Dog Days: Australia After the Boom (Redback) (2 page)

In February, I came to the view that unless the value of the dollar fell, it would condemn Australians to a recession that would be as unnecessary as, and more damaging than, the one in 1990–91. I embarked upon a series of public seminars and lectures in Melbourne, Canberra and Beijing. I also held private meetings with senior Australian economic officials.

After a big fall in the real exchange rate, it will take time for the non-resources export industries to gather strength and grow again. There will be no economic response until this fall has been with us long enough to convince business leaders that it is here to stay. You cannot fatten the pig on market day.

A big fall in the exchange rate doesn’t sound so difficult. It started to happen in May 2013, with the Reserve Bank’s cut in interest rates and change of rhetoric on the strong dollar, and it will continue as operators in the international money markets recognise the weaknesses in Australia’s external position with the approaching end of the China boom.

Unfortunately, the dollar’s fall is just the beginning of the adjustment that Australians must make at the end of the long boom. What matters is not the exchange rate that is displayed on the television news each night, but the real exchange rate – the overall competitive position of Australia after taking into account differences in inflation rates and productivity growth. A fall in the exchange rate would raise average prices. This would reduce living standards – the amount of goods and services that can be afforded – unless there are corresponding increases in the productivity with which Australian resources are used.

No doubt there would be pressure on government to negate the effects of a falling dollar by allowing incomes and spending to increase to match the rising price of imports. But if everyone is protected from the rise in import prices, no one is protected: the fall in the exchange rate gives us inflation and no improvement in competitiveness, and the old problems return exactly as they were.

Australia enjoyed growth in total productivity of 2.5 per cent per annum in the 1990s. That is as good as it gets (productivity growth has natural speed limits). It is unrealistic to think that having higher productivity growth than the rest of the world will by itself do enough to improve our competitiveness over the next few years. But higher productivity can help: the greater the improvement, the less the required cut in real incomes and expenditures. In addition, the more steps taken now to improve productivity in future (and most reforms yield their fruits only after many years), the less risky it will be to increase foreign debt to fund partial maintenance of incomes during the adjustment period.

By how much do real incomes and expenditures need to fall as productivity rises? If there is a large drop in the exchange rate and a corresponding revival of investment and exports, the fall in incomes and spending only has to be large enough to make up the gap left by the decline in the terms of trade. Not small, but not frighteningly large. We will come back to the numbers later in the book.

If we do not shift our production towards exports and our spending away from imports, and the whole of the adjustment is instead achieved by cutting spending, then the fall in living standards will be very large for many Australians. This will happen automatically if we choose ‘business as usual’. The adjustment will be forced on us by international financial markets as they gradually realise that we are at the end of the China boom, and as the unusually expansive monetary policy of the big developed countries returns to normal. Worse, it is likely that the fall will be unevenly spread, with a disproportionate burden being carried by the rapidly growing number of Australians who want paid work but can’t find it no matter how hard they look.

So this is the economic choice. Do we accept persistent large increases in unemployment and large declines in living standards under ‘business as usual’? Or do we accept a public interest approach: think hard about how to achieve a large reduction in the real exchange rate, lift productivity and share a moderate reduction in living standards across the community?

If we choose the latter approach, we can reach real depreciation in more or less equitable ways. The difference is large in relation to ordinary Australians’ standard of living. The political reality is that if we do not make the adjustment fairly, it will be hard to do it at all.

If we choose public interest reform, we are also choosing to make large changes to some recently but deeply entrenched features of our political culture. That is the hard part of the choice.

CAN OUR POLITICAL SYSTEM MANAGE GOOD POLICY ANYMORE?

Part 3, Chapters 10 and 11, analyses the deterioration in our political culture so far this century, which makes the job of a government seeking to manage in the public interest much harder.

Many changes are necessary for Australia to choose the public interest approach. Every one of them involves some loss of income for some people, and some sacrifice of short-term comfort for future gain. Viewed in isolation, each element of reform is politically challenging. Viewed together, at first sight they look impossible.

