Dog Days: Australia After the Boom (Redback) (3 page)

ECONOMIC GROWTH IN CHINA IS CHANGING

Understanding the nature of China’s economic development is essential to understanding the contemporary world. This development falls into three periods. From 1978 to 1984, reform was concentrated on agriculture and rural development. A rapid increase in rural living standards established a political base for the wider and deeper reforms that followed.

From 1984, the focus shifted to urban and industrial expansion, with a rapidly deepening interaction with the global economy. China entered a period of uninhibited expansion in investment that continued until 2011. This had three sub-plots. Until 1992, there was uncertainty about the boundaries of political and economic reform, and changes in policy were part of a search for an ideological basis to support a deepening use of markets, private ownership and integration with the international economy. From 1992 until late in the decade, there was a tighter drawing of political boundaries alongside rapid liberalisation of trade and payments, a greater use of markets to set prices, and more private ownership.

The deepening integration with the international economy was entrenched by China’s acceptance into the World Trade Organization in 2001. However, the movement towards markets and private ownership stalled with the colossal expansions of state-related expenditure following the Asian Financial Crisis of 1997–98 and the Great Crash of 2008. In response to these two external recessionary threats, large state-owned and state-connected enterprises invested massively in heavy industry, infrastructure and urban development. The Chinese economy under the Communist Party had always been associated with an exceptional intensity of metals and energy use; this was reinforced by the new pattern.

This period of rapid, investment-led growth was challenged by its own success from 2004, with a growing scarcity of labour and rapidly rising wages. The new conditions made their first appearance in coastal cities and have been present in most rural and urban areas in recent years. They have been reinforced by deliberate policy steps to counter growing inequality, increase the share of consumption and services in the economy, and deal with environmental problems. The new Chinese economic model will involve moderately lower rates of growth (averaging 7–8 rather than 10 per cent), and markedly less energy- and metals-intensive growth, together with less dependence on coal as an energy source.

While China was growing rapidly in the old model, its high savings kept the global cost of capital low, despite excessive spending in the English-speaking countries and Spain. China’s new model involves lower savings and will cause global interest rates to be substantially higher than they would otherwise have been during any return to growth in the developed countries. This will slow global recovery.

When China’s exports were concentrated in simple, labour-intensive goods, the prices of these fell on world markets. Now that its specialisation is shifting to more complex and capital-intensive products, the prices of simple manufactured goods will rise – textiles, clothing, footwear, toys and the low end of electronics.

On the import side, China accounted for more than three-quarters of the growth in world demand for steel in the early years of this century, and over 90 per cent from 2005 to 2010. In the most recent period, which straddles the global financial crisis, China contributed over 80 per cent of the increase in global demand for petroleum, just over 100 per cent of this for aluminium, nearly 150 per cent for nickel and over 200 per cent for copper.

The vastly increased demand took suppliers of these commodities by surprise. There was little investment in expanding old mines and developing new ones to meet the requirements of China. Prices for iron ore, thermal and steel-making coal and some other metallic minerals rose to unprecedented heights between 2003 and 2008, fell back briefly in the months after the Great Crash, and then rose to new record levels in 2010 and 2011. For commodities, China’s massive monetary and fiscal expansion, disproportionately focused on activities that raised demand for metals and energy, outweighed the stagnation in other major economies.

That all changed with China’s new model of economic growth. The changes were discussed and tentatively introduced before the Great Crash. They were embodied in the twelfth Five-Year Plan (2011–15), and their effects began to show up in the economic data from 2012.

China’s adjustment to this new model marks a hinge point in world history: the moment after the economic balance has shifted between the developed and developing countries. Today, developed countries are struggling with low productivity growth and growing inequality. Developing countries are mostly catching up at a historically rapid rate – although the big ones have faced new headwinds in 2013. The developing countries, by virtue of their rapid growth, are adding to pressures on the natural environment. Their entry into economic modernity raises any number of political and social challenges.

For Australia it is time to think about life after the boom, and the lessons that can be learned from the resource rushes of the past.

In the second half of the nineteenth century, Australians enjoyed by far the world’s highest material standard of living for ordinary people. A rich endowment of natural resources was turned into gold, wool and other commodities for sale to industrialising Europe, supported by institutions, policies and social structures that rounded out a dynamic advanced economy.

Scarce labour and high incomes meant many features of modern liberal democracies made their first or early appearances in Australia: compulsory school education and widespread literacy; large-scale use of public libraries; a self-confident workforce; organised sport as mass entertainment; and a democratic franchise. The reasonably equitable distribution of wealth and income, and access to education, helped to preserve democratic institutions when they collapsed in times of crisis in other nations that owed their prosperity to natural resources.

Our average incomes relative to those of other developed countries fell steadily through most of the twentieth century to below the global average, although they made up some ground during the 1990s. Then, in the early twenty-first century, average Australian incomes in international currency rose rapidly until they surpassed those in all other substantial economies.

