Melboure. It's a town of services, not manufacturing

MELBOURNE'S future is here. In the past decade, new professional services firms have mushroomed in inner Melbourne, becoming the state's strongest source of growth in private sector jobs, a conference on Victoria's future has been told.

The Victoria at the Crossroads conference, co-sponsored by The Age, heard that new firms in Victoria's two fastest-growing industries finance, and professional and scientific services are overwhelmingly choosing to set up in the CBD and inner suburbs, in the buzz of the city.

By contrast, new workplaces in transport, warehouses and wholesale trade are springing up in outer western and northern suburbs, along the Western Ring Road, Professor Bruce Rasmussen of Victoria University said.

These clusters of emerging industries hold the key to Victoria's future producing food, services and tourism, and education opportunities for the booming economies of Asia conference speakers agreed.

The secretary of the Department of Business and Innovation, Howard Ronaldson, said new infrastructure such as a Melbourne metro and the east-west link "is arguably the biggest single factor that will make us more productive".

Mr Ronaldson said most big cities now have metro systems, freeing up inner-city road space for commercial vehicles. Melbourne should do the same, he said: "It's a fair bet that most of the high-value-added jobs will be generated in and around the CBD. One of the big demographic shifts recently has been that close to half of all Melburnians live in the suburb they work in, or close to it."

The conference was convened by Victoria University, the Committee for Melbourne and The Age after the high dollar and high interest bills sent Victoria's economy sliding on a wide range of indicators: jobs, investment, retail and housing.

It ended, however, with a consensus that while the high dollar had created real problems for the state in the medium term, its long-term future looked good after a decade of strong growth in knowledge-intensive industries.

"When the Chinese no longer pay as much for iron ore and coal, what will we sell to the Chinese and other middle-class consumers to our north?" asked economist Saul Eslake, of Merrill Lynch. "The answer is likely to be: agricultural commodities, and commercial and personal services. Victoria is better placed than many other states to cater for the likely sources of export demand in the next 20 years."

Also at the conference, Prime Minister Julia Gillard lashed out at the Baillieu government's $300 million cut to TAFEs, using a speech on the Victorian economy to call it "crazy" and a threat to the state's competitiveness.

Ms Gillard also rejected suggestions from business and commentators that industrial relations reform was a "magic bullet" for boosting productivity, instead nominating strong education and training as a far more powerful avenue.

But Ms Gillard did not address demands for more Commonwealth infrastructure spending in Victoria, including calls from state Treasurer Kim Wells to bring money to the table for the east-west road tunnel project.

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For Victoria, it's a case of life in the slow lane

THE problem with the Australian economy is that there isn't one. Rather, there are two of them, or arguably several. The data groups them as one, which makes it a misleading guide.

You know the story, but even so, the data is astonishing. Half of Australia's growth is coming from investment in one sector, mining, which generates just 7.5 per cent of our output. In the past year, on the latest figures, mining investment grew by 80 per cent. This is the biggest mining boom we've seen.

The other half of Australia's growth comes from the rest of the economy. Growth in the mainstream of our economy is just 1 to 2 per cent, in line with population growth. To put it another way: take out mining and its offshoots and growth per head in the rest of the economy is about zero.

Take out mining from the capital expenditure figures, and they show business investment in the rest of the economy has slumped to its lowest level in almost 40 years: less than 5 per cent of GDP. At last report, non-mining business was forecasting a further fall in 2012-13.

If they were some minor part of the economy, you might say, so what? But this is not minor: it's the mainstream of the economy, it's High Street, it's Victoria, New South Wales, south-eastern Australia, south-eastern Queensland. It's us.

Victoria is at the centre of it. After 20 years of surprisingly solid, even enviable, growth, this state is now at the crossroads. The forces that drove its growth in recent years have gone into reverse. The headwinds it has struggled against have grown stronger and more dominant. It is not clear where the state's next drivers of growth will come from.

The story is certainly not all bleak. Victoria's housing industry is no longer running at record levels, but it's still the shining light in a weak national outlook. A couple of big hospital projects saw the state also lead Australia in 2011-12 in new non-residential building approvals. The Baillieu government has budgeted for record infrastructure spending in 2012-13 and is looking for ways to accelerate that in future. And the state continues to outperform the rest in attracting new visitors.

All through Victoria, creative minds are finding ways to overcome the problems heaping up on them: the overvalued dollar, the new wave of consumer restraint and cost-cutting by other businesses and governments. Despite the dollar, many are building or maintaining export-oriented firms. Victoria's exports of goods in 2011-12 grew 10 per cent, faster than Western Australia or the nation.

To explore the options for Victoria's enterprises, The Age has joined with Victoria University and the Committee for Melbourne to present a conference later this week, Victoria at the Crossroads, with speakers including Prime Minister Julia Gillard and Victorian Treasurer Kim Wells, and experts from a wide range of areas.

The springboard was concern that global and Australian economic conditions are now working against Victoria. The state will have to find new sources of growth or remain stuck in the slow lane of a two-speed economy.

For example:

. In the year to March, demand (total spending) grew 10 per cent in the mining states (WA, Queensland and the Northern Territory) but just 2 per cent in the rest of Australia, including Victoria.

. The state's unemployment rate has risen in a year from 4.9 per cent to 5.5 per cent, with the official figures showing 27,000 full-time jobs lost and 41,000 part-time ones added.

Ominously, the June survey of the Victorian Employers' Chamber of Commerce and Industry found only 9 per cent of its member companies surveyed expect the Victorian economy to strengthen over the year ahead, while 61 per cent expect it to weaken.

The problem is that Victoria has lost its main drivers of growth. Spending by foreign students in the state fell by $1 billion in 2010-11 as the high dollar, tougher migration policies and anti-Indian violence sent students elsewhere. The heavy debts we took on in giddier times now restrain consumer spending. In Spring Street and Canberra, expansionary budgets have given way to contractionary ones.

Housing starts in the six months to March were down 16 per cent from their record high a year earlier, and housing is a big buyer of goods and services. House prices have fallen for a year and a half, provoking caution.

Manufacturers from Ford to the backyard sheds are doing it tough and shedding jobs under the crushing weight of the high dollar. And investment surveys suggest there is worse to come.

This is not just Victoria's story; it's the story of south-eastern Australia. The Reserve Bank's recent interest rate cuts will help at the margin, but the core message from policymakers is: it's your problem.

That means it's got to be our solution. We must be tough, resourceful, patient and creative: to find better ways to work, make new products and find new customers. Good luck.

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Fringe fading, inner-city Melbourne booming

MORE than 10 per cent of new homes approved in Victoria in the past year will be built in the city of Melbourne, as developers switch gears to meet the demand for inner city living.

The Bureau of Statistics reports that in the past two years, approvals for new homes on Melbourne's outer fringe have plunged by 25 per cent. Yet approvals in inner Melbourne have almost doubled, almost entirely in the CBD, Docklands and Southbank.

In 2011-12, for the second year in a row, most approvals for new homes in Greater Melbourne were granted in established suburbs within 20 kilometres of the GPO. Of 37,885 approvals in the metropolitan area, 8639 were in the inner ring, 20,374 were roughly within 20 kilometres of the GPO, and 17,511 on the outer fringes.

The figures undercut the state government's decision to take more land out of Melbourne's green wedges for housing. They suggest that increasingly, developers themselves are redeveloping the city and established suburbs to meet demand from buyers.

Last year, Melbourne City Council or the appeals body, the Victorian Civil and Administrative Tribunal approved 5166 new homes in the city, including 1915 in the CBD, 1712 in Southbank, and 640 in Docklands. That was more than the boom municipalities of Wyndham (south-west, 2835 new homes) and Casey (south-east, 2322) combined.

One in 28 homes approved in Australia was in the city of Melbourne. Of the $75 billion of building approvals nationwide, $4.5 billion or 6 per cent was on lord mayor Robert Doyle's turf.

There are fears that supply is rushing ahead of demand, with a risk that apartments could remain unsold, or drive down prices across the inner city, or never be built. Similar fears in 2003-04, however, proved unfounded.

The trend to live closer in is not confined to the CBD. Six other inner or middle suburban municipalities Port Phillip, Stonnington, Monash, Boroondara, Yarra and Moreland each approved more than 1000 new homes, mostly apartments and units.

Of the $7 billion of non-residential building approved in greater Melbourne, $3 billion was in the city centre. But Whitehorse council attracted $554 million of non-residential building, including the Box Hill hospital redevelopment.

On the outer fringes, buyers are going north. The biggest number of approvals last year was in Whittlesea shire, where 3260 homes were approved, mostly in booming suburbs such as South Morang and Mernda. The figures will add to pressure on the state government to extend the new South Morang rail line to Mernda.

Geelong is still booming, with 1897 new homes and $911 million of new building approved in 2011-12. Bendigo approved 1222 homes and Ballarat 985. Overall, metro Melbourne dominated, taking 79 per cent of the state's new homes and 81 per cent of the total value of approvals.

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Melbourne's bustling fringe - 1000 newbies a week

MELBOURNE'S outer suburban fringe is growing at its fastest pace in decades, adding almost 1000 people a week, as greater Melbourne is swelling with almost a quarter of Australia's population growth.

