The Australian Economy - From Menzies to the Millenium

Paper to accompany presentation to Australian Society of Association Executives Conference, Hobart, June 1 2000.

Ian McAuley, School of Management and Policy, University of Canberra

Canberra awakes from its torpor only on one night of the year - May 9 this year - budget night. The funereal quiet of the Canberra evening is disrupted by scores of lobbyists emerging from the budget lockup, to engage in hours of feverish activity, reporting on the $1.5 million "stronger families, local solutions to local problems initiative", or the $0.4 million for a "national parking régime for parking at leased federal airports". Once the web pages are updated, the faxes and E-mails despatched, and the journalists' boxes stuffed full of press releases, they can embark on the vain search for a restaurant at midnight and tick off economic policy as "done" for another year.

Or can they?

For those with a serious concern with economic policy, budget night, a carefully choreographed performance, can be a serious distraction. It is as if the Commonwealth wants to divert our attention from the bigger picture. It tries to appease every interest group by handing out a few trinkets and by producing enough figures to assure us that the current administration is doing a superb job in economic management, impeded only by the legacy of the previous incompetent administration.

On first sight the Australian economy looks healthy. We have had seven years of high growth, a decade of low inflation, six years of falling unemployment and three years of balanced Commonwealth budgets (that is, more or less balanced depending on how you do your accounts).

But on closer inspection there are economic problems emerging. In pursuing a strong fiscal balance our governments have accumulated big deficits in infrastructure, external balance, human capital and social cohesion. Politicians draw our attention only to one side of the national balance sheet, the fiscal side, hoping we won't notice what's happening to the other side, where our national assets or common wealth should be recorded. If they were recorded we would see that as debt is reducing, so too are our assets.

I will suggest that these deficits are unsustainable, and that this unsustainability will lead to the end of an economic and political era, an era I call the "neoliberal boom". I don't know what will replace it, but I will suggest some possibilities, and the desirability of a return to the "mixed economy". In these times of change associations will have an opportunity to influence the future - to be at the table when the rules are re-written.

Galbraith said that all bad economic news has an air of authority. I hope to draw on the more robust authority of recent history, looking at Australia's economy over the last half of the twentieth century.

 

Economic eras

There are three reasonably distinct political and economic eras in postwar Australia.

(1) The "long boom", from 1945 to 1972

(2) The "transition years", from 1973 to 1985

(3) The "neoliberal boom", from 1986 to the present

We can summarize statistically the main economic characteristics of these periods.

While there have been changes in Commonwealth governments over this period, the transitions in economic policies have not fitted neatly into any neat Labor/Coalition model. Rather, economic policies have tended to transcend party ideologies. That is not to dismiss partisan differences, to suggest that Australian politics is a tweedledee-tweedledum affair. On most areas of social policy there are significant partisan differences, and there are differences in economic policies, but the overwhelming influence on economic policy has been the tide of global economic movements, or, perhaps, economic fashion.

In both the "long boom" of the postwar years and the "neoliberal boom" of recent years there has been strong growth. But government policies in the these two eras have been shaped by vastly different public ideas. The long boom was characterized by interventionist government and a commitment to a mixed economy. It was a period of pragmatism. The neoliberal boom by small government and a commitment to the primacy of market forces. It has been a period of strong ideology.

These two growth periods may look broadly similar in terms of aggregate economic outcomes, but behind the broad sweep of aggregates there are significant differences, the most obvious being unemployment. The dividends from growth in the long boom were distributed widely between labour and capital, between the public and private sectors, and between urban and rural Australia. Economic growth was inclusive, and contributed to social cohesion. By contrast, the benefits of growth over the neoliberal boom have been much less equitably distributed.

In both periods, while the economy generated impressive figures, there was an accumulation of costs to be dealt with in later years. History shows that the long boom was unsustainable. I will suggest that the neoliberal boom is also unsustainable, for it too is characterized by an accumulation of liabilities which, while real, are generally not appearing on any national balance sheet.

The long boom - 1945 to 1972

The long boom has its origins in 1944 at a gathering of world politicians in New Hampshire - the Bretton Woods Conference. The western powers, planning the postwar order, were determined not to see a repetition of the events of the previous 30 years, which had nearly seen the destruction of liberal capitalism. Communism had demonstrated a clear alternative to capitalism - the USSR had been virtually untouched by the Depression, and it had demonstrated an impressive wartime military capability. The Depression had given communism legitimacy by verifying Marx's prediction that capitalism was liable to self-destruction. In continental Europe fascism had briefly triumphed, at terrible cost. Both of these ideologies owed their attraction to the poor record of capitalism of the interwar years - a short period of lopsided growth and speculation followed by economic collapse, with unemployment around 30 percent.

The Depression had driven home a basic economic lesson; capitalism, left to its own devices, is not stable. Economic stability needs the visible hand of government, as pointed out by Keynes.

The spirit of the postwar era was summarized by Henry Morgenthau, Secretary of the Treasury in the Roosevelt administration. In his closing address at Bretton Woods he said:

I take it as an axiom that this war is ended; no people - therefore no government of the people - will again tolerate prolonged or wide-spread unemployment. A revival of international trade is indispensable if full employment is to be achieved in a peaceful world and with standards of living which will permit the realization of man's reasonable hopes.

This new order was to see an environment in which the world could gain from more liberal trade, with progressive reductions in tariffs and market certainty provided by fixed exchange rates. There was a commitment to the economic freedom so essential to capitalism, but these freedoms were conditional, a means to an end - full employment and social cohesion.

The spirit was global, but unlike the globalization which was to occur towards the end of the century, free trade was not an end in itself. Unlike later Treasurers, Morgenthau saw full employment as the sine qua non of economic policy. In Australia, within a year of Bretton Woods, the Curtin Government endorsed the White Paper on Full Employment embodying similar sentiments.