These averages hide some important details. The living standards of ordinary Australians increased more than those of the rich through most of the twentieth century. The inequality of incomes widened after 1980, although government policies offset this up to the end of the century. In the early twenty-first century, Australia has become less equal even when changes in government policy are taken into account, mirroring the rest of the developed world – but less markedly so than in the United States and the United Kingdom.

But still, ordinary Australians were earning more in 2011 than they ever had. We now face a great challenge to these conditions. We will not be able to hold on to all of the gains of the past two decades in the immediate future. However, a combination of good leadership, sound analysis and the successful assertion of the public interest in policy will allow us to preserve much and eventually return to growth after the current challenges are met. The question is: will we face up to them and make the decisions that need to be made in the public interest?

RESOURCES BOOMS RAISE INCOMES BUT LEAVE PROBLEMS

Throughout Australia’s history, strong growth in the industrial economies, and the high resource prices flowing from this, has brought prosperity and often economic boom-time. Subsequent downturns in the industrial economies were then transmitted with magnified force into Australia, leading to slumps that were usually followed by long periods of stagnation and high unemployment.

The mostly strong global growth from the 1850s to the collapse of 1891 kept wool and other commodity prices high, and the London financial markets loved lending to Australian governments and banks. By the 1880s, a resources boom ran alongside a housing boom. Australian asset prices rose to levels that could be sustained only while commodity prices remained high and the flow of London credit strong.

The boom ended when the collapse of resources prices was accompanied by the drying up of international credit. ‘The price of wool was falling,’ begins the ‘Ballad of 1891’, describing how pressures to cut wages in depression precipitated the great shearers’ strike that led to the formation of the Australian Labor Party. The sharpest decline in activity and employment in Australia before or since followed.

After the trauma of the early 1890s, the democratic Australian colonies yearned to be free of the vagaries of the international economy. These pressures were crucial to the ‘Australian Settlement’ in the years around Federation, where protection against imports, wage arbitration and widespread government regulation of business decisions and ownership became distinctive features of our economy. Protection increased with each passing decade until well into the second half of the twentieth century. The young Australian economics profession in the 1920s obliged the country’s political preferences by developing a unique and analytically unsatisfactory ‘Australian case for protection’.

The same democratic institutions that protected Australia from an early Latin American-style ‘locking up of the land’ also prevented the large-scale immigration of low-cost labour from Asia. The first acts of the new Federal Parliament in 1901 excluded non-white migrants comprehensively. Subsequent interpretation of the White Australia Policy tightly restricted immigration from southern Europe before World War II.

Australia was tied to the fortunes of the United Kingdom by sentiment, institutions and (from the early years of the Great Depression) preferential trade agreements. We therefore shared the United Kingdom’s economic underperformance through the three decades from the outbreak of World War I in 1914 to peace after 1945.

Sluggish growth in Australia’s main market, the burdens of high protection, poorly conceived regulation and public investment, and a legacy of public debt from World War I all contributed to stagnation. From 1927, clear-minded observers could see troubles ahead. Australia’s problems were then overlaid by the Great Depression from 1929. As in 1891, the collapse of resource prices coincided with the freezing of access to international credit to produce an economic crisis.

Unlike in 1891, deliberate if tentative policies were adopted in response: a large currency devaluation against the British pound (which had itself depreciated against gold and the US dollar); limited expansion of public works as unemployment relief; wage and interest rate cuts; and measures to ease the burden on the unemployed. These policies were conceived within an explicit if incomplete framework of shared sacrifice. They were developed, with the assistance of most leading economists, by the Scullin Labor government in its dying days in 1931 and implemented by the Lyons conservative government. The new policies helped bring about a recovery more rapid than in Britain and much more so than in the United States.

The Great Depression left a legacy of even more pervasive regulation and diminished prospects for economic growth. The regulation of external trade and payments was extended during World War II, and its aftermath saw restrictions continue in response to foreign exchange shortages in the British-led Sterling Currency Area, of which Australia was part.

A spike in demand for wool in 1950 and 1951, with tension and then war on the Korean Peninsula, lifted Australia’s terms of trade to unprecedented heights. The temporary surge in export prices generated a burst of high inflation. These were Salad Days of economic policy. The economists’ Keynesian insights from the 1930s were moulded into policy by advisers brought together under Curtin and Chifley and retained by Menzies after 1949. The community grumbled but was tolerant of restrictions on short-term private consumption for long-term national gain. After a short and shallow recession, inflation quickly fell to low levels. The second of Australia’s long booms followed, lasting till the early 1970s (only broken by a brief recession in 1960–61). Until the late 1960s, the country saw high productivity growth by previous standards – although it was well below contemporary performance in other developed countries. There were only modest expectations of rising incomes, combined with consistently low unemployment alongside high immigration and population growth.

A JAPAN RESOURCES BOOM FOLLOWED BY INSTABILITY

The early restoration of healthy trade and diplomatic relations with Japan after the war was an achievement with economic as well as strategic dimensions. Japan’s post-war industrialisation brought the centre of gravity of the global economy closer to Australia. Reduced transport costs created new opportunities for the export of bulk commodities: iron ore, coal, and raw and lightly processed aluminium and nickel ores. Through the 1960s, small towns grew rapidly and new towns appeared in remote regions of northern and western Australia.