New estimates by the Bureau of Statistics report that, in the past decade, the five areas experiencing the biggest growth in Australia were all outer suburbs of Melbourne.

South Morang grew from a fringe of 6667 people in 2001 to a large suburb of 38,895 by 2011. In one decade, it added the entire populations of Carlton, Fitzroy and Collingwood.

Point Cook was a close second; it began the decade with 2092 people and ended with 33,393, almost as many as South Yarra and Toorak combined. In the west, Caroline Springs added 21,400 people. In the south-west, Tarneit grew from 1427 to 22,473, while in the north, Craigieburn and Mickleham together doubled from 16,647 people to 35,807.

All told, the bureau estimates greater Melbourne grew by a massive 647,164 people in a decade, its population rising 18.6 per cent to 4.17 million in mid-2011.

In the sheer scale of growth, no other Australian city came close. Sydney grew by 477,645 people or 11.6 per cent to just over 4.6 million.

If both cities continued growing at this pace, Melbourne would overtake Sydney by 2028 to reclaim the title of Australia's biggest city for the first time since 1901.

Perth and Brisbane both grew faster than Melbourne Perth growing by 26 per cent to 1.83 million, and Brisbane by 25 per cent to 2.15 million.

The bureau has revised its figures after the census found its estimate of Australia's population was roughly 300,000 too high.

The rapid growth of foreign students coming to Australia to study, interstate and overseas tourists, and service industries more broadly, has been the key to Melbourne's rapid growth. The bureau estimates 60 per cent of the state's population growth came from overseas migration, and just 40 per cent from natural increase.

No other city since the 1960s has experienced growth on this scale, or the strain it has placed on services: from public transport to hospitals, electricity and road space. Those growth strains are widely seen as a key reason for the unexpected defeat of the Brumby government in 2010.

While most foreign students settle in the city and inner suburbs, the city's population growth has been overwhelmingly on the outer fringe. The census found three rings: rapid population growth in the inner suburbs, modest growth (or even decline) in the middle and outer-middle suburbs, and booming growth on the urban fringe.

The 11 innermost councils Melbourne, Maribyrnong, Moonee Valley, Moreland, Darebin, Yarra, Boroondara, Stonnington, Glen Eira, Port Phillip and Bayside added 167,500 people over the decade.

Seven outer fringe councils Wyndham (Werribee), Melton, Brimbank, Hume (Craigieburn), Whittlesea, Casey (Berwick/Cranbourne), and Cardinia (Pakenham) added almost 350,000 people between them.

There was less growth in the middle. The population in Keilor, Wantirna, Endeavour Hills and Frankston shrank.

Regional Victoria saw rapid growth around Geelong, Ballarat and Bendigo and in towns along the coast or the Murray River. The Barwon region added 29,285 people, more than 5000 of them in Torquay alone. But that growth was offset by widespread population losses inland, especially in an arc from the Western District through the Wimmera and Mallee to the irrigation areas in northern Victoria.

More than 1000 people left rural areas around Mildura. Almost 1200, or one in six of the population, departed from around Kerang. More than 3000 left the Wimmera.

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Hamer Hall is back, but at a cost...

THE centre was meant to cost $24 million and open in 1977. But that was before it emerged that it had to build it on the top of old river bed, on silt rich in acid, 40 metres above the bedrock and with workers whose union used the project ruthlessly as a pacesetter in pay and conditions.

The construction of Hamer Hall was not easy. From conception to opening took almost 40 years. It stopped and started as more problems were discovered with the site, relationships frayed, and costs blew out. Had its planners known at the outset what lay ahead, they would never have begun.

But as premier, Dick (later Sir Rupert) Hamer saw it as an act of faith in Victoria's future to build a concert hall and theatre by the Yarra, as the second stage of Melbourne's Arts Centre. Premier from 1972 to 1981, Hamer was the first leader of modern Victoria, a forward thinker who saw the arts as a vital activity to human society, and wanted Melbourne to have the best of them.

As the cost of the project kept escalating, eventually to $225 million, Hamer, as premier, treasurer and minister for the arts, kept finding the money to keep it on track. It was still unfinished when he resigned as premier in mid-1981, but his Labor opponents recognised his role in the project with two unusually generous gestures.

In 1982, as premier, John Cain invited Hamer, the political father of the project, to open the first half of it to be completed the concert hall. And 22 years later, after Sir Rupert's death at the age of 87, then-premier Steve Bracks decided to rename it Hamer Hall, as a lasting memory to a man who had changed the course of Victoria.

But Hamer Hall has many fathers and one mother. Its story began in 1942, when Sir Keith Murdoch father of Rupert, husband of Dame Elisabeth, then head of the Herald and Weekly Times group, and chairman of the National Gallery of Victoria asked a committee of trustees to draw up a 50-year plan to redevelop the gallery, then squeezed into the State Library on Swanston Street.

They decided the best option was to build a new gallery south of Princes Bridge, on the site of Wirth's Park, a popular entertainment area. Albert Dunstan was premier of a Country Party government; he had little interest in the arts or Melbourne, but agreed to reserve the land.

Then Melbourne's music-lovers wanted in on it. Margaret Sutherland, the spirited composer, led a committee that collected 40,000 signatures asking for not just an art gallery, but a "Combined Arts Centre": a 1000-seat theatre, lecture hall, recital studios and courtyard restaurant.

John Cain snr, as head of a Labor government, passed legislation in 1946 reserving Wirth's Park for a national gallery and cultural centre. But it was only when Henry Bolte led the Liberals to power in 1955 that talk gave way to action. Bolte, too, had no interest in the arts, but he wanted to show he would govern for all. He decided to build the National Gallery, and start planning the rest.

Architect Roy Grounds was commissioned to design the gallery at the southern end of the site, on solid rock that was once the cliff overlooking the deep Yarra gorge. There were rows over his design, but the building went up smoothly. When the gallery opened in 1968 to widespread acclaim, Bolte was ready for stage two.

However stage two was not ready for him. The design changed constantly to meet the needs of different users.

In 1966 the cost was put at $11.76 million, but a year later that rose to $27.5 million. Some bits were trimmed, and in March 1969 the premier unveiled a new $24.3 million design, to be built by 1976.

That too proved illusory. Soil testing revealed a site, in one consultant's words: "beyond belief . . . the site is underlaid by soft ground and Coode Island silt. Below the silt is gravel, which forms the old bed of the Yarra, and below that, the basalt rock." And the silt was so acidic it could corrode steel foundations.

Bolte left it to Hamer, Grounds, and Kenneth Myer, long-time chairman of the building committee, to find a solution.

Grounds finally decided to enclose the entire building in a vast underground tub, of concrete a metre thick, surrounded by a protective rubber membrane.

The tub sat in steel pylons reaching all the way down to the bedrock, with electric currents flowing down the pylons to neutralise the acid.

Work finally began in 1977 but not for long. Drillers digging a lift well hit an aquifer, which flooded the site. Norm Gallagher, as head of the Builders Labourers Federation, made the site an industrial relations nightmare.

But Hamer's dedication to the project never wavered, though he agreed to downsize the spire as a cost-saving measure. (Jeff Kennett as premier reinstated the original design). In her history of the Arts Centre, A Place Across the River, Vicki Fairfax writes that Hamer's role in the project was critical: "It is unlikely that without his sustained personal support, it would have had the form . . . it did."

A lover of classical music, Hamer also founded the Victorian College of the Arts and later chaired the Victorian State Opera. His hall is a fine tribute to a broad-minded, generous man who exemplified long-term thinking and tolerance.

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Construction inquiry. Why is building so expensive?

VICTORIAN Premier Ted Baillieu's campaign for an inquiry into construction costs and productivity has finally paid off. The Council of Australian Governments will appoint a panel to review the industry, with wide terms of reference, including workplace relations.

But in a significant shift, the review will be carried out by "three eminent independent people", as yet unnamed, rather than by the Productivity Commission. Unions opposed giving the commission the role, accusing it of bias.

Instead, the panel will be appointed by COAG so appointees will require bipartisan agreement from the Labor federal government and Liberal state governments and comprise people with "relevant legal, industry, workplace relations and economic expertise".

It will report back this time next year after examining:

. The changing market structure of the construction industry, including openness to foreign suppliers.

. The cost of compliance with regulations.

. The impact of taxes and other charges.

. The roles of skilled labour supply and shortages, industrial relations and project management.

Other issues such as allocation of risk, availability of finance, and new technology.

Mr Baillieu said he would have preferred a Productivity Commission inquiry but the terms of reference were satisfactory and its value would depend on who sat on the panel.

"We want to ensure that the three of them are experienced, and they are independent, and they don't have any vested interests," he said. Victoria would oppose unions having a representative on the inquiry.

The timetable envisages the panel being appointed next month, with a secretariat of Commonwealth and state officials set up by September. A discussion paper would be released by the end of the year, and a final report delivered by July 31 next year.

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Stevens thinks things are great, but in Victoria...

VICTORIAN business has sent out a mayday call, warning that the state's economy is deteriorating.

A new business survey reports that conditions have slid to their worst levels since 2009, and are expected to get worse in the coming year.