A paradox of reform is that it is sometimes easier to make many changes all together rather than one by one, even though each of them is difficult politically. Households and groups may recognise that they will benefit from the reform programme as a whole, although they are hurt by some elements of it in isolation.

Whether comprehensive public interest reform is possible depends a great deal on the quality of political leadership. Quality of leadership is partly about the confidence a society has in its leaders. This is the elusive quality of prime ministerial popularity that was important to the success of the Lyons government in managing measures that gradually took us out of the Great Depression, and to the success of the Hawke government in its reforms of the 1980s through to 1991.

Quality of leadership is partly about a capacity to explain the nature of the choices that must be made on our behalf. Public education is an essential element in any reform programme. It was critical to the productivity-raising reforms, especially of the Hawke government, and also under prime ministers Paul Keating and, in his early years, John Howard.

Whether comprehensive public interest reform is possible also depends a great deal on whether there is a substantial independent centre of the national polity. By an independent centre, I mean those people and groups who take an interest in issues affecting national economic performance and assess each policy by its effects on the Australian public interest and not by its effects on their personal or corporate interests or the fortunes of the political parties with which they are aligned. Participants in the independent centre publish the results of their work without constraint. The independent centre includes not only private elements, but also public ones with traditions and rules that support independence. In Australia these include the core agencies of government, such as the Treasury and Finance departments and the Reserve Bank. The Productivity Commission has played a big role both as part of the centre and as a contributor of information and analysis to strengthen the participation of others in policy development. The universities and their associated think-tanks have traditions of independent contributions. So do other research institutions established with funding arrangements, constitutions and traditions that ensure the people within them can undertake work and publish conclusions that are not determined by private or partisan interests. The centre also includes the best of the media.

Of course, the ideal of independence is not always perfectly realised. The contributors to the Australian independent centre are human. But there is always potential for its mobilisation within the Australian polity.

Economic reform in the public interest is difficult anywhere and anytime. It is more difficult in a democratic polity, where citizens tend to judge harshly leaders who ask for sacrifice of some private comfort for the public interest, or some current comfort for future benefits.

National difficulties or even full-blown crises do not automatically transform this reality, as demonstrated by the fate of European governments in the aftermath of the Great Crash of 2008. Difficulties and crises do, however, provide opportunities for the exercise of high orders of leadership, if the people in office at a time of crisis are up to the task and have before them well-judged programmes of reform.

It is an unhappy reality that policy change in the public interest seems to have become more difficult over time, at least in the capitalist democracies, and probably in authoritarian market economies like China as well, as interest groups have become increasingly active and sophisticated. Two things have changed. First, the range of instruments available for influencing policy has expanded with the modern media, and this has transformed the way that the old media presents public policy choices.

The second change reflects a social shift. Scholars of politics, sociology and economics have long observed that a successful market economy requires citizens to accept restraint in the pursuit of private interest outside the sphere of the market. Capitalism doesn’t work if all of us seek to maximise our private interests in every interaction with society. Leaders will take payments for delivering policies that favour one group over another. Executives will take risks with the assets of public companies in the course of making decisions that increase the value of their own share options and rights; workers will hold their enterprises to ransom; judges will extract personal benefits from their decisions. The law cannot operate if everyone pushes it to the limit for their own advantage. Yet this is how markets do work in many countries – and why markets don’t work in those countries.

The economist Fred Hirsch said that capitalism works because it stands on the shoulders of a pre-capitalist (religious) ideology, and that the waning of this moral legacy over time is a threat. Groups of many kinds have come to feel less inhibited about campaigning overtly for their private interest against government’s assertions that measures are in the public interest.

Modern economic life everywhere is testing how far private interests can set the rules for a market economy. This is making reform in the public interest more and more difficult, and explains the challenges that US and European governments have had in managing the aftermath of the Great Crash. Chapter 11 discusses an important manifestation of this phenomenon in Australia: private interests’ commitment of large sums of money to interventions against specific government proposals.