Australia’s terms of trade rose in the early 1970s to the highest levels since the Korean War boom as Japan’s industrial growth approached its apogee, and energy prices were lifted by restrictions of oil supply in the Middle East. Our terms of trade increased by 46 per cent in three years from December 1971 (a low point). Australia spent most of the higher income as the money was received. Between September 1970 and September 1974, a burst of inflation and belated currency appreciation lifted the real exchange rate by what was then an unprecedented 17 per cent. The Australian econometrician Adrian Pagan, cited by Ian McLean in an important recent economic history of Australia, described this rise in the real exchange rate as ‘disastrous’ and as bringing the post-war boom to an end.

The higher oil prices were the immediate trigger for a global slump. The developed countries in the northern hemisphere entered recession, and Japan shifted gears from rapid to moderate growth in 1974. Commodity prices declined swiftly, leaving Australia hopelessly uncompetitive with its high real exchange rate. The nominal exchange rate fell from late 1974, but real incomes didn’t, which entrenched high inflation despite recession. Australia entered nine years of low growth, high inflation and unemployment.

These years of economic instability incorporated a brief resources boom from 1979 to 1981. The restriction of Middle Eastern oil supplies from 1979 in the Iran–Iraq War encouraged export-oriented investment in thermal coal for the first time. Japan sent its energy-intensive and highly polluting industries offshore, which underpinned investment in aluminium smelting in Australia.

The collapse of this boom in 1982 again left Australia with a cost structure that was out of line with global economic reality. Unemployment rose to a new post-war peak in early 1983, while inflation remained high.

TWO PRECONDITIONS FOR REFORM

The economic disappointments between 1974 and 1983 were followed by a remarkable Reform Era. This began with the election of the Hawke Labor government in March 1983. It reached its apogee in 1989–91. It was weakened by a deep recession in 1990–91 and the long period of high unemployment that followed. It ended following the political contest over the Goods and Services Tax (GST) in 2000.

What made the Reform Era possible? One precondition was the abolition of the White Australia Policy. Discriminatory immigration had stood in the way of productive relations with Australia’s neighbours in Asia. A second precondition was growing understanding in the populace of the need for economic reform if Australians were to continue to enjoy the living standards of modern developed countries.

The first breach in the White Australia Policy was made by the Holt Coalition government in 1966. The Whitlam Labor government brought racial discrimination in immigration formally to an end in 1973, but the practical effects of this were diminished by big cuts in the number of migrants. The Fraser Coalition government ushered in large-scale non-European immigration for the first time since Federation with a politically courageous decision to accept substantial numbers of refugees from Indochina. The White Australia Policy was laid to rest in practice as well as in principle in the mid-1980s, when the Hawke government applied the new non-discriminatory policies to a large-scale immigration programme.

Each of these steps was made possible through public education and advocacy by informed members of the community – private people across the partisan political divide coming together to promote a change in policy that was judged to be in the public interest. An informed independent centre of the polity created a climate of opinion in which it was possible for leaders to make changes. However, four prime ministers over two decades had to absorb bitter criticism from parts of the community, to accept political costs and to take political risks.

The centrepiece of economic reform, and the area subject to strongest opposition from business and trade union interests, was the winding back of protection. Awareness of the costs of protection and the benefits of reform began with independent analysis, at first by a small number of people in the universities. The analysis was extended and publicised from the late 1960s by the Tariff Board (the predecessor of today’s Productivity Commission).

From its formation in the 1920s, the Tariff Board had mostly been comfortable working within the established consensus on protection. It changed in the late 1960s, under the leadership of individuals who asserted their independence from government and business pressures and were prepared to take bold professional stands in the public interest.

The work of academic economists and the Tariff Board was introduced to the wider Australian community by a small number of journalists, who put effort into understanding and explaining complex arguments, and who were allowed to do so by their editors, boards of directors and proprietors.

By the mid-1970s there was an understanding of the costs of protection to the Australian standard of living within a substantial group of independent and public interest-oriented citizens – ‘elite opinion’, as it came to be characterised by some political leaders and commentators in the early twenty-first century. There was widespread although by no means universal understanding that Australian economic performance had been relatively poor. There was widespread but by no means universal understanding of the value of far-reaching changes. There was widespread but by no means universal understanding that the necessary changes included reducing barriers to the international exchange of finance, goods and services.

Independent reports commissioned by governments widened public understanding of the need for and benefits of reform. The Fraser government’s Campbell Committee Report helped to build understanding of the value of financial reform. Although the Fraser government itself did not implement many of the report’s recommendations, together with the Hawke government’s own Martin Report it was an important part of the background to the swift and comprehensive reforms in the mid-1980s. My own
Australia and the Northeast Asian Ascendancy
, presented to Prime Minister Bob Hawke in October 1989, caught the public imagination by linking opportunities in Asia to reform at home. The Hilmer Report in 1993 helped build support for the widening of the scope of competition policy into the states following major advances in the commonwealth from 1987.