As Reserve Bank governor Glenn Stevens talked up the economy at a lunch in Sydney, the quarterly survey by the Victorian Employers Chamber of Commerce and Industry (VECCI) and the Commonwealth Bank found a very different message coming up from ground level, in Melbourne and regional towns alike.

The 300 or so employers surveyed said conditions were the worst since the global financial crisis. Sales, profits and business investment were all at their lowest level since March 2009. The only growth was in wages and labour costs, they reported.

Forecasts for 2012-13 were even bleaker. For Victoria, only 9 per cent forecast stronger growth in 2012-13, while 61 per cent tipped growth to weaken.

For Australia, they were only slightly less pessimistic: 13 per cent predicted the economy would improve while 51 per cent expected it to weaken.

VECCI chief executive Mark Stone was almost apologetic, suggesting the results might have been affected by "uncertainty due to global instability (and) . . . the introduction of the carbon tax on July 1". But he said it did reflect recent conditions and urged the federal and state governments to give a lead by:

. Lifting investment in productivity-enhancing infrastructure projects, such as the East-West Link.

. Reducing "unnecessary red tape stifling small business competitiveness".

. Helping more Victorian firms get into export markets.

The survey highlights the reality that Australia is a two-speed economy, growing mostly in the minersphere mining and industries dependent on it. Deloitte Access Economics forecast this week that in the next five years Victoria and the rest of the south-east would grow at barely half the pace of Queensland, Western Australia and the Northern Territory.

"The bulk of the evidence suggests Victoria's slowdown will be modest, with the dangers of its housing setback contained without wider damage," Deloitte said. It predicted that the state's economy would be rebooted by solid growth in consumer spending, sharply rising exports and a housing recovery from late 2013.

Others are less confident. BIS Shrapnel chief Frank Gelber has urged the state government to bump up infrastructure investment, to make it a driver of growth, rather than cut it as planned.

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Getting the roads we need. Let's talk about it.

WHAT would you think if the state decided to sell the Eastern Freeway, West Gate Bridge, or the Western Ring Road to become privately owned toll roads - and invest the revenue from the sales to build better road and rail links?

How would you react if, in future, there were no new freeways, only toll roads, so that the cost of building them falls entirely on users, rather than on taxpayers?

Would you agree if the state decided to give up its AAA credit rating and pay higher interest rates so that it could borrow more money and build the really big projects, such as giving Melbourne an east-west link or a metro rail network like that of Paris or London?

And would you object if the government built a smaller toll road to the port for trucks and commercial vehicles only, with the rest of us banned so that we don't clog it up?

If you haven't thought about all this, better start now. These radical ideas are proposed by federal Treasury, Infrastructure Australia and the private sector to solve the problem of how to finance the $700 billion of infrastructure Australia will need over the next generation.

These ideas are not Baillieu government policy; far from it. Treasurer Kim Wells says the state is considering all options (toll roads) for funding future freeways, but has no plans to sell existing freeways.

Still, that doesn't rule it out. And while the Kennett government took a bit of flak when CityLink turned existing freeways into toll roads, that didn't cost it any seats.

The Gillard government too hasn't endorsed these ideas. Infrastructure Australia chairman Sir Rod Eddington wants governments to start a community debate, but Treasurer Wayne Swan and Infrastructure Minister Anthony Albanese have been too shy to say a word about them.

Some think governments would rather sell off assets remote from our daily lives: ports, for example, although that has its own problems. And you can understand why any politician would be reluctant to suggest that we pay to drive on roads that we now use free of charge.

Similarly, it would take a brave politician to argue that Victoria should double its debt to build the infrastructure we need, rather than accept congestion and poor services as the price of a AAA credit rating.

But Infrastructure Australia, and their advisers on the infrastructure finance working group, are right: this is a debate we have to have. These are issues that touch on our daily lives: the taxes and charges we pay, and the efficiency and convenience of the cities we live in.

Yet our knee-jerk reaction is to oppose all this. Yes, we want better infrastructure, but we're against having to pay for it through higher taxes. We're against governments taking on higher debt to pay for it. And we're against having to pay for it through user charges such as tolls.

The debate needs to move beyond these prejudices. If we don't, our politicians will remain trapped within them, and we will not get the new infrastructure we need. Anyone who wants Melbourne to have better roads, or a metro rail system, needs to start thinking about how they should be paid for.

A good place to start is the refreshingly frank report of the infrastructure finance working group, Infrastructure Finance and Funding Reform, at www.infrastructure.gov.au. Chaired by Jim Murphy, deputy secretary of federal Treasury, the group brought together infrastructure and finance experts from the federal government and the private sector - but no one from the states, which allowed it to be very candid about the options.

It argues that the states have no more room to borrow without losing their AAA credit ratings. In Victoria, John Brumby and Ted Baillieu have pushed state debt almost to the limit for AAA-rated borrowers. Even to keep up existing infrastructure spending after 2012-13, Baillieu would have to tax more, or cut spending on other priorities, or bust the AAA limit and accept a downgrade and higher interest rates.

Clearly, none of those are politically palatable options, but the working group urges governments to think hard about the last one. If the benefits of having the infrastructure outweigh the benefits of having a AAA rating, then it makes sense to borrow and build. The group notes that federal government transport economists estimate that its current infrastructure projects will deliver a return of $2.65 on every $1 invested.

In the past, roads such as CityLink were built as private toll roads, but will ultimately revert to state ownership. The report suggests this be reversed. After new toll roads in Sydney and Brisbane fell far short of targets, superannuation funds see the privatisation of existing roads as much safer investments. The report argues that the states should sell them, use the money to build new toll roads, preferably as joint ventures, then once they're running smoothly, sell them and build more.

The report makes one ugly call. Believing the states will be reluctant to embrace toll roads and asset sales, it wants the federal government to coerce them into doing so, by funding new road projects only if they are built as toll roads. To me, giving Canberra more power is not progress.

Another concern is that its blueprint envisages a road network with multiple private sector owners, yet operating as one flowing entity. This suggests serious challenges that the report does not explore.

But the working group and Infrastructure Australia have put this on the table, as one of the big issues Australia must face up to. If the politicians are reluctant to do so, it's our job as a community to take it up, to think past the stereotypes and simplicities, and face those hard decisions. If it were our choice, what would we do?

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Every major road a tollway?

FREEWAYS could be sold to the private sector and converted to tollways under a radical proposal for state governments to raise money for expensive new road and rail links.

The proposal, if adopted in Victoria, could lead to major roads such as the Eastern Freeway, the West Gate Freeway and the Western Ring Road being privatised and tolled.

Infrastructure Australia, the independent adviser to the federal government which has proposed the plan, says the proceeds could be used to build infrastructure such as hospitals, the Melbourne metro rail network, the missing link of Melbourne's outer ring road, and the proposed East West link under Melbourne's inner north.

But the plan, first proposed by a federal government and private sector working group headed by Treasury deputy secretary Jim Murphy, is being resisted by the Baillieu government.

A spokeswoman for Victorian Treasurer Kim Wells told The Age: "The Victorian government stands by its position that existing roads will not be tolled".

Infrastructure Australia, in a new report on ways to bring Australia's $700 billion infrastructure wish list to fruition, endorses radical options proposed by the working group and suggests states consider:

. Building all new major roads as tollways, not freeways.

. Breaking the narrow borrowing limits required for states' AAA credit ratings to build major new infrastructure projects, if analysis shows the benefits of having the infrastructure outweigh the benefits of having a AAA rating.

. Cutting costs for road freight links to ports by making them smaller and banning private cars from them making them simply toll roads for trucks and other commercial vehicles.

But Infrastructure Australia stopped short of endorsing the working group's idea that the federal government coerce the states by funding new roads only if they are built as joint ventures for eventual private ownership.

The rules currently require states to consider building new federally-funded roads as toll roads.

While the Baillieu government says it has no plans to toll existing roads, it has blocked the release of 27 documents on the issue, after a freedom of information request from The Age.

Mr Wells' spokeswoman said Victoria would not follow Queensland's example and allow its credit rating to be downgraded in order to build new infrastructure.

"We have made it pretty clear that we believe it's important that we retain our AAA credit rating," the spokeswoman said.

The Infrastructure Australia report comes as the Baillieu government ramps up plans to build the controversial East West Link (which was part of a broader transport plan drawn up for the previous Labor government in 2008 by Sir Rod Eddington) just days before the Melbourne byelection.

The Department of Transport has invited 100 local, interstate and international financiers and constructors from 50 companies to a meeting today to discuss how to finance and build the tunnel, which would run under the inner northern suburbs and provide non-stop connections between the Eastern Freeway, City Link and the Western Ring Road.

It is believed the meeting will canvass whether it should be a toll road, the financing options, construction methods, and whether it will include off-ramps into the city.

The tunnel proposal will be a key issue in Saturday's byelection which, in the absence of a Liberal candidate, has in effect become a two-way contest between Labor and the Greens.

The Greens are adamant that the road tunnel should not be built, but Labor's position is more nuanced. It opposes off-ramps to the city rather than the tunnel itself.

Transport Minister Terry Mulder said the road would be one of the most complex projects ever constructed in Victoria. "We are doing our due diligence to ensure that we consider the latest innovations in developing, delivering and funding projects in a challenging financial environment," Mr Mulder said.