Full employment was to be supported by other government activities to take the rough edge off capitalism and to compensate for the shortcomings of an unregulated market - in particular government provision of public goods and a welfare safety net. Some key industries were in public ownership - generally natural monopolies such as water and electricity supply, and in some countries industries such as airlines and car manufacturing. Although initially implemented by left-of-centre governments (Labor in Australia, Democrat in the USA and Labour in the UK), these policies were continued by the "conservative" governments which followed. The Menzies Government did not turn away from the postwar compact - over the long boom government expenditure rose strongly. In a growing economy taxes easily kept pace with expenditure; public sector deficits were not an issue, and provision of public goods - education, health care, transport infrastructure and other services - kept pace with a growing economy.

Menzies' economic philosophy is summarized by Petro Georgiou, the present Liberal Party Member for Kooyong:

Alongside Menzies' philosophical commitments to enterprise and initiative, to the incentive to prosper and create, was a commitment to social justice. A commitment embracing a better distribution of wealth, and giving people protection against misfortune, a protection consistent with their independence and dignity as democratic citizens. He saw government as playing a central role in achieving these ends.⁽¹⁾

Many who look back on this period tend to dismiss the public ideas which guided it. In 2000, notions such as the "mixed economy" and public ownership sound quaintly old-fashioned, as some socialist impediment to the economy. What they forget is that those who met at Bretton Woods and who subsequently implemented the postwar order were absolutely committed to the survival of capitalism. But they knew their history; they had lived through the ghastly years of 1914 to 1944, when laissez faire capitalism came close to destroying both itself and the liberal democracies which had nurtured it. Capitalism is slow to acknowledge or to thank its saviours.

The transition years - 1973 to 1985

In Australia economic growth was strong in the fifties and sixties, but the long boom came to an end in the mid seventies with the convergence of a number of economic events. The USA, which had led the postwar recovery (the world "locomotive"), was no longer able to finance world growth. The currency standards negotiated at Bretton Woods, which had linked the US dollar, gold, and all other major currencies, came apart. The Arab states raised oil prices dramatically. Inflation hit the industrial countries severely - peaking at 18 percent in Australia. Unemployment rose as firms shut their doors, unable to cope with energy prices and the flood of low cost imports from developing countries which had gone through rapid post-colonial industrialization. The postwar years were over.

Governments applied the usual policy levers to deal with a cyclical downturn - stimulating expenditure - which had worked before, but they failed, for this was no normal business cycle recession; it was a fundamental change in the structure of economies. Government expenditure, instead of re-invigorating the economy, fuelled inflation. The word "stagflation" entered the language, to denote a new phenomenon, previously thought impossible - high inflation accompanied by rising unemployment. Its root causes were structural rigidities in the economy. Its legacy, still felt today, is nervousness in financial markets about public sector deficits - a notion that Keynesian economic management doesn't work.

Australia was hit particularly hard. Not by energy prices, but by other structural developments. Postwar growth had been unsustainable, resting as it did on immigration (which helped keep the population young and which provided workers for manufacturing), protective tariffs, a low exchange rate, and a reconstructing world desperate for raw materials. By 1972 the immigrants of the fifties were ageing, the firms which had developed behind tariff walls were unable to compete on the world market, and other countries, some badly in need of foreign exchange, forced down the price of many raw materials. Public finances were hard hit, for the Whitlam government had been elected on the basis of expanding government functions in areas such as health care and education, but as the economic crisis worsened taxation revenues did not keep up with expenditure.

During the Whitlam administration and in the years that followed economic policy drifted. It is easy to blame one administration, but this was a world-wide period of uncertainty and experimentation, with governments often acting quite contrary to their traditions and ideologies. In the USA, for example, the Republican Government instituted widespread price controls; in Australia the Whitlam Government cut tariffs by 25 percent in one fell swoop. The Fraser Government, unnerved by the turmoil of the mid seventies which had projected it into office, was equivocal on issues such as tariff reductions and undertook no bold reforms. It was a bad time to be in office.

The Hawke Government was elected in 1983, during Australia's worst postwar recession, triggered by another oil crisis ( the Iranian oil crisis), and aggravated by the unfortunate timing of the previous government's macroeconomic interventions.

The Hawke Government could not have taken over the reins at a more fortunate time than the trough of a recession, and it successfully embarked on an expansionary fiscal program, but by 1986 the level of government spending had hit an all time high and inflation, fuelled in part by a huge increase in money supply following bank deregulation, was unacceptably high. That ushered in the next phase, neoliberalism.

 

The neoliberal boom - 1986 to ?

The term "neoliberalism" is perhaps better known in Australia by the local term "economic rationalism", but that term is potentially misleading, for neoliberalism is not easily described by the adjective "rational", and it is not in accordance with mainstream economic theory. Neoliberalism, like communism, is an ideology. It has the same certitude and intolerance of dissent as communism. There is one "right" approach to economic management.

That "right" approach rests on two dominant planks - the primacy of private markets and the opening of markets to competition. If functions can be shifted out of government they should be shifted. And even if functions have to be funded publicly they should still be provided by the private sector - the notion of funder/provider split. The prefix "neo" is to distinguish it from the usual meaning of "liberal", referring to tolerance and openness. Neoliberalism focuses its liberalism on one aspect of human activity only - the unfettered operation of competitive markets, or laissez faire.

The philosophy of neoliberalism is normally associated with Margaret Thatcher in Britain, but its strongest and most effective proponents were in the New Zealand Labour Government. It has certainly transcended traditional partisan lines. It came to Australia during the time of the Hawke-Keating Government, with initiatives such as bank deregulation, airline deregulation, privatization of government assets, user charging for government services, modest labour market deregulation, and generally cutting public expenditure. The Coalition Government, elected in 1996, has taken such policies further and has embraced the ideology more fully, most clearly with commitments to more intense labour market deregulation, to further asset sales, to reducing Commonwealth debt, and to cutting taxes while sustaining public budgets in surplus.

