In 1991, Michael Pusey unleashed Economic Rationalism in Canberra: A Nation-building state changes its mind. In his book, Pusey took aim at the Canberra econocrats who ruled the key federal government ministries and forced out the “consensus” mandarins of the Menzies, Whitlam and Fraser governments. The economic rationalists were all roughly the same age, had the same educational background and were reared on Friedman’s supply-side economics, rather than the traditional Keynesian demand-management prescriptions of their predecessors.
Ross Garnaut was one of them.
Under Hawke and Keating, the “statists” lost the debate and the “econocrats” won. Australia became a corporate state, with Canberra mediating between business and labour. Ultimately, corporate interests won out, as Hawke and Keating floated the dollar, undertook financial deregulation, privatised government enterprises, reduced tariffs and introduced labour market deregulation, a pattern that continued under the Howard Coalition government. Federal governments also reduced real wages, providing a social welfare net instead (Medicare, superannuation, tertiary education).
Garnaut is one of the advocates of the strong link between microeconomic reform and productivity growth. However, as The Age’s Ross Gittins argued recently:
“Economists have no evidence to support their fond belief that the burst of productivity improvement in the second half of the 1990s was caused by micro-economic reform…it’s a dismal record if you undertake sweeping reform of almost every facet of the economy then, 10–15 years later, you get no more than five years of above-average improvement.”
The boom has left the building
Garnaut’s Dog Days really confronts two issues: boosting productivity to increase exports [p. 10] and getting the tax mix right. The first policy challenge may be beyond our control; the second relates largely to royalties and rents extracted from the resources industry.
Pessimism is the currency of economists, and Garnaut is no exception. In the wake of the China-fuelled Australian resources boom, the future looks less rosy. Chinese growth is plateauing; the investment phase of the mining boom, that injected A$102 billion into the sector in 2011–12, is ramping down.
That has been the prescription for the last two decades. These are what Garnaut labels Australia’s “salad days”, epitomised by the ramping-up of the Chinese-fuelled mining investment and export boom in the early 2000s, and characterised by the LNP and ALP governments’ seemingly endless trough of middle-class welfare. Between 1998–99 and 2008-09, the terms of trade rose an unprecedented 75%.
This means jobs for the professions. McJobs for Generations Y and Z (the 1.2 million in retail).
All good. As long as it lasts.
But the fact is resources industries ultimately deliver diminishing returns to scale, compared with manufacturing, which produces increasing returns to scale. The message in Dog Days is we cannot rely upon rising resources revenues in perpetuity.
In summary, the China boom produced a positive terms-of-trade shock; but slower Chinese growth could induce a terms-of-trade crash. How could Australia deal with that? By getting the exchange rate down.
Productivity: meet exchange-rate reality
The centrepiece of Garnaut’s “blueprint” is an Australian-US dollar exchange rate of around 63 cents. “The only way that we can bridge the huge gap between us and our international competitors,” Garnaut writes, “is through a large fall in the real value of our dollar”.
Following a sharp depreciation in 2009, the Australian dollar climbed above US dollar parity in 2010. This, Garnaut, argues, decimated productivity gains and destroyed export competitiveness. True, but there were other factors at work beyond the control of Australian governments. For example, the US Treasury and Federal Reserve’s third round of quantitative easing has injected US$85 billion per month into the economy in an effort to boost US consumption, growth and jobs. Indeed, RBA Governor Stevens has noted that the “‘extraordinary’ monetary policies of the US, Japan and euro zone…are ‘outside’ any historical experience”.
Australian exchange-rate depreciation would need to be matched by productivity increases, wage restraint and government cost cutting. A lower Australian dollar would also mean higher prices. This, for Garnaut, would be a “soft landing”; exchange-rate adjustment would be less painful than the significant falls in living standards that would be the consequence of a persistently-strong dollar. There cannot be a painless readjustment in a globalised economy. As Garnaut admits, “Australians on average will have to accept some reduction in real incomes”.
How could a lower dollar be achieved? Garnaut argues there is still room to reduce interest rates, as long as the Commonwealth maintains tight fiscal discipline. That, he reasons, will reduce pressure on the terms of trade as the China boom eases.
But this is indolent economic policy. Depreciated exchange rates require no boost to productivity; zero innovation; and absolutely no increase in competitiveness. The reason governments cheat and manipulate currencies is to make instant gains in inward foreign portfolio investment (cheaper stocks and bonds) and direct investment (cheaper plant, land and labour). Pain free. Adjustment free.
With currency depreciation, not only do consumer imports become more expensive, but essential imports cost more as well. Inelastics, like oil, shoot up in price, thus placing an impost upon everyone who uses oil. Which is everyone.
Garnaut also ignores the costs of essential capital equipment that is critical to Australia’s industrial infrastructure, competitiveness and productivity: imported German and Japanese machine tools, robots, farm machinery and, yes, even vineyard tractors. Shrewd capital investment in plant and equipment leads to productivity and efficiency gains.