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Melbourne's East-west link gets tentative support

INFRASTRUCTURE Australia has given tentative support to the Baillieu government's plans to build the controversial east-west link, a road tunnel under inner Melbourne. But it has refused to back plans to build a rail link to Avalon Airport.

In its 2012 update of infrastructure priorities, the federal government's independent infrastructure adviser again warns Australians they need to embrace ''user pays'' pricing for roads or end up with second-rate infrastructure.

The report says all infrastructure is ultimately paid for by taxpayers or users. Since big road projects can be easily financed by users, it says, future road projects should be built as toll roads, leaving taxpayers to finance other needs, such as railways and hospitals.

In another controversial finding, it urges the federal and state governments to allow 36.5 metre-long B-triple trucks on the Hume Highway, saying this would lift freight productivity. Infrastructure Australia puts the Melbourne metro rail project and a similar scheme in Brisbane at the top of its priority list as Australia's most urgently needed projects.

Also up there is a further rollout of IT equipment to monitor conditions on the Monash Freeway so motorists have instant updates, and upgrading the rest of the Pacific Highway between Sydney and Brisbane to a freeway.

The east-west link, which the Baillieu government calls its top transport priority, made it to the second rung of priorities, being rated as one of 20 projects with ''real potential'' to address ''a nationally significant issue''.

Its ranking implies that governments should pay for a full study of the project. Victorian Treasurer Kim Wells declared victory and ramped up his demand for the Gillard government to put $30 million into developing a business case for the controversial link.

The report's backing came at an embarrassing time for Labor, just a week before the Melbourne byelection.

The Greens oppose the project but Labor is divided, with influential Labor figures saying the city needs to link its key freeways.

The 18-kilometre project would start from the Western Ring Road in Sunshine, cut through the western suburbs and over the Maribyrnong, then run in a tunnel under the inner northern suburbs to link up with the Eastern Freeway. ''Julia Gillard must ignore the opposition of Daniel Andrews and the state Labor Party, who clearly don't care about the jobs and investment this project will bring to Victoria,'' Mr Wells said. It is assumed the project would be built as a toll road.

But an earlier version failed a cost/benefit analysis and with six-lane urban road tunnels now costing $600 million a kilometre, some believe the government will have to scale down its ambitions to make it a paying proposition. Infrastructure Australia refused to support the Baillieu government's request to finance a study into a rail link to Avalon Airport. It also passed over a request for funding to study removing level crossings.

Infrastructure Australia chairman Sir Rod Eddington said the community must ''look hard and long at our future infrastructure needs and the sorts of cities and regions we want to live in''.

''Our communities deserve appropriate, well-functioning infrastructure and we need to examine ways to provide these assets at least cost to the community,'' Sir Rod said.

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Who are we. Melbourne, as seen by the census

ONE in three of Melbourne's residents today was born in another country. Almost as many speak a foreign language at home. Nearly one in five is of Asian ancestry, mostly Chinese or Indian.

You see it every day on the streets, but the 2011 census has confirmed that Melbourne has become a different city different not only from what it used to be, but from the way the rest of Australia still is.

The census results show that more than just the ethnic make-up has changed. Migration has reinforced the city's traditional values, because the newcomers tend to be socially more conservative than those born here.

First, Melbourne has become much better educated: the census found 72 per cent of adult residents have completed year 11 at least, compared to just 60 per cent in the rest of Australia. The city has 18.6 per cent of Australia's population, yet almost a quarter of Australia's full-time university and TAFE students study here.

Second, Melbourne is relatively young. In the rest of Australia, the census found only 34 per cent of people are aged 20 to 44, with 40 per cent aged 45 and over. In Melbourne, by contrast, 38 per cent of people are aged 20 to 44, with just 37 per cent in the older group.

Third, despite what many would expect, Melbourne now leans to traditional family values. More residents over 25 are married here than in the rest of Australia. Fewer Melbourne people live in de facto relationships than elsewhere especially among under 25s.

That reflects the impact of the 433,628 immigrants who have settled in Melbourne in the past decade or so. One in four migrants makes Melbourne their home and they bring with them their homeland's values.

For example, the census found Melbourne has fewer divorces and marital breakups than the rest of Australia. Only 12.2 per cent of people over 25 in Melbourne were divorced or separated, but 13.7 per cent in the rest of Australia were.

Melbourne also has a higher rate of home ownership and, relative to housing prices, lower household debt. The census found the median weekly household income was almost $100 or 8 per cent higher than in the rest of Australia, but the median mortgage payment was virtually identical: $1810 a month in Melbourne, $1800 nationally.

While home ownership rates have fallen everywhere, 71 per cent of homes in Melbourne are owner-occupied, with just 28 per cent rented. In the rest of Australia, occupants own 68 percent and landlords 31 per cent. We re also cosier here. Melbourne

has more mediumdensity housing than average and slightly fewer children, and

45 per cent of homes have three or more occupants, compared to 41 per cent elsewhere.

But immigration has also brought diversity, especially in religion. Once, Melbourne was a

stronghold of Anglicans and Protestants. Now their numbers are fast-dwindling, as other religions advance.

The census found 35.4 per cent of people elsewhere in Australia are Protestants, but just 22.4 per cent in Melbourne. Only 10.8 per cent ofMelbourne people now identify as Anglicans, compared to 18.6 per cent in the rest of the country.

By contrast, Melbourne has more than its share of Catholics (27.2 per cent) and twice as

many Orthodox (5.8 per cent) as elsewhere. Almost half of all Australians who follow Judaism live here. And immigration has given it roughly 30 per cent of the nation s Buddhists, Muslims and Hindus.

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Victoria. Great one day, on the slide the next

KEY economic indicators are showing an alarming slide in Victoria's economic activity and weakness throughout the nation's south-east, intensifying speculation of another interest rate cut next week.

Business investment in Victoria slumped 14 per cent in the March quarter from a year earlier, Bureau of Statistics figures reveal.

This wiped away more than 2 per cent of the state's output, as investment sank to 2008 levels.

The high dollar and high interest rates have flattened Victoria's economy, along with most of the south-east and even parts of Queensland and Western Australia remote from mining.

In the six months to March, investment boomed at an annualised rate of 40 per cent in mining, but slumped 10 per cent in service industries and 18 per cent in manufacturing.

A sense of crisis is growing in the global economy. China's index of manufacturing activity slumped 5.5 per cent in May. India reported that its gross domestic product grew by only 5.3 per cent in the year to March, its slowest growth for nine years.

China and India have generated most of the world's growth since 2008, including Australia's export boom. As their demand falls, Australia's trade has sunk into deficit. Commodity prices have slumped 10 per cent, falling 1.8 per cent in May alone.

Futures markets now see interest rates going into free-fall for the rest of the year. They have priced in the equivalent of six more interest rate cuts by December, the first coming when the Reserve Bank board meets on Tuesday.

Economists are divided. The ANZ Bank said the non-mining economy was underperforming and inflation presented no threat. But Merrill Lynch chief economist Saul Eslake said a rate cut now could be wasted, with the federal government handing out $2.4 billion to households through the Schoolkids Bonus and compensation for the carbon tax.

Europe, meanwhile, is sliding deeper into crisis, with no sign of agreement on how to reverse it. Spain's central bank revealed that nervous depositors took ?97 billion ($A124 billion) out of Spanish banks in the March quarter, even before the turbulence of May.

The bureau's figures show Victoria has been flattened by the high dollar and high interest rates.

This week's data shows that:

. Home building approvals slumped 23 per cent in the year to April. Housing, one of the state's great strengths during the global financial crisis, is now in reverse.

. Total construction activity slumped 5 per cent in the March quarter, with building activity shrinking faster than engineering work grew.

? Retail turnover is now flat as shops rely on discounts to attract sales. In the past year, retail sales have simply kept pace with inflation.

. Unemployment on the smoothed trend figures has risen from 4.8 per cent to 5.5 per cent of the workforce, the highest rate outside Tasmania.

Yesterday home prices were added to the list. The RPData-Rismark index reported that Melbourne prices tumbled 2.7 per cent in May alone, and by 8.4 per cent in the past year, to a median price of $490,000.

Westpac economists said the slide in prices was even steeper after seasonal adjustment. In the six months to May, they estimate, house prices fell at annualised rate of 16 per cent, and units and apartments at over 10 per cent.

Westpac senior economist Matthew Hassan said falling prices and rising auction clearance rates suggested part of the slide in May was due to sellers lowering their prices to ''meet the market''.

Manufacturing is also in trouble. The Australian Industry Group's manufacturing index slumped 1.5 points in May to 42.4, its second lowest since 2009. The only growth was in wages, input costs and unsold stockpiles.

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Budget 2012-13: Why Baillieu had to cut.

THE Baillieu government's budget has got us talking. Is the government really so hard up that it has to break its promise not to sack public servants?

Is it taking us back to the Kennett era? Or is it, as Kim Wells claims, actually Labor's fault? Let's check some of that against the facts.

1. Does the government's pledge to cut 4200 jobs take us back to the Kennett era?

Not if you remember the Kennett era. By this stage of its life, the Kennett government had sacked 45,000 public servants, teachers, nurses and police. By its end, 81,000 state and local government jobs had gone: one in four!