The neoliberal era has seen restored growth. Apart from a recession in the early nineties (caused in large part by the government's failure regulate early enough the money supply expansion resulting from bank deregulation), it has been an era of steady growth, a slowly improving labour market and low inflation. But is it sustainable?

Just as the long boom was unsustainable, I suggest the neo-liberal era is unsustainable. Just as the costs of the long boom accumulated in the economy, so too are the costs of neoliberalism accumulating. And neoliberalism as a political philosophy, like communism, is so unaccommodating of doubt, so unable to handle complexity, so rigidly adhesive to certain simple ideas, so self-congratulatory, that it is unlikely to be able to see its own weaknesses and reform.

The deficits of neoliberalism

We are accumulating deficits in our common wealth - in our public assets of infrastructure, in our human capital, in our natural resources and in our social capital. In general, in those things we do not cover in official accounts. We have forgotten some fundamental accounting principles, and have equated fiscal stringency with sound economic management. Accounting systems, including national public accounts and public sector accounts, generally measure only things which are subject to monetary transactions, and, even these measures are limited by further conventions. We have forgotten that financial measures are only weak indicators of economic performance.

Deficits in public budgets

How many of us would buy shares in a firm which is winding back its investments in both physical assets and human resources, which pays dividends and operating expenses out of capital reserves, which fudges the differences between capital and recurrent items, which calls asset sales "revenue" and expenses "loans", which sells assets and then leases them back at usurious rates of interest, which spends down its goodwill with suppliers and customers, and which has its senior executives preoccupied in defending the board before shareholders rather than attending to the firm's business? Even if such a firm could generate some impressive financial returns, through creative accounting, we may want to look a little more deeply into its activities.

All governments celebrate a selected set of achievements, hoping we won't notice its shortcomings. The present one is no exception. The achievement of the current administration has been to achieve budgetary surplus during a period of economic growth, but that is not difficult. Doing so at the same time as reducing taxes is an achievement, but the costs of this achievement have not been brought to account. And the Commonwealth is not drawing to our attention a fundamental and unsustainable shift in public budgets - a shift which has been going on for 25 years, during two Coalition and two Labor administrations.

That shift is the increasing use of transfer payments to individuals to compensate for the incapacity of the economy to provide well-paid employment. These transfer payments are both to the unemployed and to those whose incomes from employment are insufficient to sustain a family. As these transfer payments rise, government services, particularly capital expenditure, is cut. This is economically unsustainable. At some point we need to choose between cutting personal transfer payments - welfare - or raising taxes, for those national assets (our common wealth) which cannot be provided by private markets, are being depleted. Anthony Giddens, surveying the damage left behind by the Thatcher Government in Britain, observed ironically that neoliberalism, far from reducing the size of government, resulted in larger public sector outlays to finance the welfare benefits to be paid to the victims of neoliberalism.⁽²⁾ Australia is suffering something of a similar phenomenon.

Commonwealth expenditure is becoming dominated by personal transfer and near-transfer payments (such as health care). Over the period 1974-75 to 1999-00, Commonwealth outlays on these programs - specifically health, social security and welfare - will have increased from 8 percent of GDP to13 percent of GDP, while expenditure on direct services - education, transport, defence, research, industry assistance, payments to the states and a large number of smaller programs - will have fallen from 20 percent of GDP to 10 percent of GDP. Almost all the cuts in expenditure are focussed on these direct public services.

Expenditure on health and welfare is bound to increase as Australia's population ages. Health care expenditure could be cut, but only at the high economic cost of shifting more responsibility to the private sector. And, so long as Australia's economy underperforms in terms of providing well-paid jobs, and until the benefits of compulsory superannuation cut in, welfare expenditure will need to be sustained at a high level.

The strongest manifestation of this trend is falling public sector investment. From a peak of 9 percent of GDP in 1966, it is now down to around 4 per cent of GDP. To put that into another perspective, if government capital investment were to be restored to 1966 levels, that would represent a boost of $30 billion. This is not only a Commonwealth responsibility; indeed, most is the responsibility of state and local government, but all tiers of government are suffering fiscal stress. If nations could keep proper and informative balance sheets, we would see that our impressive reductions in government debt have been matched, or perhaps more than matched, by reductions in community assets, or the common wealth.

The neoliberal counter to such criticism is to suggest that "big" government is bad for economic growth. Government is no more than an unproductive overhead on society. If we want economic growth, there is no alternative to cutting the size of government.

Research suggests that the picture is much more complex. Indeed, there is no discernable relation between the size of government and economic performance.⁽⁴⁾

Table 3 shows the alignment, or rather the lack of alignment, between countries' ranking on the world competitiveness index and the size of their public sectors, as indicated by the share of government expenditure in GDP. If small government were strongly associated with competitiveness, we would expect that the countries at the top of the table would have small governments. In fact, there is no discernable correlation between size of government and competitiveness. It is notable that the Northern European democracies, most of which have very large public sectors, generally rank well ahead of Australia in terms of competitiveness. Netherlands, for example, owes its position to conscious policy of open trade combined with a very active government domestically, and Finland to strong infrastructure investment.⁽⁵⁾

Research shows that it isn't so much the size of government expenditure that counts; rather it is the composition of expenditure that counts. Most empirical studies find that government investment expenditure, other than military expenditure, aids economic growth.^(6),(7) On other areas of government expenditure the evidence is, at best, inconclusive.⁽⁸⁾

Yet in Australia it is capital investment which has suffered the most severe cuts in government expenditure. From the late seventies to the present there have been cuts in capital outlays. The most severe capital cuts have been in roads, water and sewerage infrastructure and environmental protection. Some of this reduction can be explained by the sale of government business enterprises, such as water utilities, but that does not explain the cut in the category "general government". (See figure 6) Much of this reduction has occurred in road funding, even while there are severe deficits in both urban and country roads. Only two capital cities, Canberra and Sydney, are linked by an adequate highway - in fact, in the 2000-01 Budget the Minister for Transport and Regional Services announced an indefinite deferral of plans to complete the highway link between Sydney and Melbourne. No capital city has a completed ring road. Traffic congestion costs in Australia are $5 billion a year.⁽⁹⁾ Although rail transport has fared a little better, there are still severe deficits, with constraints of load and speed limits on most tracks which render rail transport inadequate for all but high bulk goods.