The challenges are more acute in Australia following the boom. For a long time, no private interests of any kind were asked to accept losses in the cause of improved national economic performance. A new ethos developed within the Great Australian Complacency, which held that there can be no losers from reform. Businesses demand compensation for correction to errors in policy from which they are drawing profits. Households have been led to expect that no change will cause any of them to be worse off. But compensation for any negative effect of a change in policy can cancel out much of the benefit of reform. It is a step forward that some households were moderately disappointed by the budgets of 2012 and 2013.

These are all reasons to be doubtful that our society will choose a public interest response to the problems that lie ahead. The later chapters of this book discuss the policies that would be part of such a response, as well as the political challenges that would have to be met. They seek to discuss realistically the difficulties facing reform. And they consider some reasons for hope that Australians may yet choose the public interest approach.

I also examine critically some of the recent episodes of unconstrained private pressure on the policy process. For example, a closer look leads me to question the received wisdom that the campaign against the mining tax in 2010 was effective in winning over public opinion. It was certainly effective in obtaining a policy outcome, but a cool look at the data informs us that the campaign did not persuade the public. Later chapters also take a close look at what made far-reaching change possible in the face of intense pressure from private interests in the reform period of 1983 to 2000.

Dog Days
concludes that we do have a choice. An Australian leadership committed to the public interest approach, supported by a substantial community of concerned and engaged Australians, could achieve the better outcome for the nation.

The scale of what is at stake makes it worthwhile to try.

Australia must find its way in the Asian Century, at a time when the global balance of economic power is shifting. But this is nothing new: Australia’s economic fate has always been shaped by developments in the wider world. In what follows I trace the story of the modern global economy from its inception to the present. I return to Australia in Chapter 2.

It was the participation of China in modern economic growth from 1978, and then the pace and structure of Chinese development through the early years of this century, that gave us our resources boom. It is China’s shift to a new phase of economic growth, as well as the usual global supply response to high commodity prices, that has brought the boom to an end. Nevertheless, as they continue to grow, the large Asian countries, led by China, India and Indonesia, are set to generate more diverse opportunities for Australia in the twenty-first century.

MODERN ECONOMIC GROWTH IS FULL OF SURPRISES

Modern economic growth originated on the island of Britain only 250 years ago. Today it is still young, raw and changing rapidly. It creates new challenges for humanity as it changes. Right now we are working out as we go along how to reconcile economic growth with the natural and sociopolitical conditions that maintain our civilisation.

While modern economic growth emerged first in Britain, it was the creation of the whole of humanity. It built upon the advances in science and technology that had been gathering pace since the Mongol conquest brought the technological knowledge of Sung Dynasty China to the rest of Eurasia, and since interaction with the scholarly wisdom of Islamic Spain introduced Christian Europe to the mathematical genius of India and the Arab world, and reintroduced it to the intellectual achievements of Ancient Greece. It built upon the innovations in government over large-scale concentrations of people that emerged out of what are now Iraq, Iran and North Africa; the valleys of the great rivers flowing from the Himalayas through the Indian sub-continent and China; and the Roman Empire, along with the smaller states that succeeded it in the Middle East and Europe. And it built upon the systematic questioning of established religious beliefs and practices by the Germanic communities of central Europe.

Over its first century, the new economic growth took root in Britain’s overseas offshoots, including Australia, in adjacent areas of Europe and then in the islands of Japan. It involved the accumulation of capital and the acceleration of invention, which was then applied to commercial processes in order to raise the rate of growth in output.

In the first thousand years after the birth of Christ, the world’s economic output increased by only one-sixth, entirely contributed by population growth. By contrast, in the second millennium, as the late Angus Maddison’s careful work tells us, global output increased 300-fold. In this time, the world’s population increased twenty-two times and output per person thirteen-fold. The expansion in the second millennium mainly occurred after the Napoleonic wars, as the industrial revolution spread through Europe.

Modern economic growth greatly enhances the power of those states in which it takes root. It underwrote imperialism, through which a small part of humanity came to control the lives of almost the whole of the rest. At first it conferred wealth and power mainly on a small number of people in what were becoming the advanced economies; but as it continued over long periods, it came to be associated with rising wages and a broad increase in standards of living. At this stage, it elevated the knowledge, health, longevity and mobility of ordinary people above those of the elites of antiquity.