The Baillieu government plans to cut its workforce by 4200 over two years. Treasurer Kim Wells hopes to do so by voluntary redundancies, targeting back-office jobs where there is duplication between departments and agencies, or between federal and state programs. People will be sacked only if those numbers fall short.

The state public service now has 37,000 people, up from 23,000 in 1999. Even if all 4200 job cuts come in that core, it would still have 33,000 left. It's not even Kennett Lite.

2. But do we really need it? Has state revenue collapsed?

Sure has. When the government took office, Treasury estimated that Victoria in 2012-13 would have revenues of $49.7 billion to spend. Within 18 months, on unchanged policies, that had shrunk by almost $2 billion, to $47.75 billion.

The government's revenue hikes on WorkCover, water authorities, vehicle rego, car taxes, stamp duties, tax compliance and fines have added $600 million to lift that to $48.35 billion. But it still leaves a gap of $1.35 billion that would have sent the budget into deficit, were it not for spending cuts.

Most of the revenue collapse has come from the GST. The retail slump and the Grants Commission's decision to cut our share of GST money has cost Victoria $1 in every $8 it had expected from its biggest tax. The slump in house prices and sales has created an equally sharp fall in its stamp duty. And the state has few tax options.

So it had to cut spending. It says it's lopped off $1.15 billion in savings. But in net terms, spending will be down just $650 million, or 1.3 per cent, from the forecast Treasury issued in 2010. That's frugal housekeeping, not liposuction surgery.

3. Why do we need a surplus, anyway?

Victoria's budget surplus is not like the Commonwealth surplus. It just means that revenue pays for recurrent spending the cost of running schools, hospitals, public transport, police, and so on, and a bit over.

The bit over is then spent on infrastructure. In 2012-13 the state plans to invest a record $5.8 billion in infrastructure, roughly half from its own funds and half from borrowing. The surplus is not being banked, but invested.

Second, Victoria has own-source revenues of $26 billion, a fraction of the Commonwealth's $375 billion. It has far less ability to rebound from deficits to sustain a balance over the cycle. The target to run surpluses of $100 million is a modest one.

4. Was it all the Labor government's fault, as Wells claims? Did Steve Bracks and John Brumby put Victoria on an unsustainable fiscal course?

No, that claim is phoney. The "unsustainable course" it refers to is the sudden spike in spending during the GFC, when the federal government paid the states to build school halls and the rest.

But that was never going to be sustained. When Brumby lost office, state spending was growing at only 2 per cent.

The truth is that B&B had a splurge in their first budget in 2000-01, then settled down to steady, AAA-rated fiscal responsibility.

Between 2001 and 2008, revenue grew on average by 6.7 per cent a year, and spending by 6.8 per cent. Big deal!

What is unsustainable is raiding the funds of state agencies, as Baillieu and Wells did to produce this surplus. Pots should not call kettles black.

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Victoria: Good housekeepers dust the corners

THIS is a low-key budget from a low-key government. It has few highlights and few lowlights. It will not lead ratings agencies to question Victoria's AAA credit rating, nor to demonstrators outside Parliament House.

It is not really leading Victoria anywhere. It is just good housekeeping: coping with hard times by a nip here, a tuck there, maybe lots of nips and tucks and endless restraint, resisting the temptation to buy new things, so that the state ends up saving a little rather than spending more than it earns.

This time, frugality was not enough to keep the budget in the black. So Ted Baillieu and Kim Wells pulled out a few more tricks to get it over the line. They took $300 million over four years off funding for TAFE courses they see as low priority. They pinched another $420 million from the water authorities.

As a last resort, they scrapped the state's well-targeted first home buyers bonus. That saved just enough $165 million a year to create a respectable surplus in 2012-13, and something more thereafter.

Ratings agencies Moody's and Standard & Poor's gave it a tick of approval. Many Victorians will do the same. It opened no big issues for Labor to attack.

But nor was there anything resembling a jobs plan, or anything aiming to get the economy to fire on all cylinders again.

And there was nothing to answer the question Victorians are asking: why does Ted Baillieu want to be Premier? Where does he want to take us?

At some point, his government is going to have to tell us what it stands for. The budget was a missed chance to do that.

There are good things here. The $311 million of initiatives to protect vulnerable children is welcome. The $2.7 billion of new infrastructure projects will relieve a battered construction industry. Some will welcome the $670 million to build new prisons; others will ask why the state would rather fund prisons than TAFE courses.

The odd thing about this budget is that it is so normal, given that the times we are going through are anything but.

Victoria's economy is struggling under the double burden of the high dollar and high interest rates. Unemployment has climbed to 5.5 per cent. Spending by foreign students fell $1 billion last year.

Home building, retail sales, house prices, manufacturing output, they're all down. And business confidence has sunk with them.

Yesterday's welcome interest rate cut will help, but the budget won't. Since December's budget update, the state has cut $1 billion from this year's infrastructure spending. It plans a rebound to record levels in 2012-13, but over the forward estimates, state infrastructure spending is forecast to decline from 2 per cent of gross state product (GSP) in 2010-11 to just 1 per cent by 2015-16. That's only a projection, of course. And it will have to rise if the three big projects on the budget's planning list the Melbourne Metro rail project, the East West road link, and the container port at Hastings are built any time soon.

The infrastructure needs are endless. This budget commits to remove three of the 175 level crossings that shut roads down. Wells says that on average, Springvale Road is closed for 50 minutes of the two hours of peak traffic, and Mitcham Road for 54 minutes. Who can seriously argue against spending the money needed to fix problems like that?

It's by cutting infrastructure spending that the Baillieu government plans to start reducing the budget sector's net debt by 2015-16, after it peaks at $24 billion, just 6 per cent of GSP. The debate we need is whether we want the infrastructure we desire, or a AAA rating. We can't have both.

In the budget papers, Treasury argues that Victoria's economic state is challenging, but not critical. It says that employment is flat, but not falling, as the statistics report. It believes Victoria is heading for growth of just 1.5 per cent in 2011-12 and 1.75 per cent in 2012-13, not a recession. And it forecasts a recovery to begin early next year, and a positive long-term future based on exports to rapidly growing Asia.

You hope it's right.

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Victoria: Cash tight now, but reform could help

ON TUESDAY the Baillieu government will greet Victorians with either the state's first budget deficit in a generation, or heavy cuts to government spending, or possibly both. That's not its fault: it's just part of what is happening throughout south-eastern Australia as the high dollar and high interest rates flatten the economy.

Juggling the conflicting demands of economic hardliners and Victorian voters will not be easy. While it will not help Treasurer Kim Wells this time, a report this week. however, offers a whiff of reforms in the wind that could give Victoria more revenue to meet future demands for better infrastructure and quality services, at the same time as running a healthy surplus.

Federal Treasurer Wayne Swan released the interim report by former Victorian Labor premier John Brumby, former New South Wales Liberal premier Nick Greiner and Adelaide director and company healer Bruce Carter on how to reform the distribution of the $50 billion a year that the federal government raises from the GST and hands over to the states.

Victorian and NSW premiers have railed against the system of redistributing money to weaker states since the Pharaohs wore nappies. But until now, they got nowhere, because to change it would be a zero-sum game, and the losers would make more waves than the winners. So federal governments just left it to the Commonwealth Grants Commission to be the umpire deciding how much each state will get.

Back in the 1890s, the framers of the constitution envisaged a Commonwealth with limited powers operating alongside self-sufficient states that ran most areas of government activity: education, health, transport, police etc. But they gave the states' main taxes, customs and excise duties to the Commonwealth, and authorised it to make payments to the states of ''financial assistance ? on such terms and conditions as the Parliament thinks fit''.

Gradually the Commonwealth has acquired more and more power, and more and more revenue. The system has kept changing, and the size of those payments has grown massively - as has the amount taken from the bigger states to give to the smaller ones. On average, 50 per cent of state government revenue now comes from the Commonwealth - half through the GST, half through payments for programs such as hospital and school funding.

The GST money is distributed by the Grants Commission, with the goal of giving each state and territory government the same fiscal capacity, regardless of the size of its revenue base or its spending needs. It calculates this by complex estimates of how much revenue a state could raise if it applied the average of all states' taxes, and how much it costs to deliver the average level of services in every state.

In Victoria, it estimates that the state's relatively small size and its people's concentration in Melbourne means government services are cheaper to deliver than in other states - and far cheaper than in the Northern Territory. So Victoria gets less money than its per capita share, and the NT gets far more. On revenue, Western Australia's $4 billion a year of mining royalties puts it in a far stronger position than anyone else, while Tasmania is the weakest.

Ironically, WA was the first state to line up for federal funds, in 1910. For almost a century, its government received more than its per capita share of Commonwealth payments, often far more. But now that mining royalties have made it the main source of funds to subsidise the weaker states, it has begun rocking the boat deliberately to force change to a system that takes its mineral royalties and shares them around with everyone else.

Now that WA and Queensland have joined Victoria and NSW as donor states - WA as a donor on an unprecedented scale - the political balance has changed. For the first time, reform has become possible: indeed, inevitable.