The same holds with other infrastructure and with investments which, although they would not show on national accounts as "capital", are conceptually capital in that they yield benefits into the future - such as education. In particular there have been cuts in research, environmental protection and in tertiary education, both university and TAFE. A productive environment is part of economic infrastructure, but Australia's main agricultural asset, the Murray-Darling Basin, is being devastated by salination. These deficits are being ignored in the Commonwealth's obsession with the cash balance. Most individuals and businesspeople know that it is quite legitimate to borrow for assets which yield future productive benefits, but in the Commonwealth there is a monomania about reducing debt - as if government debt is the sole measure of public sector management. Possibly it is a political point - a hope that the public or the financial markets will equate low debt with sound management. Or possibly it is sincere belief that a modern economy does not need public investment. If so, it's a costly misunderstanding.

Tony Harris, former New South Wales Auditor-General, commenting on this debt obsession (in both Commonwealth and State governments) points out simply:

Perhaps we are meant to believe that State or federal debt is bad. But when debt allows government to develop assets important to our, and our successors' living standards - assets such as roads and schools and hospitals - we should acknowledge that debt has its place.⁽¹⁰⁾

Australia's government debt (all levels of government) is now down to around 7 percent of GDP, compared with an average 40 percent in the OECD countries as a whole. This sounds impressive; if our debt were at the OECD average we would have another $200 billion of debt. Re-framing this figure sounds less impressive - we could have another $200 billion of roads, railroads and other assets without exceeding the average OECD debt level.

Michael Porter of the Harvard Business School stresses the need for infrastructure:

Upgrading a nation's industry depends on a modern and improving infrastructure. This is particularly true in advanced transportation, logistics, and telecommunications, all integral to introducing modern technologies and to competing in international markets.⁽¹¹⁾

Some infrastructure can be provided in the private sector. The conditions which define natural monopoly change with growth and with technology. For example, telecommunications was once considered a natural monopoly because of the need for a fixed system of subscriber wiring, but wireless technologies are allowing competitive provision by the private sector.

In many cases, however, private markets cannot supply infrastructure at all - in particular infrastructure characterized by "non-excludability", which is necessarily provided without immediate charge to the users. The private sector may provide a few high density urban roads, for example, but it will not provide rural roads or even trunk roads, for the transaction costs in charging users would be absurdly high. It may provide high standard urban telecommunications, but it will not provide rural communications.

In some cases, the private sector may be able to provide infrastructure, but only at higher cost and perhaps less effectively than the public sector. Melbourne's public transport has been effectively privatized, but the individual private operators are each concerned, understandably, with their own part of the system. The network as a whole is operating poorly because of this lack of coordination.⁽¹²⁾ Private toll roads in Sydney are profitable for the private companies concerned, but they are not well integrated into those cities' transport systems.⁽¹³⁾ A toll road in the middle of a "free" road system will not be well utilized. But neoliberalism fails to accept these limits of private markets.

This unqualified faith in private markets defies logic, but it is consistent with the behavior of those who are blinded by ideology. Academic research has confirmed the neoliberal belief in "private sector primacy". It doesn't matter if a function can be done better in the public sector; if the private sector can do it, regardless of cost, then it should be left to the private sector.⁽¹⁴⁾ Such an attitude is akin to the attitude of the Soviet bureaucracy, which, likewise, pursued a policy of dogmatic nationalization and collectivization, without regard to economic consequences and in ignorance of the limits of non-market supply.

The dogma of private sector primacy, particularly in infrastructure, is naive in that it overlooks the nature of capital markets. Even if governments could transfer the provision of infrastructure to the private sector, relieving the public sector of incurring debt, there are still demands on the nation's capital markets. Floating Telstra on the stockmarket makes much the same demand on capital markets as financing government debt to keep Telstra in public ownership. In fact, to the extent that private markets, understandably, place a higher risk premium than governments on infrastructure, private financing is generally more expensive than public financing, for the government, by definition, does not incur what financial markets refer to as "sovereign risk". (Private owners of toll roads, for example, build into their risk calculations the possibility that future governments may make conditions less propitious, such as by building competing infrastructure.)

One particularly wasteful practice of governments has been to sell assets and then lease them back. The practice has been widespread - the Victorian Labor Government in the early 1990s and federal governments of both parties have all entered into such deals. Financial debt is reduced, but the government also loses an asset, and has to pay for that asset's services into the future. The Commonwealth, for example, requires sale of buildings unless the Commonwealth can obtain a notional return of 20 percent on those buildings.⁽¹⁵⁾ In order to produce an impressive figure on reported debt, the Commonwealth essentially borrows off-balance sheet at up to a 20 percent interest rate.

In short, government withdrawal from infrastructure investment means we either pay too much for it, or we don't get it at all. We cannot expect the private sector to finance long lead time investments, such as education or environmental protection. The returns take too long to accrue and will not necessarily be captured by the investor. We cannot expect the private sector to be able to provide network goods, such as railroads, where the returns accrue throughout the network, but not necessarily to owners of parts of the network. Of course there will be exceptions - environmental demonstration projects, dedicated mineral railroads - and these will be championed as tangible evidence that the private sector can provide. But demonstration projects and celebrations cannot overturn the fundamental laws of economics; there are many markets in which there is no economic alternative to public financing and provision. Unless our policy makers learn this fundamental lesson, our infrastructure will slowly deteriorate to third world conditions.

