Tracing the Sources of South Australian Economic Slumps

• Author: Dou Jiang
• DOI: http://doi.org/10.1111/1467-8462.12322
• Published date: 01 September 2019
• Date: 01 September 2019

Tracing the Sources of South Australian Economic Slumps

Dou Jiang

Abstract

This article quantitatively investigates eco-

nomic fluctuations in South Australia from

1990–2014. In particular, the study applies the

business cycle accounting method to decom-

pose the economic fluctuations into their

sources. The main findings suggest that the

low efficiency wedge was the primary source of

South Australian economic slumps. Moreover,

it is shown that infrastructural and R&D

expenditures are important factors in explain-

ing the variation of the efficiency wedge. This

conforms with the fact that the South Austra-

lian Government is keen to support its

development through the economic stimulus

plan. Trade openness may also be a

contributor.

1. Introduction

Since 1990, the economic growth of South

Australia (SA) has lagged behind the rest of

Australia. Over the past two decades, SA’sreal

gross state product (GSP) per capita grew at an

annual average rate of 1.96 per cent, while

national GDP grew at an average rate of 2 per

cent. In terms of level, real GSP per capita in

SA is consistently below the national level.

Figure 1 shows per capita GSP and per capita

GDP, which are de-trended by their average

long-term growth rates from 1990 to 2014.

1

It is easily observed that SA’s economic

performance is feeble relative to the Australian

economy. The overall under-performance of

SA against Australia calls for more attention

from the Government to policy design. It is

imperative to understand the cyclical behav-

iour of the South Australian economy.

SA experienced three major economic

slumps during 1990–2014, including in the

early 1990s, the Asian Financial Crisis, the

Global Financial Crisis (GFC) and subsequent

years. In all three slumps not only were the

economic contractions more severe in SA, but

recovery was also more sluggish. Notably from

1990 to 1992, output in SA declined more

sharply than GDP and the gap widened from

1998. From 2008 the economy entered a long

slump, it was adversely affected by the GFC

and then hit by another recession in 2012.

What accounts for the fluctuations of the

South Australian economy and what factors

caused the recessions and recoveries since

1990? This article addresses these questions

based on a neoclassical model of the business

cycle with time-varying wedges. In particular, I

apply the accounting method developed by

Chari, Kehoe and McGrattan (CKM) (2007) to

decompose the economic fluctuations into their

sources from 1990 to 2014. One major merit of

* International Academy of Business and Economics,

Tianjin University of Finance and Economics, 25 Zhujiang

Road, Hexi District, Tianjin, China. Email <dou.jiang@

uqconnect.edu.au>. I am indebted to my supervisor

Professor Mark Weder for his guidance. I am also heartily

thankful to the Executive Director of The South Australian

Centre for Economic Studies, Professor Michael O’Neil,

for his valuable help.

The Australian Economic Review DOI: 10.1111/1467-8462.12322

°

C2019 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research,

Faculty of Business and Economics

Published by John Wiley & Sons Australia, Ltd

The Australian Economic Review, vol. 52, no. 3, pp. 305–320

the CKM method is that it allows four time-

varying distortions in a model simultaneously.

In a standard real business cycle model the only

primitive shocks that could affect the economy

are technology shocks.

In this approach, frictions appear as four

‘wedges’in the first-order conditions and

prevent the economy from its best outcome

as in a perfect competitive market. These

wedges are: the efficiency wedge, which

measures the efficiency of factor inputs that

are used in the production sector; the labour

wedge, which drives a wedge between the

marginal product of labour (MPL) and the

marginal rate of substitution between con-

sumption and leisure (MRS); and the invest-

ment wedge, which distorts the Euler equation.

These wedges at face value act as taxes on

labour and investment income. The fourth

wedge, the government consumption wedge, is

defined as the sum of government spending and

net export. The CKM approach provides useful

insight into government policies as it helps

policymakers to identify the transmission

mechanisms through which the external shocks

affect the economy and formulate the corre-

sponding policies that reduce these frictions. If

there are more transmission channels, then it

also pins down the primary one (Chakraborty

2006).

The main finding is that the efficiency wedge

is the primary driving force behind South

Australian economic fluctuations. The

government consumption wedge is partly

attributed to the output declines and subsequent

recoveries in the early 1990s. The labour

wedge may explain in part the decline in output

in the recent recession and is important to

labour movements. The investment wedge

plays no role in the output, as it generates

output that moves opposite to the observed

data. However, it captures the behaviour of

consumption. Although none of the wedges

could be safely ignored, the efficiency wedge is

of first importance in explaining the economic

fluctuations in all of the episodes of interest.

The accounting results suggest that attention

should be paid primarily to those frictions that

affect the South Australian economy through

the efficiency wedge. There are several possi-

ble candidates that might deteriorate the

efficiency wedge in SA during recessions.

First, the State Government as a producer

reduces public expenditures in health, educa-

tion and infrastructure. Second, business

expenditure on R&D has declined, which

may lead to resource misallocation. Third,

there is weak trade openness that may have

resulted from the difficulties experienced by

the motor vehicle industry. All of these factors

would impact the Solow residual and generate

production deviations.

In the next section I describe the framework

of the accounting method, including the

prototype model and description of the sto-

chastic process governing the wedges. Sections

Figure 1 Indexes of Real GSP and GDP (1990 ¼100)

2 The Australian Economic Review

°

C2019 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research, Faculty of Business and

Economics

306The Australian Economic Review September 2019