For 2012-13, the Grants Commission has awarded Victoria 8 per cent less GST money than it would get if the funds were distributed to states on a per capita basis. NSW got 5 per cent less than its share, Queensland 1.5 per cent less. But WA was given 45 per cent less, and it forecasts that by 2014-15 it will get only a third of its per capita share. That is politically challenging.

So the Gillard government appointed the first outside review of how the Commonwealth grants are awarded. The presence of Brumby and Greiner on the panel at first raised alarm in the smaller states: in 2002, as Victoria's treasurer, Brumby attacked one Grants Commission finding with the words: ''Victorians are sick of being ripped off by ramshackle, outdated and blatantly unfair funding arrangements.''

Their interim report, however, suggests they were put on the panel because, as smart politicians, they can judge where the best trade-offs lie, and how far reforms can go without forcing WA or the smaller states and territories to try to derail the whole process.

Their interim report is deliberately blurred, specifying directions rather than detail, ruling some options in and others out, and pointedly pressing states to come up with ideas for solving the drawbacks in what they propose. In broad terms, it gives every child a present, and looks for reforms that would smooth the sharp edges off the current system, rather than overthrow it. And that means it could well succeed in delivering real change.

On one hand, it rules out the ambit claim put by Victoria and NSW for the system to be replaced by per capita funding entitlements, with special needs in Tasmania or the NT , for example, to be met by special federal grants. That claim would have given Victoria an extra $1 billion in 2012-13, but cost South Australia a similar sum and cost the NT almost half its budget.

Instead, the panel expresses interest in returning to the former concept of providing each state with ''comparable'' fiscal capacities, rather than identical ones. It points out that no other federation attempts to provide its states with equal resources. In Canada and Germany, they try to roughly equalise revenue capacity, but not spending; in the US, poor states such as West Virginia and Mississippi are left to do their best with what they have. The report hints that it might be better to define an acceptable minimum standard of service, and equalise capacity only up to that level.

It also rejects WA's ambit claims that each state receive at least 75 per cent of its per capita share of GST revenues, and/or that mineral royalties be excluded from the GST calculations. But the panel does agree, if unconvincingly, with the WA/Queensland claim that the cost of providing mining infrastructure is not adequately recognised by the Grants Commission, and asks the states to suggest how to do it.

It also points the way to sensible reforms. Victoria is understandably ropeable that the Grants Commission is taking away almost half the money the federal government gave us to build the new railway through the outer western suburbs (the ''regional rail link''). The panel suggests that big grants for defined ''nationally important infrastructure'' should be either excluded from the process, or included over time, at a reduced rate.

The interim report has defined the contours within which reform is possible. The states will now weigh in with specific proposals for or against the changes suggested, with a final report to be handed to Swan in August or September.

The panel will also have to report back by then on a second reference Swan gave it: asking how he could use the threat of withholding GST money to force the states to accept the tax reforms he wants. Treasurer, that is not a good idea. But that's another issue, for another day.

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Construction costs too high to build things

FOR me, the penny dropped in the 2010 state election campaign. John Brumby pledged to replace the level crossing at St Albans with an underpass. Treasury put the cost at $165 million - for one underpass.

Melbourne has 175 level crossings. Most are on main roads. Andrew McLeod, former CEO of the Committee for Melbourne, warned that unless they go underground, the inevitable expansion of peak-hour train services in future will shut down those roads in peak hours. And 175 times $165 million is almost $30 billion.

Melbourne's population has doubled in the past 50 years, and is on track to double again in the next 50. To house it, we will need to build more than a million new dwellings. If they are to be, as the Grattan Institute puts it, ''the housing we'd choose'', most will be apartments, units and semi-detached homes in existing suburbs. We will build up.

If such a city is to be liveable, it will need to build a metro. It will need new freeways, wider roads and new infrastructure of all kinds. We will have to build, build, build.

But how can we build all this if it costs $165 million to replace one level crossing? Our construction costs, according to the Business Council of Australia, are now 40 per cent higher than those in the US, let alone in Asia. Construction costs in the past decade grew twice as fast as inflation.

Folks, we have a big problem. As Premier Ted Baillieu put it last week: ''Escalating construction costs are pricing us out of infrastructure.''

We pay for the infrastructure. We suffer if the housing we'd choose is unaffordable, or is not built because it would cost more than buyers can afford to pay, or if the infrastructure we need is not built because it costs too much.

We suffer if building costs are out of control. That is why we should welcome the Baillieu government's moves to try to bring them under control.

Two weeks ago, it introduced a construction code for state projects, aimed at achieving ''behavioural change on Victorian building sites'', and stamping out the union rorts that made the Wonthaggi desal plant a $700 million loser for its builders.

The code requires builders with state contracts to enforce the law on right of entry and freedom of association, and ban strike pay and over-award payments. Nigel Hadgkiss, former deputy head of the Australian Building and Construction Commission (ABCC), will head a team enforcing it.

Last week, Baillieu got Julia Gillard to agree to a Productivity Commission inquiry into why Australia's construction costs are so high. Former ACTU president Martin Ferguson, now Minister for Resources and Energy, recently voiced alarm over Australia's declining construction productivity and ''significant cost increases'', including a 24 per cent slump in productivity at one firm.

No one pretends that there is only one problem to fix. But one problem must be fixed if infrastructure and medium-rise housing are to be affordable.

The culture of Victorian building sites must become productive - and not, as at Wonthaggi, one of extorting wages and perks that are out of line with those of the workers who pay the bill.

Construction consultants Napier and Blakeley report that on building sites general labourers cost $75 an hour - including overheads - and high-value tradesmen $85 an hour. They work 36-hour weeks, receive 26 rostered days off on top of normal leave, and when it's wet or hot, they walk off on full pay. And they've just won a pay rise of 27 per cent over four years - with no trade-off to lift productivity.

Why do builders give in? John Lloyd, former head of the ABCC, now with the Institute of Public Affairs, says it's partly the nature of the industry, and partly that some builders hope that it will secure workplace harmony - often in vain.

''Contractors bear the risk and face the penalties if a project goes over schedule,'' Lloyd says. ''They operate on small margins, so they become vulnerable to industrial action and delays.'' In the short term, it's in their interests to give in.

What sort of industrial action? Industry sources say it includes go-slows, raising phoney concerns about safety, interrupting concrete pours, even sabotage. Once a contractor has been burnt by these tactics, the hint of a repeat can induce compliance.

Developers say the ABCC, set up by the Howard government with sweeping powers, brought countervailing power to building sites. ''The unions pulled their heads in,'' says one. ''And since they faced heavy penalties, contractors became more frightened of the ABCC than of the unions.''

But Gillard is replacing the commission as watchdog with what Master Builders chief Brian Welch calls ''a chihuahua brigade'' from Fair Work Australia, with neutered powers.

The state ALP's industrial relations spokesman, Tim Pallas, says he is not convinced there is a problem with the culture on building sites, and if there were, it should be dealt with by an industry roundtable to try to win consensus.

But there is no consensus. Lloyd says the solution is to keep a cop on the beat for 15 years, until union leaders accept that the old ways won't work. This will be a long war.

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Jobs. Bad for Victoria, better elsewhere

VICTORIA'S economic slump has touched a new low, with seasonally adjusted unemployment rising to 5.8 per cent, its highest level for two-and-a-half years, despite a rebound in jobs.
With the state's industries punished by the high dollar, the Bureau of Statistics estimates that in seasonally adjusted terms, Victoria has lost 50,000 full-time jobs in the past year.

Unemployment soared from 4.4 per cent in March, 2011 to 5.8 per cent now. Victoria now has the highest unemployment rate on the mainland; a year ago it was the second lowest behind Western Australia. The high dollar is stripping back its manufacturing, tourism, export and education sectors, while high interest rates have subdued housing activity and consumer spending.

But the pain could get worse, after an unexpectedly large rebound in employment nationally. The Australian dollar soared almost a cent after yesterday's figures came out, as financial markets abandoned their earlier certainty about another interest rate cut.

The seasonally adjusted figures nationally showed a spectacular zag after last month's zig, adding 44,000 jobs. It was the fourth month in a row that the figures have followed a zigzag pattern: falling, rebounding.

But the rebounds have been bigger than the falls, and in March, seasonally adjusted employment climbed to a new record of just under 11.5 million people in work. Unemployment remained at 5.2 per cent.

State Treasurer Kim Wells said the rise in unemployment was "disappointing", but pointed out that seasonally adjusted jobs in Victoria grew by 11,000 in March, wiping out the fall in February. He said the rise in unemployment in Victoria would not deter the government from delivering a surplus of at least $100 million.

"We are committed to our fiscal targets and our economic objects," Mr Wells said.

He also confirmed the government will announce new infrastructure spending in the budget. He gave no details, but said a freeway linking the western suburbs with EastLink was the government's top priority.

Opposition Leader Daniel Andrews called on Premier Ted Baillieu to develop a plan to keep people in work. "These are not numbers," Mr Andrews said. "These are families. These are workers who have lost their jobs."

Australian Industry Group Victorian director Tim Piper suggested the state government consider abandoning its pledge to deliver a budget surplus of at least $100 million.