We can live off our capital for some time, and we can hide expensive financial transactions, producing some impressive financial figures which can be used to justify tax cuts, but these figures are illusions and the real deficits eventually catch up with us. As in Orwell's Nineteen Eighty Four, Big Brother can keep reading out impressive statistics, but all know that the society is becoming impoverished.

 

Deficits in the private sector

There are also private sector deficits. As pointed out above, Australians are keeping up living standards in part through government transfer payments. They are also keeping up living standards through accumulating debt. Both are unsustainable.

Household saving is falling - in fact it has been falling for thirty years, since the end of the long boom. In response to falling incomes, or rising demands, savings are often sacrificed. Of course not all saving takes place in households; some takes place in the corporate sector and there has been the boost of near-universal employer funded superannuation.

Low household saving, however, renders people vulnerable to economic changes, and can force dependence on financial intermediaries for major purchases, such as cars. People with reasonably liquid assets can enjoy the benefits of cash purchases, avoiding high interest charges on credit cards and personal loans, and avoiding the need for over-reliance on insurance. People with a reserve of savings can sustain short periods of economic hardship without having to rely on welfare.

To an extent, governments have discouraged household saving. Social security provisions now have asset spend-down requirements, and, in health care, self-reliance through funding one's own health care is penalized by being ineligible for the 30 percent subsidy available to those who use private insurance.

In this regard the neoliberal boom is quite different from the long boom, in that the long boom did see high household savings. Perhaps this was a legacy of the Depression; by 1986, however, most of those who remembered the Depression years had passed away. The neoliberal boom is more consumption driven, and therein lies a vulnerability, for when households have low savings any small change in income can have immediate flow-on effects. Once savings are depleted there is no buffer to cope with changes in economic circumstances. That's one reason why the Reserve Bank has been very cautiously applying only small changes in official interest rates.

One thing that has not changed since the long boom is a deficit on current account, but it has worsened. We are importing more than we are exporting. Australia has almost always had a current account deficit - balanced, of course, by capital inflows. What is characteristic about the neoliberal boom is that our foreign balance has stayed in serious deficit. One may reasonably argue that a current account deficit is justifiable in a period of strong growth, on the basis that future earnings on inward investment will provide the income to repay the debt and a return on foreign equity. But that isn't happening; our foreign debt situation is worsening. In 1987 our net international investment position was a deficit of 41.3 percent of GDP - 9.5 percent equity, 31.8 percent debt. By December 1999 it has risen to 63.5 percent of GDP - 22.6 percent equity, 40.9 percent debt.

Our public budgets may look impressive, but our national performance is poor. Australia is still perceived as a commodity exporter; while manufacturing and service income has improved, just on half of Australia's exports are still of rural or mineral products. While there is rhetoric about the "clever country", there is the reality of low investment in tertiary education and basic research.

It is hardly surprising, therefore, that Australia's exchange rate is vulnerable. While the currency of a small nation like Australis is bound to show some volatility, speculation alone does not explain the recent poor performance of the Australian dollar. The problems may be more deep-seated, in the very structure of our economy.

It is in a structurally weak economy that stagflation can re-emerge. A modern economy is multi-faceted. It is not meaningful to refer to "inflation", "demand" or "unemployment" as if these are simple, homogeneous commodities. There can be excess demand in certain sectors of the economy, causing inflation and shortages of labour and other inputs, while there is inadequate demand elsewhere, causing unemployment. If resources, particularly labour, cannot move to industries and regions where there is demand, then there can be simultaneous inflation and unemployment.

A well educated labour force will be mobile, able to learn and adapt as economic conditions change. But education has been an easy target for cuts in public expenditure. There is a misplaced faith in the private sector, but firms will generally do no more than to provide training in skills which can be applied in that particular firm or industry; it would be unreasonable to expect a firm to do otherwise. They will not provide the basic liberal education which allows a workforce to be adaptable. We may be facing some of the same structural rigidities we faced in the mid seventies. The rhetoric is about adaptability and the "smart" economy, able to cope with international competition, but the reality is a devaluing of education, apart from "practical" skills such as information technology and business studies. History, shows, however, that those societies which adapt most successfully to change, have the underpinning of a strong liberal education system. Knowledge of current business fads or computer program languages are ephemeral assets.

 

Deficits in social capital

That brings us to the third deficit, social capital - the asset of goodwill and trust which holds a society together and allows it to cope with difficulties. Politicians in both main parties tend to refer to the need to balance social and economic objectives, as if there is some tradeoff.

Yet, the reality is that it is not possible to build a strong economy on a weak society. It is possible to generate some impressive short term figures, while running down social capital, but this is not sustainable. Divisions in Australian society are widening - between poor and rich, between city and bush, and between Aboriginal and other Australians. The goodwill that should hold a country together, that provides some resilience in times of national hardship, is being dissipated.

Part of Australia's social capital has been its sense of a fair go, but by any measure Australia is a far less equal society than it was during the long boom. For a start there is high and persistent unemployment. At the other end of the spectrum are the super rich - executives drawing seven figure annual salaries. The full story is more complex, however.

Table 5 shows the distribution of gross income by household by income quintile in 1986 and 1997-98. The rich have become richer and the poor have become relatively poorer. The movement at the bottom could be explained, in part, by unemployment, which rose a little over the period, and, in part, by ageing. Australia's population aged over that period; an older population means more single person households of retirees. But even within given types of household (e.g. families of two parents with children), the incidence of poverty has been increasing.⁽¹⁶⁾

Research shows that government benefits, including a progressive taxation system, tend to bring up the bottom quintiles.⁽¹⁷⁾ We can justifiably say that the picture is not as bad as it looks at first sight.