Modern economic growth fuelled the international exchange of goods, services, capital and technology. It also accelerated the global movement of people, which has been part of the story of human development from the time we left Africa sixty or seventy thousand years ago.

Imperialism extended the spread of economic exchange. However, it did not introduce modern economic growth to the mass of people in South Asia (the British Empire in India extending over what is now Bangladesh and Pakistan), China, the densely populated regions of Southeast Asia and the diverse territories of the Ottoman Empire.

The youth of modern economic growth and our inexperience with it mean that it frequently surprises us. Each new cycle and episode of structural change, each new institutional and technological development, and the accompanying changes in beliefs and institutions and practices, poses dangers to the natural world as well as to the institutional foundations of growth itself. It is never certain that each new problem will have a solution. We discover our destination when we get there.

CATCHING UP IS PAINFUL BUT REWARDING

The high-income economies are at the frontier of change. They grow through the invention of new ways of doing things that alter the economic, and in turn the social and political, structure of our lives.

We now know that once a number of essential conditions have been met, people from any cultural background can partake of modern economic growth. We also know that growth can proceed more rapidly for newcomers, while they are catching up, than for established economies. The newcomers do not have to invent the technology and institutions for themselves; they can absorb these quickly from the international economy.

But such societies must have made growth their priority. They must have effective states, which ensure the provision of a range of public goods and establish a reasonably open exchange of goods, services, technology and capital with the international economy. The new entrants to economic growth can also absorb capital from developed countries, and use their relative abundance of natural resources and labour to generate large gains from trade.

Yet for the latecomers, modern economic growth is more than catching up. It disrupts established beliefs, relationships and ways of organisation. It only takes root where the view is widely held that it is worth the cost. Otherwise, many old and new centres of political power find ways of frustrating its progress and sabotaging the reforms that are necessary to sustain it. Even when there is broad agreement on priorities, old institutions have to adapt to new circumstances, resulting in the emergence of hybrids.

It should therefore be no surprise that most developing countries at first viewed modern economic growth with caution in the aftermath of the collapse of imperialism following World War II. It was the failure of the alternatives, and the prosperity and power of those countries that experienced economic expansion over long periods, that gradually caused developing countries to seek deep integration with the international economy.

Speed limits are imposed by the quality of policymaking within government; the effectiveness of institutions, business leadership and organisation; the education and training of the workforce; and the capacity of all to accept and manage change.

Several East Asian economies were pioneers of modern economic growth in the post-war period: Hong Kong, Taiwan, Singapore and South Korea. Their success was influential in other countries, at first especially in Southeast Asia – most decisively Malaysia and Thailand.

The impact of modern economic growth increased immensely when it put down roots in the three most populous of the world’s developing economies. The shift crystallised in China in 1978, Indonesia in 1985 and India in 1991. There was a much stronger reliance on markets and a deeper integration with the international economy. This led over time to a shift in the centre of gravity of the global economy towards Asia – a development that set the scene for the Asian Century.

Since 1978, China has experienced consistently rapid economic expansion, for longer and more strongly than any country in history.

India’s inward-looking policies in the early decades after Independence generated growth rates around 3–4 per cent. Market-oriented reform with greater integration into international markets saw this rate double in the two decades after 1991.

Indonesia, the third-most populous of the developing countries, has experienced even stronger growth than India, thanks to its adoption of outward-looking policies in the late 1960s and then again in the mid-1980s. Indonesia, like much of Southeast Asia, grew especially rapidly in the 1990s, until the Asian Financial Crisis of 1997–98 provided a lesson about speed limits. The catastrophic decline of output in 1998 destroyed the authoritarian Soeharto government and led to a swift and remarkably smooth transition to representative democracy. The new political foundations were sound enough for Indonesia, like China and India, to experience only a modest downturn after the Great Crash.

