so, and have continued this major scheme of cooperative federalism for eleven years without any significant change.

As I have said, the Labor government, seen from the perspective of its total legislative programme over some eleven years, has not made much use of the external affairs power although that may now be changing.  There are nevertheless a number of political restraints which would apply to a Labor Government seeking to make full use of the power.  There is still strong State sentiment in Australia.  The Labor Party is, too, strongly based on State organisations and frequently enjoys government at the State level.  I cannot see a Federal Labor government pursuing a policy of deliberately using the external affairs power to the hilt in order to destroy the federal system.  Even if a Federal Labor government embarked upon such a policy, I am certain that the political objections and difficulties would convince it to desist.  Even if I am wrong in this assessment, the government would still have to get its legislation through the Senate and I am sure that that would be a very difficult process.

Political solutions are, of course, never black and white.  Constitutional purists would no doubt prefer a change of attitude in the High Court or a successful referendum which introduced a definite limit on the external affairs power.  Neither of these solutions, however, can be said to be certain and predictable.  A constitutional amendment may turn out to have some ambiguities which qualify or even defeat what its drafters intended.  The High Court may, of course, again change its interpretation or attitude to the power.  Although, therefore, the political solution may be blurred from time to time, it is in my opinion more likely to last as a satisfactory basis for handling this problem than either of the other two solutions.

It is important to note that the current problems with the Federal use of the external affairs power have arisen mainly in relation to issues concerning human rights and the environment.  I have already noted that in Sir John Latham's list of subjects dealt with by treaties up to 1936, neither of these issues was involved.  Interestingly, "labour matters" were, although no problem seems to have arisen until the recent Industrial Relations Reform Act.  I have pointed out that the Civil Aviation Conventions or the Australian sovereignty over the continental shelf or the war crimes legislation in 1988 have not led to the sort of Federal-State controversies which treaties about human rights and environment have caused.  It may well be that in a temperate climate of renewed co-operative federalism, an agreement could be reached whereby human rights treaties could be implemented by the Federal Parliament.  When all is said and done, there is likely to be general agreement about the objects of such treaties.  Similarly, it may well be possible to reach agreement with the States whereby those environmental issues which clearly do have an international significance -- such as pollution of the sea and air, the escape of nuclear particles, major climatic change and such like -- could be implemented by the Commonwealth, and matters which are clearly within the States -- such matters as the Franklin Dam and forestry control -- would be dealt with by them.

There are two positive initiatives on the table which would assist a solution to the problem.  Both can be implemented by Parliament and do not need a constitutional change.  I refer to the proposed Treaties Council, and the need for parliamentary ratification of treaties.  Their drawback is that -- with 920 treaties already applying to Australia -- the horse has bolted.  But not all these treaties have been given legislative effect as part of Australian law, and there is obvious scope for co-operative arrangements about their implementation.

The great art of operating a sophisticated federal system is in constant consultation and frequent if not exhaustive meetings of people at all levels of government.  This impressed me in the way the German Federation seemed to be working when I made a short study of it many years ago.  Australia has already developed a sophisticated system of Federal-State consultations which have led to many co-operative arrangements.  It is not always necessary for the Commonwealth and all States and Territories to agree on a particular arrangement.  Some, like the Loan Council, may be made to which all are parties;  others may be made between States with or without the Commonwealth, such as the Snowy Mountain Scheme.  There seems to me to be every reason for optimism about improving this method of government in Australia.

AMENDING THE CONSTITUTION

I now come to the third solution to the problem, which is a constitutional amendment to the power.  This is the most difficult solution to formulate and the most doubtful of success.  I have already mentioned a number of proposed amendments, including my own.  All have their difficulties and disadvantages, but the overwhelming difficulty with the referendum path is to have it accepted by the Australian people.  Despite the controversy about the Tasmanian dam case and the proposed legislation to decriminalise homosexual conduct by consenting adults in Tasmania, I very much doubt that the Australian electorate as a whole is much disturbed about this issue at the present moment.  That, of course, might change if a Federal government embarked upon a more extensive use of the power.  Even if a Federal government was persuaded to go ahead with such a referendum, therefore, I am satisfied that it would not succeed.  The short answer to the referendum solution is that a Labor government would never entertain it, while a Liberal government would be most unlikely to proceed with such a proposal unless it was likely to have bipartisan support.  I feel quite sure that the chosen solution by a Liberal government would be the one of cooperative federalism.  That is not to deny that the States lobby within the Liberal party would not bring a lot of pressure to bear on a new Liberal government to seek a referendum about the matter.  I just think it is most unlikely that a Liberal government with so many other important policies to implement would succumb to such pressure.

Another difficulty with the referendum road is that of achieving a satisfactory agreement about the precise details of the amendment.  I have already mentioned the experience in failing to get support for the proposal at the Brisbane Constitutional Convention when the delegates of the Bjelke-Petersen government would not support it even though their own proposal had been lost.  I fully admit that the proposal has its problems, and it was strongly criticised by the Constitutional Commission as likely to prove ineffective for its purpose.  This indicates the other difficulty with the referendum proposal:  even if one could be formulated and popularly supported it may well turn out to be a lemon.  For all these reasons, therefore, I dismiss this route as a viable solution to the problem.

CONCLUSION

The external affairs power could be used to destroy the nature of the federal system in Australia, but there is no indication that the Federal Government has deliberately set out to do so.  The Commonwealth has not used it to anything like the same extent as its financial powers in changing the nature of the Federal Constitution.  However, the steady expansion of Commonwealth influence by the use of the power would over time severely alter the federal system.  The potential of the power remains as a serious threat and it should be modified to accord with the federal principle of the Constitution.  Neither a change in approach by the High Court nor an amendment of the power by a constitutional referendum are likely solutions.  The use of the power could and should be modified by political convention.  A policy of cooperative federalism has worked and could quite easily be revived.

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ENDNOTES

1.  That is, the power to undertake executive action, identified in s.61 of the Constitution and embodied in the existence of the Federal Government.

2.  R v. Burgess;  Ex parte Henry (1936) 55 Commonwealth Law Reports, 608.

3.  New South Wales v. Commonwealth (1975) 135 Commonwealth Law Reports 337.

4.  Koowarta v. Bjelke-Petersen (1982) 153 Commonwealth Law Reports 168.

5.  Commonwealth v. Tasmania (1983) 158 Commonwealth Law Reports 1.

6.  Queensland Electricity Commission v. Commonwealth (1985) 159 Commonwealth Law Reports 192.

7.  Richardson v. Forestry Commission of Tasmania (1988) 77 Australian Law Reports 237.

8.  Queensland v. Commonwealth (1989) 167 Commonwealth Law Reports 232.

9.  Australian Constitutional Convention, Proceedings, Adelaide, 1983, volume 1, page 322.

10.  Final Report of the Constitutional Commission, Canberra, AGPS, 1988, para 10.497, page 740.

11.  This means that the Federal Government is prevented from legislating on the areas of government covered by those powers.

12.  Final Report. .., op. cit., para 10.536, page 747.

13.  For the proposals of Dr Finnis and Professor Crommelin, see Final Report ..., op. cit., paras 10.511-14, pages 743-744.

14.  Known as the immunity of instrumentalities and the reserved powers of the States.

15.  The Chief Justice has recently alluded to the role of community attitudes in helping form the High Court's decisions.  Cf his article, "Changing the Law in a Changing Society", Australian Law Journal, volume 67, 1993, page 568.  It is not clear, however, what procedures might be used to ascertain such attitudes.

16.  Bank of New South Wales v. Commonwealth (1948) 76 Commonwealth Law Reports 1.