But what happens after redistribution does not explain why Australia's gross income pre redistribution is so lopsided in international comparisons, particularly in comparison with countries with older populations. Table 6, ranked by Gini index (a mathematical indicator of inequality), shows Australia in a poor light. It was not always thus - Australia once had a reputation for an egalitarian distribution, and we still tend to live on this myth.

What appears to be happening in Australia is a "disappearing middle". People are becoming relatively richer or poorer.⁽¹⁸⁾ This aligns with the changes in the labour market and in research on work patterns. Many Australians, with skills, are overworking, while others, without skills or who live in the wrong region, cannot find work. (And they cannot shift to high growth regions because wealth imbalances have made housing prohibitively expensive.) A third of full time workers in Australia are working 'very long hours' - that is, more than 48 hours a week - and many are working a second job in addition to a full time job.⁽¹⁹⁾ While 2 million Australians are working 'very long hours' and another 250 000 are working two jobs, there are 700 000 unemployed. These figures just about offset each other. The workforce is decomposing into two camps of stress - the stress of overwork and the stress of unemployment. Both have consequences for others, in particular families who find one or more adult is unavailable, or is too readily available in the despair of unemployment. Again, this is consistent with our having a structurally imbalanced labour force.

Even those who are doing well out of the current system are uncomfortable. The social commentator Hugh Mackay summarizes a general feeling of anxiety and insecurity:

If you were forced to make a generalisation based on the available evidence, you'd say that Australians, when pushed, will decide that life is generally getting worse - violence, greed, drugs, family breakdown, unemployment, environment pollution, adversarial politics, fragmenting neighbourhoods - but that my life is okay (and might even be getting better).⁽²⁰⁾

If social security and progressive taxation compensate for inequality, however, one may say it does not matter. But it does matter for three reasons.

First, the taxation system is becoming far less progressive, with the introduction of a value-added tax and the changes in capital gains taxes (which favour speculation over long term investment). Therefore the capacity of the taxation system to offset inequality is being eroded.

Second, as we have already seen, welfare expenditure is sapping the capacity of public revenue to provide much needed public goods.

Third, inequality itself has a corrosive effect on society. The Nobel winning economist Amartya Sen warns that inequality is debilitating.⁽²¹⁾ While the poorest in Australia may, in absolute terms, be better off materially than they were ten or twenty years ago, it is inequality that causes misery. Ralph Dahrendorf, an observer of the 1960s riots in the USA, warns that a class of people who feel they have no clear stake in society can do great damage to that society. Welfare payments may help sustain material conditions, but they do not sustain self-respect. On this there is agreement across the political spectrum.

Inequality is a distinguishing feature of the neoliberal boom. Australia has been through significant structural change, but the fruits of that change have not been shared widely. Some have reaped huge rewards, and in vulgar displays of conspicuous consumption they flaunt their wealth before the less fortunate. Some, who have gained privilege through political influence, have shielded themselves from structural change. But a vastly larger number have paid dearly - through unemployment, dislocation and job insecurity. With such unfairness, and perceptions of unfairness, we risk a backlash - a backlash which could undo fifty years of economic progress.

 

Consequences

Neoliberalism appears to be triumphant. Its advocates don't even bother to argue for its virtues - to its advocates its virtues are self-evident. Just as the Marxists used to refer to historical inevitability, rather than relying on any argument on the virtues of communism, so too has the rival ideology of neoliberalism taken on such rhetoric. The triumphal confidence of neoliberalism has been given a boost by the collapse of Soviet communism.

Going back to Bretton Woods in 1944, however, it was the presence of the communist rival that kept capitalism on its best behavior. It had to demonstrate that it could outperform Soviet communism in providing public goods and a fair distribution of benefits, without damaging incentive. That constraint has gone. The rival ideology is no longer a contender. The mixed capitalist economy can give way to the all out "market economy".

This neo-liberal transformation is what the Hungarian economic philosopher, Karl Polanyi, feared in 1944. He feared that the postwar order would see a "great transformation". That was to take markets from their traditional role, as the servants of society, and to make them the masters of society.⁽²²⁾ Because of the resulting social tensions, he feared, that would ultimately be destructive of open, democratic society and of capitalism itself.

Because of the good sense of policy makers in the postwar period, that transformation did not occur. It was forestalled for forty years. But in time the warnings of Polanyi, Keynes, Morgenthau and others have been forgotten. Those who have done so well out of neoliberalism have little time for history, and they have little notion that their own behavior may be contributing to the collapse of a system which has served them so well. They are behaving like the French and Russian aristocrats who lacked the political nous and foresight to save themselves.

With the experience of fifteen years of neoliberalism there are voices of warning, however. British historian, Eric Hobsbawm, surveying the consequences of neo-liberalism warns:

The structures of human societies themselves, including even some of the social foundations of the capitalist economy, are on the point of being destroyed by the erosion of what we have inherited from the past. ... It must change.⁽²³⁾

John Gray, a former adviser to Margaret Thatcher and once a champion of the 'market economy', warns that it is no less dangerous a concept than dogmatic communism. Both are recipes for ghastly utopias, founded on simple and flawed ideas. Gray warns:

Like the Utopia envisaged by Lenin, the global free market aims to bring into being a state of affairs that has never hitherto existed in human society - and which goes far beyond the mid-Victorian English free market and the liberal international economic order that existed until 1914. In a global free market the movements of goods, services and capital are unfettered by political controls imposed by any sovereign state, and markets have been detached from their original societies and cultures. This is a Utopia divorced from history, hostile to vital human needs, and finally as self-destroying as any that has been attempted in our century.⁽²⁴⁾

A similar warning comes from George Soros - one of the world's richest people who became rich by exploiting the weaknesses and short-sightedness of world financial markets. Soros warns that communism and unrestrained capitalism are both totalitarian systems determined to fit a simple model on to a hapless community. In different ways they are both destructive of the open, liberal society. In his warning of the dogmatic ideology of neo-liberalism Soros says:

What allows economic theory to be converted into an ideology hostile to the open society is the assumption of perfect knowledge ... Whatever its form the assertion of perfect knowledge stands in contradiction to the concept of the open society (which recognizes that our understanding of our situation is inherently imperfect).⁽²⁵⁾

These are not the voices of revolutionaries or radicals. They are the voices of those who see the value of capitalism, and want to preserve it. As in earlier times, however, capitalism does not thank those who try to save it from its own destructive forces.