Mr Piper said unemployment in NSW is now 4.8 per cent, a full percentage point lower than in Victoria. "Something needs to be done to stimulate investment in the community, create confidence and to make companies feel like they can be generating some new business," he said.

The data excited the markets. The dollar soared 0.85? in five hours, to $US1.0391 at the close of local trading. The S&P/ASX200 index rose 34 points.

But the zigzag pattern of recent months also means there is no certainty that the rise in March will be sustained. The Bureau of Statistics' preferred trend measure, which smooths out the zigs and zags, shows the nation added just 25,000 jobs in the past six months.

Western Australia added 42,300 jobs in the year to March, Victoria lost 28,200.

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Recovery. Victoria is in danger of missing out

AUSTRALIA will slowly move into a broad-based economic recovery in 2012-13 but Victoria is in danger of missing out, leading forecaster Frank Gelber of BIS Shrapnel predicts.

Unveiling new forecasts in Melbourne yesterday, Dr Gelber predicted that Australia's growth rate would slowly accelerate from 2.2 per cent in 2011 to 3.5 per cent in the 2012-13 financial year. If realised, that would be its best performance for five years.

But there would be two downsides. Interest rates would start rising again, with the Reserve Bank likely to deliver seven rate rises in the next 15 months. And apart from New South Wales, the south-east of the country will continue to struggle.

"The Australian economy is expected to strengthen further on the back of improving consumer spending and continuing heavy investment in the mining sector," BIS Shrapnel said. "However, the recovery is expected to be slow to set in. We expect the increased activity to prompt businesses outside mining to start increasing investment from later this year, after an extended period of underinvestment.

"However, the high Australian dollar, relatively expensive business credit, negative news from abroad, fiscal restraint and political uncertainty domestically will continue to weigh heavily on many industries and regions."

Mining investment would continue to boom, while trade-exposed sectors such as manufacturing, education, tourism and agriculture would continue to shrink. Government would also shrink, while the great mass of other service industries would keep struggling. Victoria would be main casualty.

"We look out two or three years and it's difficult to see where Victoria's growth is going to come from," Dr Gelber told BusinessDay. "We see investment in Victoria falling."

BIS Shrapnel predicts building starts in Victoria will plunge 20 per cent in the two years to 2012-13, while all other states would grow by between 6 and 21 per cent. Housing starts would fall 28 per cent, bringing Victoria back to the pack after years of outperforming the rest, while non-residential building would shrink 10 per cent.

"Victoria has weakened considerably over the past six months. It's lost its drivers of growth," Dr Gelber said. BIS Shrapnel predicts that a big influx of mining construction workers will lift population growth nationally, but NSW and Queensland will overtake Victoria in growth, with even WA coming close.

"There will be a broadening of investment in Victoria, but what is really missing are infrastructure projects," he said. "Investment is the primary driver of growth and Victoria needs better infrastructure to lift its productivity.

"These are things [the Victorian government] could do. But we can't see the next round of infrastructure projects coming through. Victoria is just falling behind the pack."

Dr Gelber hit out at the federal government's pledge to deliver a budget surplus in 2012-13, but said the collapse of its revenue base would see it fail to get there. "Fortunately, they won't achieve it. But they shouldn't even try," he said.

He urged the federal government instead to invest in "soft infrastructure", such as the CSIRO and other forms of research and development, and to take an axe to the jungle of over-regulation that is clogging up business.

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Our facts have changed. Baillieu needs a narative.

When the facts change, I change my mind. What, sir, do you do?"

- attributed to JOHN MAYNARD KEYNES

WHETHER Keynes ever voiced these exact words is a matter of dispute. What is beyond doubt is that he expressed such thoughts and we remember them because they embody a profound truth. When we find ourselves in a new situation, our ideas must be flexible to respond to it.

Australia is now in a new situation, one unlike anything we have seen before. In the year to December 2011, investment in mining grew by more than GDP did. Mining investment grew by $8.24 billion; the volume of GDP grew by only $7.7 billion.

One industry located mostly in the outback is growing very fast. Most of the rest of the economy, located in the south-eastern cities, where the bulk of Australians live, is growing slowly or not at all.

The main reason our economy has hit a wall is that the Australian dollar has risen to hover around $US1.05 50 per cent above its long-term average of US70?. This has made a wide range of economic activity uncompetitive, forced firms to close and sent tens of thousands of jobs overseas.

Second, the Reserve Bank has set interest rates at levels appropriate for mining, not for the mainstream of the economy. Lending rates for home buyers are now at 2005-06 levels. Lending rates for small business are at late 2007 levels. The economy needs stimulus, yet interest rates are contractionary.

Third, governments are cutting spending to get back to surplus, and cutting hard because revenues have been clobbered by tax losses run up in the global financial crisis, by consumers' caution and by the lack of growth.

Our facts have changed. But our governments, the Reserve Bank and the federal opposition have not changed their minds. What is happening to Australia does not fit the stories each wants to tell us. So for different reasons their policy is to ignore it, and hope that it goes away.

One luminary tells of a recent conversation with a Chinese banker, who gave him an earful of his amazement at Australia's complacency at this threat to our industries. "What is your policy to deal with the dollar at this level?" the man from the world's most successful economy asked with vehemence.

In fact, the banker knew the answer: our policy is to allow Australian manufacturing and service industries to wither, hoping this will "free up" workers to take jobs in mining without causing inflation.

This is not good enough. Our manufacturers are constantly berated with advice that they must be flexible and nimble in responding to challenges. So they do; but it is ludicrous when the advice comes from those who are inflexible in their own job: policy.

Take the dollar. There has long been a consensus in Australia that floating the dollar was a good thing; I too was part of it. The dollar rose and fell over that time, usually between US60? and US80?, sometimes higher or lower. But firms facing trouble could tighten their belts and wait for it to change.

The situation firms face now is very different. Even well-run companies that took tough decisions to adapt to the crisis are now struggling. The dollar has made imports 33 per cent cheaper on the domestic market, and exports 50 per cent more expensive overseas. That is a huge blow to our competitiveness. China would not allow it to happen to its producers, nor would Singapore, South Korea, Taiwan or any other economic success story.

The Bank of Switzerland has drawn a line in the sand; it has intervened in the market to force the franc back below 1.20 to the euro, and keep it there. Central banks can do this because they can create currency. The downside is that increasing the money supply adds to inflation. But the risk of inflation getting out of control in a flat economy is remote.

We need to talk about this. We need to talk too about why Canberra is pledging a budget surplus that will impose a contractionary budget on an already weak economy.

In effect, Wayne Swan is promising us that he will bring down a bad budget that will be the opposite of what Australia needs. And Tony Abbott and his team are attacking him for not promising to make things even worse.

The Baillieu government is in a trickier position. The states have few sources of revenue, and ours is drying up. The Victorian Treasury and its Vertigan review have told ministers they should invest more, but pay for more of it from revenue. And in a normal world, that's the right advice. Victorians need to know that when the state runs a surplus today, it is to invest it in building new infrastructure, not to lock money away in the bank.

Victoria's economic slump into near-recession has been sudden, and due to reasons beyond any state government's control. The government has taken a long time to make decisions, but it is more important that it makes the right decisions rather than fast ones. The Baillieu team has been in power just 15 months. It did not expect to win government, and it came in with a lot of baggage from opposition, most of which it has slowly cast off. It now supports myki, the regional rail link and the desalination plant. Eventually it will abandon its silly policy to put armed guards on every railway station.

Its real problem is that it has yet to decide why it's there. It needs to have a credible central policy that tackles the real problems Victoria faces. It needs to have a story to tell, and be willing to go out, meet people and tell it.

Why was it elected? Primarily because transport infrastructure had not kept up with the demand for services. Building that infrastructure should be its policy. That would lift productivity, growth and jobs. The facts have changed, but that policy would fit them.

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Has Victoria bottomed, or is it sinking?

MATT Hampton can drive around his home town of Nyora, in Gippsland, and point with pride at sheets of metal he made while working at BlueScope Steel's Hastings plant.

Hampton, 38, worked for 15 years at BlueScope, until late last year when he was ordered into a room and offered one of hundreds of redundancies announced by the company in August. He decided to get out while "the going was good".

"We were a bit dumbfounded," Hampton says. "Nobody ever saw that kind of thing coming."

But since finishing in October, Hampton has looked for work in his local area without success. Some of his former colleagues have tried their hands at small business, some have tried the mines, some are still "twiddling their thumbs".

Hampton plans to look for work in other parts of the state or outside the state altogether. "I've lived in Victoria all my life and I love Victoria, but if I have to move to another state, so be it," he says. "It's the state that's going to suffer."

The state, it seems, is already suffering.

In recent weeks, Victorians have been bombarded with a string of bad news, as the state tries to survive and prosper in the shadow of a mining boom that, while physically concentrated in a few pockets of the country, is reshaping the national economy.

In the six months to February, Victoria lost a net 27,700 jobs, according to the Australian Bureau of Statistics. In the year to February, Victorian unemployment has risen from 4.8 per cent to 5.4 per cent, 0.2 percentage points higher than the national rate.

The latest national accounts released last week suggest Victoria is close to joining South Australia and Tasmania in recession, with spending in the state declining 0.4 per cent in the second half of 2011.