DEVELOPING COUNTRIES GROW FASTER IN THE TWENTY-FIRST CENTURY

The big Asian countries were the largest part of a more general shift. The elites of more and more countries came to view the pain and disruption of sustained rapid growth as preferable to the poverty and strategic weakness that accompany the alternatives. Developing countries generally – most powerfully in the rest of Asia and most surprisingly in Africa – experienced higher rates of growth in the early twenty-first century and maintained much of their momentum despite the aftermath of the Great Crash of 2008.

I call this period of widening participation in rapid economic growth the Platinum Age, following what economists came to call the Golden Age of the immediate post-war decades.

Before the Great Crash it seemed that the Platinum Age was also to be enjoyed by the developed countries, helped by the availability of cheap capital from the savings of China and the resource-rich developing economies. There were also expanded opportunities for trade with Asia. Australia and other suppliers of energy and metals experienced a large increase in their terms of trade. Suppliers of capital goods for which there was Chinese demand were also well placed, Germany and Japan most of all.

For reasons that we do not yet understand fully, productivity growth slumped in the developed countries from the beginning of the twenty-first century. For a while, the effects of this decline were obscured by a debt-funded housing and consumption boom. Extremes of financial deregulation and a lack of prudence and morality contributed to a historic lift in asset prices and consumption.

THE GREAT CRASH SLOWS THE DEVELOPED WORLD

From 2007, the flaws in banking were revealed in the failure of one financial institution after another in the United States and Britain, and then on the mainland of Europe. The collapse of one of the largest American banks, Lehman Brothers, in September 2008, precipitated a general disintegration of confidence in financial institutions. Banks would not lend to one another. For a while in late 2008 and early 2009, international trade shrunk more rapidly than in the early stages of the 1930s Great Depression. This was the Great Crash of 2008.

In contrast to what happened after the Great Crash of 1929, governments and their central banks moved quickly. They guaranteed the massive debts of large private institutions and provided them with cash. They reduced interest rates and loosened budgets. Heads of government attended meetings of the G20 group of major economies in an effort to build support for concerted action. The scale and speed of the implementation of anti-recessionary policies was greatest in the Western Pacific, with China’s response being crucial to the containment of the downward spiral, and then to the recovery of regional and global economies.

In some countries – notably Spain – recession turned a sound public fiscal position into a catastrophically weak one. In a number of countries, concern about public debt led to policies of austerity, leading to another slump in activity and even higher budget deficits. The US Federal Reserve, the Bank of England, later and less enthusiastically the European Central Bank, and later still but more enthusiastically the Bank of Japan stimulated their economies through an unprecedented purchase of private assets with cash created for the purpose.

The Great Crash of 2008 ended the artificial boom and left the developed world to live with the reality of low productivity growth. Conditions were made more difficult in many countries by an overhang of public and private debt from the Crash. In the Eurozone, the crisis laid bare unresolved problems of managing a common currency area without a common budgetary system.

Beyond the crucially important possibility of an increase in employment, there is no prospect in the foreseeable future of average living standards rising in the developed countries of the North Atlantic. Indeed, a focus on the average obscures declining living standards for large numbers of people. In the United States, for example, high incomes have risen strongly through this period, while those of ordinary citizens have fallen.

This tendency in most of the developed world has its origins partly in structural features of contemporary economic growth, and partly in changes to regulation and taxation. Jeffrey Sachs and the Nobel laureates Joseph Stiglitz and Paul Krugman are among US economists with high reputations who attribute the latter changes to the increased influence of money in the democratic process.

The rising living standards of ordinary people in developed countries in the decades after World War II supported the legitimacy of capitalism and liberal democracy in competition with communism. Now, if living standards for ordinary people continue to fall, this will have large and unpredictable ideological and political effects.

The large developing countries were affected much less by the Great Crash of 2008. The financial crisis therefore was an inflexion point, after which the relative shift in economic and strategic weight towards the developing countries accelerated and became more obvious to everyone.

China is the biggest story in this historic shift in the centre of gravity of the world economy and will remain so for years to come. It was the largest contributor to absolute growth in the volume of world output and trade from the turn of the century to the Great Crash, and overwhelmingly so from 2008. Its role in the growth of world savings available for investment was proportionately even greater.