But if we do not listen to the sober voices of historians and economists, who want to save democratic capitalism, the political ground will be occupied by those with more strident voices, who do not necessarily have such a commitment.

The fall of governments of neo-liberal persuasions in Victoria, New Zealand and the UK should serve as a warning of public frustration. The recent London mayoral elections show that Blair is finding strongest opposition not from the Tories, but from those opposed to neo-liberal policies. The demonstrations in Washington and Seattle have involved a wide coalition of interests - farmers, unions, churches, environmentalists - by no means confined to the traditional "left".

There are many who want to turn the clock back, impossible as that may be. The rise of the One Nation movement in Australia is a warning; the temporary absence of that political entity does not mean the destruction of the underlying sentiments which nurtured that party. If that party had been less distasteful in its comments on race, and more careful with its organizational structures, it may have become a major force on the political landscape.

 

Choices

Cleaning up the destructive trail of neoliberalism, restoring our common wealth, will be costly on public revenues, and the longer we defer it the bigger the bill becomes. A defeatist response is to suggest that small government is inevitable because people do not want to pay taxes; no government wins office promising higher taxes.

One needs to read public opinion carefully. If an opinion pollster goes out and asks "do you want to pay more tax?", the answer is a very predictable "no". In an international opinion poll in 17 high and middle income countries in 2000, only 2 percent respondents thought the taxes in their countries were too low. But when a different question was put to the same respondents - essentially "do you want more tax/more public service or less tax/less public service", the answer was quite different, as is shown in Table 7.

In the same survey people were asked how they would like their taxes spent. Australia's preferences, which were not dissimilar to those of other countries, are shown in Table 8.

These results are broadly similar to those of a major Australian survey in the early nineties.⁽²⁶⁾ That survey found Australians were generally satisfied with their levels of taxation, and that priorities for an increase in expenditure were, in order, medical and hospital (84 percent), education (78 percent), police, law and order (74 percent), environment (71 percent), and roads (67 percent). The only categories in which Australians did not wish to see an increase in public funding were defence and general government administration.

Is there an explanation for this apparent contradiction? When asked if they want to pay more taxes, people say "no", but when the question is framed differently, the opposition to tax increases diminishes or becomes a preference to pay more taxes.

The answer lies, perhaps, in trust in government. People would like a government they can trust to take taxes and provide public goods, but they don't trust the present government. Opinion polling in the USA over 50 years finds a constantly diminishing trust in the federal government over that period, from a round 70 percent in the postwar era to around 30 percent now (percentages referring to people's perception that the government will do "what is right").⁽²⁷⁾ People want public goods, and are willing to pay for them, but they do not trust governments to allocate them in accordance with their preferences.

An Australian response, to a differently worded question came from the 1998 Election Study.⁽²⁸⁾ In response to the statement "Government, by its nature, is the best instrument for promoting the general interests of society", 63 percent agreed. The question may have elicited a very different response if the question had commenced with "The Government ...".

One notable feature of Table 7 is the strongly positive response from countries which have come through the neoliberal experience, Britain and New Zealand, and the positive responses from Hong Kong and Singapore, whose success has often been attributed to their "small government". In fact the present government in New Zealand successfully went to the polls promising higher taxes. It is also interesting that there are positive and negative responses in countries with "big" government, such as Sweden, Germany and France.

Why, then, in the light of this evidence, is there an assumption that governments cannot increase taxes, particularly in Australia which is one of the lowest taxed high income countries? It doesn't seem to be vote winner to promise less tax and less public provision. Indeed, it is notable that for the first Presidential election in recent times, tax cuts are off both the Democrat and Republican agendas. In all probability the myth of the appeal of tax cuts is no more than a convenient justification for neoliberalism.

Yet, those who seek change are often defeatist, grudgingly assuming that the public cupboard is bare. They would no more ask for a justifiable increase in public expenditure than a citizen of the USSR would have tried to set up a private company during the time of Stalin. Such is the pervasiveness of the dogma of neoliberalism.

Of course increasing public revenue may require re-visiting tax reform, but we haven't really visited it properly in recent years. All we have had is a 1960s European value-added-tax presented as a take-it-or-leave- it option, and we took it, warts and all, with a few more warts and cankers added by the political process. We may have to develop quite different taxes, particularly taxes on environmental externalities. And we may have to develop new national accounts, which call governments to account for the state of the common wealth - our physical infrastructure, education, environment and social capital.

Globalization

As a last line of defence neoliberals retort that "there is no alternative" to the present order, for we live in a globalized economy. That is so, but there is no logical connection between globalization and a depleted infrastructure, environmental degradation and inequity. Those who met at Bretton Woods in 1944 were preparing the world for a global economy, and they appreciated that governments had a role in that task. The risks we face in 2000 are similar to those we faced in 1944; if the reaction to neoliberalism is a retreat to protectionism and xenophobia we would be recreating the conditions which nurtured the rise of fascist and communist totalitarianism. We need to heed the lessons of from history and re-develop the mixed economy.