On Thursday, the Baillieu government revealed a plunge in taxation revenue, driven by the damp consumer confidence that is hurting retailers and a housing market now receding after defying the gloom for so long.

Meanwhile, the stunning strength of the Australian dollar, a byproduct of the boom, is punishing Victoria's still-substantial manufacturing industry, eroding the retail sector, deterring foreign students and tempting tourists away from domestic destinations.

For the first decade of this century, Victoria consistently outperformed the other south-eastern states. It built more new homes than any other state, providing affordable new homes on its fringe, particularly in the west, and it attracted the largest share of foreign students.

Melbourne became seen as Australia's cool city, attracting tourists and interstate migrants, and it expanded rapidly in high-value services sectors, such as finance and the professions.

But in the past year, those sources of growth have shut down. Housing starts have shrunk from 16,000 in the September quarter of 2010 to 12,000 15 months later. Foreign student numbers have fallen alarmingly, especially from India. Tourists are going overseas and manufacturing jobs and now office jobs are starting to follow them.

Yet the Baillieu government remains determinedly confident. It insists its strategy of cutting costs, including 3600 public service jobs, to ensure a budget surplus of at least $100 million is the best way for the state to navigate the downturn, in part because it will protect the state's triple-A credit rating.

"The volatility of the global economy is being felt in Victoria," state Treasurer Kim Wells said this week. "However, the state is meeting these challenges head on."

Not all agree. This week, prominent company director Elizabeth Proust said the government should be investing more in the state's crowded transport infrastructure and queried the wisdom of cutting thousands of public servants when the state is already losing 1000 jobs a week.

Her comments echoed the sentiments of transport magnate Lindsay Fox, who told The Age last week that the political imperative for surpluses should not precede the need for better infrastructure to create wealth and boost employment. "My biggest concern is that by the end of the year we'll have probably one of the highest rates we've seen of unemployment for years," he said.

More than 2700 Victorian companies entered external administration in the 12 months to January, up almost 10 per cent on the previous 12 months. And Victoria's population growth, which helped keep the economy expanding in recent years, has slowed from 2.25 per cent in 2008-09 to 1.5 per cent in 2010-11.

Statewide, the economic picture is not uniform. "There are people who are doing very well," says Ian Carson, chairman of partners at PPB Advisors, a professional advisory and insolvency firm.

Carson says PPB which also helps "turnaround" troubled operations has been busy, especially with businesses exposed to the high dollar. "We have been busy for four years," he says. But those who are "pro-active" are surviving. "There are many examples of people who are prospering."

But in CBD offices, in suburban shopping centres and high streets, in outer industrial strips and in rural towns, pessimism seems to be setting in.

"People buy fear," says leading business figure David Smorgon. "You can fall into a trap that everything is negative, everything is pessimistic and there is a loss of hope in the community. We are in that cycle of fear."

Months of bad news out of Europe has helped sap the confidence of many Victorians; a Victorian Employers Chamber of Commerce and Industry survey carried out in the three months to December and published last month found just 17 per cent of businesses expected the state's economy to strengthen during 2012, while 40 per cent expected it to weaken.

"For many businesses, the environment is one of uncertainty. There's no doubt jobs are under pressure," says Steven Wojtkiw, chief economist at VECCI.

Yet uncertainty is perhaps the best description of where we're at. The latest National Australia Bank index of business conditions has Victoria at zero, implying that equal numbers of firms are experiencing growth and decline. The NAB's index of business confidence in the state was only slightly worse, at minus two.

Similarly, the Westpac-Melbourne Institute index of consumer sentiment for Victoria in March was 98.4, meaning pessimists only slightly outnumbered optimists. That was a sharp change from 105.5 a year ago and 115.5 two years ago, but it was the second best of any state, if a long way behind top-placed Western Australia (107.0).

In Collins Street high-rises, financial services firms are weary after four years of unprecedented market volatility. Banks have struggled to find people to lend to, insurers have been hit with high re-insurance costs both sectors have announced thousands of job cuts, many in Melbourne. Stockbrokers, too, are limping, with Australian shares although posting a positive few weeks failing to rebound as strongly as in other markets.

"The last few years have been as tough as I can ever remember," says Terry Campbell, the senior chairman of Goldman Sachs in Australia.

A series of retail collapses Fletcher Jones, Brown Sugar, RED Group, Colorado have illustrated the impact of wilting consumer confidence on the state's second-biggest employer.

News of the state's economic slowdown has come as a shock partly because Victoria kept ploughing on through the aftermath of the global financial crisis, its employment and housing markets staying strong.

Retail jobs, for example, surged by more than 20,000, or 8 per cent, in Victoria in the three years to February 2011, on a year-average basis. Jobs in the accommodation and food sector rose more than 15 per cent, and construction rocketed 17 per cent.

Meanwhile, as Perth house prices dropped and Brisbane's trod water, house prices in Melbourne climbed by more than 10 per cent in 2010, making the post-GFC dip a vague memory.

But something shifted over the past 12 months. Over the year to February 2012, the state lost 38,500 jobs in retail and 6300 in the hospitality sector, on the raw figures released by the ABS this week. On a year-average basis, to smooth out the volatility in the figures, the loss was about 13,000 retail jobs and 12,000 in the hospitality sector.

Jobs were gained in finance, the health and welfare sector and professional and scientific services, and construction appears to be holding up, with 3000 jobs added over the past year. But established house prices in Melbourne have dived more than 6 per cent.

"Victoria epitomises the divergence in fortunes between resources-rich states and the rest of the country," says Saul Eslake, chief economist at Bank of America Merrill Lynch.

"To some extent, the weakness in Victoria in recent months owes something to recent strengths. What I think is happening is that Victoria staged a faster recovery in employment after the global financial crisis possibly because Victoria derived more benefit from some of the [federal government's stimulus spending], especially the stimulus applied to housing.

"Now that the stimulus is wearing off and governments are tightening fiscal policy, and because Victoria, almost by definition, is more exposed to the exchange rate, Victoria is now doing worse than the rest of the country."

The high dollar is accelerating the restructure of Victoria's economy that began three decades ago, as the state began its transformation from a manufacturing powerhouse to a services centre.

But although its share of the state's economy has almost halved, manufacturing remains significant in this southern state. It is still the state's second-biggest force, even as its share of the state's economy has declined from 15.5 per cent 20 years ago, to 8.6 per cent of gross state product last financial year.

Finance is now Victoria's lifeblood, expanding from 5.3 per cent of gross state product in 1990-91 to 12.2 per cent last financial year.

Since 2008, finance jobs have jumped by almost 10,000 to 118,000, analysis by The Age shows. Over the same period, some 27,000 Victorian jobs were lost in manufacturing although it still employs almost three times as many people than finance does.

Matt Hampton, for one, is increasingly convinced that his next job wont be in manufacturing. "Manufacturing is a dying art in Australia," he says. "Guys like me should adapt, but a lot of guys can't because that's all they know."

But Ian Carson, who has seen his share of struggling businesses, believes Victoria's manufacturers can survive, as long as they adapt to the new conditions. "The ones which are struggling are the ones doing it the same way they have been doing it for many years and haven't seen the changes coming," he says.

"You can't just go along doing what your dad did or what used to work in the past. You have got to be so pro-active. There are people doing very well and they are people who are innovative."

Carson points to Victoria's continued strength in professional services firms engineers, accountants and management consultants. "Engineering firms based in Victoria and other services are serving not just the mining industry in WA and Queensland but also the world," he says.

Terry Campbell, too, believes there will be some "skim-off" to the economy from the mining boom, and believes things will soon start improving. "We're probably travelling across the bottom at the moment," he says.

Indeed, evidence is emerging that the much-promised "flow through" from the mining boom to non-mining states is taking place. The Reserve Bank argued as much in a bulletin released this week, as it noted that "the benefits of mining investment and exports flow across the country through spending by mining-related firms and workers on goods and services in other states, dividend payments to shareholders, and the tax and transfer system".

Victoria has, in its favour, its status as the second-biggest state in economic terms, and what Moody's describes as its "sizeable and diversified economic base". VECCI's Wojtkiw points to other reasons for optimism the US economy is improving, and Greece has avoided a default, for now.

But whether all of this will be enough to offset the impact of the high dollar and rebuild consumer confidence remains to be seen.

"There are no easy solutions, but in times like this we need government and key businesses people to take a leading role," Smorgon says. "We also need the unions. Maybe things have been too good for too long, because you look at our lack of competitiveness and productivity, and it is obviously a concern."

The next few months will be crucial, for businesses big and small in retail, manufacturing and tourism, for the Baillieu government as it argues the case for its surplus-centred strategy and for the thousands of Victorian workers looking for jobs, and those who may be looking in the near future.

"It's not a time for humpty dumpties in government, in the business world, in the union and the media," Smorgon says. "We don't want people who fall off the wall when it gets tough. We want strong decisions and I sense an absence of strong leadership as we get into this cycle of despair."

Adds one senior insolvency industry figure: "Right now the Victorian economy is in a really delicate position. In retail, we haven't seen the Armageddon that everyone predicted. But what there is, is a crisis of confidence. Everyone [in Melbourne] is nervous about something, they just don't know what they're nervous about."

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