Being able to depreciate the exchange rate is, for the US, EU and Japan, a negative externality that can be offloaded on to the rest of the world (in the form of importing inflation). But even that master currency-manipulator China is beginning to resist further yuan depreciation.
One also finds Garnaut’s claim that lower interest rates (which would assist dollar depreciation) and tighter budgets less than plausible. Since Hawke, Keating and Howard, federal governments have progressively reduced federal debt:GDP ratios, while Commonwealth fiscal outlays since the recession years (1992–94) have not exceeded 26% of GDP. The bottom line? There is little scope for Abbott and Hockey to move, particularly as the fiscal revenue base dries up.
Innovate or die
Economists like Dani Rodrik and the late Susan Strange have understood economic globalisation is the game changer. In The Retreat of the State (1996), Strange argued the state was through as an economic unit, and its future lay in beating an orderly, strategic retreat. This means accommodating and harnessing the transformative capacity of global capital, rather than trying to fight it. It means investing in high-tech infrastructure, high-quality health and world-class financial and education systems to make your country an attractive investment proposition for capital directed at high-tech, value-added, competitive industries.
Britain now exports more cars by value than Germany. Sure, Germany produces cars in North America, South Africa, Thailand (and Britain) as well, but remember the beleaguered, nationalised, strike-ridden British Leyland of 1975? Now the industry is no longer domestically-owned. But its quality and workforce are world class. Japanese plants in Britain produce some of the best-quality cars in the entire Japanese industry – equal or superior to Japan’s own plants. Fiat Industrial is moving its global tax residency to the UK, as its corporate taxes are much lower than Italy’s.
Irrespective of what anyone thinks of City bankers, London is the world’s financial headquarters for a reason: it welcomes foreign capital; it brokers deals in the world’s two biggest reserve currencies (the US dollar and the euro); it is global in scope, develops innovative financial products and contracts are written in English (the langue de preference of most of the world’s business community).
The financial services sector, with A$2 trillion under management, is the largest sector of the Australian economy, employing 200,000 more people than mining, accounting for 10% of GDP, and value-adding A$139 billion in 2011–12. But it lives off the fat of the domestic economy, with A$1.6 trillion in funds deriving from superannuation, while only A$77 billion is foreign capital under management. To become truly globally competitive, Australian fund managers must wrest business from Singapore, Hong Kong, New York and London. That’s where government policy can make a difference, by making Australia a genuinely competitive host of offshore funds.
World-class industry. Quality workforce. Competitive tax regime. This is what Susan Strange meant.
Or, as Dani Rodrik puts it, more succinctly, “It is not whether you globalize that matters, it is how you globalize.”
Very courageous, Minister
Australia’s political class will need to be courageous – not a quality it’s renowned for – to deal with the dual challenges of falling revenues and living standards. But squabbling between the Commonwealth and state governments on petroleum and mining revenues, together with the GST, will likely lead to lowest common denominator bargaining.
Garnaut is right to assert that the Great Australian Complacency has led governments to substitute fiscal handouts for effective public policy. Without naming them, the villains are clearly Howard, Costello, Rudd and Gillard, who pandered shamelessly to middle-class welfare, which produced serious structural fiscal deficits from 2008.
But Garnaut’s political partisanship damages his objectivity; the Magic Pudding thieves are clearly the mining industry, the saboteurs of the mining tax in 2010; the Abbott opposition “bitterly attacked” the Rudd government’s carbon scheme [p. 253]; while Gillard’s leadership is described, gushingly, as “firm and agile”.
There is much in Garnaut’s book with which economists will agree: what Garnaut terms the “Great Australian Complacency” is what is more accurately described as a Dutch-diseased, China-fuelled, resources-driven, Ponzi-schemed middle-classed welfared property binge. It really took off around 2003, collided with terra firma in 2008, and re-emerged, undaunted, in 2011.
But where are the innovative ideas and future industries, advanced by forward-thinking analysts, such as Joel Kotkins in America’s Growth Corridors? America’s new “real economy”, comprises energy, manufacturing, high-tech and aerospace industries. Australia can – and should – compete in many of these industries. But Israel and Brazil do innovation and entrepreneurship better than Australia. Even New Zealand beats us in innovation in global rankings.
Dog Days raises the multifarious challenges Australia faces, but it does not provide the solutions. Economic rationalists need to confront the reality: macro and microeconomic reform, wealth redistribution and regulatory frameworks on their own deliver only a “supply-side shock”. But Australia needs to produce innovation and entrepreneurship to escape the iron cage of Dutch disease when the China boom ends.
Globalisation is unlikely be so forgiving next time.
Dog Days: Australia after the boom by Ross Garnaut (Black Inc., $19.99).