In 2000 we are told we are living in a brave new world, with transport and communication technologies unheard of in 1944, with global capital markets, and with powerful financial institutions and corporations which can make or break the fortunes of small countries. National governments are no longer sovereign and there is no longer any government as powerful as the US was in 1944. If Australia deviates from the neoliberal path we will be punished severely by these world forces. We may not like our wages being set by competition from sweatshops, or our environmental standards being undermined by countries clearing rainforest, but we have no choice. The "race to the bottom" is on, and we are caught up in it.

This notion does not stand up to scrutiny. As we have seen, among the countries ranked the most competitive are many with much larger governments than Australia's. In any event, nation states, collectively, are not weak. The G7 industrialized countries, all democracies, account for two thirds of world measured production.⁽²⁹⁾ Four of these countries are already in a cooperative union, the European Union, which regulates labour markets and which is moving to a common currency - an even stronger force for stabilization than the old fixed exchange rate régime. The European Union, itself a creation of the postwar order, was deliberately set up to avoid destructive competition or the "race to the bottom". International cooperation is not some romantic dream; it is quite possible.

There is no reason why those same institutions, such as the WTO which facilitate trade for the benefit of corporations, cannot regulate world trade for the benefit of citizens. To ban trade in products of child labour, in products from countries without free labour association, or in products made in environmentally destructive ways, is not a retreat to protectionism; it is merely a way of bringing full costs to account, recognizing that the purpose of trade is to advance human happiness, not human misery. The problem is not powerlessness; it is short sightedness and bad economics in the service of corporate greed.

Conclusion - saving capitalism

Capitalism throughout its history has been dependent on governments. It has needed physical infrastructure, an educated workforce, and régimes of law. It has also needed governments to provide for the long term, for corporations, subject to the impatience of financial markets, cannot make the sort of long term investments which governments can make such as environmental protection and basic research. Capitalism has thrived in democracies in which citizens are confident that they will share not only the costs but also the benefits of economic progress.

We forgot these conditions in the period 1914 to 1939; unfettered capitalism came close to destroying itself and the liberal democracies which had nurtured it. Fortunately we were able to learn from history a half century ago. Can we learn from history now and abandon ideology in favour of practical economics?

References

1. Petro Georgiou "Menzies, liberalism and social justice" 1999 Menzies Memorial lecture 18 November 1999.

2. Anthony Giddens The Third Way (Polity Press UK 1998).

3. The source for budgetary data is the 1998-1999 Commonwealth budgetary documentation. Budgetary documentation for 1999-2000 and 2000-01, has suppressed the detail which would allow such analysis.

4. See, for example, Economic Planning Advisory Council, Council Paper #44 The Size and Efficiency of the Public Sector EPAC 1990.

5. Sheryle Bagwell "Going Dutch a pointer to the Third Way" Australian Financial Review 20-25 April 2000.

6. David Aschaeur "Is Government Spending Productive?" Journal of Monetary Economics Vol 23, 1989.

7. Isabel Argimon Does public spending crowd out private investment?: Evidence from a Panel of 14 OECD Countries (Banco de Espana, Madrid, 1995)

8. Francis Castles and Steve Dorwick The Impact of Government Spending on Medium term Economic Growth in the OECD (ANU Centre for Economic Policy Research 1988)

9. John Cox Refocusing Road Reform Business Council of Australia 1994.

10. Tony Harris "Debt: virtue in the middle" Australian Financial Review 16 May 2000.

11. Michael Porter The Competitive Advantage of Nations (Free Press 1990) p. 637.

12. See, for example, Paul Mees "A Public Solution to City Transport" Dissent #2 Autumn/Winter 2000.

13. Economic Planning Advisory Council Private Infrastructure Task Force Interim Report EPAC 1995. (The final report, published later in 1995, refers readers back to the analysis in the draft report.)

14. John Halligan "Implications for the Public Service of the Emerging Australian Model" Working Group III, Public Service Reform Annual Conference of the International Association of Schools and Institutes of Administration International Institute of Public Administration, Paris, 14-17 September 1998.

15. Commonwealth Department of Finance, Domestic Property Task Force Report August 1996.

16. Australian Bureau of Statistics Special Article Poverty and Deprivation in Australia (ABS Year Book 1996 Cat 1301.0)

17. Ann Harding Income Inequality in Australia from 1982 to 1993: National Centre for Social and Economic Modelling, University of Canberra, 1994.

18. Jeff Borland "Earnings inequality in Australia: Changes, causes and consequences" Economic Record June 1999.

19. Australian Centre for Industrial Relations Research and Training (ACIRRT) Australia at Work (Prentice Hall Sydney 1999).

20. Hugh Mackay Turning point Australians choosing their future (Macmillan 1999) p. 194.

21. Amartya Sen Inequality Reexamined (Harvard University Press 1992).

22. Karl Polanyi, The Great Transformation: The Political and Economic Origins of Our Time (1945, Beacon Press edition 1957.)

23. Eric Hobsbawm The Age of Extremes - A history of the world, 1914 - 1991. (Vintage Books 1996) p. 584.

24. John Gray, . False Dawn : The Delusions of Global Capitalism (New Press NY 1998) p.130.

25. George Soros "The Capitalist Threat" The Atlantic Monthly February 1997.

26. David Throsby and Glenn Withers Measuring Demand for Public Expenditure: Theory, Methods and Preliminary Results Macquarie University Research paper 383 July 1994.

27. Gary Orren "Fall from Grace: the Public's Loss of Faith in Government" inJoseph Nye, Philip Zelikow, David King (eds) Why People Don't Trust Government (Harvard University press 1997).

28. Australian election study by Clive Bean et al at http://ssda.anu.edu/au/SSDA/CODEBOOKS/AES98/title.html

29. See table 1, World Bank World Development Report 2000 (Oxford 199) for national GDPs.